Earlier this summer, the China National Offshore Oil Corporation, known as CNOOC, made a cash offer of $18.5 billion to buy Unocal. It was a friendly offer, and since 70 percent of Unocal’s reserves are near Asian markets where CNOOC operates, it seemed to make sense to the company, which is owned by the Chinese government.
But Chevron stepped in with a two-pronged attack to stop the deal. First, it made its own offer of $17 billion in cash and stock. And second, according to The Wall Street Journal, it began a fierce lobbying campaign in Congress.
One of the reasons for the concern was China’s obvious economic clout ? they are swimming in cash. Americans are also concerned that the Chinese want to take American oil back to China to fuel its booming growth. According to another report in The Wall Street Journal, many people believe that what China really wanted from Unocal was access to the vast oil reserves that lie in the deepest waters off the Gulf of Mexico ? up to 15 billion barrels of it ? as well as Unocal’s technology and know-how for getting at it.
Other concerns have been raised as well. The transformation of China in recent years into a capitalist giant in Communist clothing ? or vice versa ? makes it a threat in the eyes of some people. Moreover, CNOOC is a state enterprise with a mandate to increase China’s energy security. It and other Chinese oil companies have been aggressively attempting to snap up oil and gas reserves around the world.
Many people argued that these concerns alone should have been enough to stop the Unocal deal. Others raised worries about inadequate disclosure and transparency by the traditionally ultra-secretive Chinese as they attempted to get approval from Western shareholders and regulators.
In a similar case, the Chinese company, Haier, had bid on the American firm, Maytag.
Considering these and other Chinese acquisition possibilities, the debates take on new dimensions as Westerners increasingly fear “a grand economic Chinese takeover.”
To put this trend in context, it’s helpful to remember when Japan began buying up U.S. businesses and real estate in the 1980s, which inspired a similar reaction. That anxiety ended when Japan’s economy tanked ? and as we’ll see in Trend #5, China’s may well do the same, but that’s likely to be some years from now.
For the time being, we can only assume that China’s efforts to buy productive assets in North America and the EU will accelerate. That brings us to the crux of our discussion: How realistic are American worries about China’s corporate buying spree?
According to a recent report on the subject from Lord, Abbett & Company, the truth is that Chinese purchases of American assets may actually help the U.S. economy and American investors. China’s economy is essentially running on exports. Its low labor costs give it a clear competitive advantage. So it sends its goods to the U.S. and uses the trade surplus to build out its economic infrastructure and create new jobs for its hundreds of millions of poor.
To pull off this trick, it has to keep its currency cheap so that Americans will buy the goods. How does it do that? To finance the trade, China sells yuan for American dollars. But if it then turns around and resells the American dollars, it will cause the dollar’s value to drop. This would hurt the export market that’s keeping China’s economy afloat. The answer is to invest those dollars in the U.S.
To date, China is primarily focused on keeping its currency cheap in comparison with U.S. dollars by buying American Treasury bonds, and that in turn stimulates its export trade to the United States.
China’s recent wave of corporate acquisition efforts may simply be a smarter way to invest those yuan-bought dollars than buying more low-interest Treasury bonds. But that doesn’t mean the Chinese are going to pack up Maytag and take it overseas.
In fact, the Chinese may move fewer jobs overseas than American firms are doing themselves. They’ve already got more than enough spare capacity at home ? why bring more? They’d much rather buy the American base of operations, the brand equity, the connections, and the technologies that such companies as Maytag bring them.
The Canadians, faced with the same Chinese interest in their corporations, have embraced the deals that seek to exploit their rich stores of oil, forest products, and metals. Today, China is second only to the U.S. as a trading partner with Canada. Consider three recent deals:
Last April, CNOOC bought 17 percent of the private oil company MEG Energy Corporation for 150 million Canadian dollars.
In May, China Petroleum & Chemical Corporation bought a minority share of another oil project in Alberta for the same amount.
The Canadian oil pipeline company Enbridge is going to become partners with PetroChina Company to construct a new pipeline from Alberta to the Canadian West Coast for shipment to China.
In short, the Trends editors argue that most of the worries are unfounded. Chinese owners of American companies can buy, sell, hire, and fire, but they can’t take over the country or even do much to harm it. Their activities, should they succeed in such deals, will be under intense scrutiny. And in the end, the new owners have a lot to bring to the table in making those companies more profitable than they may have been in the past ? not the least of which is lots of money to invest in expanding and improving them.
That, in turn would lead to a plus for company stock, for job creation, and for the economy as a whole.
As discussed in Trend #1, the bottom line is that China and Europe are generating much more cash than they can wisely invest at home. Companies based in those locations need to acquire productive assets in other markets, such as the U.S, Australia, and Canada. Since China is a quasi-Communist country with an adversarial history, many Americans are concerned that relinquishing control of certain businesses would put our national security at risk. This is primarily related to strategic commodities, such as oil and valuable intellectual property.
On the other hand, selling the right assets could generate a windfall for American investors and provide an influx of capital that would help existing companies, creating jobs and lowering prices for Americans.
Overall, the Trends editors argue that Americans should not feel threatened by this development. However, it is imperative that all foreign acquisitions of major companies be reviewed by a government agency that would assess the national security implications of those deals. If an acquisition would involve strategic natural resources or intellectual property, realistic scenarios need to be developed to identify the risks.
Based on this major trend, we offer the following five forecasts for your consideration.
First, in the short term, China’s direct foreign investment in the U.S. and other countries will continue to grow and accelerate due to economic pressures from both sides. This will be done in a sometimes-contentious atmosphere where we will strive to balance trade deficits, jobs, and national security concerns. Debates over currency valuations and the openness of Chinese and American markets to trade will continue, even as such deals continue to evolve and become more common. The resistance, however, will be largely due to perceptions or misperceptions about the reasons for such commercial transactions. Because the Chinese are not traditionally adept at ? or even interested in ? managing public opinion, they will have to learn a lot to make these deals go smoothly.
Second, the Committee on Foreign Investment in the United States, or CFIUS, which has jurisdiction over such deals as China’s attempted purchase of Unocal, will quickly begin to put in place clearer guidelines for ensuring that such transactions will not negatively impact national security. With China buying ? or attempting to buy ? so many natural resources, this will be a prime concern. For example, it’s unlikely that China would be allowed to gain control over any U.S. pipeline operations. Also, evolving national security guidelines and controls will ensure that Americans will have less reason to worry about such acquisitions in the future.
Third, the flow of funds from China ? both as purchasers of debt instruments and purchasers of productive assets ? will continue to improve liquidity in the U.S. and have an overall positive effect on the American economy. We can expect foreign direct investment to boost our equity markets visibly and directly by bidding up valuations. Economic theory tells us this will also create more robust firms ? not only directly, through any upgrades the Chinese make to acquired firms, but indirectly, through the need for competitors to keep up with those improved firms. With China’s vast surplus of cash, the acquired U.S. firms will be infused with new life to expand operations and grow. This will lead not only to more capital spending, but to more jobs, higher salaries, and ultimately more consumer spending, which will in turn provide an added push to the economy.
Fourth, in order to smooth the way for China’s investments in U.S. businesses, businesses in China will have to become more transparent.5 Mergers and acquisitions in the U.S. are often carried out more like political campaigns than business transactions. China will have to learn to manage those campaigns and influence public opinion to get what it wants. Moreover, having to abide by Sarbanes-Oxley requirements will mean that their business dealings must become less secretive. This transformation in the Chinese way of doing business will have to be true not only in their dealings with us, but in their culture at large. The U.S., with its rich resources, could ultimately help transform Chinese business even more than it has already changed in the last 30 years.
Fifth, to pave the way for acquiring U. S. businesses, China will have to become more open to reciprocal practices in its home country. While China has been open to foreign direct investment in the form of partnerships and joint ventures, it has never permitted U.S. businesses to operate autonomously there. If the Chinese are allowed to buy American firms, American firms will begin demanding to buy Chinese companies on comparable terms.
References List : 1. The Wall Street Journal, July 6, 2005, “Why Is America Worried?” by Fu Chengyu. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved.2. The Wall Street Journal, July 21, 2005, “Chevron and CNOOC Covet Unocal for Its Leases in Gulf of Mexico, Deep-Water Drilling Technology,” by Russell Gold. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved.3. To access Milton Ezratis commentary “Is China Set to Buy America?” visit the Lord Abbett & Company website at: www.lordabbett.com/usa/insights/insights.jsp4. The Wall Street Journal, July 15, 2005, “Canada Welcomes Chinas Cash,” by Dennis K. Berman and Mark Heinzl. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved.5. The Wall Street Journal, July 20, 2005, “Chinese Companies Meet the West,” by Robert G. Delamater and Michael Geczi. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved.
