Significantly, Chinese FDI is pushing westward. While Asia remains the overwhelming favorite, the share of North America and Europe in the total Chinese FDI portfolio grew from less than 3% in 2008 to more than 13% just two years later. The absolute value of that expansion is equally impressive: The $9.54 billion total in 2010 is more than quadruple the level of two years before.
Most recently, China National Offshore Oil Corp (CNOOC) agreed to pay $15.1 billion in cash to acquire Canada's Nexen Inc, on the same day that Sinopec, another Chinese oil company, agreed to acquire a 49% stake in UK North Sea assets owned by Talisman Energy (another Canadian enterprise) for $1.5 billion. Regardless of whether these two deals are ultimately approved - the process continues at this writing - the sheer volume and potential of Chinese foreign direct investment (FDI) will have a profound impact on the global economy, providing both enormous business potential and new challenges.
The world, particularly the West (which is becoming increasingly attractive to Chinese investors) should welcome this trend, but governments must also develop strategies to take full advantage of the economic opportunities it presents.
The July 23 deals are part of China's growing interest in mergers and acquisitions (M&A), which has assumed a steadily expanding share of China's recent FDI. M&A constituted some 46% of Chinese FDI in 2011, up from 18% in 2003. Large state-owned enterprises (SOEs) continue to be the main driver of Chinese outward FDI, making up more than two-thirds of such deals in 2010. The average value of M&A deals is usually larger than greenfield projects: The 143 M&A deals in 2011 have almost the same value as the 918 greenfield projects (the increasing use of M&A by Chinese investors also reflects the growing sizes of Chinese FDI projects).
The westward shift of investment direction is natural after three decades of fast growth that has established China as No 2 among global economies. The growth has primarily been dependent on labor and resource-intensive industries. For the Chinese economy to continue to advance, it has to reform its giant industrial machine toward higher value-added production. The fact that Chinese outward FDI is moving toward matured markets such as the US and Europe is a reflection of this fundamental transition in its economic development. This shift will present opportunities for China to access sophisticated technology and management, mature its large domestic consumer market, and assure a stable supply of resources, as well as skilled labor.
Experts debate whether specific FDI projects are independent, profit-driven commercial decisions or driven by the government as part of its national development strategy. Whatever the conclusion, the choices of industries fit the strategic needs of China's long-term economic development. There is growing interests in China to acquire large stakes in companies in the West that have relatively safe and established energy resources, advanced technology that can supply much needed research and development for Chinese industry, manufacturers with good market bases and potential in the West and in China, or banks that provide a pathway to Western financial markets.
The impending takeover of Nexen comes after a $19 billion bid by the same company to acquire the US oil company Unocal in 2005; that bid was blocked by strong political objections based on controversial national security concerns from the US Congress. It comes at a time when Canadian energy companies are trying to reduce dependence on the US market by building new pipelines toward Asia. The takeover of Nexen will provide the Chinese company with access to sophisticated technologies for oil/gas production, including Nexen's oil-sands, shale-gas, and deep-water leases in North America. It will also provide the Chinese company significant assets in the Gulf of Mexico. CNOOC made the offer after careful preparation to satisfy the needs and political demands of Canadian authorities to avoid an experience similar that of the Unocal acquisition.
If the Nexen deal is completed, it will be another example of a company that has met with strong political resistance in the United States successfully investing in projects with US allies and close partners. Many people believe that the Nexen deal enables CNOOC to park the same money from its unsuccessful bid to acquire Unocal in another country.
Similarly, Chinese telecommunication giant Huawei has been blocked from making acquisitions of US-based technology companies citing national security concerns. But it has had a smooth ride in Europe, setting up six R&D centers and recently acquiring the UK's world-leading photonics research laboratory. Unlike the US, the European Union does not have regulations that distinguish foreign investors from domestic ones.
Without judging whether national-security concerns are credible in each case, a fundamental question remains: If such concerns about Chinese FDI are credible, then should the US be worried about breaches by Chinese investments in allies and partners? This is not to say that the US should follow suit when others make mistakes, but it should rethink its current strategy. A detailed and forthcoming national-security strategy regarding Chinese direct investment that also takes into account critical allies' activity will be key to successfully guarding US security interests and would welcome Chinese investors with clear guidance. However, if it's not about national security but other vested economic interests, then the US is hurting itself by turning away investment capital.
It is natural that the world's two largest economies are not just important trade partners, but also investment partners. It isn't just wise but necessary for the US to take full advantage of westward Chinese FDI with appropriate strategic caution. Thus the US must resist political pressure to oppose Chinese investment based on protectionist commercial interests; national-security-related concerns over Chinese FDI should not be treated in isolation. In other words, national-security concerns should not become a political tool to justify protectionist measures.
At the same time, there is a need to communicate and coordinate valid concerns to US allies and close partners so that US efforts are not compromised elsewhere. These concerns could be addressed through the numerous existing channels between the US and key ally countries, such as the communication lines with the Defense Department, congressional exchanges, and Treasury.
The westward trend of Chinese FDI will continue; the West must adapt to it. The Nexen takeover will be only one of many large-scale Chinese FDI projects to come. Some investors predict an additional $800 billion in Chinese FDI from 2011 to 2016, if current growth rates and government policy hold steady.
Given growing uncertainty in global financial markets and increasing risks in sovereign bond markets such as the euro zone, the need for direct investment by China will likely increase: Since January 2008, Chinese firms have disclosed 1,414 overseas acquisitions with a value of more than $235 billion. For the US to seize this opportunity, a number of other things must also be done: It needs to promote further its open market, good investment environment, and business opportunities. This is particularly necessary to counter the negative image created by a few failed cases that Chinese FDI is not welcomed in the US. But a better definition of national security for US companies and potential Chinese investors will be a critical step toward a comprehensive US approach to Chinese FDI.
Ting Xu
China Inc's debacle in the Outback
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| Chinese leaders and people attend a memorial for former Chinese Vice President and ''red capitalist'' Rong Yiren at the Babaoshan Revolutionary Cemetery in Beijing in this November 3, 2005 file photo. Credit: Reuters/China Newsphoto/Files |
Larry Yung Chi-kin is a loyal scion of the Chinese Communist upper crust. His late father, Rong Yiren, was the legendary "Red Capitalist," one of the few industrialists to stay behind in the mainland after the revolution of 1949. Yung himself went on to found the conglomerate CITIC Pacific and become one of China's richest men.
So, when duty called, Larry Yung answered.
In 2006, foreign mining giants were jacking up prices of the iron ore needed by China's voracious steel industry. At the urging of Beijing, Yung and CITIC Pacific negotiated the rights to exploit a vast deposit of low-grade ore in the red-rock landscape of Australia's remote northwest Pilbara region.
The multibillion-dollar deal seemed to be a coup for China's resource-hungry economy. But Yung and Beijing are now paying a heavy price.
A few kilometers down a dirt track off the North West Coastal Highway, beside a towering pile of red tailings, the company has dug itself into what increasingly looks like a bottomless pit.
The original $2.47 billion budget for the massive open-cut mine and processing complex has blown out to $8 billion and it is more than two years behind schedule. Senior company managers won't rule out a $10 billion price tag for one of China's flagship offshore resource investments. "It has the potential to be a company killer, that's for sure," says Clinton Dines, a former president of mining giant BHP Billiton in China.
It is a dramatic reversal for Yung, 70, who emerged from obscurity after the Cultural Revolution to become first tycoon among China's "princelings," the children and grandchildren of the party elite.
BUNGLED HEDGING
To compound its pain, CITIC Pacific in 2008 bungled an attempt to hedge against the overruns - exposing the company to a further $2 billion in losses. Yung and his long-time deputy, Henry Fan Hung-ling, were forced to resign that year when Hong Kong police and regulators launched investigations into the hedging transactions.
According to people familiar with the investigations, police and regulators in Hong Kong have concluded their probes into suspected fraud, theft and disclosure failings. They have handed their findings to prosecutors in the semi-autonomous city, who are weighing whether to lay charges against some of China's highest-profile business figures in the politically charged matter.
Yung's office did not return calls requesting comment. A spokeswoman for Hong Kong's Department of Justice did not respond to questions about the investigations. Officials in Beijing have been publicly silent about the probes.
But senior Chinese leaders have privately said they are worried the mine could turn into an embarrassing failure, according to Australian government officials and foreign mining executives. Soaring costs and missed deadlines in the Pilbara mine have delivered a major setback to China's global drive to secure reliable supplies of key raw materials.
CITIC Pacific's Australian subsidiary, Sino Iron, is scrambling to begin operations at the mine and release a flow of revenue that is projected to last for 25 years. Shipments were supposed to begin this year, reaching a pace of 27.6 million tonnes a year.
CITIC Pacific chairman Chang Zhenming said at the company's August 16 results briefing in Hong Kong it now expects trial production to begin only in November, the latest in a series of missed deadlines.
"Before the end of the year we should have production ready for export," said Chang, a veteran of China's state-owned finance sector who was drafted in to replace Yung.
OUTBOUND TROUBLES
The saga speaks to the broader problems that China's state-owned giants are having as they venture into the wider world. Resource projects account for most of the $380 billion of total Chinese outbound investment as of the end of 2011, according to China's Ministry of Commerce. Losses on these investments have reached almost $27 billion, official media reports say.
Most of it has been blamed on failures to undertake proper research before deals are signed. "In many of these cases, my view is that due diligence was either poor, non-existent or there was an element of hubris involved," says Mike Komesaroff, managing director of Queensland-based Urandaline Investments, a consultancy specializing in China's minerals and metals industries.
CITIC Pacific declined requests for interviews with senior managers about the Pilbara mine or answer questions about its feasibility study and background research on the project.
The market outlook isn't good. Iron-ore prices are expected to continue sliding as China's economy shows signs of slowing. Australia's Bureau of Resources and Energy Economics forecasts ore will average about $136 a tonne this year, a drop of about 11 per cent from 2011. Some analysts expect steeper declines, with China on track to record its first annual drop in steel output in more than three decades.
It's a major shift. Years of seemingly insatiable Chinese demand delivered a bonanza for Australia's BHP Billiton, the Anglo-Australian Rio Tinto and Vale of Brazil, which together account for almost 70 per cent of world sea-borne iron-ore trade.
Ore, which had traded for less than $13 a tonne in 2000, peaked at almost $200 a tonne last year. In one savage hike in early 2005, the three miners increased prices by 71.5 per cent.
"That really got their attention," says Shanghai-based Dines, who came under fire from steelmakers when he represented BHP in China and now runs hedge fund Caledonia Asia. "From that moment, China really started worrying about securing reliable supplies of raw materials, particularly iron ore, and the cost of those materials."
That's when Larry Yung headed into the Outback.
FLOUR AND TEXTILES EMPIRE
It was the biggest risk he had ever undertaken, and he was doing it without the support of his legendary father. Just five months before CITIC Pacific in March 2006 signed agreements to mine the Pilbara deposit, Rong Yiren died in Beijing, aged 89.
Rong had become a household name in China after 1949, when he remained in Shanghai and cooperated with Communist efforts to build a socialist economy. As the head of the family's flour-milling and textile empire, Rong was then estimated to be one of the 10 richest men in China, according to reports at the time. His only son, Larry Yung (Rong Zhijian in Mandarin) lived his early years at the family mansion on leafy Kanping Road in what had once been the French Concession.
Even under the Communists, Yung was extravagant. He drove a red open-topped sports car around the city and invited friends and classmates to dine at expensive restaurants, China's official media reported.
That all changed with the Cultural Revolution, when Red Guards ransacked the clan's homes, smashing and stealing valuable art and antiques. Rong was spared the brutality meted out to others with similar backgrounds. But he ended up working as a janitor, according to reports later published in the official media. Yung was forced to spend six years laboring in Sichuan Province after graduating from Tianjin University with a degree in electrical engineering.
With the end of the upheaval and Deng Xiaoping's rise to power in the late 1970s, Rong was rehabilitated. Deng tasked him with a key role in guiding China's opening to the global economy.
He set up state-owned China International Trust and Investment Corporation, now known as CITIC Group, as a vehicle to coordinate the massive foreign investment needed to jump start a shattered economy. His rehabilitation was complete when, in 1993, he was appointed to the largely ceremonial but prestigious position of Vice President.
RED CHIP PIONEER
As his father returned to influence, Yung moved to Hong Kong in 1978 and started an electronics engineering company with two cousins. He joined CITIC in 1986 before leading the takeover of an existing listed company and renaming it CITIC Pacific. The deal created one of the first "red chips," mainland-controlled companies with shares traded in Hong Kong.
CITIC Pacific gobbled up investments in aviation, property, telecoms, tunnels, bridges, power plants and mainland steel mills. The establishment Swire Group, a pillar of colonial Hong Kong, welcomed him onto the board of its airline subsidiary, Cathay Pacific, when CITIC Pacific became a major shareholder.
As the deals rolled in, the Yung family's links to the CITIC empire deepened. Two of his children, son Carl Yung Ming-jie and daughter Frances Yung Ming-fong, joined the company in senior positions.
The company's stock peaked at almost HK$50 in October 2007, valuing his 19 per cent stake at HK$20.9 billion ($2.7 billion) (The stock now trades at about HK$11.)
That year, Yung took home almost HK$67 million in pay, including a HK$48 million bonus, according to company filings.
CHINA'S RICHEST TYCOON
The silver-haired Yung fit seamlessly into the close-knit ranks of Hong Kong's super rich. He bought Birch Grove in Sussex, the former home of late British Prime Minister Harold Macmillan, for a reported 5.5 million pounds in 1989 and spent heavily adding a golf course. The house has since been sold.
Like other tycoons in gambling-mad Hong Kong, Yung invested in champion thoroughbreds and was elected a steward of the prestigious Hong Kong Jockey Club. Club records show 13 Hong Kong horses listed under his ownership won combined prize money of almost HK$100 million. By the time he began scouting for iron ore, China's official media was describing him as the country's richest tycoon.
His connections did him little good in the arid outback. Established players had already scooped up most of the best deposits of hematite, a rich form of iron ore, local miners say.
CITIC had little choice but to invest in plentiful deposits of lower-grade magnetite ore, which then accounted for less than 1 per cent of Australia's iron ore output.
In 2006, after Yung had visited Australia to explore potential investments, CITIC Pacific signed a deal for the right to mine up to 6 billion tonnes from the Pilbara deposit owned by Australian mining entrepreneur Clive Palmer.
Australian officials involved in the discussions say Yung was a confident and polished host. At a meeting in Hong Kong after the signing, Yung told his Australian guests he was flying to South America the following day on his private jet to hunt wild boar.
The Australian government approved the deal in June 2006. Within months, it became clear CITIC Pacific had underestimated the costs of establishing Australia's biggest magnetite mine. There were also unexpected management challenges.
COSTLY, UNRULY AND SCARCE
By Chinese standards, Australian labor is expensive, unruly and in short supply. Government and unions quickly dashed expectations an army of low paid Chinese workers could be imported to build the facility.
That irritated CITIC Pacific managers, who went public with critical views on local working conditions and habits. Then, in the midst of an Australia-wide mining boom, the price of energy, materials and engineering services soared. Complex projects in China had been completed much faster and at lower cost than similar projects in Australia.
"For a Chinese company coming to operate in Australia, this is a big issue," says metallurgical engineer Darryl Harris, a director of Perth-based Indo Mines who has also worked extensively in China. "The trouble is they can't transfer that know-how here."
With costs ballooning at Sino Iron, the Australian dollar began to rise on the back of soaring commodity exports. By July 2008, it had risen 25 percent since work started at the mine, effectively boosting labor and other costs by one-fourth for the company, which had borrowed from Chinese banks.
Facing the prospect of further currency losses, CITIC Pacific entered into a series of leveraged derivative contracts in June and July 2008 to hedge against the rising currency.
They struck deals with a range of banks, including Citibank, Rabobank, Standard Chartered, Natixis, Credit Suisse, Bank of America, Barclays Capital, BNP Paribas, Morgan Stanley, HSBC, China Development Bank, Calyon and Deutsche Bank, according to copies of contracts the company later disclosed.
Just as the contracts were signed, the global financial crisis hammered the Australian dollar in August of 2008, leaving the company holding wrong-way bets.
It wasn't until Sunday, September 7, 2008, five days before Lehman Brothers filed for bankruptcy, that Yung and his senior managers learned about the exposure, according to disclosures made later to the Hong Kong Stock Exchange. At the time, the Australian dollar was trading at about 81 cents to the U.S. dollar.
CITIC Pacific finally announced six weeks later, on October 20, that it faced losses of up to $2 billion on its hedging. By then, the Australian currency had sunk to 69 cents.
"Needless to say, this is a very unhappy event," Yung told a news conference that day.
POLICE, WATCHDOG INVESTIGATE
Yung blamed finance director Leslie Chang and financial controller Chi Yin-chau for failing to seek his approval for the trades and informing him of the potential risk. Both men had resigned, he added. Hong Kong newspapers later reported Yung's daughter, Frances, was demoted with a pay cut from her position in the finance department.
CITIC Pacific also announced its major shareholder, Beijing-based CITIC Group, had bailed it out with a $1.5 billion loan and would double its stake to 58 per cent in return for absorbing most of its liabilities.
Two days after the company came clean, the Securities and Futures Commission announced it had launched a probe into the delay in informing the market.
After examining documents handed to the market regulator, Hong Kong police mounted a separate probe. On April 3, 2009, detectives raided the CITIC Pacific office. Five days later, Yung and Fan resigned.
In the years since, CITIC Pacific has sparred with investigators. After first saying it would cooperate with the probe, the company began a legal effort to reclaim material handed to the SFC and seized in the police raid.
In two rulings last year, Hong Kong's High Court rejected the company's bid to claim legal privilege over the documents. The court found a prima facie case of conspiracy to defraud and of theft, and ruled the documents, including legal advice, had been produced to facilitate those alleged offences.
From stock exchange filings and court evidence, it is clear that between learning of the scale of its hedging losses on September 7 and informing the market in late October, managers made determined efforts behind the scenes to shore up company finances. Shareholders, however, were not warned
"CONSPIRACY TO DEFRAUD"
On September 16, 2008, CITIC Pacific informed the exchange about two unrelated mainland investments, but did not disclose the hedging losses senior management had learned about more than a week earlier. The board met on September 23 to discuss the crisis and directed its audit committee to begin investigating the hedging contracts, according to the two rulings.
In the following three weeks, the company borrowed HK$250 million from the bank of Tokyo-Mitsubishi, HK$1 billion from the Bank of China and HK$500 million from the Industrial and Commercial Bank of China.
Resolutions authorizing the borrowing were signed by the board's finance committee, including Larry Yung, Henry Fan, Peter Lee and Leslie Chang, according to evidence police gave the court.
Prosecutors said while securing the loans, CITIC Pacific's board sought legal advice on how long it could delay announcing the losses.
"They wanted to raise money without telling what their true financial position was," prosecutor Charlotte Draycott told the court. "This is a conspiracy to defraud."
In March, CITIC Pacific won a more favorable assessment from the Court of Appeal. It upheld the company's claim that some of the documents were privileged and thus unavailable to the prosecution. The court also disagreed with earlier findings of suspected criminal conduct.
Although police would have preferred to use the documents, the ruling does not undermine the case, people familiar with the investigation told Reuters.
PIPELINE OR PIPEDREAM?
As prosecutors ponder the evidence in Hong Kong, CITIC Pacific is intensifying efforts to end its suffering in the Pilbara.
On a recent day, the 4,000-strong work force raced to bring the mine into production. Plumes of dust whipped away in a hot dry wind as giant bulldozers sent slate-grey ore cascading down a stockpile behind a new power station and processing plant.
A 30-kilometer pipeline that will carry the ore snakes away from the processing complex through low scrub towards the coast at Cape Preston, where the company has built a port.
But even once shipments begin, it may take years for CITIC Pacific to dig itself out of trouble.
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