Lessons for Chinese deal-makers in America
Howard Chao says Chinese investment is largely being welcomed in the US, despite a few high-profile cases that may suggest otherwise, and companies can ease market access by avoiding pitfalls to deal-making
The investment community has long awaited the growing wave of direct investment by China into the United States. Now, finally, despite continuing challenges, the US is swimming in Chinese capital. The Rhodium Group calculates that total Chinese direct investment in the US last year was US$6.5 billion, the highest ever, and the first half of this year has already seen US$4.7 billion of investment.
Nevertheless, there is a lot of room to grow - the Ministry of Commerce estimates that Chinese outbound direct investment reached US$45.6 billion in non-financial sectors for the first half of this year, up 29 per cent year on year.
The first big wave of China's outbound investing was focused on natural resource and commodities plays. But, with the downturn in China's export economy and the related cooling of world commodities markets, such investments are less important. Today, a more urgent motivation to invest offshore is China's need to diversify its foreign reserve holdings.
Most of its reserves are tied up in US Treasuries and other government-backed securities, but as the Federal Reserve has made clear, interest rates will eventually go up and China stands to suffer massive principal losses on its bond holdings. Hence, it needs to diversify.
What should those other assets be? The rational choice is for China to allocate more investments to the US, still by far the world's largest and strongest economy. US property markets are recovering, gross domestic product growth is back, employment is improving and US innovation continues to outpace the rest of the world.
Yet there is still a feeling prevalent within Chinese business and government circles that the US is hostile to Chinese investment. How big is this problem?
Certainly, there have been several unfortunate cases where US government actions or public opinion caused a Chinese investor to pull out. Notable early cases include aborted transactions by China National Offshore Oil Corporation and Huawei.
Last October, the US House of Representatives' Intelligence Committee labelled Huawei and ZTE national security threats. And Ralls Corporation, owned by the Chinese founders of Sany Corporation, was ordered by the US president, on the advice of the US Committee on Foreign Investment in the United States, to dismantle and vacate wind farm sites in Oregon. The apparent reason was the proximity to restricted airspace at a naval weapons systems training facility.
Proximity to sensitive military facilities seems to be a common theme of recent transactions that encountered difficulties. When CNOOC acquired the Canadian company Nexen, with its substantial holdings offshore from the US Gulf coast, a very lengthy review by the federal foreign investment committee reportedly resulted in stringent mitigation measures, apparently because of the proximity of the assets to sensitive military installations.
Yet the attention that these few transactions receive tends to obscure the fact that the rapidly rising volume of Chinese investments has generally attracted little adverse congressional comment, public reaction or difficulties with the foreign investment committee.
Critics protested at Wanxiang's acquisition of battery company A123, but the Obama administration cleared the deal. Similarly, the foreign investment committee cleared BGI-Shenzhen's acquisition of gene-sequencing technology company Complete Genomics. And while the current proposal by Shuanghui to acquire Smithfield has prompted a few members of Congress to raise claims of threats to food supply and safety, public reaction seems muted. Most business sectors in the US are completely open to foreign investment. In most cases, the US government can only disapprove an investment if it raises national security concerns, or if there are antitrust concerns.
While in Washington there may be mixed signals, US local governments and companies eagerly seek Chinese capital. Chinese investment spurs the demand for goods and services, creates tax revenues and, most importantly, supports new jobs that are sorely needed by US workers.
What are the lessons so far learned as China expands its footprint in the US? There are many. First, there is a natural suspicion of state-owned enterprises as the primary vehicles for Chinese direct investment in the US. There is a belief by many that Chinese state-owned firms are merely agents of their government and thus may make non-commercial decisions at the direction of Beijing.
This is reflected in the fact that all notifications involving state-owned-enterprise buyers (not just Chinese ones) to the US foreign investment committee must generally undergo a second-level investigation and thus are subjected to a higher level of scrutiny than transactions involving purely private buyers. Thus, China needs to encourage more of its private enterprises to make investments in the US.
Second, greenfield projects are easier to do than acquisitions of existing American companies. These projects create new jobs, while purchases of existing companies arguably only move control to foreigners, something which is easier to attack. Under current US law, greenfield investments generally would not be subject to a security review.
Of course, Chinese companies need to pay attention to the court of public opinion too. Highly negative media reactions can end a deal because no foreign investor wants to fight public sentiment. Thus, it is important for Chinese investors to work with public relations specialists before announcing an investment.
The US offers Chinese investors a multitude of attractive US companies in non-sensitive sectors, including real estate, clean technology, health care, food, agriculture, basic manufacturing, retailing and consumer products.
We are in the difficult preliminary phase of the bilateral investment relationship, but things should get better. Chinese companies need to learn more about deal-making in the US, complete some deals, and let the news get out about how they are contributing to the US economy. Then, Chinese direct investment in the US will become more "normalised". Eventually, a new bilateral investment treaty, which the two plan to negotiate, may also help smooth the way to a less contentious investment relationship.
Howard Chao is of counsel and senior Asia adviser to O'Melveny & Myers LLP, an international law firm