Going global: Missteps and opportunities

The last few years have witnessed a growing interest by Chinese companies in overseas deals, in part as the result of the macroeconomic environment. In fact, while the recession has been hitting US and European businesses hard, many Chinese companies have been operating in a growing economy, with healthy balance sheets and buoyant domestic sales to compensate for the sluggish demand from overseas markets. As a consequence, Chinese businesses are flushed with liquidity and eyeing potential foreign targets whose valuations are in many cases lower compared to their pre-crisis levels.

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However, despite the favorable window of opportunity for overseas expansion, the world has yet to witness a wave of Chinese cross-border mergers and acquisitions (M&As). On the one hand, China's overseas direct investments (ODI) are growing at a fast pace: in 2010 China's ODI in the non-financial sector hit $59 billion (41 billion euros), up 36 percent from the year before, with around 40 percent of total investment being realized through M&As. Analysts expect a further 50 percent increase in 2011. On the other hand, China's ODI patterns, taking into consideration the country's per-capita GDP, are in line with many other emerging economies yet far behind what is observed in developed countries. And the greatest amount of ODI went towards emerging countries in Asia, Africa and South America, while Chinese investments in Europe, Japan and the US played a very limited role. This implies that while Chinese companies have been quite successful in resource-seeking acquisitions (oil, gas, minerals and metals), they have been much less effective in acquiring companies with advanced technology, brands and know-how in developed countries.

High-profile deals have certainly been concluded in recent years, but Chinese companies have also suffered significant setbacks in their attempts to go global. If it is true that Lenovo earned a global reputation in 2005 through its acquisition of IBM's PC unit, and Geely stunned the car industry last year by acquiring Volvo, there have also been significant disappointments: the failed attempt by Shanghai Automotive Industry Corporation to manage Ssangyong Motor Company, which ended up with the South Korean company filing for bankruptcy in 2009, the 2008 unsuccessful attempt by Huawei Technologies to acquire 3Com, a US IT company, and this year's failed attempt by Xinmao to acquire the Dutch cable maker Draka are all stark reminders of the difficulties encountered by Chinese companies in their process of internationalization.

What are the reasons for these mixed results? Behind the disappointing outcomes are different explanations, some of them typical of cross-border M&As everywhere, others peculiar to Chinese companies.

Foreign governments' protectionism certainly plays a role, especially in certain sectors involving natural resources and sensitive technology or when Chinese State-owned enterprises (SOEs) are involved. For example, the 2005 bid by CNOOC for Unocal, a US oil company, was blocked by the American government on concerns about the transfer of drilling technology to the Chinese SOE. Similarly, Huawei's attempt to acquire 3Com raised opposition in the US Congress based on alleged ties between the company and the Chinese military. Similar concerns were raised again this year when the Shenzhen IT company was forced to back away from its acquisition of 3Leaf's assets, a US server technology company.

In addition, bidding for publicly traded corporations is always a difficult proposition, especially for a foreign company, due to the heavy regulatory requirements and the high profile of such acquisitions. And sometimes Chinese companies can find themselves in an unfavorable position during the bidding process because approval by Chinese government agencies can be a lengthy process and so getting financing commitment from Chinese banks.

But overall, the main obstacle to the expansion of Chinese companies overseas lies in the inexperience of these companies in dealing with international markets, especially in developed countries. Chinese companies are relatively young compared to their Western competitors and their brands are often unknown to consumers in Europe and the US. This unfamiliarity generates a lack of trust by potential targets and their stakeholders. In addition, senior managers of many Chinese companies lack overseas experience, a shortcoming that can penalize the buyer both during the negotiation process and after the acquisition.

It is clear that global brand recognition and a management with global skills cannot be acquired in the blink of an eye. On the contrary, they require long-term strategic commitment and financial investments. Does that mean overseas expansion is a premature step for many Chinese companies? Should they focus on the domestic market on the assumption that due to its size, becoming a leader in China implies achieving global scale? Or should Chinese companies focus on growing organically in foreign markets, without acquiring existing businesses?

It would be a mistake to prescribe a general approach that is mainly inward looking. Nowadays Chinese companies are growing in the domestic market at great speed but they also face fierce competition, both by Chinese and foreign competitors. Access to Western technology, brands and know-how is essential to gain a competitive advantage not only globally but especially in China. In this regard, overseas acquisitions are critical for a Chinese company to protect and strengthen its market shares on the mainland and assure its survival through the consolidation process that is taking place in many industries.

And if internationalization can be achieved through organic growth in many instances (Huawei is a successful example in this regard), it is also true that often only M&As can leapfrog the development of a company. For a company with global ambitions to rule out M&As from the start would be like for a boxer in the ring fighting with an arm behind his back.

Which approach then should Chinese companies adopt in going global? First of all, they should be aware of fire-sale bargains. Unless they have a detailed business plan on how to revitalize a foreign brand in China (like Dongxiang did with Kappa) it is an extremely difficult proposition for an inexperienced player to turn around a comatose brand in a foreign market. It is much better to invest resources in a healthy company, with strategic technology, R&D capabilities, know-how, brands or distribution channels. The price is higher, but the opportunities for success are too. Secondly, Chinese companies should be flexible in their approach to foreign markets, as Western companies were when they entered China. They should consider alternatives to M&As that can allow them to achieve their goals while closing the experience gap: strategies based on the purchasing of minority stakes, the formation of strategic alliances and joint ventures with foreign partners can be valid alternatives in many situations. Fosun Group's acquisition of a 7.1 percent stake of Club Med last year is a good example of this approach.

When a full-blown acquisition is pursued it is critical to have a good understanding of the target and its stakeholders. This learning process is easier when targets are not publicly listed companies because in this case negotiations can extend for a longer period of time. It is also essential to reassure the target that the main goals of the Chinese company are not asset stripping and labor-cost reductions.

Here investment banks and private equity funds can play a critical role, thanks to their knowledge of the foreign markets. For example, when Hunan construction equipment company Zoomlion acquired the Italian concrete equipment manufacturer CIFA in 2008, a key role during the negotiations was played by one of the private equity investors, Mandarin Capital Partners, a fund specialized in Chinese-Italian cross-border transactions. The fund used its knowledge of the Italian market and access to its media to inform the public opinion and the powerful Italian unions about the potential benefits of the deal.

Post-merger integration has also to take into consideration the Chinese company's lack of global experience: for this reason, it is important to acquire a target with a good management team in place because it is unrealistic for the buyer to replace it in the short-medium term with Chinese executives. Integration should therefore be light, giving the target high autonomy, protecting the value of the foreign brand through a dual brand strategy and limiting integration to few key areas (such as procurement, R&D, production networks) where synergies can be captured in the short term.

Chinese companies are increasingly investing overseas. Their success will depend on sound strategy and flawless implementation. Those able to go global will also become the market leaders in China, and the world.

The author is professor and associate dean of the International Business School of Beijing Foreign Studies University.