In recent years, the international business community has witnessed a steady increase in outbound investment by Chinese enterprises into a wide array of industries and sectors worldwide. China has now shifted from an exportled economy whose primary source of profits was the manufacture and export of mostly consumer goods towards an economy investing in highvalue and highreturn processes and products, including retail and distribution in overseas markets.
Due to a number of economic factors resulting from China’s rapid growth, including constantly fluctuating domestic consumption behaviour, excessive competition, thinning margins and overcapacity within industries, enterprises have an economic imperative to gain access to more advanced economies to source strategic assets. In particular, the focus is on securing access to scarce natural resources and raw materials while acquiring advanced technology, intellectual property, production knowhow, and customers and consumer focused companies with a strong brand. This can be achieved through outbound mergers and acquisitions, especially in the consumer market and capital goods sector.
Domestic economies of scale have already been maximized, so Chinese investors seek a new growth model to capture a greater share of the value chain both upstream and downstream. By establishing an overseas entity, Chinese outbound investors hope to gain market shares within the Chinese and international markets and realize competitive advantages through distribution and production cost efficiencies.
The surge in outbound investment has been supported by current government policies liberalizing outbound investment schemes, decentralizing regulatory procedures, broadening financial channels and reducing administrative burden. New measures have been passed or announced to streamline and ease the outbound investment approval process. For example, outbound investment projects of less than US$1 billion are now required to register with only the National Development and Reform Commission.
Outbound investment has been particularly active overall in sectors such as energy, scarce natural resources, finance, real estate and construction, transport, agriculture and technology. While stateowned enterprises (SOEs) dominated in the past, the international business markets have recently seen increasing activity from middle market enterprises.
According to China’s Ministry of Commerce, Chinese investors drove about US$104.5 billion in 5,090 foreign companies in 156 overseas markets in 2013. Private enterprises recorded more than double the number of outbound investment made by SOEs.
One of the main problems lies in the corporate governance of the group. There is a general murkiness in the corporate governance of Chinese enterprises. Unlike the US, where the corporate model is profitdriven and shareholders have certain inalienable rights to ensure proper management of a company, Chinese shareholders do not have these managerial powers and there is a stark difference in transparency.
For example, under Chinese law, a shareholder cannot take action against a director who has not acted in the company’s best interest. A director is also not required to compensate the company if loss has arisen as a result of the director’s offending actions.
Issues that may stifle smooth outbound investment include the lack of forward corporate vision, shortage of managerial responsiveness and experience, inadequate overseas management skills and deficient knowledge of political attitudes. Longterm investment in complex crossborder transactions requires specialized strategic acumen for business as well as efficient management of overseas assets and operations.
While China may lack a readily available international talent pool, outbound investors must bridge cultural gaps and quickly acquire necessary market knowledge in respect of the different regulatory environments and standards as well as legal frameworks.
Chinese investors face a broad array of issues when engaging overseas markets, such as brand valuation, integration of staff and policies, management of expatriates and/or foreign staff, identification of competent business partners and acquisition of new customers within their overseas network. Investors must also appreciate the complex tax challenges requiring professional knowledge, planning, structuring and management to achieve optimal effective tax rates.
Foreign governments may use national security or regulatory measures to block Chinese investment, particularly in strategic industries such as natural resources or technology. For example, the US government has been reluctant to approve Chinese acquisitions and recently rejected two cases on national security grounds: China National Offshore Oil Corporation’s proposed US$18.5 billion takeover bid of Union Oil Company of California (Unocal) and Huawei’s bids to merge with 3Com and take over 3Leaf Systems. Chinese investors need to be wary of unpredictable political impediments from foreign governments.
Hong Kong an Attractive Outbound Base
Despite these obstacles, Chinese investors continue to seek better returns on the piles of cash sitting in their corporate accounts. Outbound investment continues to be on the rise, and momentum will build as more high quality distressed assets are available at competitive valuations due to the euro zone’s debt crisis and the lack of cheap capital in developed economies.
Chinese investors are becoming more experienced in overcoming these hurdles by turning to Hong Kong to set the framework for their investment structures. The principles of shareholder accountability and transparency underlying Hong Kong’s corporate governance standards are in line with those observed in other developed economies.
The private equity (PE) industry has played a significant role in educating Chinese enterprises in compliance with international corporate governance practice. Those Chinese enterprises that have accepted international PE investor shareholders must also accept new directors appointed by the PE funds.
These directors have the responsibility to supervise and establish transparency in the board of directors, where major decisions are discussed, analysed and made. Supermajority board or shareholder requirements will act as a veto on the hitherto autocratic management style of the Chinese majority shareholders. By working with PE funds, Chinese investors have become better trained and more familiar with the international managerial practice that emphasize transparency and accountability to shareholders.