On the rise of Chinese companies' overseas acquisitions: a blessing or a curse?

UBS analyzed the current rise of Chinese multinational companies in its latest research report released this month. UBS believes that the pace of Chinese capital going global is accelerating and the industry structure is constantly optimizing, but it may still face future macro and policy constraints, such as a decline in foreign exchange reserves and a depreciation of the RMB. Despite this, the globalization efforts of Chinese companies will reshape the global industrial competition landscape in all aspects.

Speed ​​and scale: Outbound investment is accelerating

According to statistics from the Ministry of Commerce, the compound annual growth rate of Chinese companies' overseas direct investment between 2008 and 2014 was as high as 14%. The growth rate of non-financial overseas direct investment in the first five months of 2016 increased by 62% year-on-year. The total amount of overseas investment realized in the first half of this year alone has exceeded the total amount of 2015.

The driving factor behind this round of outbound investment: weak domestic demand

Since 2010, China's economic growth has entered a downward channel, slowing down from 12.2% in the first quarter of 2010 to 6.7% in the first quarter of 2016. The three major drivers: consumption, investment and exports slowed down almost simultaneously, leading to a simultaneous decline in the return on domestic investment.

The decline in investment demand has led to overcapacity in the coal, steel and cement industries. The capacity utilization rate of the steel and other metal industries has been declining, with an average capacity utilization rate of less than 70%.

Faced with downward risks in domestic business, many companies facing challenging industry fundamentals have begun to seek vertical integration and move up the industry value chain through overseas investment.

Expectations of RMB depreciation

Over the past decade, the RMB has appreciated rapidly. From January 2007 to July 2015, the RMB appreciated by 21% against the US dollar and 43% against a basket of currencies of major trading partners. The high value of the RMB in recent years has also increased the ability of domestic companies to acquire overseas.

However, as the expectation of RMB appreciation turns to depreciation, it also prompts Chinese companies to accelerate their overseas expansion to avoid potential exchange rate risks. We believe that while the central bank is maintaining a stable exchange rate, overseas M&A activities will also remain extremely active.

Active support from the government

To facilitate Chinese companies to go overseas, the government has also simplified the relevant administrative approval procedures. Since 2014, overseas investment projects below US$100 million no longer require approval from the National Development and Reform Commission, but only need to be registered.

In addition, the national strategy of the Belt and Road Initiative also requires more Chinese companies to invest overseas. China's policy banks, the Silk Road Fund, the Asian Infrastructure Investment Bank, etc. will provide low financing costs for Chinese companies going overseas.

Company-level considerations

In addition, at the micro level, overseas investment is also conducive to the company's horizontal and vertical integration, obtaining more advanced technology and better-known brands, while achieving business diversification and enhancing risk resistance.

Outlook for China’s Outbound Investment: Structural Acceleration

In the future, the Belt and Road Initiative and policy support will be the key driving force for China's overseas investment to continue to accelerate. It is expected that in the next three years, the annual compound growth rate will accelerate to 18%.

Impact of domestic economic restructuring

We believe that future outbound investment will be closely linked to the adjustment of the domestic economic structure: the domestic economic structure will shift from relying on investment growth to consumption-driven, especially tourism consumption and online consumption. Therefore, we expect that the rapid development of domestic IT and tourism industries will also drive related overseas acquisitions, while the proportion of resource acquisitions will continue to decline.

In addition, we believe that the overseas real estate investment boom will continue. In terms of the number of overseas investments, the proportion of overseas real estate investment has increased from 8% in 2011 to 17% in 2015. The main reason is that domestic housing prices are too high, and overseas real estate has become a low-value area in comparison.

But the problem is that, except for first-tier cities, the entire Chinese real estate market is characterized by structural oversupply. These excess properties are difficult to digest through the recent short-term stimulus policies. Therefore, the profits of the entire real estate industry have also been declining in recent years, prompting many real estate developers to "go abroad" and seek business diversification.

Future favorable factors: One Belt One Road

As a national strategy, the Belt and Road Initiative has received great policy support and will bring more overseas investment opportunities to Chinese companies. The most obvious opportunity at present is to build infrastructure in countries along the Belt and Road. Better infrastructure will improve the investment environment in neighboring countries and create other investment opportunities. At the same time, infrastructure construction itself also has a good role in driving the development of industries, such as building materials and construction machinery.

Future headwinds: capital outflows and RMB depreciation

As mentioned above, the strong RMB has provided Chinese companies with more ammunition for overseas acquisitions. However, since 2015, the RMB has depreciated against the US dollar, foreign exchange reserves have begun to shrink, and capital outflows have accelerated (excluding direct investment). While China's current account still has a large surplus, its foreign exchange reserves have fallen by $800 billion from the peak in 2014. After taking into account factors such as exchange rate fluctuations, current account surpluses and net capital inflows, net capital outflows reached $734 billion in 2015 alone.

This will not only erode the purchasing power of enterprises for overseas mergers and acquisitions, but also affect the official attitude towards overseas investment. So far, China's current account surplus and foreign exchange reserves are still considerable, and its ability to control foreign exchange controls is relatively strong.

But in the long run, the internationalization of the RMB and the Belt and Road Initiative will make capital flows more freely, and the demand for companies and households to allocate assets globally will also increase. If capital outflows continue to increase and foreign reserves continue to shrink, the official enthusiasm and support for overseas investment will be affected to a certain extent.

Debt Burden

Since Chinese companies mainly rely on debt to carry out overseas mergers and acquisitions, they cannot do without the support of commercial banks and policy banks. However, if risks appear in the Chinese banking system, it will affect China's overseas investment.

After the 2008 financial crisis, stimulus policies offset adverse effects from overseas, but also caused the debt-to-GDP ratio to rise from 160% before the crisis to 250% in 2015.

However, as economic growth slowed, corporate profitability declined, and cash flow tightened, more and more bank loans did not enter the production field, but were used to borrow new money to repay old debts and pay interest. This vicious cycle caused the asset quality of banks to decline, and the non-performing loan ratio of commercial banks has risen from 0.9% in the third quarter of 2011 to 1.75% in the first quarter of 2016.

The combination of factors such as the country's unique high savings rate, nationalization of banks and foreign exchange controls means that a banking or currency crisis is unlikely in the short term, but risks are accumulating. If domestic banks are at risk, China's overseas investment, which is mainly bank liabilities, will also be hit.

Weak overseas demand

Overseas demand is the direct driving factor of overseas investment. The zero growth rate of China's overseas investment in 2009 is an example. Although the world economy seems to have recovered from the last crisis, the future is still full of uncertainty. The sluggish economic development of major economies, the divergence of the Fed's policies with other central banks, and the lack of structural reforms in various countries will all pose hidden dangers to continued recovery. These factors will indirectly affect China's future overseas investment path.

Chinese companies reshape global industry competition

Integrator

Chinese companies have the ability to integrate global resources in certain areas, such as railways, ports, home appliances and telecommunications equipment. In the above industries, Chinese companies account for more than one-third of the total revenue of the world's top ten listed companies in the industry. Among them, those that are capable of competing with the world's top companies include: China Railway Construction Group vs. Canada's Bombardier and France's Alstom; Huawei vs. Cisco; Midea vs. Whirlpool.

These companies have the ability to integrate their respective industries globally, and can use the high cost-performance of Chinese products to penetrate Asian, Latin American and African countries and capture the market share of Western brands. Overall, the beneficiaries of this type of industrial expansion are mainly Chinese companies.

Challenger

This type of Chinese companies are mainly concentrated in the shipbuilding and electronic equipment manufacturing industries, and their revenue accounts for 5%-25% of the world's top ten companies. The global expansion of such Chinese companies will intensify industrial competition and is likely to trigger a price war that will result in a lose-lose situation.

For example, Chinese shipyards have significantly increased production capacity and cut prices, driving down profits for the entire global industry. Competition between Chinese construction machinery manufacturers Sany Heavy Industry and Zoomlion Heavy Industry has begun to affect Caterpillar's profits. In the automotive, power generation and consumer electronics sectors, Chinese companies may challenge industry leaders through price wars.

Improver

The third category of Chinese companies has a relatively small global impact, including beverage, pharmaceutical, clothing and semiconductor industries. The strategy of this type of companies is to replace foreign brands in the domestic market through overseas acquisitions, or to acquire more advanced technologies for the domestic market.

However, these companies do not have the ability to control their own destiny throughout the process. They are affected by the uncertainty of domestic foreign investment policies and are at the mercy of foreign brands and technology owners.

Conclusion

After all, corporate globalization is a company-level behavior. Although its success is closely related to the macroeconomic, industrial and policy environment, it essentially depends on the company's own strategic vision and operational capabilities, as well as its ability to overcome cross-border operating difficulties. Even so, companies that can better utilize the historical opportunity of domestic economic structural transformation, fully explore the company's competitiveness, and acquire advanced technology through overseas mergers and acquisitions, and focus on the long-term, will be more likely to become a true multinational company capable of integrating global resources.

Xiaolei has also seen many netizens accusing and questioning capital flight, but Xiaolei does not think so. Instead of shrinking capital due to the pressure of the continuous depreciation of the RMB, it is better to go out and "buy something" and hold it in your hands, at least there is still a chance of value-added profit. You must know that any investment by anyone is risky, it depends on how the person in charge views the risk. There is no smooth road, and profit always coexists with risk! This is just like ordinary people doing some financial management when they have spare money in their hands. Depositing money in the bank is obviously waiting for depreciation. No one is stupid, let alone the capitalists who pursue profit! Of course, Xiaolei also hopes that the capitalists can "buy what they want" in this merger and acquisition frenzy to realize asset appreciation and profit and expand the overseas influence of Chinese companies!

Jack Ma once said that a family with an income of only 1,000 yuan has the worry of 10,000 yuan of debt, and a family with assets of 100 million yuan has the worry of 1 billion yuan of loans. Worry is fair to everyone and every family. Risk is also fair to everyone. Invest your value and manage your life.

This article is an original article. Please indicate the source when reprinting. The author Xiaolei is a senior investor and a practicing investment analyst. He has worked as a chief analyst for many domestic financial institutions. He is currently an associate professor at the Economic Research Center of Wuhan University and an author and commentator for a well-known financial website.
Original link: http://www.huxiu.com/article/157946/1.html

As a winner of Toutiao's Qingyun Plan and Baijiahao's Bai+ Plan, the 2019 Baidu Digital Author of the Year, the Baijiahao's Most Popular Author in the Technology Field, the 2019 Sogou Technology and Culture Author, and the 2021 Baijiahao Quarterly Influential Creator, he has won many awards, including the 2013 Sohu Best Industry Media Person, the 2015 China New Media Entrepreneurship Competition Beijing Third Place, the 2015 Guangmang Experience Award, the 2015 China New Media Entrepreneurship Competition Finals Third Place, and the 2018 Baidu Dynamic Annual Powerful Celebrity.