commentary

(Wall Street Journal)

January 24, 2011

China's Next Buying Spree: Foreign Companies

by Charles Wolf, Jr.

Beijing wants to diversify out of U.S. debt and it will have plenty of cash to make acquisitions.

From 2007 through the first half of this year, Chinese buyers—state, private and in between—acquired 400 companies located outside of the country. The acquisitions span a wide range: mining companies in Australia, Vietnam and South America; oil and gas companies in Africa and the Middle East; banking, financial services and insurance companies in Europe; and electronics, telecommunications and lab testing companies in the U.S. The total cost? $86 billion.

That may sound like a big number, but in fact it's relatively small. The number of companies at play in global cross-border M&A markets during this period exceeded 12,400, with acquisition costs of more than $1.3 trillion. China's share of the total number was 3.2%, and its share of total acquisition value was 6.6%. China ranks sixth in both number of deals and in acquisition value: behind the U.S., U.K., France, Germany and Japan, though just ahead of the United Arab Emirates. Cross-border acquisitions by U.S. investors numbered over 5,000 (42.1% of all transactions), and nearly $400 billion by value (30.1% of aggregate value).

China's acquisitions beyond its borders are also modest compared with foreign investors' acquisitions within China. Currently, China's annual cross-border acquisitions are about half of annual foreign direct investments in the country.

What is significant about China's acquisitions over the past few years is the change they represent from the negligible amounts in the past. Prior to 2007, nearly all China's foreign investments involved buying U.S. debt, along with lesser purchases of euro and yen debt. China currently holds more than $1.6 trillion of U.S. government debt and an additional $1 trillion of non-U.S. government debt and other assets.

It didn't used to be in the business of acquiring foreign companies. That's changed, and I expect that China's acquisitions will at least double in the next five years, and perhaps quadruple by 2020.

There are three principal drivers behind this forecast. First is China's extraordinarily high rate of domestic savings—above 45% of GDP. As long as this rate appreciably exceeds China's not-quite-so-high rate of domestic investment (about 35% of GDP), China will have a large global trade surplus, regardless of fluctuations in its exchange rate. This surplus, together with China's net receipts from other sources—including earnings from its prior foreign investments, the excess of inbound versus outbound investment, and remittances from Chinese residents abroad—will generate a current account surplus of $300 billion to $350 billion annually. This will provide a ready source of financing for foreign acquisitions.

Second, China has shifted its focus away from investing in U.S. government debt. While it will continue to invest in such holdings, the investments will be much smaller than in the past. China is aiming to strengthen the renminbi's role as a potential international reserve, thus it will be less willing to shore up the dollar by purchasing large amounts of U.S. government debt. The result is that it will use its surplus to acquire foreign companies.

The third and perhaps strongest driver of a growing Chinese role in international M&A markets is Beijing's interest in acquiring foreign companies that possess one or more of the following characteristics: rich holdings of natural resources, high-technology or emergent technologies, and financial know-how and close connections with other financial institutions. Because of the recession, such acquisitions may be available at more attractive prices than usual.

If this forecast is accurate, it will have significant consequences for China and global markets.

Externally, China will be a more active and influential player in global M&A markets. In some cases, China may exercise its financial leverage to successfully challenge competing bidders from other dominant countries. This competition could help integrate China more fully into the global economy.

China's prominence could also lead to increased tension with host countries, especially in light of the marked disparities between the restrictions that it imposes on foreign investors' acquisitions within China and the looser ones usually applied on China's acquisitions abroad. Demands for equivalent and reciprocal treatment shouldn't come as a surprise.

Yet such demands can be expected to evoke strong resistance within China, especially if reciprocal treatment is sought in fields like energy, natural resources, rare earths, chemicals and infrastructure that are dominated by large state-owned companies such as Sinopec, Cnooc and Chinalco.

China's foreign acquisitions will have other repercussions within China. Experience gained from corporate governance in companies it acquires abroad may be a good influence on the often obscure governance practices of Chinese companies. More diligent governance practices—like independent audits and transparent executive compensation—are likely to be met with favor from China's Securities Regulatory Commission, but resistance from corporate management. But if the more advanced governance practices prevail, it would be beneficial for China and the rest of the world.


Wolf holds the distinguished corporate chair in international economics at the RAND Corporation and is a senior research fellow at the Hoover Institution.

This commentary originally appeared in Wall Street Journal on January 24, 2011. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.