The way of the dragon

Jun 23rd 2005
From The Economist Global Agenda

The state-controlled China National Offshore Oil Corporation has bid $18.5 billion for Unocal, an American energy company, in the latest sign that China is looking overseas for natural resources and brands. Controversially, acquisitive Chinese firms are getting a lot of help from their government

OTHER than capturing the mood of cold-war paranoia, the 1960s film “Battle Beneath the Earth” has little to recommend it. But the message that Communist China was set to take over America by sending an army through a set of tunnels dug beneath the Pacific Ocean played on popular fears. Nowadays it is China’s economic might that has the world in a tizzy, and the Chinese are coming armed with money to buy assets, not guns.

China’s biggest strike so far is an offer for Unocal, a California-based oil and gas firm. On Thursday June 23rd, the state-controlled China National Offshore Oil Corporation (CNOOC) made a cash bid of $18.5 billion for Unocal ($20.6 billion including assumed debt and a break-up fee), trumping a $18 billion share-and-cash offer (including the debt) from Chevron, America’s second-largest oil company. Opponents in America have based their hostility to CNOOC’s bid on national-security issues. The Chinese firm has promised to preserve American jobs and keep Unocal’s products on sale in the country to assuage nationalist sentiment. Unocal said it will evaluate the bid but that its board’s recommendation of Chevron’s offer “remains in effect”.

China’s move for Unocal neatly sums up the two forces driving the country’s ongoing bid to acquire foreign assets: the thirst for raw materials to feed and maintain its booming economy, and the desire to obtain western brands to help market Chinese exports.

Last year China’s economy grew by 9.5%, and the pace does not appear to be slowing much. The economy is in the throes of a gradual transition from state control to the free market. Much of Chinese industry is government-controlled, and some years ago China’s authorities concluded that to challenge the rest of the world they needed to build up to 50 of the country’s better firms into globally competitive multinationals—helping them along the way with tax breaks, free land and all-but-free financing through state-owned banks. The eventual aim was to create national champions that could take on the world’s leading companies while remaining under the watchful eye of the state.

To this end, Chinese firms have made deals to gain access to natural resources. Buying Unocal would give CNOOC fresh oil and gas reserves (many of which are located in Asia) at a time when energy prices are high and China’s appetite is strong. Last year Baosteel, China’s leading steelmaker, entered into joint-ventures in Australia and Brazil to assure supplies of iron ore.
PetroChina and Sinopec, the two biggest state oil firms, have also shopped abroad. But this quest for commodities has not always proved successful. Last year China Minmetals, the country’s biggest base-metals firm, failed in a $7 billion attempted takeover of Canada’s Noranda, an ore producer. Fears that Minmetals still harbours ambitions spurred Canada’s government to introduce a bill this week intended to block foreign takeovers on national-security grounds.

As well as securing the natural resources necessary to keep output bubbling, Chinese firms are looking around the world for struggling but globally recognised brands. This is because Chinese companies, while enjoying cost advantages thanks to a vast pool of cheap labour, have an image problem. Foreign consumers think of Chinese goods as admirably cheap but lacking in quality. As Chinese firms move up the “value chain”, they are keen to buy foreign brands that they can attach to their more promising products.

Late last year Lenovo, China’s leading PC-maker, which is connected to the government through its ownership by the Chinese Academy of Science, bought the PC business of IBM for $1.75 billion. Under the terms of the deal, Lenovo acquired the right to use the IBM name on its computers for five years. And this week Haier, China’s leading appliance maker, teamed up with two American buy-out firms to bid $1.3 billion for Maytag in an effort to make a substantial move beyond China, where it has a market share of up to 70% for some products. The ailing American maker of Hoover vacuum cleaners had previously agreed to a $1.1 billion offer from a domestic private-equity firm. In early 2004, China’s TCL bought the television-making business of France’s Thomson, making it the world’s leading volume manufacturer of TV sets.

Undoubtedly, it is quicker (and possibly cheaper) to buy a well-known brand than to build one from scratch. But the Chinese are not throwing money at any and every firm with a well-known name. Shanghai Automotive Industry Corp (SAIC), which last year trumped a South Korean rival to buy Ssangyong, Korea’s fourth-largest carmaker, recently pulled out of a deal to buy MG Rover, a foundering British car company that has since folded. In fact, SAIC had apparently acquired much of the intellectual property that it wanted from Rover and was unwilling to foot the bill to keep the firm going. In this case, the Chinese were as keen to get their hands on useful technology as they were to secure the rights to a western brand.

The Chinese government’s coddling of its state-owned firms is another force behind the current wave of overseas expansion. While officials want to see markets develop at home, up to a point, they fear the fallout from the collapse of hundreds of large, communist-era basket-cases. So the government props these enterprises up with ultra-cheap loans through the banking system and other favours, which have the effect of creating overcapacity and nurturing unfair competition. This, in turn, pushes the more successful state firms, and private companies like Haier, to seek opportunities in markets abroad.

China’s favoured companies, with their access to cut-price funding, will usually be at an advantage compared with overseas rivals when bidding for assets, and may be prepared to pay over the odds. Critics suggest that CNOOC is paying too high a price for Unocal and that the money is coming from China’s government, which has let its desire to create global businesses cloud commercial logic. CNOOC has said it will borrow $16 billion from its government-owned parent and banks to finance the offer.

Shareholders of target firms like Unocal may well be pleased by this readiness to splash out, but their workers might worry. Jobs often go as Chinese buyers shift production to lower-cost plants at home. This fuels opposition to such takeovers in the targets’ countries. But for now at least, the spread of Chinese business around the world is set to continue.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.