China Enters the World M&A Stage

RECENT NEWS
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Reuters  Jun 27  Comment 
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Channel News Asia  Jun 26  Comment 
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MarketWatch  Feb 22  Comment 
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As China increasingly becomes a player in the acquisitions of foreign companies, certain companies are poised to benefit. Investment banks with a strong China franchise, such as Goldman Sachs Group (GS), Morgan Stanley (MS), Merrill Lynch (MER) and boutique firm 7 Mile Advisors may generate increasing fees advising Chinese clients on mergers and acquisitions in the U.S.

On the other side, industries where a strong product brand name has not transitioned its own manufacturing to China may face margin pressure if a competitor is bought by a large Chinese enterprise and its production is moved offshore to China.

China's Opening Dance in the U.S.

China’s thirst for fuel entered the world stage with its bid for Unocal. In June 2005, as oil prices hit $60 per barrel over concerns in the Middle East, the most surprising business news was China National Offshore Oil Corporation’s (CNOOC) unsolicited bid of $18.5 billion for Unocal, which had previously agreed to a $16.4 billion merger with ChevronTexaco (CVX).

CNOOC is one of China's largest state-controlled oil companies - one of the four big oil groups that emerged after the 1999 restructuring of China's oil industry. At that time, CNOOC was given offshore exploration and production assets. It worked closely with foreign oil majors to improve its offshore technology. Oil analysts say CNOOC has the Chinese oil sector's most professional management team, as a result. CNOOC's shares are traded in Hong Kong and New York as a well on the domestic Shanghai exchange.

The Target: UNOCAL

Unocal was a large U.S. exploration and production (E&P) company with huge gas reserves in 14 countries - 70% of which were in Asia. Unocal also offered Asia's largest storehouse of liquefied natural gas. Meanwhile Unocal’s U.S. reserves amounted to only about 1 percent of America's oil consumption – and none of it was supplied to the U.S. military. Industry observers expected that CNOOC would keep Unocal's Asian assets, and sell off the rest of the company. By combining with Unocal, CNOOC could grow from an offshore oil producer with high expenses to a diversified global oil and gas company with reserves around the world.

The average investor did not awaken to China's influence on the energy market until CNOOC's failed bid for Unocal. This bid highlighted not only the extent of China's demand for energy, but also the domestic U.S. politics that impact otherwise commercial energy investments. This article discusses why China sought to wrest UNOCAL away from impending-purchaser Chevron, the insufficient steps taken to secure approval of the deal from U.S. authorities, and the implications for future Chinese purchase of U.S.-controlled energy resources.

The Strategy to Gain Approval

To allay concerns in Washington, CNOOC hired Public Strategies, the public relations firm whose vice chairman, Mark McKinnon, led President Bush's media campaign in 2004. And it hired Goldman Sachs and J.P. Morgan as financial advisors and high-end legal and lobbying firms Akin Gump Strauss Hauer & Feld and Davis Polk & Wardell.

CNOOC offered to sell Unocal’s pipeline connected to the American strategic oil reserves and its unique rare-earth mine, if necessary to close the deal. And CNOOC promised not to sell supplies from Unocal's U.S. oil and gas reserves outside the country and said it would retain substantially all of the American employees. Nonetheless, many in Washington still balked at Communist Chinese ownership of such a precious asset.

The Result

Ultimately, on August 2, 2005 CNOOC decided to drop its $67 per share offer for Unocal after facing intense political pressure in Washington. In parting, the company stated that it would have raised its bid yet again “but for the political environment in the U.S.”. In the end, Unocal was bought by Chevron after all, at $64 a share – lower than CNOOC’s bid, but higher than CNOOC’s offer was less attractive than Chevron’s, despite its higher dollar value, because of the expected difficulty for CNOOC to gain regulatory approval for the takeover.

The UNOCAL Lesson

When considering China's pursuit of energy and other scarce natural resources, remember that factors beyond basic economics may have a huge impact on a proposed transaction. Here, the Chinese were willing to pay significantly more than Chevron, but politics rendered their offer moot. Investors in natural resources need to consider these political factors, especially with the Democratic takeover of the House and Senate as well as the forthcoming U.S. Presidential elections, when valuing China plays.

Significant Transactions

Maytag

Appliance retailers remember 2005 as the year that the Maytag Man almost developed a Chinese accent. China’s Haier Group Co., joined by private equity firms Bain Capital and Blackstone Group, launched a $1.28 billion acquisition bid for Maytag Company, where it sought to combine the venerable U.S. brand name with access to low Chinese labor costs. In the end, Whirlpool stepped up with a $1.37 billion bid to trump the Chinese offer.

Lenovo

The acquisition of IBM's personal computer business by Chinese giant Lenovo was announced December 8, 2004. In addition to bringing U.S. technology to China, the IBM acquisition is bringing management experience to the Chinese computer maker because a consortium of U.S. investors who contributed $350 million to the purchase will control key board committees.

Lenovo now has its executive headquarters in the city of Purchase, New York. The company's principal operations remain in Beijing, China and Raleigh, North Carolina, with R&D facilities in Beijing, Shenzhen, Xiamen, Chengdu, and Shanghai, China; Tokyo, Japan; and Raleigh.

Lenovo's primary PC manufacturing and assembly facilities will remain in Shenzhen, Huiyang, Beijing, and Shanghai, China. Lenovo's mobile handset assembly facilities are in Xiamen, China. Additional manufacturing and distribution facilities are located in the United States, Mexico, Brazil, Scotland, Hungary, India, Malaysia, Japan, and Australia. Lenovo's PC distribution network includes approximately 4,400 retail outlets in China for the consumer business.

The company is also boasting a worldwide workforce of more than 19,000 people.

Blackstone

On May 20, 2007, China's new state investment firm said it planned to make a $3 billion investment in the Blackstone Group, a major U.S. private equity firm which just recently had its June 2007 IPO debut.

China announced in March 2007 that it was setting up a foreign exchange investment company to help diversify part of its $1.202 trillion of foreign exchange reserves, the world's largest, to improve returns and diversify risk. The foreign exchange investment company will invest in Blackstone through the purchase of non-voting common units of Blackstone.

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