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The need for foreign acquisitions
By Jayanthi Iyengar

PUNE - While the cacophony over information-technology (IT) jobs shifting to India and China has been deafening, it has drowned out another highly significant development - the outward flow of investments from these countries to the Western world. The reasons for this reverse flow of capital are many, including the quest of Asian countries and companies for natural resources, markets and strategic assets, including technology and brand names. Other dominant reasons are the strengthening of the currency of these countries against the dollar, a slowdown in the global economy and the wealth of the Asian companies that makes it possible for them to grow inorganically through the acquisition route.

Driving this change are the governments in these countries, which function at two levels - policy and enterprise. At the enterprise level, government-owned enterprises are driving the overseas acquisitions, particularly in China, where banks, state units and the government have been working systematically to create overseas assets. "The Chinese overseas acquisition is led by public sector enterprises. This is fundamentally because bank finance is needed for such acquisitions and state-owned banks would tend to support state-owned enterprises," said Jack Z Chen, chairman, Asia-Pacific, of the US-based Barrington Associates, who has been advising several Chinese companies on overseas investments.

Chen pointed out that while private acquisitions, too, have taken place, they have been smaller in size because of funding constraints. Overseas acquisitions by Chinese companies are still subject to government approval, and provincial and other levels of government support state enterprises in various ways. This state-led approach to overseas acquisitions is less marked in India, where the outward foreign direct investment (FDI) flow is driven more by private enterprise, with the Tatas, Ambanis and the Premjis leading the acquisition brigade.

At the policy level, governments in both countries have been facilitating the capital outflow. In India, where outward investment norms have already been relaxed extensively (some controls still remain, such as reporting to the Reserve Bank of India), the Indian government has made it clear where its preferences lie. Early this year, for instance, Atal Bihari Vajpayee, the then prime minister, said, "This will enable Indian companies to take advantage of global opportunities and acquire technological and other skills for adoption in India." The comment was made in the context of allowing Indian companies to invest up to 100% of their net worth overseas through joint ventures and as wholly owned subsidiaries."

China further relaxed its overseas investment norms recently. Anupam Srivastava, who heads the Asia program at the Center for International Trade and Security at the University of Georgia, said, "Liberalization of investment norms is part of a wider process of incremental decentralization of the economic decision-making process in China. This is intended to make provincial governments and local companies bigger stakeholders in the success of the Chinese economy, and in turn secure their support for the political stability of the country under Communist Party rule."

Under the new norms, the State Council will relinquish its traditional role and instead vest greater authority with the Mofcom (Ministry of Commerce) and local companies in evaluating the soundness of individual investment decisions. The State Council would still retain its authority as the final arbiter, but exercise it only when an investment decision has significant macroeconomic or foreign policy implications. "This policy of increasing decentralization was markedly evident with the December 2003 release of China's Non-proliferation Policy and Measures, the new regulations governing China's dual-use export controls. In this case too, the State Council ceded greater authority to Mofcom and other agencies for routine review and approval of license applications, while retaining the final authority in cases where significant national security or foreign policy issues are involved with a licensing decision," Srivastava said.

The Indian scenario
Indian companies have been investing abroad for some time now, but outward investments intensified after the country opened up in 1991. The country's outward FDI has grown from US$0.6 billion in 1996 to $5.1 billion in 2003. These outward investments have primarily been in manufacturing, but pharmaceuticals, IT and IT services are emerging as the new, hot favorites. Indian companies have been investing in the US, the United Kingdom, Europe, Russia, Asia, including China, and Latin America. According to the United Kingdom's Department of Enterprise, Trade and Investment, India ranked seventh in terms of both job creation and number of FDI projects in the UK in 2003-04. In France, India ranked 13th in terms of the number of projects. Understandably, these governments are now actively wooing Indian industry to set up operations in their countries.

However, the US, the UK and France are not the only destinations where Indian companies are investing. Indian companies are casting their net far and wide. In 2003, Tata Motors acquired Korea's Daewoo Commercial Vehicle Company for $188 million, while Infosys Technologies Ltd acquired Expert Information Services Pty Ltd of Australia for $22.9 million and Ranbaxy acquired Aventis in 2003 for $70 million. The same year, Hindalco acquired two copper mines in Australia. The state-owned Oil and Natural Gas Corp (ONGC) set the investment counters ringing with India's largest ever overseas acquisition when it bought a 25% stake in the Sakhalin oil and gas field in Russia for $1.7 billion, topping Tata Tea's acquisition of UK's Tetley Tea in 2000 for 271 million pounds ($521 million).

"The increasing competitiveness of Indian firms and their interest to expand globally, particularly in IT-related services and pharmaceuticals are driving its outward FDI growth," Karl P Sauvant, director of United Nations Conference on Trade and Development's (UNCTAD's) investment division, recently noted in one of the multilateral agency's papers titled "India's Outward FDI: A Giant Awakening?"

The Chinese snapshot
The Chinese case is not very different. The average annual outward FDI approvals have grown from $0.4 billion in the 1980s to about $2.3 billion in the 1990s. Statistics released by Mofcom show the government approved about 7,000 investment projects by Chinese companies in 160 countries amounting to $9.3 billion by end-2002. [1] Chinese companies have been investing in its traditional FDI market, Hong Kong, but in recent years, they have moved out to Africa, Latin America, North America and Europe as well.

Some of the important acquisitions include TCL International Holdings Ltd's (TCL) purchase of German company Schneider Electronics in 2002 for $8 million. More recently, TCL bought 55% of Alcatel's mobile phone business for $55 million. Shanghai Automotive purchased a controlling stake in Korea's Ssanyong Motor for $500 million. UTStarcom, the US-based but China-oriented telecom equipment maker, bought the wireless business of Audiovox, the US maker of consumer electronics, for $165 million, while Chalkis, China's second-largest tomato processor, purchased a 55% holding in the French Conserves de Provence for 7 million euros ($9.4 million).

Similarly, the Huayi Group of Shanghai bought US firm Moltech Power Systems for $20 million, while in 2002, China Netcom Corp, acquired Asia Netcom, formerly known as Asia Global Crossing, for about $80 million. This is considered to be one of the biggest deals till date, though if China Minmetals Corporation's proposed acquisition of Canadian Noranda goes through, the $5-billion-plus deal would mark a watershed in Chinese overseas acquisition.

Other Chinese government-owned firms have been equally active. China National Offshore Oil Corporation (CNOOC) has investments in 14 countries. The partly privatized Baosteel Group is now negotiating with Brazil's Companhia Vale do Rio Doce (CVRD) for controlling stake in three steel plants that the latter is proposing to set up in the country's northern coast.

The main drivers
One may wonder why Indian and Chinese companies are looking outward at a time when foreign companies are looking toward Asia for investment opportunities and markets. Srivastava ventures three reasons for this trend:
  • An Indian or Chinese entity is acquiring a company or basing its production in the US or West Europe in order to reduce its production and transportation costs to service its clients in the developed world.
  • When an Indian or a Chinese company bases its operations in, say, the US, it generates local employment, offsets the criticism that its sales are leading to a net job loss in the US economy, and facilitate US investment in that company. This strategy is similar to that of Japanese companies such as Toyota in earlier decades.
  • A company's decision to invest or shift any or all of its production to another country is based on the cost of the factors of production (land, labor, capital, and entrepreneurship) and other enabling conditions (infrastructure, bureaucracy and the operating environment). With multinationals operating in Indian and Chinese markets, the competition for the domestic market has become stiffer. As such, Indian and Chinese companies are seeking to base some components of their production abroad to compete for the larger international market while still enjoying the cost advantages of producing other components relatively cheaper at home.

    The UNCTAD lists other reasons. These include acquiring natural resources, acquisition of foreign brand names and access to foreign technology. China Minmetals' proposed acquisition of Noranda or ONGC's acquisition of stake in Russian oil fields falls in the first category. For instance, in 2003, Wipro acquired Nerve Wire Inc (US) for $418.7 million to gain deep domain knowledge and other benefits. I-Flex, another Indian IT company, paid $1.5 million for Supersoulutions Cor (US), while Reliance Infocomm bought Flag Telecom (UK) for $211 million to gain access to the undersea cable network and connect with the key regions in Asia, Europe and the US.

    Srivastava points out that having one or more domestic companies with globally recognizable brand names has significant advantages. Brand name stems from a successful differentiation of a product from the pool of its competitors, helps it secure a niche market, and enables oligopolistic pricing or at least a price higher than that possible in a free market situation. "A globally recognizable brand name indirectly helps improve investor confidence or consumer perception of the economy of the home country, such as L'Oreal for the cosmetic industry and the French economy, although it is not critical to the overall success of a country's economy," he said.

    Chen of Barrington Associates pointed out that for Chinese companies, an overseas acquisition presents another advantage. Traditionally, the Chinese have been OEMs, or original equipment manufacturers, who have preferred to manufacture and supply to global manufacturers of branded products. This route has been attractive thus far since the returns that the OEM suppliers made more than offset the cost and effort involved with brand building. However, with growing competition in the OEM space, suppliers have also been forced to contend with constantly shrinking margins. "Acquiring brands and selling branded products has given Chinese manufacturers a greater control over their margins," he said.

    [1] These figures obviously do not include Wednesday's announcement by China's largest personal computer maker, Lenovo Group Ltd, that it is buying IBM's PC-making business for $1.25 billion. The deal calls for Lenovo to pay IBM $650 million in cash and $600 million in stock. It will also assume $500 million in IBM debt. IBM will hold an 18.9% stake in Lenovo, which will relocate its PC business from Beijing to New York, and possibly list shares on Nasdaq or the New York Stock Exchange.

    Jayanthi Iyengar is a senior business journalist from India who writes on a range of subjects for several publications in Asia, Britain and the United States. She may be contacted at

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