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.
Note [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 jayanthiiyengar1@hotmail.com.
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