China Inc. sometimes seems unstoppable. The perception is understandable; no other nation has come close to matching the economic strides China has made since the late 1970s. The changes in the country have been so rapid and dazzling, however, that they often blind observers to the fact China has had its share of failure, too.
The cross-border mergers-and-acquisitions spree that Chinese companies went on in the past decade bears ample testimony to that. In 2000, shortly before China acceded to the World Trade Organization, its government realized that local companies would need to be globally competitive to survive and announced a zou chuqu (which loosely translates as “swarm out”) policy that permitted local companies to make acquisitions abroad for the first time. Numerous state-owned enterprises, as well as private corporations, jumped at the opportunity. The value of Chinese M&A shot from $1.6 billion in 2003 to $18.2 billion by 2006, triggering worldwide unease about the China takeover threat.
Yet it’s worth looking back at that first wave of takeovers. Many of those mergers—which included TCL’s acquisition of France’s Thomson Electronics, SAIC’s takeover of South Korea’s Ssangyong Motor Company, Ping An’s investment in the Belgian-Dutch financial services group Fortis, Ningbo Bird’s strategic partnership with France’s Sagem, and the D’Long Group’s purchase of America’s Murray Inc.—ended in utter failure, with Chinese companies having to pull out of or sell off their acquisitions.
Unlike other developing nations, however, China wasn’t paralyzed by failure, and it has quickly—and quietly—changed course to take another shot at its goals. The Chinese, especially the older generation, believe that failure is not about falling down but about refusing to get up. “If you get up one more time than you fall, you will make it through,” runs an old Chinese saying. In short order, China’s policy makers and executives have refashioned their M&A approach and altered both the kinds of targets they pursue and their rationale for global takeovers.
Instead of buying global brands, sales networks, or goodwill, Chinese companies now mainly try to acquire concrete assets, such as mineral deposits, or state-of-the-art technologies and R&D facilities. In addition, Chinese companies no longer use their overseas takeovers to gain market share abroad; they deploy them to strengthen their positions in the Chinese market.
It’s too soon to say whether the new approach is working, but the initial results, which we will describe in the following pages, are encouraging. Wisdom comes from good judgment; good judgment comes from experience, and—say the Chinese—experience comes from all the times you use bad judgment. By failing spectacularly and early, China’s takeover artists could well have discovered how to succeed in the future.
A Race off a Cliff
China’s global M&A strategy has evolved rapidly over the past decade. In the 1990s, when the government swapped access to China’s markets for technologies from abroad, it mostly allowed state-owned enterprises (SOEs) to buy small equity stakes in overseas energy companies and natural resource producers. Beijing preferred that other companies use a yinjin lai (or “pull in”) strategy, entering into joint ventures, partnerships, and technology-licensing deals with foreign companies. That approach changed in October 2000, 15 months before China signed the WTO agreement, partly because the government became convinced that Chinese companies would forever play second fiddle if they depended on technology transfers from multinational companies.
Over the next three years, Beijing dismantled several hurdles to cross-border investments that it had erected in the 1990s. In late 2004, Premier Wen Jiabao formally announced, “The Chinese government encourages more enterprises to go global,” and the race to buy companies overseas began in earnest. The number of foreign acquisitions made by Chinese companies rose rapidly: They doubled from 40 in 2003 to 82 in 2006 and reached a peak of 298 in 2008.
China Inc.’s Buying Binge
After the government declared its support for overseas takeovers, China’s corporations rushed abroad. The value of foreign acquisitions rose dramatically after 2004, before slowing down during the global recession. In 2010, however, Chinese companies hit the takeover trail again.
However, many takeovers, especially those executed by China’s private sector groups, ended quickly and badly. Some acquirers had to sell off their investments, some scaled back their ambitions radically, and some even went broke. To understand why things went wrong, we studied three big headline-grabbing acquisitions of the time—one by an SOE, one by a private company, and one by a joint venture. Together they provide a comprehensive picture of Chinese acquirers’ mistakes.
The SAIC–Ssangyong Motor Company saga.
Shanghai Automotive Industry Corporation’s short-lived attempt to run the South Korean automaker Ssangyong demonstrated that Chinese companies weren’t ready to deal with changes in the global marketplace.
One of China’s biggest and oldest automobile manufacturers, SAIC picked up a 49% equity stake in Ssangyong for $500 million in October 2004, beating out many bidders, including General Motors. Ssangyong was then struggling under the weight of its debt burden, but it had launched some smart sports utility and recreational vehicles. As South Korea’s fourth-largest automaker, it had a 10% share of its home market as well as a growing export business. Buying Ssangyong, SAIC thought, would allow it to improve its automobile development capabilities and make headway in markets such as the United States.
After the deal an SAIC-Ssangyong joint management team drew up plans to swiftly expand manufacturing capacity in South Korea and launch five new models worldwide. However, things did not go as planned. Rising gasoline prices in 2006 and stringent new emissions standards in Europe and North America sent SUV sales tumbling. During this crisis, SAIC’s relations with Ssangyong’s powerful trade unions grew strained, culminating in a seven-week strike, and because of cultural reasons, Chinese and Korean executives couldn’t agree on how to improve performance. Once the global recession started in December 2007, automobile demand collapsed. Sales of SUVs were particularly hard hit, and Ssangyong’s sales fell by 53% in December 2008 compared with the previous December.
SAIC initially supported its subsidiary, buying $4.5 million worth of Ssangyong’s vehicles in late 2008 to sell in the Chinese market. When the situation worsened, however, SAIC unveiled a restructuring plan that included an overhaul of work practices to improve productivity and a 36% reduction in the workforce. Those were its conditions for pumping $200 million more into the Korean company. Ssangyong’s unions refused to endorse the plan, protested, and initiated legal action against SAIC for allegedly transferring to China SUV designs and technologies developed with South Korean government funding—a charge SAIC denies.
In the five years that SAIC controlled Ssangyong, it invested $618 million in the Korean auto company—and earned virtually nothing.
Left with no alternative, Ssangyong filed for bankruptcy protection in January 2009. That spring, angry workers went on strike again, barricading themselves inside the automaker’s plant near Seoul for 77 days. Even as Ssangyong struggled, SAIC wrote off most of its original investment, blamed the losses for a 26% drop in its first-half profits for 2009, and in mid-July 2010 diluted its holdings to just 3.79%. In the five years that SAIC controlled Ssangyong, it invested $618 million in the company—and earned virtually nothing.
The D’Long Group–Murray disaster.
The first overseas takeovers by China’s private sector companies also went badly. One of the first to push into North America was the $4 billion D’Long Group, a new-style conglomerate with businesses ranging from tomato paste to automobile parts. In 2000 it entered the lawn mower and garden equipment business by acquiring Murray Inc., in a deal backed by GE Capital, which provided $400 million in financing.
Murray, based in Brentwood, Tennessee, was then one of the leading brands of outdoor power equipment in the West. Its profits had been falling steadily because of price-based competition from overseas (read: China). After the acquisition, D’Long integrated its Chinese manufacturing facilities with Murray’s, identified lower-cost sources of components, and restructured the organization to reduce overhead.
Soon after the integration began, the American company suffered from a series of quality issues and product recalls. In 2004, for instance, it had to recall nearly 100,000 lawn tractors because their fuel tanks were prone to developing large cracks. These problems dented the brand, made it difficult for Murray to raise money, and caused sales to slide.
Meanwhile, after the Chinese government hiked interest rates and reduced money supply to cool down the overheated economy, D’Long found itself running out of resources. With its options becoming limited, the group raised capital by pledging the shares of its listed companies as collateral for loans, making rights issues, and providing guarantees for loans. To keep the cycle going, it illegally started using funds from its trusts and finance companies to prop up its share prices.
In 2004 the house of D’Long collapsed, after the China Banking Regulatory Commission named it among the country’s highest-risk companies and banks refused to extend it any more loans. Murray Inc. filed for bankruptcy in November 2004. Its operations were shut down, and Britain’s Briggs & Stratton bought its brands.
The TCL-Thomson debacle.
If one deal epitomized the inability of Chinese companies to assimilate foreign corporations, it would be TCL’s acquisition of France’s Thomson. China’s largest maker of color televisions and second-largest maker of mobile telephones, TCL started promoting its brand internationally in 2000. Emboldened by its early successes, in January 2004 it struck a $560 million deal to merge its TV and DVD operations with those of consumer electronics giant Thomson. The new company, TCL–Thomson Electronics (TTE), in which TCL held a 67% equity stake, went into operation that July.
By 2006, it was clear that TCL had bitten off more than it could chew. TCL hadn’t examined Thomson’s balance sheet carefully before investing in the venture. It had refused to hire M&A experts to perform due diligence, and when a Boston Consulting Group analysis suggested that too much risk was involved, TCL’s chairperson, Li Dongsheng, ignored the “pessimistic” report.
TCL just hadn’t realized that the Thomson brand in Europe and Thomson’s RCA brand in America were both old and tired. In fact, the French manufacturer’s TV and DVD operations had lost more than $100 million in 2003, which is why the company had been looking for an investor. The deal was a complex one, which didn’t help. For instance, TCL had to negotiate separate contracts to access those parts of the business that weren’t transferred to TTE, such as the sales division and critical intellectual property.
Above all, TCL lacked the capabilities to assimilate Thomson’s people. The shortage of Chinese managers with international experience and expertise in global marketing proved to be a major constraint. The new company was dysfunctional because people came from different cultures and had different routines. When TCL imposed its practices on the venture, culture clashes erupted. For example, Chinese executives were shocked to find that if they tried to schedule meetings on weekends—a regular occurrence in China—their French counterparts would turn off their phones and be unavailable. TCL also had been expanding so rapidly that it didn’t have the bandwidth to cope with Thomson.
Because of its troubles in Europe, TCL suffered a combined loss of RMB 5.07 billion ($680 million) in 2005 and 2006. In May 2007, TCL declared the European operations insolvent and overhauled them by doing away with Thomson’s business model and distribution channels—and even the brand. It closed five of its seven European centers and terminated a large number of employees. The grand alliance between TCL and Thomson had taken just three years to unravel.
As these cases and others show, the first wave of Chinese acquirers bought foreign companies mainly to grow their global sales. Their logic seemed impeccable: Take low-cost Chinese manufacturing capacity and connect it to the global brands and distribution relationships of a Western company hampered by high costs. What sounded like a dream marriage of Chinese manufacturing with American or European marketing proved to be a nightmare, however, because of the errors committed by the acquirers. (See the box “China’s M&A Mistakes.”)
China’s M&A Mistakes
Beijing Gets Cold Feet
By 2007 the Chinese government was concerned about the problems its companies were facing overseas. The last straw was probably the troubles that Lenovo—the poster child for Chinese M&A after its acquisition of IBM’s PC division for $1.75 billion in December 2004—ran into with its global push. Although the merger made the Chinese company the world’s third-largest PC maker, after HP and Dell, a year later it slipped to fourth place behind Taiwan’s Acer. As Lenovo struggled with integration issues, the exodus of technical employees, and substandard service, its market share and profitability slid further. For instance, its net profits from July through September 2008 fell to $23.4 million—a 78% decline year-on-year.
Word then went out from Beijing that only SOEs and private companies with adequate managerial capabilities and merger integration skills should attempt takeovers. The government also signaled that as far as possible, Chinese companies should pursue profitable targets. A line had been drawn—and no one would be allowed to cross it. When the unknown Sichuan Tengzhong Heavy Industrial Machinery wanted to acquire General Motors’ Hummer division in June 2009, the National Development and Reform Commission refused to endorse the bid, even though China’s Ministry of Commerce didn’t think it was a bad idea. The deal fell through—one of the first takeover attempts that the Chinese government publicly shot down.
However, with China’s foreign exchange reserves crossing $2 trillion in 2009, diversification beyond U.S. Treasury bonds into physical assets that didn’t run the risk of having their value decimated by inflation looked more appealing. The stock market crash also made overseas company valuations attractive. The government and its agencies, like the State-Owned Assets Supervision and Administration Commission, keen to ensure that Chinese companies became globally competitive before they allowed the renminbi to appreciate, began to rethink their policies on M&A.
The Revamped Approach
An analysis of half a dozen recent takeovers by Chinese companies suggests that a new three-pronged strategy is helping China Inc. make its global acquisitions perform better.
China’s New M&A Approach
A shift to hard assets.
Instead of purchasing brands and distribution relationships, Chinese companies are increasingly buying tangible assets such as mineral deposits and oil reserves. Performing due diligence on hard assets is relatively straightforward; they can be objectively assessed by engineers and don’t require evaluations of variables such as corporate culture or brand essence. Integration is simpler because companies with tangible assets have proven supply chains, and the acquirers can leave their operations more or less alone. Besides, there’s a strong demand in China for these companies’ output.
By 2009 more than 70% of Chinese deals involved either energy or natural resources. Among them: Yanzhou Coal’s $2.8 billion takeover of Australia’s Felix Resources, and Sinopec’s $7.2 billion acquisition of the Swiss-registered oil and gas company Addax.
A quest for high tech.
The Chinese are also targeting organizations that can deliver emerging and new technologies and possess offshore R&D facilities. Their value lies in their intellectual property, knowledge, and research and design processes. Although integrating those assets is a bit more difficult, it’s less complicated and risky than assimilating an entire organization.
Patents and blueprints can be beamed to China, where an engineer can easily interpret them. R&D centers have relatively small staffs, although they do need a lot of motivation. Given the acquirers’ willingness to invest in R&D and the prospect of adapting and selling their innovations to the Chinese market, most researchers are excited about takeovers by Chinese companies. Interfaces with the Chinese organization are simple: Foreign engineers come up with ideas for new products and processes, and the Chinese use their skills to scale up the inventions and drive down their manufacturing costs.
One company attempting this kind of takeover is Xi’an Aircraft Industry Corporation (XAC), a subsidiary of the state-owned Aviation Industry Corporation of China (AVIC). AVIC’s first several attempts to buy aircraft manufacturers met with failure, so it was a surprise to industry experts when, in October 2009, XAC announced that it had reached an agreement to buy 91.25% of Austria’s Fischer Advanced Composite Components. FACC is one of the leading suppliers of the composites used in everything from airplane wings to engine nacelles and cabins. However, it had invested heavily in supporting the new generations of the Boeing Dreamliner and Airbus A350 XWB, and when those programs stumbled, FACC found itself struggling with losses and depleted cash reserves.
The Chinese company agreed to invest $60 million in FACC as part of an undisclosed purchase price estimated to be near $135 million. FACC’s management thus secured the company’s financial future, obtained capital for expansion, and got access to the booming Chinese market through AVIC. In turn, XAC gained leading-edge composite materials technology and a large pool of engineers that its parent, AVIC, could use in China’s aircraft programs, including the development of the ARJ21 regional jet and the C919, which will compete with the Airbus A320 and Boeing 737.
Meng Xiangkai, XAC’s vice chairman, doesn’t wish to change FACC into a Chinese company in Europe. He wants to retain the management culture that underpins FACC’s success in high-tech R&D.
The pursuit of growth at home.
In a reversal of strategy, some Chinese companies are no longer using takeovers to gain market share abroad. Instead, their goal is to strengthen their positions at home. This fits in with the Chinese government’s desire to boost domestic consumption in the aftermath of the global recession.
After its $1.8 billion acquisition of Volvo in 2010, Geely announced that its first goal would be to integrate Volvo’s technology and design know-how into three new manufacturing facilities—in Shanghai, Chengdu, and Daqing—to serve the Chinese market. The plan is to ramp up Volvo’s sales in China from 24,000 to 300,000 cars a year—and nearly double Volvo’s worldwide sales.
The new strategy has distinct advantages over the old approach. One, the Chinese market is a good environment in which to test and understand an acquired company’s assets and capabilities. Two, rather than trying to wrest share from entrenched rivals abroad, the acquirer can reap a deal’s benefits quickly in the fast-growing local market. Three, integrating new technologies, products, and know-how is easier at home, where the parent’s executives know the terrain well. Finally, since the deal provides the employees of the acquired company an opportunity to apply their skills to the world’s most promising market, it helps them see the takeover in a positive light.
Rather than trying to wrest share from entrenched rivals abroad, acquirers are using cross-border deals to reap benefits quickly in the Chinese market.
Another company that has deployed this approach successfully is China National Chemical Corporation (ChemChina), which took over a French manufacturer of animal nutrition additives, Adisseo, in January 2006. The world’s second-largest producer of methionine, a key additive used in the poultry industry, Adisseo had a global market share of 29%, but it had failed to make any headway in China’s rapidly growing poultry sector and couldn’t expand on its own because of a weak balance sheet that bore the scars of the severe acute respiratory syndrome (SARS) outbreak in 2003.
By buying the French company for $480 million, ChemChina obtained methionine production technologies that were then nonexistent in China. As one of the country’s largest chemical producers, it already had the distribution channels and ground organization needed to rapidly ramp up sales. ChemChina’s chairperson, Ren Jianxin, aptly calls the M&A strategy “going out” and “bringing in.” He sold the idea to Adisseo’s top management, which recommended the ChemChina bid to shareholders mainly because it would open the door to the Chinese market.
So far, no one has been disappointed. Given the responsibility of growing the methionine business in China, Adisseo’s managers and engineers have made ChemChina the country’s largest supplier of poultry additives.
In keeping with the partnership approach to M&A that other emerging giants have used, Chinese companies are increasingly leaving incumbent managements in place. (See “Don’t Integrate Your Acquisitions, Partner with Them,” by Prashant Kale, Harbir Singh, and Anand P. Raman, HBR December 2009.) Some even task the acquired teams with running the Chinese operations as well. After ChemChina acquired Adisseo and Rhodia’s silicone unit, it made their CEOs responsible for those businesses both globally and in China.
Once they grow profits in the booming Chinese market, it’s easy for acquirers to set off that elusive postmerger cycle of growth. Wanxiang, China’s $10 billion automotive components powerhouse, is deploying this two-step plan. After buying more than a dozen companies in the developed world and integrating their technologies and know-how into its Chinese operations, Wanxiang is now aiming to build global market share by investing in several overseas subsidiaries.
Knowing when to walk away from a deal is usually the hallmark of M&A sophistication. At least some Chinese acquirers are finally doing it. For instance, Bright Food, a leading food company based in Shanghai, wasted more than a year trying to buy Sucrogen before losing out to Singapore’s Wilmar last July. In December 2010 it came close to acquiring GNC, the American health products retailer, but just a month later Bright Food dropped out of the negotiations, apparently because the price was too high. Ten years ago, Chinese companies would have insisted on clinching a deal at any price. That they no longer do so is perhaps the brightest sign that China Inc. is learning from its M&A mistakes.