Chinese FDI in the United States: Q1 and Q2 2012 Updateby Thilo Hanemann | July 25, 2012
After a temporary slowdown in H2 2011, Chinese direct investment in the United States has once again picked up. Investent flows rebounded from a three-year low of $69 million in Q4 2011 to $442 million in Q1 2012 and $3.2 billion in Q2 2012, totaling $3.6 billion in H1 2012. This has set the stage for a record-breaking year with the potential to significantly outpace the high of $5.7 billion recorded in 2010. This note analyzes the patterns of Chinese investment in the US in H1 2012 and discusses the most important industry trends and policy developments.
Accelerating momentum in H1: Robust greenfield investment and several big-ticket acquisitions during H1 2012 show that Chinese direct investment in the United States continues to accelerate, despite a temporary slowdown in the second half of 2011.
Next generation policy risks: While traditional impediments to cross-border investment like national security concerns remain, other policy issues such as reciprocity in market access, competitive neutrality and transparency are becoming more important for the future of US-China investment relations.
More deals in the pipeline: Pending multi-billion dollar acquisitions, including Dalian Wanda’s $2.6 billion bid for movie theater chain AMC and a potential $1.8 billion bid by Chinese aerospace manufacturer Superior Aviation for Hawker Beechcraft, will make 2012 a record year for Chinese investment in the United States if they are completed.
Trends and Patterns
In H1 2012, Chinese companies spent $3.6 billion on 33 foreign direct investment (FDI) projects in the United States (see Figure 2). We recorded 12 acquisitions, a below average figure. However, the combined value of these acquisitions ($3.1 billion) nears record-breaking levels, thanks to a high average transaction value. Greenfield trends followed a similar pattern: although only 21 projects have been recorded so far in H1 2012, the total value of these deals ($457 million) is notably high. The combined investment figure in Q1 and Q2 of $3.6 billion represents the highest half-year investment value on record. Given several big-ticket deals pending in the second half of 2012, a record-breaking year is likely.
At least seventeen states hosted Chinese investment projects in H1 2012. The most popular states were North Carolina and California, with seven and five projects, respectively. While these states received the most deals, neither state ranked in the top five for total investment value, a reflection of their status as destinations for private, smaller-scale projects like marketing operations and logistical centers. The largest greenfield investments made during H1 2012 were in manufacturing and electricity generation operations that began construction in Minnesota, Alabama, South Carolina, and Oregon. The biggest acquisitions during H1 2012 occurred in the gas industry, with major deals in Ohio and Massachusetts.
Chinese investors continue to target a wide range of industries, but a few sectors deserve special attention. Investments in oil and gas accounted for the vast majority of Chinese investment dollars during H1 2012, led by Sinopec’s $2.5 billion minority stake in several Devon Energy projects (see below). The industries that received the most investment dollars behind oil and gas were the aerospace, banking, metals processing, and plastics. The highest number of deals during H1 2012 was recorded in the alternative and renewable energy sector. While the average deal size of these clean energy investments remains small relative to the massive investments Chinese have made in American oil and gas, at least $60 million was invested in clean energy from January to June 2012.
As of this update, we have significantly expanded the coverage of our China Investment Monitor (CIM). The CIM now provides data for Chinese FDI in the United States from 2000 to present and includes all greenfield projects and M&A transactions with an investment value of more than $1 million. For the period of 2000-H1 2012 the CIM counts almost 600 transactions worth $21 billion. Please visit the CIM website to explore the patterns of Chinese investment by state, industry and ownership in greater depth.
Sinopec – Devon Energy
In April, China Petrochemical Corporation (Sinopec) wrapped up the purchase of a one-third stake in five shale oil and gas fields across the United States from Ohio-based Devon Energy. The deal, worth $2.5 billion, was by far the largest single Chinese direct investment in the US in H1 2012.
This acquisition follows a trend of increasing investment activity in the United States by Chinese state-owned oil firms that are eager for access to the US, and more broadly, the North American gas and oil markets. Spending by Chinese state-owned enterprises in Canadian oil sands and shale gas has reached over $20 billion since 2005, and China National Offshore Oil Corporation (CNOOC) this week announced its intention to spend another $15 billion for the acquisition of Calgary-based oil and gas producer Nexen. Investment in US energy assets has been slower, partly due to hesitation following the Unocal debacle and uncertainly of the receptiveness of the US to such investments. However, it has picked up significantly in recent years (see Figure 3). In addition to Sinopec’s investment in Devon assets, CNOOC has acquired two stakes in Chesapeake Energy shale oil and gas projects. Other big-ticket US energy investments include a stake purchased by Wanxiang earlier this year in GreatPoint Energy, a Massachusetts firm with a technology that converts coal to natural gas. Investment in renewable energy assets has gained momentum in recent years but remains small in value compared to capital-intensive oil and gas investments.
Investment in North American oil and gas assets is soaring for a variety of reasons. First, Chinese companies are eager to expand their global upstream assets and North America is where the deals are happening. In 2011, more than 50% of all global oil and gas M&A took place in North America due to the boom in unconventional oil and gas. Second, recent events in Libya, Sudan and other resource-rich developing countries have led to a re-assessment of political risks related to investments in politically less stable regions compared to developed economies. Third, China has vast reserves of unconventional oil and gas – up to 50% more “technically recoverable” reserves than the United States – and Chinese firms are gearing up for the development of these reserves. Partnerships with overseas firms that allow them to gain experience and knowledge will put them in a better position for developing these resources at home. In addition to equity stakes in unconventional gas and oil projects, smaller firms providing drilling technology and services are potential future targets for Chinese acquisitions.
Golden Dragon Precise Copper Tube – Alabama Plant
Initially announced early in 2011, copper tube producer Golden Dragon has broken ground on its $100 million manufacturing facility in Wilcox County, Alabama. The facility is expected to create 300-500 jobs over the first few years. The project illustrates the growing importance of tariff jumping as an incentive for Chinese investment in the US. Golden Dragon announced the investment shortly after the imposition of antidumping tariffs on copper tubing from China in 2010. Similar penalties on the import of aluminum extrusion products have sparked manufacturing investments in North America, such as Nanshan Group’s $100 million aluminum production facility in Lafayette, Indiana. In May of this year, the Department of Commerce announced antidumping penalties against Chinese importers of solar panels as high as 31%. Several Chinese solar firms have already established manufacturing facilities in the United States to improve their position in local markets, for example Arizona, and the latest import tariffs provide an additional incentive for Chinese solar PV suppliers to localize operations.
Alabama’s new immigration law nearly cost the state the $100 million investment and related jobs. The law, held by many to be the harshest immigration law in the country, has already caused problems for foreign nationals seeking to do business in the state. For example, in November 2011 a German Mercedes-Benz executive was arrested for violating the law by only having his German identification card on him. Following the incident, at least one sardonic editorial appeared inviting Mercedes-Benz to relocate its manufacturing facility to a more welcoming state. There were some claims that Golden Dragon was considering doing just that. In the end, Golden Dragon decided to stick with Wilcox County in Alabama, citing Alabama tax incentives, proximity to a rail lines, and access to the Port of Mobile as key factors in its decision.
ICBC – Bank of East Asia
ICBC announced its intention to acquire an 80% stake in the Bank of East Asia’s US operations for $140 million in January 2011, but until May of this year the transaction was under review by the Federal Reserve. The Fed must approve such transactions as stipulated in the Foreign Bank Supervision Enhancement Act of 1991. On May 9th, the Fed announced that it would allow the transaction to proceed, making it the first instance of a Chinese bank claiming a majority stake in a US retail banking institution. The deal provides ICBC with ten California branches and three in New York, creating a toehold and foundation for future growth in the United States.
The approval of this investment by the Federal Reserve is not significant for its size –$140 million represents a paltry 4% of all Chinese investment dollars recorded during H1 2012 – but rather for the precedent it sets. By allowing the acquisition to proceed, the Federal Reserve has signaled its tolerance of Chinese banks’ expansion into the United States (on May 9th the Fed also gave the go-ahead for Bank of China and Agricultural Bank of China to establish US branches). As Chinese banks anticipate a series of domestic financial reforms, they are aware that the system which for so long has provided banks with easy profits may soon change. Faced with this reality and other real economy developments, Chinese banks have incentives to focus less on China and more on overseas operations to gain experience, modernize, and ultimately strengthen their position against new market entrants. Economies with a sophisticated and experienced financial sector such as the United States stand to receive more Chinese investment in the coming years.
There were several noteworthy positive investment policy developments in the first six months of 2012 in both the US and China, though obstacles to strengthening cr0ss-border investment remain on both sides. The US made progress in technical issues such as visa issuance, yet national security concerns remain a crucial impediment, particularly in regards to telecommunications and critical infrastructure. Looking forward, second-generation policy issues such as competitive neutrality and equal market access are getting more attention from officials in the US and other developed economies. On the Chinese side, positive commitments have been made to open up financial services to greater foreign participation. China is also increasingly pushing for more outward FDI (OFDI) by private sector firms. However, several new policies to address risk management and the strong state involvement in outbound investment decision-making could potentially weigh on future outbound investment flows.
The United States: Political concerns beyond national security
Several developments on the US side in H1 2012 contribute to a positive outlook of the China-US investment relationship. The implementation of simplified visa procedures for business travel and tourism in the United States represented one of the most important positive policy developments. On January 19th, President Obama signed an Executive Order that included a goal to increase visa-processing capacity in China by up to 40% during 2012. The Beijing Embassy responded by assigning 50 new consular officers to facilitate more rapid processing of visa applications and reports that the average wait time for a consular interview was no greater than six days throughout China. Stipulations of the law that make it easier to reapply for visas should be especially welcome to Chinese nationals with investment interests in the United States.
Another notable development on the US side is the official rhetoric supporting Chinese participation in US infrastructure development that has emerged during the last few months. In December of last year, Chinese commerce minister Chen Deming indicated interest in channeling some of China’s vast foreign exchange (FX) reserves into infrastructure investment projects in the United States. US officials responded to this stated interest during the May US-China Strategic and Economic Dialogue meetings in Beijing. The official release contained the following:
The United States supports improving its infrastructure sector, enhancing market mechanisms for infrastructure investment, incorporating best practices and lessons learned from all applicable global infrastructure systems, and working to enhance Public-Private-Partnership (PPP) investment opportunities where appropriate, including from foreign investors… The United States and China recognize the potential for their firms to play a positive role in infrastructure financing in each country, and commit to explore opportunities for deepening cooperation in this field.
This positive rhetoric has yet to translate into actual investment projects, but the welcoming tone is a first step in the right direction. The main challenge firms will face in pursuing such projects will be finding ways and legal structures to participate more directly in infrastructure development without eliciting national security concerns. Whether or not this can be done successfully remains to be seen.
As these positive developments have emerged, other traditional difficulties faced by Chinese firms in the United States have continued or even intensified over the last six months. Telecommunications and information technology security concerns remain at the heart of the debate on Chinese investment and continue to impede Chinese equipment vendors (Huawei and ZTE) and increasingly telecommunications services providers from operating in the US market. For example, the US government is reportedly considering denying operating licenses to China Mobile to provide service between China and the United States and build local facilities on national security grounds. The public debate on the seriousness of cyber theft threats is also not easing. To date, months of crafting and compromising have not been able to get a bill bolstering US cyber-security measures through Congress, although a recent report indicated that such a measure may have enough support in the Senate to make it to a vote sometime before the end of July. Needless to say, telecom remains a very difficult industry to operate in for Chinese firms, and these security concerns are unlikely to diminish in the immediate future.
The past six months have also shown that next-generation policy issues including reciprocity in market access, competition policy, and regulatory transparency are becoming increasingly important and could add to political risks for Chinese investors in the United States. In light of increasing Chinese investment, OECD policymakers have begun to focus more on symmetry in market access and competitive neutrality of state-owned investment vehicles. In April, for example, the United States and the European Union announced a set of Shared Principles for International Investment, which call for non-discriminatory treatment of foreign investors and a coordinated approach to address the “challenges posed by state influence in relation to commercial enterprises”.
The US increasingly intends to find leverage in the form of regulatory approvals to elicit policy concessions from China. The timing of the Federal Reserve’s approval of ICBC’s takeover of the Bank of East Asia (during the S&ED, at which China announced a partial liberalization of foreign investment in China’s securities industry) suggested to many that such a quid-pro-quo approach to market access was afoot. In a March 2012 speech Secretary of State Clinton also suggested that US officials are increasingly ready to use Chinese investment interests in the US as leverage for achieving broader goals in US-China economic relations:
As economic partners, we can make it possible for more people in both countries to work, trade, invest, create, and prosper. Whether we do or not depends on how we deal with some of our differences. China has things it wants, including more opportunities to invest in the United States, and we have things we want, including an end to discrimination against U.S. companies and protection for their intellectual property; an end to unfair preferences for domestic firms; and more opportunities for American goods, products and services; and of course, an end to what we see as unfair, distorting currency practices.
US regulators and courts are also stepping up their actions against Chinese companies out of compliance with local regulations. The US Securities and Exchange Commission (SEC) continued to investigate and prosecute cases of investor fraud by US-listed Chinese firms. Among multiple recent examples is that of Puda Coal, against which fraud charges were filed by the SEC in February of this year. Together with the Public Company Accounting Oversight Board (PCAOB), the SEC is currently negotiating with the China Securities Regulatory Commission (CSRC) and other Chinese regulators over a cross-border auditing cooperation framework including the sharing of Chinese auditing documents. Some accounting experts are speculating that the SEC could delist all Chinese companies from US capital markets if an agreement is not reached.
Antitrust is another area in which the clash of different philosophies and regulatory frameworks has started to cause trouble for Chinese firms. During H1 2012 Aland Nutraceutical became the first Chinese company to settle antitrust allegations in the United States by agreeing to pay $10.5 million to settle price-fixing allegations. The company defended its position by claiming that the Chinese Ministry of Commerce required the firm to coordinate production and fix export prices, and that compliance with Chinese regulations should supersede US antitrust lawMOFOCMs. Several other Chinese makers of vitamin C will face trial on November 5th under the same price-fixing allegations.
China: Continuing liberalization but new emphasis on OFDI risk management
The first six months of 2012 have seen a range of new policies promoting foreign investment with the goal of offsetting a drop in FX inflows. The State Administration of Foreign Exchange (SAFE) and the PBOC have taken several steps to ease the inflow of portfolio investment flows. In April, regulators increased the quotas for the Qualified Foreign Institutional Investors (QFII) scheme, which allows selected foreign investors to invest in China’s stock market. In March, the National Development and Reform Commission (NDRC) significantly expanded the annual long-term foreign debt quota allocated to foreign banks.
With regard to inward FDI, the most significant development was the May announcement to raise the limit on foreign participation in joint ventures in the banking sector. The maximum foreign ownership threshold in joint ventures in the securities industry (underwriting and sponsoring bonds and stocks) and brokerages (commodities and financial futures) was raised from 33% to 49%. The concession came after the US Federal Reserve approved the takeover of Bank of East Asia’s US operations by ICBC, a decision that paves the way for more acquisitions by Chinese firms in the US banking sector. In early July, SAFE also announced the elimination of regulatory supervision of FDI-related foreign exchange accounts and the abolishment of regular examinations on reinvestments of profits by foreign companies in China.
Wen Jiabao’s work report to the National People’s Congress in March summarized the high-level priorities of the central government concerning outbound FDI. The document states that the government sees “China’s outward investment in an important stage of accelerated development” and will continue to support outward FDI of firms across all sectors and ownership forms. Proposed measures include streamlined approval procedures, greater technical and political support for investors, and relaxation of restrictions on individual and private sector investors. At the same time, the document highlights the increasing awareness of risks and the desire to “guide Chinese enterprises”, “coordinate their growth” and “strengthen risk management of overseas investments”. In short, the government sees the necessity of greater internationalization but is not willing to give up its tight grip on overseas investment flows, and will put even greater emphasis on risk management in the future.
Several new policies in H1 2012 reflect this stance. In March, the State-owned Assets Supervision and Administration Commission (SASAC) issued new rules on state-owned enterprise (SOE) investment abroad. The rules stipulate that centrally-owned SOEs are not to engage in overseas investments in areas not related to the firms’ core business without special SASAC approval. They also increase the accountability of executives for unsuccessful overseas ventures by introducing reporting and management requirements for overseas investments. These rules add to regulations issued in 2011 that require all 117 centrally-owned SOEs to report overseas assets, deregister “unnecessary” offshore holding firms and get approval from SASAC for new overseas investments.
At the same time, the government announced measures to support outward investment by non-government controlled investors. In March, the Wenzhou government received approval from the State Council to initiate a pilot program increasing an individual’s ability to invest abroad. In June, SAFE issued a circular that eases restrictions for Chinese firms on the cross-border transfer of foreign exchange. Greater flexibility in FX transactions will particularly benefit private sector firms, which are at a disadvantage when it comes to financing outward investment. In early July, several Chinese ministries announced a new policy initiative to promote outbound FDI by private firms. The policy package mostly aims at improving financing channels for private sector OFDI. Most importantly, the procedure for remitting foreign exchange back to China will be simplified by abolishing mandatory approvals for FX transactions related to overseas projects approved by the Ministry of Commerce (MOFCOM).
It remains to be seen if these measures are more successful than past efforts to promote private sector outward investment to the US and elsewhere. In spite of past rhetoric, to date there has been no major change in the dominant position Chinese state-owned firms enjoy in pursuing investment activities abroad. In H1 2012, trends in Chinese government involvement in investment activities in the United States remained consistent with previous years. While private firms dominate in terms of number of deals, the value of investment deals from government-owned firms average considerably higher than those made by private firms, both for greenfield and acquisitions (Table 1).
In regards to competition policy and global merger control, China continued to increase its global profile, approving several high-profile deals under certain conditions akin to acquisitions by Pfizer and GM in 2009. In June, China approved United Technologies Corporation’s $16.5 billion takeover of aircraft parts maker Goodrich, under the condition that Goodrich divests its electrical power generation and transmission systems businesses and 60 percent of Aerolec, a joint venture with Thales Avionics. Western Digital’s $4.5 billion acquisition of Hitachi Global Storage Technologies was approved under the condition that the Hitachi entity operates independently for at least two years after the acquisition. After receiving clearance from US and EU competition authorities, MOFCOM also gave nod to Google’s $12.5 billion takeover of Motorola Mobility in May. However, Google is required to keep its Android software free and available without discriminating against any particular device maker for five years. China also continued to further simplify and professionalize its merger review structures. In June, the director of MOFCOM’s Anti-Monopoly Bureau said that China would come up with a fast-track process for the review of mergers and acquisitions (M&A) under China’s Anti-Monopoly Law. The announcement was followed by the issuance of a simplified form for notifying MOFCOM about M&A transactions.
2012 looks to be a record-setting year for Chinese direct investment in the United States. Multiple big-ticket deals are currently pending. Dalian Wanda’s $2.6 billion acquisition of American movie theater chain AMC received approval from China’s National Development and Reform Commission in June, and now awaits US regulatory approval. The Committee on Foreign Investment in the United States will provide a final regulatory decision before the end of the year. It appears unlikely to be blocked under national security concerns. Wanda has indicated its intention to invest as much as $500 million in US operations after the close of the deal.
Another significant pending deal is Chinese aerospace manufacturer Superior Aviation’s $1.8 billion bid for Hawker Beechcraft in early July. The acquisition excludes Hawker Beechcraft Defense Co., a separate entity that would likely elicit national security concerns were a Chinese firm to seek to purchase it. Superior Aviation has committed to maintain present facilities and inject additional capital into the company. If both deals are successful, Chinese direct investment will surpass the $8 billion mark in 2012, far higher than any previous year’s total.