Chinese FDI in the United States: Q3 2012 Updateby Thilo Hanemann | October 18, 2012
At the beginning of 2012, many observers predicted a dismal year for Chinese investment in the United States, pointing to the economic volatility and major political events in both countries. However the opposite has proven true: in the first three quarters of 2012, Chinese firms invested more capital in the United States than ever before. The pipeline of pending deals remains strong, but the increasingly heated public debate in the United States is aggravating existing tensions in the US-China investment relationship. This note discusses the trends, key transactions and political developments in Q3 2012.
A record year for Chinese investment: In the first three quarters of 2012, Chinese firms invested $6.3 billion in FDI projects in the United States, setting a new record. The deal pipeline is strong, with major pending acquisitions in aviation, auto parts and energy.
New sectors: While energy and advanced manufacturing continue to land the most investment dollars, 2012 deal flow suggests that Chinese investors are increasingly interested in US service firms, including entertainment, hospitality, finance and information technology.
Heated politics: President Obama’s decision to block the Chinese acquisition of a wind farm does not represent a tightening of US policy. But a controversial new report by two members of the House Intelligence Committee has politicized the important debate about Chinese investment in critical US infrastructure.
Trends and Patterns
In Q3 2012, Chinese companies spent $2.7 billion on ten foreign direct investment (FDI) projects in the United States (see Figure 2). While the number of investments is slightly lower than in previous quarters, the average size of transactions this year has reached an unprecedented level. Valued at $2.6 billion, the acquisition of movie theatre operator AMC by Wanda Group not only accounts for the lion’s share of Q3 flows, but is also the biggest completed Chinese US acquisition in history. Sinopec’s investment in shale oil and gas assets from Devon Energy earlier this year, valued at $2.5 billion, comes in a close second. Chinese appetite for large-scale deals has clearly increased.
In addition to higher average deal size, another remarkable trend is that service sector firms are attracting greater attention from Chinese firms. While sectors like high-tech manufacturing and energy remain major draws, higher value-added service sectors including finance, entertainment or information technology are attracting an increasing share of investment. Please visit RHG’s China Investment Monitor to explore the patterns of Chinese investment by state, industry and ownership in greater depth.
Back in September we released a note describing how the positive employment impacts from Chinese investment are becoming increasingly tangible. We estimated that Chinese firms employed around 27,000 people in the United States as of June 2012. The Wanda-AMC transaction and other deals in Q3 added another 1,000 people to the payrolls of Chinese parent firms, lifting the total employment figure to 28,000 – and this is not including indirect jobs, such as those in construction or at suppliers. The figure also excludes hourly workers, which in the case of AMC alone total 18,000.
Dalian Wanda – AMC: The Marquee Chinese Investment in a US Services Firm
Dalian Wanda’s $2.6 billion acquisition of movie theater chain AMC in September represents the largest single Chinese FDI transaction in the United States to date. It also showcases a new trend: Chinese investors are increasingly spending their investment dollars on firms in consumer services. In the past big-ticket acquisitions all targeted US businesses with tangible manufacturing assets or commodities — see Sinopec’s stake in Devon Energy projects, CIC’s investment in AES Corp, Lenovo’s purchase of IBM’s personal computer division, or Shanghai Electric’s acquisition of Goss International. Along with other recent transactions in banking (ICBC-BEA), software (Tencent-Riot Games) and hospitality (Shenzhen New World-Sheraton Universal in L.A.), the Wanda-AMC acquisition illustrates how providers of higher value-added services outside of trade facilitation and manufacturing-related functions have come into the focus of Chinese investors.
The Wanda-AMC deal illustrates the motives behind this new interest. First, service capabilities are the missing link for achieving a competitive edge back at home in China’s fast-growing domestic market. The historical focus on manufacturing and infrastructure build-out as the engines for economic growth has left China with one of the smallest service sectors in the world relative to its GDP (see Figure 3). In coming years China is expected to go through a macroeconomic rebalancing process that will shift huge amounts of capital from manufacturing, real estate, and infrastructure into service sector activities. The “China 2030” report drafted by the Development Research Center and the World Bank project the share of the service sector in China’s economy to grow from 43% in 2011 to 52% in 2020 and 61.1% in 2030. Chinese firms looking to get a jump on this new era of growth have two choices: built it or buy it. Buying is quicker, and Western services firms are highly attractive takeover targets. As China’s rebalancing intensifies, more overseas investment in modern services is likely. Second, Chinese executives are increasingly aware of the risks that rebalancing will bring and they recognize the urgency of diversifying their operations to hedge against an economic slowdown in China. As Wanda’s chairman Wang Jianlin said at the closing of the AMC deal, Chinese firms have realized that “putting all their eggs in one basket” is too risky. Underscoring how big of a strategic point he was making, Wang announced that he has earmarked an additional $10 billion for investments in the United States.
Jilin Hanxing – Glasair: Chinese General Aviation Taking Flight
The acquisition of small kit aircraft manufacturer Glasair by Jilin Hanxing Group in July has not attracted much public attention. But, together with the pending Hawker Beechcraft acquisition, it demonstrates Chinese investors’ continued interest in US general aviation (GA) assets. More than 20 years after the first Chinese aviation takeover in the US was blocked on national security grounds, Chinese investors made a comeback in 2010 with the acquisition of Epic Air, a small GA manufacturer in Oregon. In 2011, Chinese firms spent $400 million to acquire Teledyne’s general aviation piston engine business and Cirrus Industries, a Minnesota-based aircraft manufacturer (Table 1).
Domestic forces, again, are driving this push into the global general aviation industry. Since the foundation of the People’s Republic, China’s GA industry has been controlled by the military. Airspace has been generally closed to private jets, landing permits were hard to get, and China’s GA airport infrastructure and pilot training programs were minimal. Officially China currently has around 90 GA airports and about 1,000 GA planes in use, most of those in industry, farming and forestry, training, and scientific monitoring. In comparison, the United States has around 5,200 airports and a fleet of 228,000 GA aircraft. With a limited but protected domestic market, Chinese firms did not have much incentive to go abroad in the past.
However structural and political changes in China are shifting the landscape. A bourgeoning wealthy class has sparked demand for private jets and other personal aircraft, and important regulatory changes are under way. The Civil Aviation Administration of China (CAAC) has announced its intention to open China’s low altitude airspace for GA by 2015. In March 2011, China listed GA as a strategic growth industry in the 12th Five Year Plan for 2011-2015. The China General Aviation Association (CGAA) expects that China will build almost 200 general aviation airports within the next five years. Bullish Chinese reports project that the number of general aviation aircraft will reach 10,000 units in this period, with a total investment of RMB 1 trillion. The 2010 China General Aviation Development Report more conservatively estimates the number of general aircraft planes to double by 2015, from the current 1,000 to slightly more than 2,000 units. Helicopters and business jets are expected to be in particularly high demand.
Chinese aviation firms are now positioning themselves to capture a bigger share of this expected boom in China’s GA market. China’s major state-owned domestic players in the GA market, like Aviation Industry Corporation of China (AVIC) and its subsidiary, China Aviation Industry General Aircraft (CAIGA), have started to modernize their operations through domestic investment, joint production ventures in China with firms like Cessna, and overseas acquisitions. Home to the world’s most advanced and established general aviation industry (North Dakota’s GA industry is larger than all of China’s judging by the number of aircraft and flying hours), the United States can expect more investment from Chinese aviation firms in the years ahead.
While the first half of the year was relatively calm, the topic of Chinese investment has risen to great prominence in the US public debate in recent weeks. China continues to fine-tune its domestic regulatory environment and risk controls for overseas investment and is becoming more active with regard to investment protection and international arbitration.
United States: Politics are heating up
Two notable developments have electrified the issue of inward investment from China in the US in recent weeks. The first big splash was caused by President Obama’s Executive Order requiring Chinese-controlled Ralls Corporation to abandon a wind farm project near a military base in Oregon and divest all related assets. This is only the second time a US President has formally blocked a foreign acquisition, and the first since 1990. There are a lot of misperceptions about the motives behind the President’s decision and its implications for Chinese investment in the United States. Our view is that the Ralls case is not a political game of chicken, but instead is another case of espionage concerns based on proximity to critical defense installations. The situation could have been avoided if the investor had followed existing precedents and filed with CFIUS before pushing through with the deal. It is surprising that the executives of a Chinese firm with significant experience operating in overseas markets (Sany) pressed ahead with this acquisition without getting a proper CFIUS review in advance, and then saw fit to publicly blame US protectionism and campaign tactics for the failure. They are now pursuing a novel legal case which offers an opportunity to discuss some important questions and refine the understanding of the CFIUS mandate and process, but it will not substantially change the US’s policy stance towards Chinese investment. The United States will stick to its traditional openness to foreign investment, while still diligently screening investments for security threats, including commercial and political espionage. Our detailed discussion of the case can be found here.
The second big event that drew media attention was a House Intelligence Committee’s investigation of Huawei and ZTE, which resulted in a widely circulated report by two of its members. The report highlights some real and legitimate concerns about Chinese firms, for example a lower degree of transparency, obscure corporate governance structures, and a legal system at home that hinders firms from working with overseas regulators and does not protect firms from the omnipotent Chinese Party-State, and business dealings with regimes that are hostile to the US. At the same time, the report is a missed opportunity to advance an important debate about the security of telecommunications networks and other critical infrastructure. By singling out two firms, providing no substantial new evidence except in a classified appendix, discussing areas outside of narrow national security concerns (for example labor rights and IPR conflicts) and ruling out in advance the possibility of mitigation measures, the report discredits itself and provides a perfect springboard for populist debates that will damage the hard-won reputation of the United States as an open investment environment. Unfortunately, the Obama campaign jumped on this bandwagon and used some of the accusations from the report in a new online ad targeting Governor Romney.
More importantly, the authors of the report appear not to have thought through the implications of their findings. If “[s]ignificant security is available only through a thoughtful design and engineering process that addresses a complete system-of-systems across the full lifecycle”, the United States would have to re-build its entire telecommunications infrastructure from scratch using domestic components made under the supervision of a yet-to-be created government body. The report also damages the future prospects of US companies in overseas markets by creating a precedent for singling out specific companies and undermining their business prospects with private sector entities without reference to specific national security risks. In China, the report is seen as unreasonable and protectionist and it has already triggered popular demands for retaliation against US high-tech companies like Cisco and Apple.
Other Chinese investments in North America have provoked critical responses from US policymakers in recent weeks too, mirroring concerns about technology transfer (Wanxiang’s agreement with battery producer A123Systems), reciprocity in market access and national security (CNOOC’s bid for Canadian oil firm Nexen), and the South China Sea conflict (ICBC in California).
China: Bureaucratic turf wars and a new focus on risk management
In China, policymakers and regulators were busy fine-tuning the regulatory framework for cross-border investment to improve the decision-making and risk management for overseas investment.
In July, the National Development and Reform Commission (NDRC) published guidelines for China’s FDI and OFDI development for the period of the 12th Five-Year Plan (2011-15). On the inward side, China plans to encourage investment in high-tech manufacturing, research and development, and other advanced service sectors like healthcare, while limiting foreign investment in energy-intensive and polluting industries. On the outbound side, advanced manufacturing, energy, mining and agriculture are listed as preferred areas. The document also emphasizes the quality of investment decisions and the need to boost private sector investment.
In an effort to further streamline the regulatory framework for outbound FDI, the NDRC in August posted new draft regulations on its website for public comment. The draft rules consolidate the 2004 preliminary provisions and subsequent modifications in 2009 and 2011. The new regulations aim to strengthen the NDRC’s role in the outbound investment review process by making clear that NDRC decisions shall supersede the authority of the other regulatory agencies involved, among them the Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange (SAFE). This delegates most of the decision power for smaller projects to local DRC offices, and reflects concerns by the central planning agency about risks related to overseas projects. In its latest decision, the NDRC has asked Hanlong to lower its bid for Australian miner Sundance because it considered the price too high. The new rules mean that the legal framework for outbound FDI remains fragmented and that the bureaucratic turf war at home will continue to be a major impediment for Chinese firms’ global investments.
In September, Ping An filed an arbitration claim against Belgium with the International Centre for Settlement of Investment Disputes (ICSID), a body under the World Bank that handles disputes between investors and governments. Ping An had to write down most of the $3.8 billion it spent for a 5% stake in the financial services group in 2007 when the company was nationalized and sold during the financial crisis to BNP Paribas. The arbitration filing came after negotiations with the Belgian government about compensation for losses failed. It is the first time in history that a mainland Chinese company turns to the ICSID, an event that highlights the growing importance of global investment protection and arbitration for Chinese investors.
With regard to global merger control, the Ministry of Commerce approved two transactions in Q3: in August, Wal-Mart received conditional approval to raise its stake in online retailer Yihaodian from 18% to 51%. And in September, the merger of Pentair with Tyco International’s Flow Control Business was given the green light. MOFCOM’s Anti-Monopoly Bureau also needs to approve Glencore International’s takeover of Canadian grain handler Viterra, which is expected in November.
At the end of Q3 2012, the deal pipeline was stronger than ever before. In August, Wanxiang executed an agreement with insolvent battery maker A123Systems that provides A123Systems with a credit line of $25 million with the option to acquire a strategic stake in the company worth $465 million. A123Systems recently filed for Chapter 11 bankruptcy protection this week, but Wanxiang confirmed it is still interested in the firm’s assets. Hawker Beechcraft concluded a similar deal with Beijing Superior Aviation, which could result in a $1.8 billion acquisition of the firm’s general aviation and private jet businesses. During Xi Jinping’s US visit in February, Smithfield entered into an agreement with Beijing DQY Agriculture to form a new bio-fuel joint venture with a total investment of $1.8 billion, but the project has not moved forward yet. The new outlook for the US energy sector and the related capital expenditures continue to provide good entry opportunities for Chinese investors. After China Investment Corporation (CIC) reportedly took a stake in Cheniere’s new LNG export terminal (along with Blackstone and Singapore’s sovereign wealth fund), Chinese firms are in negotiations to co-finance two coal liquefaction plants in the United States, the Texas Clean Energy Project and the Medicine Bow project in Wyoming.