Chinese FDI in the United States: Q4 2012 Update
Foreign direct investment in the United States has dropped dramatically in 2012 on the back of structural adjustments in Europe and uncertainty about the US economic outlook. While still at a comparably low level, FDI from China ran counter that trend, growing 41% year-on-year in 2012. This note reviews deals and policy developments in Q4 2012, summarizes the full year figures and gives an outlook for the China-US investment relationship in 2013.
A new record year for Chinese FDI: 2012 was a record year for Chinese direct investment in the United States, with completed deals worth $6.5 billion, a 17% increase from the previous record of $5.5 billion in 2010.
But fewer deals are happening: However, the number of greenfield projects and M&A transactions fell sharply compared to previous years, probably reflecting the reluctance of smaller private sector firms to make the step abroad in light of difficult economic conditions in China and anemic consumption growth in the US.
Growth to continue in 2013: Chinese US acquisitions currently awaiting regulatory approval amount to almost $5 billion. Structural reforms in China, a favorable policy environment for outward investment, and a better outlook for the US economy will help sustain the inflow of Chinese capital.
Trends and Patterns
As in 2011, the fourth quarter was a very slow one. Chinese firms closed only 8 deals that qualified as direct investment, for a total of $178 million (Figure 2). Several pending transactions either broke down or were postponed into 2013: Beijing Superior Aviation abandoned its acquisition of Hawker Beechcraft in October; the $1.8 billion bio-fuel joint venture between Smithfields Foods and Beijing DQY Agriculture announced in February has not yet materialized; Wanxiang won the assets of battery maker A123 Systems in bankruptcy court but is still awaiting regulatory approval to close the transaction; and BGI Shenzhen’ $118 million takeover of Complete Genomics was cleared by CFIUS in late December but still had to get approval from US antitrust authorities and Chinese regulators.
With only 8 completed deals, Q4 2012 had the fewest transactions since Q4 2008, continuing a downward trend in number of deals that began in 2011. The drop in number of greenfield deals in 2012 is at least partially accounted for by the difficulty of capturing small deals in the $1-5 million range. Often these deals are discovered with a slight delay, for example through annual filings, so those figures will most certainly be upward revised with the next quarterly update. However, the unusually sharp decline in greenfield projects and the simultaneous drop in M&A deals suggests that the downward trend in deal volume is real.
One explanation for this decline in number of deals is the state of the Chinese economy since mid-2011. After a successful stimulus, Chinese policymakers have been engineering a “soft landing”, which squeezed corporate profits and the availability of credit. It seems like the domestic credit crunch in combination with an uncertain outlook for the US economy has temporarily diminished smaller firms’ appetites for overseas expansion.
Despite a weak Q4 and the low number of deals, the total investment value for 2012 broke a new record high of $6.5 billion. The most alluring sectors in the US continue to be oil and gas extraction, advanced manufacturing operations that help Chinese firms move up the value chain, and assets that allow investors to store value and gain stable returns such as utilities, real estate or hospitality (Figure 3). Deals closed in 2012 show this diverse mix of motives, with large-scale investments in the extractive industry (Sinopec’s $2.5 billion stake in Devon Energy), high-tech manufacturing (Wanxiang’s $420 million stake in GreatPoint Energy) and entertainment (Dalian Wanda’s $2.6 billion purchase of AMC). For a more comprehensive view on patterns of Chinese investment from 2000-2012 please visit RHG’s China Investment Monitor.
Continued growth of Chinese FDI is even more remarkable in light of an otherwise bleak FDI picture in the United States. In the aftermath of the global financial crisis, annual FDI inflows dropped to $150 billion, down from $200-300 billion in previous years. In 2010 and 2011 inflows somewhat stabilized, but declined again sharply in 2012 in light of the fragile situation in Europe (the major source of FDI for the US) and uncertainties surrounding the US growth outlook. Preliminary data from the Bureau of Economic Analysis shows that FDI dropped by more than 30% in the first three quarters of 2012, which indicates that the full year figure will come in at levels not seen since the crisis year 2009.
These trends suggest that China could follow other Asian economies in becoming an important source of FDI for the United States. China today accounts for less than 1% of total US inward FDI stock, but it has become one of the few bright spots in an otherwise gloomy FDI environment. Compared to five years ago, FDI flows from European economies and Canada were down by more than 50% in the first three quarters of 2012. FDI from Asia was holding up better, and China is among the few countries that invested more in the United States than five years ago – an increase of more than 300% according to official statistics from the Bureau of Economic Analysis (Figure 3).
These estimates are likely too low, as the BEA Balance of Payments figures do not account for flows through offshore financial centers. Figures from Rhodium Group’s China Investment Monitor, which account for such flows, suggest that the increase was even more significant, by nearly 1,300% over five years.
Xinyuan in New York: Chinese Real Estate Developers Going Abroad
Prime commercial and residential US property has become an important target for Chinese buyers over the past two to three years. While this investment largely came from wealthy individuals in the past, the deal flow in 2012 shows that professional real estate developers and financiers are increasingly betting on the US property market as well.
In previous years Chinese real estate developers had little incentive to look abroad: a blistering domestic real estate market promising high returns made complex real estate plays far away from home not very attractive. However, in late 2011 Beijing implemented a series of policies aimed to cool the domestic housing market, reducing opportunities for Chinese real estate developers at home. At the same time, the slowdown in domestic growth and the anticipation of a difficult structural reform process has increased the demand for overseas property investments among wealthy Chinese nationals. These developments provide Chinese property developers and financiers with an incentive to pursue overseas projects that can be marketed to wealthy Chinese back home.
A recent deal in New York illustrates these new frontiers for Chinese real estate developers. In late 2012, NYSE-listed Xinyuan Real Estate Co. purchased a 92,000 square-foot development site in the Williamsburg neighborhood of Brooklyn for $54 million, becoming the first Chinese company to lead the development of a major US residential real estate project. Construction is slated to begin in 2013 and will result in more than 200 units with 500,000 square feet of space. Conditions in the Chinese property market have somewhat stabilized in recent months, but given the strong demand from private and institutional investors for prime overseas property, we expect Chinese interest in US real estate projects to grow further in coming years.
RATO Power: Localizing Operations to Better Serve the U.S. Consumer
Chongqing RATO Power, a manufacturer of vehicle engines and general-purpose machinery, entered the US market in January 2012 through a $70 million acquisition of a specialized provider of power-equipment (Denver Global Products). In October, the company announced a further $30 million greenfield investment in a large assembly and distribution center in North Carolina that is expected to create 450 new jobs. According to RATO, the greenfield expansion was motivated by a desire to cut transportation costs and minimize exchange rate risks while moving closer to American consumers.
Chongqing RATO’s investment illustrates the economic rationale for Chinese firms to invest in US greenfield operations. There is no evidence of a massive “re-shoring” of manufacturing to the United States, but Chinese firms are realizing the opportunities from building out local operations in the US. A local presence allows firms to better react to consumer preferences, market their goods as “Made in the US”, hedge against punitive tariffs, tap into the local talent base, and expand into the downstream segment of the value chain. Other Chinese firms that announced greenfield investments in the US in 2012 include Lenovo, Golden Dragon Copper Tube and Uniscite.
The second half of 2012 highlighted the importance of national security concerns for Chinese investors, as a series of deals got torpedoed by CFIUS reviews and politicization outside of the formal review process. China’s new leadership shows continuity in supporting global investment by Chinese firms and criticizing foreign investment protectionism. However, officials are stepping up their rhetoric in support of global investment norms, which could open the door for new approaches to global investment governance.
United States: National Security Back in the Spotlight
The United States continues to advertise an open investment environment to government officials and firms in China, for example during the annual meeting of the US-China Joint Commission on Commerce and Trade in December. The federal government also continues to step up its role in coordinating investment promotion efforts. In early December, the US embassy in Beijing for the first time held an official event to bring together Chinese investors, US government officials and US service providers.
At the same time, the second half of 2012 also underscored how important national security considerations have become to Chinese investors. Several deals were derailed by national security considerations, including a wind farm in Oregon that was blocked by the President upon CFIUS recommendation and the $1.8 billion sale of Hawker Beechcraft to China’s Superior Aviation that collapsed due to a range of factors including national security concerns. Other transactions got delayed by CFIUS reviews, for example CNOOC’s purchase of Canada’s Nexen Inc, Wanxiang’s bid for the assets of bankrupt battery maker A123, and Beijing Genomics Institute’s (BGI) bid for California’s Complete Genomics.
The recently released 2011 CFIUS report shows that the number of Chinese investments reviewed by CFIUS has indeed increased substantially in recent years. Transactions with a Chinese buyer accounted for almost 10% of total covered transactions in 2011, up from zero just 5 years ago (Figure 5). The report also revealed several important adjustments in the CFIUS review process. First, it expands the list of factors that CFIUS takes into consideration for national security assessments. The most important explicit addition is geographic proximity to certain government facilities, which was cited in the Oregon wind farm case in September 2012 and other recent negative CFIUS decisions on Chinese investments (Northwest Nonferrous-Firstgold, TCIC-Emcore, Far East Golden Resources -Nevada Gold). Second, the report says that the US intelligence community is now “moderately confident” that foreign companies or governments are pursuing a coordinated strategy to acquire critical technology in the United States, which indicates greater scrutiny for high-technology acquisitions with dual-use applications.
In addition to the official CFIUS review, Chinese investors also had to deal with an uptick in politicization of deals from lawmakers, media and commercial competitors. In September, two members of the US House Intelligence Committee released a report attacking telecommunication firms Huawei and ZTE. Wanxiang’s purchase of A123 Systems faced opposition from Republican lawmakers calling on CFIUS to protect taxpayer interests and US technological competitiveness, competitors that wanted to purchase the assets themselves, and special interest groups lobbying on behalf of the US defense industry. BGI Shenzhen had to fight off similar attacks from security circles and a US competitor who tried to obstruct its friendly takeover of Complete Genomics by portraying the deal as part of a systematic buying spree by the Chinese government to advance China’s capabilities for biological warfare – a claim that most industry experts and scientists rejected as preposterous.
Extensive media coverage of criminal investigations involving Chinese firms and nationals added to public debates on the impacts of Chinese investment. After the Federal Bureau of Investigation launched an investigation into ZTE for illegally selling US technology to Iran, Reuters broke a story in December that one of Huawei’s partners offered embargoed equipment to Iran as well. Media reports in November documented hacking attacks on Coca Cola aimed at stealing highly confidential information related to Coke’s failed acquisition of Huiyuan Juice Group in 2009. In December, two Chinese engineers were convicted of industrial espionage after stealing information on hybrid vehicle technology from General Motors to sell it to a competitor in China.
Looking forward, the ongoing dispute between US and Chinese regulators over access to auditing documents could have a serious negative impact on the broader US-China investment relationship. High-level US officials such as SEC chairwoman Mary Schapiro have publicly accused Chinese regulators of lacking cooperation in prosecuting cases of securities fraud and increasing regulators’ access to the books of Chinese firms. The diplomatic failure to find a solution did not only illustrate the different standards of transparency and corporate governance in both economies, but also some of the structural problems for China in converging with global standards, such as the need to protect privileged individuals and families from the public exposure of their wealth.
China: New Leadership, Same Tone on Overseas Investments
China’s new leadership closely follows the messaging of the previous leaders when it comes to outward FDI. The final statement of the Central Economic Work Conference in December stressed China’s commitment to boost outward FDI. At the same time, the new leaders are picking up previous rhetoric that foreign countries, including the United States, are placing unnecessary barriers on Chinese investors. China’s next Prime Minister Li Keqiang told US business leaders that the US needs to “continue to open up, including an opening up to investments from China.” He did not specify the barriers he was referring to. New CCP Standing Committee member Wang Qishan was more concrete in a recent speech, criticizing “political background checks” that Chinese investors would have to undergo to invest in the United States.
One interesting development is that senior Chinese officials have begun calling for international cross-border investment rules. In an interview with Xinhua in November, Deputy International Trade Representative Chong Quan complained about the lack of international rules for cross-border investment. These calls are increasingly echoed by academics and researchers at government-affiliated think tanks, which suggests greater readiness on the Chinese side to participate in multilateral discussions on global investment rules. However, it remains to be seen how serious China will be in committing to bilateral and multilateral investment agreements that require China to make concessions to foreign investors. The talks over a US-China BIT, which were resumed in October using the new model US BIT, may be an indication for how serious China is about new international rules that go beyond the current commitments.
On the inbound side, China in November loosened foreign exchange restrictions on foreign investors. The State Administration of Foreign Exchange (SAFE) issued new regulations that allow foreign-invested companies (FIEs) to make payments and transfer forex between accounts registered with SAFE without previous approval. The new rules also simplify procedures for reinvesting profits locally, for purchasing additional equity in Chinese companies and for providing offshore FX loans to affiliated companies. The new rules were aimed at boosting confidence among foreign investors after data from the Ministry of Commerce (MOFCOM) showed a drop in foreign direct investment inflows over the first 10 months (Figure 6).
With regard to global merger control, the Ministry of Commerce approved several transactions in Q4, including Nestle’s acquisition of Pfizer’s baby food business and Eaton Corporation’s purchase of Cooper Industries. In December, Switzerland-based commodity trader Glencore received approval from the Ministry of Commerce to acquire Canadian grain trader Viterra. The other large Glencore deal, its merger with Xstrata, is still awaiting regulatory approval in China and elsewhere. MOFCOM’s Anti-Monopoly Bureau also vowed to further increase transparency by publishing quarterly updates on the cases it has cleared. A summary of transactions since 2008 can be found here.
Deals currently awaiting regulatory approval suggest that the growth story will continue in 2013: A Chinese consortium has agreed to purchase an 80% stake in AIG’s aviation leasing unit International Lease Finance Corp. (ILFC) for $4.2 billion; auto parts maker Wanxiang has won the non-defense business of battery producer A123 Systems in a bankruptcy auction; and BGI Shenzhen is expected to close the purchase of California-based biotech company Complete Genomics for $118 million in Q1 2013 after receiving regulatory approval in the US and China.
The expected acceleration of structural reforms in China, a favorable policy environment for outward investment (see the recently announced expansion of forex lending for overseas investment) and a more robust economic recovery in the US will help to sustain the inflow of Chinese capital.