RSM Resources

For the past decade, China has been a well-publicized target for U.S. venture capitalists, who have invested billions of dollars into that nation’s burgeoning economy. However, experts say that rise is starting to level off as cash-rich Chinese businesses start looking for investments of their own. It’s a shift that could eventually widen the options for midsized U.S. companies needing growth capital.

"You can bet your bottom dollar that the flow of outbound direct investment from China will increase," says Pieter Bottelier, an international economist and China scholar in the advanced international studies school at Johns Hopkins University. "They have the financial resources,a rising need for raw materials, and a long-term need to reach consumer markets in Japan, Europe and North America."

A closer look at the numbers helps illustrate Bottelier’s point. According to the Chinese Ministry of Commerce, overall foreign cash investment in 2006 dropped 4 percent to $69.5 billion. Total U.S. investment was down 6.4 percent, to $2.87 billion. On the other hand, Chinese outbound net investment in other markets increased an average of 36 percent each year from 2002 to 2005, totaling $18 billion during that period. Based on that trend, Trusted Sources, a London-based investment intelligence service, projected that outbound Chinese investment would overtake inflows by 2010.

There’s little argument that China remains one of the world’s fastest-growing economies, but some experts say the cash outflows may slow. After a lengthy period in which foreign investors got a significant tax break for putting cash into Chinese companies, Bottelier says, the Chinese government has passed a bill that will unify taxes on investment capital at 25 percent. That change will generate an 8 percent tax windfall for domestic investors, which is expected to spur an increase in homegrown private equity activity in the near term.

A second — and perhaps more important — reason is "economic nationalism." While years of outside investment have successfully ignited China’s economic boom, they’ve also delivered Western-style influences on culture and commerce. With more than $1 trillion in foreign exchange reserves, including a sizable percentage of that total in U.S. Treasury notes, Chinese leaders have become confident enough in their own resources to begin restricting outside access to certain market opportunities.

For example, foreign investors now face greater barriers on purchasing Chinese real estate or in doing business with local firms the government says have a "famous trademark." The latter was in evidence when the Carlyle Group,a U.S.-based private equity firm, attempted to buy an 85 percent stake in Xugong Construction Machinery. After fierce opposition from several Chinese business leaders, Carlyle was forced to reduce its proposed stake to 50 percent in order to close the deal.

Learning the ropes

When it comes to outside investments, Chinese business and political leaders are playing most of their cards close to home. The nation’s Commerce Ministry reports that 60 percent of Chinese outbound investment last year went to Asia, most notably to companies in Hong Kong, South Korea,Thailand, Cambodia and Japan. Another 23 percent went to Latin America and Africa, mainly in the form of investments to secure energy products and raw materials for manufacturing. Conversely, North American investments were on a much smaller scale, at just 6.7 percent of the overall outbound cash flow.

To date, Bottelier says, the most notable Chinese acquisition in the United States is Lenovo Group’s$1.75 billion purchase of IBM’s personal computing business. But that success — as well as a failed $1.13 million bid by China’s Haier Group to acquire appliance manufacturer Maytag — received scant attention compared with the dust-up when China National Offshore Oil (CNOOC) bid a whopping $18.5 billion to buy Unocal. Facing intense public and political pressure over the prospect of foreign ownership of a major energy producer, the California-based oil giant eventually agreed to a purchase by domestic rival Chevron Corp.

"The CNOOC management team mishandled this, largely because they were naive in thinking that a large takeover plan in a sensitive industry would not have political ramifications," Bottelier says. "And that experience, combined with the Dubai ports issue [foreign investors seeking to operate selected U.S. ports], really rankled the Chinese. They don’t believe that the U.S.genuinely welcomes Chinese investment."

While it’s likely that Chinese investors will gradually play more significant roles as suitors or venture capitalists to U.S. companies, experts say business owners should not expect too much, too soon. In the post-9/11 world, the Committee on Foreign Investment in the United States is taking a much closer look at deals proposed by overseas interests — with an especially wary eye cast on China. In a China Business Review article earlier this year, authors David Marchick and Richard Mintz reported findings on a recent survey of 400 U.S. opinion leaders, in which 54 percent said it was "too easy" for foreigners to buy U.S.assets. When the prospective acquirer was identified as Chinese, that number jumped to 69 percent.

In some respects, the prospect of substantial Chinese investment in U.S. businesses and infrastructure generates comparisons to the 1980s, when Japanese investors aggressively pushed into U.S. commerce. But experts note at least two distinct differences. First, Japanese investment was mostly private,while Chinese investment is still largely driven by state-owned companies. And, after more than two decades of studying Western business practices, the Japanese executives were much better versed in the art of the deal.

"The biggest hurdle the Chinese have right now in growing their outbound foreign investment is a lack of knowledge," Bottelier says. "They have very little experience indeveloping and closing Western-style acquisitions, so they are really learning how to do this almost from scratch."