Merlin

China: Patterns of International Investment

Summary

Unocal Corp.'s board of directors voted July 19 to accept a takeover bid from Chevron Corp. This development likely marks an end to the controversial China National Offshore Oil Corp. (CNOOC) effort to acquire Unocal. The failure of CNOOC here, and the July 19 collapse of Haier's bid for Maytag Corp., reveal a good deal about where China's international ventures will succeed and where they will fail.

Analysis

The Unocal Corp. Board of Directors voted July 19 to endorse an improved takeover bid from Chevron Corp., likely ending an effort by the China National Offshore Oil Corp. (CNOOC) to acquire the California-based energy company. Chevron upped its offer to $17 billion and increased the proportion of cash in the deal to 40 percent. This is still lower than the market value of Unocal shares -- and far below CNOOC's bid of $18.5 billion. Political pressure on the Unocal board likely spurred this decision.

As China becomes increasingly aggressive in its attempts to acquire foreign companies, Chinese firms' strengths and weaknesses are becoming more apparent.

One asset sets Chinese firms apart: nearly unlimited amounts of cash.
Businesses such as CNOOC, which are mostly owned by the Chinese government, can rely on the state and state banks for capital. This is especially true when Chinese strategy comes into play. However, these firms lack managerial capacity, technology and brand recognition in U.S. markets. To address these shortcomings, Chinese firms historically have tried to acquire well-functioning units they can add to existing operations with minimum managerial changes. Put another way, Chinese businesses purchase what they need to succeed, and purchase self-operating entities. This differs from U.S.-style takeovers, which often seek to revamp failing companies; American firms purchase what they need to expand, and then shoehorn their new assets into existing business plans.

The Haier Corporation sought distribution markets and brand recognition when it attempted to purchase Maytag. When Whirlpool outbid Haier on July 17, the Chinese company chose not to make a counteroffer. When Haier realized it would take intensive managerial capacity to turn Maytag Corp. around, Haier realized it could not succeed in that effort and removed itself from competition.

In contrast, Lenovo's successful acquisition of IBM's PC division involved $1.7 billion in cash, equity and debt. IBM constituted a functioning company whose brand recognition and market share could provide immediate benefits to a Chinese company. This deal proved politically difficult in the United States, but the national security implications of China acquiring one of America's least-respected computer firms were not large enough to stop the deal.

In the energy sector, all stakes are considerably higher.

CNOOC was able to rely heavily on state banks to make an all-cash bid at $67 per share (with market value at $65 per share) because acquiring reserves and offshore technology are both in the interests of the Chinese government. Unocal represented a functioning unit with offshore technology that China needs. The political backlash of this deal influenced the Unocal board -- and will likely influence Unocal shareholders. Chevron will likely win here because of political influence, as the company could never win a bidding war with CNOOC.
Whether this bid succeeds or fails, it falls into the Chinese patterns of acquisition attempts.

CNOOC and fellow state-sponsored oil company Sinopec attempted to buy into the Kashagan offshore project in Kazakhstan. The pursuit of technology and reserves led the Chinese government to put up considerable cash. Because the Chinese firms could not bring anything to the table other than money, they were left out. The established majors in the Kashagan venture had no interest in sharing their technology with the two Chinese upstarts.

In the future, look for Chinese firms to continue to seek functioning business units with brand recognition and cutting-edge technology. But when the ventures they aspire to require more than simply buckets of cash, look for these bids to fall through.

__________________