Planet China

August 15, 2011

Planet China

It was a very small article in the Financial Times that triggered my interest today, located in the News digest section of the paper. It announced the acquisition of Australia-based Manassen Foods by China's state-owned Bright Food Group (Bright Food). Bright is making a $516 million investment to gain 75% ownership of the company. According to the Financial Times, Bright Food has attempted previous expansion, but failed to close bids for other players including the French company Yoplait.

Yet, today's post is not about Bright Food, Manassen, or Yoplait.

I am intrigued by China's continued ambition to dominate and build emerging allies. I am fascinated by the country's prowess and the hype. It was time to take stock, particularly after Mark Blyth outlined a noteworthy scenario for China's global dominance, accelerated by the financial crisis in the U.S. and Europe. Though he referred to his own scenario as far-fetched, I think it deserves attention. [An absolute must-read: China's European Shopping Spree, Foreign Affairs, July 25, 2011.] The following is not meant to imply negative intentions by China or give into some kind of conspiracy theory. Nonetheless, I better  inquire whether my son's preschool offers Chinese language classes…

Over the last 12 to 24 months, many excellent features have been published on China and the country's drive often lovingly described as wanting to "take over the world" (see links of select articles at the end of this post). China currently holds an estimated 8% stake in U.S. debt and is the largest single foreign investor in U.S. treasury securities. It is estimated that China accounted for 10.4% of Africa's total trade in 2010. China is pouring investments into Brazil, Australia, Canada, Pakistan, India, Iran, as well as many other countries. China holds over $3 trillion in currency reserves, reportedly the world's largest.

China's acquisitions have focused largely on natural resources and commodities such as iron ore, oil, zinc, oil, aluminum, oil, minerals, oil and other resources. Oh yes, and did I mention oil? There was a short period of investments in the Western financial services space in 2007, but China has since seemingly pulled out of this (unstable) sector. It's only paper after all. China has invested billions of dollars in oil, minerals, and other resources in Africa and the investments are welcome under the premise of building Africa's infrastructure.

China has been building a network of interesting allies across the globe and found willing partners in Africa, as well as Brazil and Russia. Combined, the latter two countries borrowed roughly $35 billion from China in return for a seemingly endless supply of oil. In an article dating back to 2009 in The Independent, the managing director of an investment bank was quoted as stating "China could [have bought] every bank in Europe [with the deal…] but it chose not to." The question that should have been asked here, but was not, is "Why not?" China does not want debt! It's only paper. China wants assets, resources, commodities. What better way to claim economic dominance than by controlling the majority of global resources and commodities. When financial and technology markets fail, it’s those natural resources – the basics – that will determine economic strength.

Analysts have evaluated China's motives many times over and not a day goes by China's actions are not reported on in the news. But typically, analyses end with the conclusion that there is "no real evidence of predatory behaviour by Chinese investors in the global resources sector." What kind of evidence are analysts looking for?

In early 2010, some journalists already noted "now China has more worldwide clout, and public opinion at home has taken on a combative (and sometimes downright jingoistic) tone. […] Beijing has begun to push harder to reshape international systems to make them more China-friendly. […] Already one can see worrisome changes in the way China deals with foreign firms. [The principle behind] the country's overall drive to move ahead of the rest of the world: to make sure it gets a real say in setting its future rules and standards. […] The idea that as China got rich it would simply become more like America, or at least more sympathetic to the U.S. agenda, is turning out to be wrong." This was in March 2010!

China's most recent shopping spree appears to be a bit more "diversified" i.e., automobile, food industry [Intentional diversion?], but resources/commodities continue to be the core of China's acquisition strategy. (Recall July acquisition of Canada-based oil sands producer OPTI).

As developed economies crumble, the timing appears to be once again right for China to take its assets and expand its global stake. A 2010 article in the Economist accurately framed the concerns of developed markets in the following way: "Chinese firms are going global for the usual reasons: to acquire raw materials, get technical know-how, and gain access to foreign markets. But they are under the guidance of a state that many countries consider a strategic competitor, not an ally." When China made some heavy investments in commodities in Australia in 2009, nay-sayers raised concerns about "leaving Australian sources of wealth in foreign hands. The Australian government would never be allowed to buy a mine in China, so why would we allow the Chinese government to buy and control a strategic asset in our country?"

It would probably take months to draft an accurate timeline of Chinese acquisitions between 2005 through 2011, but it would highlight a clear focus on commodities, with some (possibly intentional) distractions by making bids and acquisitions for other foreign companies. According to an Economist article, governments are creating greater hurdles for China to gain control over their resources and the author states "China is miles away from posing […] a threat. […]Even in natural resources, where it has been most active in dealmaking, it is not close to controlling enough supply to rig the market for most commodities." Hm,….

The much acclaimed article by Mark Blyth, starts by hypothesizing about a potential acquisition – by China – of as much as 50% of Greece's debt, after Chinese Premier Wen Jiabao commented on how a "stable eurozone is vital to China and that China is Europe's friend." An estimated quarter of all of China's foreign currency reserves are in euro-denominated assets. Blyth goes on to lead the reader through an economic scenario that would allow China to purchase key aerospace, technology, and defense-related assets. Assets that would allow China to obtain global dominance, largely due to a lack of remaining financial options for the United States and Europe and are seeking alternative revenue sources.

Blyth closes his feature by stating that the scenario may be far-fetched, but possible. I would like to close my feature by saying, no ill-will intended, but "Welcome to Planet China."

Worthy reads:

China's European Shopping Spree, Mark Blyth, Foreign Affairs, July 2011.

China buys up the world, The Economist, November 2010.

The Queensway syndicate and the African trade, The Economist, August 2011.

It's China's World We're Just Living in it, Rana Foroohar, The Daily Beast, March 2010.

China's shopping spree, The Independent, March 2009.

China's control over world resources?, Peter Drysdale, China, Development, Investment, September 2010.

Image Credit: Modification to image obtained from www.kenmusgrave.com/planet.jpg.

Brazil: Hot or Too Hot? That is the Question.

August 13, 2011

Brazil: Hot or Too Hot? That is the Question.

[Maybe, I should be writing about Google and the launch of social games a couple of days ago in a direct move against Facebook. It has been debated and discussed in all the key newspapers along with Facebook's response, etc. But I don't want to and so I won't.]

Instead, I found much more intriguing food for thought and that was an article in the New York Times entitled "Foreigners Following Money to Booming Brazil, Land of the $35 Martini". [Besides the fact that I would enjoy a Martini right now…] The "BRIC" investment that is referenced in everyone's Annual Report and/or quarterly earnings call these days, is what let me to think about this article twice. I was also recently engaged in a market entry project for a client specifically looking at Brazil, so I figured I would ponder this one for a minute.

To take stock: Brazil experienced GDP growth of +7.5% in 2010 and is expected to grow an incremental +4% in 2011. The unemployment rate is the lowest it has ever been, reported at 6.2% in June 2011. The currency appears stronger than ever, and interestingly, Brazil is "now one of the biggest buyers of U.S. Treasury securities" aka, a significant stakeholder in this country's economy.

The economy is booming, expatriates are drawn to partake. Simon Romero's NYT article highlights that work authorizations for foreigners increased +30% in 2010, not shocking, considering the national U.S. unemployment rate and penetrating news of layoffs [see Job Cuts in the U.S. or "The Large Emigration"]. But, while there may be professional opportunities for individuals, is it yet a safe investment for foreign companies? 

Under the most recent leadership and the current government, Brazil seems eager to cement its strength in the global economy. It still ranks #6 behind Britain, but is reportedly on course to claim the title of 5th largest economy no later than 2026 (see Economist: Measuring Brazil's Economy, Statistics and Lies). Sounds appealing for investment, doesn't it?

Inflation has become a big problem, hence the $35 Martini reference. Infrastructure remains underdeveloped, labor laws favor local players, the educational system is still "behind". In many cases the remote undeveloped rural areas demand collaboration with local distributors. There seems to be little support for innovation and R&D. The economy is largely export driven, but the strong currency has made exports more challenging and hurt the local manufacturing businesses. These days, China is Brazil's largest trade partner. China surpassed the U.S. in relevance to Brazil in 2009; an interesting trade alliance between the two developing economies to say the least. Approximately 80% of the exports to China are petroleum, soy, and iron ore, which has Brazil reportedly somewhat concerned over a (de-)industrialization and in most recent trade negotiations with China, China appeared willing to consider "other products" for import as well.

Current concerns are that the economy is getting too hot. Already, June 2011 data indicates that industrial output is declining and the economy is slowing down even earlier and faster than initially expected. Experts also raised concerns about Brazil's stability during this new global financial crisis given its heavy dependence on external financing. Good thing, they have strong ties to China, which is still growing as an economy (+10.3% in FY:10).

Given the Olympics will be held in Rio in 2016 and the World Cup in 2014 [Go Germany!], money has to flow and will flow into continued development of the region. The question is [when] will the bubble burst? I recall that one of our project conclusions at the time was that investments in our particular sector remained risky. The currency may be strong right now, but I consider it far from stable. The devaluation of the currency occurred not that long ago. Notable is that those foreign companies that stayed put during the crisis at the time, benefited greatly from their commitment, both in terms of brand/image, as well as market share. In the sector that I was investigating, those players continued to hold over 50% market share well past the reentry of well-established global, competitive products once the crisis was over. There is something to be said about "sticking it out" in the hope of improving positioning once the crisis is resolved. It is all about the value of short-term ROIs versus long-term ROIs.

Finally, let's not forget corruption. Connections with key stakeholders are absolutely critical independent of which industry you are competing in.

Conclusion:  The promise of returns is high in this emerging economy, but as far as I am concerned, so are the risks to this day. The currency could depreciate any minute, economic growth could come to a screeching halt. Government is driving economic growth, but with interesting approaches and cautious tactics, carefully evaluating who gets to purchase land, and limiting volume imports of certain products to maintain local product dominance.

There are plenty of conflicting opinions on what the short-term future may hold for Brazil. While returns appear promising, risks remain high. It's a puzzle for anyone company that is interested, and by rights… all should be. There is no global company [or wanna be] that can afford to ignore or turn its back to Brazil at this stage, it's simply about "managing expectations"...

Let's just hope that this little piggy did not build its house out of straw and that the big bad wolf won't blow it in…