As of April 2013, China had about US$3.44 trillion worth of foreign reserves and approximately US$1 trillion in related sovereign wealth funds. These funds are expected to continue growing. But when it comes to how to invest them strategically, China has a problem. Investing in cross-border assets has been done, but the scale of this activity does not match the available financial resources or take advantage of the full potential that the global asset market represents. And significant deal failures have occurred. The question that arises, therefore, is: How can China better manage its global acquisition effort.

Seeking to offer an answer to this question, this article examines Chinese attempts at U.S. asset acquisition from 2004 to 2008. We then explore an apparent link between lacklustre performance and the observed concentration of acquisition efforts within U.S. industries, which has political ramifications. Relying on conceptual frameworks on industry concentration analysis and current data on China’s investment practices, the article (which provides a novel blend of concentration-based industry structure analysis and strategy formulation and refers to an earlier IBJ article by the same author on strategic thinking in times of turbulence) then suggests an acquisition strategy based on industrial concentration levels.

THE CHINESE DILEMMA

China’s investment capital resource base is substantial. And yet, according to The Economist, the nation owns only six per cent of the total global investment in international business, leaving a sizable portion of Chinese funds invested in developed-country government bonds.

The search for global investment opportunities is assigned to specialized agencies whose sole function is identification of opportunities with, presumably, rewarding and strategic investment potential. These agencies include The State Administration of Foreign Exchange (SAFE), The China Investment Corporation ( CIC) and The National Social Security Fund (NSSF), with the roles differing somewhat and mandates evolving with the Chinese economy and politics. As things stand, SAFE focuses on managing China’s foreign exchange reserves, while CIC attends to investment and management of overseas assets and the NSSF invests domestically (although it is moving towards foreign investments in traditional capital market instruments).

These specialized agencies have a common dilemma, the essence of which is an inherent contradiction between generic capital investment requirements (such as high rate of return and manageable investment risk) and the specifics of China as an investor, not to mention the realities of global markets. Keep in mind that China is not just an investor. It is also a formidable global market competitor. Indeed, it seeks strategic supremacy in industries considered strategic to other major economies and whose oligopolistic structures render entry a tall order. China is also a centre of political and economic gravity for many developing economies, especially in the African continent. Last but not least, China is a rising military power with ambitions, visions and challenges.

All of the above create a complex and often blurred decision-making environment for the agencies in charge of the identification of investment opportunities.

CHINA’S FOREIGN ASSET ACQUISITION PERFORMANCE

China’s favourable export balance, its sizable foreign currency reserves and its strong business balance sheets have induced a decade of foreign direct investment (FDI) outflow. Entry into the foreign asset acquisition arena began around 2001 and assumed significance in the late 2000s. Most of this outward FDI seemed to flow first to developing and emerging economies. It then changed direction to more mature economies.

Entry into the U.S. asset market was motivated by a search for businesses with international brands, established distribution channels, valuable intellectual property and proven R&D records. Most China-based acquisitions of U.S. assets, however, have targeted small or middle market businesses. Furthermore, successfully consummated deals have not generally been high-profile transactions. Minority investments, public and private, have accounted for most China FDI in businesses in the United States. Even China’s “greenfield” investments in the United States, which have been actively sought by many states and municipalities, have not been substantial.

Control investments by China in the United States have been few, not to mention small in aggregate dollars (Ross, 2010), although a number of acquisitions aiming at control but not full ownership were unsuccessfully pursued. Three of these attempts by Haier, CNOOC and Huawei warrant examination.

CASE ONE: CNOOC AND UNOCAL

In the face of strong political resistance, an attempt by China’s National Offshore Oil Corp (CNOOC) at acquiring Unocal, an independent U.S. oil and gas operator, was abandoned in 2005. The move was followed by a takeover of Unocal by Chevron. CNOOC’s interest in Unocal was triggered by its strategic Southeast Asian assets and the enhanced regional profile this new asset would have created. According to BusinessWeek, CNOOC would have paid US$18.5 billion if the transaction was consummated. But Washington viewed CNOOC as a Chinese state-run enterprise that could pose a threat to American national interests. Statements made in Congress alluded to the fact that CNOOC’s “Communist government ownership is not consistent with free market principles.”

CASE TWO: HAIER AND MAYTAG

In 2005, Haier Group, China’s largest domestic appliance maker, expressed interest in buying Maytag, an established American appliance brand that suffered from structural cost pressures. Haier was voted China’s most valuable brand name by Forbes in 2004. Maytag could have enhanced the brand, provided a strategically located manufacturing facility and helped battle possible American anti-dumping charges. Haier abandoned the acquisition attempt, however, when Maytag’s rival Whirlpool proposed a US$17-per-share deal. Haier, which had been willing to pay US$14-per-share (about US$ 1.5 billion in total), threw in the towel, expressing concern over the take-over price, the complexities of integrating American and Chinese operations and fear of a political backlash.

CASE THREE: HUAWEI AND 3LEAF

Chinese telecom-equipment maker Huawei Technologies has a history of failed acquisition attempts in the United States. Thanks to national security concerns, it was forced to abandon a 2010 acquisition attempt of 3Leaf Systems, an American server-technology firm. Huawei’s close ties with the Chinese military led the U.S. House of Representatives to call for a complete ban on acquisitions of U.S. assets by the Chinese telecom-equipment maker. Another attempt at U.S. asset acquisition by Huawei took place in 2007, when the Chinese company partnered with American private-equity firm Bain Capital to bid for 3Com, a networking company. 3Com agreed to a proposed US$2.2 billion transaction that would have seen Bain buy 80 per cent of the company. But six months later, Bain retreated due to security concerns raised by U.S. lawmakers, who didn’t want to see a Chinese entity exercising influence over a U.S. networking company.

Why did these acquisitions go wrong? Politics aside, it is the author’s contention that an explanation for the failure of many Chinese acquisition attempts in the United States asset market can be found in the structure of the respective industries and the high or very high measure of concentration they demonstrate—a measure that could constitute a formidable entry barrier.

Concentration connotes the existence of a few major competitors within a given industry. Concentration ratios, or the ratio of sales by the four largest firms in the industry to aggregate industry sales, are one of the adopted measures of the level of competition within the respective industry. Another measure of industry concentration is the Herfindahl index or the sum of the squares of the market shares for each firm within the industry and this is always less than one. Concentration ratios will provide the base of analysis in this article. A low concentration ratio suggests a high level of competition and a high concentration ratio suggests low competition (Scherer, 1996).

A mergers and acquisitions strategy of seeking concentration involves deals that limit the number of competitors to a specific high concentration norm and create, in the process, a forbidding entry barrier. Several industries demonstrate this propensity to concentrate in the United States and beyond (see Table 1), including strategic industries, such as aerospace and semiconductors, and possibly less strategic ones such as household appliances, soft drinks and detergents. Search for concentration is usually motivated by a mix of goals from high returns to market dominance. Views regarding what is considered a high level of concentration vary, but 60 per cent is generally considered high and 80 per cent and beyond is considered extreme.

TABLE 1: U.S. Industry Concentration Ratio for Selected Industries (2007)

INDUSTRY	CONCENTRATION RATIO
Aerospace products and parts	58.1%
Aircraft manufacturing	81.3%
Heavy duty truck manufacturing	65.5%
Household appliances	63.8%
Petroleum refineries	47.1%
Semi-conductors	55.7%
Soft drinks	58.1%
Pharmaceutical preparation manufacturing	34.5%
Soap and detergent manufacturing	67.1%

Source: US Census 2007, American FactFinder

High concentration levels seem to provide a common denominator to the cases highlighted above. In 2007, the concentration level in petroleum refining, household appliances and semi-conductors amounted to 47.1 per cent, 63.8 per cent and 55.7 per cent respectively. This level of concentration could constitute a significant entry barrier.

A high concentration state of an industry is also more likely than not to give rise to a politically motivated rejection or even a ban on the contemplated take over. The political challenges are enhanced by The Committee on Foreign Investment in the United States (CFIUS) and Section 721 of the Defense Production Act of 1950, which grants the United States president authority to prohibit any deal that is deemed a potential threat to national security by evidence that the White House considers credible.

CFIUS was originally created to conduct objective reviews of proposed foreign investments in the United States. But in 2007, Congress passed the Foreign Investment and National Security Act, amending the CFIUS review procedure in a way that offers more avenues for political intervention. The Act altered the CFIUS review process by including enhanced congressional reporting requirements and a 45-day national security investigation whenever a foreign government buyer is involved or a transaction occurs that would result in unmitigated foreign control of critical infrastructure (von Ingersleben and Braden Cox).

While U.S. industry concentration has acted as a deterrent to Chinese acquisitions, this article argues it could equally act as a boon if addressed strategically. There are different “states” of concentration. There is absolute concentration, partial concentration, functional concentration, reversible concentration and dynamic concentration.

• Absolute Concentration: This implies total or majority acquisition of a key concentration player or creation of a new concentration player by acquiring, and merging a number of minor players.

• Partial Concentration: This implies partial acquisition of equity in a key concentration player.

• Functional Concentration: This implies acquisition of a function-based key concentration player (brand, supply chain, communication, research and development, etc .).

• Reversible Concentration: This implies acquisition of a high-concentration operator in a declining industry or subsiding technology.

• Dynamic Concentration: This implies rapid acquisition and divestment of key business units within an industry in search of shifting competitive advantage.

Industries considered strategic by the Chinese government (such as new energy, next generation information technology, biotechnology, advanced equipment and new materials) are attractive targets for U.S. market acquisition. Many of these, of course, may not qualify for an absolute concentration strategy given their strategic importance to the United States.

Chinese acquisition operators could improve their chances by opting for an M&A strategy based on concentration. Indeed, companies in less strategic industries such as food and apparel could be candidates for an absolute concentration acquisition while others such as cigarette and automotive enterprises may be candidates for functional or brand concentration. Computing firms could be candidates for reversible concentration.

The article highlights the close association between China’s less than successful acquisition moves in the United States and high concentration in the targeted industries. To get better results, Chinese investment agencies could strategically look at industry concentration and distinguish between different types of concentration to tailor acquisition moves. Chinese investment agencies may opt for absolute concentration in specific industries, partial concentration in others and even reversible concentration in specific cases.