A sour taste

As one major foreign investor inked a new China deal this month, another was heading for the exit. Disney’s $3.6 billion theme park investment – in partnership with the Shanghai city government – is being greeted as a joint venture blockbuster. But Disney might do well to review the experience of French food giant Danone, which recently closed the book on a bitter dispute with its erstwhile Chinese partner Wahaha.

Although a Swedish arbitration panel seemed to have ruled largely in Danone’s favour 10 days ago, its findings were non-binding.

Besides, Danone had already decided to call a halt to the Wahaha relationship, having agreed to sell its stake back to the Chinese firm for $450 million.

What lessons might be learned?

Why the falling out?

The dispute, which has ricocheted around the courts since 2007, related mostly to accusations made against Zong Qinghou, the founder of beverage maker Wahaha Group.

It was a high-profile confrontation: France’s president Nicolas Sarkozy is said to have made representations to his Chinese counterpart, Hu Jintao in 2007.

Zong (see Who’s Hu, WiC29) started Wahaha in a grocery at a school in Hangzhou in 1987 (Wahaha is supposed to sound like a child’s laugh). In 1996 Danone then bought into a JV with Wahaha, which grew to 39 businesses and Rmb14 billion ($2 billion) of bottled drink and fruit juice sales over the next 10 years. Forbes magazine hailed it as a “showcase” relationship.

But Danone alleged that it then discovered that Zong had set up numerous “mirror” companies to sell products almost identical to those in the Danone-Wahaha deal. Zong countered that there was nothing blocking this in the original agreement, throwing in for good measure that the Danone JV had no claim on the Wahaha trademark either.

So a dispute over control?

The bad feeling stems back to 1998, when Danone bought out a minority share in the JV owned by Peregrine, the failed investment bank. This gave it a 51% controlling stake.

Zong felt blindsided, speculates Dan Harris at China specialist law firm, Harris & Moure, and resolved to strike back.

Harris also says that Western notions of securing effective control through a 51% majority stake don’t always translate well into the Chinese context. Some local partners will see it as little more than a technicality, and assume weighting equivalent to a 50/50 deal. Wider 60/40 or 70/30 splits are more advisable for a partner wishing to crystallise its controlling position.

But it is even more important to take other steps, like securing the right to appoint (or remove) the venture’s operational head.

Another key issue is to ensure control of the company’s seal (or “chop”) from the outset of the JV’s founding. This is often an alien concept to many Western investors, Harris admits. But the person who controls the seal essentially controls the JV’s decision approval process.

And there was a cultural clash too?

Zong managed Wahaha with a “strong man” leadership style that saw him personify the company and its brand. This rubbed up against Danone’s more bureaucratic culture. Zong’s frustration with French caution on expansion plans may have led to the setting up of the shadow distribution structure too.

With his entrepreneurial background, Zong also disliked having to answer to Danone oversight (and to the Swedish arbitration panel too – one of his responses: “Just like me making love to my wife, it’s none of your business”). But Danone relied heavily on Zong to run the JV, giving him de facto management control – regardless of equity share or contractual arrangements.

Danone now admits that for long spells it did not have a single executive based at Wahaha’s Hangzhou headquarters and that it never participated in the joint venture’s day-to-day operations.

Wahaha played the “China card” too?

Once the legal dispute began, Danone tried to take on Zong in a PR war.

This is a battle that few foreign participants are going to win. WiC has written before (in Issue 7) about how Coke’s bid for Huiyuan Juice struggled in the face of patriotic opposition to foreign firms buying Chinese brands. Buyout firm Carlyle Group faced something similar in its bid for control of machinery firm Xugong.

So Zong stoked up national sentiment, telling Sina.com in 2007 that he had warned Danone that “the Chinese have stood up and the era of invasions by foreign armies is long-gone.” The local media has been universally sympathetic (although there are occasional grumblings about Zong’s US Green Card, and the fact that his daughter is apparently an American citizen – neither of which is completely in keeping with his patriotic credentials).

Still, newspapers like the People’s Daily warned against the “hegemonic” ambitions of the French firm.

But wasn’t Danone protected legally?

Li Shanju, writing in the Beijing News last week, was representative in thinking that the dispute had ended in a “personal victory” for Zong. But he also wondered if it came at a cost; the “stigma of non-compliance with contracts and the law.”

It’s true, of course, that foreign firms do not have much of a track record of winning cases in the Chinese courts. But Danone fared poorly when it tried to take its legal efforts on the road too.

In 2007, for instance, it failed in a California filing against members of Zong’s family, which aimed to target their interests in the external ventures.

The major blow came the following year when a Hangzhou court confirmed that Danone had no claim on Wahaha trademarks. It turned out that the state’s trademark office had blocked the transfer of the mark to the new venture at the outset, on the grounds that it originated from a government-owned enterprise, and thus belonged to the state.

The fallback option was an exclusive licensing agreement. But Danone then failed to ensure that the JV had got the licence fully registered (it hadn’t).

So the JV’s ownership of the brand was on weak foundations from the start. Correspondingly Wahaha won the key legal head-to-heads with its French partner.

So, a joint venture disaster?

Not completely, even if it did ultimately sour. Wahaha claims that Danone received over Rmb4 billion in cash dividends (on the Rmb1.4 billion of investment it had made in China over the duration of the relationship).

Not all joint ventures are destined to end up in similar straits, and many foreign firms continue to benefit from working with Chinese partners. AMP, Exxon, LG, GE and BMW have all made the news so far this month with announcements on new joint ventures or the expansion of existing ones. One of the more successful – Caterpillar’s 1994 tie up with state-owned Xuzhou Construction Machinery Group – was also getting coverage in the Financial Times this week for its impressive revenue contribution ($2.5 billion in 2008) to the US firm.

Overall, however, the number of JVs being established on the mainland fell annually between 2000 and 2008. One factor is that it has become easier for companies to establish wholly-owned foreign enterprises (although there are sectors like media, mining, energy, telecoms and financial services where a local partner must still be involved).

Dan Harris says he always advises clients to go down the wholly-owned route if they can.

But he thinks too that the tighter financial conditions of the last 18 months may have seen more firms switch back to a joint venture approach, because of the lower upfront investment costs.

That ups the ante on getting the JV structure right from the start. It also means planning to avoid the common mistakes, like a divergence of goals, disagreements on how to expand the business, and disputes over management style and responsibilities. The Danone-Wahaha venture seems to fit the bill on all of these criteria.

An additional question is whether Chinese businesses still need foreign partners in the same way that they did 15 years ago. Although there are instances in which technological know-how might still get a foreign firm through the door – in GE’s announced deal with AVIC this month the US firm brings an expertise in avionics – many of the other skill-sets have long been learned. Financing is more plentiful too.

Of course, partnering up to gain access to international markets is a different issue. But local firms may be less convinced of the need to find a foreign partner to help grow their businesses at home.

Perhaps Wahaha came to a similar conclusion.

---

© ChinTell Ltd. All rights reserved.

Sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.