Economy, Talking Point

Problems going overseas

China Inc’s ambitious plans to ‘go global’ are experiencing setbacks

Problems going overseas

They may need a stiffer drink after news of Sinosteel’s aborted multi-billion dollar investment

At a cost of $7.2 billion, San Francisco’s new Bay Bridge will be one of the most expensive bridges ever built. But California officials say it would have been even more costly had it not been built by the Chinese.

“They’ve produced a pretty impressive bridge for us,” Tony Anziano of the California Department of Transportation told the New York Times. He reckons building the bridge in China (step forward, Shanghai Zhenhua Heavy Industries) and then shipping it 6,500 miles to Oakland saved Californian taxpayers about $400 million.

Readers of the New York Times may have more mixed emotions – the story, after all, showcases yet another instance of a Chinese company besting American firms.

Readers of The Times of London may have a similar feeling. Wen Jiabao this week visited the MG car plant in England that’s now owned by SAIC, a Shanghai-based auto firm. Tellingly, it was not David Cameron who arrived to announce the launch of MG’s first new model in 15 years, but the Chinese prime minister. The MG6, Wen explained, symbolised MG’s achievements since the Chinese took over in 2007.

Framing it as a win-win, Wen declared: “The model can be summed up as designed in the UK, manufactured in China and assembled in the UK, thereby making the most of China’s capital and markets, as well as the UK’s technology and managerial expertise.”

And in a further example of Beijing’s foreign forays, Wen was also in Budapest this week. There, he signed a strategic accord that promised China would build a 60,000 metric tonne citric acid factory, as well as a new logistics hub for telecoms equipment maker Huawei. Bloomberg reports it’s all part of efforts to grow Chinese trade with Hungary from $8.7 billion last year to $20 billion in 2015.

So does this all amount to a globe-trotting tale of success for Chinese businesses?

Not quite. In fact, an increasing number of overseas deals are going wrong. Less to Wen’s liking are the stories of loss-making foreign acquisitions, cancelled contracts and inept management. Some in the local media are even starting to question if the troubled transactions outweigh the successful ones…

Exhibit One: Sinosteel

Last Thursday, Sinosteel announced it was shutting operations at a giant iron ore mine it owns in Australia. The company said its Weld Range mine was losing $100 million per year.

Sinosteel paid A$1.4 billion for the mine in late 2008 – a valuation that the West Australian newspaper described as “top-of-the-cycle”. The plan was to produce 15 million tonnes of ore per year, but to do so the Chinese firm announced it would need to pump a further A$2 billion ($2.1 billion) into the mine.

That investment has now been halted.

Not surprisingly, Sinosteel’s pullback grabbed headlines. WiC has reported (on numerous occasions) on China’s desire to secure more of its own iron ore resources – a strategy designed to diversify its supplies away from BHP Billiton, Rio Tinto and Vale.

So you know it is a major setback when a state-owned firm abandons work on a mine of this scale.

The problems are not entirely Sinosteel’s. It blames a consortium (comprising Mitsubishi and Murchison) that is building a rail line and port network to get the iron ore out of Australia. The so-called Oakajee project was supposed to be completed next year. Project delays and cost overruns now mean that it won’t be ready till 2015.

Until that infrastructure is functional, Sinosteel’s mine looks like it will bleed red ink.

That’s a situation that Sinosteel can ill afford due to cashflow problems it’s facing at home. According to China Business News, the delays to the Oakajee project are not the only reason for Sinosteel to suspend its investment in Weld. It quotes Zhang Lin, an analyst with Lami Research who says the pullback in Australia also relates to Sinosteel’s financial losses in China.

Last month, Sinosteel’s former longtime boss Huang Tianwen was removed – at the behest of controlling shareholder Sasac (for more on this organisation, see WiC45). The state asset manager was angered by mismanagement at the steel trading firm, which had led to bad debts of Rmb8.08 billion. The National Audit Office found that Sinosteel had been offering credit to privately-owned steel mills to distribute their products (see WiC74). This turned into what CBN calls a “financial blackhole”, when steelmaker Zhongyu failed to make good on its sales commitments. How all this occurred is an evolving scandal, with fuller answers yet to surface.

Meanwhile Sasac now views Sinosteel as one of the most problematic companies in its portfolio.

Other problems in Oz?

Yes, Sinosteel has more to worry about than the Weld. The 21CN Business Herald reports that it has also been in fractious negotiations with Rio Tinto over the Channar iron ore mine in Western Australia.

The two firms have operated the mine as a joint-venture since 1987 under a long term contract. That is about to expire and, in negotiating the new contract, Rio wants better terms at Sinosteel’s expense.

The newspaper reports that Rio has “unilaterally proposed” that a condition for renewing is a rise in the resource fee and service charge it receives to $10 per tonne. Sinosteel had agreed to pay Rio $3-5 per tonne in 2006, but calculates the new rate will wipe out any profit it earns from the mine. It likewise worries that locking in this rate on a new 20-year deal could prove fatal if the currently tight supply situation of iron ore reverses, and prices start to fall in the coming five to 10 years.

21CN Business Herald quoted an insider who was privy to the negotiations as saying: “Rio Tinto intends to increase the price. For Sinosteel, it either accepts it or quits.”

Channar, with an output of 12.5 million tonnes a year, is an important source of profits for Fortune 500 company Sinosteel. It was also one of China’s earliest and most successful overseas resources projects. Sinosteel’s 40% stake has seen it earn about $100 million in annual profits in recent years – making it a cash cow for the company, and the most profitable part of the group.

Other problems abroad?

A couple of other well-publicised debacles also point to situations in which Chinese firms have got their foreign business plans wrong.

Late last year, China Railway Construction Corporation (CRCC) announced it had lost Rmb4.1 billion building an 18km light-rail project in Saudi Arabia. The causes were numerous: after signing the contract the client increased the planned capacity, changed other instructions and delayed land purchases, reports Bloomberg. CRCC was also forced to throw in extra resources to make sure that the project was completed on time.

In an announcement, CRCC said the fundamental problem was that “there was only a conceptual design at the signing,” with the owner adding new requirements subsequently, thus bumping up the cost.

In another example of flawed tendering, the Financial Times reported that “a high profile attempt by China to break into the European transport infrastructure market has turned into a fiasco after Poland cancelled a controversial highway contract with a Chinese company midway through construction.”

China Overseas Engineering was awarded the contract to build a 50km road between Warsaw and Germany in 2009. At the time, competitors complained its bid was ridiculously low (half that of rival tenders) and sure enough the Chinese firm got into financial difficulties and halted work on the road in May. The Polish government is now suing it for $265 million in compensation, reports the FT.

On a steep learning curve?

China Business Times laments that state-owned enterprises have suffered “one after another investment losses overseas”. It thinks that it’s partly a mentality issue: rich men like trophy wives, big state firms like trophy transactions. That often means the economics of deals don’t add up.

According to the Nanfang Daily, Sasac’s leadership has recently scolded the managers of state firms for precisely this shortcoming. In internal meetings it has criticised them for blindly investing overseas so as “to create political achievements”, “create their own empires”, and (this one may be a bit lost in translation) “to show great determination with unclear understanding”. All of this causes losses.

But the Guangzhou Daily says that the scale of Chinese investment overseas is rising regardless. It points out that Chinese foreign direct investment increased 36% last year to $59 billion and that the country’s firms set up or invested in 15,000 enterprises abroad. But it also notes that the experience is frequently an unhappy one. In the most recent data it could find, the newspaper says that 68 state-owned firms lost a combined $11.4 billion from overseas operations in 2008.

Back to Sinosteel

Some Australian commentators believe Sinosteel’s decision to halt activity at the Weld Range mine could be a negotiating tactic. Back in 2007 it had bid with other Chinese groups to get into the Oakajee consortium, and was disappointed to have lost out.

But Oakajee is only viable if Sinosteel marches ahead with its own mine investment – given it will account for a third of the port’s capacity. So it may be that it wants to force Mitsubishi and Murchison to allow Chinese entities to take a stake in the transport project as well.

But whether Sinosteel is indulging in a game of hardball negotiations, or merely nursing its wounded finances, will only become clear in the coming months.

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