The rise and fall of the world’s preeminent ‘great’ power is an event witnessed perhaps just once in a lifetime.
For example, those who came of age in the middle of the last century lived through the last hurrah of the British Empire and the surrender of its primacy at sea to America.
This thought struck the editor of WiC last weekend on reading an article in The Spectator about Britain’s Royal Navy. It pointed out that in 1945 the UK had almost 900 warships. The magazine estimated that today the figure is closer to 35, a colossal downsizing for a fleet that once ‘ruled the waves’.
Warships have long been a proxy for great power ambitions, and it’s no surprise that the growing Chinese navy gets plenty of media attention – in particular its aircraft carrier programme. However, there are subtler signs of how a country may be edging towards top dog status. Moves to dominate strategic industries (i.e. microchips) or secure access to natural resources are often part of the transition process too.
In the first five weeks of 2016 there have been renewed signs of China’s growing ambitions via a series of audacious M&A deals. In this brief timeframe Chinese firms – mostly state-linked – have announced acquisitions in Europe and America worth $61.7 billion (not far off the $67 billion spent on overseas purchases in the entirety of last year).
The most eye-catching deal – ChemChina’s $43 billion acquisition of Switzerland’s Syngenta – will also rank as the largest international M&A transaction yet by a Chinese firm (should it go through). And it’s a deal unusually loaded with symbolism: throughout history one of the primary concerns of great powers has been food security, and that’s the stated rationale here.
A long time in the making?
WiC has written before about the highly acquisitive ChemChina (see WiC275), which last year spent $7.8 billion to buy iconic Italian tyre brand Pirelli. The forerunner of ChemChina was founded in 1984 by Ren Jianxin, an entrepreneurial ex-bureaucrat, who grew his business empire with more than 100 acquisitions – mostly turning around failing state-owned chemical factories.
One of the most significant of these deals came in 2004 when Bluestar – the firm he’d founded two decades before – was merged with the Ministry of Chemical Industries to create what is now ChemChina.
According to Reuters, Ren was looking at Syngenta even as his 2004 deal was being inked (not to mention other overseas targets such as Dow Chemical).
A veteran ChemChina staff member told Reuters: “We’ve been following Syngenta from shortly after the group was founded, scouting for cooperation projects and joint venture opportunities. To ChemChina, Syngenta and Dow were goddesses that we hoped one day we could win.”
ChemChina’s core businesses are concentrated in petrochemicals, traditional chemicals and advanced materials, but in more recent years it has been encouraged by changes in government policy to grow in pesticides and agribusinesses.
Over the past 12 months that put Syngenta squarely back in the Chinese firm’s sights, as the Swiss giant is a leader in these areas, particularly in seed production.
Nor was an approach by Ren as fanciful as Syngenta executives might have considered it in 2004.
The opportunity emerged when Syngenta’s US rival Monsanto launched a hostile takeover attempt last year. Syngenta’s board and management rejected the part-stock, part-cash offer, and instead opened up a dialogue with the Chinese firm, knowing there was far less overlap in their businesses and greater growth opportunties.
As one of ChemChina’s advisers told Reuters: “When it became clear that Syngenta was under attack from Monsanto, ChemChina called them up and asked if they should play the white knight.”
The deal that was struck last week is the product of these talks, with ChemChina claiming to offer Syngenta better terms – both financially and strategically.
ChemChina has agreed that Syngenta will retain its separate identity and its headquarters in Basel. It has also promised there will be no job losses. Both sides are playing up the potential advantages, as unlike Monsanto, ChemChina has a much less developed seed business.
What it can offer is the power to distribute Syngenta’s patented seeds more effectively in China. As Syngenta chairman Michel Demaré remarked when the deal was announced: “Everyone benefits. Syngenta remains Syngenta. The Chinese are naturally concerned about the food security of 1.4 billion people. This is a good problem for our company to focus on.”
China Business News is enthusiastic too. Syngenta, it notes, is “the world’s largest pesticide company and third largest seed company, and has an outstanding ability to create value, as well as strong profitability”.
For Syngenta shareholders the financial terms are superior to those offered by Monsanto last August. That’s because ChemChina is offering to buy the company outright with cash (Monsanto’s $46 billion bid offered less financial certainty because it was in stock as well as cash). Hence the Lex column in the Financial Times thought that ChemChina’s terms were better for Syngenta shareholders, stating that the bid was “more liquid” and at a rich valuation of 26 times the Swiss firm’s profits.
How will it be financed?
According to Reuters, ChemChina’s advisers China Citic Bank International and HSBC have arranged two separate loans to cover the cost of the deal.
Chinese state sector banks look likely to finance the $30 billion loan Citic Bank is arranging. And since the unlisted ChemChina is supporting a national policy objective (i.e. food security), this loan is being viewed by the banks as akin to government-guaranteed lending.
A separate $13 billion loan will be taken on by Syngenta as non-recourse debt, arranged by HSBC. Reuters says the size of this loan has been capped because “ChemChina wants Syngenta to keep its investment grade rating”.
Buyers from other countries might have struggled to assemble such an enormous (guaranteed) financing package so quickly. China has an ace: its domestic market and the transformational boost it could give to Syngenta’s bottom line.
China’s enormous agricultural market is largely closed to genetically modified (GM) crops. Syngenta is one of the world’s top players in this area, with about 7,000 patented seed varieties. Should Beijing allow the sale of (China-owned) Syngenta’s GM seeds its revenues will skyrocket. That is to say, with the stroke of a pen, the Chinese government could dramatically increase Syngenta’s value.
The Financial Times points out that the well-connected Ren is “betting the ban on GM crops will be relaxed soon” and there are already indications that his wager might work.
China’s State Council has just released its first policy document of the year (traditionally it deals with agriculture) and there were strong hints of a relaxation in GM policy. Speaking at a media briefing at Syngenta’s Basel offices, Ren called for a “cautious rollout of GM technology” adding that the Chinese government now has a “positive position on this point”.
There is a strong underlying logic for Ren’s ‘bet’ too. As WiC has pointed out previously, China has to feed 20% of the world’s population on 10% of the planet’s arable land. Because of old-fashioned farming methods, its agricultural yields are 40% lower than US equivalents. Some of that gap could be closed with higher-yielding GM seeds.
As Demaré told analysts on a recent conference call, ChemChina and the Chinese government both want to guarantee the food supply of nearly 1.4 billion people “and know that only technology can get them there”.
GM technologies – widely used in the US – are banned in many countries on health concerns. The Chinese government has also resisted their introduction in the past. However, if more of the GM technology is Chinese-owned – as it will be if ChemChina takes control of Syngenta’s GM patents – there is reason to think that policymakers could be persuaded to change their minds.
One US executive told the FT that this seems to be the strategy: “China has systematically blocked regulatory approvals of foreign-developed biotech seeds, resulting in billions of dollars in losses for companies like Dow, DuPont, Monsanto and Syngenta. China has said explicitly that foreign companies will not dominate China’s seed market. Now you have a Chinese SOE acquiring one of those foreign companies.”
Which GM seeds might Chinese regulators permit first?
The FT predicts Syngenta’s higher-yielding GM corn will be the initial beneficiary of policy changes “given corn is primarily used for animal feed – as opposed to rice, which would be harder to sell to a wary public”.
ChemChina will certainly be pushing for changes in policy. Its fertiliser and pesticide businesses face headwinds owing to government plans to cap sales by 2020 to limit environmental damage. Flattening revenues for these products could be offset by a push to sell more GM seeds.
Will the takeover go through?
Both companies have said they see none of the security concerns that might give the US government the motive to block the bid.
To forestall a possible challenge, both firms have submitted the deal to the Committee on Foreign Investment in the United States (CFIUS). That body chose not to block Chinese firm Shuanghui’s acquisition of US meat giant Smithfield (see WiC196), which some analysts view as a precedent.
However, China Business News points out that the North American market is Syngenta’s largest, accounting for 33% of sales. Opponents of the takeover might argue that a Chinese-controlled Syngenta could pose risks to US agriculture. Others will advocate that Syngenta’s patents and technology shouldn’t fall into Chinese hands.
And there is a precedent here too. Late last month Dutch electronics firm Philips terminated its agreement to sell its LED components business to a consortium led by China-based venture capital fund GSR. The $2.9 billion deal was agreed last year, only to be scuppered after CFIUS raised objections. The New York Times has reported the purchase was blocked because of “regulatory concerns”, with speculation that Washington’s worry about technology transfer was the key issue.
Reactions to the Syngenta deal?
In the wake of the announcement, the international media has been struggling to better understand ChemChina, with the FT opting to describe it as “octopus-like”. Indeed, while Ren has hinted that ChemChina might list in the future, its current status means financial information about the firm is limited.
Can it afford Syngenta, for instance? That was one of the primary reactions when the deal was first announced. Information about its debts, for example, are disputed. A reporter with CBN claims to have got hold of ChemChina’s third quarter financial statements. This noted it had cash reserves of Rmb29.8 billion ($4.5 billion), debts of Rmb57.7 billion and a gross profit of Rmb1.76 billion between January and September last year.
But the FT has painted a less rosy picture. It reports that ChemChina made a net loss of Rmb889 million in the third quarter, and carries total debt of Rmb156.5 billion, which it calculated was 9.5 times 2014 earnings before interest, tax, depreciation and amortisation (EBITDA). Typically, companies with debt levels of more than eight times EBITDA are thought to be over-leveraged, the FT says.
Some of the reaction to the deal in China has been unfavourable too, although less because of worries about the financial burden ChemChina is taking on.
Instead, the fear is what might happen to the food chain if restrictions on the sale of GM crops are relaxed. Chen Yiwen, a consultant with the China Disaster Prevention Association, even noted on weibo that in order for ChemChina to make the acquisition viable it must “intensify the harm to the Chinese nation”, going on to scare his followers by comparing the potential for experimentation with GM foods to Japan’s Unit 731, which carried out lethal chemical tests on Chinese civilians during World War Two.
A spate of other acquisitions too?
Chinese firms have been busy in a series of other sectors, including Zoomlion (which has bid $3.3 billion for American construction equipment maker Terex), Cosco (acquiring a port in Athens) and Beijing Enterprises (which is looking to buy the technology knowhow of German waste-to-energy group EEW). Another deal saw Shandong Henyuan grab a Malaysian oil refinery from Shell for $480 million; and Haier has just bought General Electric’s home appliances business in the US. And it isn’t just the state firms that are buying abroad. Wanda has paid $3.3 billion for Hollywood studio Legendary while lesser-known Ningbo Joyson has just bought another American firm, KSS, a maker of car safety parts.
In some cases – as with ChemChina’s bid for Syngenta – there is unquestionably a national policy objective underpinning the move. In others there are the ambitions to go global (Wanda fits that criteria, as does Haier). Some companies, like Zoomlion, are trying to diversify away from their reliance on sales in the Chinese market at a time when activity is slowing. And there is plain opportunism too – some analysts see a desire to ink deals before the renminbi weakens further.
Next step, chips…
As The Economist pointed out in an article last month: “China wants to become a superpower in semiconductors and plans to spend colossal sums to achieve this.” Last year China consumed $145 billion-worth of microchips, with 90% of them imported. The central government has already stated its plans to spend $150 billion to build up a domestic semiconductor industry, which seems likely to be focused on a few national champions.
One is Shanghai’s SMIC, a foundry. Another is Shenzhen’s HiSilicon, a chip designer owned by tech giant Huawei. However, the Economist thinks that most of the financial firepower will be dedicated to Tsinghua Unigroup (see WiC270), a state-controlled firm that it calls “a Chinese challenger to the mighty Intel”.
Tsinghua Unigroup has already bought 25% of Powertech, a Taiwanese firm that packages and tests chips, and it owns the chip design firms Spreadtrum and RDA Microelectronics too. It also spent $2.3 billion on a Hewlett-Packard subsidiary in Hong Kong, and its boss Zhao Weiguo says he intends to fork out $45 billion more on deals over the next five years.
Just as the Syngenta takeover has a security angle (food), there is a national security component to the chipmaking push too: the concern that if China is reliant on foreign chips rather than its own, it leaves itself vulnerable to intelligence breaches and cyber attacks.
Given the sensitivity of the sector, it looks likely to be an area where today’s ‘preeminent great power’ – the Americans – might seek to thwart Chinese M&A efforts. Indeed, when Tsinghua Unigroup was reported to be bidding $23 billion for American DRAM maker Micron last year the bid faltered because of political opposition.
And thus the main restraint on further Chinese dealmaking in the months ahead may be the US presidential election and the fear that candidates will seize on higher-profile takeovers as an excuse to bash Beijing.
That may even explain a little about the flurry of deals in January. The closer we get to the November elections, the more hostile the political environment is likely to become for Chinese acquirers.
Indeed, if Donald Trump were to get the Republican nomination, expect the rhetoric to ratchet up further. “I like making deals, preferably big deals. That’s how I get my kicks,” he wrote in his bestseller The Art of the Deal.
But if the Chinese come calling for American businesses this year, politician Trump may not be quite as keen on such deals.
Keeping Track: Our predictions appear to have panned out. First off, Fairchild Semiconductor dropped a superior $2.5 billion bid from China Resources and Hua Capital to buy the firm outright, opting to go forward with the bid from ON Semiconductor instead. Fairchild’s management said it felt the Chinese bid would be rejected by the Committee on Foreign Investment in the United States (CFIUS). Similarly this week Tsinghua Unigroup pulled its $3.8 billion bid for a major stake in Western Digital, a data storage group, after the investment was flagged for an investigation by US authorities.
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