China's M&A binge is disappointing

Despite its recent domestic economic slowdown, Corporate China's foreign acquisition binge continues apace. Chinese corporate giants have been relentlessly pursuing Western foreign assets in a shopping frenzy with no signs of abating.

On the surface, Chinese foreign acquisitions appear to be geared toward industries that meet the strategic resource needs of its domestic population — agriculture, food, and energy. The companies leading the charge are typically large, global champions with access to abundant capital, and with the explicit or implicit backing of the state. But this does not make them good deals, and this does not relieve the Chinese acquirers of their profit obligation.

A woman walks past signage displayed outside of the W Hotel Hollywood in Hollywood, California.
Patrick T. Fallon | Bloomberg | Getty Images
A woman walks past signage displayed outside of the W Hotel Hollywood in Hollywood, California.

Between 2004 and 2014, Chinese foreign direct investment into Europe and North America more than tripled. According to the Rhodium Group, Chinese companies completed a record $60 billion worth of outbound global deals in 2015. And, according to my calculations, 2016 is on track to outpace last year's record.

The total value of the investment has not only grown, but individual deals are becoming bigger and bolder. In 2012, state-owned Cnooc bought Canadian oil giant Nexen for about $15 billion. That set the record for the largest Chinese acquisition abroad. The following year, Chinese meat processor WH Group took over Smithfield, America's largest pork producer, for $7 billion. That set the record for the largest Chinese acquisition in the United States. (Smithfield accounted for just over 25 percent of daily hog slaughter according to the National Pork Board's 2014 report, which means China's WH Group owns approximately 1 in 4 pigs raised in the U.S.)

Just last month, the China National Chemical Equipment Corporation (ChemChina) announced plans to acquire Syngenta, a Swiss agricultural giant. If approved, this $47 billion transaction will replace Nexen as the largest Chinese foreign acquisition ever.

"China's WH Group owns approximately 1 in 4 pigs raised in the U.S."

Despite their deep pockets and large appetites, Chinese acquisitions are beginning to disappoint. They face a toxic cocktail of political, economic, and cultural headwinds. And the cracks that now appear in some of the early deals should serve as an early warning sign for future deals.

Certainly a number of deals face political risks and are thwarted before they even have the chance to get off the ground.

Anbang, an upstart insurance company,is attempting to acquire Starwood Hotels and Resorts, after having acquired Strategic Hotels and Resorts for $6.5 billion and the Waldorf Astoria property in New York City for almost $2 billion. Though Starwood accepted a higher bid from Marriott, Anbang has reportedly raised its offer.

Fairchild Semiconductor recently rejected a takeover by a state-backed Chinese company. In spurning the deal, Fairchild suggested that the deal was likely not to receive approval from the Committee on Foreign Investment in the United States (CFIUS) because acquisitions in the semiconductor industry raise substantial national security concerns. But even those that are allowed to go through face political risks after the deal gets done. Cnooc, for example, is currently embroiled in a series of battles with political officials over its hiring and firing practices in Canada.

A number of deals also face economic risks. Chinese acquirers have demonstrated a willingness to be eager buyers, paying exorbitant premiums and taking on too much debt along the way. Cnooc paid a 61 percent premium to acquire Nexen. And Chinese acquirers routinely bid far more on a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization) basis than is prudent. Paying back a high debt load is burdensome and can hamstring managers, leaving them with limited strategic growth options.

Beyond well-documented economic and political risks, there is another obstacle that foreign acquirers often overlook that is especially pronounced in Sino-Western deals — cultural risk. Chinese culture is exceptionally different from Western culture, and Chinese acquirers often have trouble integrating and effectively managing their newly acquired targets.

Cnooc has not been able to generate synergies from Nexen, partly because Canadian employees are struggling to understand the management style of its Chinese parent and partly because Cnooc does not fully understand Nexen's business model. Employees and former employees of Nexen claim that Cnooc has engaged in mass layoffs in an effort to cut costs; however, Cnooc has yet to realize cost savings from those layoffs. It continues to lose money; having lost so much that it is likely to have to write down $5 billion by some estimates.

Unfortunately, Cnooc's experiences in Canada are not the exception. They are increasingly looking like the norm. Chinese companies WH Group, China Investment Corporation, and Three Gorges are experiencing similar problems.

All of the issues that Chinese companies are facing in Western markets harken back to Japan Inc.'s problems in the mid to late 1990's. In both cases, record-breaking foreign acquisitions were viewed as a source of national pride at first. It signaled each country's arrival to the global grown-ups table. But, as we have seen before, pride all too often precedes a fall.

Commentary by Robert Salomon, an associate professor of international management at NYU Stern School of Business and author of "Global Vision: How Companies Can Overcome the Pitfalls of Globalization."

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