TREND #3: Acquisition of Foreign Assets and Key Development Competencies by Chinese Companies

August 15, 2009

by Bill Russo

The forces shaping the third of the Eight Overarching China Automotive Trends That Are Revolutionizing the Auto Industry were addressed in my article entitled The Path to Globalization of China’s Automotive Industry (posted on this blog on May 18, 2009). The principal focus of this piece was to explain the challenges faced by Chinese Original Equipment Manufacturers (OEMs) in their efforts to develop and expand, and how the global financial crisis was presenting China's automotive industry with an unprecedented opportunity to accelerate their industrial development by "inorganically" acquiring the assets of foreign manufacturers.

The highly fragmented nature of the domestic Chinese auto industry presents challenges to the longer-term development of the domestic industry. The fact that that there are over 150 registered manufacturers is an outgrowth of a start-up phase for China’s auto sector. Provincial governments, with the support of the central government, were encouraged to develop industrial bases to create investment opportunities and jobs in order to accelerate China’s economic development. However, the highly fragmented industry that results from this creates enormous inefficiencies in the area of capital investment. This fragmentation also makes it very difficult to focus and allocate resources to the development of critical technologies related to safety and fuel economy. This is an area of particular weakness for Chinese OEMs who have relied on their foreign partners to lead the development of key component technologies.

While the China policy makers have prioritized the need for strengthening its industry via consolidation of the domestic players, the simple fact is that the global financial crisis has created a need to rethink the global allocation of automotive assets. As noted in the previous article in this series, many non-Chinese manufacturers are shifting their focus from their domestic markets to the growth markets like China. However, many are in a position to dispose of assets that are no longer critical to the business going forward. The historic restructuring underway in the global automotive industry will undoubtedly result in a redistribution or liquidation of automotive OEM assets. Whole companies, brands with installed dealer networks, product platforms and associated component technologies are all available for a mere fraction of the investment needed to create these assets. It stands to reason that such an "inorganic" approach to development could significantly shorten the time frame for going global.

While Chinese firms have learned very quickly how to assemble cars and develop supply chains, they are very inexperienced at the vehicle development and synthesis process. An automobile is a complex engineered system requiring advanced technology and know-how in order to test and validate the achievement of benchmark targets in the areas of performance, fuel economy, safety and quality. It is in this area that Chinese firms are weakest. Chinese vehicles, while improving rapidly, are still not up to the world-class standards required to compete in the mature markets of the world. As a result, numerous Chinese firms are seeking opportunities to acquire foreign assets for a fraction of the cost of their original development. Many noteworthy examples include the potential sale of Ford's Volvo brand, GM's Opel and Hummer brands, and Chrysler's discontinued products and powertrains. While China's policy makers have urged caution in bids with the Big 3, they remain supportive of deals which bring critical technologies to the domestic industry. Such a deal was Geely's $58M acquisition of Australian transmission manufacturer Drivetrain Systems International.

By acquiring the assets of a distressed but well-known international manufacturer, Chinese auto companies are hoping to significantly accelerate their development and expansion plans. Chinese companies with global ambitions who are considering a major acquisition would do well to study the lessons learned from those who have tried to create a cross-border alliance. While it may be relatively easy to negotiate a deal to acquire such assets, there is enormous risk and the vast majority of cross-border acquisitions ultimately fail. The most recent case of SAIC’s acquisition of Ssangyong ultimately failed because the interests of both parties were not aligned. SAIC was: unable to secure concessions from Ssangyong’s labor union to lower costs, unwilling to inject billons of RMB incremental capital to fund the business, and unable to manage the loss of leadership at Ssangyong. Ultimately, SAIC decided to dissolve the deal. Sadly, cross-border acquisitions are rarely successful. The 9-year marriage of Daimler-Benz and Chrysler dissolved in 2007 largely driven by an incompatibility of products, brands, business models and management structures.

Even the more successful partnerships have had mixed results: by all measures, the Ford alliance with Mazda has been a very good example of a successful cross-border alliance. Ford benefited from access to Mazda’s fuel-efficient technologies and platforms, and both sides benefited from a shared global production and distribution footprint. However, Ford recently made the decision to liquidate its shares in Mazda in order to raise much-needed cash. Lenovo’s acquisition of IBM’s PC division is largely viewed as a success because of the compatible interests of both sides, but had to overcome challenges from the US authorities fearful of national security risks. It remains to be seen if the merged company will be a stronger competitor in a highly competitive electronics industry.

Clearly there is a need, on the part of the European and North American OEMs and suppliers, to find additional sources of funding in order to keep their operations going, while the rapid growth of China auto market in recent years has provided Chinese companies more capacity to invest. The shifting of economic and industrial power to the east will require a corresponding redistribution of the asset base of the industry. However, there are real challenges in finding suitable partners. Partners in the west are not necessarily going be compatible, both from a technological and from a cultural standpoint with a Chinese suitor. A Chinese company investing in a western company or its assets must understand how to align the interests of the partner in the transaction with their own, or they will likely end up owning assets without the technological development know-how that went into creating those assets. It all should start with a comprehensive risk-assessment and plan for post-acquisition integration. I described the key areas of risk mitigation in a recent interview entitled "China companies shouldn't jump too early or take on too much in acquiring foreign suppliers".

While there is every reason to doubt that Chinese domestic firms are ready to take on a foreign acquisition, it is happening. Those who dare take on such acquisitions are also wise to learn the lessons from others who have tried – and often failed – to use an acquisition to accelerate the process.

In the next posting in this series, I will describe "China's Investment in New Energy Vehicles and Associated Infrastructure".

Click here to read this article on GLG News
Click here to view article published in Gasgoo.com China Automotive News


Chery revives IPO plans for expansion, perception boost

China Economic Review, August 2, 2009

In mid-July, Anhui-based Chery Automobile announced it would resume plans for a domestic stock listing it had shelved in March 2008. The company didn't give a timeline for the listing or say how much it expects to raise, but analysts said it's not surprising Chery is talking listing now. Markets are rallying – contributing to Beijing’s decision to lift the freeze on initial public offerings in late June – and Chery would be wise to seize the moment.

“It needs to raise capital if it is going to expand both domestically and internationally,” said Bill Russo, president of Synergistics Limited, a Beijing-based business consultancy with a focus on the auto industry.

Russo said Chery's plans for expansion are ambitious and include entering into mature markets such as North America, Europe and Australia. The company has also expanded from one to four brands – Chery, Karry, Riich, and Rely – to target businesses and higher-end consumers.

Chery currently has the capacity it needs to fulfill domestic demand. An IPO, however, would give the company the funding it needs to finance its brand roll-out and build up technical and production capacity. More funding would also help Chery build up dealer networks internationally to compete against established international players in their home markets.

But an IPO would be about more than just additional capital. It would also help Chery to change from a locally government-owned company into a publicly listed company, said John Zeng, senior market analyst for Asia automotive research with IHS Global Insight.

“Their financial information will be more transparent and their corporate governance structure will be more visible. Government officials won’t be able to put as much influence on the company,” Zeng said.

He cautions, however, that the degree of change depends on what percentage of Chery is publicly tradable. Synergistics’ Russo said he expected about 20% of the company to be listed, noting that while Chery would remain a state-owned firm, a listing would help with public perception.

“A Chinese company that doesn’t list has a perception of lack of transparency as to its true financial status,” said Russo. “So the process of listing will go a long way in alleviating those fears.”

While having little effect on the company’s operations, analysts say a listing would be more than cosmetic. While Chery is not the first Chinese automaker to pursue a listing, the company’s size and high profile mean that it could nonetheless send a strong signal to the international community.

“It’s another sign that the Chinese car manufacturers are taking steps to become global players, and a warning for the international players that the Chinese are there and wanting to get into the international market also,” said Klaus Paur, director of automotive research for North Asia, Greater China and Korea at TNS.

Perceptions are worth little without the products to back them up. Paur says Chery does not have the high-quality products needed to compete against international brands selling in China. That could cause problems for the development of the company’s luxury and business brands.

“If you’re not able to deliver the products that go along with your brand ambition then you destroy your brand image,” Paur said. Confidence from the market and financial community of Chery’s ability to deliver on its brand promises would determine its success or failure on the financial markets, he said.

The risks are unlikely to deter the company from pursuing its IPO, however.

“[Chery] had wanted to do this for quite some time, but with the meltdown last year they didn’t press the button,” said Synergistics’ Russo. “Now seems like an opportune time with the markets starting to rebound.”