China cross-border investment

“The Tough Battle to Bring Western Brands to China” the Financial Times

Leave a Comment / August 9, 2020

When John Zhao sealed the £900m takeover of the UK’s PizzaExpress in 2014 he burnished his reputation as a pioneer in China’s private equity industry. Two years later Hony Capital, his buyout firm, ploughed money into WeWork as the New York shared-office provider set its sights on an aggressive expansion in China.


Both deals shared a simple premise: take well-known western brands to China and they will flourish. “We have capital; we have a huge market to give access to,” Mr Zhao said shortly after the capture of PizzaExpress, which set a record for a Chinese buyout deal in the UK.


The acquisition was one of a wave of Chinese private equity investments over the past decade but few firms were as ambitious as Hony in their targets. Spun out of state-backed Legend Holdings in 2003, Hony shot to prominence through a series of restructurings of other state-owned groups. As it grew, so did its appetite for higher-profile, cross-border investments.

However, almost two decades on, Hony’s breezy confidence that China’s increasingly wealthy middle class would be ready-made consumers of all western brands has proved misplaced.


PizzaExpress restaurant openings in China have lagged behind an ambitious goal while local, lowercost competitors have lured customers away. Confidence that middle class would eat up imported names such as PizzaExpress prove misplaced.

This lacklustre start in China, combined with rising costs and a slowing casual dining market in the UK, left PizzaExpress with a £1.1bn debt pile that has set the scene for a restructuring battle between Hony and other bondholders.

After a calamitous 2019 in which WeWork was rescued by Japan’s SoftBank, its biggest backer, the New York-based company has ditched its leasing model in many cities, laid off thousands of staff and struggled with a particularly poor performance in China.

“The ‘can’t-miss’ strategy continues to do just that,” said Peter Fuhrman, chairman and chief executive at Shenzhen-based investment bank China First Capital. “Chinese investors and corporates have mainly fizzled when buying and localising western consumer brands.”

Other Hony investments — including the Beijing-based bike-sharing business Ofo, which collapsed in late 2018 — have soured, causing competitors to rethink importing western brands to China.

Chinese business history is littered with cases of western multinationals making the opposite mistake. UK retailer Marks and Spencer closed its Shanghai stores in 2017 after its combination of clothing and imported food confused local shoppers. US electronics retailer Best Buy retreated from China in 2014 after struggling to compete with cheaper domestic competitors.

But Chinese private equity groups appeared undeterred. They raised $230bn of capital between 2009 and 2014, according to investment bank DC Advisory.

Nanjing-based Sanpower largely flopped with its buyout of high-end retailer House of Fraser in 2014 and its failed attempt to expand the UK retailer across China. Bright Food, the state-owned Chinese group that bought a 60 per cent stake in Weetabix in 2012, failed to make the UK breakfast dish popular in China and eventually had to sell the brand in 2017.

“Four years ago everyone thought [buying foreign brands and bringing them to China] was the best thesis — but a lot of people got burnt,” said Kiki Yang, the partner leading Bain & Co’s Greater China private equity practice. “It’s not easy to bring something with no brand awareness to China. In reality, the success rate is very low.”

People who know Mr Zhao have said he was one of the first serious Chinese investors to have a solid grounding in the way deals were done in the US while also enjoying deep ties to state-owned groups, putting him in an enviable position at the advent of the Chinese private equity industry.

In its early days, that helped Hony become a rare channel connecting investors such as Goldman Sachs and Singapore’s Temasek with lucrative state deals that were otherwise inaccessible to foreign capital.

The PizzaExpress deal was a turning point for Hony and
other investors in the sector.

By 2014, the group had completed several successful cross-border deals, including an investment in Italian concrete producer Cifa. But the takeover of a popular British restaurant chain won instant global attention for Hony and Mr Zhao, who had spent most of the 1990s working at Silicon Valley technology companies such as Vadem and Infolio.

Hony’s investment in PizzaExpress came just as the UK’s casual dining market began to suffer from oversupply. It was also beginning to face stronger competition from local restaurants in China, a sign the UK brand name meant little to many Chinese diners.

PizzaExpress originally intended to open 200 outlets over a five-year period. So far it has launched about a dozen restaurants in the mainland, giving it a total of about 38, according to its website. In its annual results in April, the chain admitted it had “experienced challenges in China as we face intensifying competition from local brands”.

Without the promised growth in China to cushion the decline in the UK market, PizzaExpress has been pushed towards a debt restructuring process, cementing the deal’s position as an emblem of troubled Chinese investments overseas.

 “Every time you say ‘China cross-border’, people think of PizzaExpress,” said one senior Chinese private equity executive. “It’s become a laughing stock — and bad for the reputation of China PE.”

PizzaExpress, Mr Zhao and Hony declined to comment.

As it seeks to resolve PizzaExpress’s problems, WeWork’s near collapse has inflicted further damage on Hony’s reputation. Hony and Legend Holdings led a $430m investment round in WeWork in 2016, and Mr Zhao became a member of WeWork’s board and later a consultant to its China business. SoftBank and Hony led a $500m investment round a year later.

With Mr Zhao acting as a consultant, WeWork expanded aggressively across the country, buying Chinese rival Naked Hub for $480m in cash and stock in 2018. Yet demand for office space fell in 2019, leaving some of its new areas of business virtually empty.

For example, in the western Chinese city of Xi’an, nearly 80 per cent of its desks were vacant, the FT reported in October. In the bustling start-up hub of Shenzhen in southern China, 65 per cent of its 8,000 desks were vacant.

WeWork declined to comment.

The poor performance of the business in China has left investors questioning how one of China’s private equity superstars could lead the group so far off course, according to people familiar with the matter.

“My impression is that Hony is not doing well these days,” said Liu Jing, a professor of accounting and finance at Cheung Kong Graduate School of Business in Beijing. “The economy has shifted to technology and they have lost their edge.”

https://www.ft.com/content/f735c956-15b6-11ea-9ee4-11f260415385


China’s Bold “One Belt One Road” Move To Dramatically Extend Its Power and Commerce in the Indian Ocean — The Financial Times

Leave a Comment / August 11, 2020

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Much has been said — but far less is understood — about the One Belt One Road initiative, the centerpiece of Xi Jinping’s expansive foreign policy. That Mr. Xi has ambitions to extend across Eurasia China’s commercial, political and military power is not in doubt. But, the precise details on OBOR remain just about as unclear now as they did four years ago when the policy was unveiled — which countries are included, how much cash China will invest or lend, where are the first-order priority projects, will any of the trillions of dollars of proposed spending achieve commercial rates of return? Questions multiply. Answers are few.

There is one remote corner of the planet, however, where the full weight of OBOR’s grand strategy and profit-making potential are coming into view. It’s in a small village called Hambantota along the southern fringe of Indian Ocean beachfront in Sri Lanka.

One of China’s largest and most powerful state-owned companies, China Merchants Group, with total assets of $855 billion, is in the final stages of completing the purchase for $1.1 billion of a 99-year lease for a majority stake in a seven-year-old loss-making deep-water container port. It was built for over $1 billion on a turnkey basis by Chinese state-owned contractors. It is owned and operated by the Sri Lankan government’s Port Authority.

I’m just back in China from a rare guided visit inside Hambantota port. Like other bankers and investors, we’ve felt the pinch as much of Chinese outbound investment has been cancelled or throttled back this year. Hambantota, though, is full steam ahead.

Hambantota’s future appears now about as bright as its present is dreary. On the day I visited, there was virtually no activity in the port, save the rhythmic wobbling of a Chinese cargo ship stuck in Hambantota for three weeks. Due to choppy seas and also perhaps inexperienced Sri Lankan port staff, the Chinese ship has been sitting at anchor, unable to unload the huge Chinese-made heavy-duty cranes meant to operate on the quayside.

Though the Chinese ambassador to Sri Lanka has pledged that Hambantota will one day resemble Shanghai, as of today, elephants in the nearby jungle are about as numerous as dockworkers or pedestrians. Tragically, the region was ravaged, and partly depopulated, by the Tsunami of 2004. China Merchants will take over management of the port within the next month or so. There is much to do — as well as undo. The Hambantota port, under Sri Lankan government management, has been a bust, a half-finished commercial Xanadu where few ships now call. The port has lost over $300 million since it opened.

China Merchants’ plan to turn things around will rest on two prongs. Its port operations subsidiary, Hong Kong-listed China Merchants Port Holdings, will take over management of Hambantota. It is the largest port owner and operator in China. Almost 30% of all containers shipped into and out of China are handled in China Merchants’ ports. The ports business earned a profit of $850 million last year. China Merchants has what the Sri Lankan government’s Hambantota port operator could never muster: the operational skill, clout, capital and commercial relationships with shippers inside China and out to attract significant traffic to Hambantota. China’s state-owned shipping lines deliver more containers than those from any other country.

In addition, China Merchants will enlist other large China SOEs to invest and set up shop in an 11 square-kilometer special economic zone abutting the Hambantota port. The SEZ was created at the request of the Chinese government, with the promise of $5 billion of Chinese investment and 100,000 new jobs to follow. China Merchants is now drawing up the master plan.

A who’s who of Chinese SOE national champions are planning to move in, beginning with a huge oil bunkering and refining facility to be operated by Sinopec as well as a large cement factory, and later, Chinese manufacturing and logistics companies. This “Team China” approach – having a group of Chinese SOEs invest and operate alongside one another — is a component of other OBOR projects. But, the scale of what’s planned in Hambantota is shaping up to be far larger. The flag of Chinese state capitalism is being firmly planted on this Sri Lankan beachfront.

Hambantota is only ten to twelve nautical miles from the main Indian Ocean sea lane linking the Suez Canal and the Malacca Straits. Most of China’s exports and imports sail right past. An average of ten large container ships and oil tankers pass by every hour of every day. From the Hambantota port office building, one can see the parade of huge ships dotted across the horizon. Along with transshipping to India and the subcontinent, Hambantota will provide maintenance, oil storage and refueling for shipping companies.

Sri Lanka is the smallest of the four Subcontinental countries, with a population of 20 million compared to a total of 1.7 billion in India, Pakistan and Bangladesh. It has one geographic attribute its neighbors lack — a deep-water coastline close to Indian Ocean shipping lanes and conducive to building large deep-water ports able to handle the world’s largest container ships and supertankers. This should make Sri Lanka the ideal transshipment point for goods and natural resources going into and out of the Subcontinent.

The Port of Singapore is now the region’s main transshipment center. It is three to four times as distant from India’s major ports as Hambantota. Singapore is now the world’s second-busiest port in terms of total shipping tonnage. It transships about a fifth of the world’s shipping containers, as well as half of the world’s annual supply of crude oil.

Even before President Xi first articulated the OBOR policy, Sri Lanka was already seen as a key strategic and commercial beachhead for China’s future trade growth in the 40 countries bordering the Indian Ocean. China and Sri Lanka have had close and friendly diplomatic ties since the early 1950s. Both style themselves democratic socialist republics.

Sri Lanka is the one country in the region that enjoys cordial relations not only with China but also the US, and the three other Subcontinental nations. Sri Lanka’s GPD is $80 billion, less than one-tenth the total assets of China Merchants Group. Sri Lankan per capita GDP and literacy rate are both about double its Subcontinental neighbors. While a hardly a business nirvana, it is often easier to get things done there than elsewhere in region.

The first port was established in Hambantota around 250 AD. It was for centuries, until Chinese emperors sought to prohibit Chinese junks from sailing the open seas, a stopping point for Chinese ships trading with Arabia.

China Merchants has been trying for four years to close the deal there. China Merchants Port Holdings is a powerful presence in Sri Lanka. It already built and operates under a 35-year BOT contract a smaller, highly successful container port in the capital Colombo. It opened in 2013. It’s one of the few large-scale foreign direct investment success stories in Sri Lanka. The future plan is for the China Merchants’ Colombo port to mainly handle cargo for Sri Lanka’s domestic market, while Hambantota will become the main Chinese-operated transshipment hub in the Indian Ocean.

Chinese SOEs are also in the throes of building a port along the Pakistani coast at Gwadar and upgrading the main ports in Kenya. The direction of Beijing’s long-term planning grows clearer with each move. If not exactly a Chinese inner lake, the Indian Ocean will become an area where Chinese shipping and commercial interests will more predominate.

During the Hambantota negotiations, the Sri Lankan government blew hot and cold. The country needs foreign investment and Chinese are lining up to provide it, as well as additional infrastructure grants and loans. Chinese building crews swarm across a dozen high-rise building sites in Colombo. Chinese tourist arrivals are set to overtake India’s. The main section of the unfinished highway linking Colombo and Hambantota was just completed by the Chinese.

The new coalition government that came to power in Sri Lanka in early 2015 has sometimes showed qualms about the scale and pace of Chinese investment. India has already signaled unease with the Chinese plans to take over and enlarge the port in Hambantota. Prior to signing the contract with China Merchants, the Sri Lanka government provided India with assurances the Chinese will be forbidden to use the port for military purposes.

China Merchants will effectively pay off the construction loans granted by the state-owned Export-Import Bank of China to the Sri Lankan government in return for the 99-year operating lease. China Merchants plans to invest at least another $1 billion, but perhaps as much as $3 billion, to complete Hambantota port and turn it into the key Indian Ocean deep-water port for ships plying the route between Suez and East Asia. Rarely if ever in my experience do OBOR projects have the crisp commercial logic of Hambantota. Assuming ships do start to call there, Hambantota should prove quite profitable, as well as a major source of employment and tax revenue for Sri Lanka.

As of now, there is almost no housing and no infrastructure in Hambantota, only the port facility, a largely-empty international airport and a newly-opened Shangri-La hotel and golf course. The airport and port were pet projects of a local Hambantota boy made good, Mahinda Rajapaksa. He was Sri Lanka’s president from 2005 to 2015, when he was voted out of office. In December last year, the port was taken over by a mob of workers loyal to the Rajapaksa. They took several ships hostage before the Sri Lankan navy sailed in to end the chaos.

The port will be able to handle dry cargo, Ro-ro ships transporting trucks and autos, oil tankers as well as the world’s largest 400-meter container ships. Hambantota should lower prices and improve supply chains across the entire region, and so drive enormous growth in trade volumes — assuming power politics don’t intrude.

China and India have prickly relations, most recently feuding over Chinese road-building in the disputed region of Doklam. India has balked at direct participation in OBOR, and complains loudly about its mammoth trade deficit with China, now running about $5 billion a month. Chinese exports to India have quadrupled over the past decade, in spite of India’s extensive tariffs and protectionist measures. Hambantota should allow India’s manufacturing sector to be more closely intertwined with Chinese component manufacturers and supply chains. That is consistent with India’s goal to increase the share of gdp coming from manufacturing, and manufactured exports, both still far smaller than China’s. But, India will almost certainly push back, hard, if Hambantota leads to a big jump in its trade deficit with China.

China’s exports may be able to come in via the Sri Lankan backdoor. India and Sri Lanka have a free trade agreement that in theory lets Sri Lankan goods enter the vast market duty-free. Chinese manufacturers could turn the Hambantota free trade zone into a giant Maquiladora and export finished products to India. This would flood India with lower-priced consumer goods, autos, chemicals, clothing. Bangladesh, Pakistan and Burma — smaller economies but friendlier with China — would likewise absorb large increases in exported Chinese goods, either transshipped from Hambantota or assembled there.

No area within OBOR is of greater long-term significance to Chinese commerce. Fifty years from now, if UN estimates prove correct, the population of India, Pakistan and Bangladesh will be about 2.3 billion, or about double where China’s population will be by then.

Some China Merchants executives are dreaming aloud the Thai and Chinese governments will close a deal to build a canal across Southern Thailand. This would shave 1,200 miles off the sea route from Suez to China. The preferred canal route across the isthmus of Southern Thailand is actually shorter than the length of the Panama Canal. The canal would re-route business away from Singapore and the Malacca Straits. The likely cost, at around $25 billion, could be borne by China without difficulty. Hambantota would grow still larger in importance, commercially and strategically.

For now, though, the Thai canal is not under active bilateral discussion. Not only does the ruling Thai junta worry about its landmass being cleaved in two, the governments of the US, Japan, Singapore would likely have serious reservations about altering Asian geography to enhance China’s sea power and naval maneuverability.

By itself, a Chinese-owned and operated Hambantota will almost certainly reconfigure large trade flows across much of Asia, Africa and Europe, benefitting China primarily, but others in the region as well. It is a disruptive occurrence. While much of China’s OBOR policy remains nebulous and progress uncertain, Chinese control of Hambantota seems more than likely to become a world-altering fact.

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As published in The Financial Times

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Turbulence and Paralysis: the Year Ahead in US-China Relations — Financial Times

Leave a Comment / August 11, 2020

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A month before his official inauguration, Donald Trump is already tossing diplomatic grenades in China’s direction. It is a sign of things to come. 2017 is shaping up to be a highly eventful, taut and precarious year for China-US relations. This is partly due to a simple scheduling coincidence.

2017 will be the first time ever when both the US and the PRC in the same year will usher in new governments. The US will kick things off on January 20th by swearing in Donald Trump as President. China, meanwhile, will undertake its own large political upheaval, its five-yearly change in political leadership, culminating in the 19th Communist Party Congress sometime late in the year. Virtually the entire government hierarchy, from local mayors on up, will be changed in a monumental job-swapping exercise orchestrated by Xi Jinping, China’s president.

The US under Mr Trump, with a Republican Congress at his back, seems intent to challenge China more assertively in trade, investment and as a currency manipulator while intensifying the military rivalry. China’s leadership, meantime, will become deeply absorbed in its own highly secretive, inward-looking and internecine political maneuvering. While Mr Xi tries to further consolidate his power, Mr Trump will likely be asserting his, leading to a globally ambitious US and an introspective China. This would represent something of a role reversal from recent precedent.

With the chess pieces all in motion, businesses should be plotting their moves in China with caution. The proposed Trans Pacific Partnership (TPP) trade deal is dead, leaving China’s still-evolving “One Belt,One Road” initiative as the main impetus for new trade flows in Asia. Donald Trump says he will push for what he claims to be more “more fair” bilateral trade deals. China, with its $365bn trade surplus with the US and high barriers to much inward investment, is clearly in his sights.

How will China react? The only certainty is that as the year progresses, China’s government apparatus will slow, and with it decision-making at policy-making bodies and many State-owned enterprises (SoEs). All will wait to hear what new tunes to march to, once the new ruling Politburo is revealed to the public in the fourth quarter.

Chinese officials at all levels are already jockeying for promotion. That means falling into line with Mr Xi’s anti-corruption campaign. The Party Secretary in Jiangsu province, one of China’s wealthiest, got an early head start. He instituted his own form of localized prohibition, ordering that government officials could no longer drink alcohol at any time, in any kind of setting, anywhere in Jiangsu.

The booze embargo did include one loophole. If senior foreign guests are present, alcohol can flow as before, like an undammed torrent.

As the Party Congress approaches, it will be even harder to get a deal with a Chinese SoE lined up and closed within any kind of reasonable time frame. Even after the Party Congress ends, it will likely take more months for any real deal momentum to return. Investment banking bonuses along with billings at global law, accounting and consulting firms are all likely to take a hit.

One other certainty: the renminbi will come under increasing pressure as the US ratchets up its moves to apply tariffs to Chinese exports and China’s own economy remains, relatively speaking, in the doldrums. How much pressure, though, is another question.

Anyone making predictions about the speed and degree of the renminbi’s decline is playing with a loaded weapon. A year ago some of the world’s biggest and loudest hedge fund bosses, including Kyle Bass, David Tepper and Bill Ackman, were proclaiming the imminent collapse of the renminbi. The renminbi, despite slipping by about 6 per cent during 2016, has yet to behave as the money guys predicted.

The Chinese government uses non-market mechanisms to slow the renminbi’s decline. A recent example: its abrupt move in November to tightly control outbound investment and M&A. But shoring up the currency will undercut one of China’s larger economic imperatives, the need to upgrade the country’s industrial and technological base. That will require a prodigious volume of dollars to acquire US and European technology companies such as recent Chinese deals to acquire German robot-maker Kuka and US semiconductor company Omnivision.

Chinese investors and acquirers not only face tighter controls on the outflow of US dollars. The US is also becoming more antagonistic toward Chinese acquisitions in the US and globally. Deals of any significant size need to pass a national security review overseen by a shadowy interagency body known as the Committee on Foreign Investment in the United States, or CFIUS.

CFIUS works in secret. In recent months, it has blocked Chinese investment in everything from a San Diego hotel, to Dutch LED light bulbs as well as US and European companies more explicitly involved in high-tech industry including semiconductor design and manufacturing. The strong likelihood is CFIUS will become even more restrictive once Mr Trump takes over.

Unlike most areas of bilateral tension between the US and China, this is one area where the Chinese have no room to retaliate in kind. China already has a blanket prohibition on investment by US, indeed all foreign companies, into multiple sectors of the Chinese economy, from tech industries like the internet and e-commerce all the way to innocuous ones like movies, cigarettes and steel smelting. So, for now, China quietly seethes as the US intensifies moves to prevent China investment deals from being concluded.

China will probably need to regroup and start playing the long game. That means investing more in earlier stage tech companies, especially in the Silicon Valley, and hoping some then strike it big. These venture capital investments generally fall outside the tightening CFIUS net. China wants to spend big and spend fast, but will find it often impossible to do so.

Even as political and military tensions rise between the US and China in 2017, one ironic certainty will be that a record number of Chinese are likely to go to the US as tourists, home buyers or students and spend ever more there. China’s ardour for all things American – its clean air, high-tech, good universities, relatively cheap housing, and retail therapy – is all but unbounded.

If informal online surveys are to be believed, ordinary Chinese seem to like and admire Mr Trump, especially for his business acumen. Mr Xi, understandably, may view the new US President in a harsher light. Xi faces cascading complexities as well as factional opposition within China. He could most use a US leader cast in the previous mold, committed to constructive cooperation with China. Instead, he’s likely to contend with an unpredictable, disapproving and distrustful adversary.

https://www.ft.com/content/b1801637-4219-3222-9f45-658740aa1187

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