Who's buying what and where
WHEN STATE-OWNED company China National Offshore Oil Corporation announced its intention to buy US rival Unocal for $18.5 billion, there was a predictably irrational response from certain American politicians, who saw the bid as an assault on strategic interests. But it is something they will need to get used to – CNOOC's June bid was exceptionally ambitious, but was otherwise typical of a new-found aggression from emerging-market companies in their growth strategies. For years, companies in the developing world have been prey to takeover bids from businesses in north America, western Europe, Japan and Australasia. Now, the tables are beginning to turn.
A handful of regional champions, mostly in Asia and Latin America but also in eastern Europe, the Middle East and Africa, are on a global hunt for assets. Buoyed up by strong emerging-market economic growth, relatively low funding costs and ambitious management, companies such as Mexico's Cemex, China's Lenovo, Russia's Severstal and Egypt's Orascom Telecoms are blazing a trail in the US and Europe.
Some of these companies first spread their global wings a few years ago but most are recent converts to international expansion. "This trend has really exploded over the past 18 months," says Michael Klein, chief executive of global banking at Citigroup, which in June published a report titled Emerging Market Acquirers in Developed Markets – A Growing Force.
Such is the potential of this trend that Klein reckons emerging-market companies buying developed-world counterparts will be the biggest feature of global cross-border M&A within the next few years. "It's difficult to quantify how big volumes will be but global cross-border M&A volumes will eventually reach $1 trillion a year, and the largest and fastest-growing subset of that will be emerging-market companies buying developed-market ones," he says.
This would have been unthinkable a few years ago. Even intra-emerging-market acquisitions were rare until the turn of the century. Between 1981 and 1989, the 14 leading emerging-market economies made an annual average of about $272 million of cross-border acquisitions, according to Citigroup. Between 2000 and 2004, this grew to $19.6 billion a year, up about 7,000% (unadjusted for inflation).
Underlying this are better economic conditions in emerging markets. Nearly all are on an uptrend. More than 40% of Fitch Ratings-related emerging markets enjoys investment-grade status. As important, companies face benign financing conditions. Emerging-market bond spreads are hovering at historically low levels, equity financing is again a realistic option and bank lending is more readily available. Throw in high commodity prices and emerging-market companies now enjoy the most favourable environment to buy abroad.
At the same time, many of these businesses have matured and reached a stage where foreign expansion is imperative if growth is to be sustained. Awash with cash and operating from a relatively low cost base, they "have scale, funding capabilities, strong management and ambition," says Klein. He identifies three specific forces driving this type of expansion.
Natural resources
The first is the search for natural resources. Headed by Chinese companies, these transactions have dominated headlines in recent months. The most famous is the CNOOC bid, which was an attempt to hijack Chevron's attempt to buy Unocal with a bid that was $1.5 billion higher.
To further gain support for its deal, CNOOC offered cash whereas Chevron's bid was cash and stock. However, CNOOC's intentions proved too much for some US politicians, who were whipped into a protectionist frenzy by the Chinese bid. Eventually CNOOC withdrew its offer.
Despite CNOOC's failure, Chinese oil and gas companies are unlikely to be deterred from making further bids for US or European assets. "We are only at the beginning of what is likely to be a significant medium- and long-term trend of outbound investment," says Steve Wallace, head of advisory, Asia-Pacific global investment banking, at HSBC. "Chinese companies have gone through big restructurings; some have accessed international capital markets. Now they are expanding because of strategic needs – they need natural resources to feed the domestic economy."
Pushing many of these companies forward is the state. Chinese oil and gas transactions will be driven as much by political considerations as commercial pressures. "Where the government is a significant shareholder, their support is very important," says Wallace. "Ultimately, for the big strategic acquisitions, there will need to be a clear commercial rationale for the company, and a strategic and political rationale to ensure government support."
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In CNOOC's case, however, the presence of the Chinese government proved too controversial. American politicians and other vested interest groups joined forces to put pressure on the US government to block the bid. The House of Representatives voted 398-15 for the non-binding resolution that called on the US government to reject the offer.
A takeover by the Chinese state-owned firm "would threaten to impair the national security of the United States," the resolution said. "The Chinese government's control of CNOOC made the bid possible, not the free market," said House Democratic leader Nancy Pelosi.
Nor is the CNOOC/Unocal controversy an isolated incident. In March, state-owned China Minmetals Corporation abandoned a multi-billion dollar plan to take over Canadian copper and zinc miner Noranda. Again vociferous local opposition to the bid played a crucial part in its failure, although it would be simplistic to assume that the Chinese government's presence was the only reason. Chinese companies are still relatively immature and it will take time for them to properly bring their presence to bear on the world stage.
Russia's steel companies have fared better. In particular, the country's second-biggest steel concern, Severstal, is proving to be one of the emerging markets' most aggressive buyers in the developed world. Its first foreign acquisition was Rouge Steel, the fifth-biggest steel producer in the US. Originally founded by Henry Ford, Rouge had filed for Chapter 11 bankruptcy before Severstal took it under its wing. Severstal followed this up with a €430 million purchase of Italian company Lucchini. Most recently it tried but failed to buy Canada's Stelco.