Listen to Wall Street Radio Joyce Bone July 22, 2012 interview with Janet Walsh on key legal, financial, tax and human resources success factors in establishing a business overseas. Janet discusses doing business in the CIVETS and BRIC countries as well as types of industries going global and location incentives.
“Funding Foreign Direct Investment in China(c)”
Janet L. Walsh
The Chinese economic market is powerfully attractive to foreign direct investment. Despite predictions for a slow down, projections for the rate of real GDP growth in China is currently a robust 8.7% (United Nations, 2012).
Companies interested in expanding operations into China do so to follow their customers, improve their supply chains or manufacture at reduced cost. Companies considering a move to China may find it helpful to look at the entry strategies of firms currently operating in this market. Different types of businesses are expanding into China but the following four broad categories of organizations represent some of the most active areas of foreign direct investment (FDI).
a. Medical and health related technology, manufacturing, and services
b. Alternative energy, solar, wind
c. Light manufacturing including consumer goods, industrial production
d. Technology related businesses, manufacturing, and services
Although in the recent past, FDI into China focused on manufacturing there is a rising demand for service sector, professional services including legal, financial, accounting, human resources and retirement. Several areas are of particular interest to those interested in this market. For example, incentives for FDI in China include an aging population, the average age in China is 37 (Dezan Shira, 2012) and more than 60% of the population smokes (Ma, 2010) making health care, retirement communities, medical device manufacturing, and technology businesses take notice.
Services businesses however face different market entry hurdles than do manufacturing firms. Firms in this sector often face additional regulatory requirements that include the involvement of local companies or organizations. As a result service sector firms may find purchasing local “mom and pop” companies or strategic alliances the easiest way to enter this market,
China’s labor rates are increasing. This makes manufacturing in China not the bargain it once was but higher salaries and desire for a broader array of products mean more opportunities for retail sales (Dezan Shira, 2012). Standing on the Bund in downtown Shanghai is not much different than standing in the middle of any other large western, sophisticated city where one can purchase a luxury watch, shop for Prada clothes, drink gourmet coffee, and drive around in a Buick. General Motors, for example, a participant in the Chinese car market for many years, finds this country to be their largest market for car sales (China Business Review, 2011).
Chinese industrial upgrading and green energy initiatives are a feature of the 12th Five Year Goal Plan the cornerstone of state central planning. These initiatives have attracted US FDI from wind, solar, and lighting companies (Dezan Shira, 2012).
Also featured in the Five Year Goal Plan are technology incentives with the objective of increasing China’s technology impact from production to innovation. This emphasis on growth offers partnership opportunities for technology, software, and IT firms to access a growing market (Dezan Shira, 2012).
Businesses currently operating in or expanding into China are funding expansion through some of the following foreign direct investment strategies:
China Investment Financing
Chinese Government Funding
Investing Revenue from Growth Operations
FDI into Traditional Entry Ports-Hong Kong/Singapore
Multiple Investment Strategies
Private Placement Funding
Examples are as follows:
Joint ventures, partnering with a local Chinese firm for vertical or horizontal integration strategies, have two important advantages. The first is the advantage of an immediate presence in country and the second, a partner familiar with the business landscape. An established firm is also able to access government funding more easily than a foreign firm new to the market. China Cord Blood Corporation, a life sciences company which stores umbilical blood stem cells is one example of a successful partnership which has benefited from Kholberg Kravis Roberts & Company’s capital investment of $65 million (China Cord Blood).
For these joint ventures a key component of success is managing expectations, costs, performance measures, and cultures.
Cessna and Aviation Industry Corporation of China, an aviation joint venture and Ascletis a joint venture between United States and Chinese entrepreneurs in specialty therapeutics for cancer and infectious diseases, are two other recent examples of successful joint ventures in this market.
Chinese Investment Financing:
In the future, funding for operations in China may increase as the government seeks to develop a more robust, freely traded internationalized Renminbi currency (RMB). For example, from 2010 to 2011 there has been a quadruple rise in “dim sum bonds” or “Ronald McDonald Bonds.” These bonds are money raised in RMB in China to support Chinese investment. Companies such as McDonald’s, Tesco, BP Capital and L’Air Liquide have benefited significantly from this type of investment (Kriegler, 2011).
A recent conference with HSBC bank’s “Business Without Borders” group on May 16, 2012 in New York City, moderated by the Economist magazine’s Global Forecasting Director, Leo Abruzzesse, also discussed the rising attractiveness of RMB financed bonds particularly as the currency becomes more internationalized.
Chinese Government Funding:
Companies entering the Chinese market find two government funded programs. The first is direct investment by the Chinese government and second the development of economic free trade zones and corresponding incentives for locating in a zone. The Chinese government’s 12th Five-Year Plan has as one of its focuses R & D funding for emerging technologies. China is raising R&D funding for emerging technologies by 159% to as it anticipates moving from manufacturing technology to innovating technology (Lux, 2012).
For example, Ascletis has received a record level research and development grant from Hangzhou National Hi-Tech Industrial Development Zone under that organization’s “5050 Plan.” The 10 million RMB grant (approximately US$1.6 million) is the largest startup company grant in the history of the 5050 Plan, whose goal is to incentivize and assist start-up, technology-based companies within HHTZ, Hangzhou, Zhejiang Province (Ascletis).
As China opened its markets to foreign direct investments economic development zones were established in cities like Shanghai and Beijing. The economic development in these zones varies significantly and illustrates the role the state and local conditions play in successful investment (Yehua and Chi Kin, 2005). For example, Coca Cola established bottling operations in Shanghai in the 1990’s which induced their suppliers such as the Mead Corporation to become established in the region to support their customer.
Metaps Inc. a Japanese firm is a company that specializes in increasing revenue for Smartphone apps, provides a one-stop shop service for Smartphone app developers, from boosting traffic through monetization. Metaps has arranged private placement financing to raise US$4.2 million from five venture capital firms. The proceeds from this capital raise are to be used to increase the company’s Asia-focused business platform (Metaps).
Multiple Investment Strategies-Public/Private/Investment:
Large organizations, such as Siemens, benefit from multiple investment strategies to finance their global operations, combining public, private investment, and revenue from growth operations (Katz, 2010). Smaller firms can also use this concept to fund investments that may serve to hedge any concerns over disruption in elements of their strategy.
As mentioned, General Motors’s has done well with multiple strategies to establish a strong presence in the auto manufacturing market. Their efforts have been helped by Chinese subsidies and other incentives (China Business Review, 2011).
Growth Fund Investments:
Growth Fund Investments offer another way to enter the Chinese market.
Sino-Ocean Land Holdings Limited its subsidiary Gemini Investments Limited and KKR China Growth Fund, L.P., a China focused investment fund managed by Kohlberg Kravis Roberts & Co L.P. has established an investment process to capitalize on the long-term potential in China’s real estate market (Sino-Ocean Land Holdings Limited).
Revenue from Growth:
Entry into the China and Asian markets can be funded through revenue from growth operations as evidenced by the LED lighting industry. The use of LED lighting to lower energy usage is increasing as the price declines for LED products.
Given the amount of infrastructure development business opportunities are being created for LED lighting systems and prices are expected to rise sharply after 2015 according to a recent report from Pike Research. They project revenue from LED lighting in the Asia Pacific region to total $11 B USD through 2021 (Pike). This rising revenue growth can be transferred into building local strength and presence in this market.
Foreign Direct Investment into traditional entry ports such as Hong Kong:
Historically Hong Kong has been a gateway for foreign direct investment into the Chinese mainland. Companies that wish to enter the Chinese mainland market but lack experience or business partners begin the process by entering into Hong Kong a special economic zone. Hong Kong has a high per capita GDP but also some of the highest land and labor costs in Asia, much more expensive than the lower cost Chinese mainland. Entering the Chinese market through Hong Kong, establishing a sales or subsidiary office on the island and production facilities on the mainland is a useful market entry strategy.
The duty free status for Hong Kong goods into mainland China, minimized restrictions on Chinese tourists visiting Hong Kong, and the aging population in Hong Kong offer business opportunities in manufacturing, retail, tourism, and health related businesses.
Private Placement Funding
Private placement funding is a fairly typical way to enter a foreign market and may involve multiple investors sharing the risk. Metaps Inc. announced they have arranged private placement financing from five venture capitals. The proceeds from this private placement will secure human resources from the Singapore-based, wholly owned subsidiary “Metaps Pte. Ltd.”, and also to advance the company’s Asia-focused business platform.
In conclusion, there is no one fixed methodology to entry the Chinese market. The above illustrations provide a short summary and serve to illustrate the broad range of options firms have when considering foreign direct investment. These options should be considered in light of future trends and opportunities as this market continues to evolve.
Ascletis, I. c. (0001, April). US-China Pharmaceutical Venture Ascletis Receives Record-Level Research and Development Grant from Hangzhou. Business Wire (English).
China Cord Blood, C. (0004, December). China Cord Blood Corporation Announces Investment by KKR. Business Wire (English).
Huang, D., 2012. Emerging Asia Comparison: China vs. India and Vietnam. Dezan Shira Publications, Bejing.
General Motors Races Ahead in the China Market. (2011). China Business Review, 38(2), 54.
Katz, J. (2010). Siemens Puts Green on Fast Track. Industry Week/IW, 259(8), 34.
Lux, R. (2). Innovation China: The Middle Kingdom Boosts R&D Funding on Emerging Technologies by 159% to $18 Billion. Business Wire
Kriegler, Y. (2011). Dim sum finance: tasty. Lawyer, 25(43), 10.
Lux R. Innovation China: The Middle Kingdom Boosts R&D Funding on Emerging Technologies by 159% to $18 Billion. Business Wire (English) [serial online]. 2:Available from: Regional Business News, Ipswich, MA. Accessed May 30, 2012.
Ma, S. (2010). Affluence prompts more women in China to light up. CMAJ: Canadian Medical Association Journal, 182(12), E557-E558. doi:10.1503/cmaj.109-3307
Maitland, E., & Sammartino, A. (2012). Flexible Footprints: RECONFIGURING MNCs FOR NEW VALUE OPPORTUNITIES. California Management Review, 54(2), 92-117. doi:10.1525/cmr.2012.54.2.92
Metaps, I. c. (12). Smartphone Monetization Platform “Metaps” Secures US$4.2 Million Funding, Accelerating Its Asian Expansion from Singapore. Business Wire (English).
Pike, R. (4). Revenue from LED Lighting in Asia Pacific Will Total $11 Billion Through 2021, Forecasts Pike Research. Business Wire (English). Regional Business News, Ipswich, MA. Accessed June 4, 2012.
Sino-Ocean Land Holdings Limited and, K. (0009, May). Sino-Ocean and KKR Announce Real Estate Investment Platform in China. Business Wire (English). Regional Business News, Ipswich, MA. Accessed June 4, 2012.
SWOT Analysis. (2012). Hong Kong Commercial Banking Report, (2), 7-9. Retrieved from Business Source Complete, Ipswich, MA. Accessed June 4, 2012.
United Nations. (2012). World Economic Situation and Prospects 2012. Retrievedfrom//www.un.org/en/development/desa/policy/wesp/wesp_current/2012wesp_pr_eastasia_en.pdf
Yehua Dennis, W., & Chi Kin, L. (2005). Development Zones, Foreign Investment, and Global City Formation in Shanghai. Growth & Change, 36(1), 16-40. doi:10.1111/j.1468-2257.2005.00265.x
Birchtree Global, LLC New York based staff attended the Business Without Borders presentation hosted by HSBC bank in Manhattan on May 16. An excellent program on the emerging CIVETS countries and their attractiveness to foreign direct investment. The program was presented by Leo Abruzzesse Global Forecasting Director at the Economist Intelligence Unit.
Abruzzesse provided a compelling presentation on the emerging markets of Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa. He concluded that from a political, economic, legal and business perspective these growing economies are attractive FDI targets. His illustration of GDP growth patterns over the next several years showed the BRIC countries bracketing the CIVETS with the G7 countries at the bottom.
We asked him to compare the service sector investment opportunities in these countries. He and the panelists he brought with him indicated that services were needed but had different regulations that would require a slightly different approach to FDI. Acquiring an in country firm or merging with an in country firm was seen as the most expeditious approach.
HSBC bank provided a summary of their financial products and services that were designed to get cash back to investors more quickly improving cash flow. These were interesting and innovative, are worth considering and can be seen on their website.
Entry into these markets is not without risk and is more complex than market entry into the BRIC countries. We note that Birchtree Global has worked in all these locations over the past several years and can provide guidance to businesses wishing to establish company activities in these countries.
Last week I attended a conference sponsored by EUCE (European Union Center of Excellence) on “Financial Innovation in the Transatlantic Economy”. The conference proceedings showcased:
Generators of financial reform efforts in the US and European Union
Future trends in regulation
Financial challenges under Basel II
European financial reform and access to finance and commercial bank lending
Business growth strategies and access to capital
The speakers included:
Mr. Edouard Franciois de Lencquesain, from Paris Europlace (former S.W.I.F.T. board member)
Dr. mark Blyth, Professor of International Political Economy, Brown University
Ms. Cecile Noziere, CEO of Finadvia LTD (formerly Credit Lyonnais)
Keith Green, Vice President of Government Relations, ING North America.
There were several key items are of interest and importance to C-Suite business leaders as they chart the cost of capital, financial reform and the likely impact on their companies. Here are some of their comments to consider:
a. Innovative financial products help spur business growth and this innovation is likely to continue. What this means to companies is the way in which business are financed is likely to evolve. Public/private partnerships are likely to continue, interbank products and services will evolve as the way in which financial institutions evaluate lending risk continues to change. For business expanding overseas this means reliance on only bank funding will limit opportunities to grow. Evaluating government, public/private partnerships should be thoroughly explored to maximize funding options.
b. The financial crisis looks (looked) different to different markets. The response to the financial crisis is quite different around the world. For example, Canada for example has weathered this particular crisis better than the US as a result of decisions taken with regard to financial risk, regulation, capital requirements and consumer behavior. When expanding globally, consider that your firm may be evaluated using a different economic model. Make sure you understand that country’s model and include this as part of your financial evaluation.
Another reason that forecasting the economic crisis wasn’t more precise was the intersections of interest were not obvious because of heavily siloed organizations. While this is a continuing problem in organizations it has particular implications for regulators. Horizontal thinking and innovation may have helped avoid the catastrophic results of failing to share and understand information. We need a way to look at the impact of regulation of markets so the impact across governments, institutions and borders is apparent. Failure in this area is not an option which may spur additional innovation.
c. Politicians and regulators don’t necessarily really understand financial markets and the impact of their decisions. In general, their ability to assess and analyze risk factors is limited and this subject is complicated. It can only be dumbed down so far.
d. Basel II reforms will affect large as well as small banks. While smaller banks will not necessarily participate in Basel II, they will be affected by the risk sensitivity of capital allocation requirements, quantifying operational and credit risk, among other standards. (Basel II is the second of the Basel Accords which are recommendations on banking laws and regulations. The purpose is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the type of financial and operational risks banks face. Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall market stability. It use a “three pillars” concept, A. Minimum capital requirements, B. Supervisory review and, C. Market discipline to promote greater stability in the financial system. Basel II accords have been adopted by countries around the world but timetables and implementation vary widely.)
e. GDP of EU is number one in the world but their influence doesn’t always equal income. As such the EU seeks to increase competition, level the playing field and reduce risk in the financial arena.
f. Private equity funding for small businesses will expand as cost of capital for this group tightens. In addition to exploring government, public/private partnership groups growing companies should look to explore private equity funding opportunities. However care must be taken to identify private equity firms with robust business experience, solid financial and operational leadership skills. Private equity firms are also seeking to reduce their exposure to risk so an understanding of how risk is apportioned is critical.
Birchtree Global staff will be attending several financial and legal conferences over the next several weeks and will provide our clients and readers with updates and alerts.
For additional information on this article please contact Janet Walsh-01 770 590 8338.