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Profitability for multinationals now turns on fortunes in China

China remains the top destination for foreign investment, according to an annual survey by A.T. Kearney, a management consultancy. Investment has been boosted by the trend of establishing regional headquarters and research and development centres in China. For the multinationals involved, profitability is now turning on their fortunes in China.

The size and scope of the China market is now having a significant effect on other country’s economies and influencing the way multinationals do business. China has replaced the U.S. as Japan’s biggest trading partner with 22.2 trillion yen (US$213 billion) in two-way trade between Japan and China and Hong Kong. All of Asia-Pacific region economies are focusing their trade on the China market.

China’s trade volume exceeded US$1 trillion in 2004, making it third in the world in international trade. The trade deficit between the EC and China soared to 41.1 billion euros (US$53.4 billion) for the first 10 months of 2004, according to Eurostat. Chinese products are penetrating higher value-added markets, such as electronics. European investment in China also remains high and goods made in China are re-imported to Europe, economists said.

Trade figures reflect changing patterns in the way multinationals do business. The Japanese have moved most of their manufacturing offshore, initially to Taiwan and now to the mainland. Companies that still manufacture domestically make parts or components that are then assembled in China. The value-added component of goods made in China is increasing. Foreign firms still worry about intellectual property, but the risk is outweighed by the need to stay competitive. The necessity of keeping costs down is forcing multinationals to move deeper into China and further integrating Chinese business into the world.

China remains the top destination for foreign investment, according to an annual survey by A.T. Kearney, a management consultancy. The U.S. comes second, followed by India. Investment has been boosted by the trend of establishing regional headquarters and research and development centres in China. For the multinationals involved, profitability is now turning on their fortunes in China.

Profits made in China

U.S. companies reported more than US$8 billion in profits inside mainland China in 2003, according to a survey by the China Economic Quarterly. For Agilent Technologies of the U.S., China is now the second-largest market in the world in terms of orders and revenue. Agilent plans to establish a holding company to consolidate all its entities in China.

U.S. iron ore pellet producer Cleveland-Cliffs Inc. recently took over Australian-based Portman Ltd. in what is essentially a China play. Portman produces six million tonnes of ore annually, most of it destined for the China market where Cleveland-Cliffs wants to expand. German industrial group Robert Bosch Gmbh is planning to invest 550 million euros (US$715 million) in China over the next three years. It will expand factories and launch a 30-million-euro (US$39-million) ad campaign which is Bosch’s biggest-ever effort to market its name in a single region. China has played an increasingly important part in the German firm’s long-term strategy.

Toshiba Corp.’s personal computer business is likely to return to profitability this fiscal year because of cost-cutting reforms, including moving its manufacturing operations to China. In the first half of 2003, it suffered operating losses. Spanish bank BBVA reports its earnings in Latin America have doubled, helped by that continent's economic expansion. Latin America’s expansion is partly driven by booming exports to China. LG Electronics Inc. of Korea said it expects combined revenue from its China operations to rise 50% to US$15 billion this year. Revenue from China made up a third of LG’s total in 2004.

Big jump in M&A activity

Multinationals’ ties with China are going beyond the old joint venture model that first attracted investment to China. Multinationals and Chinese firms, including state-owned firms, are striking increasingly sophisticated mergers and alliances. Mergers and acquisitions in China were up 85% in 2004 to US$54.5 billion, according to a study by Dealogic.

For the past two years, Chinese firms have engaged in a frenzy of initial public offerings in stock markets around the world in an effort to raise capital. Now they are exploring different ways of raising money, through mergers and selling off assets. For Chinese firms, inexperienced in global equity markets, these kinds of deals present the opportunity to build a company without the complication of trying to satisfy shareholders or monitor volatile stock prices. They can concentrate on getting the product right, then become part of a larger global company that gives them access to world markets.

Mittal Steel Co. NV will spend US$314 million to buy 37.17% of Hunan Valin Steel Tube & Wire Co., the largest single stake a foreign investor has taken in a mainland-listed company in one move. Mittal’s holdings will be equal to the firm’s largest Chinese shareholder, Valin Group. The Netherlands-based company, the world’s biggest steelmaker, also gains a firm grip on the world’s biggest market for steel.

In a deal approved by the State-owned Assets Supervision and Administration Commission, France’s Thomson will buy a 4.82% stake (valued at 156.6 million yuan in November 2004) of China’s home appliances and mobile phone maker, Konka Group. Thomson is buying unlisted legal person shares sold by Konka’s largest shareholder, a state-owned company named China Overseas City Group. Thomson has already partnered with Shenzhen-listed TCL Corp.

Eastman Kodak Co. has a 20% equity stake in China's Lucky Film Co. Morgan Stanley has received approval from Chinese regulators for a deal in which it will take a 25% stake in China Yongle Home Appliance Co. for US$50 million. Morgan Stanley took a stake in Ping An Insurance (Group) Co. and China Mengniu Dairy Co. before they went public, then helped to underwrite the IPOs of both firms. It is increasingly active in merger activity in China.

In addition to these mergers among listed units, there were 22 private equity deals totaling US$900 million in China in 2004, compared with just four worth a total of US$37 million two years ago. Carlyle Group, one of the largest private equity groups in the U.S., has pledged to invest up to US$1 billion in China by 2006.

IT firms want to be known worldwide

China's information technology companies are likely to be at the centre of merger and acquisition deals in the next year, in the wake of the landmark deal between IBM Corp. and Lenovo Group Ltd. China’s information technology companies are making most of the components and assembling finished products for the electronics and computer industries. Now they aim to raise their profile worldwide.

Chief among the players is Huawei Technologies Co., which has an agreement with Britain’s Marconi Group to distribute its products in Europe. The deal takes advantage of Marconi's long-standing relationships with European telecommunications carriers. This has led to speculation that Huawei may take over the company. Huawei also may be interested in buying Siemens AG’s mobile phone unit. Or Huawei may follow the example of the multinationals and focus its core businesses by selling off some of its diverse units. This would open even more opportunities to establish links in international markets.

TPV Technology Ltd., a large Taiwan-based maker of computer monitors, has bought the monitor operations and certain television businesses of Koninklijke Philips Electronics NV for US$358 million. TPV will now be the biggest manufacturer of computer monitors, bigger than Samsung Electronics of Korea.

Faith in the potential of these mergers is not universal. Some observers question whether Lenovo has the expertise to manage all of IBM’s personal computer division. IBM? has promised to lend expertise, but can the Chinese partner take on administration of such a large asset? Sichuan Changhong Electric Co., China’s largest TV maker, is facing losses and large debts due to its aggressive foray into the U.S. market through a U.S. distributor. Most Chinese firms have some way to go to meet international standards for management expertise.

This is one area where India outshines China. Top Indian firms continue to outperform their Chinese counterparts in terms of return on equity and corporate governance.? Chinese firms' average 16.4% return last year is lower than India’s 26.4%. India’s GDP growth and foreign investment figures don’t approach China’s, but its Mumbai stock market has a longer history than China’s exchanges. India’s corporate sector went through a period in the 1990s when access to capital was difficult and companies learned to focus on cash management, efficiency and profits.

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