EY: Chinese Companies Now More Rational About Their Overseas Investment

China’s outbound investment slowed down in H12017, while Chinese companies going abroad became more rational and further optimized their investment structure, according to the 6th issue of EY’s China outbound investment report “China Go Abroad: Strategic collaboration – How inclusive Management Helps Chinese Enterprises Win Overseas.”

EY remains positive about China’s outbound investment over the long term and predicts that China’s outward Foreign Direct Investment (FDI) flows will surpass those of the US in the next decade.

The report, jointly released with China Mergers & Acquisitions Association (CMAA), finds that cultural integration is the biggest challenge faced by Chinese companies when they are operating abroad, followed by strategic alignment and local talent acquisition and retention.

EY suggests that Chinese companies should focus more on post-investment integration, leverage the synergies generated from mergers and acquisitions (M&As), develop talent management program for inclusive development and create a diverse business environment to build mutual understanding and develop mutual respect for people with different cultural backgrounds.

In 2017, as political and economic uncertainties have increased, such as Brexit and the executive order signed by US President Donald Trump to “Buy American, Hire American”, they have created potential challenges for Chinese companies investing overseas. According to the data released by the Ministry of Commerce (MOFCOM), China’s non-financial outward FDI flows in H12017 reached US$48.2 billion, down 46% on a year-on-year basis.

“China’s outward FDI flows slowed down, but compared to 2016, its structure was better optimized in H12017,” says Loletta Chow, Global Leader of EY’s China Overseas Investment Network (COIN).

“Outbound investment in the real economy, especially in emerging sectors, has increased significantly, reflecting a stable and positive trend. Furthermore, as Chinese companies have accumulated extensive experience in overseas investment, many of them are exploring innovative financing channels, such as leveraging Hong Kong as a platform or using the offshore assets of overseas entities for financing, leading to a statistical decrease in outward FDI flows.”

Reasons for decline in deals

According to Mergermarket, Chinese companies announced 302 overseas M&A deals worth US$65.7 billion in H12017, down 51% compared to the same period in 2016.

There were three main reasons for the decline in China’s cross-border M&As. Firstly, Chinese regulators have issued policies to prevent Chinese companies from making irrational outbound investment. Secondly, compared to 2016 when a series of large deals, including Syngenta, dominated the M&A market, there was a decline in both the size and number of deals. Thirdly, increased geopolitical and economic uncertainties have led Chinese companies to be more cautious in investing overseas.

Chen Shuang, Rotating Chairman of CMAA and Executive Director and CEO of China Everbright Limited says: “We believe that the prospect for China’s outbound investment remains positive over the long term despite some fluctuations in the short run. Recent data shows that China’s outbound investment is steadily slowing down and Chinese companies are becoming more rational. With various sources of financing and increasingly diversified ownership of Chinese investors, financing channels are becoming more varied. Buyout funds with deep insights and resources are playing an increasingly important role in overseas mergers and acquisitions, as they can help Chinese companies manage risks more effectively and succeed overseas.”

Data from MOFCOM showed that China’s non-financial FDI flows along the Belt and Road reached US$6.6 billion between January and June this year, representing 13.7% of the total non-financial outward FDI flows and increasing by 6%.

Meanwhile, the amount of newly signed engineering, procurement and construction (EPC) contracts with countries along the Belt and Road reached US$71.4 billion in the same period, up 39%.

During the “Belt and Road Forum for International Cooperation” (Forum) earlier this year, Chinese President Xi Jinping pointed out a clear path for international cooperation, clarified action plans and shared a list of more than 270 detailed outcomes. Furthermore, China has committed to host the second Forum in 2019. All these initiatives provide important support for Chinese companies seeking to “go abroad”.

EY expects that as these outcomes are being implemented, China will increase investments in countries along the Belt and Road. EY also believes that China will remain well capitalized and that its outward FDI flows will surpass those of the US in the next decade.

EY recently conducted a survey among Chinese enterprises that are most active in outbound investments and are headquartered in China’s 17 provinces, municipalities and Hong Kong SAR. Results show that the greatest contributions made by overseas operations are “increased brand awareness (72%)”, “increased market share (52%)” and “improved technology and production (50%)”.

Loletta Chow says: “Chinese companies need to keep their focus on brand, market and visible benefits delivered by a technology-oriented global expansion strategy, as well as performing regular reviews of whether or not their overseas operations fit in with their strategic goals.”

Biggest challenge

About 70% of respondents said “cultural integration” is the biggest challenge faced by Chinese companies when they are operating overseas, adding that both investors and investees showed unwillingness to change their established culture or had difficulty in doing so. They believe cultural conflicts may jeopardize the operational effectiveness of Chinese companies operating overseas, and impede them from pushing forward their globalization strategies if they cannot bridge the cultural gap based on the potential synergies available.

To overcome the difficulty of cultural integration, EY suggests Chinese companies take the following steps: make efforts to understand the differences, evaluate the gaps, strengthen communication and build a diverse and inclusive business environment to help manage their global teams.

As for strategic alignment, Chinese companies need to analyze the vision and strategy of targets prior to investment, to ensure careful selection and a deep understanding of the macro economy in the targeted market. Regarding post-investment integration, Chinese companies need to develop a detailed coordination plan and put it into action, striving for strategic alignment.

Chinese companies also need to understand what they should do to retain the investee’s core talent, develop a tailored retention plan and embed diversity and inclusiveness into post-investment process design and change management.

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