Investments signal rise of multinationals

LUO JIE/CHINA DAILY

The direction of the financial tides flowing in and out of China's shores has been changing. The perception that China is primarily attractive as an inbound investment center is now being outpaced by Chinese money heading across the world to acquire assets.

In 2015, China's non-financial outward direct investment (ODI) was $118 billion. Based on the Ministry of Commerce's 2015 data for foreign direct investment (FDI), which stood at $128.5 billion and the non-financial ODI of $118 billion, one can therefore assume China's total ODI (financial and non-financial) actually exceeded FDI for the first time in 2015. This represents a significant shift.

UBS expects China's ODI to accelerate to an 18 percent compound annual growth rate from 2015 to 2018, having recorded on average at 14 percent during 2008-14.

Globally, developed markets have attracted a far higher share of China's ODI. Nearly two-thirds of China's offshore investments are currently being routed to those markets, with North America, Europe and Asia accounting for more than 80 percent of Chinese acquisitions in 2015.

By specific industry sector, more Chinese money has been invested in tech and tourism businesses, while investment in resources, such as energy and metals, has declined. UBS projects that sectors with solid domestic fundamentals such as consumer, IT and tourism will continue to record accelerated ODI during the medium term. In sectors such as rail, ports, home appliances and telecom equipment, emerging Chinese multinationals may significantly alter the global competitive landscape in upcoming years.

State-owned enterprises were the original initiators of Chinese ODI, because they enjoyed government support and had access to low-cost funding. Today, private enterprises have access to the same kind of funding levels and there is a perception that the days of SOEs embodying the biggest momentum supplied by the Chinese economy has passed.

However, that hypothesis is not borne out by the information gleaned from Chinese investment offshore. Participation by the SOEs in ODI has actually been rising, and now represents over half of offshore mergers and acquisitions. Overseas expansion should be positive for Chinese companies, given the still relatively strong yuan and cheap domestic funding. The ability to pick up debt finance at a relatively modest cost is key to the proliferation of Chinese ODI. Eighty to 90 percent of Chinese outward investment has been financed with debt, though we have noticed that A-share companies have been more inclined to rely on equity financing.

However, growth in Chinese ODI is not a foregone conclusion. There are still challenges. The sustainability of overseas expansion depends on capital flows, foreign reserves and the yuan's value. Also a weaker global economic environment may jeopardize bullish sentiment toward investing overseas.

There is a misconception that Chinese companies are insensitive to acquisition costs and as a result are willing to pay a hefty premium. But the data suggests otherwise. Chinese companies pay on average a 27 percent acquisition premium compared with the global average of about 24 percent.

This year, the momentum has increased. Chinese companies have announced $145.4 billion of overseas M&A during the first half of 2016, although not all them may be successfully completed. That figure exceeds the all-time high of $116.2 billion during the whole of 2015.

There is still a long way to go, though. China's direct investment abroad in 2014 was about 1.2 percent of GDP, compared with the US' 1.9 percent and Japan's at 2.5 percent. In the coming years, Chinese investment will be spreading across the world.

The author is Head of China Strategy, UBS Securities.