newsfilter.io
Panel

China's Trade-Off: The Outlook on Investment

Milken InstituteKevin Lu, Wei Sun Christianson, Kenneth Gaw, Richard Hu, Weijian Shan, Jing Ulrich
Watch on YouTube →

Inbound Investment (FDI) Trends and Dynamics

  • Foreign Direct Investment (FDI) into China has plateaued since 2012 due to domestic capital abundance, low funding costs, and high target valuations.
  • 2017 marked the first time in years that macroeconomic GDP growth (6.9% in H1) and corporate sector earnings (nearly 20% industrial profit growth) moved in sync.
  • 80% of covered companies met or exceeded earnings forecasts in H1 2017, including traditional sectors like steel and aluminum that were previously unprofitable.
  • The Chinese government reversed previous restrictions in 2017 to actively welcome FDI, citing a need for foreign capital to offset recent capital outflows.
  • New policy incentives include reducing the negative investment list, facilitating profit repatriation, and extending tax deferrals for foreign investors in priority industries.
  • Ownership caps remain a significant barrier in financial services, currently limiting foreign institutions to a 49% stake in joint ventures despite regulatory efforts to remove them.
  • Exit mechanisms for foreign investors remain constrained by a backlog of hundreds of IPOs at the CSRC, though a 12-to-18-month clearing is anticipated.
  • Chinese currency stabilized and appreciated 6% against the USD in H1 2017, reversing the depreciation seen in 2016 and boosting foreign exchange reserves.

Private Equity and Deal Structures

  • Partners Group (PAG) manages $18 billion in assets, with approximately $6 billion in private equity; $2 billion of this was invested in China this year, doubling to $4 billion including debt.
  • PAG's strategy focuses on acquiring 100% control of assets, citing a premium on control to manage destiny and valuations, as seen in deals like Golden Apple and a $3 billion industrial gases company.
  • The "hybrid economy" (SOE reform) remains a long-term theme but has yielded few accessible assets in the near term compared to the rapidly scaling private sector.
  • Succession issues in the private sector are creating opportunities, as aging founders face reluctance from younger generations to continue running businesses, necessitating control changes.
  • Real estate investment has shifted from traditional residential development to converting obsolete department stores into creative office lofts and building logistics warehouses for e-commerce.
  • PAG invested in China's largest matchmaking business and established a Greenfield project for European food producer Food Union, including two new plants in China.
  • The largest private equity deal cited was the acquisition of a 50% profit-share in China's consumer finance sector, highlighting the depth of opportunities in financial services.

Outbound Investment and Geopolitics

  • Chinese outbound investment surged to $186 billion in 2016 (up from $126 billion inbound) before facing government scrutiny and restrictions in late 2016.
  • New government guidelines categorize outbound deals into "encouraged" (technology, One Belt One Road), "restricted" (real estate, entertainment), and "banned" (gambling, adult industries).
  • Outbound deal volume has dropped 44% year-to-date due to scrutiny on high leverage, deals exceeding a company's market cap, and those exceeding $10 billion.
  • European targets, particularly in Germany, France, and Italy, are increasingly filing joint letters with the European Commission to block Chinese acquisitions of premium technology firms.
  • The acquisition of Lattice Semiconductor by a Chinese consortium was blocked by the US Committee on Foreign Investment (CFIUS) citing national economic security concerns.
  • Despite regulatory headwinds, Chinese buyers remain attractive to foreign sellers due to their cash availability and strategic intent to become global sector leaders.
  • One Belt One Road initiatives continue to drive infrastructure and industrial capacity export transactions, particularly in Asia and non-China Asian markets.
  • JP Morgan advised ChemChina on its $43 billion acquisition of Syngenta and HNA Group on its $6.5 billion stake acquisition in Hilton Hotels.

Strategic Outlook and Predictions

  • Wei Jian (Morgan Stanley): Predicts that Chinese outbound capital flows will become the most significant global financial flows within a few years.
  • Weijian (PAG): Forecasts China will become the world's largest middle-class and consumer market within 20 years, with a stable political system providing business predictability.
  • Richard (WorldQuant): Predicts that by 2040, China will be home to a quarter of the world's top companies, driven by a pipeline of over half of its top students now studying finance rather than engineering.
  • Wei (J.P. Morgan): Notes a 20-year outlook where China's advanced society and human capital (specifically engineering and science talent from institutions like Tsinghua and Peking University) will sustain long-term growth.
  • Kevin Lu (PAG): Warns of potential economic damage from future trade conflicts with the US and geopolitical instability regarding North Korea.
  • Jin (J.P. Morgan): Highlights that the line between private and state-owned enterprises is blurring, with private entities like Alibaba and Tencent increasingly investing in SOEs to drive mixed-ownership reforms.