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December 14, 2005

Are Some Chinese Going Nuts?

[Editor's Note: A weblog I've only recently discovered is Value China, and find to be worthwhile reading simply because of its presentation of unusual and contrarian commentary on China business. The article below, written in June of 2005 when CNOOC still pursued Unocal, is an example. I have translated it not because that deal, now dead, is currently relevant, but simply to show that there are Chinese in the investment community who do not support global mega-deals, and the reasons for their disapproval. We rarely hear the contrarian viewpoint expressed so bluntly and forcefully.

Commonly heard in conversation with Westerners, and rarely in official media, are arguments like that below. In other words, that China is poor by any standard and functioning substantially on borrowed money. Hence, China should be made strong by directing investment to its own domestic markets rather than allowing capital leak out onto the global market. The government's energy policy is thus indirectly criticized, despite a clause inserted to direct blame away from high-level government officials. Note also the strong flavor or nationalism that percolates through the piece, as well as the final line, a gratuitous thrust at unmentioned parties, a subtle stab at the U.S., thus considered an enemy who would, it is assumed, wreak havoc upon the Chinese economy with pleasure.]

Some Chinese Have Gone Nuts
--A Commentary on the CNOOC “mad swallow” of Unocal

By Song Tai-wei, Shanghai Cai Sheng Investment Information Co.
上海财盛投资咨询有限公司 宋太伟

Recently, the boldness of a few Chinese have stunned both Chinese and the world. The Lenovo Group invested USD 1.25 billion to purchase IBM’s global personal computer business. Thereafter, the Haier Group invested USD 2.25 billion to purchase Maytag, the American appliance giant. Followed quickly thereafter, CNOOC astonished when it madly swallowed a soon-to-be bankrupt Unocal Corporation with a cash investment of USD 18.5 billion (about RMB 154 billion). After all this purchasing of large American businesses by Chinese government supported companies, using what are astronomical sums of capital to the still not wealthy Chinese, won’t there be even more astonishing, crazy purchases?

Actually, the average living standard of Chinese makes China a backwards nation in the world. To the foreigner, attracting foreign capital remains the most important work of the vast majority of Chinese local authorities. At such a time, can foreigners not be surprised when Chinese enterprises frequently spend astronomical sums of US dollars to purchase American enterprises that are nearly bankrupt? Aren’t Chinese very poor? So how can they have suddenly become rich overnight? We ourselves feel that some Chinese have changed too quickly, are too bold, and behave without restraint, almost as if crazy.

In this article, I do not wish to vainly aim criticism at the behaviors of Lenovo, Haier or the CNOOC / Unocal incident. What I wish to say is this: their legality, necessity and business economics all are problematic.

Legality: the ownership of CNOOC, although a listed company, is controlled by the Chinese state. The purchase used RMB 160 billion, nearly the investment in the SanXia project (planned at under RMB 180 billion). Such a large investment in socialist China, even if national leaders had no authority to make such a decision themselves, was even more so at the national enterprise leadership level! Only the entire Chinese people have the complete authority regarding national and personal property, even if, from the perspective of the business management level, CNOOC’s huge purchase is illegal, its net net assets are just over RMB 80 billion. Putting up double the company’s net assets in cash in US dollars to make an overseas investment is prohibited under the “Company Law,“ national capital investment management regulations, foreign exchange management regulations and several other laws. The ultimate risk is for the great mass of people (the nation) who must take on the burden.

Next is the problem of necessity. First, from a national strategy perspective, the energy problem is long-term and global. Moreover, what we can definitely say is that, unless people incessantly innovate science and technology, developing new environmentally sound energy production, this problem will never be resolved. Oil assets are the joint wealth of all of mankind, and any monopolistic behavior can bring on international tension, even war. This is directly connected with national foreign policy and security issues. If Unocal were really worth the SanXia Project, would the Americans, who need oil even more, sell it?

The several decades of rapid growth in China proceeded without sufficient oil reserves. What great problem will it be to continue on this basis for a few years or even long term? Thinking about it, fuel guzzlers are backed up everywhere -- cars creating serious environmental pollution -- so what is the necessity of counting the cost of a purchase when oil is at a historical high of USD 60 per barrel? Go back a step. Even if there is a national oil shortage crisis, so what? We need even more capital for technology innovation. A one-time investment of RMB 160 billion for energy saving technology – solar, atomic, hydrogen or other technological developments – wouldn’t that be a smart national strategy!

Second, Unocal is an American company. Even if the CNOOC purchase had succeeded, guaranteeing a lot of oil production, would it be entirely directed towards the domestic market? The shortage America and other developed regions experience have created great national discussion.

Third, use of this method as a way to ease the RMB exchange rate conflict and take care of dollar reserves is extremely stupid. The RMB exchange rate problem is just an excuse used by others in their interests, and those who think it real are being deceived. Should the RMB really be revalued at all? China’s GDP has reached RMB 14 trillion, the M2 money supply RMB 30 trillion, and as the efficiency of the usage of currency drops, the bubble has become extremely serious. America’s GDP is US$ 12 trillion, with M3 at USD 9.3 trillion. Moreover, 60% of the supply of US dollars may be found overseas! In 2004, China’s foreign reserves had a net increase of USD 280 billion, mostly investment capital. I estimate that China’s foreign reserves are currently USD 660 billion. At most, only USD 100 billion have been earned by enterprises within China that have made this money through the trading of products. The vast majority is direct inflows of investment funds or the savings of foreign enterprises. This is a national debt. The foreign exchange is “used only to make a profit,” and can (in a short period of time) be taken out of the country. If the foreign exchange within the country is wasted, what will be used to repay it? If the stability of the ren min bi or the nation is to be guaranteed? I estimate that within two years, even if China becomes the largest holder of foreign reserves, it will mostly be other people’s money, and one may not dare to consider oneself wealthy. According to the current situation, I estimate that the ren min bi, if freely convertible, can only depreciate. Long-term appreciation is something a nation can be proud of, but it must be based upon reality. Perhaps we have just been deceitfully selling out our labor and our markets.

Economic efficiency. First, the commodity-based economy is cyclical. Crude oil prices can’t continue to increase for very long. A price of USD 80 or 100 per barrel in the near future is a fool’s dream. If the price of crude remains at USD 60 per barrel for a year, a global economic recession is unavoidable, and oil prices would naturally fall. To enter into purchases during the period of crazy high prices, the rational Americans whose companies are being purchased would surely find no end to their joy. Chinese would become the Japanese of the early 90s. Second, Unocal, with assets USD 13 billion, a company needing to apply for bankruptcy protection, certainly has little in the way of net assets. Is it worth USD 18.5 billion? According to documents provided by CNOOC, Unocal’s oil reserves are equivalent to 180 million barrels (about 24 billion tons). Even if it, in its entirety, were figured at 15% profit, its profit from it being drilled at one time would only come to USD 16 billion. If one considers the current value discount and usage losses, the estimate would be even less. CNOOC’s reserves approach 27.53 billion tons (100 times that of Unocal), with production approaching 37 million tons (exceeding Unocal’s by 1.6 times). CNOOC can be valued at only USD 22 billion. Logically, the company that should be acquired is CNOOC. Third, Unocal is global with 6,600 personnel huge management costs and definitely plenty of problems, otherwise it would not apply for bankruptcy protection during a spike in oil prices. One estimates that CNOOC’s huge capital infusion would not be as simple as using that capital directly on the international market to purchase oil, and thus make money.

Chinese enterprises and the domestic market are not conformed to work well together. Is going to far-away America the way to become a hero or savior? The Chinese market is the one world market experiencing the greatest activity. Business from all over the world are running to China. Shouldn’t national enterprises first become strong and sufficient within China? What are they doing running off to America?

Given this situation, aren’t some Chinese going nuts? Those who are secretly happy are naturally those who would cause you to go nuts. Those who will pay the bill (and be buried by the total), is the ordinary Chinese on the street.

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