China Is ‘Going Out’

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By Greg Peel

For the first time, Chinese premier Wen Jiabao has publicly acknowledged his government’s policy of encouraging offshore acquisitions by Chinese companies. The London Financial Times reports Jiabao spoke to a gathering of Chinese diplomats this week, and stated:

“We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises.”

“Going out” simply means funnelling some of China’s US$2 trillion of foreign currency reserves towards Chinese companies for the purpose of making equity-based acquisitions abroad, and particularly towards state-owned enterprises such as PetroChina, China Telecom, the Bank of China and, of course, Chinalco.

This will come as no shock to Australians, who have already agonised over Minmetals’ moderately successful swing at OZ Minerals ((OZL)) and the failed attempt by Chinalco to take a larger stake in Rio Tinto ((RIO)). Behind these major headlines, nevertheless, Chinese companies are quietly tying up deals with and investing in more junior companies in the resources sector. However, the policy has finally been formally acknowledged.

While the focus is clearly on resources, China is not limiting itself. The US$200bn Chinese sovereign wealth fund has taken a cheeky 1% stake in British distiller Diageo, for example. But it is resources China is really after. The chairman of the China Development Bank, Chen Yuan, has suggested outbound investment should focus on resource-rich developing economies.

Note the word “developing”. Clearly China now knows it’s in for a battle if it tries to take too much interest in Australia’s nationally significant companies, but resistance may not be quite as stringent in other less mature economies. China has already tied up significant oil deals in Brazil, has spent a lot of time over recent years in making inroads into Latin America and Africa, and has greater ease than the US in dealing with Russia or the Middle East, including Iran.

That doesn’t mean Australia can’t be quietly plundered on a softly-softly, under the radar basis. Many junior miners and drillers are begging for Chinese support.

“Everyone is saying we should go to the Western markets to scoop up underpriced assets,” noted Chen Yuan. “I think we should not go to America’s Wall Street but should look more to places with natural and energy resources”.

And there seems little point in China looking for bargains in the US, given the “going out” policy is all about going straight to the source and by-passing the need to park funds in US dollar debt assets. Commodities may not pay a fixed interest coupon return, but who cares? By parking funds in US dollars in the interim, China is taking a risk that the US dollar will fall under the weight of national debt and push commodity prices higher.

That is one reason China has clearly been sucking up commodities in 2009 ahead of, rather than in the course of, its significant domestic infrastructure stimulus plans. China is using its US dollar reserves to go straight to the source and by-pass the dangerous Western financial system. But buying commodities directly is still a step away from the actual source. Buying into the foreign companies that produce the commodities that China would otherwise have to pay a margin for is the real source.

This is good news/bad news for Australia. Rio and BHP Billiton ((BHP)) have, for example, countered China’s push into Australian iron ore by joining in protecting prices out of the Pilbara. But at the same time, miners such as Fortescue Metals ((FMG)) are keenly opening their doors to China, looking for investment to fund production expansion. Such investment will quietly undermine BHP/Rio’s pricing power. And what if Chinalco were to dive in to a more receptive Brazil and take a stake in Vale, for example?

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