TCS Daily

The U.S. Orders Chinese Takeout

By Dominic Basulto - August 26, 2005 12:00 AM

This summer, a firestorm of controversy erupted in the nation's capital when Chinese oil giant CNOOC made a hostile $18.5 billion bid for U.S. oil company Unocal. Most troubling for some U.S. politicians, the CNOOC bid followed a number of other high-profile bids by Chinese companies for U.S. assets. China's Haier Corp. made a $1.28 billion unsolicited bid for appliance maker Maytag and, before that, IBM sold off its world-famous PC business to Chinese computer manufacturer Lenovo Group. All of a sudden, it looked like a bulked-up China was using its new-found muscle to seize control of key U.S. assets. Making matters worse, mainstream media publications like Business Week made like Paul Revere, breathlessly warning that "The Chinese are coming!"

But now, the capital flows have been reversed. Instead of China attempting to scoop up U.S. assets, it is now U.S. companies that are buying large equity stakes in Chinese companies. In just the past few weeks, Yahoo has invested more than $1 billion in Alibaba for a 40% equity stake in the Chinese e-commerce company, while a number of U.S. banks -- including Bank of America and Goldman Sachs -- have been investing billions of dollars for a strategic foothold in China's financial sector. Before that, Amazon, CNET Networks, eBay and IAC/InterActiveCorp all made key investments in the Chinese Internet market. And now, there are rumors that Google -- armed with $4 billion from a follow-on public stock offering -- plans to go on a major Chinese Internet acquisition spree.

The lesson is clear: with China increasingly integrated into the world capital markets, both American and Chinese companies will attempt to allocate capital to the highest returns, irrespective of geography. As long as the U.S. and Chinese governments avoid meddling in the process, capital will naturally flow to the highest-yielding sources, pushing both countries to become more competitive and open. Distortions will only occur when governments attempt to erect protectionist barriers.

What's interesting is how the Chinese appear to be reacting to the influx of U.S. capital. Instead of whining about American control of strategic assets, they are embracing American know-how and American marketing muscle that will enable companies like Alibaba and Baidu to become future market leaders in China's burgeoning Internet sector. In the financial sector, government regulators view the arrival of U.S. banking institutions with a wary eye, but have thus far not attempted to derail Bank of America's $2.5 billion investment in China Construction Bank or Goldman's billion-dollar investment in China's Industrial & Commercial Bank.

For now, the Chinese realize that access to U.S. capital is the key to fueling future economic growth. Any wonder that Chinese Internet search leader Baidu (the "Google of China") turned to the NASDAQ stock market to raise capital via a hugely-successful IPO? That a number of other Chinese Internet companies -- including Shanda Interactive, Sina and Sohu -- have all sought to raise capital in the West rather than take their chances with under-developed, immature Chinese capital markets? In one day, Baidu earned a $4 billion valuation and raked in more than $100 million in cash to expand its Internet search operations. Would that have been possible in China?

The problems start when the politicians get involved. Take the dust-up over the hostile bid by CNOOC for Unocal. As TCS host James Glassman recently pointed out in "Deals and Demagogues," the CNOOC deal was nothing more than "a straightforward transaction -- one of dozens of billion-plus deals each year that involve global corporations." That it happened to involve China was the point that stuck in the maw of politicians. The deal inevitably attracted politicians and their meddling as they took their case to Capitol Hill, with some demagogues calling CNOOC a "front company for the Chinese communist government." What does that make Google and Yahoo, then? Using a similar (lack of) reasoning, should the Chinese consider Google and Yahoo handmaidens doing the bidding of the Bush administration?

Let's hope that the Chinese don't overreact to the recent wave of American investment in the country by erecting barriers to capital flows. There are already some troubling signs when it comes to the Chinese financial system, where the Chinese are finding it difficult to compete with foreign players. There is always the risk that the Chinese government will attempt to meddle with the reformation of the banking sector, especially before the Chinese banking sector is officially opened up to foreign investors in 2006. In the Internet sector, firms like Yahoo and eBay have already struggled with China's highly regulated Internet market, which places strict controls over Internet control and ownership. For now, most U.S. tech companies have preferred the route of indirect investment as a way to minimize the risk of government interference in the Chinese market.

There is no reason to fear the globalization of capital markets or the rise of China as a potential buyer of U.S. assets. In open, competitive markets, capital should always be allowed to flow to the highest-yielding sources. The integration of China into the global capital markets, if transparent and unimpeded by political interference, is a welcome development.

The author writes for TCS about business, technology and venture capital markets.


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