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Asia-PacificJanuary 4 2016

Chinese investors take aim at UK

China's outward direct investment will outpace foreign direct investment in the country for the first time in 2015. Stefania Palma maps where this investment is going in the UK.
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Chinese investors take aim at UK

Chinese outward direct investment (ODI) is set to outpace foreign direct investment into the country for the first time in 2015, underpinning China’s long-term shift from recipient to funder. Chinese investors are also jumping into new sectors and countries. Where they once prioritised commodities-rich, less developed markets, now increasingly sophisticated Chinese investors have started targeting the services industry. This is in turn pushing them into more advanced markets.

So in the case of the resource-poor, economically advanced UK, which sectors are Chinese investors moving into? Investments in UK firms such as private equity firm Resolution Property, scientific instruments-maker Kore Technology, cereal maker Weetabix and high street retailer House of Fraser show China’s range of interests in this new investment wave.

New-style investments require new types of managements and Chinese investors have ditched their traditional autocratic management style in favour of a more hands-off approach. They are also prepared to invest for the long-term and wait for results. In the UK, where government funds for research and development (R&D) are scarce, Chinese investment has in some cases filled the funding gap normally undertaken by the public sector.

Outward investment boom

Growth in Chinese ODI has been impressive. Only in 2003, volumes were relatively insignificant at $3bn. Consultancy EY predicts numbers will have grown to $128bn in 2015 – $6bn above inward foreign direct investment in the same year.

This strong rise is due to a combination of factors. During the subprime crisis, the Chinese government pumped enormous amounts of money into the economy to keep the corporate and banking sectors afloat. This generated overcapacity that, coupled with sluggish demand, is the main drag on China’s economy and is eroding profitability in strategic sectors, according to Standard Chartered. ODI became a way to declutter China’s economy.

Growth in ODI is also down to China upgrading its economic model from an export-driven, low-end manufacturing hub to a consumption-driven, high-end manufacturer; as well as financial market liberalisation now making it easier for Chinese investors to go abroad. Overseas mergers and acquisitions (M&A) have also become cheaper for Chinese investors with a strong US dollar damaging the euro and pound sterling against the renminbi. Some analysts still see the renminbi as effectively pegged to the dollar.

Real estate soft spot

In the UK, if Chinese M&A focused on only five sectors in 2010, this number had grown to 12 by early December 2015, according to financial information group Dealogic. In addition to the conventional real estate and extractives sectors, Chinese investors have started focusing on retail, dining, food and beverages, and professional services.

But despite this clear diversification, Chinese buyers still have a soft spot for real estate. “At the core of their business philosophy and investment culture is the safety you get by buying property and the ability to do different things with it,” says Keith Pogson, global assurance leader of banking and capital markets at EY.

European office buildings offer yield pick-up compared with similar buildings in Asian cities. European and US property markets have been inundated by Chinese investors since 2012, when mainland insurers were finally allowed to invest overseas. The Chinese insurance industry spent about $15bn on overseas properties in 2014, according to realtor Knight Frank LLP.

In the UK, Ping An Insurance group, China’s second largest insurer, bought Tower Place, an office property in the City of London financial district, for $482m in 2015 and the iconic Lloyd’s building for $394m in 2013.

Some analysts argue that Chinese investors’ soft spot for real estate might also be driving investment in other sectors, meaning Chinese overseas investment could be less diversified than it appears. “Investments in sensible franchises with strong brand names also include a ton of real estate. A solar farm is built on land. House of Fraser owns a bunch of prestigious buildings all over the sleepy old UK countryside. If the investment goes horribly wrong, you can still fall back on a chunk of real estate,” says Mr Pogson.

Real estate appeal

In a sophisticated investment decision, Fosun Property, the real estate arm of conglomerate Fosun Holdings, acquired majority ownership of a joint venture with UK real estate private equity fund Resolution Property in July 2015. Fosun, whose group chairman, Guo Guangchang, went missing for four days in December,  also became the cornerstone investor in Resolution Property’s newest Fund V – the largest to date for the firm. The chairman, who has since reappeared, was assisting Shanghai authorities in an unspecified investigation.

This deal marks the first time Resolution Property has secured a sizeable cornerstone investor and an Asian partner, according to Scott O’Donnell, partner at Resolution Property. “This joint venture was very important to us. It’s a way for us to kickstart Fund V with a solid cornerstone investor and [for us to] go to the market from a position of strength,” he says.

The deal also shows how Chinese buyers are willing to offer financial backing to firms with strong expertise in attractive overseas markets. “Since Fosun is based in Shanghai, it was looking for someone who shared their same investment goals and philosophy but had local knowledge. This is a way for it to access the European property market,” says Mr O’Donnell.

Resolution’s portfolio focuses on distressed assets and commercial property in prime locations in London and northern Europe, which are bought, fixed and sold to institutional investors.

UK tech in demand

Technology is another historically key UK sector for Chinese investors, who are keen to import innovative technology to be modified for the mainland market. Chinese appetite for foreign technology could drastically change the fate of Cambridgeshire-based Kore Technology – a 12-person producer of mass spectrometers. These instruments identify atoms by measuring their mass and can be used for medical diagnosis or for gauging air pollution.

Beijing SDL Technology, a Chinese manufacturer of analytical instruments and environmental monitoring systems, bought 51% of Kore Technology in 2015. Until then, the company's clients were mostly UK research institutes. Now, Beijing SDL is selling Kore’s instruments for air pollution measurement to environment protection agencies across cities in China – the world’s biggest polluter. 

“For us, this could be possibly huge. We normally sell 10 of these instruments a year. Beijing SDL looks to sell hundreds per year,” says Barrie Griffiths, chairman at Kore Technology. “We realised that if we wanted to bring our tech to a wider market and grow further, we needed to get in with a larger instrument company that had the marketing and manufacturing muscle of a large firm.”

Beijing SDL, whose turnover is 100 times bigger than Kore’s $2m-plus annual mark, will provide unprecedented R&D investment in exchange for the UK company's technology. “To them, we are their UK-based R&D centre,” says Mr Griffiths. Once production for the Chinese market moves to the mainland, Kore Technology will receive payment in royalties.

Beijing SDL also plans to support Kore Technology’s recruitment efforts as it starts coping with its first Chinese orders. It will also help increase production for the US and European markets, which will remain and be mostly managed in the UK.

In the UK, entrepreneurs frequently complain of a lack of government support for R&D and start-ups compared with the funds available in countries such as the US. Kore Technology did receive some tax breaks but they were insufficient to meet all the company's funding needs, according to Mr Griffiths. This gap has now been filled by Beijing SDL’s investment.

Tucking into Weetabix

The Beijing SDL deal involving a small UK firm highlights the breadth of Chinese investment in the country. At the other end of the spectrum, Bright Food, China’s second largest food manufacturer, bought 60% of Weetabix – the UK’s second largest manufacturer of cereals and cereal bars – for £1.2bn ($1.8bn) in 2012.

This transaction also underscored Chinese investors’ appetite for well-known, top-quality brands they can support financially and bring back to China’s enormous consumer market. This rings true especially in the context of China’s food industry, which has been hit by scandals such as the 2008 toxic infant milk scandal, which caused the deaths of six children.

“Bright Food was looking to expand globally by investing in a well-known business like ours. It also got to learn about innovation, food safety and quality and technological capabilities,” says Giles Turrell, chief executive at Weetabix.

To Weetabix, Bright Food is the entry ticket to China’s market. “[Bright Food] has been our most valued partner on the ground as we look to expand in China. It knows the market and understands the consumer.” Weetabix is targeting cities such as Shanghai, Guangzhou, Shenzhen and Nanjing through a distribution network built with Bright Food’s help. Bright Food has 3000 stores in the Shanghai region alone.

“We see opportunities in China’s major cities, where there is modern retail, a more diverse and probably better educated population that has travelled overseas and understands our product,” says Mr Turrell.

Weetabix’s next goal is to build its own e-commerce platform for the Chinese market, which is very receptive to online buying. The cereal maker already experienced success during China’s singles’ day, a festival on November 11 celebrating being single. In recent years, online retailers – led by Alibaba – have turned this into the world's biggest online shopping event through sales and strong marketing campaigns.

Beyond China’s borders, Bright Food signed off key investment capital to expand Weetabix’s two joint ventures in eastern and southern Africa. “That’s what you look for from good investors. [Even though] it may take a few years for payback [to materialise], it sees the opportunity of growing business,” says Mr Turrell.

House of Fraser’s open door

As with the investment in Weetabix, Nanjing Xinjiekou Department Store’s (Nanjing Cenbest) takeover of Highland Group Holdings – the holding company of historic luxury UK retailer House of Fraser – is an example of Chinese investment in strong UK brands and in the more sophisticated services sector. Conglomerate Sanpower is the largest shareholder in Nanjing Cenbest – China’s oldest department store.

Before the 2014 deal, House of Fraser was considering an initial public offering to refurbish UK stores, grow its online platform and expand overseas. Sanpower was simultaneously in talks with the retailer to open franchises in China. “Sanpower understood the value of bringing a quintessentially British brand to the Chinese market and finally decided to acquire House of Fraser,” says a source familiar with the matter. Nanjing Cenbest will invest £150m in House of Fraser to accelerate growth in the UK, Ireland and overseas, and to develop the retailer’s e-commerce platform, says the source.

On the back of this acquisition, House of Fraser is building three stores in China, including one in Chongqing. The first store is set to open in late 2016. To mark further collaboration, Chinese brands might be added to House of Fraser’s conventional retail selection, says the source.

Hands-off management

So, as the flow of Chinese investments into the UK grows in volume and scope, how are these investors managing their target firms, post-M&A? According to popular belief, Chinese investors keep a firm grip on firms they buy. But analysts and the companies interviewed by The Banker tell a different story.

“Chinese investors have generally been quite hands off,” says Mr Pogson. “They have been more sophisticated versus the Japanese in recognising when integration makes sense and when it doesn’t. Their approach is more about getting involved slowly, maybe put a few people on the board and a finance guy or a [chief financial officer] to control finances. There are times when you think: ‘Are they too hands-off?’."

It is true that Chinese investors are driving UK firms’ expansion in China. But this is down to their competitive advantage on their home turf and not due to an aggressive management culture. Growth outside China's borders is still spearheaded by UK firms themselves. Each player simply focuses on what it is best at.

Even a small firm such as Kore Technology has not experienced management changes, save for two non-executive directors appointed by Beijing SDL. At most, some Beijing SDL workers will come to the UK for training. “Nothing else has changed. We just send management accounts on a quarterly basis. [Beijing SDL] almost has a ‘what do you need?’ approach [with us] for research money or resources. It is prepared to invest in new technology – it is not as cautious as European firms,” says Mr Griffiths. In his view, an American investor might have been more prone to revolutionise the firm quite quickly.

Fosun Property is also leaving Resolution Property’s investment strategy and management untouched. “The whole point was for nothing to change [at our end],” says Mr O’Donnell. “Fosun just sends a few [London-based] people to our offices a few days a week and they come with us to look at property…They realise they are not property experts in London, but they also want to make sure we maintain a link.”

Even larger firms such as Weetabix and House of Fraser do not feel overtaken by their Chinese investors. Weetabix’s Mr Turrell says: “I am still the CEO. Bright Food, like [private equity firm] Barings [which bought the retailer’s remaining 40% stake from peer Lion Capital in 2015] has seats on the board and Bright Food also has a non-executive presence, which works normally.”

Weetabix is also overseeing the China business set-up. It sent a senior member of staff to Shanghai for the occasion and to recruit a local general manager, who now reports into one of Mr Turrell’s directors.

By contrast, Chinese management typically makes itself felt in strategic sectors such as extractives. “For investments in Africa’s oil assets, the Chinese typically send in all their guys to take control because they do not have much confidence in local management; and these are very big investments in extractives. In many parts of Africa it has left an unpleasant taste,” says Mr Pogson.

In the UK’s case, Vatukoula Gold Mines, owner of the largest gold mine in Fiji, now headquartered in the South Pacific island, sold 54.7% of its shares to Zhongrun International Mining in 2013. The board is now entirely made up of Chinese staff.

Chinese investment in the UK is growing both in volume and in breadth as China upgrades its economic model and looks to digest overcapacity through ODI. Chinese M&A deals in the UK illustrate how investors are diversifying away from the classic real estate and technology sectors into services. Finally, Chinese investors have passed the ultimate litmus test for a mature approach to ODI – their laissez-faire management style is leaving target UK firms, analysts and market participants pleasantly surprised. This can only be laying the foundations for more Chinese ODI to flow into the UK economy in future.

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