In mid-August Australia’s mining tycoon and newly elected Member of Parliament Clive Palmer caused outrage when he referred to a Chinese company he is in dispute with as “mongrels” on live TV.
The dispute centres on China’s largest Australian investment, Palmer’s iron-ore mine in Western Australia. Chinese investor CITIC Pacific offered what Australian financial media described as “extraordinary” concessions: agreeing to pay high mining fees and cover the cost of building ports, roads, desalination plants and power stations, which would then be owned by Palmer’s company, Mineralogy. This was described by the Financial Times as “the business opportunity of a lifetime”. But progress on the project has been badly delayed and spending has gone five times over budget. CITIC Pacific has suffered significant losses.
Palmer wrote a letter to the Chinese embassy in Australia apologising for his remarks. But it is clear the Chinese firm’s offer did not earn the respect it should have. This is a phenomenon seen in many of China’s overseas investments.
chinadialogue spoke to Edwin Lee, a lawyer and overseas investment consultant, to find out why no one likes Chinese companies.
Zhang Chun (ZC): What image do Chinese companies have overseas?
Edwin Lee (EL): The main aspect of Chinese overseas investment today that makes host nations nervous is too strong a focus on obtaining resources. The issues reported in the media – pollution, poor community relations, a failure to use local labour – are all results of Chinese companies taking an unsuitable approach.
This is very similar to when Japan started investing overseas. But now Japan has changed its strategy, to good effect. It’s a stage that can’t be avoided when countries start to expand overseas. All China can do is make sure it’s as short a stage as possible, and that overall the country doesn’t look too bad.
Of course, some of the bad publicity is a result of biased reporting in the media. For example in late August chinadialogue published an article on copper mining in Peru, in which the author said that China’s demand for copper was causing increased pollution there. That’s not the whole story. The copper ore is being exported to China, but it ultimately gets processed into finished products by manufacturers, some of which are foreign firms operating in China, and shipped to third countries. Part of the profits goes to European and US firms, and consumers worldwide benefit. China is just a part of the chain, and what’s more it also suffers from the resulting pollution.
ZC: What causes China’s overseas investments to fail? Are the companies not good enough? If not, in what way?
EL: There are a lot of reasons, and the failings of the companies are a big part of it. Mainly it’s a lack of experience in doing business: in overseas operations, and in investment concepts, strategies and methods.
Take legal issues as an example. In some countries lawyers or consultants are able to provide the legal knowledge that decision-makers need. But those decision-makers often ignore legal matters or give them little thought. They stick to the usual Chinese methods, relying on relationships and personalities. Also, as I mentioned, too much focus on their own aims will create major problems for later cooperation.
About 30% of China’s overseas investments fail in this manner.
Another problem is companies blindly accepting what they are told by overseas partners. For example, in mining, many companies fail to employ local geologists to provide expert advice – they wait until the investment is complete, then discover there’s nothing worth mining. That’s a problem with procedures and experience. Costs that should be paid to third parties aren’t, and as a result the investment fails.
When you don’t know how things work overseas you need financial consultants, tax consultants, environmental consultants, legal consultants, even HR consultants. You could blindly invest hundreds of millions of yuan and have your project fail. But employ consultants and you pay set costs, maybe 10 million yuan depending on the project, and you’ll know what you should be doing, and whether you should invest or not. Even if you train your own people, you can avoid a certain amount of risk. It’s worth the cost.
Of course, how China invests is tied up with the fact that state-owned enterprises have plenty of cash on hand. The government started encouraging firms to expand overseas, so there was a political demand there, it was part of how government officials were assessed. That meant there was a strong motivation to invest, but not much careful consideration.
ZC: Are there any successful case studies? What’s your view of those experiences?
EL: There are. Sinosteel’s Channar project in Australia, which again is about supply of ore, is one example. Sinosteel isn’t much involved in the running of the mine, it just made the initial investments. So far it is the only Chinese mining investment in Australia which has successfully gone into production and brought large quantities of ore back to China.
In Zambia, the China Non-ferrous Metal Mining Group has a project mining, refining and processing copper, and it’s done very well for a Chinese company. It has plans for developing long-term in the area, including community-building, hydropower, employment, and it has built very good infrastructure. For the African mining sector, it’s quite a success.
Personally I prefer that kind of investment, where some of the jobs and taxes stay local, rather than just exporting the raw materials. The host nations don’t just want to sell the raw materials, they want some of the added value, and that’s the only way to keep the company, the government and the local community happy.
And for the company this is more sustainable. If you just take the raw materials it’s very easy for a new administration to halt your operations. If you have an industrial chain in place then cutting off your supply of raw materials means employees in the processing and manufacturing operations lose their jobs, which means the government will be more cautious.
ZC: Are changes to China’s overseas investment strategy and policy needed? How can we reduce the chances of failure?
EL: Some changes to policy design may be needed. One is incentive mechanisms. If the current system of encouraging overseas expansion doesn’t change and we continue seeking only ownership and control, it’ll be harder to succeed.
Another issue is the approach taken by state-owned enterprises. Officials in charge of SOEs are subject to evaluations, and are only in their posts for five years. That means they are unlikely to undertake large-scale prospecting projects which take longer than five years to come to fruition. Those projects only pay off after a certain length of time.
In terms of reducing failures, there are two aspects to consider.
First, in the host nation, at the very least you need to be in compliance, you need to follow the local laws and regulations. When Chinese firms invest in the US and other developed nations they bring in lawyers to make sure they don’t break local law. But in developing or undeveloped nations they don’t do so well.
Second, decision-making mechanisms need to change. There needs to be a more comprehensive examination of various issues at a very early stage. For example, output from some projects is restricted as the infrastructure isn’t in place: there’s no railway or no port. If you build those yourself what was meant to be a 100 million yuan investment could cost 10 times as much and the return on investment takes much longer. It’s not something a single company can undertake alone. All the different costs need to be considered.
This all needs to be learned. Investment approaches up to now have been too costly. SOEs have often suffered large losses, and are more likely to fail than private firms. Private firms are spending their own money and so are more cautious.
Investors from other countries also fail when working overseas, but more often due to economic factors – for example, because fluctuations in commodity prices mean costs can’t be recovered – rather than due to internal decision-making processes, lack of experience or a failure to use consultants.
Chinese companies do have some failures to address. For example, they tend to share their successes, but never mention any failures. But it’s the failures which are most valuable and most worth learning from.
One more: don’t jump on bandwagons. That’s a major reason for investment failures in recent years. Often two Chinese firms are competing for the same project and that creates a lot of losses. Companies need to be realistic and only expand overseas when they actually need to, rather than just following others.
Edwin Lee is an associate at Chadbourne & Parke LLP. He provides legal consulting services for overseas investment, primarily in the energy, renewables, mining and infrastructure industries