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Here We Go Again

George C. Fisher

I’m not sure most investors noticed a bit of intriguing news last week. There is a fascinating trend emerging that will impact the economic and investment horizon for the next decade. All I can say is: “Here we go again.”

During the late 1970s and into the 1980s, Japanese manufacturers were gaining a foothold in American markets. Automobiles, steel, and electronics were a few of the industries that experienced successful competition from Japanese firms. As the US economy imported higher amounts of Japanese products, our trade deficit exploded and a huge outflow of US dollars ended up in the hands of the Japanese. They invested their newly earned US dollars in our Treasury bonds, recycling their profits back into America . In addition, they bought real estate and entire companies. For example, Mitsubishi Estate Company purchased 80 percent of Rockefeller Center and Sony purchased movie studios Columbia and Tri-Star Pictures. Between 1980 and 1991, direct foreign investment in the US by Japanese firms skyrocketed from $36 billion to $353 billion. Giddy with their new found wealth, there are abundant stories of irrational exuberance as the Japanese became international players for the first time since the 1940s.

Fast forward to 2005.

The US has another huge trade deficit, but this time with China . As we all know, Chinese manufacturers have a developed a significant presence in many of our domestic markets. Just as the Japanese built up excess US dollars in the 1980s, the Chinese have done so early in this decade. In 2003 alone, Chinese firms sold $124 billion more in goods and services to US markets than they purchased from us. A growing trade imbalance has created gigantic amounts of Chinese capital that needs to be put to work. Just as the Japanese bought US companies and assets twenty years ago, the Chinese have announced their entry into major international acquisitions.

For example, Chinese computer manufacturer, Lenovo, recently announced an agreement to acquire the personal computer business from IBM for an eye-popping $1.2 billion. This represents the largest overseas acquisition by a Chinese firm. However, it was not the only deal in 2004. According to data compiled by Bloomberg, overseas acquisitions by Chinese companies surged 99 percent to $3 billion in the year to Dec. 20, from the same period in 2003.

The US is not the only country to see increased Chinese direct investment. Companies such as Sinochem, China 's biggest chemicals trader, are buying assets abroad to feed surging domestic demand for natural resources. Sinochem paid $553 million for Inchon Oil Refinery of South Korea last September and is believed to be planning to buy more overseas assets in later this year. Shanghai Automotive Industry purchased a stake in Ssangyong Motor of South Korea for about $500 million in October.

If the Chinese devalues their currency (Yuan) in mid-2005, as widely expected, we could see an up tick in direct investment in the US . A currency revaluation will make Chinese goods more expensive in the US , but will also make US assets less expensive in Chinese currency. If the decade old fixed exchange rate of the Yuan to the Dollar is adjusted by 10 percent, US assets become corresponding cheaper, facilitating a new goal of building global Chinese companies.

According to Agnes Deng, a fund manager at Standard Life Investments in Hong Kong, “Chinese companies going to overseas markets will be a long-term trend starting now, and we're going to see more acquisitions like Lenovo and IBM. A revaluation of the Yuan would be a big bonus for them. A stronger currency would help China expand from a low-cost manufacturing hub into a base for companies with the global reach to compete with multinationals.” According to Chen Xingdong., Beijing-based chief China economist at BNP Paribas Peregrine Securities, " China doesn't want to keep exporting cheap toys and clothes. Global expansion is a stepChina feels it must take as its economy evolves."

The issue of Chinese acquisitions now focuses on the sensitive subject of oil and ownership of US domestic oil companies.

State-controlled group China National Offshore Oil Corporation (CNOOC) is considering a $13-billion bid for US-based oil group Unocal (UCL), a move that analysts said underscores the determination of Chinese energy companies to purchase assets overseas to power the country's fast-paced economy. The Financial Times in a report on Jan 5 said that China 's third-largest energy group is interested in taking over Unocal's Asian assets and requested a study on a takeover strategy of the entire California-based company. It is reported CNOOC would then sell all US assets, retaining the international operations of Unocal.

This is not the first international energy acquisition for the Chinese. In 2003, CNOOC paid $348 million for an Australian natural gas company. In November, 2004, CNOOC reportedly launched a bid to buy Canadian oil and gas giant Husky Energy Inc. from Hong Kong tycoon Li Kashing. In addition, the Wall Street Journal reported CNOOC is in multi-company negotiations to buy Canadian oil-sands assets in Alberta province.

I have read several articles that indicate CNOOC is particularly attracted to Unocal's oil and gas operations in Asia, including Indonesia , Thailand , Bangladesh andMyanmar .' CNOOC's has a growing string of LNG terminals in China and is keen to secure a long-term supply of gas. Most of Unocal's production assets in Asia are natural gas.

US investors are entering a new age. As our dollars flow into the hands of foreign countries and companies through trade and account deficits, some of those dollars are recycled back as foreign acquisitions of US assets. Now it’s the Chinese turn, and they are looking to buy our oil companies.

The report, if confirmed, would mark the most significant overseas acquisition by a Chinese company ever, well exceeding Lenovo's high-profile $1.75 billion buyout of IBM's PC business last month.

A potential agreement would also signal Beijing's concerns about energy shortages and a desire to secure new resources to fuel its booming economy, which grew at over 9% last year.

"It does play into the overall strategy to try and achieve growth even in a market that is not very favourable," said Scott Roberts, an analyst at Cambridge Energy Research Associates based in Beijing.

Detailed talks have yet to take place on Unocal and the Chinese group is reportedly also looking at other overseas targets, the Financial Times said.

Xiao Zhongwei, a spokesman for CNOOC, refused to comment on the report, saying only that the company was looking to expand its business, as it had in a $348 million natural gas deal in Australia signed in 2003.

China 's largest oil companies, Sinopec, China National Petroleum Corp (CNPC) and CNOOC in the past aimed to accumulate a portfolio of separate production assets but that strategy has now changed, Roberts said.

Record high oil prices last year led to a reluctance on the part of many of the world's oil companies to sell assets piecemeal, especially oil and gas fields.

"Chinese companies are trying to grow quickly and going for a big bag approach is another way to do it," Roberts said.

As the world's second-largest oil consumer after the United States , China has been a net importer of oil for the last 10 years as domestic supply fails to keep up with soaring demand.

It is reliant on overseas producers for one third of its supplies and in turn accounts for about 7% of world oil demand.

At the government's urging, Chinese oil and gas companies have over the last few years scoured the globe in hopes of tapping new energy sources.

Chinese oil demand is expected to keep growing at or above forecast economic growth of 8% this year, Zhang Xiaoqiang, vice-chairman of Chinas National Development and Reform Commission, said on Thursday.

but it was not the only mainland company looking at the under-performing US oil entity.

"A number of Chinese companies have been thinking about this deal for a while," Roberts said.

Buying all of Unocal, which is valued at about $11 billion and at the end of last year was carrying debt of $2.68 billion, could prove financially challenging for China 's largest offshore producer.

However, the Chinese group, whose market value is around $21.5 billion and had some $1.6 billion in cash at the end of 2003, could count on state backing for financial help, the newspaper said.

CNOOC, China 's third biggest oil and gas group, is considering a bid of more than $13bn for its US rival Unocal in a deal that would mark the largest and most significant overseas acquisition by a Chinese company.

People close to the situation said the was interested in Unocal’s Asian assets and had asked bankers to study a takeover of the whole company followed by a subsequent sale of the US assets.

People close to the negotiations warned that they were at an early stage and detailed talks had yet to take place. It is understood the Chinese group is also looking at other overseas targets.

CNOOC’s plans are the latest sign of Beijing’s determination to push its flagship commodity companies to acquire natural resources to fuel the country’s rapid industrialisation and economic growth.

Chinese oil demand is expected to keep growing at or above forecast gross domestic product growth of 8 per cent this year, Zhang Xiaoqiang, vice-chairman of China’s National Development and Reform Commission, said yesterday. CNOOC’s plans also underline the recent emergence of Chinese companies on the global merger and acquisitions stage, with private and state companies attempting to exploit their domestic strengths to expand overseas.

An acquisition of California-based Unocal would represent a change in strategy for China 's three oil majors CNOOC, Sinopec and Petrochina which have so far focused on buying oil fields and asset packages in developing countries.

Industry experts said buying the whole of Unocal, which is valued at about $11bn and had net debt of $2.68bn at the end of last year, would be difficult for CNOOC, whose market value is about $21.5bn and had cash resources of $1.6bn at the end of 2003.

However, the Chinese company would be able to draw on financial help from its state-owned parent China National Oil Offshore Corporation and on the proceeds of any sale of Unocal’s US assets, which accounted for an estimated 33 per cent of production and profits last year. (1 image)

China chases a global oil presence

By Richard McGregor, Enid Tsui and Andrew Yeh

The mooted takeover bid by China National Offshore Oil Corp, the country's third-largest oil and gas group, for Unocal shows little is off limits for ambitious Chinese companies in their search for secure resources.

But as with other Chinese acquisitions overseas, the possible USDollars 13bn deal raises questions about the prices mainland companies are willing to pay and their ability to manage the transaction and, later, the assets themselves. State-owned CNOOC, which has a listed arm in Hong Kong and New York, has asked bankers to study a takeover of Unocal, the ninth-largest oil company in the US , to be followed by the immediate sale of its US assets. Although progress is at a preliminary stage, foreign energy executives, who judge CNOOC to be the best of China 's state energy groups, said yesterday the company should not be underestimated. CNOOC had been looking at Unocal's assets in Asia, in countries such as Thailand , Indonesia and Myanmar for some time, these executives said, and had the balance sheet to handle such a large transaction.

But China's strategic search for overseas resources and its own rising short-term demand is driving up prices for oil and other resources, and providing an incentive for the present owners to hang on to their assets. "Chinese companies are finding overseas acquisitions difficult because of the high oil prices, so not a lot of assets are for sale . .. as it's more practical to hold on to them," said a Beijing-based energy consultant.

David Hurd, the head of energy research at Deutsche Bank in Hong Kong, said the Unocal acquisition appeared to be a lot more expensive than CNOOC's previous purchases. By his calculations, the US group has an enterprise value per barrel of the equivalent (EV/BOE) of US$ 7.71. CNOOC paid $1.98 in EV/ BOE for its stake in Australia 's Northwest Shelf gas project, and $0.98 in EV/BOE for raising its stake in Indonesia 's Tangguh LNG project last month.

Lawrence Lau, the oil and gas analyst at the Bank of China (HK), agreed that, based on initial reports, the price tag could be too big for the company. It would be best, he said, if CNOOC sold the non-Asian assets back-to-back, as it is believed to be planning to do, to ease the financing pressures. CNOOC's overseas-listed vehicle, along with its parent company, has a growing string of LNG terminals in the mainland and is keen to secure the long-term supply of gas. Most of Unocal's production assets in Asia are gas.

"But the realisation value of gas is low, especially in today's high oil price environment," Mr Lau said. "And given that there may be other bidders out there, Unocal may prove to be a very expensive purchase by CNOOC." CNOOC's possible purchase of Unocal also represents a new approach for Chinese oil companies in that it would not just be acquiring single oilfields but an extensive regional network.

This trend will accelerate if oil prices decline because companies abroad will become less valuable and some smaller operations may struggle for profitability, said the Beijing-based analyst. Each new Chinese deal overseas also ratchets up the global political dimensions of such purchases.

With China reportedly preparing to sign a framework agreement for investment in Canadian resources this month, including the oil sands project in Alberta, Chinese investments have roused debate in Ottawa about the sale of strategic assets.

The purchase of Unocal would be the first by the Chinese of a large, listed resources company, and might attract the attention of regulators and oliticians.

George C. Fisher is a 30-year veteran in DSP/DRIP investing. He is author of All About DRIPs and DSPs (McGraw Hill, 2001) and The StreetSmart Guide to Overlooked Stocks (McGraw Hill, 2002). Mr. Fisher is an avid dividend reinvestment advocate and utilizes the strategy with all dividend paying stocks, both at the broker and direct with the companies using their DRIP programs.


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