The China temptation: are Western investors being foolhardy?

• Author: Malmgren, Philippa

Do you believe that the best business managers in the world are the communist leaders of China? Most investors seem to think so. Billions of dollars are being thrown at firms in China that are either directly controlled by the Politburo or subject to micro-management by politicians to some degree or another. After all, who decides whether the state-owned banks will make capital available to businesses that are engaged in construction or those that are involved in supplying auto parts? Who really makes the decision to invest when Chinese state-owned or state-backed firms start to engage in foreign deals or make acquisitions of a foreign company? That would be the Politburo.

Of course many state-owned firms have been given a high degree of autonomy in their management of the balance sheet. But we cannot ignore that fact that Chinese companies have become the darlings of the mergers and acquisitions professionals. When a Chinese state-owned firm announces its intention to expand internationally or acquire a foreign firm, the order comes from Beijing. These firms do not want their investment banking advisors to prepare any cash flow analyses or profitability parameters because those tasks are plainly irrelevant. The point is simply to identify the price at which the deal can be done. No deal is too risky and no price is too high to pay if Beijing has ordered it to happen. That means fantastic fees for the advisors (with very little work) and it should raise some questions about the use of capital.

Perhaps we should also be asking about who these decision makers are and what they know about investing. It seems that only one member of the standing committee of the Politburo (where all the instructions come from) has any market experience or any international experience. Happily we can all be reassured that comrade Luo Gan was educated in engineering at the Karl Marx University in the former East Germany where he then spent eight years working in a steel factory. Unfortunately, this reservoir of market experience is now being deployed on "interior" matters rather than asset allocation decisions.

Let us consider Beijing's priorities. Obviously, there is an overwhelming need to secure access to oil, raw materials, and even food. Strategic security priorities are driving the allocation of capital. Consider Beijing's offer to build an oil refinery for Mr. Chavez in Venezuela. Or, consider the efforts by China to become the largest buyer of oil from Iran. The Iranian oil minister has welcomed China's efforts and said that Iran is glad to see China...