|Chinese are coming: C. Larry Pope, president and CEO of Smithfield Foods Inc., left, and Wan Long, chairman of Shuanghui International Holdings Ltd after acquisition (top); Michigan battery factory acquired by China’s Wangxia Group from bankrupt A123 Systems|
WASHINGTON: Much as Japan Inc. caused a sensation in the 1980s, acquiring prominent US companies and landmarks, Chinese companies are making their presence felt. Prior acquisitions range from AMC Entertainment Holdings, Inc., to the landmark Chase Manhattan Plaza in New York, and pending ones include IBM’s low-end server business and Google’s handset business. Despite a common perception of difficulties for Chinese investments in the US market, the total deal value hit a record $14 billion – double the amount in 2012 – and is only set to grow.
A key player at the center of future investment in the US is the little-known Committee on Foreign Investment in the United States, or CFIUS. The committee reviews certain inbound investments on national security grounds. As the investment relationship between the world’s two largest economies evolves into “a two-way street,” China Inc.’s interface with CFIUS is increasingly essential for policymakers and businessmen in both nations to understand.
CFIUS is an inter-agency committee chaired by the Department of Treasury and including members from eight other departments and offices. It operates pursuant to a 1988 amendment to the 1950 Defense Production Act that authorizes the president to suspend, block or otherwise modify transactions that could result in foreign control of businesses that threatens US national security.How Chinese firms fare under CFIUS review is an unknown as while CFIUS discloses the total number of firms that file with CFIUS each year, broken down by nationality and target sectors of investment, it does not disclose the outcome by country or individual firms which is often gleaned through press reports and corporate filings. The perception is that Chinese firms attract considerable CFIUS scrutiny. Indeed in 2012, Chinese investors accounted for the largest number of notices filed with CFIUS for review. Based on the latest CFIUS report to Congress, however, topping the list for review on a three-year basis are companies not from China but from the United Kingdom. Between 2010 and 2012, UK firms accounted for 21 percent of notices filed; Chinese investors accounted for 12 percent.
Chinese firms seeking to invest in the US are faring better than assumed with the CFIUS national review.
The volume and sophistication of Chinese firms looking to enter the US market is growing: CFIUS filings by Chinese investors more than doubled between 2011 and 2012, from ten to 23. So far the data suggest that Chinese firms are not grossly singled out. Should the US-China trust deficit deepen, further hurdles may arise as may an aversion to invest. For now, Chinese companies are faring better than assumed. Five transactions involving Chinese firms reflect a range of issues regarding CFIUS review:
Mitigate and Acquire: In January 2013, Wanxiang USA, a unit of Chinese auto-parts giant Wanxiang Group, was cleared to acquire the assets in bankruptcy of US lithium-ion battery maker A123. To allay concerns relating to Wanxiang potentially acquiring A123’s defense contracts and taxpayer-funded core battery technology that could be used to develop military applications, the company excluded military contracts from the transaction. Wanxiang’s experience underscores the role of mitigation agreements in enabling Chinese firms to proceed with investments in a manner that balances investment and security imperatives. From 2010 to 2012, 8 percent of cases, 24 in all, resulted in the use of legally binding mitigation measures. The ability to craft and consent to such measures to address concerns will become a key element for Chinese firms seeking to invest in the United States.
Although CNOOC had to withdraw and refile, its ultimate clearance is notable given opposition in Congress.
First you don’t succeed: The leading example of an unsuccessful Chinese bid in the United States is energy giant CNOOC’s bid for Unocal in 2005. The year the deal collapsed, volume for China-inbound deals fell from $2 billion and 11 deals to three deals totaling less than $1 million. In February 2013, however, CFIUS cleared the US component of the $15.1 billion acquisition by CNOOC of Nexen Inc., a Canadian energy company with a relatively small quantity of assets in the United States. Although CFIUS scrutinized the transaction closely and CNOOC had to withdraw and refile its voluntary notice, its ultimate clearance is notable given opposition in Congress, the national-security sensitivity of the energy sector and the prior blocked bid. CNOOC’s experience underscores the case-by-case nature of CFIUS review where even a firm with a fraught history involved in a sensitive sector may clear the CFIUS process in a subsequent go-around, lending credence to the review process.
Location, Location, Location: In contrast to Wanxiang and CNOOC, the acquisition by Ralls Corp., a Delaware corporation owned by two Chinese nationals, failed and ended up in unprecedented litigation. Ralls sought to acquire four wind-farm projects in Oregon without initially filing a notice with CFIUS. CFIUS halted the acquisition and, later, a rare presidential order mandated divestment due to the farms being “all within or in the vicinity of restricted air space at Naval Weapons System Training Facility Boardman in Oregon.” In the first direct challenge to the validity of a CFIUS order, Ralls brought a lawsuit against the committee and President Barack Obama in the US District Court for the District of Columbia that was dismissed. The Ralls case has implications for all investors relating not just to the limited legal recourse vis-à-vis CFIUS review but also to proximity of the target’s assets to sensitive facilities. Given that at least three Chinese investors have reportedly run afoul of the proximity issue, Chinese firms must contend with this factor, no matter how benign the investment target, given espionage concerns.
Huawei’s troubles underscore how mounting concerns regarding cyber activities spill into the investment domain.
Lost interest in the US: If Ralls’ unsuccessful bid had an unspoken undercurrent of espionage, Chinese telecommunications giant, Huawei, has contended with the issue upfront. In October 2012 the House Permanent Select Committee on Intelligence stated that CFIUS “must block acquisitions, takeovers, or mergers involving Huawei” given the founder’s links to the Chinese military. Huawei’s troubles underscore how mounting concerns regarding cyber activities are spilling into the investment domain. As part of securing Congressional support for Japan-based SoftBank’s acquisition of US mobile carrier Sprint last year, both parties had to pledge not to integrate Huawei equipment into Sprint systems. CFIUS approval was conditioned on the appointment of an independent member to the Sprint board to serve as a security director – a position filled by retired Admiral Mike Mullen. In the aftermath of the Sprint deal and on the heels of various derailed transactions, Huawei’s executive vice president announced “[w]e are not interested in the U.S. market anymore.”
Target sectors: The largest Chinese acquisition to date was last year’s $7.1 billion acquisition by Shuanghui of pork producer Smithfield Foods. Following the deal’s announcement, the question of CFIUS review arose and Smithfield’s CEO publicly made his company’s case: “[we]’re not exporting tanks and guns and cyber security…These are pork chops.” Although CFIUS approved the deal, three potential issues may have arisen: First, food security may have been seen through a critical infrastructure prism. The Department of Homeland Security which sits on CFIUS has defined 17 critical infrastructure sectors, including “Food and Agriculture.” Second, Smithfield reportedly had been a direct supplier to the Department of Defense, perhaps drawing scrutiny as a vendor with access to potentially sensitive information. Third, the proximity of any Smithfield facilities to military installations would likely have raised concerns. In addition to CFIUS review, both parties had to navigate congressional scrutiny with Smithfield’s CEO testifying before the Senate Agriculture Committee as to why the investment was not detrimental to US interests.
The Smithfield deal weaves together key themes from the experiences of Chinese firms seeking to invest in the United States in potentially sensitive sectors including congressional scrutiny and evolving areas of national security concern. These factors are causing firms like Shuanghui to proactively engage CFIUS and Congress, making the case for the merits of their investment while providing transparency and inflows.
While considerations unique to Chinese firms exist and frictions can rise in tandem with investment and a fluid strategic dynamic, the United States remains open for business.