F&P Quarterly – What about China?

Continued growth or an impending crash? The image of China as the obvious future market for Swedish companies has recently come into question. Instead, concerns are being raised regarding China’s crackdowns on foreign companies, weak real estate market and lack of focus on sustainability.

For this edition of F&P Quarterly we have met with Frédéric Cho, independent China advisor and author of the book China according to Cho, to discuss the situation for Swedish companies in China, how exposure to China affects the stock market’s view of a company and what Chinese institutions are like as investors and owners.

How would you describe the situation in China today?

”Even if there is more cause for concern today, there are still significant opportunities in China. It all depends on how you view the country.  Production in China has become increasingly expensive, but that also means there is a growing middle class and a fast growing customer segment in demand of higher quality goods. Companies that look at China as a market rather than a production site can benefit from this development. Chinese companies are reforming to focus more on quality than quantity, driven by more conscious consumers”, says Frédéric Cho.

”If you look at Swedish companies with successful operations in China, a lot is pointing towards a continued positive development going forward. Companies such as Sandvik, Atlas Copco, SKF, Elekta and Gambro have all worked consistently and long-term, which has awarded them enough experience and knowledge to handle potential changes in market conditions. The products offered by these companies are considered “state-of-the-art”, i.e. quality products that will become increasingly in demand in China.”

“Furthermore, Swedish companies have the advantage over their Chinese competitors of operating in an international market. This creates an opportunity to access the fast growing customer segment in demand of higher quality goods by identifying partners or potential acquisition candidates in need of international experience.”

How does the stock market factor in a company’s exposure to China?

“In the long term, the stock market’s view on China is cyclical. The current view is somewhat pessimistic, partially driven by excess capacity in the real-estate sector and tendencies of falling real estate prices. This could also become a burden for the Chinese banking sector. There are also concerns regarding the political situation domestically, with changes within the communist party, and China’s geopolitical role, not least its relations with Japan and the U.S.”

“There is, however, a risk that the stock market is too focused on China’s macro-challenges and misses out on its micro-possibilities. I believe analysts have to look at China’s development on two levels. Macro-level development is one thing, development on company-level is another”.

Sustainability has become an important factor for analysts and portfolio managers. The sustainability dimension is also hard to disregard when you discuss China as a market and production location. How should foreign companies with Chinese operations relate to this?

“A company has no choice but to become best in class when it comes to sustainability. You have to scrutinize all parts of the value chain and be certain that all suppliers, producers and agents are acting in a coherent and satisfying manner. Swedish companies must be able to provide answers to all possible questions. It is a challenge, but several Swedish companies have already come a long way with this. “

China has made a transition from being on the receiving end of foreign direct investment to becoming the world’s third largest outbound investor today. With China becoming more outward looking – what are Chinese players like as investors and owners?

“Simplistically you could say that there are two types of Chinese investors – one group with international experience and one which is off trophy hunting rather than seeking positions as responsible owners. The first group includes the state-owned investment funds CIC and SAFE, which acquire small positions in foreign companies as it generates good returns and an opportunity to get to know the company. Another example is Geely and its acquisition of Volvo Cars. Although this could be regarded as a trophy, Volvo is of such great importance for Geely and the government in Beijing that anything but long-term and responsible ownership is out of question.”

“The other type of Chinese investor is less familiar with western ways of doing business and tend to want full control of a company. They also tend to want too much too soon, blinded by China’s high pace of growth. However, Chinese companies are becoming more understanding and it is highly likely that we will see more deals coming through with Chinese on the buy-side.”

How does the market react to Chinese ownership?

“It is still relatively unusual that Chinese investors take substantial positions in foreign companies. It is therefore difficult to make any general conclusions. These types of transactions are however becoming more common so the questions will become more relevant over time. A good example is Dongfeng and its acquisition of a large position in Peugeot earlier this year. The market’s view on Peugeot has not changed significantly as a result of that.