The recent agreement on the sale of Serbia’s only steel mill Zelezara Smederevo to China’s Hebei Iron and Steel Group (HBIS) epitomises the wider trend of Chinese companies taking advantage of relatively low valuations to snap up European industrial assets.
In 2015, Chinese foreign direct investment (FDI) into EU countries reached a record €20bn, of which €7bn was from the year’s largest deal, ChemChina’s takeover of Italian tyre company Pirelli, according to think tank Rhodium Group.
The Chinese economy has slowed recently, an inevitable part of its transition from an emerging economy based on low-cost labour. Higher wages, coupled with the delayed effects of the recent global crisis, have caused growth rates to decline, while remaining well ahead of those in most developed economies at an expected 6.5% this year and 6.2% in 2017, according to the International Monetary Fund (IMF). This has contributed to the Chinese interest in a growing range of assets abroad.
“The government’s agenda is to invest abroad in order to fuel the Chinese economic engine, and notably to utilise the liquidity accumulated over the course of the past several decades to acquire the technologies that are still lacking in China,” write Philippe Le Corre and Alain Sepulchre in “China’s Offensive in Europe”, published by the Brookings Institute on May 17.
“The new realities of lower growth and transition to a new economic model explain Chinese investors’ focus on advanced industrial assets, modern services, and real estate,” says a report from Rhodium Group. “Beginning structural adjustment and growing volatility has increased the pressure on Chinese companies to diversify and gear up for even greater competition at home, which is fostering a greater appetite for international expansion and risk taking.”
While there have been some recent deals in Central and Southeast Europe - among them Zelezara Smederevo in April 2016 and the acquisition of Romania’s Petromidia refinery by China Energy Company Limited’s (CEFC) in May - this started as a West European phenomenon.
Chinese interest was initially focused on the “big three” economies - France, Germany and the UK - but has recently broadened to southern Europe, which accounted for almost half of China’s investment to the EU in 2015. In addition to the Pirelli acquisition, the region attracted other high profile deals such as Wanda’s investment in Atletico Madrid football club and Haitong’s in Banco Espirito Santo.
The picture is similar in the European real estate sector, where investment reached a record €8.5bn in 2015, according to a Cushman & Wakefield report. Chinese companies used to hone in on London, but here too they are diversifying - both in terms of property types and geographically. “There was greater investment in continental Europe. We see this trend continuing with Germany coming more into focus,” the report says.
China has also been a big investor in the US, but rising tensions between the superpowers and the greater openness of the EU market have led to a recent focus on European acquisitions. “American and Chinese strategic interests collide in a great number of domains, pushing China to turn its attention more widely to another part of the Western world,” write Le Corre and Sepulchre.
Germany is of particular interest to Chinese investors because of the potential for technology transfer, while other parts of Europe have a different rationale for investment.
“A lot of the deals in Germany and to some extent the UK were technology driven. This is a relatively cheap method to acquire technology,” says Bernd-Uwe Stucken, consultant at Pinsent Masons in Shanghai and founding member and director of the Asia Transformation and Turnaround Association (ATTA).
“However, this is not a motive for investments in Eastern Europe, which is mainly an opportunity to acquire cheap assets. Other European countries are more expensive but given the rise of the renminbi against the euro, Europe as a whole is good value for money.” The same is true for crisis-hit countries in Southern Europe such as Greece and Portugal.
HBIS bid just €46mn for Smederova, but plans to invest several hundred million euros in the mill, Prime Minister Aleksandar Vucic said after the sale contract was signed in April. After US Steel handed the company back to the Serbian state and a failed privatisation attempt in 2014, the HBIS deal is seen a critical for Serbia, given Zelezara is a major employer and one of the country’s top exporters. A revival of production could boost Serbia’s GDP growth by 1 or even 1.5 percentage points in 2017.
From HBIS’s side, the main motivation is likely to be the chance to export Chinese steel to the European market, according to Dragan Pavlicevic, visiting research fellow at the National University of Singapore’s East Asian Institute.
“China has a massive surplus capacity in steel. This is currently perceived as one of the toughest challenges for the Chinese economy,” he tells bne IntelliNews. “A part of the effort to deal with this surplus capacity is to develop and market some of that steel abroad. Zelezara buys iron ore from overseas and now is likely to start buying it, as well as semi-finished products, from China.”
Pavlicevic also expects that Chinese industrial companies in Europe and Chinese-financed projects in the region could provide a market for Zelezara’s products. Potential customers might include car manufacturer Great Wall in Bulgaria, the new high-speed Belgrade-Budapest railway and - assuming the CEFC deal goes ahead - the modernisation of Romania’s Petromidia refinery.
Stucken believes there is a similar rationale for Chinese investments into wind energy in the region. These include the $541.2mn deal signed between Romanian Paunescu Corporation and China’s Ming Yang Wind Power Group in 2013 to build a large wind farm in western Romania. OMV Petrom is also rumoured to be in talks over a potential sale of a Romanian wind farm to CEE Equity Partners, manager of the China-CEE Investment Cooperation Fund.
“Investing into a wind park in Southeast Europe means they can bring in Chinese producers of wind turbines,” Stucken says. This then gives Chinese turbine producers access to the European market.
Balance of power
Wind energy is just one of the areas within the sector where Chinese companies have invested. Under the Petromidia deal, CEFC, which is already active in Central Europe, will buy a majority stake in the refinery’s owner, KazMunaiGas (KMG) International, in a $680mn deal. KMG International says the probe recently launched by Romanian prosecutors will not affect the transaction.
Two new reactors at Romania’s Cernavoda nuclear power plant are also expected to be built under an agreement with China General Nuclear Power Corporation (CGN), while Chinese investors may also revive the stalled pumped hydropower storage project at Tarnita-Lapustesti.
Romania’s economy is the largest in Southeast Europe, but in smaller economies such as Bosnia & Herzegovina and Montenegro, the size of some recent Chinese investments are substantial compared to the overall economy. In Montenegro in particular, construction of the Bar-Boljare highway, which is mostly being funded by China EximBank, is currently the main growth driver.
This has raised questions about the influence of China on policymaking within countries that rely heavily on Chinese money - an issue in countries across the continent including the UK. Inevitably higher levels of Chinese FDI, especially into important power and transport infrastructure projects, means Beijing has greater clout with national governments. The fact that European governments are now competing for Chinese investment further alters the balance of power.
“This race for Chinese investment ... is contributing to a division between European economies over important policy decisions,” says the Rhodium report, citing the question of whether to grant China market economy status (MES) and negotiations on a free trade agreement with China. While the European parliament voted on May 10 to deny China MES, pressure is expected to continue.
There is some debate over whether China can continue to invest at such a rapid rate in Europe and other worldwide destinations.
Potentially, a deeper slowdown could mean less money to invest abroad. In particular the model where a Chinese state bank issues a soft loan for a large project, which is then contracted to Chinese companies - as seen in several SEE countries - could become less common.
“The Chinese debt problem [and] the slowdown could mean fewer soft loans and fewer investments in Eastern Europe as the renminbi falls and European assets become more expensive,” says Stucken. However, he adds that, “private companies are quite cash rich so they may continue to invest and diversify.”
Rhodium expects an addition $1trn of Chinese outward FDI in the next five years, while Cushman & Wakefield is also bullish, saying there is “little sign that the Chinese dragon is running out of puff”. It forecast that, “uncertainties at home are expected to drive further investment overseas as investors seek to diversify their holdings and spread their risk.”