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UPDATED: June 29, 2015 NO. 27 JULY 2, 2015
The Price of Good Investment
Are Chinese investors buying European companies at low costs?
By Mei Xinyu  

A Chinese consumer reads Club Méditerranée brochures during a promotion show in Shanghai. The holiday resort operator was sold to a Chinese company (CNS)

As China's outbound direct investment into the EU continues a path of significant growth, its European counterparts have raised questions regarding the validity of investment prices.

According to the 2013 Statistical Bulletins of China's Outward Foreign Direct Investment, China made $4.52 billion of direct investment in the EU in 2013. The Financial Times said in a report on February 10, 2015, that Chinese foreign direct investment into Europe hit $18 billion last year, quadrupling the 2013 level.

Against the backdrop of the European Central Bank conducting quantitative easing measures as well as a weakening euro, it is expected that direct investment from China and other countries will be stimulated, due to cheaper European assets and lower financing costs for acquisitions.

Since 2015, China's outbound investment has continued to grow, and Chinese companies have made two big acquisition cases in Europe. In early January, China's Fosun International Ltd. secured a deal to buy French holiday resort operator Club Méditerranée (Club Med); in late March, China National Chemical Corp. (ChemChina) purchased Pirelli from Italy, the world's fifth largest tire maker, for 7.1 billion euros ($7.98 billion).

European media sources have condemned Chinese investors' low-price purchases. The quantitative easing measure the EU is now using has created opportunities for external investors, including Chinese investors, to buy European assets at low prices, further amplifying such charges. For instance, Fosun's purchase of Club Med was interpreted as part of a political agenda by the public in France and aroused arguments, resulting in a lengthy merger case.

Is it true that Chinese investors are offering low prices or harsh terms? It goes without saying that the management teams of purchased European companies hold different views.

Club Med's management team had been hoping for acquisition by Chinese investors since they intended to sell the company. As for ChemChina's acquisition of Pirelli, the Italian tire maker considered it a worthwhile transaction and the best way to avoid dissolution of the company, and the negotiation gained the tacit consent of Italian Prime Minister Matteo Renzi.

Like it or not, as far as company acquisition, embracing Chinese investors may be the option that most favors the companies in question. It's impossible to ignore the fact that China is now an international tourist market with all the potential that goes along with it. In 2013, Chinese tourists spent $128.6 billion overseas, and in 2014, citizens from the Chinese mainland made more than 100 million trips to overseas destinations. Meanwhile, the European tourist market is dwindling. Club Med, for example, has encountered a business bottleneck in recent years, and the Chinese mainland market is able to bring it the growth it desperately needs. The business needs a Chinese investor to open the door to the Chinese market. Meanwhile, the Pirelli's Chinese investor can help the company gain a more favorable market position, as China has become the world's largest automobile producer and market.

From a business perspective, Fosun's purchase of Club Med and ChemChina's purchase of Pirelli will both be worthwhile to European host nations, because they will not suffer losses from these transactions.

It's easy to see from transaction prices that it is the Chinese who should be concerned about paying excessively high prices. In those transactions, Chinese buyers offered much higher prices than their rivals did.

At the first takeover offer in May 2013, Fosun offered a price of 17 euros ($19) per share, higher than the stock price of Club Med at that time. The ultimate purchasing price reached 24.6 euros ($27.7) per share, which was 45 percent higher than the price at the first takeover offer. When purchasing Pirelli, ChemChina paid a per-share price that was 23 times of Pirelli's price-to-earning ratio (P/E), while the stock prices of French tire maker Michelin and Korean tire maker Kumho were only 16 times and 11 times of their P/E ratios, respectively.

The concern should be that Chinese investors may offer exorbitant prices when purchasing European assets due to overvaluing the appeal of European assets to Chinese consumers. They may also overestimate the production efficiency of European manufacturing companies and underestimate the rigidity of the European labor market. As a result, Chinese investors may overestimate potential profit growth of the companies they want to buy and pay excessively high prices for the acquisitions.

When acquiring Club Med, the Chinese investor cited the fame of the French entertainment and leisure lifestyle as the reason for their confidence in their ability to transform such resources into real profits. They may believe that these results would follow the growth of Chinese tourist consumption. However, as China's economic power improves and more Chinese travel abroad, will they still be willing to pay for Western tourist services at a price much higher than the average level in their domestic market?

In the case that ChemChina purchases Pirelli, we should never underestimate the damage caused by the rigid European labor system to labor productivity.

In 2013, Maurice Taylor, CEO of U.S. tire maker Titan, said, "The French workforce gets paid high wages but only works three hours [a day]." He went on to say that his company would be "stupid" to take over an ailing French factory.

Why does the unemployment rate in Europe remain high? A labor system featuring high pay and inadequate flexibility should be blamed. It weakens the international competitiveness of European industries, and European companies still competitive would rather outsource their production than investing in their home countries to avoid labor disputes.

Many wise men inside and outside the EU have recognized this, but the European elites and public alike have become accustomed to this type of work system. They not only lack originality but also criticize those who—ironically—criticize them. Taylor's words, for example, provoked an outrage in France, which offered no solution to their problem.

Investment failure due to over-optimistic—or uninformed—expectations has sadly become a common occurrence. After years of huge losses, Japanese investors had to sell New York Rockefeller Center; in 2006, Chinese company CITIC Pacific spent $415 million purchasing two iron mines in Australia but suffered losses because of sharp decline of iron ore prices.

China's outbound direct investment will certainly benefit both the home country and host countries. We agree that Chinese investors should pay reasonable prices and hope that the investors should not be over-optimistic.

Copyedited by Kylee McIntyre 

Comments to yushujun@bjreview.com

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