June 24, 2005

China on the Prowl: CNOOC Bid for Unocal Must First Overcome Chevron

Unocal Targeted by Chinese Oil Company, CNOOC, Challenging Former Bidder Chevron

China's $700+ billion current account surplus is calling out for application to something besides U.S. bonds, so the Chinese state-controlled offshore oil company is bidding to buy Unocal. The $18.5 billion unsolicited takeover proposal is $1.5 billion more than Chevron's proposed deal to buy the company, but analysts think Chevron's offer has other advantages (like not being Chinese) and will ultimately prevail... unless there's a bidding war:

    One of China's largest state-controlled oil companies made a $18.5 billion unsolicited bid Thursday for Unocal, signaling the first big takeover battle by a Chinese company for an American corporation.

    The bold bid, by the China National Offshore Oil Corporation (CNOOC), may be a watershed in Chinese corporate behavior, and it demonstrates the increasing influence on Asia of Wall Street's bare-knuckled takeover tactics.

    The offer is also the latest symbol of China's growing economic power and of the soaring ambitions of its corporate giants, particularly when it comes to the energy resources it needs desperately to continue feeding its rapid growth.

    CNOOC's bid, which comes two months after Unocal agreed to be sold to Chevron, the American energy giant, for $16.4 billion, is expected to incite a potentially costly bidding war over the California-based Unocal, a large independent oil company. CNOOC said its offer represents a premium of about $1.5 billion over the value of Unocal's deal with Chevron after a $500 million breakup fee.

    Moreover, the effort is likely to provoke a fierce debate in Washington about the nation's trade policies with China and the role of the two governments in the growing trend of deal making between companies in the countries.

    This week, a consortium of investors led by the Haier Group, one of China's biggest companies, moved to acquire the Maytag Corporation, the American appliance maker, for about $1.3 billion, surpassing a bid from a group of American investors.

    Last month, Lenovo, China's largest computer maker, completed its $1.75 billion deal for I.B.M.'s personal computer business, creating the world's third-largest computer maker after Dell and Hewlett-Packard.

    After years of attracting billions in foreign investment and virtually turning itself into the world's largest factory floor, China appears to be nurturing the growth of its own corporate giants into beacons of capitalism. China wants to be a player on the world stage, and it is eager to have its own energy resources, its own multinational corporations and its own dazzling corporate names.

    And some of China's biggest companies are now on the hunt, trying to snap up global treasures.

    "If there's an asset up for sale anywhere in the world, people are looking to China, particularly if there's a manufacturing element involved," said Colin Banfield, who runs the mergers and acquisitions practice at Credit Suisse First Boston in Asia. "And if these two deals go through this year, no one is going to doubt the credibility of the Chinese corporates when it comes to M & A."

    The deal making and bidding wars are all the more remarkable because they involve Chinese companies taking on American multinationals in a series of transactions certain to be a boon for Western lawyers and investment bankers, many of whom have been betting hundreds of millions of dollars on China's rise.

    Indeed, CNOOC is being advised by an army of bankers from Goldman Sachs, J. P. Morgan Chase and N M Rothschild & Sons of Britain.

    In a response, Unocal said in a statement that its board would evaluate the offer, but that its recommendation of the deal with Chevron "remains in effect."

    CNOOC's bid faces an uphill battle, with hurdles that probably rise above those usually confronting a corporate bidder. Already, lawmakers in Washington are questioning whether the Bush administration should intervene to block the bid for Unocal, which was founded in 1890 as the Union Oil Company of California.

    Two Republican representatives from California, Richard W. Pombo and Duncan Hunter, wrote a letter last week to President Bush, after speculation concerning the deal arose, urging that the transaction be scrutinized on the grounds of national security.

    They wrote: "As the world energy landscape shifts, we believe that it is critical to understand the implications for American interests and most especially, the threat posed by China's governmental pursuit of world energy resources. The United States increasingly needs to view meeting its energy requirements within the context of our foreign policy, national security and economic security agenda."

    Energy Secretary Samuel W. Bodman said at a meeting of the National Petroleum Council late Wednesday that the government's review of the deal would be "truly a complex matter," according to Reuters.

    In Beijing, Liu Jianchao, a spokesman for the Foreign Ministry, told reporters on Tuesday that "this is a corporate issue," according to Bloomberg News. "I can't comment on this individual case," Mr. Liu said, "but I can say we encourage the U.S. to allow normal trade relations to take place without political interference."

    TCL, a Chinese company that began by making cassette tapes in 1981, is suddenly the world's biggest television set maker, after its acquisition last July of the television business of Thomson of France, which owned the old RCA brand.

    Chinese companies still have a long way to go to become global giants that can compete head-to-head with Toyota, Siemens or General Electric. Most of the China deals are small in value - about $1 billion to $2 billion - when compared with big American or European deals.

    Whether CNOOC's bid will succeed on it merits is unclear. It is interested in Unocal, once known for its 76 brand, less for its exploration and production in North America than for its huge reserves in Asia. Twenty-seven percent of Unocal's proven oil reserves and 73 percent of its proven natural gas reserves are in Asia, according to Merrill Lynch.

    To succeed, CNOOC will have to persuade Unocal's shareholders to vote against their deal with Chevron. The new deal would then face a shareholder vote.

    Even though CNOOC's offer is worth $1.5 billion more than Chevron's, some shareholders could still decide that the regulatory review process and the time required to complete a deal with CNOOC would pose too great a risk, given the size of the offer.

    Chevron, which could raise its bid to counter CNOOC, is racing to complete its deal and submit it to a shareholder vote as early as August. The company made no specific comment on the Chinese offer.

    CNOOC's all-cash offer values Unocal at $67 a share. Chevron's cash and stock offer values Unocal at $61.26 a share, based on Chevron's closing price on Wednesday of $58.27 a share. Shares of Unocal jumped 2.2 percent, to $64.85, as investors anticipated CNOOC's higher bid.

    In CNOOC's letter to Unocal, it went to great lengths to say that its bid was friendly, despite being unsolicited. "This friendly, all-cash proposal is a superior offer for Unocal shareholders," wrote CNOOC's chairman and chief executive, Fu Chengyu.

    Trying to assuage concerns of some in Washington, CNOOC pledged to continue Unocal's practice of selling all of the oil and gas produced in the United States back to customers in the United States. The company also said it would retain substantially all of Unocal's employees in the United States.

David Andelman on Forbes.com has a pretty concise analysis of the situation that started yesterday and is sending a few shivers down the spines of those concerned by Chinese competition:

    Then there's your friendly Maytag repairman, who could soon find his paycheck signed by the folks from China's Qingdao Haier, which is joining Wall Street stalwarts Blackstone Group and Bain Capital to bid for the U.S. appliance-maker.

    So what's wrong with that? On the face of it--nothing. After all, the Russians are talking about selling a chunk of Yukos' reserves to China.

    Still, a host of issues complicates what should be an arrangement of the open borders, global investing that has so long been a hallmark of the growth of the American capitalist system. Yet, from the nature of the Chinese investments to the goal of the Chinese system, there are a number of priorities that the two nations may not share.

    First, the most basic--what do the Chinese want and what are they prepared to pay?

    What they seem to want is several things. First and foremost is natural resources--with oil at the top of the shopping list. UNOCAL controls more than 500 million barrels of oil in North America, has large natural gas reserves in Southeast Asia, and a minority stake in a big Azerbaijan oil field.

    David Hale, publisher of the Hale China Report wrote last month in the Wall Street Journal that China is investing $1 billon in a nickel mine in Papua New Guinea, joined with BHP in buying into the Australian iron-ore industry, while a quarter of all China's oil needs come from Africa. Why shouldn't UNOCAL be next?

    Another top priority is brand names. UNOCAL is a big U.S. brand. Maytag is even bigger--especially in the U.S. And IBM and Think-Pad are all but priceless names everywhere. Compare these with Haier, NCPC, FAW and Broad in appliances, pharmaceuticals, cars and air-conditioning respectively, and it's not hard to see why China's on the cusp of a shopping spree.

    As for what they're prepared to pay, the answer is easy. Apparently, whatever it takes. After all, in China's case, the bidders are barely private companies. Certainly, there are private companies in China--even publicly-traded shareholder-owned companies. But in the final analysis, this is not a free capitalist market, not even as free or capitalist as Russia, where the state can step in and confiscate on the flimsiest of motives. Still, until they do so, their money comes from profits, shareholders and the debt markets.

    Not so, in China where Chinese companies in any bid could go straight to the mother lode--the Chinese treasury--for more money to win any bid. Even if they are public, in many cases their financing comes at least in part from Chinese banks. And who owns those? In most cases, the state. How can even the wealthiest hedge fund or private equity fund investing state and local retirement dollars beat that? Let's see, the Salem, Ore. school district retirement funds versus the Beijing treasury? Who'd win that one?

    Then there're jobs. Why would Qingdao Haier, a big name in appliances in the Orient, want with Maytag? They would, of course, like the Maytag brand name which could suddenly attach itself to Haier products made in its very low-labor cost Chinese factories. At some point down the pike, then, what's to keep more production migrating offshore to China? Or for that matter, design and engineering functions as well? While there may be American money in the Haier-Blackstone-Bain bid, the guys who know the appliance biz are from China.

But there's a lot more afoot and at risk in the growing intertwining of two national economies. The ability of the U.S. government to sustain its deficit, and American consumers to sustain their appetite for Chinese-made goods, both hinge in part on China's willingness to help us finance it. As Andelman says, that's about "$230 billion in U.S. Treasury securities that the central bank has bought (as of April), according to U.S. government records--and that's nearly a third of its entire foreign exchange reserves. These purchases of treasuries has helped underwrite the U.S. trade deficit. Any hint that China was selling off any of those reserves could send shudders through every financial market in every time zone."

Can we deal with it?

Undeniably, there's still tremendous momentum and competitive spirit in U.S. business and industry. But there's also an addiction to consumption that could undo those strengths if we fail to control our appetites. Get ready - the real shock will come when China floats the yuan - and suddenly all that Wal-Mart underwear isn't so cheap anymore.

And, just to put things in perspective, China's US$700 billion in U.S. cash could not only buy UNOCAL - which, by the way, is a "strategic acquisition" that goes far beyond the short-sighted business opportunity Chevron might sacrifice... I think the Chinese government would pay ANYTHING to acquire UNOCAL... hell, they'd DOUBLE the offer if that's what it takes.

In fact, with $700B, they could buy the ENTIRE U.S. petroleum production industry sector (based on current market cap), at a little less than $600 billion! And still have enough left over to buy Boeing, Lockheed-Martin (combined at $81 billion), and the whole U.S. airline industry ($4 billion) long before they ran out of cash.

I believe that, despite any promises offered by Beijing to the contrary, commitments to route UNOCAL's massive oil reserves to the U.S. market are hollow. In fact, if China can acquire this asset, it may even overcome the downside risk of invading Taiwan... the threat of which has only been held at bay by a U.S. commitment to defend the island nation under any such circumstances.

On the flip side of that, UNOCAL could prove to be an ultimately very unwise move on the part of China in their quest for global manufacturing and industrial competitiveness... especially once the House and Senate Armed Services committees have had their way with them.

And now, they've tipped their hand... and it's up to us to refute what is sure to be an overwhelming show of support in the business and economic press to deny protectionist mercantilism on all such issues and let the "invisible hand of the market" do its work (b***s***).

And protectionism is the real red herring in this deal. Fact is, until Beijing allows a U.S. oil company to buy into a Chinese energy firm (which is forbidden as a point of Chinese national interest at the moment) the U.S. will NEVER face a level playing field.

It's up to our nation's leaders to realize this truth, and prevent this deal. To do that, a great deal of courage on the part of the Bush administration and Republicans in Congress will be required to resist business' vested interests and reject the arguments surrounding "the free flow of trade and capital".

There is a new line in the sand. A line that will determine whether China leverages their new wealth for good or ill... and the advantage in economic power that hangs in the balance.

- Arik

Posted by Arik Johnson at June 24, 2005 02:53 PM