To take three examples, the cost of CITIC Pacific’s Sino Iron mine in Western Australia, which is two years behind schedule, has risen from a projected US$1.9 bn to a staggering US$7.1 billion. China Metallurgical Group Corporation (CMGC)’s US$1.5 bn Ramu nickel project in Papua New Guinea is mired in legal difficulties, largely because CMGC failed to consult local landowners. And widespread labor abuses in Zambia, where managers at China Non-Ferrous Metals Corporation’s Chambishi copper mine are accused of shooting protesting workers, have seriously damaged China’s reputation in one of Africa’s most mineral-rich countries. (Komesaroff, "Screwing up in foreign climes," supra, 1).
SOEs find it hard to replicate their model outside China, partly because managers suffer from a lack of international business experience, particularly in cross-cultural management. But many foreign investments are doomed from the start, as they are often designed to serve national strategic objectives ahead of business interests. (Ibid).
First, approvals for domestic projects are comparatively straightforward. In foreign countries, the existence of multiple stakeholders makes the process more complicated—and, for Chinese managers, more opaque. At home, Chinese companies negotiate directly with the political elite; but abroad they must struggle with greater public scrutiny, contend with local labor unions, and comply with unfamiliar international building codes. Second, problems in many investment destinations cannot be solved by simply hiring more cheap workers, as they often are in China. Foreign governments demand that jobs go to local workers, who may be more expensive and less compliant than those back home. And third, SOEs’ domestic success depends on a network of experienced local suppliers. Moving offshore extends supply lines and compromises this competitive advantage.
In 2004, following the failure of Minmetals to acquire the Canadian mining company Noranda, they set up a formal approval system for SOEs wishing to invest aboard. The process is designed to filter projects that are risky or unlikely to succeed. SOEs must register with both the State-owned Assets Supervision and Administration Commission (Sasac) and the National Development Reform Commission (NDRC). Sasac judges potential SOE investors on a number of financial and operating performance measures, and confirms that the project at hand is within the particular SOE’s business scope. NDRC then judges whether the project is consistent with national industrial policy. Copper and iron ore have long been considered strategic acquisition targets, and bauxite and nickel were recently added to the list.
After SASAC and NDRC confirm an SOE’s registration, the SOE must carry out a feasibility study to support its proposed investment, including a financial evaluation. If the project requires extra financing, institutions like China Development Bank and Export-Import Bank of China will become involved. Managers must also submit details of their proposed risk management and auditing systems. Until 2007, SOEs used a traditional accounting approach to evaluate overseas investments. Now they use techniques like discounted cash flow, internal rate of return and payback period—all techniques that are standard in global companies. (Komesaroff, "Screwing up in foreign climes," supra, 2).
Project evaluation has improved as feasibility studies have taken on a more commercial orientation. This increased analytical rigor is fostering greater investment discipline. One good example was the decision by Yanzhou Coal’s Australian subsidiary to pass up an attractive opportunity after due diligence revealed that local geological conditions were not compatible with its proprietary technology. More stringent analysis is a consequence of reforms that make the management of listed SOEs more responsive to movements in their share price. Crucially, this metric is used by the Communist Party’s Organization Department to evaluate senior cadres. Recent amendments to Sasac’s regulations also make top SOE managers responsible for losses from foreign investments. (Ibid.).
Yet the political dimension to corporate leadership in China means that managers have different priorities from their foreign counterparts. Because their careers are managed by the Organization Department, which regularly rotates cadres between corporate positions in SOEs and government posts, enterprise leadership need to balance corporate objectives with the demands of their political patrons. One example was Aluminum Corporation of China (Chinalco)’s stunning share raid on Rio Tinto in 2008. On a corporate basis, Chinalco probably overpaid for its 9% stake—but because the purchase blocked a possible takeover of Rio Tinto by BHP, China’s national objectives were achieved. The Chinese government was determined to prevent the emergence of a combined BHP Rio Tinto, which would have dominated the seaborne market for iron ore and gained intolerable pricing power over Chinese steel mills. (Ibid).
Lengthy delays and cost blowouts on the Sino Iron project are a consequence of pursuing national objectives at the expense of corporate profitability. CMGC only got involved with the project at the behest of Beijing, even though it had no experience of building structures needed to withstand Western Australia’s harsh conditions, particularly cyclones. CMGC also encountered difficulty managing local employees: many contractors have resorted to the courts to recover money owed to them. Involving a global engineering company with experience in Australia as a lead design and construction partner would have prevented such problems. (Ibid).
Interestingly, the failures of China’s mineral investments over the past decade or so stand in stark contrast to the handful of successful investments made early in China’s reform process. In 1987, China Metallurgical Import Export Corporation (later Sinosteel) partnered with CRA (later Rio Tinto) to develop the Channar iron-ore deposit in Western Australia. A year earlier, CITIC joined an Alcoa-led consortium to build an aluminum smelter at Portland in Australia. . . . In both cases, the lead partner was a large global company with undisputed experience in the sector—in direct contrast to most of the investments pursued since the launch of the Go Out policy.
The Channar and Portland investments occurred more than 25 years ago—well before China embraced the sophisticated financial evaluation techniques that underpin its current investment decision making. . . . These projects served a national strategic purpose, but were also sound business investments. By comparison, too many foreign investments today smack of political overreaching—a problem aggravated by managerial incompetence. (Ibid).