Currency risk: why the Chinese M&A wave is shrewder than some pundits think

Every now and then we read or listen in the mainstream media that Chinese companies are overpaying for assets. Or that they are undercharging for contracts - like building infrastructure - they entering into in many parts of the world . Every so often we hear the same arguments from the western companies that lost in competition to their Chinese counterparts. Quite often the companies that lost to the Chinese protest and make accusations about Chinese state subsidies, unfair competition, etc. All in all the prevailing media image of the Chinese is that their decisions are not commercially sound (because they are overpaying) and politically driven (by overpaying they are trying to build a political influence). Nothing can be further from the truth. Anyone who dealt with the Chinese knows that they are commercially very shrewd indeed.

Where is the answer? China is sitting on a mountain of foreign reserves, some 3 trillion of the US dollars in value. Around half of that is in the US dollars. It is impossible to spend or invest such massive reserves, or a meaningful portion of it, without undermining their value. In the current economic climate there is also a very high risk that these reserves will lose value. On top of that Chinese reserves keep on growing, and if Chinese stopped this process, i.e. stopped buying the US securities, the dollar would have collapsed, so their reserves would have lost a very significantly. A solution that China pursues is spending a significant portion of their dollar (and generally foreign) reserves on buying assets representing long term tangible value such as natural resources, or making investments that would allow to derive a long term value, e.g. in infrastructure.

In the process of making an investment decision Chinese investors have to take into account that the money they spend carries a significant risk of losing value. Something around 30% - 50%. So if a seller (or a contractor) asks a Chinese company for $1, it represents a risked value of between $0.50 to $0.70 to the Chinese. This is the fiscal arithmetic of Chinese investors that takes into account their currency reserves risk.

On the other side, western companies, especially US' operate under different principles. Even if they make investment with their own money, and more often it is borrowed money, they have to account for its costs. For example with an effective interest rate of 5%, $1 investment carries costs for an investor of 5 cents a year.

Therefore facing a competition with Chinese investors, western companies, especially US', cannot compete on price. An investment of $1 represent a spending of 50 to 70 cents to Chinese whilst it represents still $1 plus interest to a US or western companies. Assuming all other factors are the same (and usually they are quite close) a Chinese company can pay 1.42 to twice the price that a western company can pay acting on the same level of commercial rationality and soundness.

Such issues are well above the heads of mainstream media pundits, politicians and even western companies executives. They are very important however. They show how western governments' fiscal policy (especially the US') heavily undermined competitiveness of the western companies in the global economy. Crying about and protesting Chinese "commercial irrationality" will not help as it is... commercially irrational.