1. PERSPECTIVE Key drivers and success factors for Chinese companies investing abroadChinas Outbound Direct Investment (ODI) has been increasing sharply and is likely to continue Enrico Lanzavecchia this trend in the coming year. The ODI structure is concentrated in Asia and is currently oriented Directortowards natural resources, although there may be some diversification in the future. From along-term perspective, Chinese companies should consider three key factors when investing inforeign markets: exploit market opportunity; accelerate technical and business skill evolution Claire Zhongand improve the overall risk or opportunity profile. Although expanding into new markets is Managera complex process, there are many lessons that Chinese companies could learn from other countries. This could help them to successfully manage the process by addressing critical issuesChinas Outbound Direct Investment (ODI) increases sharply A consistent growth of current account surplus has accumulated huge assets for both foreign currency reserve and outbound investment. Under the macro scenario, that China growth model is changing and the Chinese government has strongly supported Chinese companies who want to invest internationally through a series of policy incentives. Chinas ODI has been increasing sharply, with a narrowing gap between ODI and Foreign Direct Investment (FDI). Chinese Outbound Direct Investment increases sharplyChina current account surplus evolution China ODI, FDI and outbound M&A evolutionODI CAGR 03-08US$ billionUS$ billionFDIOutbound M&A100 CAGR 03-0845056% 92 426 Sharp400 372 75 decrease80 due to financial350 66 crisis616030025360 54 52 12%250 43200 161 40 27150 2621692078%100 1212* 46 6 8 6 503 73** 3* 121%0 0200320042005 200620072008 1H2009 2003 20042005 20062007 2008 % of outbound 17%45% 53%39%24% 50% 22% M&A vs. ODI* 1H2009 ODI data not include outbound investment for financial sectors; M&A data is from Merger Market database ** 2004 Outbound M&A data is calculated based on growth trends between 2003 and 2005 Source: Ministry of Commerce, Sate Administration of Foreign Exchange; Statistic Bureau, Value Partners analysis However, Chinas ODI still represents a much smaller fraction of its GDP than in other countries. By 2007, Chinas cumulative ODI was only 3% of its GDP, while for the same period, the UKs ODI was 61.5%, Frances 54.7%, Germanys 37.3% and the USAs, 20.2%. Such a low ODI reflects the fact that Chinese companies still rely heavily on the domestic market, as well as on the natural resources sector. Going forward, along with GDP growth and the globalization of Chinese companies, there is huge potential for an increase in Chinese ODI.1

2. PERSPECTIVE In terms of ODI geographical and industrial structure, Chinese companies used to rely on nearby countries, where they could leverage an established supply chain and familiarity with local markets. A shift to North America and Europe, though, indicates that they are now looking to mature markets for new opportunities and business capabilities. Competing for natural resources has consistently been the main theme of Chinas ODI, and this activity has traditionally been conducted by huge state-owned enterprises (SOEs). Since 2006, Chinese financial institutions have started to aggressively purchase overseas assets. This is due to a rapid growth in the financial industry, with huge funding capability following the spin off of Non Performing Loans (NPL). So far a large share of ChinaS ODI flow has been concentrated geographically in Asia and oriented towards natural resources and commercial services ODI distribution by regionsODI distribution by industry sectors100% 100% 100% 100% 100%100%100% 100%100% 100% 1%Asia Energy &1% 2% 2% 3%5%4%2% 1%Latin America* 10%6%9% mining 2% 3% 3%4%5% 4% Commercial 3% 3% 3%6%Africa3%3% 22% 19% 8% service** 6%Europe 14% 6%17%Financial 6% North Americaservice18% Manuafcturing36%32% 48% Oceania53% Other sectors 26%44%33%63%61% 63%53%55% 43% 48%36%40%33%14%15%2003 2004 20052006 200720032004 200520062007 Possible over count % of Asia and LA, because companies report the first stop of investment (HK or Tax heaven) instead of destination *: Mostly to Cayman Iland or BVI **: including wholesale& retail trde, transport Source: MOFCOM, Value Partners a nalysis An analysis of the outbound M&As of Chinese companies shows that, since 2005, 85% of the large deals have been strategically motivated. Among the strategic outbound M&A deals, 70% are aimed at acquiring natural resources and entering new markets. Up to now, important drivers for Chinese companies going abroad are entering new market and gaining access to natural resources US$ billion, Jan. 2005 - Aug. 2009 No. of outbound M&A with deal size over US$ 10 million Seems to show that Chinese companies tend to adopt defensive strategy in outbound 12218 M&As 15% 104 37 30% 100%3485% 28% 21 17% 1210% TotalFinance Strategic Access toAccess to Access toAccess toresourcesnewskill/tech.product marketsfacilities Deal Value 85.0 8.176.946.211.8 13.2 5.8 Top 3 countriesHong KongHong Kong Hong Kong Australia Hong KongHong Kong Hong KongAustraliaUSA Australia CanadaSingaporeUSA Canada (by Deal No.)IndonesiaCanada CanadaUSAUSAUKVietnamTop 3 sectors (byEnergy Finance EnergyEnergyFinanceFinance Mining Deal No.)Mining EnergyMiningMiningIndustrial IndustrialConsumerFinanceMedia IndustrialIndustrialproductsproducts IT products products Energy TelecomSource: Merger Markets, Value Partners analysis2 3. PERSPECTIVE If the ODI structure of Japan and Korea is compared to that of China, what is apparent is that Japan has shifted away from Asia and now invests more heavily in North America, Europe and Latin America and that nearly 80% of ODI has been devoted to the financial and manufacturing sectors. Korea also invests considerably in the Middle East and Latin America, and is more focused on manufacturing, trade and mining. Based on this, it is expected that Chinas ODI is likely to see greater diversification in both regions and sector structure.Three key drivers to foreign investment for Chinese companies Exploit market opportunitiesChinese companies are sustaining a relatively favorable economic performance despite the financial crisis. While developed countries and regions such as the United States and Europe are experiencing negative economic growth, China is expected to maintain a GDP growth rate of 8%. According to a forecast by the International Monetary Fund (IMF), Chinas contribution to the rate of global economic growth will increase from 29.9% in 2008 to 46.4% in 2009.The stock market capitalizations of developed countries, affected by the recent economic downturn, have been reduced by more than 15%, compared to pre-crisis figures. Bank credit was reduced by a similar amount. Foreign companies have difficulties in obtaining financing from both capital market and bank loans, leading to a strong need for the injection of capital. Foreign companies are also interested in working with Chinese partners because of their interest in the Chinese market. As Dr. Tadao Kasahara, CEO of MSK, commented about Suntechs acquisition of MSK, one of Japans largest photovoltaic (PV) manufacturers: As a subsidiary of Suntech, MSK will be able to access Suntechs support in terms of advanced PV cell/module products and cost competitiveness, financial resources, and distribution channels, as well as have the possibility of pioneering BIPV applications in the Chinese market.Generally speaking, foreign markets are attractive, not least because their consumption expenditure levels are much higher than Chinas. If evaluated by consumption expenditure, the Chinese purchase capability per capita is significantly lower than that of developed countries. According to UN statistics, in 2008, Chinese household consumption expenditure per capita was US$ 1,030, while in the same period, American expenditure was US$ 32,564 and Japans US$ 21,747. Even taking into account that Chinese first and second tier cities have a higher than average expenditure, there is still a big gap compared to developed countries. This creates significant potential for Chinese companies in terms of both market size and margin.Accelerate technical/business skill evolutionIf we consider the intellectual property figures of its main industries as a guide to its technological development level, China still has a long way to go to catch up with developed countries. In 2007, for example, the number of effective patents per 100,000 inhabitants for the Chinese mainland was 22, while Korea had 1,170, Japan 968, and the United States, 593.Large Chinese companies have already committed significant technology investment abroad. For example, Huawei has established its R&D centres in Silicon Valley, California, and in Bangalore, India, and hired thousands of local experts in those centres. These decisions have played a crucial role in helping Huawei keep abreast of cutting- edge overseas technologies and product development. This strategy has allowed the company to minimize its time spent catching up with competitors and fully seize the rapidly changing opportunities in international markets.Some Chinese SMEs have leveraged overseas technology investment to upgrade their market positioning. Pearl River Piano acquired, for instance, the R&D centre of Rudisheimer, obtaining its advanced technology in piano manufacturing and gaining a 40% market share of the US vertical pianos segment. It later acquired the R&D centre of Herman Miller in the US and further expanded its market share by leveraging its techniques in baby grand pianos, a piano design in line with modern American furniture styles.For most Chinese enterprises, expanding in the global value chain is a shortcut to gaining complementary business skills. They could obtain an advanced overseas R&D centre, leveraging the local high-tech incubator to accelerate innovation, or develop a global brand to enhance their anti-risk capability and profitability. Similarly, they could 3 4. PERSPECTIVE leverage a local distribution network to effectively penetrate local markets, or acquire local expertise, which is crucial for Chinese enterprises building global competitiveness.Chinese companies could strengthen their skills portfolio through overseas investment Assessment of Chinese companies positioning along global value chainIndustryR&D Raw materialManufacture Brand Distribution Customer services Homeappliances Lack of high- Improved Own brand and Some end productsharply, whileOEM coexist , enterprises hasindustrial crafts Lack in set up his owngap still existsworldwide outboundadvanced player distribution Plastics Imitation Large Mostly own brand Mostly Limitedproduction Lack in wholesale investment incapacity andworldwide R&Dlow price advancedplayer Clothing Mainly imitate The raw for Large production Mainly OEM Few players Lack in designadvanced capacity and lowLack of own set up their own and innovationproducts needprice brands especially distribution to be imported in high-end networkmarketworldwide Consumergoods- Improving Large production Mainly OEM Few players rapidly whilecapacity and low Lack of set up their ownElectricsadvanced price worldwide distribution know-how isbrand network limitedworldwide Toys and Weak design The raw for Overcapacity in Mainly OEM Few playerschildren'straditional Lack of own set up their own capability inadvancedproducts high-end products need products whilebrand distribution products to be importedlack in high-endnetworkonesworldwide Source: Industry research, Value Partners analysis Improve the overall risk or opportunity profileAlthough China is the largest country in terms of population, and is growing fast, in many leading industries, the Chinese market still accounts for a limited share of global demand and will continue to do so for the near future. For example, Chinas market values as a percentage of the global market are lower than 10% for the banking, construction, chemical and telecom industries.In many industries, the domestic market experiences significant, though temporary, fluctuation, and companies that have diversified their business in secondary markets could be better positioned to offset the impact of a downturn. Considering that several industry sectors already face the risk of a short-term saturation or slow down, it is important for companies not to invest exclusively in local markets. 4 5. PERSPECTIVE Chinese companies could strengthen their skills portfolio through overseas investment China %, growth rateworldGrowth of Auto industryGrowth of chemical industry 40% 20% 20%0%10% 2001 200320052007-20%0% -40%2004 2005 20062007Growth of construction industryGrowth of consumer good* industry30%20% 20%10% 10%0% 2002 200420062008 0%20012003 20052007 2009 20112013-10%* Consumer good without food market valueSource: Global Insight's Global Construction Outlook 2008, Datamonitor , Euromonitor, EIU; Value Partners analysis Lessons and experiences developed by other countries For Chinese companies, moving into foreign markets seems to be a complicated process, due to a lack of international experience. A study of instances in which Chinese companies failed to succeed in foreign environments suggests that these companies have some key weaknesses. For example, they have a limited knowledge of international markets, including market situation, regulations and customer base. There is also a limited availability of managers who can operate in an international context, with sufficient language proficiency, foreign culture understanding and an established social network. Last but not least, they seem to lack systematic process, for instance in strategy definition, roadmap development and execution.By examining the experience of companies who have already invested in developed countries, Chinese firms could prepare for some unavoidable issues: Culture clash: generally speaking, English proficiency is limited for the Chinese, and the Chinese vague communication style is different from the direct style of western business practices. The Chinese work-life balance is also quite different to that seen in Europe; Higher uncertainty in a global context: rapid changes in global social, environmental, technological and business trends could lead to systematic risks, such as financial crises or regional conflicts; Lack of availability of many professional managers who have solid overseas business experiences and local background; Stronger social tension: needing to manage a multinational environment in-house, while externally needing to deal with local government, communities, partners, etcDeveloped countries have accumulated many overseas investment experiences to tackle these basic problems, which could be valuable references for Chinese companies. First and foremost, they need to build a dedicated team that focuses on international expansion, including recruiting local professional managers with international business experience, seeking help from third-party professionals such as consulting firms, lawyers, PR agencies, and lobbyists, and get training on culture difference management and international communication.It is critical to develop an effective model of international governance. One method would be to choose an appropriate governance model based on the target countrys business climate. This would mean caution in shareholding investment in emerging countries, for instance, due to the high risk of partner default, and flexibility during transition periods. 5 6. PERSPECTIVE It is necessary to engage in comprehensive planning to fully understand local context and possible changing factors and to reduce setback risks. ,It is advisable not only to prepare a contingency plan after thoroughly considering all the possible risks in strategy, social environment, and economy but also to have a proper exit plan.Being committed to developing local networks is also important for example, by hiring a key relationships contact person who could operate effectively in the local business community and apply a PR approach to promoting the companys commitments and contributions to the local community.Chinese companies have many possibilities on the spectrum that fall between resisting overseas investment and duplicating domestic models. The first approach could be to form an alliance with peers or strong players to share the resources and risks. For example, a large SOE could build partnerships with other sizeable players in some negotiations, so as to avoid internal competition and to get a lower price. SMEs could form a consortium with other SMEs, or work with large players as their suppliers, service providers, or distribution partners.Target areas might be the ones where a company has already done business in the past, or even the regions where many Chinese communities exist. The firms could set up a joint venture with a local partner, leveraging their local resources and learning about the local market and culture.It is important to focus on a niche market in which the company has its core expertise identifying those markets that have a good return and less competition, thereby avoiding having to compete in the mass market. This unique expertise should be strengthened, and differentiated products and services should be provided to local customers.As for organization and HR, it is best to build through practice. Organization formats could be structured as sales agent-sales subsidiary-manufacturing facility-full operation, which creates the right governance structure. Chinese talent should be trained on the job, and local talent should be motivated from a long-term perspective.It is also essential to adapt to the local rules of the game, fitting in to the community and building business models that are a win-win for both parties, by maintaining certain levels of local employment, instead of just acquiring a small expert team while dismissing all manufacturing labourers.Finally, it could be helpful to assess the critical issues in each step of foreign investment. Focusing on four steps in particular, the main critical issues could be: Defining the objective: - What is the main investment target for market, technology, skills, or profits? - What is the minimum target? - What is the time frame for the target? - How much funding is needed, considering both the whole investment cycle and the contingency scenario? - What are the main risks and how can we reduce or migrate them? Preparing to go: - What are the top three criteria to evaluate targets and investment results? - Who are the right people to join a dedicated international expansion team? - What external resources could be leveraged, in order to understand the feasibility and the risks of targets, and also to grant support, so as to make things happen? Manage the process: - Which is the appropriate governance model? - How is it possible to communicate proactively with all stakeholders? - How could a positive image of the company be promoted and how could branding be established in local communities? 6 7. PERSPECTIVE Integrate effectively: - What is the integration blueprint, with specific milestones, timelines, and key actions? - What is the integration plan and the governance structure during the transition period? - What is the new business model and how should it be implemented? - Who should be appointed to the board? - How can company culture be rapidly integrated and communication efficiency improved? About Value PartnersValue Partners Management local financial institutions and For more information on the issues Consulting has been present intelecom industry players inraised in this note please contact China since 2005, and has longstrategy definition, organizationclaire.zhong@valuepartners.com or term commitment to China market optimization and operation enrico.lanzavecchia@valuepartners. and its sustainable economy improvement areas. com or one of our offices below. Find growth. Our 40 professionals all the contacts details on www. based in Beijing, Shanghai andFounded in 1993, Value Partnersvaluepartners.com Hong Kong offices has supported is a global management local companies and international consulting firm that works withMilan companies who considering tomultinational corporations and Rome grow in China market with our high-potential entrepreneurial London solid experiences. Value Partners businesses to identify and pursueMunich provides comprehensivevalue enhancement initiativesHelsinki consulting services, ranging from across innovation, international Istanbul Strategy to Organization, and expansion, and operational Dubai from Operation Improvementeffectiveness. It comprises twoSo Paulo and International development sister companies: Value Partners Rio de Janeiro to Technology support. We haveManagement Consulting andBuenos Aires assisted many multi-nationalValue Team IT Consulting and Mumbai companies successfully developSolutions. Beijing China business, providing Strategy Hong Kong development, M&A, local support With 14 offices across Europe, Singapore and sourcing consulting. In the Asia, South America and past years, we have supported MENA, Value Partners expertise operation of Luxury and FMCGspans corporate strategy and companies, as well as Energy andfinancial business planning, cost Environmental areas.transformation and organizational development, commercial Value Partners has strong globalplanning, technology decisions, functional practices, particularly in and change management. Its TMT (Telecom, Media, Technology)3,000 professionals from 25 and Financial Institutions. In Chinanations, combine methodological we have successfully supportedapproach and analytical international banks and Financial frameworks with hands-on Groups to develop China marketattitude and practical industry entry strategy and M&A, and weexperience developed in executive also help top Telecom Operators capacity within their sectors of to define channel strategy andfocus: media, telecoms and IT, improve operation. Nowadays luxury goods, financial Value Partners are working with services, energy, manufacturing more and more China and hi-tech.7