Following the partner abroad: European multinationals and China’s new wave of outbound investment

For most of the past decade the message from European capitals to European boardrooms has been consistent: reduce your dependence on China, diversify your supply chains, do not let a single market decide your fate. The companies have listened, and many of them have drawn a conclusion their governments did not intend. Faced with a Chinese home market in which price competition has become brutal, and with Chinese rivals who are now moving production abroad to escape it, a growing number of European multinationals have decided that the better strategy is not to leave the field but to join the team.

The clearest evidence comes from German industry, which has partnered with Chinese firms for forty years and has the deepest relationships to draw on. A recent survey of German companies operating in China found that more than a third regarded the internationalisation of Chinese firms as their single most relevant business opportunity, and that roughly two-thirds had already engaged in some way with Chinese companies investing overseas. Other European groups are understood to be doing the same, more quietly. From a Luxembourg desk that finances both ends of the corridor, the trend is visible in the mandates.

A different kind of outbound wave

China has exported capital before. The earlier waves were dominated by state groups buying resources and infrastructure, and later by acquisitions of European brands and technology. The current wave is different in composition. It is led by private manufacturers — electric vehicle makers, battery producers, industrial robotics and automation firms, component suppliers — moving production abroad in search of margins their home market no longer offers, and of tariff-free access to the markets that buy their goods. Official figures put Chinese outbound direct investment at more than 170 billion dollars last year, up around seven per cent, and the manufacturing share is rising.

Companies that go abroad for the first time need what any first-time investor needs: a plant, a distribution network, a compliance function and the confidence of local regulators and customers. Their European partners, who built all of these things in China a generation ago, have them ready-made elsewhere. That is the exchange at the heart of the trend.

Five ways of helping, and one factory shared

The survey identified five broad forms of cooperation: supplying products and services to Chinese partners’ overseas operations; helping them meet foreign compliance and regulatory standards; lending international management experience; expanding jointly into new markets; and following them into third countries. The examples are concrete. An automotive supplier has let its Chinese partners produce inside its own plant in south-east Asia, in what is described as a factory-in-factory model: the Chinese side brings the technology, the European side brings the site, the workforce and the permits. A logistics group lends its brand and network in Europe to help Chinese customers gain access to markets where their own name carries little weight. A technology supplier helps Chinese vehicle manufacturers certify their driver-assistance systems for export markets.

The de-risking debate assumed European companies would put distance between themselves and China. Many have concluded that the way to protect margins is to shorten it.

China Everbright Bank Europe — Corporate Banking

What the Europeans get in return

The motive is defensive first. Partnering is a way to hold on to market share and margin in a Chinese market that has become the most competitive in the world, and to earn a share of the growth as those competitors expand abroad. The second motive is the more interesting one: learning. European managers speak of the need to operate at “China speed”, the ability of Chinese firms to take a product from concept to market in roughly a third of the time a European development cycle requires. Working alongside those firms is the most direct way to learn how it is done.

Most participants also agree that the window is narrow. The European contribution — local know-how, compliance experience, brand — is exactly the kind of capability a competent partner acquires quickly. The working assumption in many boardrooms is that the period in which it commands a premium is measured in eighteen months or so, after which most Chinese firms will have learned to do it themselves. That shapes the commercial terms: partnerships are being structured to capture value early rather than to build annuities.

The political bill

None of this is comfortable in Brussels or Berlin. The Union and Beijing are at odds over an inflow of highly competitive Chinese exports that is blamed for job losses in European industry, and European champions are cutting tens of thousands of positions at home. Against that backdrop, the sight of European companies helping their Chinese rivals gain global market share is difficult to defend in public, and the assumption of ten years ago — that what was good for European companies in China was good for Europe — is no longer taken for granted. Headquarters will have to make the case for engagement more explicitly than they are used to.

• Document the commercial rationale for each partnership in terms a home-country regulator and a works council can follow; the question will be asked.
• Screen partnerships against the Foreign Subsidies Regulation, export-control and investment-screening rules in every jurisdiction the joint activity touches, not only the host country.
• Structure the arrangement so that the European partner’s contribution is priced and paid for during the window in which it is scarce.
• Treat the partner’s third-country plant as a new counterparty for credit and compliance purposes, whatever the relationship in China.

What we see in the financing

For a bank that serves both sides of the relationship the trend has practical consequences. Chinese sponsors building capacity in Europe, south-east Asia or Mexico need term debt, guarantees and working-capital lines in the host currency, and increasingly they arrive with a European partner already inside the project, which changes the credit analysis for the better. European suppliers following a Chinese anchor customer into a third country need receivables finance against a counterparty their home bank may not know. And joint ventures with mixed ownership need documentation that works under two legal traditions and two sets of sanctions and export-control rules. Our corporate banking and trade finance teams are spending an increasing share of their time on exactly these structures, and we expect that share to grow.