Another Deal Blown, Where Will China Invest Now?

Xiong Weiping, the chief executive officer of China's largest aluminum company, Chinalco, spent the better part of the last four months doing something no other CEO of a state-owned Chinese company had ever done. He campaigned — in an open, very western way — to gain approval in Australia for what would have been China's largest foreign investment ever: a proposed $19.5 billion stake in Rio Tinto, the world's second largest mining company. The deal would have given Chinalco roughly an 18% stake in Rio, as well as outright control of some valuable copper and iron ore mines.

Xiong travelled to Australia in March and made television appearances to plead his case. He pressed the flesh with politicians in Canberra who were both for and against the deal. It was a bravura performance. It was also unprecedented. Outsiders should understand: big, state-owned companies in China (and most everywhere else) tend to be stodgy, intensely conservative organizations. Often, top executives will practically read from a script prepared for them by minions when meeting foreigners. Not Xiong. (See pictures of Chinese investment in Africa.) A lot of good it did him. On June 5, Rio Tinto told Chinalco that their deal would not go through after all. It would, instead, float a rights issue to raise money needed to pay down a massive debt load, as well as enter into a joint venture with BHP Billiton — the mining giant that last year tried to buy Rio outright. Xiong, in a statement issued by Chinalco, simply said he was "disappointed" at the outcome. Analysts were quick to argue that this was not a rerun of China's ill-fated attempt to buy the American oil company UNOCAL four years ago, political opposition in Washington led CNOOC to withdraw its bid.

This deal, they said, fell apart for economic — not political — reasons. The proposed Chinalco investment came when global commodity prices were at their nadir; BHP had walked away from a merger with Rio a few months earlier, and the company was in sudden and desperate need of cash to cope with a nearly $40 billion debt burden. Now, minerals prices have rebounded — in part (and ironically) because of a huge government spending binge in China that has had companies here frantically restocking their supplies of copper, iron ore and other commodities used in industrial production. "The biggest driver of discontent [with the Chinalco deal] among Rio shareholders," says Grant Craighead, managing director of Australia-based independent research group Stock Resource, "was that the deal was being struck close to the low point in the current financial crisis. Over recent months the market decided that the worst of the crisis was over, and life's likely to get better. The Chinalco deal went from looking like a win-win to looking a bit cheap," he says. That may be true, but the outcome is going to leave a bitter taste in the mouths of some Chinese executives and policymakers. They are all too aware that this proposed Chinese investment had become a big political football in Australia — in a manner, indeed, that dwarfed the fireworks in the U.S. when state-owned CNOOC tried to acquire UNOCAL. Opponents of the Australia deal went so far as to sponsor television commercials that actually invoked the June 4, 1989 massacre in Tiananmen Square.

A banker close to the Chinalco side of the deal said management there was "deeply disappointed" by some of the rhetoric used by opponents of the deal. In fact, this source says, Chinalco had in many respects "gone to school" on the CNOOC deal, in terms of "what not to do." Unlike CNOOC's attempt to buy UNOCAL outright, this was a minority investment, welcomed — at first, anyway — by Rio's management. There was the PR charm offensive by Xiong, who went to great pains to convince Rio's stakeholders that his aims were strictly commercial and that there was no hidden agenda to buy up supply in order to keep transfer prices down later, as many critics contended. The Rio decision to walk away spared the government of Kevin Rudd, the Mandarin-speaking Prime Minister of Australia, from having to make the tough decision as to whether to let the Chinalco investment go forward. After the Rio announcement, Rudd made a point of saying that Australia was very much open to foreign investment, and then met in Canberra on Friday with Xiong to reinforce the point. Analysts say the government was likely to approve the investment, but only after imposing what surmised would be "tough conditions." It s still unclear what those "conditions" might have been. Even though the economic rational for nixing the deal muted criticism in China today, the way it went still stings in Beijing. If a private sector company in the west had proposed buying a minority stake in Rio Tinto, would the Australian review process have taken as long?

Or it would it have been waived through much more quickly — before commodity prices recovered? Now, far from gaining access to a giant iron ore reserves, Chinalco has to watch the two biggest producers in the world — BHP and Rio — do a joint venture with their reserves in the famed Pilbara region of western Australia. It's no wonder that the executive director of China's iron and steel institute was warning about a possible "monopoly." The deal's outcome also leaves another basic question unanswered: What is China going to do with all of it's money, if the developed world sends signals that it doesn't really want it — at least in forms other than investments in US Treasury debt? One of the things a country with more cash than it can possibly invest at home — a description which China fits in spades — does is recycle its surpluses is through foreign direct investment. And China, in fact, has done scores of resource deals in the developing world — of late with Russia, Kazakhstan and Brazil in the old and gas sector, for example. But twice now in the developed world, big Chinese investments have been spurned. First CNOOC, now Chinalco. Rudd insists Australia remains open for investment from all comers. And that may well be true. But whether the Chinese remain interested in Australia might be another story.

Recently, Fu Chengyu, the CEO of CNOOC and the man who tried to acquire UNOCAL in 2005, told reporters from TIME and Fortune that his company was still keenly interested in overseas investments. And then added, smiling, "though not in North America." Not in North America? he was asked. Not a chance? His smile dissipated a bit, and he said, simply: "No." Any guesses as to why that would be?

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