China's outbound investments grew 250 percent in the first quarter compared with a year ago, with a focus on North America. Grisons Peak's Henry Tillman breaks it all down.

Many people are focused on how to do business in China or how to invest in China, but it's equally interesting to consider where the Chinese are investing. After all, while much of the globe continues to struggle out of recession, China's economic engine just chugs along, generating more assets to invest.

That's why a recent report from London-based merchant bank Grisons Peak, titled China Outbound Investments, piqued our interest. Where have the Chinese been investing their assets and where do they see opportunity?

We decided to ask the report's author, Henry Tillman, a managing partner at Grisons Peak, to shed some light on the subject and add some addition detail to the raw numbers. The following Q&A is the result.

China’s outbound investment increased 7.5% in the first quarter over the fourth quarter of 2010. How did it compare to the first quarter of 2010?

Henry Tillman: In the first quarter of 2010, total outbound Chinese investments had an aggregate value of $41 billion. The Q1 2011 figure of $144.6 billion represents an increase of over 250 percent compared with Q1 2010.

TF: When you talk about China’s outbound or overseas investments, are you only talking about government (sovereign) capital (e.g., currency reserves)?

HT: No. China’s outbound investment is herein used as the sum of all capital with Chinese origin invested for a given quarter – both private and state through M&A/equity investments, trade agreements/contracts and bank loans.

TF: Where (geographically) are the Chinese investing?

 HT: Of the 50 outbound M&A/equity transactions in the first quarter, 14 were in North America ($8 billion), 13 in Europe ($5.4 billion), 11 in Asia ($2.6 billion), seven in Australia ($6.6 billion), two in the Middle East ($5.2 billion), two in Africa ($4.5 billion) and one in South America ($100 million).

This marked a major shift in investments away from Asia and emerging markets to OECD markets. More than 50 percent of total equity/M&A transactions in the first quarter took place in North America and Europe.

In the first quarter, North America led both in terms of aggregate amounts invested and volume of transactions announced; 14 deals worth $8 billion represented around 25 percent of total Chinese outbound equity/M&A volume, which marks a first in nine quarters for North America to lead in volume Europe was the second most active region for Chinese outbound M&A/equity investments, with 13 deals with European companies accounting for more than $5.4 billion aggregate amount; these figures represented approximately 17 percent of aggregate investment and 26 percent of the total transaction volume (which marks a first for Europe).

Seventy-five percent of trade contracts and cooperation agreements signed in Q1 2011 (out of a total of more than $100 billion) were in OECD markets.

TF: Within Europe, what are the hot spots for Chinese investment? Why?

HT: Chinese investment in Mediterranean Europe (Portugal, Italy, Greece and Spain) has grown significantly over the past 13 quarters. Chinese investment activity in Portugal, Italy, Greece and Spain increased substantially throughout 2010 and into Q1 2011, following virtually no activity (outside of isolated transactions) during 2008/2009.

Major trade agreements were signed in South Europe in the last year and a half. For the past seven quarters the Mediterranean Europe total represents an average of approximately 30 percent of total Chinese investments in Europe.

A number of these agreements could lead to future equity investments (e.g. cooperation agreements with Portuguese banks, or more importantly, investments in their African businesses).

A possible explanation for China’s focus on Mediterranean Europe could be that trade agreements/contracts and bank loans are part of China’s support during Eurozone’s sovereign debt crisis (mainly South European countries affected in the crisis). In exchange for Chinese assistance, Eurozone member countries and Mediterranean countries, in particular, have allowed/will allow more Chinese M&A/equity investments. In our advisory business, we have historically heard of selected European constituencies rejecting Chinese investment; we now hear considerable softening in these previously strong stances.

TF: What has driven that change? Historically, how quickly do the Chinese change their investment focus? In other words, is this a long-term change or a short-term trend?

HT: The change has been driven through a combination of the Eurozone’s sovereign debt crisis (as set out above) and by major state-owned enterprises (SOEs) that have matured to the point where they can expand outbound. It has been supported by China’s overall economic growth and its well capitalized banks (which have raised approximately $90 billion fresh capital in the past 15 months).

TF: What are the Chinese investing in? What kind of vehicles/structures are they using primarily (e.g., private equity, venture cap, direct investment)?

HT: As has been the historical trend, the natural resources sector accounted for the most significant portion of M&A/equity aggregate amounts with $14.9 billion (45 percent of the total $32.7 billion of China’s M&A outbound investment) in 10 total transactions in the first quarter of 2011.

Investments in large natural resources projects accounted for nearly 85 percent of North American transactions; investments in Europe were much more diversified (there were numerous transactions spread across manufacturing, distribution and retail (MDR), technology and energy & utilities).

However, the major change in Q1 2011 was that MDR led in transaction volume, with 18 deals ($6.7 billion) representing nearly 40 percent of total M&A volume. This marks a shift from historical Chinese outbound equity investment patterns.

Of the remaining sectors, seven deals were in energy & utilities ($7.5 billion); five were in technology ($1.1 billion); five were in financial services ($1.8 billion); three were in other non-traditional sectors ($700 million); and two were in healthcare ($200 million).

We have not seen China-based private equity invest outbound, although we believe it will do so in the future, most likely supporting SOE expansion.

TF: Can you give examples of some of the bigger deals that were struck in the first quarter?

HT: In Q1 there were nine M&A/equity transactions greater than $1 billion. Some of them include: 

Sinopec signed a roughly $5.5 billion agreement for 20 years of LNG supplies with Australia Pacific LNG Pty Ltd and will acquire a 15 percent stake in the coal steam project, with total worth valued at $35 billion ($5.5 billion).

PetroChina Co. Ltd. agreed to buy a 50 percent stake in a Canadian natural gas project in a joint venture with Encana Corporation for $5.4 billion.

Saudi Aramco and Sinopec signed a memorandum of understanding to jointly build a $10 billion Yanub refinery on the Red Sea coast in Saudi Arabia, Chinese company participates with 37.5 percent of the investment in the project ($3.75 billion).

Norwegian conglomerate Orkla agreed to sell its Elkem unit’s silicon manufacturing operations to China National BlueStar for $2 billion in one of the biggest industrial takeovers by a Chinese group in Europe.

In addition, the largest component of aggregate value in the first quarter was trade contracts and cooperation agreements, which exceeded $100 billion for the first time ($103.4 billion), up slightly from the fourth quarter of 2010 ($99.2 billion).

Five of these seven agreements, representing approximately 75 percent of aggregate amount, were based in North America and Europe. Major agreements with European countries were signed during an early January European tour of Chinese Vice Premier Li Keqiang to Spain, Germany and UK. The three European trade agreements represented nearly $20 billion while the two U.S. trade agreements represented nearly $55 billion.

TF: What does or might this trend mean for other investors looking for (or at) the same or similar investment opportunities?

HT: We believe that there will be an increasing number of China-based SOEs that will consummate successful international acquisitions outside of natural resources/commodities/energy. In many of these cases, China-based acquirers can be expected to "re-pod" the international technology into their domestic businesses to drive further growth.

These emerging, more international SOEs are already becoming more visible to the international community as evidenced by the launch of China funds such as Anthony Bolton’s.

We also believe that increased knowledge of such developments among shareholders of U.S. and European companies will lead increased acceptance of Chinese acquirers/investment.

TF: How long can this trend last?

HT: We expect China itself, its major SOEs and private companies as well as selected China-based PE funds to continue outbound investments at an increasing rate throughout the foreseeable future.

TF: What implications does this shift have for global capital markets?

HT: It is already clear to most major global capital markets participants that China itself via its rapidly growing economy will become an increasingly powerful force over time, across all capital markets products.

All one needs to do is examine the tectonic shift in IPO issuance by PRC-based organizations in the past several years as a reasonable proxy as to how debt issuance by Chinese companies will also shift in the future (and as the Yuan becomes global currency).