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China and Brexit – What Next?

Via LinkedIn : Now that we are emerging from the period when all I was asked by Chinese businessmen about Brexit was “what just happened” and “why did it happen”, conversations are shifting to what actions to take as a result. Much of the focus is extremely tactical. As a result of the pound’s depreciation, the U.K. is currently seen as “bargain central” across both board rooms and middle class living rooms in China. “What to buy” is the question of the day.

This week we have seen the first of what I expect will be many near term investments by Chinese corporates in the UK, with Wanda buying the Odeon cinema chain for 920 million pounds. This cinema business had been up for sale by its prior owners for many years. The sharp 15% depreciation pushed the price over the line in terms of attractiveness to Wanda. The U.K. was pre Brexit was already seen as one of the most welcoming major economies for Chinese investment, with the fewest political restrictions on what can be acquired and a local media that focuses more on whether jobs remain than who actually owns a business. Creat’s 800 million pound investment in BPL earlier this year was an example of investments that resulted from this. One UK based advisor focused on UK inbound investment from all around the world, already saw over 50% of his activity be with Chinese investors in the first half of 2016. In the second half of the year it could be three quarters.

Chinese businessmen believe that a post Brexit decision political imperative for the UK is to be and be seen to be even more open to foreign investment. They heard what Osborne had to say on this in his last speech as Chancellor. Overlay on to that that assets, when priced in US$, now look much cheaper and there also is a Brexit uncertainty discount, it is not surprising that the intent to invest in the UK now is very very high. And there is a fear of missing out, of getting left behind by peers that encourages entrepreneurs used to winning on the basis of being a first mover to act now. This certainly is the mindset of the private sector. State owned enterprise leadership who have much lower tolerance for risk, volatility and uncertainty are likely to stay well away unless it is to invest in something fairly modest in size that delivers something must have such as a truly unique piece of technology.

Even the tourism sector is seeing similar behaviors. Chinese social media there has been buzzing since the day after Brexit on where to get the best bargains in the UK on luxury goods. The weekend after Brexit, Chinese tourists in Paris (who were prepared enough to have UK entry visas) took the train over to London to be the first wave on this. Visa applications to visit the UK from China appear to be up more than 40% year on year in the current month. Bargain hunters are also showing up in the real estate sector, not just in London but also around university cities with their large numbers of Chinese students. London’s auction houses saw a very strong Chinese buying presence in their most recent summer sales. It certainly feels like this should be good news for airlines flying to China.

What other sectors might see significant investment? Certainly service sectors with high growth in China today, beyond the movies, wealth management companies, sports management and service companies (as well as teams themselves), medical services and educational services. Certainly consumer brands, particularly in the food sector, and maybe even in traditional media. It would not surprise me if a Chinese entrepreneur invested in a major UK print group. In manufacturing I expect continued investment in the auto sector, especially in EV technologies and maybe an F1 team, and other industries prioritized in the five year plan such as green tech, advanced materials and biotech.

Will exports from the UK to China benefit? Theoretically of course. Practically maybe not so much in the short term. JLR’s Jaguar and Range Rover cars made in the UK could become relatively cheaper in China. But if they did chose to price down their imported cars in RMB terms this could well cannibalize sales of their Chinese produced cars. So they may chose not to price down. Agricultural products could well benefit but again most are positioned as premium quality, branded products that come with a certain expectation on price. Pricing down might not lead to an uptick in sales.

Finally in the short term, let’s not forget companies operating in the UK with a business of selling China manufactured products. For example, the price of a China made mobile phone (i.e. most all of them) or PC is about to rise considerably in pounds. And if importers can’t pass price increase through to consumers, they will be pushed into losses.

Beyond the Short Term

What happens once this investment surge runs its course over the next 12-18 months? There is lots of talk in the UK and China of fast tracking a free trade agreement, using the Australian agreement as an example. While this could be of benefit to UK based manufacturers exporting to China (an increasing number of which will be Chinese owned), especially in the agricultural sector it is unlikely to be of a scale to give a measurable boost to the UK economy. On services, which is by far the largest part of the UK’s economy and where China has generally high barriers to foreign participation, there is hope that the UK could gain unique access through a FTA. I am skeptical, being the UK negotiator on a China FTA could be one of the tougher jobs in the new UK government. I don’t see the UK having much leverage in negotiations on service sector access. To the extent that China wants foreign participation in such sectors in wants the global best to be involved from whatever country they come from. Hong Kong’s preferential access to China service markets through the CEPA agreements have delivered relatively little.

Sooner or later Chinese investors will have to face up to the question of whether or not they bought a good underlying business. It is likely that many will have overpaid or not undertaken a through due diligence in assessing an asset in the first place. How much patience will they have for the hard work of turning around businesses that are lower growth than anything they are used to? Will they be able to find the right local talent, to know if that talent is really doing the best that is possible? Will they be able, should they want to, to integrate a UK acquisition into their China business? For a good number of these acquirers, a UK investment in 2016 is likely to be the largest overseas investment they have ever made. There will be a steep learning curve and some will mess things up. Tata’s challenges in the UK steel industry should be learned from.

The impact of constraints on the movement of people is not much talked about by Chinese investors yet but could become a big issue. While it remains very unclear what methodologies will be used to assess visa applications to the UK in the future, Chinese businesses in the UK already face difficulties getting work visas for senior management to relocate to the UK. Can the UK expect to attract Chinese regional headquarters to the UK if it doesn’t give potential members of such headquarters a visa? Can the UK really expect Chinese investors to run all these investments in the UK at arms-length forever, without leadership from China on the ground?

Then there is the Chinese student population in the UK, one of the UK’s biggest service export success stories with China over the past decade. As universities have become more “business-like” they have prioritized attracting high paying overseas students. Some masters courses now have as many as 80% of their students from China Many universities have grown their campuses significantly and borrowed to do so, anticipating large numbers of overseas students into the future? Will Chinese student still be able to get a visa to come to university in the UK? Will the Chinese student be even more needed if there is a decline in EU student numbers? What chance will there be for Chinese students to join one of these Chinese companies investing in the UK and work in their UK businesses once they graduate? Students are counted in UK net immigration numbers and so all of this becomes as much a political as an economic decision. Maybe it would even become part of FTA negotiations?

*****

The “golden era” in Sino-Britain relations launched during President Xi’s UK visit in October 2015 seems likely to continue, at least for business in the year to come, as Chinese investment into the UK flourishes, but material challenges lie not far ahead.

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