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The China Connection (Int'l Edition)


International -- Cover Story

THE CHINA CONNECTION (int'l edition)

There are thousands of Chinese companies in the U.S. Here's how they got there, how they operate, and how their influence is growing every day

For over half a century, Southwest Products Co. has been a stalwart supplier to the U.S. defense and aviation industries. The small but highly regarded Irwindale (Calif.) company has carved out a niche as a leading manufacturer of spherical bearings for aircraft made by Boeing, McDonnell Douglas, Lockheed, and even Europe's Airbus. Today, its 60 factory workers make bearings for the Pentagon's C-17 military transport plane. And NASA uses Southwest bearings in the Space Shuttle.

Figuring out just who owns the company leads to a tale of some complexity. Last January, a recently formed U.S. company named Sunbase Asia Inc. bought Southwest. But it is an American company only on paper. Although it's listed on NASDAQ, the over-the-counter market, Sunbase's real owners are based in Hong Kong and China.

In fact, Chinese government companies are among those owners. The key player is Gunter Gao, a skilled dealmaker from the mainland, now in Hong Kong, who has valuable connections across China. His partner is New China Hong Kong Group Ltd., an investment fund that includes some of Beijing's largest state-owned conglomerates. Thanks to those ties, Sunbase in 1994 was able to acquire 51% of a huge government-controlled bearing company in Harbin, a city in China's northeastern Rust Belt. Harbin's government still owns part of Harbin Bearing Co.

Clearly, Southwest's new owners wanted to buy the company for more than quarterly earnings. What they got in the deal was a company with solid U.S. government contracts and skilled manufacturing processes, and technology sensitive enough that Southwest needed to get U.S. government approval to transfer certain ball-bearing knowhow to a joint venture in Shanghai. Now, Southwest can help transfer technology to Harbin. "We have the opportunity to take them to the next level," says former Southwest CEO William R. McKay, an American who is now CEO of Sunbase.

Sunbase is a link in America's new China connection. It is mne of hundreds, perhaps thousands, of companies with Chinese ties that have quietly stepped up operations in the U.S. From gigantic state monopolies run by Beijing to provincial-government trading companies to nimble new enterprises backed by local municipalities, the Chinese corporate presence is spreading in myriad ways. A prosperous village in Shandong province now owns a 213-room hotel, the Cockatoo Inn, near Los Angeles International Airport. Conglomerates with links to the Chinese military have staked out a claim, too. A company partially owned by the People's Liberation Army (PLA) advertises its 999 brand pharmaceutical products on a Times Square billboard.

Despite the ups and downs in relations between Beijing and Washington, the Chinese have lots of reasons to expand in America. Many see the growing $35 billion trade surplus with the U.S. and want to get a greater piece for themselves. Others crave U.S. technology and capital to give them a big boost in their campaigns to compete in China and elsewhere. Within 10 years, "we'll see a significant number of internationally competitive Chinese firms," predicts Barry Naughton, an economist at the University of California at San Diego.

But there's a darker hue to some Chinese activity. In many cases, companies are testing the limits of U.S.--and Chinese--policies. At a time when many U.S. lawmakers and business and labor leaders worry about technology flows to China, Chinese entities operating in the U.S. are winning access to knowhow through their investments. Trade is another area of potential abuse. In May, U.S. representatives of PLA companies were among 14 people charged in San Francisco in an alleged scheme to smuggle AK-47 machine guns and other munitions into the U.S.

Moreover, an estimated 100 Chinese companies have employed sophisticated maneuvers to acquire listed companies in North America, gaining backdoor access to Western financial markets while bypassing securities regulators in Beijing. If the practice expands, it could undermine the ability of regulators to maintain the transparency of U.S. markets and protect smaller investors.

The China connection thus is a double-edged sword. It can help introduce Western business concepts into China's economy. But it also means that Americans are confronting a new kind of foreign investment, sometimes made by companies that aren't really private. As China Inc. moves to the U.S., so too does the Chinese government and army. And the corporate model favored by Chinese companies is so complex, with multiple layers and various offshore entities as buffers, that it is often hard to determine the real ownership (table).

HUGE POTENTIAL. If current trends hold, this influx of Chinese entities could be just the beginning. According to Shen Beizhang, president of the new China Chamber of Commerce in U.S.A. Inc., fewer than 400 companies from China have approval from Beijing to be in the U.S. But Shen estimates the actual number to be more than 1,000. Add companies run by Chinese nationals in the U.S. and the number is more than twice that figure, says Xiaomin Chen, a Chinese-born graduate of Brigham Young Law School who is president of the U.S.-China Lawyers Society.

Since only a tiny percentage of China's millions of enterprises are operating in the U.S., the potential for growth is huge. Many in Corporate America anticipate a spending spree. "They'll do what the Japanese did in the 1980s," predicts Robert S. Bodey, a senior manager at Deloitte & Touche in New York. "One day, they'll get wired $300 million [from China] and buy something." To get a piece of that future business, Deloitte & Touche has formed the American Association for Chinese Companies (AACC), a new group also backed by Merrill Lynch & Co., American Express Co., and six other companies. AACC helps mainland businesses to get established in the U.S.

For Chinese companies starved for capital, perhaps the biggest attraction is U.S. cash. China's first forays into the U.S. markets have been largely unsuccessful. Big state enterprises have been listed on the New York Stock Exchange since 1992. But investors have been lukewarm. At home, many smaller, locally owned companies can't even get permission to list in the Shanghai and Shenzhen markets. That leaves these enterprises in a cash squeeze. "The tighter conditions get in China, the more desperate the search for capital becomes," says James Haft, managing director for emerging-markets investment banking with Furman Selz.

So the Chinese have devised new ways to reach American investors. The process usually starts with the company forming a joint venture with overseas partners, often Hong Kong-based subsid-iaries of Chinese outfits. That turns it into an overseas joint venture, beyond the reach of Beijing's regulators. The new company finds an American shell, buys out the old owners, changes the name and management, and starts doing business as a new U.S. company. Sunbase Asia, for instance, got its listing on NASDAQ through a reverse takeover of Pan American Industries Inc. last year. Chinese companies favored reverse takeovers in the early 1990s in Hong Kong until regulators there cracked down.

As at Sunbase, the ball-bearing manufacturer, American executives often head up these new companies. Joseph R. Wright Jr., for example, a former vice-chairman of W.R. Grace & Co., is the unlikely chairman of AVIC Group International Inc., a telecom company. AVIC's largest shareholder is Beijing Catch Communications, owned by the Beijing city government. Beijing Catch started AVIC last year to get capital for telecom projects such as paging and satellite networks. AVIC has relied on Beijing Catch officials to help put together four deals worth more than $1.1 billion in total investment. "We wouldn't do this if we weren't partially owned by the government," Wright says.

Dozens of companies have used this method to get into American financial markets. S.L. Chen, who owns a boutique investment banking firm in New York, specializes in leading Chinese enterprises through this labyrinth. "These companies can't wait," says Chen, 65, who as a child fled China for Taiwan before the 1949 Communist takeover.

Now, he has built extensive ties on the mainland. One wall in his New York office holds 13 framed certificates from Chinese universities where Chen has lectured on financial markets. Since 1994, he has arranged five reverse takeovers and has 20 more in the works, helping Chinese companies raise "anywhere from $5 million to $50 million." For his efforts, Chen takes a sizable fee, from 10% to 15% of the new company.

The complexities of these deals can boomerang on investors. Many of the companies trade as penny stocks, long notorious for involving unscrupulous players. According to investment banking sources in New York, American dealmakers can take fees that are much larger than customary. And Chinese unfamiliar with the market sometimes don't understand what they're getting into.

Technology is another powerful lure for Chinese entities. In an industrial park on the northern shore of Long Island, Brian Z. Li runs a new subsidiary of Livzon Pharmaceutical group, a Guangdong drugmaker that is trying to soak up U.S. knowhow. Li, a Guangdong native who got a masters degree from St. John's University in 1991, says the small plant started production of acetaminophen last month and will begin producing aspirin in September. The goal is to have a line of over-the-counter drugs for store brands of U.S. chains.

As he proudly shows off his new lab, Li says the sales from those products will be used to support the main goal: "a very aggressive research and development program." To learn about developing new products as well as to follow strict U.S. safety standards for drugmaking, the company has hired a chemist, laboratory supervisor, production manager, and marketing specialist from other companies in the area. Says Li: "We're well-established in the domestic business. The next step is to go international."

Like Livzon, more Chinese companies want to use expertise gained in the U.S. to help their home business. Jianlibao America Ltd., a subsidiary of China's largest soft-drink company, has set up a small iced-tea and sports-drink operation in New York to learn more about the industry. Shanghai Tire & Rubber Co. has an R&D center in Akron. Thanks to research conducted by local hires there, the company's Shanghai factories in June started rolling out radial tires for the first time.

General Manager Wang Dengxiang says he's trying to match rivals such as Goodyear Tire & Rubber Co. and Bridgestone Corp. "So many foreign companies are coming into China," he says. "We have to speed up our technology development or we will have lost our opportunity." That means introducing products developed largely in Akron.

Such talk worries some U.S. China-watchers. Chinese companies have a license from headquarters to acquire technology--and they're not shy about how they acquire it, says Ron Montaperto, senior fellow at the Institute of National Strategic Studies in Washington. He believes government and military companies may be getting some technology illegally. "They'll get it most any way they can," he says. So far, no Chinese have been convicted in cases involving industrial espionage.

NOT SO CUTE. Of all the Chinese entities operating in the U.S., the most controversial are those owned by the People's Liberation Army. One of the biggest is China North Industries Corp., or Norinco. With some 10 subsidiaries in California, Michigan, New Jersey, and elsewhere, Norinco is an active importer and exporter of sporting goods, medical equipment, auto parts, and other products. A Norinco subsidiary imports Chinese-made toy dogs and cats named "Spunky" and "Princess."

Other imports from China aren't so innocuous, according to the U.S. Attorney in San Francisco. Norinco employees in China and the U.S. were among those charged after a U.S. Customs and Bureau of Alcohol, Tobacco & Firearms sting operation allegedly implicated them in smuggling weapons into the U.S. Others charged included the president of Dynasty Holdings, a subsidiary of Poly Technologies, another company with ties to the PLA. All defendants have pleaded not guilty; no trial date has yet been set.

Even with such setbacks, companies affiliated with the Chinese military are expanding their U.S. business. Xinxing, run by another branch of the PLA, has set up a new trading company in El Monte, Calif. While the home company exports military and police uniforms to other countries, Xinxing (U.S.A.), which opened last year, sticks to imports of nonmilitary clothes for the American market, says a Xinxing manager in El Monte who insisted on being identified only as Michael.

The network of PLA companies throughout the U.S. has expanded even as congressional critics of Beijing, having failed to cut off China's most-favored-nation trade status, have targeted PLA companies for sanctions. Representative Benjamin A. Gilman (R-N.Y.), chairman of the House International Relations Committee, is planning to hold hearings this September on the PLA's role in the U.S. economy. Gilman and another GOP congressman, Christopher Cox (R-Calif.), had sponsored a ban on imports from Chinese enterprises owned by the military, but the bill was put on hold after congressional approval of China's MFN trade status in June.

U.S. labor unions are also uneasy about the growing Chinese economic presence. AFL-CIO Secretary Treasurer Jeffrey L. Fiedler has started an effort to track PLA companies. "They're more aggressive, there's no question," he says. "You have American people as consumers unwittingly subsidizing the PLA."

But military-related players are in a distinct minority. More typical is BNU Corp., a wholly owned subsidiary of state-owned China National Cereals Oils & Foodstuffs Import & Export Corp. (COFCO). It plans to break ground later this year on the first stage of an $80 million commercial retail, office, and hotel complex in Phoenix. Another subsidiary has issued $150 million in commercial paper out of Chicago since 1994. The goal, says BNU's Chinese-born president, Elizabeth N. Mann, is "to make COFCO a real multinational company" (page 39).

That's the goal of many Chinese enterprises operating in the U.S.--to transform themselves into much more globally competitive companies. "It's hard to imagine a well-developed country without big, well-known companies," says Yang Hongwei, president of Beijing-owned Sinochem (USA) Inc., a conglomerate with ambitions to rival South Korean chaebol, or conglomerates. "We want to develop into a company like Daewoo." The U.S. businesses of Sinochem range from futures trading to fertilizer manufacturing to real estate, with revenue of $2 billion last year.

Managers such as Yang are adapting surprisingly well to the world of Western executives. He works out of an office in New York's World Trade Center, as do officials from dozens of other Chinese companies. Unlike most, who commute from company-owned houses in the suburbs of Bergen County, N.J., Yang, 34, lives with his wife and daughter in nearby Battery Park City. At the start of an interview, he apologizes for his informal dress: polo shirt and chinos. It is a dress-down Friday, he explains.

Chinese companies such as Sinochem are in only the beginning stages of absorbing U.S. capital and knowhow. Likewise, many Americans are just now learning about China's expanding connections. For Americans who have finally learned to understand Japanese investment, China represents a different model. Japan's investments are led by its big keiretsu, or industrial groups. But with China, many investments are spurred by government-owned entities. Others are from companies whose true identity is often far from clear.

LOSING CONTROL. Ultimately, China's expanding connections in the U.S. could have an impact on how Washington manages overall relations with Beijing. China's recent stands on Taiwan, human rights, and trade have made it more unpopular in the U.S. than at any time since the Tiananmen Square massacre. An American government might lose some leverage in shaping the Chinese government's conduct if state-owned entities and military-backed units are able to raise capital and win access to technology in ways that Washington can't control.

But it's also possible that a growing presence of Chinese companies in the U.S. could have a beneficial impact. American companies with big investments in China might not be so vulnerable to Beijing's scorn if Washington is able to retaliate against Chinese state-backed companies in the U.S. More broadly, the U.S. could emerge as a base that encourages the most entrepreneurial Chinese to push for economic liberalization. Many of the Chinese companies are moving to the U.S. to survive the best way they can--by tying themselves to the American market and American capital. In so doing, they're forging closer ties between the two countries, ensuring a greater exchange of ideas and expertise. If Beijing shifts gears and cracks down on freewheeling companies after Deng Xiaoping's death, Chinese companies with American subsidiaries might even regard the U.S. as a haven.

No one can predict yet whether the expanding China connection will be a long-term force for better or worse. But it clearly is destined to grow rapidly and touch many sectors of the American economy. Ever since China opened to the U.S. in 1979, American leaders have talked about how U.S. business investment will help transform the Middle Kingdom. The scale is smaller, for sure, but the Chinese are starting to show that they can have an impact in the U.S., too.By Bruce Einhorn in New York, with bureau reportsReturn to top


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