If investors weren’t concerned enough about the fate of U.S.-China trade, the arrest of Meng Wanzhou last Saturday and new reports that Chinese state-sanctioned hackers were behind a massive Marriott data breach have ramped up those worries.
As President Donald Trump and Chinese President Xi Jinping hammered out a truce in the two countries’ trade conflict at the G20 summit, Meng, the chief financial officer of Chinese technology giant Huawei, was arrested in Canada for allegedly violating U.S. trade sanctions against Iran.
Meng’s arrest outraged Chinese officials, reigniting investors’ concerns over heightened trade tensions. Meanwhile, U.S. investigators are reportedly zeroing in on China as the culprit in the theft millions of guests’ personal data from Marriott’s Starwood hotel chain.
One person tracking these developments closely is Louis Lehot, DLA Piper’s co-managing partner in Silicon Valley, who specializes his practice on cross-border transactions. Lehot has been spending much of his time facilitating U.S.-China deals, and he talked with Law.com’s California-based publication, The Recorder, about his recent trip to China and what he has learned about Chinese investors.
U.S.-China foreign direct investment (FDI) flows appeared to hit a steep decline last year after peaking in 2016. What do you think is behind that drop?
While in China in September visiting clients near Shanghai and Hangzhou, the big topic of discussion was the brewing Sino-U.S. trade war. I think the reverberations of our president’s public statements and tweets were felt more strongly in China than realized. Numerous companies in China recounted their experiences attempting to purchase assets or businesses in the United States that were purportedly blocked by the U.S. government. Digging deeper, I heard stories of unpublished decisions of CFIUS (the Committee on Foreign Investment in the U.S.) where it was allegedly communicated to the Chinese buyers that, while not officially blocked, if the Chinese buyers were to insist on proceeding, CFIUS would refer the matter to the President.
How have Chinese investors been reacting?
There is great frustration in China about the state of Sino-US relations. Reacting to the perception of U.S.-heavy-handedness has become a question of national pride in China. Five years ago if a Chinese entrepreneur bought a house in Silicon Valley, acquired a U.S. business or moved to the U.S. to create a business, this was viewed as innovative, courageous, and in the national interest. I sense now there is fear that if you are a Chinese company or entrepreneur, and you try and expand by deploying a significant amount of capital in the U.S., the Chinese government might say, “why are you doing that, you know those people are hurting us, they are putting tariffs on our goods, why would you invest our money in their country. Why would you take three million and buy a house in the United States?” Five years ago, I don’t think that people would worry about that, but I think today there is fear. I think that really explains the drop-off in investment.
I also meet with a lot of U.S. CEOs of Chinese subsidiaries of U.S. businesses, or joint ventures in China of U.S. businesses. They were complaining that there was a huge drop-off in sales in the China market purportedly because Chinese companies are afraid or feel that it is unpatriotic to purchase goods or services from U.S. businesses.
If they aren’t investing in the U.S., where have they been investing?
In the DLA Piper ecosystem, we have seen a huge uptick in acquisition and outbound investment from China into Europe, and a big drop in deals from China into the United States. That being said, there was already so much capital here… so many iconic name brands, Chinese companies, and investment funds—those funds are already here, and they are continuing to transact, albeit with a much smaller media profile.
What are you expecting to see next year?
U.S. businesses need Chinese capital and market access to Chinese consumers and businesses to grow. By the same token, Chinese companies need access to U.S. markets to grow and to U.S. technologies to evolve. I believe we are likely to see at least one trade deal with China in the first quarter of 2019 to give confidence to both economies and to prevent a recession. This will not likely be an all-encompassing deal, but something that allows both parties to get through 2019 and reevaluate.
I think 2019 is going to be a really good year for trade and investment between China and the United States. Then I think, as we ramp up to the 2020 presidential election in the U.S., Sino-U.S. relations will again come into the spotlight, and there is a risk that it becomes politicized again.
As far as the regulatory landscape, the world is adjusting right now to FIRRMA, which was a law passed by the U.S. Congress and signed by President Trump on August 8th that significantly revamps CFIUS…. I think we’re going to see consensus come together in the next month or two on how to manage CFIUS risk. I think the startup market is going to suffer a small drop off from the fact that all these investors are not able to invest with confidence right now. Starting in early 2019, as more rules and practices come out and develop, they’ll get back to the business of investing in Silicon Valley startups.
In terms of acquisitions, if Silicon Valley doesn’t have the capital from Asia and the rest of the world to finance and grow innovation, we are dead in the water. Nobody wants that to happen. By the same token, if we create massive disruptive technologies or medication or medical devices, if we can’t access what is assumed to be the largest consumer market in the world, we are dead in the water. I am confident that these realities will prevail over whatever are the politics of the day. The election is behind us. The economy is strong and growing. I think this bodes well for activity in the Silicon Valley deal economy in 2019.
What are some of the industries/areas have been popular among Chinese Investors?
Artificial intelligence is the number one area where everyone has been trying to figure out, how can I adjust my business model to take advantage of machine learning? I think artificial intelligence is revolutionizing the way we see the world. It is changing how we work, how we get transported, every aspect of our life is being changed by that. The second area where we are seeing a lot of investment is in financial technologies involving blockchain. The blockchain has become this decentralized way and secure way of tracking transactions in an open and secure format, and I think that the applications to supply chain, to currencies, to the financial markets, are only just being discovered. The third thing I would say is the industrialization of manufacturing and distribution.
So, you take artificial intelligence and you take blockchain, and other technologies and you say, how can we move products and ship them to customers more quickly, how can we create them more quickly? Finally, a big factor in technology, which has been the focus of investment, is absolutely automatic driving, which leverages all of those things I mentioned before to help transportation move in a way that is more secure, that involves fewer people and is superior.