Negotiation strategy and game theory of CNOOC/Unocal

To continue the dealbreaker discussion, for which the similar deal breaking issue has just been reported by NYT tonight, let's lay out the options and strategies for each party and see what kind of game play it may lead to .

1) CNOOC: the best strategy is to maintain the deal as it is now. Raising the offer will not help. Although it could put more pressure on Unocal board, but will not be able to sway their vote. However, they could raise the bid right before the shareholder vote on Aug 10 to sway the shareholders but it is going to be a long shot.

• a) A creative, though difficult to implement, solution is to "insure" against CFIUS objection through the derivative market, if they can find someone to bet (e.g.) 1 for 20 that CFIUS will approve the deal they only have to pay $500/20=25M to the insurance taker. Maybe some gambler (investment bank, or someone close to US politics - that invited some ethical question though) will take that bet, a lot of risks, but if you know the politicians......
  -- this should be JP Morgan and Goldman Sach's job, as their fees are so lucrative.
• b) A better option is to "blackmail" Chevron into selling some of the Asian gas field to CNOOC.

2) Unocal: the hope is to play the 2 bidders against each other, and try to entice or trick Chevron into raising its bid. Otherwise, the best option is to stick with Chevron deal.
However, if the shareholders opt for CNOOC. Then Unocal has to join CNOOC to lobby for the CFIUS approval, because otherwise they may have end up with no deal and might(?) still be responsible for the breakup fee (Does Unocal have to pay the break up fee if shareholders (not the board) reject Chevron? I suppose it doesn't, otherwise it will be quite dumb.)

3) Chevron and its investment banks: maintain the same bid. Raise bid only in the case of (1a) or right before Aug 10. A better option is to sell off a small slice (Indonesian or Burmese gas field) to CNOOC for a 10% premium. This way they also rid themselves of a potentially troublesome asset in Myanmar. Happy meal for everyone.

4) JPM and GS: try to implement solution (1a) for CNOOC; and try to dissuade CNOOC from making a deal with Chevron as that would slice the CNOOC deal size (hence their fees) by 90%

5) Chinese goverment officials: try not to say a word if it wants CNOOC to succeed. If Unocal rejects CNOOC, it is a business decision. Do not blame Unocal, blame the neo-convervatives or "China-containers" in Washington for creating the havoc/uncertainty which sways Unocal's normal business decision.

Deal breaker for CNOOC/Unocal

I have long suspected this will be the deal breaker. Now as news of the negotiation on specific terms arrives, it becomes more imminent.

The problem lies in the $500M break up fee for Chevron, and the uncertainty in CFIUS approval. Unless CFIUS approval went through before the break-up deadline with Chevron in August, this deal is doomed to fail.

Why? Because it is unlikely (and irresponsible to its shareholders) if CNOOC agrees to pay for the $500M when there is uncertainty that the deal may be blocked by political pressure. On the other hand, Unocal board cannot accept the CNOOC bid without a firm guarantee of the break up fees. Therefore, the priority for CNOOC is to get the deal approved before the deadline to remove the uncertainty, which now seems hard to achieve. As a result, I conclude that the deal will very likely fall through and Unocal board will accept Chevron's offer. If Unocal board recommends the CNOOC offer, they will risk being responsible for paying Chevron the $500M break up fee. Even if the CFIUS uncertainty is only 1%, no one is going to risk it. So it is the uncertainty that will kill this deal.

As for CNOOC, they didn't spend too much on this deal yet, as the investment banks are working for free. They might have spend $1M or so on P.R. and Rothschild, to learn a valuable lesson in corporate M&A. More importantly, they become more experienced after testing the water in this case. I even suspect CNOOC used this deal to secretly entice Chevron to sell them a piece of Unocal's Asia gas field. After all, there was rumor that they tried to bid for Unocal's asset together. We will see.

It started with China's investment in US Treasury...

I am not an economist. I did most of my works in business strategy. But I got interested in the issue of RMB exchange rate, and started reading blogs of some economists and writers. A recent discussion posted by Michael Mandl (see 1 and 2) of Businessweek and Brad Sester raised an interesting issue. I see it a little differently and here I am trying to present my view from a "business" perspective.

One of the issues under discussion is on the implications of the increasing foreign ownership of US treasury. Some view this as "selling away your country", some believe there is nothing to worry because it is not a "zero sum game". Dr. Sester believes one should compare external debt to external credit (and assets), plus perhaps export values (minus import). He is therefore concerned that US may have to sell off the country when the debts are due. Dr. Mandl believes that, to answer Dr. Sester's question, the meaningful parameter one should look at is the net worth of a nation. I am not an economist. So I simplify the problem by imagining US as a corporation (US Inc), and look at the cashflow of this corporation. My result is in agreement with Dr. Mandl's, with some caveats.

The Financial Model

1. Let's use the usual financial parameters and tools for a business corporation to describe US as a country, including its government, corporations and residents. We can find analogy for all the usual financial parameter for a country, including Net Worth(NAV), Cashflow, NPV, etc. In particular, one can view the Treasury bonds as corporate bonds, and selling of subsidiary/asset of a company as selling of corporations (e.g. Unocal) or other assets (e.g. Rockefeller Center), foreign assets (gas fields in Asia owned by Unocal) can be considered as minority investment in companies controlled by other "Inc", etc.
2. Selling and buying assets in "fair market value" is business activities among corporations. It should also be considered as normal commerical activities among these "Inc"s, as are trading of physical goods, services, or equity stocks.
3. When one tries to address Mr. Sester's concern of "selling off the country", one wants to consider if there is a scenario that the company has to sell its assets in a "fire-sales". In normal circumstances one would not, unless the "Inc" is under severe financial pressure due to major disruption in the market (e.g. financial melt-down, natural disaster). Therefore, one should look at the cashflow of the Inc, i.e., whether the Inc can afford to pay off the interest and principal of these external debts. The answer is obviously "yes" in the case of US Inc, because the debt is denominated in US$. US government can always issue domestic bond to pay off its foreign debt (or even print more paper money :) ). Mr Sester's concern will be valid if the bonds are denominated in Euro or RMB.
4. To look more closely into the issue of the ability to deal with the debts in future , what really matters is the future "cashflow". i.e. The amount of inflow (domestic earning, earning from foreign investments (external credit/asset), revenue from export) - outflow (payment of interest, principal, and for import). If one generates more cash inflow than the payment, one should not worry about Dr Sester's concern.
5. Example: let's assume my net asset is $100. I owe $15 debt. I own $20 credit/asset under other people's management (is equity a reasonable analogy?). So my gross at home under my own name is $95. My net is $(95+20-15=100).
   Is this good or bad? I would say it depends on the return for each piece.
   If my $95 is yielding 3% a year, and $20 4% a year, $15 debt i pay 2.5% a year. I would definitely issue more 2.5% bond and buy more asset that yields 4% if i could, provided I can find these deals. Because I am now sure I have the cash to pay my interest in the future. However, if the yield % (interest rate and investment return) are reversed, borrowing more is not a good deal for me.
6. In an efficient market traded by "rational" managers one should be striking for the maximum return. (I have ignored the volatility in future for simplicity) each person/Inc will try his/its best. Therefore, for these Inc's only the combined long term return should matter (domestic and external asset asset yields - debt interests + trade balance, where trade includes revenue for intangible goods such as services).
7. Now the question should be: is US trying its best (collectively, govt and enterprises) to secure the best long term return? By borrowing money cheaply via bond issuing and use the cash raised to finance investment for better return?
8. Dr Mandl used DCF (discounted cashflow) to demonstrate that the total wealth of US is still increasing. So one should not worry about foreign debt, as long as the increase in domestic wealth surpass the increase in foreign debt. If my total net worth increase, it does not matter if my debt increse, because my gross asset would have increased more. I agree with his conclusion in principle. However, I believe the DCF calculation at such a macro-level may be problematic. There are a few ways to prove his point that it is not a zero sum game. One can use book value (i.e. valuing assets such as housing price based on the most recent transaction), market value (e.g. market capitalization of stock and market price of asset, incorporating current value and anticipated future cashflow by the market) or NPV (Net Present Value, using DCF, Mandl's method). Calculating NPV involves a number of assumptions. The result usually attracts debate and controversy. (how many reports from Wall Street analysts do you believe?) Since the market price is equally likely to go up or down, there is no reason to adjust it up or down. I see the current market value as the most reliable measure of value
9. To justify the claim that the debt help to increase wealth, one probably could compare the ROCE (return on capital employed = GDP / Total Asset Investment) and the bond interest rate
10. Dr Brad DeLong believes external debt vs future export still matters. I agree, but I want to add that US domestic value (including land and home) also matters, mainly because these debts are denominated in US$.
11. Dr Sester's claim that one should look at external debt vs external assets. I think there is a value to look at this ratio, especially if neither conutry has control on the exchange rate (even through regulating internal interest rate), or when there is a short term squeeze such that you cannot convert your domestic earning to fill the difference in cashflow. In fact, the more appropriate measure is external interest due to external debt vs return generated by external asset. Even in this case one should include surplus in domestic calue creation (not to mention that all these external debts are denominated in US$ for US).
    

Other discussions

• What about China? China has been taking FDI in large sums all these years, and the FDI generates return for the investor and also for China (employment, corporate expenses, to a much lesser extent, tax, etc). They are "selling" themselves in a way. This is what the Chinese leaders maybe thinking: as long as the future return can be justified for the land and the tax/etc concession I have given away, I am willing to owe more debt. China had virtually no external asset when they began 25 years ago. I believe they even took some loans back then. Now they have external assets in terms of US treasury, to a large extent due to the help of these FDIs. China's ability to attract FDI has been well praised internationally
• What China should really worry is a sudden depreciation of US$, in that case all its investment in US Treasury Notes will become worthless. Therefore, it is another reason to revaluation RMB before it is too late
• A question: do you call Australia selling its nation when it exports its irn ore? Or Saudi selling its nation when it exports oil?
  

another view on Chinese business

see here:

"China: The best of all possible models" and "China and India: The race to growth"
in McKinsey Quarterly (you may need to register to their website)

Tao Guang Yang Hui (韬光养晦) - is China a threat? (II)

(Continuation from this earlier post)

Let's first look at two essays from within China.

1) Pursue for hegemony is NOT the the objective of TGYH (韬光养晦 ≠ 卧薪尝胆) -- the link is to an essay by Wang Yusheng, diplomat and academic, ex-Ambassador to APEC

According to Wang Yusheng, TGYH is a long term strategy. It is not, as Pillsbury has suspected, a tactical ploy. China should always maintain low profile and be humble. Humble is a virtue in Chinese culture. Adopting this strategy is also for the long term benefit of China herself. Hegenomy does not do China any good -- after all, what does US get by sacrificing so much resources and lives in Iraq? Deng's wisdom is quite obvious to the peace loving people and pragmatic business community. However, it is not as straightforward to the hawks in China, or their equivalents in the US. Therefore, from time to time, especially recently, people (in China and also some China specialists in US) debate about what TGYH strategy really is. Mr Wang's article serves as a reminder to the Chinese people about what TGYH really means. He first refuted the misconception that TGYH is a short term (or deceptive) tactical move to buy time, by spelling out the difference between the world today and the ancient China political environment in Warring State Era. From Deng's view TGYH is good for China irrespective of her (economic) developmental stage or how powerful she is.

Deng Xiaoping is quoted as saying "even if China is well developed and has become a strong nation in the future, we will never seek to become a leader, never seek hegemony, never seek a sphere of influence, never involve ourselves with any faction in world politics, never interfere with the internal affairs of other nations." ("即使将来中国强大了，也永远不当头，不称霸，不谋求势力范围，不搞集团政治，不干涉别国内政") As a senior diplomat who is close to the senior leadership, Mr Wang knows the diplomatic strategy in China very well. His quote and interpretation of Mr Deng should be very accurate and should also represent what is in the minds of the present leadership -- unless the current leadership is rejecting Deng, which is a fairly unlikely scenario.

He also points out a few areas of misunderstanding of the rest of the world about China. China does not believe in hegemony or Huntington's theory of culture clashes or Kennedy's rise and fall of power. He asserts that such views are "very western". The wisdom of the world today has surpassed these. Being a hegemon does not necessarily get you the best benefit. China has learned that minding her own business and integrating into the rest of the world is the golden rule to successss. Wang also points out that any effort to pursue hegemony by any country any time in the future will be futile and short-lived, using an analogy that "even if you use all your ten fingers, you cannot suppress ten fleas at the same moment" (一个国家，即使国力超强，十个指头也不可能按住十个跳蚤) (incidentally a corollary is that it is impossible for US to sustain its hegemony as the cost to maintain will evetually drain its resources, thus supporting a school of thought in China that China should be patient and wait for any hegemony to fade back to multi-polarity, instead of confronting it.).

2) Wang Dao (王道 the kingly way) vs Ba Dao (霸道 hegemony)

Xiao Dong's elegantly written short essay (originally published in an overseas Chinese paper in the US) argued from the same perspective as Wang. He first point out that hegemony is an out-dated concept in international politics, and hence should not be pursued by China. He then goes on to discuss the heavenly objective of political achievement, based on the ancient Chinese doctrine of Wang Dao (The Kingly Way). Pillsburyry did an excellent job in studying Chinese theory of statecraft circa 800-300B.C. However, he has focused on the hegemony aspect of the statecraft, and missed the highestst form of statecraft called Wang Dao. Wang Dao basically means achieving the ultimate respect of the world through righteous morality and supported by good ruling, which ensures your winning the hearts of all foreign power and their people. (What US did to Europe after WWII in the name of Marshall Plan was a close implementation of Wang Dao, but Wang Dao emphasizes domestic governance as historically China never bothered about its neighbors) Wang Dao has always been considered the idealistic achievement in China statecraft. Because it is so difficult to achieve, most kings have compromised for hegemony and given up on Wang Dao. It is therefore overlooked by even experts like Pillsbury. Note that Confuciusus advocated Wang Dao and despised Hegemony.

Xiao goes on to argue that Wang Dao is also consistent with the highest form of achievement in Sun Zi's "Art of War" , quoting Chapter 5, "the righteous target and strategy shall be emphasized as the ultimate goal, while the deceptive tactic is (only) auxiliary and complementary to the righteous goal." (<<孙子兵法>>中除了说"兵者﹐诡道也"﹐要"以奇胜"外﹐更提倡"以正合"。) He then quotes Mencius and uses historical facts to show that only the Kingly Way will lead to sustainable achievement, while any hegemony is ephemeral. Finally he concludes that TGYH should never be given up, and should be adopted as a permanent measure, with Zheng Dao (The Righteous Way, replacing the feudal term "Kingly") as the ultimate goal and practice. Only with Zheng Dao will China be able to bring back the glory she once enjoyed in ancient time.

Having reviewed these two essays, both widely quoted in the Chinese media (one of them from a prominent diplomat close to Deng, the other was listed in dozens of prominent web-sites for Chinese military academics and popular web-sites, perhaps as an explicit message to convince those who believe the time for TGYH is up), we should not be in much doubt about Deng's original intention and that such interpretation is the best strategy for China's own good, even thousands of years into the future. Inevitably, there are hawks in China, just like those in US. Therefore, to answer the question "Is China a threat", we need to understand if the aforementioned belief should prevail in China, and if there are abundant fundamental driving forces to ensure that the rational strategist will prevail against the hawks.

(to be continued in Part III)

-------
Wang's essay in Chinese below


关于“韬光养晦”的再思考
www.XINHUANET.com
2001年夏秋之交，国内一些报刊先后发表和转载了我的文章：关于“韬光养晦”战略相关问题的探讨。
文章主要介绍邓小平同志提出“韬光养晦，有所作为”战略的时代背景，认为“韬光养晦”战略充分考虑了国际形势，特别是中国处于社会主义初级阶段这一现实和面临的任务，并非权宜之计。文章认为，中国应坚持以经济建设为中心，不能放弃“韬光养晦”战略，应该联系外交实践，总结经验，更好地运用这一战略。
3年过去了。国内外形势发生了重大而深刻的变化。为此，国内一些专家学者和广大读者对“韬光养晦”战略也开始有了新的思考和认识。
有些人认为，中国的大国地位和大国能量是一种客观存在，无法回避；美国遏制中国崛起和独霸天下的战略也是一种客观存在，无法回避。“树欲静而风不止”，继续奉行“韬光养晦”战略，实际上是“苟且偷安”和“鸵鸟政策”，“客观上帮了美国霸权主义的忙”。他们认为，不能老是以“韬光养晦”为主，邓小平当年提出“韬光养晦”时的国内外环境既已发生变化，就应适时调整政策，以“有所作为”为主。
还有一些人赞成继续奉行“韬光养晦”战略方针，认为“小不忍则乱大谋”；中国现在国力不够强大，不能不“忍辱负重”，10年、20年，甚至几十年，这是必要的代价。但总有一天中国会扬眉吐气。等中国真正强大了，就可以明确地对霸权主义说“不”，可以战而胜之，甚至“不战而屈人之兵”。
这些意见是社会各界人士关心国家命运和前途的一种表现。不同意见的提出和探讨，有助于澄清问题，有助于深入领会邓小平外交思想，也有助于我国外交工作更加贴近社会。
目前，社会上对“韬光养晦”不是权宜之计分歧似乎不大，但对“韬光养晦”的战略目标和图谋，意见显然不同；对“韬光养晦”与“有所作为”的关系，认识很不一致；对什么是“有所作为”以及怎样才能“有所作为”，想法也不一样。以下笔者仅就这些问题谈谈个人看法，以期引起对“韬光养晦”一些问题的再探讨。
“韬光养晦”≠“卧薪尝胆”
“卧薪尝胆”的要害是“复仇”和“争霸”，有明显的敌人，而且，为了达到目的，可以不择手段。历史上越王勾践可以俯首称臣，下跪求饶参拜，甚至亲口尝吴王夫差的粪便。我们讲的“韬光养晦”，其核心不是图谋霸权，也没有假想敌人；其根本目的，对内是要抓住机遇，以经济建设为中心，振兴中华；对外是要追求“和而不同”和“共同繁荣”的世界，而且是有原则的，不是屈辱的，更不是乞求的。在事关国家主权和领土完整以及重大国际问题上，中国作为最大的发展中国家，是要“有所作为”的；如果触及不可以容忍的底线，中国也是“不怕鬼，不信邪”的。我们绝不能像某位学者说的那样，当今时代，发展中国家只有放弃美国担心你要发展的那种武装，完全投向美国，安全才有保证。如果那样，中国可就真地成了“东郭先生”了。中国不仅需要有现代化的强大国防，而且要认真准备军事上的“杀手锏”，以防“天有不测风云”。
对中国“韬光养晦”战略，国际上一直都很关注，一般都持肯定态度。但也有两个动向值得注意。
一是蓄意歪曲，如美国2002年的《中国军力报告》，硬把中国的“韬光养晦”战略说成是“在国际上进行战略欺骗”。这是极个别的。
二是有误解和习惯性的误判。如美国知名学者约翰·米尔斯海默，他一再强调，所有大国都是无情的权力追逐者，中国也不例外。如果中国日益强大，也将仿效美国，使用理想主义的辞令来描绘中国的外交政策；也会像美国一样，最大限度地占有世界权力。他是根据历史的经验和美国现在的行为作这种判断的，正好像美国总统国家安全事务助理赖斯女士所说，“多极化”是一种“竞争理论”，它“导致了第一次世界大战”。他们的看法并非没有一点道理。历史上，由于资本主义政治经济发展不平衡规律的影响，当一个占统治地位的帝国衰落而另一个帝国兴起的时候，后者就必然要向前者挑战，要求重新划分势力范围，重新瓜分世界，从而引起对抗和战争。
但米尔斯海默先生和赖斯女士似乎没有看到，现在时代真的大不一样了。发展中国家的兴起，是不可逆转的时代现象。发展中大国的兴起，其性质也不同于历史上某个帝国的兴起。它们要求的不是重新划分势力范围和重新瓜分世界，而是“平等的伙伴关系”，是公平和公正的国际政治经济新秩序，是国际关系民主化。这一点已经为大量事实所证明。不仅正在兴起的中国如此，印度、南非和巴西等大国也大体如此。从亚欧会议的成立和实践情况可看出，很多欧洲发达国家，包括原来是帝国主义和殖民主义的国家，也开始认识到这一点。
“韬光养晦”与“有所作为”
“韬光养晦”和“有所作为”不是对立的，而是辩证的统一。前者是矛盾的主要方面，后者也是不可或缺的。
过分强调“韬光养晦”，消极地理解和执行，容易陷于被动和“无所作为”，甚至在国际上被“边缘化”，或为人所用。这当然是中国外交需要警惕的。过分强调“有所作为”，容易“左”，实际上是自不量力，充好汉，打头阵，引火烧身。固然，随着中国综合国力的提高，在国际上“有所作为”的分量也要相应增加，如对贫困国家的援助，有选择地参加联合国维和行动，积极推动重大国际安全问题的合理解决等。这一切说明，中国的“韬光养晦”战略是积极的、主动的，而不是消极的，无原则的。但如果“有所作为”太过了，甚至以一种“大国主义心态”处理国际问题，热衷于在国际事务中起“带动”和“领导”作用，热衷于“富人俱乐部”成员地位，事事想冲在前面，那就可能引起本可避免的、不必要的对抗，从而影响乃至破坏“韬光养晦”的大局。
邓小平同志在作“韬光养晦，有所作为”指示的同时，一再强调，“千万不要当头”，而且说，“头头可不能当，头头一当就坏了。搞霸权主义的名声很坏，当第三世界的头头名声也不好。这不是客气话，这是一种真实的政治考虑。”他还说，即使将来中国强大了，也永远不当头，不称霸，不谋求势力范围，不搞集团政治，不干涉别国内政。邓小平同志的这些话，我们应该牢牢铭记在心。这些话也是对国际上关心中国事务人士的很好回答。
“有所作为”和“有所不为”
要真正“有所作为”，首先要深入了解和掌握国际形势总体发展趋势，以及时代的主要问题和矛盾。在我看来，冷战结束后，世界各国民众普遍渴望和平与发展，渴望国际关系民主化；美国新霸权主义和它当前反恐谋霸的一系列政策行为，与之背道而驰。这之间的矛盾和斗争，正在形成新世纪的主要矛盾。
其次是要“有所为，有所不为”。一个国家，即使国力超强，十个指头也不可能按住十个跳蚤。“有所作为”不能没有重点，不能没有选择。一定要看有关事情的性质及其与我国切身利害关系如何。
具体说来，目前在国际上，我国提出国际关系民主化和发展模式多样化，努力推动世界多极化的发展，主张“和而不同”，要求在联合国框架内解决重大国际安全问题；在亚太经合组织（APEC），提出以承认多样性和自主自愿、协商一致为主要内容的“APEC方式”, 在上海合作组织提出新安全观，在同东盟关系方面，积极推动自由贸易区的早日实现；在反恐方面，既认真进行国际合作，又同有关国家保持一定距离，提出反恐要标本兼治，不应搞双重标准，不能随便给人扣“恐怖主义”帽子；在周边关系方面，积极奉行“以邻为伴，与邻为善”方针，等等，都是中国外交争取在力所能及和可行的范围内“有所作为”。而且，这种“有所作为”，随着中国综合国力的增长和形势发展，在可预见的将来，还要加强。（王嵎生）

How would the CNOOC-Unocal deal affect oil price?

CNOOC/Unocal deal can only lower oil price, as explained by this Washington Post Editorial, and this commentary. Because

• China (or any oil importer) has the incentive to lower oil price by maximizing production, while the oil corporations (and Saudi, and even many in the US government) do not
• In the deal proposal Unocal's reserve in US will not be touched (or will be sold away back to US business). Unocal's reserve outside US are mostly natural gas (need to be converted into LNG as there is no pipe connection), so the most likely scenario is for China to divert the LNG back home, hence shifting China's oil consumption into LNG, or in longer term helping with the global effort in learning how to lower the cost of LNG power generation. In either case, the world demand in oil will be soothed
• The sums of supply and demand of oil in the world do not change even if all Unocal's production are sold to China, because such activity reduces supply to rest of the world at the same time it reduces demand from China, by the exact same amount. China is going to purchase that amount of oil from world market if it does not buy it from Unocal, perhaps at a higher price, hence pushing up the oil price in the world market.
• As stated previously, if CNOOC tries to push up the production of the Unocal field, it is going to increase demand and hence lower the oil price in world market. The supply will only be squeezed if China buys more oil than its own demand. Because Unocal's total daily capacity only represents less than 15% of China's import, or less than 7% of its daily damand (much lower in future as its demand increases), it is impossible for China to hoard oil

In short, only oil exporters such as Russia and Saudi has the power to change the oil price, and hence the power to pose security threat to US oil supply. Economic analysis shows that changing hand of an oil field to a net importer does not change demand supply balance. The Unocal deal is not neccessarily a good deal to CNOOC as viewed by many (see also WSJ Jun 23rd about PE comparison), the US congress is probably doing CNOOC shareholders a favor by blocking the deal. However, conflicting message to China about free market is not going to help US achieve its goal of promoting free market and democracy, whatever such goal is or if such goal exists. Even worse, does US prefer to corner China into where it has no other option for energy than dealing with Sudan, Libya and Iran? or to push China into hoarding more crude oil reserve than it plans as a result of insecurity of lacking oil reserve (China has the greenback to do so)?

Chinese companies moving abroad - another perspective

Here is an article on WSJ today, written by two senior management consultants from BCG (excerpt below). They have advised the CEOs of Fortunte 500 companies and also top enterprises in China, such as GM, Pepsico, Pfizer, Volkswagon, SAIC, TCL and Haier. Their insights speak a lot about the management and strategic implications for these deals. See also p.13 of this Wharton Knowledge Article (right click to download also from this link).

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The Talent Behind 'China Inc.'
Thomas Hout and John Wong.
Wall Street Journal, Jul 5, 2005. pg. A.18

you shall find it in Wall St Journal and later on www.bcg.com as well.

A STEREOTYPE IS forming around China's acquisitions in the U.S. -- buy fast rather than build slow. Lenovo's buyout of IBM's PC unit, TCL's buyout of France's Thomson and with it RCA, and now Haier's bid for Maytag all suggest that China is in a hurry to go global and will freely spend low-cost money to acquire our brands and distribution access, plus secure an outlet for their low-cost products made in China.
The problem with this view is that China's most successful acquisitions to date in the U.S. have little to do with China's low- cost money and workers or buying our brands. They are instead all about Chinese management skill and U.S. workers. These no-name Chinese acquisitions are turn-arounds founded on hard-nosed Chinese business practices, and they import less product from China than most U.S. manufacturers do.
Haier in fact doesn't fit the mold either. It has spent 10 years building its own brand in the U.S. and now has its name on 10% of new U.S. refrigerator sales. Large units, too expensive to ship from China, are made in the U.S. Haier succeeded by partnering with a young, market-savvy U.S. entrepreneur, Michael Jemal, who created down-market, niche refrigerator products that the big U.S. brands ignored and won its own distribution access by customizing products for the big box retailers. Haier's bid for Maytag is a turn-around play premised on Haier's proven management practices. Otherwise, sophisticated co-investors like Blackstone and Bain Capital would not be aboard.
Chinese companies that are successfully building slow in the U.S. include Wanxiang and China International Marine Container (CIMC). Wanxiang Group, China's leading auto-parts maker, tried to export auto parts from China to the U.S. but found itself underpriced by Polish and Romanian imports. So it adopted a private equity role in building a U.S. business: it joint ventures or acquires stakes in struggling U.S. manufacturers, then restructures their management and operations based on what Wanxiang learned in China. The Group now has equity positions in over 30 auto-parts companies world-wide, and its U.S. sales of nearly $400 million are more profitable than its business back home.
CIMC may be the world's least visible globally dominant company, making 40% of all shipping containers. In the 1990s it consolidated South China's big container business -- much like GM rolled-up U.S. autos in the 1930s -- by buying up smaller local producers with non- voting stock, then rationalized production among these subsidiaries. Only then did CIMC acquire a U.S. truck-trailer maker from a bankrupt parent and turn it around, using Chinese-made container components and factory floor technology.
Chinese management is an under-rated asset in American discussions of China's global strategy. Almost all large successful companies in China are turn-arounds of formerly politically managed state-owned enterprises. The managers who took them over during the 1980s and 1990s reforms had to learn what any turn-around specialist does -- flatten layers, fire the pretenders, prune losing businesses, and hammer operating costs down. The CEOs of Haier, Wanxiang, and CIMC all started and spent their careers on the factory floor. China's low-cost mentality is just as much about cheap management as about cheap labor.
So it makes sense that China's first and surest global companies will be in mid-tech or modest brand businesses built on ground-level operating skills, opportunism, and local partnerships -- not high- profile consumer brands or high tech. These proven Chinese strengths also play perfectly to deep changes going on in the U.S. economy -- revitalization of distressed small manufacturers through new partnerships, private equity's growing role, and even lower income consumers' trading-down to lower-priced household durables.
Not all Chinese companies, however, think they have the time to build slow. Lenovo and TCL are in fast-moving businesses where strong global competitors are breathing down their neck in China -- especially, Dell, Samsung, Nokia and Motorola. Computers, flat-screen televisions, cell phones, and mobile consumer electronics devices of all kinds may be made in China but controlled by multinationals there who are pulling away from Chinese competitors.
This issue of pace is a problem for China. Product and marketing innovation is rooted in close contact with customers and close collaboration with adjacent, complementary technologies. Chinese state-owned companies have typically been separated from end customers by government-controlled distribution intermediaries. The result is China doesn't have what Silicon Valley and other innovation clusters have -- diffusion of knowledge horizontally and movement of technologists between firms.
Too much can be expected of China's high-profile companies now. The early rounds of Chinese globalizing favor less glamorous, hard-nosed Chinese companies who have a lot to offer to industrial America right now.
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Mr. Hout is a senior adviser and Mr. Wong is senior vice president at The Boston Consulting Group's Hong Kong office.

Tao Guang Yang Hui (韬光养晦) as a strategy - is China a threat? (I)

Fareed Zakaria in Newsweek made a great observation in China's strategy on Tao Guang Yang Hui (韬光养晦), literally translated as "Hide brightness, nourish obscurity" (see Mike Pillsbury for a good introduction in English, but some of his conclusions would be argued against in part II of this blog) or "Bide our time and focus on building ourselves". Zakaria also praised the wisdom of Lee Kuan Yew's comments on education for China's next generation, whom he worries may not understand the importance of being humble. LKY's deep insight contrast sharply with the views from some low ranking officials in China and many western observers (perhaps including himself) who seem to have missed one of LKY's points. LKY's comment has two fold meanings, about popular education / indoctrination of TGYH and about the need to ensure that TGYH will be adopted as the long term strategy in future generations.

I googled the word TGYH and found a few extremely insightful essays on the issue from China's respected strategists (plus amateur interpretations by writers such as Liu Xiaobo, who is not a strategist). Unfortunately these are mostly written in Chinese. In Part II, I will recap the key point of an excellent discussion in this link here by Xiao Dong, and another by Wang Yusheng, who in my opinion truly understand the essence of TGYH. I hope this view would help those who are worried about "China threat" to understand the implication. Even if Chinese GDP/cap is on par with the Japan, which is at least 25 to 50 years away from today, they argued that it still serves China's best interests to remain TGYH.

First, an approximate translation (with a little of my elaboration) of the synopsis of the TGYH (see link of Pillsbury's description in English for some background information) strategy, as laid out by Deng Xiaoping in early 1990s (see the end for Deng's original quote in Chinese ) -- the basic idea of Deng is to "mind our own business and be humble in world affairs"

1. avoid leading or forming faction in any international conflict, stay neutral in all circumstance, "Don't stick your head out"
2. do not try to lead an opinion in international politics, do not try to represent any interest group, stay away from any sphere of influence
3. avoid any trouble, controversy or antagonism in world politics, be humble but try not be humiliated, and even accept minor humiliation if you have to, "yield on small issues" in every possible occasion
4. concentrate on economic development
5. focus on forming a friendly relationship with ALL countries in the world, irrespective of the ideology of the countries you deal with. i.e., forget the old "party ideology"

Note Deng's instruction was very specific, perhaps he feared his successors may not able to implement the strategies correctly. Note also that Deng's instructions depart from the common proverbial connotation with Guo Jian (越王勾践) and Liu Bei (刘备), which implies that being humble is a means, an indirect way to realize ambition in future (Pillsbury got it wrong here, because he failed to notice the significance of Deng's elaboration of TGYH). Deng probably needed to choose a proverb with a connotation to ambition so that his successors will be motivated to follow, and he cleverly defined his true vision in the five principles above. Deng's hope was that by the time his great grand successors are ready to think about being ambitious they would have been benefited from being humble so much that they would then recognize that TGYH should serve as the 'permanent' strategy like Xiao Dong stated in his great essay (LKY, himself a great visionary, obviously understood Deng's intention very well). Deng saw the world of his time as one 'tending towards greater relaxation' in which 'peace and development are the main themes'.

I hope the above description and links explain the TGYH strategy, the history and the present situation well enough for us to proceed to the discussions in Part II. i.e. is China a threat, or will China ever become a threat to world peace? or to US? The question that has also attracted discussion and hearing in the US Congress.

(to be continued here)

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the original in the above essay copied below, other discussions can be found here and a generic search result here, where you can see the majority of opinions.
中国没有理由放弃“韬光养晦”
　　新华网2005年6月20日消息 美国侨报近日发表萧冬的文章，说随着国力的增长﹐中国将更偏重“有所作为”﹐但绝不应放弃“韬光养晦”。同时﹐也要向世界表明﹐“韬光养晦”不是一种“诡道”﹐不是一个“阴谋”﹐不是权宜之计﹐而视为一种“正道”，一种立身之本﹐不仅应行之于中国崛起之前﹐而且还会行之于崛起之后。
　　近来﹐中国对外一改过去模糊﹐柔弱的作法﹐在重大问题上强硬出击﹐明快应对。继对台推出《反分裂国家法》﹐邀请连宋大陆行后﹐对日本﹐吴仪断然拒会小泉﹐明确表态在日德印巴入常案上投反对票。对美国﹐强力顶住迫人民币升值的压力﹐在纺织品等贸易战中﹐也针锋相对，据理力争。对此﹐有人欢呼﹐也有人疑惑。有论者说﹐中国将终结“韬光养晦”﹐进入一个大声说“不”的时代。
　　对中国“韬光养晦”政策含义的理解﹐见仁见智。最近的一个例子﹐就是据报导﹐美国五角大楼中国军力报告的起草人﹐“中国通”白邦瑞(Mike Pillsbury)曾宣称﹐战国时代越王勾践“韬光养晦”，最后灭了吴王夫差。如果今天不遏制中国，30年后，美国也会像吴王夫差一样完蛋。白邦瑞是以兵不厌诈的“诡道”来解释“韬光养晦”，以弱肉强食的“霸道”来管窥中国的行为。
　　这并不奇怪﹐因为﹐在西方文明中﹐“霸道”的观念根深蒂固。从马基雅弗利(Machiavelli)﹐摩根索(Morgenthau)﹐到米尔雪默(Mearsheimer)﹐这些主导了西方主流意识的现实主义者﹐无不信奉以力服人﹐明确把“利益最大化”作为国家的最高利益。
　　在历史上﹐两次世界大战﹐美苏冷战﹐乃至近年的局部战争﹐不论打着什么旗号﹐背后无不是以争夺和保卫霸权为最终目标。抱着这些观念来看中国崛起﹐当然会对“中国威胁论”念念不忘，对“韬光养晦”如芒刺在背。
　　西方有学者认为﹐中国在近代所受到的来自西方的苦难与屈辱太深太重﹐使中国人产生了一种“受害者”情结﹐因此生怕中国强盛起来后﹐象越王勾践那样“复仇”，“雪耻”。殊不知﹐对于中国人而言﹐正道是“王道”﹐而不是霸道。
　　《孙子兵法》中除了说“兵者﹐诡道也”﹐要“以奇胜”外﹐更提倡“以正合”。霸道以力服人﹐王道以德服人。霸道追求国家权力最大化﹐对外扩张。王道追求天下大同﹐对外协和。如孟子说：“以力假仁者霸，霸必有大国。以德行人者王，王不待大。”(孟子-公孙丑上)。追求霸道的列强﹐可以建显赫帝国﹐无边功业﹐但“城头变换大王旗”﹐当年霸主今安在﹖而追求王道的中国﹐历时几千年﹐依然屹立在东方。因此﹐王道是内敛的﹐而不是外张的。是宽容的﹐而不是排它的﹐这也是“韬光养晦”的应有之意。
　　换言之﹐“韬光养晦”应是走向王道的姿态﹐而不是走向霸道的掩护。越王勾践的卧薪尝胆﹐刘备的“巧借闻雷来掩饰”﹐其中的“隐忍”与“诡道”﹐并非是“韬光养晦”的全部含义和精神。当然﹐需要指出的是﹐王道必须建立实力上的﹐落后只有任人宰割。
　　近代中国百年积弱，差点成为别人的“王道乐土”。而在汉唐之时﹐声教播于四?o同时国力之盛也举世无双。王道也必须建立在智慧上的﹐不能象宋襄公那样﹐行愚不可及的“仁义”。也不是该出手时不出手。只不过在出手之时﹐先考虑好收手的方式。
　　因此﹐回到今天现实﹐中国没有放弃韬光养晦的理由。其一﹐中国经济结构的深层矛盾，社会阶层的潜在冲突，都使中国没有放弃“韬光养晦”的本钱。对中国经济发展的成果﹐对外界沸沸扬扬的“中国热”﹐一定要头脑冷静。其二﹐在对外关系中，根据实际情况，采用积极主动和明确的对策，并不一定是放弃“韬光养晦”。其判断的底线是，对外出击时不强出头﹐在现有的国际政治经济秩序中谋求中国的国家利益﹐而不是一厢情愿要建立自己的“新秩序”。在对日美关系中﹐应有理有节，斗而不破﹐留有余地。
　　随着国力的增长﹐中国将更偏重“有所作为”﹐但绝不应放弃“韬光养晦”。同时﹐也要向世界表明﹐“韬光养晦”不是一种“诡道”﹐不是一个“阴谋”﹐不是权宜之计﹐而视为一种“正道”，一种立身之本﹐不仅应行之于中国崛起之前﹐而且还会行之于崛起之后。

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The 5 principles Deng Xiaoping instructed to the Chinese leadership for the implementation of TGYH in early 1990s as below
-- source (note the author in this source understands TGYH a bit differently)
第一，不当"头"，自然也不结盟；
第二、不打旗，不充当某种力量和某个群体的"代言人"；
第三、不主动招惹是非。要不卑不亢，沉着应付，不搞对抗；
第四、集中精力发展经济。
第五、致力于和所有的国家发展友好关系，不再以意识形态来划线。

CNOOC/Unocal: the business perspective of the Rothschild proposal

A lot has been said about this deal, in the press and in blogs. These discussions focus on the political implications in the US. Not many commented on the matter from the business perspective.

Here (right click to download because pdf loads very slowly, thanks to MovieGuy for the link) is the CNOOC proposal which outlines its (claimed) business rationale. I will try to comment on some of its claims on "strategic fit" here (quoted are the claims in the presentation)

• "double production and increase reserve" -- no doubt there is scale effect in this industry, but with CNOOC pledging to forgo a lot of the logical cost-cutting, plus the cost/uncertainty for the PMI (post-merger integration), it is unclear if the net will be positive. How did they quantify the overall value creation?
• "world class international portfolio/leadership in Asia" -- I do not know how to translate the abstract "world class"/"leadership" concept into shareholder value, the consultants in Rothschild seem to be addressing the ego of Mr Fu instead
• "Complementary gas/LNG position" -- yes, I am convinced there is synergy here. However, it bothers me that this more important point was listed as the last point in the presentation.
• "EPS accretive" -- not sure how 'accretive' is such a big deal or what 'accretive' really means. Analysis at CNOOC/Unocal's Combines PE (slide 8) demonstrated clearly the bid was overpriced unless oil price continue to rise significantly. In fact, CNOOC share price declined after the announcement, the best measure of shareholder value.
• "investment grade credit rating expected to be maintained" -- it sounds to me from the tone that what is "expected" is synonymous to "best case scenario", i.e. there is sizable probability that it will not be maintained

On the other hand, the better reasons for the acquisition were pushed to the sideline as "additional opportunities" (slide 12), therefore not receiving the right attention and I am not sure if they have been quantified and presented to CNOOC board, especially the point about "Unocal's deepwater drilling capabilities and other expertise".

Overall, my gut feeling is that there are opportunities for synergy and capability improvement for CNOOC. The price may be a bit too high, but no one can predict the future value of these assets (there should be an analysis on the valuation vs oil price scenarios). It is a medium size deal in this industry which would serve as an experiment for Chinese corporations, expect to see more in the future. If I am a CNOOC shareholder I would certainly not be disappointed if the deal does not go through. I hope Rothschild does back it up with some quantification which were not released in the presentation. Otherwise, I would seriously advise any corporation against hiring them as consultant.

For either US or China as a country, it makes most sense to view this deal as the business decision of two individual corporations. The integration after acquisition could equally likely to be successful or failed. It is an attempt by the Chinese to play by the rules in US, listening to investment banks and hiring lobby groups. The success of the bidding will encourage Chinese companies to play by these rules. If it is blocked without good reason by the right wings in US, the consequence might turn to something they are more unwilling to see. Lastly, if CNOOC fails at integrating the acquired assets and operations, it would be an expensive lesson for CNOOC shareholders, although for the Chinese busness in general this lesson needs to be learned sooner or later.

Not to be ignored is that this deal throws a new perspective into the pressure for RMB revaluation (that the reval will boost the purchasing power of Chinese corporations and that China's cash reserve will be looking for other investment alternative, e.g. by lending to corporation for acquisition, hence achieving higher yield for the banks now that there is enough reserve for reserve purpose).

Future of P2P: implications of MGM vs Grokster ruling

The Supreme Court in US ruled on Monday, see details in EFF, and Village Voice.

1) it only affects USA. Canada, e.g., is still a free country for P2P.

2) Betamax is still sacred. Hollywood will have to prove "intent", which can be tricky for some

3) It is widely believed that Bit Torrent will be safe, because it always declares the purest and most innocent intent.

4) some P2P will be proved of 'guilty intent', some will not. the future will be messy and costly for Hollywood. see this, e.g.

5) other legal circumvention will be invented, a few examples:
a) separate the technology supplier from the advertising revenue generator, with a contract paying the technology supplier a revenue proportional to that of the advertiser.
b) one technology supplier for several off-shore advertisers, hence insulating the technology supplier (who also has customers who share only legal contents -- therefore the technology has substantial use which respects copyrights )

6) other technology innovations to mask content and user IP address identifications