By Benjamin A Shobert

Outbound investment by Chinese businesses in United States entities last year exceeded for the first time US investments in Chinese companies, according to a recent report from Dealogic, a fact too easily lost amid cries of concern over China’s ownership of US Treasuries, now estimated at around US$789.6 billion.

Cumulatively, Chinese outbound merger and acquisition (M&A) activity was at an all-time high in 2009; however, the actual amount invested – $28.6 billion – was still a distant third to the

United States’ international M&A activity, estimated at $51.5 billion. Answering the question of what is to be made of thisinversion, of Chinese outbound investment now exceeding inbound US investment in China, presents an interesting challenge.

Admittedly, 2009 is a year most multi-nationals would like to forget. Marked by scarce capital, frightened consumers and a receding domestic economy, most American companies dramatically pared back their growth plans. As a result, it may not be too surprising that Chinese companies overtook their American counterparts with respect to outbound investment.

The nature of the deal-flows from both countries further suggests a more nuanced interpretation of this change; namely, that while American M&A activity within China remains extremely diverse, Chinese outbound investment (whether in the US or elsewhere outside of China) is still predominantly focused on securing natural resources and forward integrating into sources of critical raw materials deemed integral to China’s manufacturing infrastructure and industrial capacity.

Overall, of the biggest international deals completed by Chinese companies in 2009, three were explicitly to expand access to oil fields (the purchase of the UK company Emerald Energy, of the Swiss company Aldex, and finally the Singapore Petroleum Co). Two of the five biggest were for other raw materials in the mining sector, both of which were Australian companies (Felix Resources and the Oz Minerals).

The motivation for these acquisitions appears to revolve around China’s desire to have tangible ownership of particularly critical raw materials in the hopes that, should scarcities emerge, it can lay claim to these first, or even at the exclusion of other international players. Similarly, but often overlooked by many, is that ownership of these entities provides an additional lever of control for Beijing to manage inflationary pressures on high profile at-risk commodities like oil, coal, steel, copper and aluminum.

But thus far, Chinese attempts to acquire US raw material suppliers like those they were successful with internationally in 2009 have been met with extreme resistance, as best evidenced by the rebuffed attempt in 2005 on the part of China National Offshore Oil Corp (CNOOC) to purchase Unocal. The need for reliable access to energy which propelled China forward into the Unocal deal has not diminished or gone away; instead, Beijing has changed its focus towards other countries more amenable to changes in ownership of their raw material and energy sectors.

As has been seen over the last several years since the CNOOC deal fell apart, this has meant China has sought out ties with countries and regimes the established international order is deeply troubled by; many had been intentionally isolated in the hope that the countries in question would have to reform. This phenomenon has been widely discussed, but the failure of the CNOOC-Unocal acquisition may provide a cautionary note about how US-China business relationships could change for the worse in the coming years.

Whether hungry for raw materials, energy, access to markets or new technology, Chinese businesses recognize the need to locate these regardless of where they may be found. To this point, companies in China have shown a remarkable resilience in searching out and finding critical inputs to their success. If these can be found and accessed in the US, then American businesses- and the American economy at large – have the potential to benefit. But to the extent Washington feels it politically necessary to limit further integration of Chinese businesses into the national economy, China will increasingly turn towards other countries deemed more hospitable to investment.

A good test of this will be the anticipated 2010 purchase of the GM Hummer brand by Sichuan Tengzhong Heavy Industrial Machinery (Tengzhong). Announced last year, but not a part of the 2009 investment totals between the two countries, this deal will present an interesting insight into the political climate for Chinese businesses looking to further invest in the US. Most industry watchers expect the deal to be ultimately approved, but not before all manner of media uproar and calculated pot-shots on the part of Washington insiders about how this deal represents the death of American industry.

The Hummer brand, originally envisioned as an extension of the successful US military vehicle, is manufactured in Northern Indiana, a manufacturing-intensive region heavily impacted by the recession of the past 18 months. Its demise and its now-apparent rescue at the hands of a Chinese company pose a challenge to those who would stand in Tengzhong-Hummer’s way: if not this as the exit strategy for GM, then what?

Unfortunately for the new entity, the challenges is it likely to face are going to be equal parts political pressure and cultural adjustments. Most important is the message this will send to other businesses in China, specifically those outside the natural resource or energy sectors: if the price to enter North America is not only the hard costs themselves but the ability to withstand political attack, do they really need to be here at all?

The inflection point reached in 2009, where Chinese businessesinvested more in the US than the US did in China, may prove to be misleading over the long term if the Tengzhong-Hummer acquisition is handled badly by American politicians and the national media. Chinese businesses desire to be in North America, and many recognize the need to build brand recognition in the US, and to forward integrate into new parts of their business in order to get closer to their customers, capturing more of the value-added portion of their go-to-market distribution channel.

For many American businesses, the ability to attract Chinese investors could mean jobs kept, plant capacities preserved, and new products launched. But if the price of investing in America is weathering accusations about their agenda or intentions, Chinese businessmen will likely look elsewhere for investmentopportunities, just as China did in the natural resource segment once the CNOOC bid for Unocal was spurned.

Ultimately, Chinese investment in the US faces three primary challenges, each of which is exemplified in the Tengzhong-Hummer acquisition. First, the political pressures and name-calling likely to result from any worthwhile and high-profile activity between an established US company and its Chinese suitor. Second, Chinese companies have to prove that they can adapt their management cultures to the American way of doing business.

Even with its purchase of IBM’s laptop business almost five years in the rear-view mirror, Lenovo still faces persistent questions about its ability to integrate the two cultures and execute abusiness plan that builds on what both entities were purported to do best (the one, low-cost manufacturing; the other, branding, product development and distribution). As Chinese businesseshave continued to grow, their chronic shortage of skilled managers has become increasingly obvious. Consequently, many Chinesebusinesses simply lack the ability to export a competent Chinese manager into their newly purchased American subsidiary. The unfortunate result is that many Chinese companies avoid seriously considering how to purchase or invest in Americanbusinesses simply because they recognize their own inability to manage a culture foreign to their own.

Third, for the Chinese economy to advance to the next stage of global competitiveness, their national champions must prove they can use M&A activity to fund expansions of more than raw manufacturing power; that they can, in fact, build innovative products that consumers want. As much as the world respects China’s manufacturing power, very few know of, or are interested in, any Chinese brands. The opportunity for Chinese businessesis not only to invest in one of their key export markets, but to find in North America a set of skills that will enable them to build fewer “me-too” products, and more core innovations.

While China’s investment in the US may be most visible and obvious through its holding of the national debt, China’s outbound investments in America seem to suggest a country serious about taking the next step of further integrating the two economies together. They face enormous challenges in doing this – learning new skill sets, navigating a culture very much foreign to them, being open to different ways of making business decisions – but these were all many of the same issues American businesses had when they first invested in China.

More critically, China’s desire to take this next step, to foster increasingly large investments between the two country’s private sectors, sends a strong message of mutual reliance. For those who would look otherwise negatively at China’s outbound investment in the US, it might be wise to consider what the other options are: distance and distrust. Neither should be an option for the US or China.

Benjamin A Shobert is the managing director of Teleos Inc (www.teleos-inc.com), a consulting firm dedicated to helping Asian businesses bring innovative technologies into the North American market.