This Bloomberg report documents how China's two telecom network equipment giants, Huawei and ZTE Corp. (ZTCOY.PK), have used cheap financing from China Development Bank to outflank competitors like Ericsson (ERIC) and Alcatel-Lucent (ALU). Here is a key excerpt from this report:
China Development Bank’s support for Huawei and other Chinese companies is the cornerstone of the country’s “going out” policy, meant to nurture companies in telecommunications, alternative energy and oil. The bank’s low-interest loans dwarf those offered by U.S. and European development agencies, helping Shenzhen-based Huawei and crosstown rival ZTE Corp. increase market share. While vendor-financing in itself isn’t unusual, the extent of the financial backing sets Huawei and ZTE apart, according to the Chinese companies’ competitors.
In other words, while many countries- including the U.S.- offer vendor financing support for exporters, the Chinese are unparalleled in the size and attractiveness of such support. Huawei has a $30 billion credit line with China Development Bank, while ZTE has a $15 billion credit line. Such support for Chinese multi-nationals extends to every sector that Chinese firms compete in globally.
For example, see this other Bloomberg report on a recent deal involving India's electricity producer, Reliance Power. The company ordered $10 billion worth of coal-fired generators from Shanghai Electric Group Co. (SIELY.PK), based on financing support provided by many Chinese state-owned banks including China Development Bank. It is notable that General Electric (GE) only got $750 million worth of gas-turbine equipment orders from the same Indian power producer.
Buyers in developing countries such as India, Mexico, and Brazil find such low-cost financing irresistible. Even for blue-chip firms in India and Brazil, borrowing costs can be quite high. Thus, when China couples low-cost financing with acceptable quality equipment deals, these firms have virtually no choice. This places Western multinationals like GE, Siemens (SI), and Nokia (NOK) at a significant disadvantage when competing for deals in emerging markets like South Asia, Africa and Latin America.
Such low-cost financing is particularly beneficial to giant Chinese engineering and construction companies which compete for projects globally. This Wall Street Journal article provides a good overview of the modus operandi of firms such as China State Construction (CCOHY.PK). These firms combine three factors to win deals: Cheap financing from state-owned banks, low-cost Chinese labor, and experience with large domestic infrastructure projects in China.
In a nutshell, the Export-Import Bank of China and the China Development Bank, along with other banks, provide cheap financing for an overseas real-estate construction project on the condition that a state-owned enterprise (SOE) like China State Construction is hired to do the building and engineering work. There are several benefits to China from this arrangement. Many (otherwise unemployed) Chinese laborers get jobs. The Chinese SOE gets lucrative and prestigious overseas contracts, which it can further leverage to increase its overseas business and build a global brand name. The Chinese banks get to deploy their immense capital that they get thanks to (inexpensive) deposits from their frugal citizenry. This is also another way for China to deploy its massive foreign exchange reserves overseas. The Chinese banks and the SOE (in this case China State Construction) take a stake in the real-estate or other construction project, thus benefiting from the long-term capital gains and revenues that accrue.
So, how can you play this trend? Invest in Chinese exporters like ZTCOY, SIELY, and CCOHY which benefit from low-cost vendor and contractor financing from China's state-owned banks. At the same time, be wary of investing in Western companies like Nokia (NOK), Alcatel-Lucent and Ericsson that compete with these Chinese firms. Even if the Western firms have superior technology, they cannot match the low-cost financing and the attractive pricing offered by the Chinese. Nokia, in particular, has already been hurt badly by low-cost Chinese competition both in network equipment and in mobile handsets. It is only going to get worse.
Disclosure: I am long ZTCOY.PK.