Can China's biggest companies become true global players?

08/06/2010 8:30 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The next six months will test the power—and the limits of that power—of China’s global champions.

First, sometime in early 2011 California will decide what company will build the high-speed rail link between Los Angeles and San Francisco. The Japanese companies that built that country’s pioneering Shinkansen bullet trains and France’s Alstom (ALSMY), which built Amtrak’s disappointing high-speed Acela, will go head to head with Chinese rivals that nobody in this market ever heard of ten years ago.

The ability of Japanese and European companies to beat Chinese upstarts on the relatively neutral ground of California will speak volumes about China’s ability to win dominant positions in new global markets.

Second, the success—or lack of success—of Huawei, China’s champion in the telecommunications gear market, in breaking into the U.S. market will tell investors exactly how big a handicap the ties between China’s biggest companies and the Chinese government in general and the People’s Liberation Army in specific will be as these companies try to break out onto the global stage.

Between them, what happens with California’s bullet trains and Huawei’s attempts to break into the U.S. market will show investors the lay of the competitive terrain as the next generation of corporate and government spending speeds up as the global economy returns to whatever “normal” is after the Great Recession.

Every manufacturer of high-speed trains in the world will be taking its best shot at winning in California. The state won the bulk of the $8 billion in grants for high-speed rail included in President Barack Obama’s stimulus plan. With the U.S. the global laggard in building out a national network of high-speed trains among the world’s big economies the California tender is seen, rightly or not, as the beginning of a huge new market for rail equipment.

The competition would have been very cut and dried 10 years ago. Two consortia—one from Europe and one from Japan—would have gone head to head. But in 2004 Japan’s Kawasaki Heavy Industries (KWHIY) signed as $1.6 billion deal to supply 60 eight-car high-speed trains to China’s national railroads with the Qingdao Sifang unit of Chinese partner China South Locomotive & Rolling Stock Industry Group (CSRGY).

The agreement included what other Japanese companies now condemn as a too generous transfer of technology from Kawasaki to Qingdao Sifang. Within two years, Qingdao Sifang says, it had absorbed Kawasaki’s technology and, the company says, it is now producing equipment that inside a shell that resembles the famous bullet shape of Japan’s Shinkansen is built on totally Chinese technology.

Whether that claim is true or not, China’s high-speed rail companies are now the team to beat. I outlined China’s strategy in my March 10 post "Faster than a speeding bullet train: Three high-speed rail plays to put on your watch list. "“The rise of the Chinese high-speed rail industry is built on China’s creation of a huge market for rail equipment of all kinds—everything from traditional rails, to rolling stock, to signaling equipment to high-speed equipment. China’s market for all rail equipment, running at about $10 billion a year on average between 2004 and 2008, is projected to grow to more than $50 billion by 2013, according to McKinsey & Co. In 2010 China is projected to account for at least half of total global spending on rail equipment.”

That huge domestic market, largely protected from competition is the base that China’s rail companies are now using to bid for—and win--high-speed rail projects in Brazil, Saudi Arabia, across Southeast Asia.

Japan’s companies, in contrast, seem to have gone to sleep at the switch. In early July the assistant vice-minister for international affairs in Japan’s Ministry of Transport, Akihiko Tamura, told Bloomberg that Japan should consider setting up a consulting company like France’s Systra to help it compete against Alstom.

 Consider? To help compete against Alstom?

It’s little late to be “considering,” isn’t it? And France isn’t the toughest competition any more.

California is expected to issue the tender for its Los Angeles to San Francisco high-speed project in 2011. By that time the question of whether Huawei can break into the U.S. market for telecom gear despite its connections to the Chinese army—the company was founded by Ren Zhengfei, a former officer in the People’s Liberation Army—is likely to have been decided. Again.

In 2008 Huawei was forced to abandon a bid for 3Com because of security worries. Now Huawei has launched a big push to sell equipment to Sprint Nextel (S), the third largest U.S. wireless operator. That push has revived worries in Washington that the deal would give a Chinese company, and a Chinese company with a history of connections to China’s military, access to anti-hacking and other technology used by the U.S. Defense Department.

A renewal of those worries isn’t the only problem currently facing Huawei. At the end of July Motorola sued Huawei for allegedly conspiring with former Motorola employees to steal trade secrets. In its suit Motorola charges that a staff engineer shared information about Motorola technology with company founder Ren Zhengfei and that it has recovered e-mail showing transmission of confidential product specification documents to Huawei.

Huawei has said that the complaint is utterly groundless and without merit.

Despite these recent setbacks it’s clear that Huawei hasn’t given up and that the company has learned a great deal from its 3Com experience. First, it’s hired new advisors and lobbyists to convince Congress that worries about the security of U.S. technology are baseless.  Second, it is considering an IPO (initial public offering) on a U.S. exchange or in Hong Kong in an effort to increase transparency to investors and government regulators. The company is also said to be considering setting up a U.S. company that would be independent of Chinese control and shaking up management to increase distance between the company and the Chinese army and government.

This effort to shed light on the relationship between China’s biggest companies and the People’s Liberation Army should be of huge interest to investors. The People’s Army owns or controls a big piece of the Chinese economy but no one is sure exactly how much or what “control” means in the case of specific companies.

 If Huawei can manage to create a mechanism for showing investors—and customers—what degree of control the army has over a specific company or convincing them that the company has severed its military ties, it would enable China’s domestic champions to take a much bigger role in the global economy.

 I’d keep my eyes peeled for that Huawei IPO, if I were you.

 Full disclosure: I do not own shares of any company mentioned in this post.

Related Articles on STOCKS

Keyword Image
Conoco: A Breakout in Energy
09/21/2018 5:00 am EST

Our daily breakout stock ideas are most suitable for aggressive investors seeking ideal entry points...