OPINION
Updated August 15, 2012, 7:38 p.m. ET
China, the World's Greater Fool?
A question or two about the wisdom of buying struggling Western companies.
By JOSEPH STERNBERG
Everyone knows the greater-fool theory of investing—you buy any asset at any price, no matter whether the price has any rational relationship to the underlying value, in the hope you can sell it at an even higher price. The method is more than a little dangerous, and plenty of people have lost a lot of money when they discovered they were the fool at the end of the chain.
Consider last week's announcement that a Chinese company will pay $450 million for an 80% stake in a struggling battery maker. A123 Systems, which produces high-tech batteries for electric cars, has received roughly half a billion dollars in U.S. government grants and aid in recent years. It was still on the skids despite the help. Now Wanxiang Group Corp., one of China's largest auto parts manufacturers, will essentially bail out American taxpayers by offering the company a financial lifeline.
This follows last month's announcement that state-owned Cnooc Ltd. will pay $15.1 billion in cash for Canada's Nexen, an oil and gas firm. That's a more than 60% premium over Nexen's pre-deal stock price, for an acquisition target that was reeling from leadership turmoil and technological problems at one of its marquee oil sands projects.
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Buying ailing companies isn't inherently foolish. Mitt Romney and his colleagues at Bain made lots of money doing exactly that.
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A smart acquirer can change the underlying value proposition. Mr. Romney's success lay in his ability to transform a struggling firm through an injection of better "management technology."
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Bloomberg News
The new A123 Systems lithium ion automotive battery
manufacturing plant.
The contrast between that model and the China model are striking. The most common justification presented for so many Chinese acquisitions, including A123 and Nexen, is technology transfer. The idea is that Chinese companies, at their government's urging, are buying Western companies mainly for their know-how.
Think about this for a minute. The successful market-economy acquirers focus on transferring skill into their purchases: Management acumen better unlocks the value of a viable but struggling company, or integrates a reasonably successful firm into a larger whole that can better exploit its resources.
China is interested mainly in transferring mechanical and managerial know-how out of struggling companies, without any apparent thought for why the companies are struggling in the first place.
The unasked question is whether China is sure the technology is worth having. A123 is by all accounts reasonably successful insofar as it has lined up orders from automakers such as General Motors. The problem is that there isn't much of a market for electric cars. American lawmakers have caught on to that reality, which is why Congress has become less willing to subsidize such projects.
Chinese policy makers haven't caught on, which is why Beijing persists in plans to concoct an electric-car market in China through subsidies and diktats. Having A123's battery technology available to a Chinese firm helps that effort, but only helps China overall if the effort itself is worth pursuing.
The principle also applies to Nexen. The Canadian company was a takeover target in large part because it has been less efficient than competitors at extracting petroleum from oil sands, especially when oil prices may be entering a period of decline amid a greater volume of conventionally extracted oil from places such as Libya.
While a management overhaul earlier in the year led to improvements at the long-struggling Long Lake sands project in Alberta, it remains a work in progress. Shareholders took the cue and sent the stock into a prolonged decline, even if Beijing didn't notice or care.
China's admirers say the country is playing a long game. Car batteries are commercially useless today but will be critical one day. Nexen engineers will get that company's projects to work and China will be there to learn from their solutions, and to exploit that know-how when conventional supplies become less reliable.
Maybe. But a very fine line separates such notions and the rationalization of the greater fool who, even if he knows something is worth less than he's paying for it today, believes events beyond his control will eventually lead someone else to pay more for it tomorrow. China's buying spree could be the making of an economic juggernaut. It could also be stocking the world's greatest technological junkyard.
Mr. Sternberg is an editorial page writer for The Wall Street Journal Asia.
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