Corporate America's China Expansion No Longer a Slamdunk With Investors

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Expanding into China and think your investors will love you for it? Think again. It's by no means a slam dunk these days. Maybe 5 or 10 years ago, but now investors may be a little more circumspect, say portfolio managers.Expanding into China and think your investors will love you for it? Think again. It's by no means a slam dunk these days. Maybe 5 or 10 years ago, but now investors may be a little more circumspect, say portfolio managers.

Why this change in investor attitude? China, after all, is a huge, huge market with enormous potential to make millions in revenues for a company. For starters, consider recent events in China.

The Chinese government has a Saturday deadline, in which any company that sells technology security products to the government must first obtain a China Compulsory Certification (CCC). This certification process requires companies to have their products extensively tested to ensure they work, leaving some companies fearful that their trade secrets may be stolen during the process.

Opting Out of China?

As a result, a number of European companies have informed the European Commission that they are considering opting out of the certification process, because of these concerns, notes a Commission spokeswoman.

And last month, Google (GOOG) discontinued its search operations from mainland China over censorship issues. These are just some of the latest examples of companies encountering a troublesome relationship with China, which has the potential to send a company packing it home after spending thousands and sometimes millions of dollars in establishing a presence in the country. Investors, of course, hate wasted capital.

"If a company wants to be involved in China, I wouldn't say it's a negative, I would say it depends on whether they're doing it in a logical way," says Walter Price, portfolio manager of Allianz RCM Technology fund, which manages about $1.1 billion in assets. "But 10 years ago, there weren't any 'it depends.'"

It's difficult, however, to be a large technology company and not have a presence in China, Price adds. The country's population is over a billion, making it an attractive market for consumer electronics; its technology base is far behind the U.S.'s, making foreign products attractive; and the region's labor costs are lower than in the U.S.

Controlling Your Product in China

"The bias is to be in China," said Brian Barish, president of Cambiar Investors which manages $5 billion in assets. "I don't think of it as a negative bias, but if being there means you can't control your product offerings, then it may be better not to be there."

In the case of the CCC certification, the Chinese government is requiring a range of technology security products be tested to ensure they work: Website recovery, firewall, secure separation and information exchange, network secure separation card and line selector, secure router, smartcard COS, data backup and recovery, secure operating system, secure database system, anti-spam, intrusion detection systems, network vulnerability scanner and security audit products.

Usually the CCC is used like a Good Housekeeping Seal of Approval to show that products are safe -- not that they work. But in this case, China is requiring that companies' security products to undergo testing to ensure that they work.

Officials from the U.S. Trade Representative's Office and the European Commission's Trade Commissioner's office note that it's difficult to ascertain the number of companies that may choose to forgo certification and the amount of revenue that could potentially be at stake.

Competitive Threat From Chinese Companies

Investors and companies are also concerned that China, which is hungry to improve its technology base, will welcome foreign companies, acquire as much knowledge as possible on their processes and materials used, and then develop their own competing technologies.

The Chinese government is focusing on 15 key technology areas over the next five to 15 years, as part of its five-year plan and 2020 Long-Term Planning Framework, according to a Gartner Research report, "Emerging Market Analysis: IT, China, 2010 and Beyond."

These industries are: Integrated circuits (IC), software, new components, electronic materials, network and communications, computer, storage, digital audio and video, optoelectronic, display, measuring instruments, electronic equipment manufacturing, IT applications, navigation-telemetry-remote control-remote sensing and network and information security.

China's Infrastructure Still Lacking

"China is open to foreign investment in these areas, but foreign companies aren't interested in doing business here because they're afraid their technology will be stolen," says Steve Dickinson, an attorney with international law firm Harris & Moure, headquartered in Seattle. "So, these companies bring their third-tier technology, not their first-tier. China wants them to bring their first-tier, but even if they did, China does not have the infrastructure to support it."

Although companies fear their intellectual property will be stolen, Dickinson said the CCC process is designed to avoid disclosure of proprietary information, such as source code. He notes it's rather bizarre that the Chinese government wants to certify security technologies under CCC.

And that's likely to further fuel suspicions by investors and their portfolio companies.
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