China’s Construction Industry and its Drive Towards Internationalisation

Friday, 17 February 2017

2016 marked the first year following the implementation of China’s 13th five-year plan. It was a pivotal year of strategic transformation for the country’s engineering, procurement and construction (EPC) industry, as it head-dives into new business models in its domestic and international endeavours.

In this week’s blog, PwC Strategy& authors Tiger Shan and Joshua Yau discuss the rapid development of China’s EPC industry and its contributions to raising China’s international competitiveness. To further drive this internationalisation, China has implemented national reform strategies such as the 13th five-year plan and the “Belt and Road” initiative, which has encouraged companies to continue aggressive merger and acquisition (M&A) activities overseas. However, increased international activities also raises exposure to many risks, which require careful management for success.

In 2016, China’s construction industry continued to develop rapidly, achieving 17% growth in industry value. This was an increase of 5% from 2015, which marked a strong contrast to the slow-down of other traditional industries in China.

This strong growth can be attributed to two policy changes – first, China’s central government strongly pushed fiscal stimulus in the form of infrastructure investments in recent years as a means to sustain economic growth. Second, local governments also gradually relaxed real estate regulations, purchase criteria and credit availability, resulting in a boost to the domestic real estate market.

Going forward in the short to medium term, these policies will propel China’s construction industry to new heights, reinforcing its strong contributions to GDP growth – making it a bright spot amongst China’s traditional industries.

 

 

Bringing China’s construction industry to new heights on the international stage

Not only has China’s construction industry clocked strong growth at home, it has also been recognised for its stellar achievements globally.

On the international stage, China’s leading construction enterprises have even been ranked ahead of other global players. Engineering News Record (ENR), one of the industry’s leading publications, ranked China’s construction companies as the top four “Global Contractors” over the last three consecutive years. This comprises China State Construction Engineering, China Railway Group Limited, China Railway Construction Corporation Limited and China Communications Construction Co. Ltd.

In ENR’s ranking of “International Contractors”, which measures overseas revenue, Chinese enterprises have also clinched seven out of top ten rankings, an improvement versus the six spots it captured in 2015 and five in 2014. While some rose up the ranks, there were also newcomers – for instance, the China Shanghai Architectural Design and Research Institute made it to the top 10 list for the first time.

This outstanding performance on the international stage can be attributed to China’s national reform strategies, such as the “Go Out” policy, which encourages Chinese enterprises to invest overseas, and the “Belt and Road” initiative – a concerted effort by the Chinese government to invest and develop overseas infrastructure, drive greater connectivity and integration across Asia, and create demand for China’s industrial capacity oversupply.

As such, Chinese construction companies have continued on aggressive overseas ventures, especially in countries along the “Belt and Road” routes. According to the Ministry of Commerce in China, the total value of overseas contracted projects reached RMB 1.6 trillion (roughly USD 244 billion) in 2016, an increase of 18.1% over the previous year.

The success of Chinese construction players on the international front has led to an investment-led EPC model and an increased appetite for corporate M&As

As Chinese construction players continue to internationalise by expanding overseas via investments, acquisitions and partnerships, they have also realised the need for a shift in the approach to their international ventures.

Two key trends have emerged, posing implications to other global stakeholders – first, Chinese construction companies are increasingly shifting to an investment-led EPC model, and second, they are exhibiting an increased appetite for corporate M&As.

First, a growing trend in the last few years has been of Chinese construction players increasingly bringing their own financing into projects, switching from being merely the contractor to being the ‘owner’ and ‘operator’. Reacting to its host governments’ demand to use the Public Private Partnership (PPP) model, these top Chinese players leverage their strong balance sheet and fundraising capabilities to invest in concessions, therefore securing more projects and negotiating more favorable EPC terms. They have also grown increasingly sophisticated in project structuring, risk management, negotiations, and global partnerships.

A classic example is of China Three Gorges Corporation’s investments into the USD 1.65 billion Karot hydropower station, which is in partnership with Chinese banks, the Silk Road Fund, and International Finance Corporate. Another is of PowerChina’s investment into the USD 2.08 billion Pakistan Qasim thermal power plant, with the participation of Chinese financiers and a Middle East fund.

This trend will continue to grow, enabled and accelerated by the Chinese EPC companies’ transformation domestically, and motivated by various policies and market factors.

This means that these EPC companies could become the largest investors and asset managers in China. For other global stakeholders and competitors, this transformation to an investment-led EPC model will bring in diverse opportunities as well as challenges.

Secondly, Chinese construction enterprises have also continued aggressive M&A activities overseas in order to enhance competitiveness, build on existing capabilities and create access to new markets overseas. For example, in 2014, the China State Construction Engineering acquired Plaza Construction (one of the largest builders in the United States); and in 2015, another of its state-owned enterprises, China Communications Construction, successfully acquired John Holland, Australia’s third largest construction company. Subsequently in 2016, the China Railway Group spent RMB 4 billion on acquiring 60% share of Bandar Malaysia, an urban development project in Kuala Lumpur, Malaysia.

From our conversations with the Chinese players, we found that they continue to be keen in partnering with global players, especially in developed markets. We believe this will also have far-reaching implications in the global construction and infrastructure landscape for both private and public stakeholders.

However, the outlook for Chinese EPC companies is fraught with a number of challenges which require careful management

As the global EPC industry grows more homogenous, coupled with the urgency to internationalise, China’s major infrastructure companies are increasingly faced with multiple challenges.

One major challenge is in managing and optimising operating assets worth nearly trillions of dollars, which are characteristic of large scale overseas construction projects.

While the “Belt and Road” strategy will continue to pave the way for the internationalisation of China’s construction companies, profiting from EPC projects has become more challenging. While some are still new to the game and in the early phases of building and managing global assets, others have made painful financial losses as part of the learning process.

As China’s construction enterprises rely on the “Belt and Road” as a way forward, the associated exposure to highly unstable environments – characteristics of developing countries along the “Belt and Road” routes – is another cause for concern. This makes risk management processes all the more critical in order to achieve a sound understanding of the country’s political, economic, cultural, legal and regulatory environments.

In addition, the ability to enter and navigate developed markets is yet another key hurdle. With the 13th Five Year Plan in place, Chinese construction players are venturing not only into developing markets, but also to developed ones such as the UK. However, significant obstacles in terms of standards, regulations, construction capabilities, financing, human resources and other issues stand in the way.

As a way to address the challenges above, Chinese construction companies have since welcomed global partnerships with financiers, suppliers, advisers and even competitors, in order to enhance their abilities in managing their assets. Partnering with other international players who have prior experience in markets that are less familiar to Chinese enterprises can help bridge gaps on many fronts as described above.    

While construction companies continue to promote internationalisation reforms via M&As to increase competitiveness abroad, Chinese construction companies also need to prioritise the development of capabilities in risk management, making investments and operations, entering into mature markets as well as in establishing global partnerships. Only with these measures in place, can China’s construction enterprises’ internationalisation be a true success.

 

Tiger Shan | Partner, PwC Strategy&
Website |  [email protected]

Joshua Yau | Principal, Infrastructure and Belt & Road lead,
PwC Strategy&
Website |  [email protected]

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