How Taiwan's China Deal Will Magnify Investor Profits

By: Money_Morning

Keith Fitz-Gerald writes: Just last week - for the first time in 60 years - Taiwan opened its doors to investments from Mainland China.

The impact was almost immediate.

On Friday, Guangzhou-based China Southern Airlines Ltd. (NYSE ADR: ZNH) submitted the first bid under the new regulations and became the first mainland company to apply to invest in Taiwan. By the day’s end, three more of China’s air carriers had joined the race and filed applications to invest in Taiwan: Air China Ltd. (OTC ADR: AIRYY), China Eastern Airlines Corp. Ltd. (NYSE ADR: CEA) and Hainan Airlines Co. Ltd. Clearly, these companies understand the stakes here, which is what’s behind the rush for these potentially lucrative new routes between Taiwan and China.

Speaking for China Southern, spokeswoman Zeng Qingning noted in the Taiwan News “we can begin selling tickets once our office is approved to become a branch.” My experience suggests that other companies are well advanced in their preparations too, which is why this probably isn’t the last we’ll hear on this topic.

One-Way Street

Just last Tuesday, Taiwan’s Ministry of Economic Affairs (MOEA) announced that China-based companies and investors would be permitted to invest in more than 100 different product-and-service categories, and that regulations governing applications by China-based companies seeking to open branches or subsidiaries in Taiwan also were ready.

These initiatives were an outgrowth of several new investment accords reached in May between the Association for Relations Across the Taiwan Straits (ARATS) and the Straits Exchange Foundation (SEF). When I reported on these at the time, I told Money Morning readers that they literally were watching history in the making just as I was from my perch in China as the news unfolded.

Prior to last week, “cross-strait” investments had been a one-way street - from an official standpoint, at least - with Taiwan companies having invested hundreds of billions of dollars in Mainland China, including about $77 billion since just the late 1990s alone, The Wall Street Journal Asia reported.

In return, China’s been allowed absolutely zilch and has been legally barred from making investments in Taiwan. The fear - at least what’s been stated publicly - is that China would use its rapidly expanding economic might to blunt Taiwan’s efforts to remain an independent nation.

(You may recall from your history books that China views Taiwan - formerly known as Formosa - as a “breakaway republic,” a position the island nation has held since 1949, when the two split during a civil war that led to the creation of the communist-controlled People’s Republic of China.)

China’s Newfound Role as an Economic Savior

Behind the scenes, however, the story is much different. Many Taiwanese business leaders I’ve spoken with confidentially welcome normalized relations and view the opening process as a development that’s long overdue. For them, it’s not about political aspirations; it’s about what China can do for their over-leveraged, underutilized assets. Many, including new Taiwan President Ma Ying-jeou, for example, are acutely aware of the fact that Taiwan missed out on many of the benefits of China’s rapid industrialization and global emergence over the past 10 years, thanks to poor political relations and antagonistic regulation.

And it’s cost Taiwan dearly. The desire for continued independence aside, once-proud Taiwan has become another in a long list of nations around the world that are eating big slices of humble pie and that now see China as a potential savior from the current global financial crisis.

Taiwan’s experience with the Taipei 101 Tower is a concrete example of the potential benefit of China’s emerging economic might. The tower was supposed to stand as a symbol of Taiwan’s newfound economic prowess and, at the time of its construction, was the world’s tallest building.

But it soon became a colossal white elephant. In fact, until very recently, it stood less than 50% occupied. That’s when several of China’s corporate powerhouses took up residence, including:

• Lenovo Group Ltd. (OTC ADR: LNVGY), the growing global PC giant.
• Sinosteel Corp., the major iron-ore importer.
• And Tiens Group Co., a China-based direct-selling conglomerate that is the world’s fifth-largest healthcare products firm.

According to The Wall Street Journal, the building is now more than 80% occupied and rents in the area have risen by 5% to 10% in anticipation of more highbrow Chinese clients. Of course, it doesn’t hurt to have such big-name players as Bank of America (NYSE: BAC), Google Inc. (Nasdaq: GOOG) and even Merrill Lynch (NYSE: SAR) as tenants, but the reality is that the Mainland China companies are the firms that are really being sought right now. That’s particularly true at a time when the mainland economy remains on track for annual growth of 8% or more this year, and appears to be the only one of the world’s top industrialized economies that’s not in a deep state of denial or contraction or both.

The fact that China’s bucking the trend is not lost on the Taiwanese business community. Nor is the fact that many of the best-positioned and fastest-growing Mainland China companies are state-owned enterprises.

“In contrast to the past, when this was seen as a threat, they’re more attractive now for their deep pockets,” said one local real estate professional I interviewed who wanted to remain anonymous.

Not surpassingly, the welcome mat is not out for military-backed enterprises. Nor does it include potential investments in high-tech or real-estate-development projects. I think that will change, particularly if Taiwan’s economy registers a couple more consecutive quarters of contraction, and if its companies continue to experience weakened global demand for its products.

The Art of the (Asian) Deal

Despite the very clear need, Taiwan is still trying to exercise some caution in deciding which deals to approve. According to Deputy Economic Minister John Deng, if the capital comes directly from China the economics ministry will review it. Capital coming from third party destinations “investing over 30% in, or effectively controlling local companies” falls under the same scrutiny. Likewise, Deng noted, if China invests in more than 10% of a company’s stock, it will be “seen as [a] direct investment.”

So far, the first couple of Mainland China delegations have already reached $68 billion worth of deals in various industries.  Some are undoubtedly smaller and involve a smattering of the 200 industries open for direct investment, but it’s the bigger transactions that have everybody excited because they are a harbinger of better times and more profitable relationships ahead.

In April, for example, China Mobile Ltd. (NYSE ADR: CHL) offered $527 million for a 12% stake in Taiwan-based FarEasTone Telecommunications Co. Ltd. Because it was made prior to the new rules and involved the politically sensitive telecom industry, the consensus is that the deal won’t pass scrutiny. But you never know and that’s part of the thrill of the hunt.

Portfolio manager Henrietta Luk of Melchior Asian Opportunities Fund notes that “local retail investors have gone on a treasure-hunt frenzy guessing which is the next industry or company to link up with China, leaving foreign investors chasing any stocks that are not limit up to make up for their hugely underweight positions in Taiwan.”

And they will have to chase them - literally. According to the Taiwanese Tourism Board, more than 300,000 Mainland Chinese visited Taiwan through April of this year, versus 320,000 during all of 2008. The number of mainland airports serviced from Taiwan has increased from 21 to 27, while the number of direct flights has soared from 108 to 270 per week, an increase of 150%.

Given that jump, it’s no surprise that China Southern Airlines submitted the first bid under the new regulations - or that the three rivaling carriers joined the hunt that same day.

If you’re of the same opinion, and want to attempt to ride this wave yourself, consider getting started with an investment in an exchange-traded fund (ETF) - specifically, the iShares MSCI Taiwan Index Fund (NYSE: EWT). With top holdings in computer hardware (42.44%), industrial materials (21.93%) and financial services (16.42%), you’ll no doubt hit something on China’s wish list soon.

Watch for agreements either late this year or early in 2010 that will permit the two countries to trade one another’s shares for the first time in 60 years - and then watch for the huge jump in liquidity that goes with it. I’ve been hearing for several months now - very quietly, I might add - that regulators in both Taiwan and China are considering a dual-listing agreement that would at least partially remove restrictions that prohibit individual investors from directly investing in each other’s stocks.

There’s clearly a long way to go here with regard to the global financial crisis, but the flurry of cross-straits activity we’re seeing and the accelerating nature of the activities there provide important confirmation that we’re on the right track.

I have no doubt that Taiwan will turn out to be one of the region’s powerhouse investments over the next five years - albeit one that is more closely tied to Beijing’s fortunes than many people on this side of the Pacific are inclined to accept.

[Editor's Note: Fourteen trades. All profitable. Since launching his Geiger Indextrading service late last year, Money Morning Investment Director Keith Fitz-Gerald is a perfect 14 for 14, meaning he's closed every single one of his trades at a profit. And he did this during one of the most volatile periods for the U.S. stock market since the Great Depression. Fitz-Gerald says the ongoing financial crisis has changed the investing game forever, and has created a completely new set of rules that investors must understand to survive and profit in this new era. Check out our latest insights on these new rules, this new market environment, and this new service, Geiger Index.]

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