PetroChina surpassing GE in terms of stock market value, and now being only second to ExxonMobil in this category, got me interested in how other Chinese companies are faring. I found an article on SeekingAlpha.com whose title, “List of World’s Largest Stocks Dominated by U.S and China, Energy Sector,” tells the whole story.

In scanning the names of the 25 largest stocks in the world, I found myself getting into the spirit of the upcoming Olympic Games and analyzing the results, just like I might score gold, silver and bronze medals next August.

Of the 25 largest companies, not surprisingly, 11 were from the United States. Following close behind, however, was China with eight. Of the remaining six companies, Great Britain had two, and Japan, France, Russia and the Netherlands accounted for one each. When I looked at a more exclusive test, the Top 10—the Gold Medal of stock market valuations if you will—China was tied with the U.S at four, and Russia and the Netherlands accounted for the other two.

Chinese companies on the list read like a Who’s Who of Chinese industry. They include PetroChina (#2), China Mobile (#4), Industrial Bank of China (#5), China Petroleum (#9), China Life Insurance (#11), China Construction Bank (#16), China Shenhua Energy (#18) and Bank of China (#20).

Energy companies and banks had the most entries among the top 25, with each having six companies on the list. Two of the six energy companies were Chinese, the same as the United States. Russia and the Netherlands had the other two.

Of the six largest banks, however, China led with three, followed by the U.S. with two and Great Britain with one. Industrial Bank of China with a valuation of $334 billion is the largest bank in the world, $100 billion larger than 13th ranked Citigroup.

China Mobile is the largest telecommunications company in the world, also topping its biggest foreign rival, 10th ranked AT&T, by more than $100 billion in value. China Life Insurance is the largest insurance company in the world, larger than AIG. AIG is one of top 20 companies in the United States, but did not make the top 25 in the world list. And finally, China Shenhua Energy is the largest utility in the world, just nudging out France’s electric utility.

In addition to their size, the Chinese companies enjoy much higher valuations than their counterparts around the world. The average price earnings multiple for the group of 25 is 22.5. The average for the eight Chinese companies is 31.4.

If China’s Olympic athletes perform next year like China’s largest companies have performed in the stock market, the trip home from Beijing next summer will be a long one for many athletes from other countries.

During the Internet boom, GE and Microsoft battled each other for the honor of being the world’s most highly-valued company. While Microsoft has settled in at a meager $292 billion in stock market value, GE’s stock market value has soared to just over $410 billion. Even with its impressive increase, however, GE has been surpassed in value by ExxonMobil, which has been riding the rise in the price of crude oil to nearly $90 per barrel. Valued at over $500 billion, ExxonMobil is now the world’s most valuable company by market cap.

But wait. The combination of oil and China is proving to be an even more potent recipe for stock market valuations. In mid-October, PetroChina surpassed GE with a valuation of over $430 billion, and is now closing fast on ExxonMobil.  Traded on the Hong Kong Stock Exchange, PetroChina’s shares have surged by 13 percent over the past five months. The recent rally in Hong Kong, part of a record year for Chinese stocks, underscores PetroChina’s key role in supplying oil to the world’s fastest-growing major economy. “Chinese oil companies deserve higher valuations compared with their international peers, given the strong domestic economy and an expected influx of capital from mainland investors,” said Wang Jing, a senior oil analyst with Orient Securities Co. Ltd. in Shanghai.

In addition to the growth of the China market and potential discoveries that will add further to its reserves, PetroChina and its domestic rivals are benefiting from the Chinese government’s decision to allow its citizens to invest in Hong Kong-listed shares. Household savings in China total $2.3 trillion and JPMorgan Chase & Co. estimates $60 billion of that may flow into Hong Kong in the next year.

Not everyone is convinced that PetroChina’s valuation will see further increases, however. Despite impressive gains made on the 11 percent stake Warren Buffet’s Berkshire Hathaway bought in 2003, Buffet has been selling down his shares in the company. Berkshire Hathaway’s shares were worth $3.31 billion at the end of 2006, well above the $488 million that Berkshire paid for them, according to Berkshire’s latest annual report. Buffet has been clear to point out that he is selling on grounds of valuation, not due to any criticism of the company.

When China began the reform of its state-owned sector in the 1990s, the government stated its goal of creating world leaders in key sectors of its economy. China appears to have found a champion in the case of PetroChina.

The 17th National Congress, which has resulted in several personnel changes at the very top of China’s Government, will inevitably have significant ramifications on the business landscape in China. The main headline has been that General Secretary Hu Jintao has strengthened his position slightly, but fell far short of obtaining the dominance that many expected him to secure at this point. Along the same lines, many are pointing out that ultimate power is no longer being held by a single individual as several coalitions now compete to influence how the country is led.

On the business front, much remains unclear, but here are some key issues being discussed:

First, with Hu in a stronger position, following the retirement of several Jiang loyalists from the top posts, it could be predicted that he is in a stronger position to take bold measures on the exchange rate–letting it appreciate faster. Evidence that this might occur is backed up by the fact that the central bank governor, Zhou Xiaochuan was granted a place in the central committee for the upcoming five years, despite initial rumors to the contrary.

On the other hand, this Congress has demonstrated that coalitions (i.e. Jiang Zenmin’s Shanghai clique, versus Hu’s clique) are becoming more powerful, and that the government is being ruled more by coalitions. This would indicate that bold moves on monetary policy will be more difficult to implement in the coming term.

As such, it is difficult to analyze with any degree of certainty what will happen with the Yuan’s exchange rate.

Either way, it seems that inflation will likely remain a major issue. With China’s deficit at 1% of GDP, and the economy continuing to grow, it seems likely that fiscal spending will increase over the coming years. The government is awash with cash, and Hu has pledged to help the rural sector in the name of harmonious development. His major initiative to date was the abolishment of the income tax on peasants. Although this was a major milestone for China, he will need to do much more in order to truly deliver on his commitment to China’s peasants and he has indicated that he will (healthcare, social security, and education spending are other areas spending would likely increase). With upward pressure globally on commodities, promised environmental regulation pushing up the costs of business and government cash flooding into the countryside, one would have to be concerned that inflation will continue to rise.

As a final note, one government relations expert that I spoke with noted that all the recent talk about coalition politics in the upper reaches of the Chinese government is focusing too intently on the power play between the Shanghai clique and the Hu clique, but is neglecting the Taizi Dang which refers to the children of former communist bigwigs who now hold commanding positions. This group includes Liu Qisan, Bo Xilai, and Xi Jinpin. Xi Jinpin is actually in the ideal position of straddling that group and the Shanghai clique. In one sense, this puts him in a very strong position to muscle his way to the top, despite apparently not being favored by Hu himself.

Congratulations to my good friend, Mitch Presnick, whose company, Tian Rui Hotel Corporation, recently raised $50 million from Aetos Capital, a real estate investment management firm, to expand its Super 8 hotel operation in China.

New investments in hotels are not particularly big news in China, since new hotels open on almost a daily basis in Beijing, Shanghai, Guangzhou and other major, and not so major, cities in China. However, the vast majority of these hotels are targeted at the luxury or high-end segment of the hotel market. Mitch’s announcement is significant because his company has targeted China’s vast local market–hotels which provide rooms for approximately RMB 200 per night.

Born in Brooklyn, Mitch first came to China in 1988 and, until a few years ago, worked in Beijing, handling public relations for many major multinationals with operations in China. Then Mitch caught the entrepreneurial bug and saw an opportunity in China’s economy hotel sector. Along with a few friends, Mitch formed Tian Rui, which succeeded in 2004 in obtaining the China franchise for the Super 8 brand, owned by Wyndham Hotel Group (NYSE:WYN). Since then, Tian Rui has opened 49 Super 8 hotels in China, representing more than 4,700 rooms, and has signed agreements to develop an additional 67 hotels. The Super 8 brand already is among the largest economy chains in China.

Hotel growth in China has been propelled by the country’s rapidly-growing economy, which has increased the amount of business and leisure travel. The World Travel & Tourism Council has predicted that China will become the second largest travel and tourism economy in the world by 2016. In addition, the 2008 Olympic Games in Beijing are expected to bring hundreds of thousands of international visitors to China and attract additional worldwide interest in China as a travel destination.

For hoteliers, Super 8 offers an opportunity previously unavailable to the mid-range: unified marketing and a national brand. China’s highly-fragmented hospitality market leaves numerous two- and three-star hotels as unrecognized islands in their respective cities, left to market themselves against numerous competitors in the same boat. By becoming a Super 8 franchisee, they tap into a national advertising and reservations network unavailable to independent operators.

Mitch’s concept was very simple when he started Tian Rui. He saw that most international investors and hotel chains were targeting the high end of the market, leaving the much larger economy hotel market to the local players. It’s no different than the 1950s, when the first of the national hotel chains like Holiday Inn saw the same opportunity in the United States. Mitch recognized that China’s local business travelers and tourists wanted to stay at hotels which could offer rooms with good, consistent, quality nationally–at an affordable price. By securing the franchise for the Super 8 brand in China, Tian Rui has been able to offer local hotel operators the opportunity to be a Super 8 franchisee, benefiting from the know-how and systems which Super 8 has developed over many years and tapping into a domestic and international reservation system. The capital provided by Aetos will enable Tian Rui to not only franchise, but also to own and operate hotels.

Every product in China has two markets: a higher-end market where international players compete with the best of the Chinese companies; and a much larger local market where prices are at levels that are affordable for the vast majority of China’s population, but which is dominated by purely local players. Mitch has shown great vision in figuring out a way to tap into this local market because it will ultimately represent the main source of growth in China over the long-term.

Like Paul Midler at www.thechinagame.com, I too was curious as to the financial impact of the recent product recalls on Mattel and expected it to be nothing short of catastrophic. While news from the company didn’t set off major alarms—the company’s third-quarter results included charges of about $40 million for recalls—the stock has in fact sold off from a high of near $30 per share in May of this year to just under $22 today, a 27 percent decline.

Nonetheless, the Street seems to think that this sell-off is overdone. Credit Suisse analyst Scott C. Barry’s view is that Mattel can still deliver strong margins, returns and free cash flow. “Recent recall-related issues have not altered our belief that Mattel is a 3 to 4 percent top-line grower with stable to improving margins that generates strong returns and prodigious amounts of free cash flow,” Barry wrote. “The recent share-price decline appears overdone, as we do not believe recall-related fallout will persist beyond the current holiday season,” Barry concluded.
With this conflicting data, I scratched my head, decided that this issue would require further investigation, and went on to more pressing matters. But Paul’s recent post, “Mattel: Knocked Down and Muzzled?” got me thinking some more about Mattel, toys from China and Christmas, so here are my current thoughts.

In a previous post, “China’s Toy Manufacturers Feel the Aftershock of Recalls,” I noted that a Chinese-language newspaper under the supervision of The People’s Daily (presumably a reliable source) had reported on September 13 that many of China’s small scale toymakers had already closed and that orders at the larger companies had been cut significantly. If this is in fact true, it raises some interesting questions. For instance, where are U.S. retailers going to get the toys to stock their shelves for Christmas? China reportedly accounts for 80 percent of toy production around the world, so if orders have been cut and Chinese companies have gone out of business, they won’t get nearly as many from China as in the past. To get to the U.S. by Thanksgiving and the start of the Christmas selling season, toys would have to leave China by mid-October at the very latest, leaving only one month for re-sourcing to more reliable Chinese companies or to companies located in other countries. While this might be accomplished in time for the 2008 season, it simply is not possible in such a short time frame for 2007. Santa and his reindeer may have an easier time of it this year with much lighter bags.

Moreover, anecdotal evidence suggests that consumer habits may change as a result of the “Made in China” crisis. How much it will change buying patterns over the long term is a matter of debate, but there is certain to be an impact this year. My oldest daughter, who has a one-year-old son and is at the peak of her toy -buying years, told me that she is already alarmed at the toys she has in the house, and vowed to take a close look at any toys that she or others might buy for her son this Christmas. Whether this crisis fades and her view changes in 2008 are a question mark, but I feel quite certain that she will buy differently in the coming months.

Meanwhile, a number of new toymakers are coming on the scene in the United States to fill the void and appeal to her concerns and those of others. The advertising slogans are not difficult to imagine: “Made in the Good Old US of A”; “No Lead Paint”; and “Toys Made With the Highest Quality Materials and Workmanship.” Perhaps all of these new entries will fail, but my guess is that an interesting niche where price is not as much of an issue has been created.

Bottom line: I think that we need to wait and see what story the fourth quarter numbers say, not only for toys but also for China exports. In my opinion, the jury is still out on all of this—the ultimate impact on Mattel as well as the ultimate impact on China.

Despite a summer of recalls and a flood of negative publicity alleging shoddy goods made in China, China’s exports grew by 27 percent in the first nine months of 2007, as compared to the same period last year. While specific data is not yet available for the nine-month period, China’s food and agricultural exports to the United States also increased by 27 percent, and exports of toys from China increased by 18 percent, through August.

Not all of the news was positive, however. Exports of certain food products, such as shrimp and eel, to both Japan and the United States fell sharply. Also, exports of toys to Germany fell by 42 percent during the first eight months of the year. While quality concerns no doubt had an impact, currency concerns are also playing a role in exports to Europe. Since China revalued the Renminbi and allowed the currency to float within a narrow range in July, 2005, the Yuan has appreciated by 10 percent against the U.S. dollar, but has depreciated by five percent against the Euro, causing increased concerns with China’s European trading partners.

Anecdotally, the “Made In China” crisis appears to be having a long-term, positive impact on China’s attitude towards the importance of quality. In addition to the attention it has received at the highest levels of the Chinese government, the New York Times cited a recent survey which indicated that over 60 percent of the Chinese companies surveyed said that they were investing heavily in new quality control systems.

Although the news on China’s exports so far seems to indicate that the country has survived the recent crisis with little impact, it still may be too early to tell for certain. The recalls and much of the negative publicity was largely a third-quarter event and would not have impacted orders that were already placed or on the water. Export results for the fourth quarter will provide a more accurate indication of how the aftermath of the crisis will play out.

U.S. private equity firms are discovering that capital markets in China are more like the U.S. capital markets of the 1970s than those to which they are accustomed today. In the U.S, acquiring majority stakes in companies of all sizes has been limited only by one’s imagination—and the willingness of capital markets to provide financial lubricant in the form of cheap debt financing.

Until the recent credit tightening brought on by the sub-prime mortgage crisis, lots of cheap credit with little in the way of restrictions has given private equity firms a virtual blank check to hunt for corporate elephants. Despite the temporary lull in lending activity, it is likely that those days will return once the current backlog of deals clears.

China is a completely different story, however. Carlyle, a Washington D.C.-based private equity firm with plenty of political clout provided by an army of former administration officials, tried to buy an 80 percent plus stake in Xugang, one of China’s major construction equipment companies, only to find its bid rejected by Beijing. Over the past several years, China’s central government has become increasingly concerned that too many of its leading companies are coming under the control of foreign investors and firms. Acquiring majority ownership of a company of any reasonable size in China is very difficult as a result, and it may already be too late to have any hope of doing so in the future. The last time I checked, Beijing has not yet approved even a minority investment in Xugang by Carlyle.

No doubt learning from Carlyle’s experience, other large private equity firms are setting their sights lower and appear content to take minority positions in Chinese companies. In September, Blackstone announced that it would invest up to $600 million for a 20 percent stake in China National Bluestar Corp., a specialty chemical subsidiary of China National Chemical Corp., a leading international diversified chemical company.  This represents Blackstone’s first ever investment in China.

The Bluestar investment comes just months after China’s new state agency decided to invest $3.0 billion for just under 10 percent of Blackstone’s newly listed shares. The investment by China is one of the first of what is expected to be more financially oriented investments as China seeks to increase returns on its foreign currency reserves. At the time, many observers predicted that Blackstone’s investment program in China would be helped by its new relationship with China.

In another first, KKR announced that it would acquire a minority interest in Tianrui Group Cement Co., a Chinese cement maker for $115 million.

Beyond the fact that they represent minority stakes, the investments by Blackstone and KKR are very different than those typically made by these firms in the United States and Europe, reflecting their strong desire to find some way to invest in the China market. First off, a few board seats may come with a minority interest, but not the management control which both Blackstone and KKR would insist upon in the United States. Secondly, the investments are unleveraged and are being made with all equity. In the United States, a company’s shares are purchased with a relatively small amount of equity plus a large amount of debt that is based solely on the borrowing power of the company itself. In the United States, buying a company is like buying a house with some savings and a mortgage. In China, it is like buying an apartment with all savings and no mortgage.

The fact of the matter is that, unlike the U.S. capital markets with its diversity of financial instruments, China’s capital markets are undeveloped and consist primarily of short term working capital loans from Chinese banks. That is why KKR had to call upon JP Morgan and the International Finance Corp., two foreign based financial institutions, to provide an additional $335 million of USD and RMB long term financing to Tianrui to help finance its growth and expansion needs.

With the continued growth of the China market and the strong market positions which Bluestar and Tianrui undoubtedly have, these investments are likely to do just fine. The point is that both Blackstone and KKR have decided to depart from well honed investment strategies developed in their home markets to adapt to actual conditions on the ground in China. In the U.S, they do leveraged buyouts where they have management control. In China, they are providing growth equity to industrial companies where they don’t—two very different investment strategies.

If not entirely a one-way street, then globalization and the trading relationship between the United States and China has been no more than a road with three lanes.

On two of those lanes, a vast amount of goods have flowed from China in giant container ships to ports in the United States. On the third, money and goods have flowed from the United States to ports—and banks—in China. Largely as a result of its trading and investment activity with the United States, China has amassed over $1.3 trillion of foreign currency reserves.

Although the financial impact of China’s emergence as an economic superpower is not as apparent to everyone, what is clear to all is that U.S. manufacturers have been severely impacted by China’s rise. Whether one believes that the shift of manufacturing jobs to low-cost countries like China is good or bad, the fact is that a shift has occurred. But, recent events suggest that a fourth lane in the relationship between the two countries is now being built.

On the capital front, China recently invested $3.0 billion into Blackstone, the large private equity firm, and most observers believe that this is only the beginning of more equity-type investments in developed countries like the United States. It now appears that Chinese companies, in their quest to become global players, are also making strategic investments in the United States, bringing both capital and jobs.

In September, Sany Heavy Industry Co. signed a memorandum of understanding with the state of Georgia to build a manufacturing facility with an investment of $60 million.

The company announced that it plans to acquire over one million square meters of land in Georgia’s Peachtree City to build the plant.

The factory would make Sany the first Chinese construction equipment maker to own a plant in North America, home to industry giants like Caterpillar Inc. “The project in the U.S. will further boost our competence in the global market, especially in the U.S., which is the world’s largest construction machinery market,” said He Zhenlin, vice-president of Sany Group.

For those who believe that all manufacturing jobs in the United States are destined to move elsewhere, Sany’s announcement indicates that is not necessarily the case. Just like Toyota and the other Japanese car makers have found, Sany has decided that it is smart to put plants in a large market like the United States as a way to increase market penetration. While there are certainly cost advantages in China, there are also advantages to being close to the end consumer.

This does not mean that U.S. companies will be immune from competition from their Chinese counterparts—-in fact, Chinese companies may become more of a threat due to moves like Sany’s. (Toyota is gaining market share at the expense of U.S. carmakers as a result of its growing manufacturing presence in North America.) But it does mean that whether U.S or Chinese companies emerge as the winners, the U.S. economy has a fair shot of winning as well. Ask the State of Georgia. I am sure that they are feeling like winners today.

Now that we are counting down to the 2008 Olympic games, first-time and not so recent visitors to China are no doubt wondering what they will see when they land in Beijing next August. In the run-up to the games, we will take every opportunity to describe the changes that are taking place in China and paint the picture of how the country will look in another year.

With China’s continued economic prosperity and the increase in wealth it has meant for hundreds of millions of Chinese, one sector that is changing rapidly and is getting added impetus from the expected onslaught of visitors next year is services. China has made its mark so far as a manufacturing powerhouse, but some of the biggest areas of growth and the best investment opportunities going forward are likely to be in providing an upgraded and larger array of services to an increasingly affluent class of Chinese customers.

Certain consumer and business services such as food service, lodging, air transportation, logistics, distribution, health care and beauty are basic to any economy. While these services have existed in China in some form for a number of years, the quality of the service that is being provided is being dramatically upgraded. Take air transportation. In the early 1990s, airports were 1950s vintage, and finding yourself on an old Tupolev plane was not at all unusual on many domestic flights. Today, nearly every major city in China has a modern airport built within the last five years, and China boasts one of the most modern aircraft fleets in the world. In a post-9/11 environment, travel around China is in many ways much easier than in the United States.

In addition to the general upgrading of basic services that is taking place, enterprising companies are now segmenting the market to appeal to different classes of consumers. Haircuts, both women’s and men’s, is a good example. Ten years ago, you could get a haircut for a few yuan at hundreds of shops or streetside barbers in any decent sized city, or you could pay 1,000 yuan in a Western-oriented beauty shop, most likely in one of the city’s five-star hotels. There was nothing in between. Today, a wide range of prices to fit any consumer’s pocketbook can be found in beauty shops scattered across the same cities.

Finally, services previously unheard of in China are now being offered. One simple example is getting a shoeshine. In a country where it has been easier to get a foot massage at 10 at night than a shoeshine at 10 in the morning, I was pleasantly surprised to see a shoeshine stand near my gate at Beijing’s Capitol Airport on a recent trip within China. Since then, I have noticed similar stands popping up where none existed before. Beginning my career in the States where “dressing for success” included a pair of clean and well-polished shoes, it took some adjustment to get used to seeing shoes that were anything but that when I first moved to China. This was understandable when dirt roads and walkways were common and everyone came to work on a bicycle, but China has come a long way since then. Anxious to do my part to ensure the success of the new shoe shine stand, I took the extra five minutes to have my shoes polished. The shine was as good as I’ve gotten anywhere, and the price was right at 10 yuan.

I recently read the following post from Bespoke Investment Group’s “Think B.I.G.” site, which puts forth the following train of thought:

• A: Last week the Hang Seng index was very volatile (moving at least 1% every day) and ended the week at a gain.
• B: In the past, when the index was very volatile and ended at a gain, it usually carried that gain into the next week and month.
• The implicit conclusion C: it’s a good time to invest in the Hang Seng.

Now, I don’t purport to be an expert on investing, but I do know enough about logical reasoning to know that a lose correlation like the one between point A and point B does not warrant a rational investor’s attention. The myriad of causes that led to the index doing well for 3 weeks after seesawing intensely in December 1993, does nothing for me in 2007. I don’t even know why an article like that would be written.

The article caught my attention, because it reminds me of the faulty reasoning that is gripping Mainland Chinese investors these days. With the market soaring, Chinese investors continue to line up with little more than a gambling spirit backing their investment strategies. When evaluating how to take advantage of the enticing gains available in China, the following advice from the Everyday Finance Blog would be worth listening to:

Based on valuation and revenue growth, China is still considered to be THE value market of the BRIC four by many prominent investors and economists. However, before long, Vietnam, Columbia, and others could start to draw some of the speculative emerging market funds seeking 50%+ returns per year.

Given the massive runup in share prices in recent weeks, it would be prudent to take some money off the table. However, pulling out altogether could result in missing the investment opportunity of a lifetime. A good approach would be to continue to leave the speculative portion of your portfolio in SOLID Chinese stocks. This would include companies with some history, proven earnings, and you should be able to articulate what this company does.