Tempted by China? 3 ways to cut risk

Consider the ongoing acquisition battle for China Eastern Airlines (CEA, news, msgs), for example. In late 2007, Singapore Airlines (SPOAF, news, msgs) had offered roughly 49 cents per share in U.S. dollars for 24% of China Eastern Airlines.

The deal would have brought China Eastern badly needed operating expertise as it expanded. Initial reaction from the company was positive, leading many outside observers to conclude that Beijing approved of the deal, as the Chinese government long has considered airlines and airports one of the country's strategic sectors. Then Beijing seemed to change course. Air China and its parent, China National Aviation Holding, became the favored bidder at about 65 cents per share. In late January 2008, shareholders at China Eastern voted to reject the Singapore Airlines bid.

What should concern an overseas investor in Chinese stocks was the price of both offers. When Singapore Airlines and Air China made their offers, China Eastern shares were trading at between 78 cents and $1.04. It's possible -- just possible -- to conceive that the Singapore Airlines bid was fair because the Singapore airline was bringing so much skill in airline and airport management to the table. But it's hard not to conclude after both bids that the Hong Kong market price for China Eastern was too high.

Beijing bureaucrats decide

And what should concern an investor even more is the clear picture of bureaucrats in Beijing deciding what's best for China Eastern. The company does need better operational skills to expand its business in the fast-growing market for domestic air travel in China. Singapore Airlines brought that to the table. Air China is offering less in operational skills but more in market share. The tie-up would give China Eastern more clout in the domestic travel market.

But the battle between these two alternatives isn't being fought out in the boardroom at China Eastern or in the stock market, but rather behind closed doors in Beijing. After government pressure put the kibosh on the Singapore Airlines effort, the Air China bid ran into unexpected opposition, also from Beijing.

On Feb. 4, a Chinese government official said that a hookup between Air China and China Eastern would violate Chinese antitrust laws. Government officials don't go public with statements like that unless they've got the backing of one of the competing power centers in Beijing. The battle for China Eastern will go on for a while, it seems, and investors in the company won't know the basis for any decision until it is made -- and maybe not even then.

Expect that this battle will be more protracted and fought with minimal concern for shareholder interests, because what's at stake here is the direction of one of China's strategic sectors.

Stocks to try

In addition to the short ETF strategy I mentioned, I've got two more suggestions for strategies to lower your China-specific risk.

First, you can buy China without buying Chinese stocks. You can do this by buying developed-market stocks with big business in China. Four examples are:

• Luxottica (LUX, news, msgs), a manufacturer and retailer of glasses and sunglasses under its own and licensed brands, which has in the past two years acquired Modern Sight in Shanghai (28 stores), Ming Long in Guangdong (113 stores) and Xueliang (79 stores in Beijing) to bring its total in China to 270 stores. (This stock is a former Jubak's Pick.)
• Joy Global (JOYG, news, msgs), which sells coal-mining equipment to China and Australia. (This one is a current Jubak's Pick.)
• HBSC Holdings (HBC, news, msgs), which has been mauled in the meltdown of the U.S. subprime-mortgage market but which runs the largest bank in Hong Kong and is a presence across developing economies in Asia.
• Everlight Electronics (EVLEF, news, msgs), a Taiwan-based manufacturer of LED and other display technologies that manufactures in China and is a major supplier to Chinese makers of consumer electronics.

Second, you can buy China stocks outside what China has decided are the strategic sectors of its economy. Three examples are:

• Suntech Power (STP, news, msgs), the No. 4 producer of solar cells in the world
• Ping An Insurance (PNGAY, news, msgs), which grew premiums by 15% in 2007 and owns about 16% of the Chinese life insurance market.
• China Mengniu Dairy (CIADF, news, msgs), the No. 1 player in China's growing milk market.

I'd wait to buy any of these until the overall risk in China's stock market comes down. But sometime in 2009, I'd estimate, buying any of these seven would be a way to increase your chance at China profit while keeping your China risk under control.

Continued: An update and a development

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