California: China's gateway state to American investment?

October 12, 2012: 11:58 AM ET

The Golden State might be in financial turmoil, but that hasn't scared off Chinese investors. At least not yet.

FORTUNE -- California has attracted more Chinese investors than any U.S. state. And in the coming decade, thanks largely to California's robust tech industry, the Golden State is poised to be America's gateway for Chinese investment, according to a new report by Asia Society.

This could be viewed as good news for California, which in recent years has dealt with strained budgets and joblessness worse than most other parts of the country. Over the summer, bond investors were stunned when three California cities filed for bankruptcy.

While Chinese investors aren't exactly going to save California from financial malaise, the report underscores the state's potentials and its position to court new money in a place that needs it. Badly.

Researchers Daniel Rosen and Thilo Hanemann analyzed Chinese investments into the U.S. over the past decade. Since 2000, the U.S. drew more than 500 deals worth $16.4 billion. Of that, California accounted for nearly one-third, or 156 deals. At $1.3 billion, California isn't necessarily locking in the priciest investments, but in terms of the number of deals, the state has attracted more than any U.S. state. With 69 deals totaling $614 million, southern California leads Chinese investments, followed by the San Francisco Bay Area and Silicon Valley/South Bay regions.

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It's perhaps not all that surprising to find Chinese investors in California. For one, the state has had a long history with China -- it has one of the highest Chinese American populations in the U.S. California is also the largest economy of any U.S. state, and lead investors view it as a gateway to the rest of the country. More specifically, California is home to some of the country's biggest tech companies -- an area that many of China's private firms wish to invest in.

A look at investments since 2000 show the Chinese poured most of their funds into software and IT, followed by leisure and entertainment, communications equipment and services, electronic equipment and components, and alternative/renewable energy. Online gaming, in particular, has grown into a popular investment for Chinese companies, with notable acquisitions including Riot Games by Tencent in 2011, Mochi Media by Shanda Games in 2010, and Cryptic Studios by Perfect World in 2011.

To be sure, these investments are tiny compared to the size of California's economy. Detailed statistics of foreign investments in California specifically are unavailable. But if the state reflected trends nationwide, China would be "a very small player," Hanemann said. While trends might change given Europe's ongoing debt crisis, countries like Japan, Germany, the United Kingdom, and Canada have historically dominated foreign investments into the U.S.

In the coming decade, though, the Golden State could attract $1 billion to $60 billion worth of Chinese investments, Rosen and Hanemann estimate.

That's quite a range, which may or may not play out, depending on whether a few very uncertain things go right. Consider California's troubled finances, which could deter not just Chinese investors but investors in general. Municipalities rarely ever default, but bankruptcies declared by Stockton, San Bernardino, and Mammoth Lakes over the summer have prompted credit agencies to consider a much less rosy outlook for the Golden State's other cities.

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On Tuesday, Moody's Investors Service announced it would scrutinize the ratings of various types of bonds in 30 California cities, including Santa Monica, Sacramento, and Fresno. The announcement follows an August report in which the agency predicted more municipal bankruptcies and defaults, warning that some cities are turning to bankruptcies to tackle budget deficits and abandon promises to bondholders.

All that might scare off any investor, but perhaps not the Chinese, who haven't exactly been known for their aversion to risk. And so some may just see California as an undervalued investment, just as some have viewed debt-troubled Greece. Also, Chinese investments into the U.S. were miniscule prior to 2008. In the years following the financial crisis, investment surged as financial turmoil across the globe reinforced to Chinese firms that they couldn't just continue relying on exports or markets at home to grow their business. Whereas investments from China to California between 2000 to 2007 averaged less than $25 million a year, Chinese firms in 2011 invested a record $560 million.

Rosen and Hanemann have called on Californians to actively lure Chinese investment. That may be easier said than done, though, depending on how Californians digest the tone Washington lawmakers have been setting. Earlier this week, a congressional report warned that the potential expansion of two of China's largest telecom firms -- Huawei and ZTE -- into the U.S. market threatened U.S. national security. Just a few days before the report was issued, President Obama, in a rare move, blocked a Chinese-owned wind farm project in Oregon, citing national security concerns. Even if Chinese investors may want to invest more in California, it's not necessarily guaranteed that Californians want to do more business with the Chinese.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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