Contents Provided by China Daily
Foreign investment, which has played a significant role in sustaining the rapid growth of the Chinese economy, has acquired a new form, that of mergers and acquisitions (M&As).
As China has become more conscious about the quality of its foreign investments, rather their quantity, foreign companies have also made adjustment in their mode of entry into this market, with more and more tilting toward M&As.
In the early stages of economic reforms, Chinese companies were eager to tap foreign capital, often ready to cede market share for advanced technology from foreign partners. And foreign companies, being new in the market, were only too happy to have a local partner to steer them through the unknown terrains in the form of joint ventures.
An apparently mutually beneficial arrangement, these tie-ups - encouraged by the Chinese government at the time - created more problems than they solved. Foreign investors were unhappy that they, often as minority shareholders, couldn’t run the joint ventures to their liking, while Chinese companies discovered that the joint ventures did not always result in the technology transfer and management expertise expected of them.
Chinese companies would also often be tricked by their foreign partners. At times foreign companies would let the joint ventures languish in the red, safe in the knowledge that they could always offset their losses by selling their shares and charge high patent fees. When it got too difficult for the Chinese companies to bear the costs after years of losses, their foreign partners would often come to the “rescue”, offering to buy out the venture altogether, having gained sufficient knowledge of the Chinese market by then.
But many multinational companies today wouldn’t choose this roundabout way of entry, preferring instead to go it alone. Thus foreign companies, private equity funds (PE) in particular, now prefer to acquire local players directly.
M&A boom
Foreign PE inked 129 deals in China last year, with a total investment of US$12.9 billion, according to industry consultancy Zero2IPO. In the first quarter of this year, the investment soared to US$7.56 billion, a year-on-year jump of 329 percent, says the Beijing-based consultancy.
“The increase of cross-border M&As is a new trend in China,” Pan Biling, deputy director of the Foreign Investment Department under the Ministry of Commerce, was quoted as saying by Beijing-based Economic Reference.
“The number of foreign investors who are seeking our advice for their intended M&A deals on the mainland has been increasing briskly in recent years,” says Li Ying, a lawyer with US law firm Heller Ehrman’s Beijing office.
Experts say foreign M&A activity in China is expected to increase in the coming years. Over the past two decades, many local firms have grown into leading players in their respective industries. For foreign players, acquiring these local companies could provide them with a short cut into the booming Chinese market, they say, allowing multinationals to put the acquired firms on their global chessboard to increase their efficiency and ride the Chinese economic boom.
“Acquiring controlling stakes in the target firms, which are usually leading industry players, and taking the reins of their sales networks are two prime goals of multinationals’ M&A activities,” says Feng Baoshan, director of the market development division under the China Machinery Industry Association. The multinationals then gradually strip acquired firms of their capacity to independently develop technology and products, Feng says.
This, say Feng and other experts, is an alarming trend threatening national economic security. “If all leading domestic companies are acquired by foreign firms and their existing technology and product development capacity left uncared for by the new masters, how can innovation and technological upgrade be realized?” asks Feng.
Tightening rules
The government has been actively trying to avert such outcomes since US buyout firm Carlyle Group’s high-profile bid to take 85 percent of China’s biggest construction equipment maker Xugong Group Construction Machinery in 2005. Carlyle has since scaled down its original 85 percent bid to 45 percent, but the deal is still pending approval.
China issued Provisions on Acquisition of Domestic Enterprises by Foreign Investors last year in a bid to regulate foreign M&A activities in the country. In August, the Anti-Monopoly Law was enacted and will take effect next August. The new rules require any major foreign M&A deal to be examined and supervised for national economic and industrial security reasons by relevant government bodies.
But the tightening regulatory environment, experts say, will not deter or scale back foreign M&A activities. “The interest among foreign investors is still overwhelming despite their concerns about regulatory uncertainties,” Heller Ehrman’s Li says.
The number of M&A deals involving foreign capital decreased slightly to 296 in the first half of this year, down from 316 in the first half of 2006, according to data complied by industry journal M&A Asia. The slump was mainly due to the bull stock market, which has pushed up share prices and transaction costs, and the uncertainty about regulatory approval procedures, experts say.
The situation is likely to continue in the second half of this year until valuation expectations subside, and financial investors are likely to remain focused on minority positions in larger transactions until they sense a change in the regulatory landscape, says Gabriel Wong, a corporate finance partner of international accounting firm PricewaterhouseCoopers (PwC).
“The slowed pace is mainly due to the increasingly complicated approval procedures, which may also vary from one locality to another,” Li says. “It (the tightened rules) would prolong the approval time and make deals more difficult to structure, but would not deter foreign investors from chasing M&As.”
Some experts say the recent government moves to regulate foreign M&A activities will make China more attractive for foreign investors in the long run.
“A more transparent M&A regulatory mechanism, which reduces uncertainties, will benefit all parties in this game,” says Feng Lei, a researcher with the Chinese Academy of Social Sciences.
