The deal represents the first such strategic stake in a Chinese company by Sumitomo, which has previously been restricted to joint ventures. Although the consideration was reportedly less than $25 million (no sales price has been announced), the deal has been dogged by lengthy delays. These were due to a mixture of nationalistic and technical reasons, say specialists.
ôIf this had been a US company, rather than a Japanese company, there is a side of me that says the deal would have gone through more promptly,ö estimates Toshiyuki Arai, a partner in the Shanghai office of Paul, Hastings, Janofsky & Walker which advised Sumitomo on the deal.
The objections were not from Topfond, say specialists, which was very keen for the deal to go ahead.
MOFCOM (the Ministry of Commerce), for example, one of the key regulators in the deal, repeatedly queried the suitability of Sumitomo as a strategic investor, despite SumitomoÆs established trading business in pharmaceutical products. SASAC (the state-owned assets supervision and administration commission), the body responsible for state-owned assets, was also involved on the issue of price.
Observers mentioned that one clear problem would have been the gulf between the low price at which the state-owned shares were sold, and the price of the Shanghai-listed shares.
The shares acquired by Sumitomo belonged to a class of non-listed, state-owned shares which have numerous safeguards built into their tradability. This was originally to protect state ownership. The law stipulates that they be priced at no less than net asset value, a very low floor compared to the price at which listed shares trade.
Unusually, once Sumitomo acquired them, the shares were converted into tradable shares. This is in line with the governmentÆs efforts to gradually convert all state shares into tradable shares.
Sumitomo was theoretically sitting on a great arbitrage opportunity, since the price of the domestically-listed shares was far higher than the price at which they were sold. However, the Japanese company is bound by a three year lock-up.
The lock-up could have been avoided if the investment had been classified as a Qualified Foreign Institutional Investor (QFII) investment. Not being a financial company, Sumitomo was not eligible.
Since Sumitomo was an owner of state-owned shares before the conversion to tradable shares, the company is responsible for providing compensation to tradable share holders. These believe they have the right to compensation because converting the state-owned shares to tradable shares increases the total amount of shares outstanding and will lower the share price. Sumitomo has opted to pay cash rather than issue further shares, in order to avoid dilution.
ôSumitomo wanted to employ modern M&A techniques in China rather than relying on traditional relational approach with the government and the seller,ö comments Arai.
Thus, one aspect of the deal which is common in the US but not in China, was to ensure that a percentage of the consideration was placed in an escrow account. In the event of Henan Topfond contravening its warranties, the buyer will thus have leverage over the seller.
The lesson learnt by those involved could be that onshore negotiations are still arduous and uncertain.
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