How strong is the appetite among Chinese firms for overseas investment? What risks and challenges do they face and what opportunities are there? We talk to Guy Facey, regional head of corporate at Withers Hong Kong, for his views.
What appetite do Chinese businesses have for overseas acquisitions?
Royal Bank of Scotland did a survey in March this year that interviewed 106 respondents in the mainland and Hong Kong -- over half (63%) responded that they expect M&A activity to increase and corporates were even more bullish (70%).
The reason why Chinese companies are keen to expand overseas is obvious: the search for natural resources and security of supply is well known. Other reasons could be the desire to acquire access to new markets, market share and strategic clients; to diversify; acquire technology; and to gain scale. Some acquisitions are for simple reasons: having first ventured overseas by appointing a national distributor, scaling up may lead to buying the distributor.
It appears as if Chinese companies today face more political opposition when they seek to do deals abroad than they did before, and also more than firms from other countries. What's your view?
A famous example was the blocking of CNOOC's attempted acquisition of UNOCAL. As a general rule, opposition is always likely to arise where the assets are regarded as strategic and China does exactly the same with its restricted industries, so it should come as no surprise. Competition or anti-trust laws may apply if the merger will mean a significant concentration of competition in the relevant market. Generally though, if a Chinese acquirer purchases a Western business but there is no concentration, then competition laws should not apply. Indeed, the entry of the Chinese manufacturer may increase competition in the market and benefit consumers.
The Rio Tinto-BHP Billiton proposed joint venture is causing China's authorities to voice concerns and flex their muscles, first in relation to China's new competition laws and more recently alleging the stealing of state secrets. If there was political opposition to a Chinese acquisition of a British business in circumstances where it was alleged inside information was obtained, it is unlikely that Britain would lay criminal charges for stealing state secrets. Confidential commercial information is generally regarded as the asset of the company, not the state and any action would be a civil action by the company. Some years ago a target company in the UK took legal action and successfully blocked a takeover where confidential information had been secretly obtained, and the bidder and its investment bank settled for an undisclosed sum in damages. The bidder also withdrew its bid.
It's well known that one of the biggest challenges for companies that choose to do overseas acquisitions, particularly Chinese companies, has been integrating their businesses after the takeover. How do you achieve integration?
The published examples indicate that the best solution may be temporary partnerships or joint ventures. Lenovo's IBM deal left IBM with an 18.9% stake in Lenovo; IBM granted a licence for the use of its brand; and technical assistance and support agreements to assist integration. For example, IBM's sales team provided product support and an associated IBM company provided lease finance, maintenance and warranty support as the preferred provider. Published analysis indicates that these were key in enabling Lenovo to achieve integration. Profits in the two years after the acquisition, in 2007 and 2008, were 12 times 2006 profits and most of the growth came from the original IBM PC division.
Commentators observe that subsequent losses by Lenovo may fairly be attributed to the downturn in the PC market globally, rather than to Lenovo's performance. The key to success appears to be the creation of a structure (in the above cases temporary partnership) which incentivises both sides to achieve a win-win situation. It is interesting to note that Lenovo spent more than a year planning for the acquisition even before the deal was done.
But there are many companies that don't want to enter into a joint venture -- what alternatives are there?
Well, there are earn-outs, which are commonly used in deals with SMEs (small- and medium-size enterprises) but may also be used in larger deals. An earn-out is an acquisition where the seller is paid part of the price on closing and the remainder is variable based on the profits of the business for a period after closing (commonly two or three years). The purpose is to retain management and give them an incentive to grow the business. The problem with earn-outs is that if the management feel they are locked in and do not truly integrate they frequently cease to perform immediately after the earn-out period and we have seen examples of break-downs in relationships with managers after acquisitions. The other possibilities are a strategic alliance without a merger or JV, or a cross licensing or distribution deal.
So what are the opportunities?
Overseas assets are now looking very cheap, especially in the UK because of the fall in sterling (17% from January 2008 to July 2009) and the fall in asset values. Some UK-listed companies have a share price of only one-third of their quoted price in 2007. This would be true in any economy where the currency is down, because asset values have fallen worldwide.
Who are the possible targets or partners?
In the UK there are many well-managed businesses that are in difficulty merely because of the credit crunch: in more normal times they would easily be able to borrow from banks. There are also those who do not want to sell but who may well be prepared to consider a strategic alliance if they are facing the possibility of a low-cost manufacturing Chinese competitor making an entrance into their market. There are also potential partners among investors seeking to make pre-IPO investments in Chinese companies looking overseas -- who may also help find acquisition targets.
What is the current outlook?
Many Chinese companies feel they are disadvantaged in acquisitions in the West but with the right preparation there is no reason why a Chinese acquisition should not succeed. It will probably take one or two high profile successes to give successful Chinese businesses the encouragement they deserve.
