Mergers and Acquisitions In China

Difference

- combination of two companies to form a new company

- the purchase of one company by another with no new company being formed

Merger

Acquisition

3% 2%

95%

Number of M&As deals in 2010

Outbound - 55 deals

Inbound - 30 deals

Domestic - 1713 deals

Adopted from ChinaVenture.com.cn

36%

3%

61%

Value of M&As in 2010

Outbound

Inbound

Domestic

Adopted from ChinaVenture.com.cn

Outbound mergers

• Outbound deals exceeded the size of the average merger• China carries the most outbound M&As in such sectors as Energy, Mining,

Manufacturing and IT.

Reasons:

The need to acquire raw inputs and diversify foreign exchange reserves

The desire to expand abroad

Acquisition of rights to high-technology to move in the production chain

Acquisition of reputable brands

For further notes refer to the slide 19

Dumping – dubious reason for combination?

Dumping – selling on a foreign market at a low price, below the fair price in order to:

• Dispose of temporary surplus • Achieve monopoly by eliminating competitors

• Solar panels• Steel Cylinders• Silicon Metal• Diamond Sawblades• Warmwater Shrimp• Fresh Garlic

U.S. has imposed anti-dumping duty on China regarding products such as:

Inbound mergers• Countries that carried the biggest M&As in Chinese market in 2010: Japan,

France, Denmark • The biggest domestic M&As were in Shanghai - 13% in terms of number

of deals and 20% in terms of value• The inbound deals dominated in sectors: Manufacturing, Food &

Beverage, Logistics and Healthcare. The amount of healthcare deals accounted for over 50% of all inbound M&As.

Reasons:

Low labor costs

Growing economy

Well-established distribution network

Enter a new market

Restrictions

• PRC’s law states that companies in China are not allowed to engage in ‘all lawful activities’.

• Not all industry sectors are open to foreign investors.

• Encouraged• Permitted• Restricted• Prohibited

The industry sectors are classified as

For further notes refer to the slide 20

Encouraged / Permitted• Mining • Manufacturing• Transportation • High-technology

Restricted – strict scrutiny

• Banking and Insurance Industries

• Tobacco • certain textiles• Electricity, gas and water

production • Mining of precious metal • Golf courses

Prohibited • Postal services• Gambling• Arms and ammunition

manufacturing• Publication of books, magazines,

and newspaper

M&As in China have different forms:

Acquisition or merger of :

Privately-owned

enterprises

Foreign-invested

enterprises

State-owned enterprises

Listed companies

For further notes refer to the slide 21 and 22

Merger versus Acquisition

• Acquisition

Equity Acquisition

Asset Acquisition

• Merger

Merger by ‘absorption’

Merger by new establishment

For further notes refer to the slide 23

M&As in West (UK) and ChinaWest -> UK China

1. Main means of obtaining control of a public company

Contractual offerScheme of arrangement

Direct acquisition – stock exchange, tender offer, transfers by agreementIndirect acquisition

2. Disclosure requirements 3% of target issues shares 5% of target issued share

3. Break fees Prohibited In certain deals break fees are provided

4. Hostile bids Common. Approximately 16% of all the bids

Rare. Tradable and non-tradable shares. No rights to sell the whole 100% of non-tradable shares.

5. Minority shareholders <10%

Shareholders have to sell the rest of their shares

A bidder cannot compulsory purchase the shares of remaining minority shareholders

6. Stamp duty 0.5% of the transfer price 0.1% of the transfer price

For further notes refer to the slide 24

The Importance of GuanxiTight monetary

policies implemented

by the authorities

Liquidity problemsNO GUANXI

Buyer: Difficulties

in paying its purchases

GUANXI

Seller: No pressure for the debt payment, further credit

extension

For further notes refer to the slide 25

Whenever the seller provides its buying Guanxihu with

commercial credit,

the buyer is expected to

purchase more from the seller

according to the reciprocity

principle of Guanxi

Relationship between M&A and Private Equity

Why do takeovers fail???

Cultural differences

Little transparency – Chinese companies operate two sets of books

International community knows very little about Chinese companies –

people afraid of the unknown

Absence of Guanxi – no connections

Managers’ Inexperience in dealing with international markets

Failure to plan for post acquisition period

Failure – example

Shanghai Automative Industry Corporation (SAIC)’s

acquisition of Korean funded

Ssangyong Motor in 2005.

After five years of hard work and

countless negotiations and

restructuring, SAIC ultimately had to

declare bankruptcy

SAIC assigned Chinese managers to Ssangyong and they had difficulty

with the trade union.

$500 million investment

Outbound mergersReasons for outbound transactions: The need to acquire raw inputs and diversify foreign exchange reserves• SOEs buy miners and Oil & Gas production and exploration firms in order to keep Chinese economy

supplied with input of raw materials Desire to expand abroad• Most often privately-owned companies expand abroad to benefit by increasing a market share, often by

‘dumping’ – setting prices below the fair market price. Acquiring well-know brands and rights to the high-technology• Reputable brands give a head start in a new market.

RestrictionsForeign investors have to be in compliance with all the laws and regulations of the PRC – even If local Chinese companies are not. Foreign investors are the number one target of legal and financial control mechanisms in China. Before the Chinese authorities check local companies’ compliance issues, they will check the foreign investor.

M&As in China have different forms

a) Acquisition or merger of privately-owned enterprisesForeign investors who acquire a privately held company will need to convert it to a Foreign Invested Enterprise (FIE). As a result, all related FIE rules and regulation have to be observed. These includes restrictions relating to the available investment vehicle, the necessary qualifications of investors, the possible scope of business, and the minimum registered capital.

Where the ratio of a foreign investors’ capital contribution to the registered capital of the FIE established as a result of M&A is less than 25%, the enterprise shall not be entitled to the treatment for FIEs.

All M&A between a foreign and domestic enterprise should determine the transaction price on the basis of the result of an evaluation conducted by an asset evaluation institution. The institution must be established within the territory of China in accordance with the law.

b) Acquisition or merger of foreign-invested enterprisesParties involved in transaction of FIE equity are free to arrive at a transaction price themselves, with no regulations or requirements.

The most important thing to realize is that the transfer of equity interests in FIEs, even between two foreign investors, requires state verification and approval.

M&As in China have different forms

c) Acquisition of stated-owned enterprises (SOEs)According to the provisions, foreign investors who invest in SOEs or acquire stated-owned equity interest shall:• Have the business qualifications and technical ability as required for the operation of the target• Have a good business reputation and management capabilities• Have a solid financial position and economic strengths

Regulations state that an appraisal of the acquisition object, be it property rights of a target SOE or state-owned equity interests or assets, must be conducted by a competent state-owned appraisal authority

d) Acquisition of listed companiesChinese law makes a legal distinction between listed and unlisted shares, of which listed shares are divided into three categories, namely A-shares, B-shares and shares listed overseas.

A-shares – traditionally reserved for Chinese businesses or individuals, however foreign investors may purchase up to 10% of A-shares provided they qualify as a Qualified Institutional Investors.

B-shares – are RMB-denominated shares and can only be purchased and traded for in foreign currency and are traditionally reserved for foreign entities or individuals. However, the number of B-shares compared to A-shares in a listed company is quite small, and in most cases, companies have not issued B-shares at all.

The unlisted share can be purchased by either an agreement between the purchaser and the target shareholders or by a tender offer.

Merger versus AcquisitionUnder Chinese law mergers are only possible as onshore transactions. Therefore foreign investors must have set up FIE in China in order to be able to complete a merger deal.

There are two types of mergers:

• Merger by ‘absorption’ – the absorption of one company by another whereby one company is dissolved and its registered capital and assets are merged into the remaining entity. The legal entity of the absorbed business would then cease to exit.

• Merger by new establishment – each of the companies in question are dissolved and a new legal entity is formed by combining the assets and registered capital of the old companies

M&As in West (UK) and China1. China • Indirect acquisition – achieved by purchase of a controlling interest in the parent or controlling

shareholder of a listed company. On completion the target is converted into a foreign-invested enterprise, which then controls the listed subsidiary below the target.

UK• Contractual Offer to all of the target company’s shareholders to acquire their shares. For the contractual

offer to succeed a bidder must secure acceptances in respect of more than 50% of the target company’s share capital.

• Scheme of arrangement – statutory mechanism involving a shareholder vote and court approval

3. Break Fee Supposedly used to recoup costs and fees associated with due diligence during an acquisition. These

break fees are seemingly used more and more for the purpose of restoring lost reputations arising from deals falling through.

Common in lease agreements, these break fees are penalties charged against parties not wishing to fulfill their portion of a contract.

4. Hostile BidsA specific type of takeover bid that is presented directly to the target firm's shareholders because the target's management is not in favor of the deal. If takeover is hostile – shares are going to have to be bought.

The Importance of Guanxi

• Guanxi – express the relationship of one person to another, or one party to another. This boils down to exchanging favors, which are expected to be done regularly and voluntarily.

• Guanxihu – a new term derived from guanxi; ‘specially connected firms’

“The other side of credit-granting, the intensity of accounts receivable for the seller, is also tightly associated with guanxi. Whenever the seller provide its buying guanxihu with commercial credit, which is today of utmost importance to buying firms in China, the buyer is expected to purchase more from the seller according to the reciprocity principle of guanxi. This marketing and efficiency effect precisely corroborates Ambler's (1994) point that guanxi constitutes the most effective (sales growth) and efficient (low costs) promption tool in the Chinese business environment. Moreover, guanxi-based credit extension has a fairly lower bad-debt risk than non-guanxi-based credit granting since the buyer has to pay the purchase upon its selling guanxihu's request in order to maintain its mianzi in the business society and beyond”. Luo Y., Guanxi and Performance of foreign-invested enterprises in China; Management International

Review; vol. 37; 1997; page 51-70