New signs of life have begun to emerge in China’s restive domestic M&A market. The past years of relative quiet are giving way to political and economic reforms and China’s new normal economy. For example, at the end of 2014, 1,536 transactions were closed for an average value of $131 million.

Seventeen of the total transactions were valued at over $1 billion, the majority of which (65 percent) was related to the restructuring of state-owned enterprises (SOEs). E-commerce and technology also played a prominent role, with seven of the top 17 deals involving these two industries.

In aggregate, technology, industrial and consumer represented 52 percent of total transactions. Most of the consolidation was domestically focused, with only 15 percent of deals happening across borders compared to 50 percent in 2005 — a remnant of the global financial crisis.

But inbound deals, which had decreased over the past three years, are now increasing with the rejuvenated global economy. In a low growth and increasingly tough business environment, acquisitions have become the top initiative for many multinationals in China. Based on an InterChina survey of more than 50 China CEOs, “plan for acquisition and strengthen inorganic growth” came in as a top priority going into 2015. Foreign players feel the urgency in maintaining growth as China’s economy slows and top lines increasingly rely on inorganic growth.

Succession issues and the diminished confidence levels of some Chinese founders are creating a larger pool of available sellers and more humble valuations. China’s desired rise in the manufacturing value chain — strong tech, high-end manufacturing, brands, etc. — has generated many acquisition and divestment opportunities.

We have seen MNCs across a high number of sectors exhibit foresight by embarking on these global opportunities.

For instance, several companies in low value-added industries like commodities, steel, etc., are looking to divest or move away from traditional core businesses that will be uncompetitive in the long run. Other companies, particularly those in downstream food and beverage industry are looking upstream for secure and quality supply.

The regulatory environment is growing more supportive of consolidation trends. The State Council has issued seven guidelines on and opinions for M&A. The Council has also encouraged foreign companies to participate in domestic consolidation.

Stated goals of the State Council for industry concentration in China are as follows: The top 10 Auto OEM companies should occupy 90 percent of the market, the top Steel companies should occupy 60 percent, Cement-35 percent, shipping-70 percent. The China Securities Regulatory Commission (CSRS) also reduced the M&A approval requirements for listed companies so long as they are not reverse merging or issuing stocks.

The outbound deal environment is also improving as more than 150 strong Chinese players and Chinese private equity firms become capable of global acquisitions across various industries. Domestic sovereign funds — CIC, etc. — are adding to the regulatory environment support.

While market activity builds, several on-going developments may impact the M&A environment.

The “Mini Happenings” and Their Potential M&A Impacts

The Mad Bull Effect

Traditionally, the equity market’s expansion corresponds with the expansion of merger and acquisition activities, but the relevance of domestic acquirers and multinationals are drastically different.

For Chinese listed companies, now is the best time for M&A activities. Chinese companies are taking advantage of arbitrage opportunities and using highly valued stocks as currency in acquisitions. Now is also an opportune time to raise funds for expansion. For example, Hainan Airline will raise 21 billion RMB for acquisitions, capital expenditure and debt retiring. Additionally, several companies are emerging as highly active acquirers, including Shanghai Pharma who consummated 15 transactions in just 2 years.

IPO Registration Reform

Under the current IPO system, firms aiming to list themselves must undergo a complex application process that can involve multiple rounds of review before approval by the CSRS. Unlike current verifications for IPOs in China, the widely adopted registration-based system allows investors and companies to decide the valuation and timing of new share offerings in light of the country's situation and market circumstances. The opening up of the IPO market will have an adverse effect on M&A. For some companies, listing will be more a more appealing option.

Buyout Funds

There are approximately 62 listed companies with buyout funds and growing. This will constitute a growing force of acquisition in China. Unlike traditional private equity, the buoyant equity market allows these funds to be well capitalized.

New Third Board Listing

As of recently, there were over 2,000 companies listed on the new third board, China’s OTC equity market. The effect on M&A is mixed. The third board could be a source of targets for acquirers. At the same time, listing provides an alternative route to trade sales. For strategic acquirers, this poses a challenge in terms of valuation and securing a majority.

Acquisition Financing

China's banking regulator revised its restrictions on loans to finance mergers and acquisitions in a bid to encourage industrial combinations that could ease overcapacity problems as the economy slows. According to the new rules posted on the China Banking Regulatory Commission website, maturities of bank loans for corporate mergers and acquisitions have been extended to a maximum of seven years from five years previously.

In The Spotlight

The regulator also raised the share of bank lending in such financing to a maximum of 60 percent of the total transaction price, up from 50 percent previously. These changes may not have a major impact immediately, but it does represent a positive trend. The continued ease of acquisition financing will eventually allow management buyouts and leveraged buyouts to happen.

SOE Reform

The central theme of current SOE reform is improving efficiency of state owned assets by “hybrid” ownership — a mixture of private and state ownership. This should theoretically bring the market mechanism to the state-owned companies. This will open up more SOEs for private participation. It is anticipated that second half of 2015 will see increased number of SOE restructuring, particularly in the sectors which experienced serious over capacity such as steel, non-ferrous metal, construction material, coal, etc.

MNC Divestment and Restructuring

More and more MNCs are willing to make a critical review of their portfolios in China and make a decision on exiting non-performing businesses or portfolios. In 2014, we have seen notable exits from Nokia and some Japanese companies.

The Beginning of an Era of Big Companies

One noticeable trend is the emergence of giant Chinese companies. As of 2014, the number of Chinese companies on the global 500 list had reached over 100. In 2014, the merger of CSR and CNR created another giant with a market capitalization of nearly 900 billion RMB.

Rumors have been circulating of mergers in the oil and gas and other industries. Acquisitive Chinese companies are building scale and creating world class companies that are able to compete globally. These companies will pose a challenge to MNCs not only in China, but in other geographical markets as well

Leveraged Acquisitions for Strategic Growth

Compared to local acquirers, MNCs carry substantial (often self-imposed) burdens through the transaction process. Approximately 70 percent of MNC transactions do not reach the finish line due to weak target searches, valuations or due diligence. Proper deal sourcing and careful attention to warning signs in early stages will save considerable transaction costs and improve the odds of closing the deal.

In terms of deal-sourcing, the obvious targets are unavailable and transformation deals are difficult — these are the common themes for most MNCs. It will take some resources and effort to find suitable targets. There are many aspects to deal sourcing.

The finding mission is not equal to having a list of companies. It involves testing the targets’ interest levels, handling early communication and identifying early deal issues. Sourcing is not simply a research project. It will take an experienced hand to isolate feasible and executable deals. These factors can help build a solid foundation for future success.

Spotting early warning signs will save considerable effort and costs in later stages. The following are the things to be watchful of before moving into a late stage of transaction:

Lastly, in an increasingly competitive environment, turning around a non-performing business is becoming more difficult as it sucks in the attention of management. It is increasingly common for MNCs to exit non-performing and marginal businesses in China. However, we have seen that the timing of the sale is often an issue.

In many cases, the decision to exit should have been made earlier when the business still held some value. Unfortunately, sales are often last resorts as the businesses run themselves into the ground. This is a critical lesson to be learnt.

Sometimes, the M&A transaction is not about acquiring a Chinese target to expand within China, but rather about forging strategic alliances and selling non-core business to Chinese buyers. China’s 2014 inbound investments — $120 billion — almost equaled outbound investments into China.

Inbound investments are growing at a rate of 1.7 percent while outbound investments are growing at over 10 percent. Leveraging this trend and making a strategic exit could present interesting opportunities. We have seen MNCs across a high number of sectors exhibit foresight by embarking on these global opportunities.


Barry Chen
About The Author Barry Chen
Barry Chen is Corporate Practice Director for InterChina Consulting in the Shanghai Office.

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