Our Insights into Cross-border M&A Trends in China November 2011

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James Blair
6 years ago
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1 November 2011

2 Contents 1. Activity Levels 2. Key Trends Long term increase in cross-border M&A Revived interest in joint ventures Global partnerships Increased regulation Increased focus on compliance Rise of domestic PE funds Gap between buyer and seller s expectations VIE structure under threat Exits triggered by shareholder and regulator pressure 3. Deal Execution - What s Market? This is not intended to be comprehensive or to provide legal advice. For more information, speak to your usual contact. 2

The Asia-Pacific region remains the bright spot for M&A activity Variations

Q1-Q3 2011 and growth/decline in activity compared to Q1-Q3 2010): +49%

8 billion Europe US$ 538.3 billion Asia-Pacific (ex-japan) US$ 255.

1 billion Middle East & Africa US$ 30.2 billion + 4.9% growth -2.

3 The Asia-Pacific region remains the bright spot for M&A activity Variations in M&A activity across the globe (showing value of M&A transactions in Q1-Q and growth/decline in activity compared to Q1-Q3 2010): +49% growth* +26.9% growth North America (inc Canada) US$ billion Europe US$ billion Asia-Pacific (ex-japan) US$ billion Central and South America US$ 78.1 billion Middle East & Africa US$ 30.2 billion + 4.9% growth -2.4% decline* -21.6% decline Source: mergermarket M&A round-up for Q1-Q * Using mergermarket round-up for Q1-Q for 2010 comparison figures 3

4 China M&A activity 4

5 Key Trends Increased regulation 5

6 Key Trends 6

Long term increase in cross-border M&A Chinese industries are consolidating Mature Chinese companies are seeking technologies and managerial expertise, not cash Foreign investors entering/expanding

7 Long term increase in cross-border M&A Chinese industries are consolidating Mature Chinese companies are seeking technologies and managerial expertise, not cash Foreign investors entering/expanding in China are directing attention to the domestic market (not simply a manufacturing base) ### Chinese companies are investing overseas to acquire brands, technologies and products to bring back to China 7

8 Revived interest in joint ventures To comply with foreign ownership controls To acquire a distribution network To secure favourable treatment as a local player To acquire new products To break into the non-premium brand market G.E. to Share Jet Technology With China in New Joint Venture By DAVID BARBOZA, CHRISTOPHER DREW and STEVE LOHR On Friday, during the visit of the Chinese president, Hu Jintao, to the United States, G.E. plans to sign a joint-venture agreement in commercial aviation that shows the tricky riskand-reward calculations American corporations must increasingly make in their pursuit of lucrative markets in China. G.E., in the partnership with a state-owned Chinese company, will be sharing its most sophisticated airplane electronics, including some of the same technology used in Boeing s new state-of-the-art 787 Dreamliner G.E. executives would not comment on the details of the joint venture. But a person involved in the talks said the venture is for 50 years. G.E., the person said, is putting in technology and start-up capital of $200 million. Avic will initially contribute $700 million, the person said, including the cost of a new research and development lab already under construction. Source: The New York Times, January 17,2011 8

9 Global partnerships a case study Global alliances are increasing as international companies seek to gain greater market access in China and Chinese companies pursue their international ambitions with a trusted partner DSM/Sinochem joint venture Sinochem holds 50% equity in the business group for a cash payment of 210 million on a cash and debt-free basis Effective date: 1 January 2011 Locked box: Both shareholders share on a 50/50 basis the cash in- and outflow of DSM Anti- Infectives as from the effective date. JV headquartered in Hong Kong Key issues IP and R&D Antitrust & approvals Restructuring Relationship & trust DSM and Sinochem Group establish global anti-infectives joint venture Royal DSM, the global Life Sciences and Materials Sciences company, announces today that it has established the 50/50 global joint venture for its business group DSM Anti-Infectives with Sinochem Group. The joint venture will be headquartered in Hong Kong. Current DSM Anti- Infectives employees, in total around 2,000 people globally, are part of the new group, to be named DSM Sinochem Pharmaceuticals Limited. The joint venture includes all of the current DSM Anti-Infectives activities across the world. Source: DSM press release, Heerlen (NL), 31 August

Increased regulation (1) an evolving merger control environment Since China's merger control regime came into effect in August 2008, there have been over 400 notifications reviewed by China s

10 Increased regulation (1) an evolving merger control environment Since China's merger control regime came into effect in August 2008, there have been over 400 notifications reviewed by China s competition regulator, with the vast majority cleared unconditionally, nine cases subject to conditions and one prohibited. The difficulties of navigating the new regime has increased deal uncertainty (especially on timing) for high-profile, cross-border transactions. August 2008 May Reviewed Notifications Unconditional Clearances Phase I cases Phase II cases Conditional Clearances Extended Phase II cases Prohibitions Source: MOFCOM Since then, two conditional clearances - one involving a Chinese SOE, and two Extended Phase II cases 10

11 Increased regulation (2) a new national security regime CHINA KEY FEATURES OF THE NATIONAL SECURITY REVIEW REGIME Details of China s new national security review mechanism were published earlier this year. The national security review regime requires acquisitions of Chinese companies by foreign investors which raise national security concerns to undergo review by the Ministry of Finance and Commerce ( MOFCOM ) Reviews will be undertaken by a joint ministerial-level review committee ("Committee") led by MOFCOM and the National Development and Reform Commission, and other industry authorities may also be involved M&A activity M&A activity covered by the new regime includes: o o o purchases of equity in or assets of domestic companies by foreign investors; purchases of equity in or assets of existing foreign-invested enterprises from Chinese shareholders; and the establishment by foreign investors of wholly foreign-owned enterprises ("WFOE") by whom assets or equity are purchased from domestic companies Sectors subject to national security review A broad range of sectors not only national defence concerns but also economic stability and social stability In particular, review will be required in respect of: o the acquisition of any stake by foreign investors in companies operating in the military industry or related industries; and o acquisitions that may result in foreign investors acquiring "actual control" in the following sectors: key agricultural products, key energy resources, key infrastructure, key transportation services, key technologies and key equipment manufacturing Process for review If the proposed M&A activity falls within the remit of this regime, MOFCOM is required to file a request for national security review with the Committee within 5 working days The initial review process can last up to 30 working days. A special review process which can last up to a further 60 working days may be imposed on applications that are not cleared by the initial review process An applicant may not complete an M&A transaction which falls with the remit of the regime prior to obtaining MOFCOM approval If the Committee determines that the M&A activity under review will have a significant effect on national security, the transaction cannot be completed. Alternatively, it may approve the transaction subject to conditions so as to address the national security concerns. To avoid termination, transactions can be modified during the national security review process and re-submitted for the Committee's review Conclusion The new national security review system brings a heightened risk of deal uncertainty in China and has a potential impact on deal closing timetables Many ambiguities in the new law exist. For example, there is no clear definition of what is meant by "national security" or what constitutes a "key sector. As such, the authorities have a broad discretion when assessing whether a transaction is ultimately subject to the regime In addition, there is no minimum size or value threshold for transactions before they trigger a national security review Foreign investors will need to consider potential Chinese targets carefully and develop a coordinated strategy to address possible concerns, and consider possibly modifying the scope or the structure of the transaction so as to simplify the national security review process and secure approval 11

12 Increased focus on compliance With increasingly aggressive enforcement under the US Foreign Corrupt Practices Act, with a focus on high-risk countries like China, and the UK Bribery Act coming into force in 2011, international companies have increased their attention on anti-corruption measures We are seeing the following impact on China M&A transactions: Buyer Earlier, and more thorough due diligence on target's anti-corruption policies and compliance history (particularly if a "red flag sector or jurisdiction) Consideration of transaction structure e.g. asset deal/share deal/ joint venture? (JVs may lead to responsibility for violations of a JV partner) Additional robust representations, warranties and indemnities from sellers in relation to historical compliance Obtaining anti-bribery certifications from key persons at target Avoidance of transactions that lead to unmanageable liability risk Planning ahead detailed plans regarding anti-corruption practices and procedures that will be implemented post-completion Seller/Target Commencing and/or refining internal policies to ensure compliance with anti-bribery legislation before sale Statements of commitment from management Risk assessment and monitoring of compliance Vetting prospective employees and appropriate disciplinary procedures Education of employees Diligence of business relationships Policies and procedures that meet highest standards It s OK, the contractor pays Maxwell Technologies fined $13.65 million (January 2011) The Swiss subsidiary of Maxwell Technologies hired Chinese consultants who passed on bribes through inflated invoices to sell products in China Management s response in 2002: This is a well known issue. No more s please 12

Rise of domestic PE funds The rise of domestic RMB funds is acting to increase competition for quality targets in China China s private equity market is under transformation In 2010, over two-thirds

13 Rise of domestic PE funds The rise of domestic RMB funds is acting to increase competition for quality targets in China China s private equity market is under transformation In 2010, over two-thirds of the 580 PE transactions announced were by domestic funds (up 66% from prior year) Blackstone, TPG and Carlyle are all setting up RMB funds with local governments or partners to consolidate their position Source: Zero2IPO, a leading integrated service provider in China venture capital and private equity industry: 13

14 VIE structure under threat The variable interest entity structure (VIE structure) is an investment structure commonly used in China to enable foreign investors to indirectly participate in restricted sectors or enable Chinese companies owned by PRC nationals to flip their investment offshore to achieve an offshore financing or listing. The VIE structure was typically used in the internet, entertainment and media, telecoms and healthcare sectors but has spread to other sectors in recent years, and has been tacitly accepted by the Chinese authorities. Recent government signals suggest the structure is under scrutiny. The key risks associated with the VIE structure are: The regulator may revoke the business licence or shut down operations The foreign exchange authorities may block the overseas repatriation of profits or capital Exclusive: China company structure under threat By STEPHEN ALFRED and DON DURFEE Hong Kong/Beijing (Reuters) China s securities regulator is asking the government to clamp down on the controversial corporate structure used by companies such as Sina and Baidu overseas, and employed in thousands of other investments by foreigners into domestic Chinese companies, four legal sources told Reuters. Lawyers at four different firms in China and Hong Kong said they have seen an internal report, dated August 17, said to come from the China Securities Regulatory Commission, which seeks China s State Council, or cabinet, to take action against the structures known as Variable Interest Entities (VIEs). The Chinese partner may challenge the enforceability of the contracts protecting the foreign investor s rights Source: Reuters, September

15 Gap between sellers and buyer s expectations Significant gaps continue to emerge between sellers and buyers expectations, particularly in relation to valuation, but also in relation to deal terms. In addition, we are seeing a return to the more prolonged deal doing processes of the past as buyers require more extensive diligence to underpin their valuations as well as more downside contractual protection Buyer Valuation Seller Foreign investors are cashflow driven, and rely on projections based on long-term growth prospects Common mechanisms to bridge the gap in expectations, particularly on high value transactions are: contingent value mechanisms uncommon in China earn-outs - common in China but often limited to one year under Chinese law strategic asset swaps - less common in China due to regulatory hurdles consortium bids - most commonly seen for overseas acquisitions by Chinese companies Chinese sellers benchmark against P/E multiples on closed local capital markets or use multiples of net asset value 15

16 Exit triggered by shareholder or regulatory scrutiny A number of foreign investors have pulled back from their Asia Pacific investments as part of a strategic refocusing or repositioning and often under shareholder pressure or mandates from their home jurisdiction regulator Key features are: Controlled auction processes Regional players are serious contenders and cash-rich Large-scale restructurings/retrenchment are uncommon due to concerns over social order November 16, 2010 Tuesday The Business Times Singapore (SINGAPORE) More than half of French grocery giant Carrefour s stores in Thailand, Singapore and Malaysia were sold for a whopping 868 million euros (US$1.2 billion or $$1.57 billion) to a unit of France s Casino Guichard-Perrachon SA in a deal that could help improve its lead against current Thai hypermarket leader Tesco plc. Present in Thailand since 1996, Carrefour said its decision to sell its Thai operations is part of its strategy to focus its resources on markets where it is a leader and optimise its capital employed. 16

17 M&A in China What s Market? M&A in China What's Market? Consideration Completion accounts common Locked box is rare Escrow/retention fairly common (but subject to time limits for onshore deals under PRC law) Earn outs fairly common (also subject to time limits for same reasons) Fixed price possible for smaller-mid sized deals Financing conditions and break fees Financing conditions very unusual Break fees are sometimes used MAC Common (approximately 60%) for private (non-pe) deals although not always specifically defined in terms of fixing a monetary value Parent guarantee Very common if buyer or seller are SPVs Personal guarantees are also usually obtained from the founder sellers Basket levels for reps and warranties Uncommon for smaller-midsized private deals Where adopted, typically 0.05%-0.1% Warranty limitation period Approximately 60% of private deals do not have any limitation in warranty period 2-5 years for general warranties, 10 years for tax and environmental and unlimited period for title warranties Uncommon for small-midsized deals Cap on liability Approximately 50-60% of deals may have caps Range varies widely: caps of 100% still common for corporate deals (but can be as low as 10% for PE sellers) 17

18 Worldwide contact information 33* offices in 23 countries Abu Dhabi 13th and 14th Floors Al Niyadi Building Airport Road Sector W-14/02 PO Box Abu Dhabi United Arab Emirates T F Amsterdam Droogbak 1A 1013 GE Amsterdam PO Box AG Amsterdam The Netherlands T F Bangkok Sindhorn Building Tower 3 21st Floor Wireless Road Pathumwan Bangkok Thailand T F Barcelona Av. Diagonal Barcelona Spain T F Beijing Room 33/F China World Tower 1 No. 1 Jinguomenwai Dajie Chaoyang District Beijing People s Republic of China T F Brussels Avenue Louise 65 Box 2, 1050 Brussels Belgium T F Bucharest Badea Excelsior Center Academiei Street 12th Floor, Sector 1, Bucharest, Romania T F Doha Middle East LLP QFC Branch, Suite B, 30th Floor, Tornado Tower Al Funduq Street West Bay PO Box Doha State of Qatar Tel Fax Dubai 3rd Floor, The Exchange Building Dubai International Financial Centre PO Box 9380 Dubai United Arab Emirates T F Düsseldorf Königsallee Düsseldorf Germany T F Frankfurt Mainzer Landstraße Frankfurt am Main Germany T F Hong Kong 28th Floor Jardine House One Connaught Place Hong Kong T F Istanbul Kanyon Ofis Binasi Kat. 10 Büyükdere Cad. No Levent, Istanbul Turkey T F Kyiv 75 Zhylyanska Street Kyiv, Ukraine T +38 (044) F +38 (044) London 10 Upper Bank Street London E14 5JJ United Kingdom T F Luxembourg 4 Place de Paris B.P L-1011 Luxembourg Grand-Duché de Luxembourg T F Madrid Paseo de la Castellana Madrid Spain T F Milan Piazzetta M. Bossi, Milan Italy T F Moscow Ul. Gasheka Moscow Russia T F Munich Theresienstraße Munich Germany T F * also has a co-operation agreement with Al-Jadaan & Partners Law Firm in Riyadh New York 31 West 52nd Street New York NY USA T F Paris 9 Place Vendôme CS Paris Cedex 01 France T F Perth Level 12, London House 216 St Georges Terrace Perth WA 6000 Australia T F Prague Jungamannova Plaza Jungamannova Prague 1 Czech Republic T F *Riyadh Al-Jadaan & Partners Law Firm P.O.Box 3515, Riyadh Fifth Floor, North Tower Al-Umam Commercial Centre Salah-AlDin Al-Ayyubi Street Al-Malaz, Riyadh Kingdom of Saudi Arabia T F Rome Via Di Villa Sacchetti, Rome Italy T F São Paulo Rua Funchal º- andar São Paulo-SP Brazil T F Shanghai 40th Floor, Bund Centre 222 Yan An East Road Shanghai China T F Singapore One George Street 19th Floor Singapore T F Sydney Level 16 No. 1 O'Connell Street Sydney NSW 2000 Australia T F Tokyo Akasaka Tameike Tower 7th Floor , Akasaka Minato-ku Tokyo Japan T F Warsaw Norway House ul.lwowska Warsaw Poland T F Washington, D.C K Street NW Washington, DC USA T F

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