Tuesday, April 29, 2008 6:30 AM - 7:45 AM Investing in China Workshop Speakers: Jim Lavelle, Managing Director and Group Head of Industrial and Environmental Technologies, Houlihan Lokey Mitchell Nussbaum, Partner and Chair, Corporate Securities Practice Group, Loeb & Loeb LLP David Tang, Managing Partner, Asia, Kirkpatrick & Lockhart Preston Gates Ellis LLP; Chairman, Federal Reserve Bank of San Francisco Moderator: Nicholas Sandler, Senior Vice President, Crestwood Pacific Group; Head of Business Development, Crestwood China Hydro LLC
Considering investment in China Foreign investments into China are restricted. Foreign Investment Industrial Catalogue (the latest version revised on October 31st, 2007 and effective from December 1st, 2007). Foreign investment in businesses are categorized as: Encouraged; Permitted; Restricted; or Prohibited.
Encouraged industries Typically involve industries using advanced or new technologies. Examples include mining, oil & gas, food and beverage manufacturing, high and new technology development centers, and scientific research, technical services and geological exploration. Foreign investments are generally permitted through WFOEs.
Restricted industries Typically involve old technology or sectors that are in the process of gradually opening up. Examples include telecommunications, legal services, printing of publications, construction and operation of oil refineries with an annual output of 8 million tons or below, repair, design and manufacturing of vessels; production & supply of electricity, gas and water. Investments in restricted industries are often subject to higher-level government approvals. Often limited to joint ventures and, in some cases, with the Chinese partner as the major partner.
Prohibited industries Typically involve projects of public interest, national security or that may cause environmental pollution. Examples include construction and operation of nature reserves and wetlands of international importance; publication, distribution and import of books, newspapers and magazines. Prohibited industries are closed to foreign investment
Permitted industries Projects not listed in the Catalogue are generally considered permitted and do not require special approval, unless specifically barred in other PRC regulations
Types of entities in China Domestic Companies Limited Liability Company Joint Stock Limited Company Foreign Invested Enterprises Wholly Foreign Owned Enterprise Equity Joint Venture Contractual Joint Venture Representative Office
Joint ventures (JVs) A new business entity (Equity Joint Venture) or contractual relationship (Contractual Joint Venture or Cooperative Joint Venture) Share investment and operation expenses, management responsibilities, and profits and losses. Two types: Equity Joint Venture or Contractual (Cooperative) Joint Venture.
JVs (continued) Pros: Access local market expertise and preferential market treatment. Use Chinese partner s manufacturing capacity, relationships with the local government combined with foreign party s technology, know-how and marketing experience. Exit opportunities (can do China domestic listing).
JVs (continued) Cons: Need to manage relationship with JV partner; and JV partner s relationship with local governments. Shared ownership, control and management. Loss of technology. Exit opportunity not attractive for foreign listing.
Wholly foreign owned enterprises (WFOE) Independent legal entity entirely owned by foreign investor(s). Pros: No issue on ownership, management, control or culture. Secure ownership of IP Cons: On your own, no local partner. Not permitted to carry on certain businesses - Examples include mining, tobacco, restaurants, bars, building and construction, car production, airplane production, etc.
Representative office Not an independent legal entity. Cannot carry on direct profit-making business activity. Perform liaison on market research for parent company only.
Recent SAFE and MOFCOM issues China has currency exchange controls. RMB trades within a band pegged to currency basket. Upward pressure on (and inflows and exchange to) RMB continues. On May 29, 2007, the State Administration of Foreign Exchange of China (SAFE) issued new Operating Procedures which clarify Circular No. 75 Circular 75 imposes foreign exchange control on financing and round-trip investments by domestic residents through offshore SPVs.
Recent SAFE and MOFCOM issues Operating Procedures impose new burdens on investors in transactions with Chinese round-trip. SPV refers to an offshore vehicle established or controlled by a PRC domestic resident individual or legal person for the purpose of overseas equity financing of domestic assets or interests. "Round-trip investment" refers to investment from offshore SPVs invested in or controlled by a PRC resident individual or legal person. PRC resident individual can be foreigner (US)
Recent SAFE and MOFCOM issues Regulation on M&A of Domestic Enterprise by Foreign Investors issued by MOFCOM, SAFE, CSRC, SASAC and Tax Bureau released September 2006. Share or assets swaps between PRC residents and foreign companies require MOFCOM approval. No approvals given to date. Blocks foreign listings for PRC businesses which did not have foreign ownership before September 06.
Sina model Offshore holding company sets up WFOE. WFOE and offshore company contract with a Chinese company and its shareholders. Chinese company operates the restricted business Economics flow to WFOE and Offshore company through contracts. Used by Chinese Internet-related company listed on the NASDAQ as well as other companies in restricted businesses.
Sina model Offshore Co Loan PRC Nationals Hong Kong Co WFOE Pledge interests In PRC Co Grant control Services, license, etc Fees PRC Co
Loans to PRC companies Offshore investor of FIE (EJV, CJV and WFOE) may make loan to the FIE and the amount of such loan can be limited up to the difference between the total investment and the registered capital for the FIE.
Using JVs for flexibility in A share listing Foreign invested company limited by shares technically allowed to list on A-share markets. In practice, only JVs granted approval for listing No WFOE granted approval. JV can have additional exit option in A-Share Listing. A-Share listing can only access RMB market.
New Enterprise Income Tax Effective January 1, 2008 Imposes standard enterprise income tax ( EIT ) rate at 25%. Reduced EIT rate of 20% for small-scale and thinprofit enterprises. Preferential EIT rate of 15% available to approved high / new technology enterprises.
Chinese New Enterprise Income Tax Imposes 10% withholding tax on dividends, interest and other passive income paid to non-chinese entities. Tax treaties and arrangements reduce withholding tax to 5%. For payments to some jurisdictions (eg. Hong Kong)
Enforcement of contracts: mutual enforcement arrangement between China and Hong Kong Arrangement between the Mainland and Hong Kong for mutual recognition and enforcement of civil and commercial judgments as agreed. Arrangement for mutual enforcement of arbitral awards between the Mainland and Hong Kong. Facilitated enforcement of contracts entered into between parties in Mainland and Hong Kong.
Key structure related issues for investors Investment Structure Corporate Governance/ Management Intellectual Property Restructuring Financing Taxation Exchange Controls and Repatriations Exit Considerations Holding company vs. discrete entities Onshore vs. offshore Minority / strategic investment vs. controlling stake Understand the existing corporate governance / management structure change if necessary Alignment of management s interests with investor s interests Establish new and effective corporate culture, organizational structure, employee incentive plan Effective operational / management control Increasing legal protection of intellectual property rights through new laws and regulations Restructuring needs for business, operations, balance sheet, and additional SOE considerations Availability of local currency financing opens alternative options in raising capital Ability to borrow domestically Equity financing feasibility in the domestic market: foreign-invested enterprises (FIEs) are allowed to list in the A share market Hedging is another issue for consideration in the foreign vs. local currency decision Cash flow management across different legal entities Understand Chinese national tax regime and use effective investment structures such as BVIs to minimize taxes Take advantage of local tax treatment regime for foreign investments, e.g.. three-year exemption and two-year 50% reduction Changes in taxation post WTO, e.g. Elimination of preferential tax treatment Take the appropriate route to channel investment into China Understand State Administration of Foreign Exchange (SAFE) regulations on repatriation of funds Feasible exit strategies include listing on the domestic and/or international markets; sell to potential China financial investors Be aware of restrictions on repatriation of investment and dissolution of JVs Possible trade sale to Chinese or non-chinese groups Source: Houlihan Lokey.
Case study: Fushi acquires 100% of Copperweld Client profile Fushi International, Inc. is a China-based wire manufacturer with a market capitalization of USD 345 million Fushi is a leading Chinese manufacturer of bimetallic composite wire products, principally copper clad aluminium wires, which is used in a wide variety of applications Target profile Transaction snapshot Copperweld Bimetallics, LLC is a leading U.S. manufacturer of copper-clad steel and CCA wire Copperweld produces a range of products for use in communications, utility, transportation, and industrial applications in both the U.S. and international markets A second manufacturing location in Telford, England principally services the growing European market Completed on October 29, 2007, the transaction expanded Fushi s base of products and customers and established the Company as a worldwide industry leader Houlihan Lokey acted as sole financial advisor to Fushi on all aspects of the transaction and was responsible for negotiating and structuring the deal Fushi International, Inc. has acquired Copperweld Bimetallics, LLC We served as exclusive financial advisor and structured and negotiated the transaction on behalf of Fushi International, Inc. Source: Houlihan Lokey.
Industrial technology joint venture case study Project Diana transaction highlights the complexity of JV transactions in China, the impact of the current Chinese financial markets as well as developing nature of Chinese M&A and IPO law Overview A North American industrial technology company ( Acquiror ) sought to form a partnership with the leading Chinese company in its segment through either a JV or full control acquisition. The ultimate transaction structure negotiated needed to allow both parties to meet their respective strategic objectives and fiduciary obligations Acquiror s objectives Access to China market Low-cost production Securing low-end product line to enter a rapidly growing segment Protecting IP Creating value for shareholders Cultural fit Protecting market positions Target s objectives Obtain premium valuation upfront Preserve control over operations Preserve flexibility to take JV public at a later point Receive endorsement of the leading global player Access to technology Increase in scale/size (to make a more attractive IPO candidate) IPO regulations Issues addressed Corporate law requirements Shareholder agreements Flexibility to take JV public Bridging valuation expectations Source: Houlihan Lokey. Accounting/consolidation of financials Managing governance/operational control Shareholder impacts of future capital investment
Corona Shenzhen Juchang Fashion Co. Ltd. Case Study
Company overview Corona Shenzhen Juchang Fashion Co. Ltd. ( Corona or the Company ) is a leading women s fashion company in the People s Republic of China Currently has 412 franchises and 42 owned stores in 28 provinces and autonomous cities in china management is forecasting 1473 stores by 2010 2007 Revenue over US$60 million; Net Income of US$11 million Head quarters are in Shenzhen, in the province of Guangdong population 80 million Source: Crestwood Pacific Group.
Projected growth Projected revenue 2008-2010 Projected stores 2008-2010 Revenue, US$ millions $350 $300 $250 $200 $150 $100 $50 $0 2008 2009 2010 Year Number of stores 1,600 Franchised Stores 1,400 Owned Stores 1,200 1,000 800 600 400 200-612 156 860 1,070 265 313 2008 2009 2010 Year The company is forecasting revenue and net income of over US$ 328 million and US$70 million respectively for the fiscal year ending 2010 Source: Crestwood Pacific Group.
Outlook China s clothing market: US$40 billion industry Foreign companies are rapidly entering the 1 st and 2 nd tier Chinese city market, as the average income is higher between US$776 and US$1,034 Chinese brands have more recognition in 3 rd and 4 th Tier cities, as foreign brands face challenges such as infrastructure, which is less developed in these cities Department stores sales: 40% of the market Franchise chains and individual clothing outlets: 60% of the Market Profit margins: 50 to 70% due to the lower cost of manufacturing Source: Crestwood Pacific Group.
Company facts Corporate HQ is in Futian Central District of Shenzhen Currently has over 169 employees reporting to the various heads of departments Mr Chen is seen as a strategic leader, who adopts a hands on approach to management and is actively involved both management and design Source: Crestwood Pacific Group.
Growth strategy Franchises Currently 412, which represents 60% coronas sales - long term plan for franchises to represent 50% of stores 1145 total stores by 2010 Owned stores Currently 42 Forecasting 328 owned stores by 2010. Source: Crestwood Pacific Group.
Use of proceeds The proceeds will be used for the following: Uses of financing SAP and enhanced ERP implementation Additional company owned stores $1.5 million $11.0 million Total $12.5 Million Source: Crestwood Pacific Group.
Investment highlights Extensive retail network well positioned throughout the PRC Multiple distribution channels Vertical business model: Own branding, research, design, manufacturing and sourcing, distribution and retail capabilities Technology investment SAP implementation and enhanced ERP system in 2008 results in Marketing strategy intensify Corona brand building throughout the PRC, targeting customers and future franchisees Committed management team Expansion opportunities Source: Crestwood Pacific Group.
Corona WFOE Structure Chen Yuzhen 82.9% Crestpac 8.55% Where Crestpac & SBI money flow in (US $10 M) Corona Int l (BVI) 8.55% SBI E2 100% Offshore 70m RMB registered capital (US $10 M) Corona Shenzhen (WOFE) PRC Juchang 100% Where the Corona s assets are held in China Source: Crestwood Pacific Group.
Thank You