Overview of Mergers & Acquisitions and Investment in the People s Republic of China Sherry Yin Tel Aviv, Israel May 4, 2011 hk-113336 2011 Morrison & Foerster LLP All Rights Reserved mofo.com
1. China M&A Market Annual Review 2. China M&A Basics 3.RMB Funds 4.Exits in China This is MoFo. 2
I. China M&A Market Annual Review This is MoFo. 3
China M&A Market Annual Review China's M&A market yielded a burst of growth in 2010 622 M&A deals were completed in 2010, up 111.6% year-on-year; among those deals, 501 ones disclosed a total transaction value of US$34.80B. This is MoFo. 4
China M&A Market Annual Review 57 outbound M&A deals were completed, disclosing an aggregate value of US$13.20B, with a year-on-year increase of 50.0% in the number of deals from 38 in 2009. 44 inbound deals were closed in 2010, with merely US$2.22B disclosed, producing an increase of 33.3% in the number of deals from 33 in 2009. This is MoFo. 5
China M&A Market Annual Review Real estate, energy & mineral industries led the M&A surge The year 2010 completed 69 deals and US$11.89B transaction value, representing 11.1% and 34.2% of the totals respectively. Among the top 10 deals in China's M&A market in 2010, resources-related industries took five positions, for instance, CNOOC Limited paid US$3.10B for acquiring Bridas Corporation, the largest M&A transaction in the energy & mineral industry. This is MoFo. 6
II. China M&A Basics This is MoFo. 7
Acquisitions of different types of Chinese targets are subject to different regulatory regimes Foreign-invested Enterprises ( FIEs ) Limited Liability Companies Joint Stock Companies Non-listed Joint Stock Companies Listed Joint Stock Companies State-owned Enterprises ( SOEs ) Offshore Holding Companies / Onshore Operating Companies This is MoFo. 8
Some of the Key Regulators: MOFCOM: Ministry of Commerce (with potentially significant differences between national and local offices) CSRC: China Securities Regulatory Commission SDRC: State Development and Reform Commission SASAC: State Owned Assets Supervision and Administration Commission SAFE: State Administration of Foreign Exchange SAIC: State Administration for Industry and Commerce SAT: State Administration of Taxation Additional regulators, depending on: topic (such as national security) industry (such as banking) This is MoFo. 9
SAFE Notices 11/29/75 Listed Company Company Law Reform Measures 2004 2005 Securities Law Strategic Investment Measures SAFE 106 Enterprise Income Tax Law 2007 Labor contract Law Catalog Guiding Foreign Investment (Revised 2007) Anti-Monopoly Law (effective August 2008) Rules on Foreign- Invested Partnerships (eff. March 2010) 2010 Shanghai RMB Fund Pilot Measures (1/11) 2003 2006 State Council Acquisition Filing 2008 2009 2011 Thresholds RMB Fund Rules Interim M&A Rules IPO / Takeover Listing Measures Admin Measures New M&A Rules QFII Measures New Equity Pledge Rules SAFE 142 Implementation Rules on Enterprise Income Tax Law Acquisition Financing Guidelines Revised SH/SZ Listing Rules MOFCOM Delegates Foreign Investment Approval Authority to Local Levels Watershed Anti-Monopoly Decisions State Council Notice on National Security Review (eff. 3/5/11) This is MoFo. 10
Catalogue Guiding Foreign Investment Revisions effective December 1, 2007 (A new draft revision has been published to solicit public opinion) Policy Objective: Sustainable economic development Prohibited Category Updates Radio and television program production and operation companies; film production companies; news websites; and internet-based video and audio programs have been added to this category. Heighten control over foreign participation in news and cultural services. Restricted Category Updates Limited to majority Chinese controlled joint ventures. Wholesaling business (30 or more branch stores, designated products). Futures trading, and underwriting of A-shares and underwriting and trading of B-shares, H-shares and government and corporate bonds. High-end real estate development and operation subject to MOFCOM or NDRC approval (per deal size). Encouraged Category Updates Most additions in the encouraged category are businesses in the broadly defined manufacturing sector. This is MoFo. 11
Regulations on the Merger and Acquisition of Domestic Companies by Foreign Investors Effective September 8, 2006 Also known as Circular 10 Replaced the 2003 Interim Provisions on the Acquisition of Domestic Enterprises by Foreign Investors MOFCOM confirmed as key M&A and antitrust regulator Acts as gatekeeper/coordinator with other agencies Application may be flexible Anti-circumvention and other discretion allowed Advance notice/approval to MOFCOM required if an acquisition involves: a key industry affects national economic security or results in transfer of control of well-known trademark or historic China brand MOFCOM approval required for round trip investments CSRC approval required for offshore IPO by an SPV holding China assets This is MoFo. 12
Anti-monopoly Law Filing Thresholds Filing Thresholds Effective August 3, 2008 Notification required if either of the following thresholds is met: All parties to the transaction had aggregate global sales revenues exceeding RMB10B ($1.4B) collectively, and at least two parties to the transaction each had more than RMB400M ($57.1M) in revenues from sales within China, all during previous FY; or All parties to the transaction had aggregate revenues from sales within China exceeding RMB2B ($300M) collectively, and at least two parties to the transaction each had more than RMB400M ($57.1M) in revenues from sales within China, all during previous FY. Even if the filing thresholds are not met, MOFCOM may investigate and review transaction for compatibility with AML Lobbying by customers, competitors, industry associations, or other governmental authorities could trigger inquiry, public hearing and review Supersedes filing thresholds in the M&A Rules This is MoFo. 13
New National Security Review System The review process will be crossing the river by feeling the stones Effective from March 5, 2011 Scope loosely defined; no dollar value threshold Foreign acquisitions involving defense and military industries, enterprise adjacent to key or sensitive military facilities and other industries relevant to national security Foreign acquisitions involving a change of actual control of an enterprise in key agricultural, energy, basic infrastructure, transportation, technology and equipment manufacturing sectors Review authority Panel To be established by State Council and led by NDRC and MOFCOM, in coordination with relevant industrial authorities Process no separate filing required Application to MOFCOM MOFCOM may submit the case to Panel Panel may require additional filing and information This is MoFo. 14
Offshore Holding Structure Investor Founder(s) ESOP Investor SPV / Fund Offshore HoldCo Cayman Company Hong Kong Company Offshore Notes: Flexible capital structure, preferred stock, stock options, convertible debt OK PE economics: Valuation adjustment mechanism, liquidation preference, antidilution provisions OK Flexibility to select U.S. or HK listing Minimize regulatory approvals required for major transactions (financing, restructuring or exit) In general, 180-day contractual lock-up for U.S. and HK listings Practically difficult for domestic PRC companies to restructure offshore under current rules Difficult to structure back onshore for A-share listing PRC WFOE(s) This is MoFo. 15
Foreign Direct Investment / JV Model Investor Investor SPV H-share Listing Overseas Listing Offshore PRC Founder(s) / Shareholder(s) PRC EJV FICLS A-share Listing Notes: Foreign ownership/ form of ownership restrictions apply (per Catalogue Guiding Foreign Investment) Investment subject to prior approvals from MOFCOM and potentially other PRC governmental At closing, PRC target converts to a joint venture (JV) by virtue of receiving foreign investment Prior to IPO, JV to be restructured into a foreign-invested company limited by shares (FICLS) (additional approval) This is MoFo. 16
VIE Structure Overseas Listing Founder(s) Founder Offshore SPV Offshore Holdco Hong Kong Company Investor(s) Option Pool Offshore PRC Notes: Contractual agreements among WFOE, PRC founders and captive domestic affiliate(s) Structure enables consolidated financial accounting while complying with PRC foreign ownership restrictions for overseas listing: WFOE control over ownership and operations of PRC business Transfer of revenues from PRC business to WFOE Relevant contracts may include: Financing Support / Loan Agreement Share Pledge, Exclusive Option Agreements IP Licensing Agreement Consulting Services Agreement Technical Support Agreement Proxy / Voting Agreement Indemnification Agreement Captive Domestic Affiliate WFOE Contractual Arrangements - Control - Revenue transfer This is MoFo. 17
Licenses and permits Books and records Real Estate proof of title Payment of social insurance Material contracts with suppliers or customers Intellectual Property This is MoFo. 18
Transaction Approvals Post-deal Operations Transition Services Industry-specific Liability Due Diligence is Critical Can You Operate What You Buy? licensing and permits Evaluate Risk of Permit/License Loss or Inability to Obtain This is MoFo. 19
Common mistakes include: Failure to uncover improper related-party transactions Over-reliance on personal relationships Not anticipating possible inconsistent regulatory interpretation between local and state-level officials Not recognizing or not anticipating changes in the regulatory environment Ignoring industry-specific regulations Violation of foreign exchange rules Failure to capture specific tax incentives And all the usual ones This is MoFo. 20
III. RMB Funds This is MoFo. 21
Continuing PRC Government policy line of promoting domestic VC/PE industry and further development of domestic capital markets (tax revenues) Access to significant onshore LP capital pool Appeal of RMB fund to certain local founders and companies Difficult to offshore a domestic PRC company today Faster and simpler approval procedures at time of investment Exit via PRC capital markets Sends the message: We re committed to being onshore This is MoFo. 22
RMB Fund Benefits Expected continuing RMB appreciation Partnership entity status, flow-through tax treatment Ability to access significant onshore LP capital pool Government approval process more streamlined Tax deduction equal to 70% of investment in non-listed small / medium high-new technology companies held for 2 years (for certain funds) RMB fund vehicle avoids difficulty of portfolio companies restructuring offshore with complex structures given Circular 10 / SAFE 75 A-Share Listing This is MoFo. 23
Important to understand Domestic LP ecosystem is improving but remains at an early stage; sophistication varies widely PRC tax treatment of relevant funds flows; important uncertainties exist Onshore Investment Caveats Shareholder rights, preferences, and privileges are difficult to structure into a domestic JV or LLC Limited listing options once onshore, difficult to get offshore and vice versa Lack of certainty on timing of CSRC approval required for a PRC listing This is MoFo. 24
Pilot Fund statute allows GP to contribute up to 5% to Fund capital without affecting domestic fund status National treatment for Pilot Funds ability to invest without compliance with foreign investment restrictions that otherwise apply to foreign investment funds But stringent Foreign investment requirements apply: assets owned ($500m) or under management ($1B) in prior FY, 5 years investment experiences; only Sovereign Wealth Fund, Pension of Endowment funds, Funds of Funds, Investment companies and other approved foreign institutional investors are eligible Real estate listed security investments not permitted for non-pilot funds This is MoFo. 25
IV. Exits in China This is MoFo. 26
A-Share Listing in the PRC Conversion into a Foreign-Invested Company Limited by Shares (FICLS) Lock-Up Period Transferability of listed A-Shares Repatriation of proceeds Capital Gains tax M&A Trade Sale Practical challenges of dragging along local partner(s) This is MoFo. 27
Main Board (Shanghai) Market for enterprises of large scale, with proposed number of shares to be issued being more than 100 million SME Board (Shenzhen) Market for small and medium sized enterprises which meet the listing requirements for Main Board ChiNext (Shenzhen) Market for growth enterprises This is MoFo. 28
As of March 31, 2011, Shenzhen Stock Exchange No. of Listed Companies 1246 Main Board 484 Small & Medium Enterprise 566 ChiNext 196 Total Market Capitalization RMB 8,747.5 billion (US$ 1,343.8 billion) No. of Companies Newly Listed in 2011 78 Small & Medium Enterprise 35 ChiNext 43 Average P/E Ratio at March 31, 2011 (Times) 35.26 Main Board 29.67 Small & Medium Enterprise 43.34 ChiNext 55.50 This is MoFo. 29
As of March 31, 2011, Shanghai Stock Exchange No. of Listed Companies 905 Total Market Capitalization RMB 19,018.7 billion (US$ 2,921.6 billion) No. of Companies Newly Listed in 2011 12 Average P/E Ratio at March 31, 2011 (Times) 22.8 This is MoFo. 30
Market / Regulatory Perspectives Chinese investors hungry for new market for investment Growth platform for the next Lenovo, Chinese Intels, Microsofts CSRC is mindful of stabilizing Chinese stock market and protecting relatively inexperienced Chinese investors Listing and Exit Issues One-year lock-up depending on time of investment; 3-year lock-up if de facto controlling shareholder Discretionary listing approval Listing applicant traffic jam Quality of companies getting listed This is MoFo. 31
FIE Listings on PRC Stock Exchanges Legally permissible for foreign invested enterprises (FIEs) to go public and be listed on PRC stock exchanges More than 20 FIEs have completed IPOs and are listed Some uncertainty regarding CSRC willingness to approve listing application by foreign-controlled FIEs Certain foreign-controlled FIEs have been successfully listed on PRC exchanges (Ningbo Dongmu) Foreign strategic investors have been acquiring controlling equity interests in PRC listed companies (Supor, Huaxin Cement) This is MoFo. 32
3-year track record period From the date of the establishment of the joint stock company Tacking of prior limited liability company operations allowed where LLC converts to joint stock company using entire book value of net assets Profit and revenue Aggregate net profits > RMB 10 million during the last two years plus continuing growth; OR Net profit > RMB5 million with revenue > RMB 50 million during last year, and annual revenue growth rate > 30% for the last 2 years Net assets > RMB 20 million as of the end of last financial year and no uncovered deficit Registered capital > RMB 30 million Shareholding and management continuity during the last 2 years A major / core business (not diversified operations) No material non-compliance with PRC law by the issuer, controlling shareholder or actual controller during the last 3 years This is MoFo. 33
Lock-up period varies depending on date of purchase and whether ownership level constitutes control Company Law requirements Promoters 1 year lock-up from establishment date All shares issued prior to IPO 1 year lock-up from IPO date Shanghai / Shenzhen Stock Exchange rules Controlling shareholders 36 month lock-up from IPO date Prior 3-year lock-up for shareholders acquiring shares via capital increase within 12 months prior to prospectus date now revised to 1-year lock-up from the listing date ChiNext General 1 year lock-ups for pre-ipo shareholders Controlling shareholder 3 year lock-ups for IPO If the issuer has raised additional funds from investors within 6 months prior to IPO - 1 year lock-ups for 50%, 2 year-lock-ups for other 50% of the shares newly issued prior to the IPO This is MoFo. 34
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