M&A muddle gives warning

WHEN INFLUENTIAL MORGAN Stanley economist Stephen Roach recently issued a research note that began by describing China as 'the closest thing to an oasis in an otherwise struggling global economy', one United States-based executive forwarded it on to colleagues with the following exclamation: 'Things are hopping in China! Pack your bags folks.'

Though the research note's core point was a cautionary one about the global deflationary implications of China's dramatic export-led growth, it began by emphasising the mainland's strong gross domestic product and export figures for this year. It also pointed to the China Securities Regulatory Commission's recent decision to allow - in principle - foreign and privately owned takeovers of listed state-owned enterprises (SOEs) as evidence that 'the restructuring of SOEs is unstoppable and new market-opening reforms continue to be put in place in the aftermath of China's accession to the World Trade Organisation [WTO]'.

The executive's reaction to Mr Roach's initial observations is a good example of the unbridled optimism with which many multinationals view the mainland in light of its WTO accession.

As such, it is reminiscent of the giddiness that infected China's foreign investment community in the mid and late-1990s, before the hard realities of doing business there induced a hangover - albeit only a temporary one.

But for those foreign investors who have once again been bitten by the China bug, draft merger and acquisition (M&A) measures published this week should serve as a cautionary reminder that their wildest China dreams are not going to be realised overnight.

The draft temporary measures were released Tuesday by the Ministry of Foreign Trade and Economic Co-operation (Moftec) through the China Securities Journal.

In the absence of a law governing M&A activity on the mainland, any regulations that might at least eventually contribute to one are welcome.

'We've been waiting for lots of new laws that have been promised,' said Ken Davies, principal administrator of the China investment office at the Organisation for Economic Co-operation and Development in Paris.

What is not welcome are anti-trust provisions contained in the measures that specifically target foreign-invested enterprises (FIEs), rather than just monopolies in general.

'What is needed at the moment is some clarity on competition overall. If monopoly is a bad thing it's a bad thing. Discrimination against foreign firms is not what is needed,' said Mr Davies. Such discrimination would go against the trend towards 'liberalisation and the evolution of a rules-based investment environment'.

'The importance of having [a competition law] is that it helps to provide the type of environment where firms compete. This applies if a firm is domestically owned or foreign-owned.

'Just targeting FIEs tends to be the sort of thing that's on the agenda of large SOEs that are worried about foreign competition.'

According to the draft measures, government review and approval would be required for any merger or acquisition that gave an FIE more than one-third of the domestic market, brought its total annual investment in China to more than US$100 million, exceeded US$30 million or was the 11th project announced in any one industry in the course of any one year; or if the foreign firm already controls one-fourth of the domestic market.

At least one of these triggers is oddly redundant: Central government approval has long been required for any foreign investment in excess of US$30 million. Another - the unlucky 11th investment - is bizarre; 13 would at least have indicated someone at Moftec had a sense of humour.

Other provisions in the measures refer to asset and China sales ceilings - 300 million yuan (about HK$281.13 million) and 500 million yuan respectively - which if exceeded by any party in an M&A transaction would also trigger special government scrutiny.

A number of foreign multinationals have previously made investments in China that put them on the wrong side of these measures. In 1998, for example, Eastman Kodak basically bought lock, stock and barrel much of what was left of China's failing state-owned film industry.

If these measures are eventually enshrined in law without grandfather clauses to protect the likes of Kodak, it is hard to imagine their investments could be retroactively reviewed and companies forced to divest.

After all, Kodak's deal was worked out with the central authorities directly. Beijing saw it as a way to rid itself of responsibility for an industry that was being chronically mismanaged at a huge cost to the state.

But even so, the regulations as drafted certainly appear to violate the spirit - if not the letter - of China's WTO accession agreements.

As is often the case when Chinese ministries float a trial balloon to gauge public and foreign investor reaction, Moftec officials would not comment yesterday on whether there was method to their madness. But their counterparts at the State Economic and Trade Commission (SETC), who are working on more comprehensive draft M&A legislation, said this would not discriminate against FIEs.

Perhaps the most important things about Moftec's draft temporary measures are that they are 'draft' and 'temporary'. Moftec is just one of many bodies that will have a say in any final M&A or competition legislation.

'The various ministries are still groping towards some sort of co-ordination but still haven't achieved it,' Mr Davies said.

Moftec's draft temporary measures would have to be blended together with those promulgated by STEC and other interests. There is no guarantee the anti-FIE bias will survive.

Indeed, it is clear there remains a crying need on the mainland for a more transparent policy-making process. This is a core requirement of China's WTO accession agreement.

As this latest episode reminds, policy makers on the mainland remain prone to the sudden release of scary suggestions that have the potential to cause a lot of confusion among some foreign investors.

Food for thought, perhaps, for all those giddy overseas executives now packing their bags.

Graphic: game24gbz