Opinion: China’s overseas acquisition spree has mysteriously cooled
Mergers and acquisitions by Chinese entities have fallen off sharply in the first four months of the year, underscoring a shift in the economic and political climate
Novelist Margaret Drabble once said: “When nothing feels sure, everything is possible.”
This characterises the current China international acquisition scene. Bankers are supposed to be enjoying the golden age of international mergers and acquisitions by deep-pocketed mainland Chinese companies seeking expansion.
But even major deals that look closeable from a distance are sinking like they were built on quicksand.
According to Bloomberg data, China set an outbound takeover record of US$246 billion in 2016. However, in the first four months of this year, international acquisitions have dropped 67 per cent.
But beyond the data lies a treacherous landscape for deal making and telltale signs of recklessness are now emerging.
Capital controls have clearly discouraged China’s outbound M&A activity. Chinese companies, especially those that are domestically listed, will likely have a much harder time funding purchases, particularly if they have not developed offshore financing vehicles or access to offshore banking sources.
Foreigners have always faced challenges completing deals with mainland Chinese companies. Gaining mainland regulatory approval, extensive due diligence on your local partner or senior manager were only their initial hurdles.
If your Chinese counterpart said, “Trust me” in order to make a deal work, it was usually a signal to run away. Now, if they say, “Don’t worry, we have the money to close the deal,” you better be prepared for the deal to die a slow death.
Even Chinese buyers who possess funding have been thwarted. The US$1 billion purchase of Dick Clark Productions by billionaire Wang Jianlin’s Dalian Wanda Group was called off in March as authorities appeared to oppose the acquisition. However, Dalian Wanda Group was willing to pay Eldridge Industries, owner of Dick Clark Productions, a US$50 million breakup fee after the deal fell apart.
Whether or not that is the exception or the rule showed that mainland companies are willing to bear the substantial transaction costs that come with grandiose deals. However, if they didn’t pay breakup fees, it might impair its ability to approach other Hollywood players for future business.
According to bankers, break up fees have ballooned to as much as 10 per cent to cover the considerable cost of investment bankers, lawyers, pre-acquisition auditors and consultants who must be employed before the acquisition is completed. But, penalty fees may not be worthwhile especially if your mainland client refuses to pay them and forces sellers to sue them in a Chinese court.
Bankers ignore almost science fiction fantasy levels of financial ratios that defy gravity and credulity. Ultimately, if the seller is politically connected to government authorities and a Chinese bank is willing to overlook the lopsided ratios, any deal can theoretically be done.
Yancoal Australia, a unit of state-owned Yanzhou Coal, has bought Rio Tinto’s shareholding of Coal & Allied in New South Wales, Australia, in a strategic move making it one of the largest coal miners in Australia. However, reports say that it is expected to take much of 2017 for the deal to be settled.
One of the ominous signs is that the client doesn’t immediately appear to have the funds for an over-geared deal. Yancoal Australia, likely needs to raise high levels of debt or equity to close the deal. Its net debt levels are currently sitting around US$5 billion. With 2016 EBITDA of US$185 million, Yancoal has a net debt to EBITDA ratio of about 26 times. This is far in excess of its peer, ASX listed, dedicated coal miner Whitehaven at four times, who analysts remarked was over leveraged. Investment grade ratings require a ratio of less than three times.
Bankers could demand stricter proof of funding in the form of showing offshore account balances or a letter of credit before beginning acquisition talks. But, even if a Chinese buyer demonstrates that Beijing authorities can veto a deal for any or no reason.
Chinese buyers tend to sign agreements and ask for long closing periods in order
to shop the deal around for lenders or investors. On the other hand, most financial advisors and serious buyers push for a fast closing so sellers cannot find a reason to back out or renegotiate the terms.
Part of misperception over the last 20 years arises from mainland companies, in particular, state-owned enterprises masquerading as international private sector companies. It creates the illusion of endless cheap financing. But, it usually results in reputation risk for everyone involved as deals collapse. Yet, financial advisors have no choice but to entertain what appear to be substantial and serious buyers willing to pay high valuations and lucrative fees.
Peter Guy is a financial writer and former international banker