Mergers & Acquisitions

Why China’s outbound investment has swung from feast to famine

China’s effort to invest in strategic industries globally has struggled as foreign regulators block key deals

PUBLISHED : Sunday, 24 September, 2017, 5:18pm
UPDATED : Monday, 25 September, 2017, 9:18am

China’s initiative to invest in strategic industries globally is running into difficulties from foreign regulators who are increasing blocking the deals, reflecting the second major blow to outbound investment after Beijing cracked down on the overseas corporate acquisition boom last year.

“It’s kind of a conundrum,” said Howard Zhang, a partner with Davis Polk&Wardwell LLP, acknowledging that this year saw a sharp cooling in outbound mergers and acquisitions in terms of the number of deals, their value and the range of businesses involved.

An overseas acquisition bonanza, which saw private Chinese companies snapping up film studios, hotels and sports clubs, suddenly ground to a halt last year after Chinese authorities probed some high-leveraged buyouts by a number of the most acquisitive conglomerates. Beijing later issued new rules that identified investment in property, film and sports as “irrational” and should be “restricted”.

However, the document “encouraged” investment that aligns with the country’s strategic interests, such as those along the “Belt and Road” initiative and those helping to boosting technology.

Still, private companies have done little to invest in “Belt and Road” countries, while state-owned companies are subject to ever harsher scrutiny in deal involving advanced technology in mature markets.

China’s outbound non-financial investment slumped 41.8 per cent to US$68.7 billion in January-August from a year earlier, according to the Ministry of Commerce.

Earlier this month, US President Donald Trump rejected Lattice Semiconductor’s US$1.3 billion sale to a China-backed fund. Lattice had appealed directly to President Trump after the Committee on Foreign Investment in the United States (CFIUS) recommended that the sale be blocked. Other Chinese-backed acquisitions of American companies now under review by the committee include the proposed sale of MoneyGram, the payments company, to Ant Financial.

“In the US CIFUS and public opinion have turned increasingly negative toward Chinese investment, especially in sensitive areas such as semiconductors,” said Zhang. “Europe may be more receptive but it presents other challenges, such as antitrust.”

From the Chinese companies’ perspective, Davis Polk lawyers said it’s all about “transparency” and “certainty”.

Zhang said despite an attractive headline price, foreigners are hesitant to accept Chinese buyers because of execution risk. Among the reasons, Chinese buyers may not get the regulatory approval needed to take funds out of the country, or the deal may run afoul of foreign regulators.

Enforcement against a defaulting Chinese buyer is another problem. As a result, the Chinese buyers may have to pay a premium to win the deal, as well as make a significant upfront deposit to backstop the payment obligations.

“When they get a US$100 bid from a Chinese company and an European one, they’ll hesitate on the Chinese bid because there are so many uncertainties,” said Zhang. “If they take the European money they think they know how the buyers’ fundraising, regulatory environment and the buyers’ corporate governance.”

Zhang said Chinese don’t need to copy western corporate governance standards, but they should strive to make it easier for foreigners to understand their corporate culture. Robust governance, transparency and predictability also matter in post-merger integration.

He Li, a partner with Davis Polk, said Chinese buyers should be more transparent towards acquisition targets and local regulators. They should also flag unique resources they bring to the table. For example, pledging to retaining key employees and customers of the acquisition target can help sway the deal momentum.

He said the law firm’s mainland clients have expressed strong interest in Hong Kong’s proposed third board, which would allow the listing of the dual-share structure similar to the New York Stock Exchange.

He added that his clients are eager to see the details of how the new board would function, if approved.

“A lot of Chinese companies with a promising future are hesitating between US and Hong Kong, but they also feel uncertainty abounds. For example, the timetable and whether there will be conditional clauses attached on dual-share structure companies,” He said.

He, who has participated in many of blockbuster IPOs in Hong Kong market during the past decade, said Hong Kong’s proposed third board comes as global stock exchanges are competing with each other to lure good companies.

“To be honest Hong Kong has lost many great opportunities in the past years,” He said.

Compared to New York, He said Hong Kong’s strength lies in its proximity to where Chinese companies are doing business, relatively lower communication cost and compliance cost.