What’s going on in China’s M&A environment?

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New signs of life have begun to emerge in China’s restive domestic M&A market. Years of relative quiet are giving way to political & economic reforms, and China’s new normal economy.

In 2014, 1,536 transactions were closed with an average value of €118m; 17 of the total transactions were valued at over €900m, 65% of which were related to the restructuring of SOEs. E-commerce and technology played a prominent role, accounting for 7 of the top 17 deals, with the technology, industrials and consumer sectors representing 52% of total transactions. Most consolidation was domestically focused, with only 15% of deals happening across borders compared with around 50% in 2005 – a remnant of the global financial crisis.

Inbound deals are now increasing with the rejuvenated global economy. In a low-growth and increasingly tough business environment, acquisitions have become the top initiative for many multinationals in China.

Succession issues and the diminished confidence levels of some Chinese businesses are creating a larger pool of available sellers and more humble valuations. China’s desired rise in the valuation chain has also generated many acquisition and divestment opportunities. Several companies in low value-added industries – such as commodities and steel – are looking to divest or move away from traditional core businesses that will be uncompetitive in the long run. Other companies – such as those in downstream F&B – are looking upstream for secure and quality supply.

The regulatory environment is growing more supportive of consolidation trends. The State Council has issued 7 guidelines on M&A and has also encouraged foreign companies to participate in domestic consolidation. The China Securities Regulatory Commission (CSRS) has also reduced the M&A approval requirements for listed companies, so long as they are not reverse merging or issuing stocks.

The outbound deal environment is also improving, with more than 150 Chinese players and Chinese private equity firms now capable of global acquisitions across various industries. Domestic sovereign funds such as CIC are adding to the regulatory support.

While market activity builds, several ongoing developments may impact the M&A environment:

“The Mad Bull Effect”

Traditionally, the equity market’s expansion corresponds with the expansion of merger and acquisition activities – but the relevance of domestic acquirers and multinationals are drastically different. For Chinese listed companies, now is the best time for M&A activities. Chinese companies are taking advantage of arbitrage opportunities and using highly valued stocks as currency in acquisitions. Now is also an opportune time to raise funds for expansion.

IPO Registration Reform

Under the current IPO system, firms aiming to list themselves must undergo a complex application process that can involve multiple rounds of review before approval by the CSRS. Unlike current verifications for IPOs in China, the widely adopted registration-based system allows investors and companies to decide the valuation and timing of new share offerings in light of the country’s situation and market circumstances. The opening up of the IPO market will have an adverse effect on M&A.

Buyout Funds

There are approximately 62 listed companies with buyout funds and growing. This will constitute a growing force of acquisition in China. Unlike traditional private equity, the buoyant equity market allows these funds to be well capitalised.

New Third Board Listing

There were over 2,000 companies listed on the new third board (China’s OTC equity market). The third board could be a source of targets for acquirers. At the same time, listing provides an alternative route to trade sales. This poses a challenge for strategic acquirers in terms of valuation and securing a majority.

Acquisition Financing

China’s banking regulator revised its restrictions on loans to finance mergers and acquisitions in a bid to encourage industrial combinations that could ease overcapacity problems as the economy slows. Maturities of bank loans for corporate mergers and acquisitions have been extended to a maximum of 7 years, up from 5 years. The regulator also raised the share of bank lending in such financing to a maximum of 60% of the total transaction price, up from 50% previously. The continued ease of acquisition financing will eventually allow management buyouts and leveraged buyouts to happen.

SOE Reform

Current SOE reform is improving the efficiency of state-owned assets by ‘hybrid’ ownership – a mixture of private and state ownership. It is anticipated that the second half of 2015 will see an increase in SOE restructuring, particularly in the sectors which experienced serious overcapacity.

MNC Divestment and Restructuring

MNCs are increasingly willing to undertake a critical review of their portfolios in China and make a decision on exiting non-performing businesses or portfolios.

The Era of Big Companies?

One noticeable trend is the emergence of giant Chinese companies. As of 2014, over 100 of the companies on the global 500 list were Chinese. Acquisitive Chinese companies are building scale and creating world class companies that are able to compete globally. These companies will pose a challenge to MNCs not only in China, but in other geographical markets too.

Leveraged Acquisitions for Strategic Growth

Compared to local acquirers, MNCs carry substantial (often self-imposed) burdens through the transaction process. Approximately 70% of MNC transactions do not complete due to weak target searches, valuations or due diligence. Proper deal sourcing and careful attention to warning signs in the early stages will save considerable transaction costs and improve the odds of closing the deal. In terms of deal sourcing, the obvious targets are unavailable and transformation deals are difficult. The finding mission involves testing the target’s interest levels, handling early communication and identifying deal issues. It will take an experienced hand to isolate feasible and executable deals.

 

In an increasingly competitive environment, turning around a non-performing business is becoming more difficult as it diverts the attention of management. It is increasingly common for MNCs to exit non-performing and marginal businesses in China. The timing of the sale is often an issue: the decision to exit should be made early (when the business still holds some value) – in many cases, sales are often last resorts as the business runs itself into the ground.

M&A transactions are sometimes not about acquiring a Chinese target to expand within China, rather about forging strategic alliances and selling non-core businesses to Chinese buyers. China’s 2014 inbound investments (€108bn) almost equalled outbound investments into China. Inbound investments are growing at a rate of 1.7%, whereas outbound investments are growing at over 10%. Leveraging this trend and making a strategic exit could present interesting opportunities. We have seen MNCs across a high number of sectors exhibit foresight by embarking on these global opportunities.