Antony Dapiran
Introduction
The emergence of China as an international acquirer has been one of the major stories in international business in this second decade of the 21st century. Over the past several years, Chinese companies have become increasingly active in making acquisitions globally,[1] culminating in Chinese offshore oil company CNOOC Limited’s proposed US$15.1 billion proposed acquisition of Canada’s Nexen Inc., which is expected to be the largest outbound M&A deal by a Chinese acquirer to-date.[2] According to the Wall Street Journal, Chinese companies spent more than US$10 billion in 46 deals to acquire U.S. companies in 2012, and an additional US$23 billion worth of deals for Canadian companies.[3]
While privately-owned Chinese enterprises have been increasingly active, it is the state-owned enterprises that have been leading the charge, encouraged by Chinese government policy to “go out” and funded by Chinese state-owned banks.
The rise of China’s appetite and capacity for making sizeable overseas acquisitions has coincided with difficult economic conditions, weaker foreign currencies against a stronger Renminbi, falling valuations and, often, forced sales overseas. In these circumstances, the prospects of a potential Chinese buyer for an asset – in other words, the opportunity to “sell to China” – is an attractive one for overseas sellers. This is even more so if sellers feel that they can insert one or more eager Chinese bidders into an “auction” situation for a company or asset, therefore fetching the sellers the highest price and/or most favorable terms.
However, Chinese companies – and in particular state-owned enterprises – are often uniquely mal-equipped to participate in an international auction sale process. This is a result of a range of regulatory, cultural and practical factors. Vendors looking to sell to China need to be aware of these issues, and should structure their sale process to maximize the likelihood that it will be navigable for Chinese bidders and therefore hopefully maximize the price achieved for the vendor’s assets.
Challenges for Chinese Bidders
For Chinese bidders, there are a number of challenges they face participating in an international auction sale process, resulting in their often not being able to compete on an equal footing with other international bidders.
Domestic Regulators and Approvals
Chinese companies are subject to regulation by a number of domestic regulators, whose approvals must be obtained for any overseas acquisition. The key regulators and their respective areas of jurisdiction include the following:
National Development and Reform Commission (NDRC): This is the agency responsible for formulating China’s industrial policy, and is a somewhat “marketized” version of the old State economic planning agencies. NDRC approval must be obtained for any offshore acquisition by a Chinese company. A filing with the NDRC must be made before a Chinese bidder submits a bid for an overseas asset. NDRC review will generally determine whether the acquisition is consistent with China’s overall economic policies and the policies for development in the particular industry.
Ministry of Commerce (Mofcom): Mofcom is the government ministry with broad responsibility for domestic and international commerce. Mofcom approval is also required for any offshore acquisition by a Chinese company (including acquisitions by offshore subsidiaries of companies that are ultimately Chinese controlled).
State-owned Assets Supervision and Administration Commission (SASAC): SASAC is the government entity responsible for overseeing State-owned enterprises and ensuring proper use of State-owned assets. If an offshore acquisition is to be undertaken by a State-owned enterprise, SASAC approval will be required. The main aim of this review is to ensure that a State-owned enterprise is not “over-spending” or using an offshore acquisition to dissipate State assets.
State Administration for Foreign Exchange (SAFE): The Renminbi is not a fully-convertible currency, and currency controls remain in place for capital account transactions. China’s foreign exchange regulator SAFE must give approval for the conversion of Renminbi into foreign exchange for the purposes of funding any overseas acquisition. This will include approval for the conversion of Renminbi to fund any deposit required to be paid in foreign currency.
Industry-specific regulators: In addition to the above regulators, Chinese companies operating in particular industries are subject to industry-specific regulators. These include, for banks, the China Banking Regulatory Commission (CBRC), for insurance companies, the China Insurance Regulatory Commission (CIRC), and other ministries for other industries.
Any offshore acquisition by a Chinese company will need to navigate this complex regulatory path to ensure a successful transaction. The need to report frequently and in detail to these regulators affects the information required by a Chinese bidder in the course of making an acquisition, and the time required to respond to regulators’ requests and obtain the necessary approvals at various stages through the process (prior to submission of a bid, at the time of signing/paying a deposit and prior to completion).
Complex Internal Bureaucracies
Not unlike the bureaucracies to which they report, Chinese companies themselves have complex internal bureaucracies, with a decision-making process characterized by lengthy chains of approval, much of which is paper-based. This is invariably the case for State-owned enterprises, which have evolved out of government bureaucracies, as well as many of the larger privately-owned enterprises have modeled themselves on the State-owned system and also operate similar internal hierarchies. Coupled with the Chinese penchant for collective decision-making and a desire to avoid individual responsibility, the result is a very slow decision-making process that often cannot keep pace with the timetable of an international M&A transaction, particularly an auction process with strict deadlines coordinated across multiple bidders.
Different Approach to Risk Management
Chinese companies are often keenly aware of their lack of experience in international markets, a point often emphasized by Chinese government spokespersons, who remind Chinese businesses to conduct thorough due diligence and to be aware of risks when doing business overseas.[4] At the same time, like anywhere in the world, individual careers are often riding on the success of a major acquisition. Accordingly, Chinese purchasers tend be extremely thorough in their due diligence and relatively risk-averse, demanding a thorough understanding of all potential risks and related contingencies before committing to a transaction.[5] This can cause further friction with a tight deal timetable.
Marketplace Mentality
International businesses negotiating with Chinese parties often comment upon the marketplace “haggling” mentality with which Chinese parties approach a negotiation.[6] This deeply ingrained cultural approach to deal-making, with each party opening with an extreme price and then gradually working their way towards a mutually acceptable middle-point through a give-and-take process of haggling, is the way negotiations are conducted in China, from the vegetable market through to the boardroom. However, the approach does not always translate well into international markets, where Chinese bidders risk losing credibility if they are seen to be coming in with “low ball” bids. In an auction situation, this may mean that a Chinese bidder, by putting in an inappropriately low initial bid, may fall at the first hurdle of expressions-of-interest and not even proceed into the auction proper.
Minimal Involvement of Professional Advisors
Chinese companies have been slow to learn the value of professional advisors, whether lawyers, accountants or financial advisors. Thus it will not be unusual to find a Chinese bidder on an international M&A transaction to be working without any professional advisors at all, or at best advised by a one-man “consultant” or middle-man. This means that an inexperienced Chinese bidder will not always be fully informed of international market practices, deal dynamics, and how to work through the auction process. The educational role in such cases may fall upon the vendors themselves and their advisors.
Helping Your Chinese Bidders
Given the above challenges, what can international sellers to do maximize the chances of having a Chinese bidder participate meaningfully in their sale process?
The first step is clearly an increased awareness of the challenges facing a potential Chinese bidder, including the factors outlined above. An understanding of why, for example, a Chinese party comes in with an initial bid that appears insultingly inadequate, or has trouble meeting the milestones in an auction timetable, will allow vendors to at least consider how to deal with the challenges and/or allow for flexibility in the process to accommodate Chinese bidders.
An understanding of the PRC regulatory approval process is also essential, not just for purchasers but for vendors also. If a vendor envisages having a PRC purchaser, it should obtain independent advice on the approval process that purchaser will face (and not just rely on the PRC party’s representations on this issue). The vendor should consider break fees, deposits or an appropriate adjustment in valuation to account for the inherent regulatory risk in having a PRC purchaser.
International sellers should also be aware that it is not realistic to have a genuinely competitive sale process involving two PRC bidders – the NDRC and other PRC regulators will generally step in to select their preferred Chinese bidder to participate in the process alone, to avoid the (to Chinese government minds) undesirable result of having two Chinese companies bidding the price up against one another.
International sellers should provide as much information as possible to their Chinese bidders during the due diligence process, to give them plenty of time to digest the information, and should be prepared for extensive follow-up questions and discussions as the Chinese parties seeks to address their risk concerns.
Finally, international sellers should be prepared for frequent and lengthy delays for even seemingly minor decisions in the sale process as the matter winds its way through the convoluted bureaucracies of both the regulators and the company itself.
Conclusion
As Chinese businesses gain experience in international business transactions and become more sophisticated, many of the “quirks” in dealing with Chinese purchasers will disappear. Indeed there are some Chinese companies – just a couple of examples include CNOOC among the State-owned enterprises and Wanxiang among the private enterprises – who already have extensive international deal-making experience and operate seamlessly in international markets. However, it will be some time before Chinese companies generally have the kind of extensive deal-making experience of these veterans. In the meantime, sellers wishing to maximize their prospects of selling to China will need to strategize accordingly.
Preferred citation: Antony Dapiran, Selling to China, 3 Harv. Bus. L. Rev. Online 76 (2013), http://www.hblr.org/?p=3015.
* Antony Dapiran is a partner based in the Hong Kong office of international law firm Davis Polk & Wardwell LLP. He regularly advises Chinese companies on international transactions, including securities transactions and offshore acquisitions.
[1] See report published by Deloitte, “The Resurgent Dragon: Searching for value in troubled times – 2012 Greater China outbound M&A spotlight” available at: http://www.deloitte.com/view/en_CN/cn/services/csg/eb80ac5b279fa310VgnVCM1000003156f70aRCRD.htm# (accessed 19 February 2013).
[2] Benoit, David, “Cnooc-Nexen: Where the $15.1 Billion Deal Ranks in History”, Wall Street Journal, 23 July 2012 at http://blogs.wsj.com/deals/2012/07/23/cnooc-nexen-where-the-15-1-billion-deal-ranks-in-history/ (accessed on 19 February 2013).
[3] Trelep, Sharon, “China Steps Up Buying in U.S.”, Wall Street Journal, 8 February 2013.
[4] See, for example, Wang Qishan’s remarks in 2009, reported in, amongst others, Rabinovitch, Simon, “Unscripted reply shows China’s foreign M&A caution”, Reuters, 12 March 2009, available at: http://www.reuters.com/article/2009/03/12/china-investment-prudence-idUSPEK32476120090312 (accessed 19 February 2013).name=”_ftn
[5] Zhang, Zigang, “Cross-cultural challenges when doing business in China”, Singapore Management Review, January 2004.
[6] See, for example, Graham, John L. and N. Mark Lam, “The Chinese Negotiation”, Harvard Business Review, October 2003. |
