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We ask Nicolas Pechet, Vice President and Head of GIA Group's operation in China and head of the firm’s global M&A and Partnering practice.
How would you describe China’s recent M&A activity?
"In spite of the severely illiquid global capital markets, the year 2009 set several milestones for Chinese M&A activity. The availability of discounted assets due to the international financial crisis in particular, helped embolden China’s outbound M&A activity.
Close to 25% of all Chinese M&A deals during the first three
quarters of 2009 comprised of outbound deals. Compare this to 2007,
where overseas M&A activity comprised only 8.5% of all M&A
volumes for the entire year. In addition, the value of Chinese
acquisitions abroad has also been steadily rising - over a quarter of
the 20 largest outbound M&A transactions were announced in 2009
China's overseas M&A activity has unfortunately, also become increasingly controversial. Many recent deals, such as Yanzhou Coal Mining’s US$2.6 billion bid for Australia’s Felix Resources, have encountered regulatory complications.
Public capital is increasingly being used to fund
foreign acquisitions, with the China Development Bank recently loaning
the state-owned China National Petroleum Corporation US$30 billion in
order to fund its overseas M&A shopping spree. In addition, China’s
sovereign wealth fund is making big moves, directly accounting for two
multi-billion dollar M&A deals. These were the US$3 billion
acquisition of a stake in US asset manager, Blackstone, in 2007 and the
US$1.5 billion purchase of a 17.2% stake in Canada’s Teck Resources in
What strategic drivers are behind outbound M&A activity from China?
“Chinese companies are driven to undertake cross-border deals for many reasons, with some of the most common ones including access to resources, expertise, brand building, and what I’ll call other strategic reasons.
For starters, access to resources is a clear and well-known driver.
However, while Chinese resource firms often have government directives for going overseas, evidence suggests that once an overseas M&A deal is consumed, profit trumps imperatives. For example, about 75% of the oil from China’s overseas holdings does not get sent back to China. Rather, it is sold in the global marketplace at spot prices. Gasoline prices in China are capped, so oil refineries in China tend to operate at a loss, unless the Government subsidizes them.
Beyond that, Chinese firms use mergers and acquisitions to move up the value chain. One example is Lenovo’s acquisition of IBM’s laptop business, which allowed it to gain global distribution, operational expertise and brand value.
Chinese companies are hungry to learn from their global competitors and access best practices in many areas, from risk management right through to quality control and information technology. These companies are often government-backed and play to win.
Chinese companies also use acquisitions as a back door to indirect but important strategic benefits. For example, Industrial and Commercial Bank of China’s 20% stake in Standard Bank in South Africa cost it US$5 billion and provides it with access to mining, energy and other resource firms in Africa.
Chinese state-owned enterprises (SOEs) are also looking to M&As to help them rapidly achieve economies of scale, ultimately allowing them to achieve a foothold abroad and strengthen their bottom line.
Another key driver influencing outbound M&A activity lies in the fact that Chinese monetary authorities are pushing state-owned enterprises to acquire resource, mining and energy companies abroad, to secure the basic necessities to feed the country’s growing appetite for just about everything.
The other key benefit of course, is to diversify away from declining US dollar-denominated government securities."
What is the future outlook for continued outbound M&A activity?
"My view is that Chinese outbound M&A activity looks likely to continue strongly over 2010 and into the future, driven by a massive appetite for deal-making in China as well as relatively attractive asset valuations in overseas markets.
Overall, the prognosis is fundamentally strong, despite the existence of significant operational and political barriers to deal flow that may continue to hamper some transactions. It is increasingly likely that outbound values and volumes will eventually overcome such obstacles, ultimately resulting in the expansion of this particular market.
One simple way to weigh the outlook for Chinese outbound M&A is to consider JP Morgan’s forecast that by the year 2020, China will have US$16.4 trillion in aggregate domestic savings. If only 5% of these savings are deployed abroad, China will export US$822 billion of capital annually. This implies a tectonic shift in M&A activity in the coming decades.”
Which will be some industry targets?
“Investments will focus on sectors such as automotive, mining and resources, agriculture and financial services for the short to medium term.
Energy, mining and utilities transactions have dominated Chinese M&A activity overseas. Since early 2003, acquisitions in these sectors have accounted for about 30% of total outbound deal flow by volume and approximately 65% of total deal value. These ratios increased to 40% and 93% respectively, over the first three quarters of 2009.
This activity is driven by some basic realities. China has roughly 20% of the world’s population and a spectacular growth rate in consumption, but relatively few natural resources - besides coal, which is extremely abundant. With increased spending power, Chinese consumers will acquire more automobiles, electronic goods, home appliances etc. and the Chinese government will continue to build the infrastructure to support this.
All of these require resources that China does not have sufficient quantities of.
Therefore, outbound energy, mining and utilities transactions, primarily focusing on Australian assets, are likely to continue into 2010. Such transactions are likely going to get more difficult with increasing nationalism and protectionism as foreign nations awaken to these austere realities and their strategic implications.
Another key target area is farming. China has 40% of the world’s farmers but only 7% of the world’s arable land and 6% of the world’s renewable water resources.
Many leading economists have concluded that China must expand overseas in order to guarantee its food security. China’s self-sufficiency in food is eroding, as its increasingly wealthy citizens change their dietary habits and consume more meat. China is still a net exporter of agricultural commodities, but will be increasingly reliant on soybean imports. (China imported 60% of the soybeans it consumed last year)
Though agricultural investment abroad has been limited so far, China’s Ministry of Agriculture is actively encouraging Chinese farming companies to acquire overseas farmland and farming companies, implying that this is now a central government decree. Similar policies have been enacted with great effect in the petroleum, mining and financial services sectors.
In July 2008 - in a deal that may be the first of many similar to come - China’s leading grain, oils and food company, COFCO, acquired 5% of Smithfield Foods, the largest pork processor in the United States.
The financial services sector will be another key sector. Until recently, Chinese banks that were primary targets for foreign acquirers have now turned into buyers.
With access to greater liquidity, Chinese banks and insurance companies have been busy buying up foreign assets. Among the more prominent cases was the acquisition of a US$3 billion stake in Barclays by China Development Bank.
This is the result of Chinese banks having cleaned up their balance sheets, listing and taking on foreign shareholders. Several years ago, Chinese banks had extremely high ratios of non-performing loans (NPL’s) on their balance sheets. As NPL’s were weaned out of loan portfolios, the higher performance of the top Chinese banks vaulted their stock market value to the top 10 globally, affording them tremendous M&A purchasing power.”
Which geographies will be favored investment stops?
“Geographically, China will continue its acquisition spree in places such as Africa and Latin America, where there are abundant natural resources available. The national security concerns and caution that Chinese companies often face in the European Union (EU) or the United States, often take a back seat to official desires for capital.
In May 2009, the China Development Bank announced a loan of US$10 billion to Petrobras, the state-owned Brazilian oil company, in exchange for a guaranteed supply of oil over the next decade. We can expect many similar deals to come.
China's M&A activity into US assets will continue into 2010 and beyond, with buyers primarily eyeing assets to boost their technological capabilities. Moreover, Beijing is also working to strengthen ties with the EU, in order to drive economic integration and gain market economy status, which will most likely boost Chinese acquisitions of European assets in the years ahead.”
What advice would you offer M&A professionals involved in China’s outbound M&A activity?
“It is widely agreed that some Chinese bidders may have undertaken poorly executed investments and that Chinese acquirers can benefit from better pre-deal planning of cross-border M&A strategies.
For example, Chinese state fund investments in Blackstone, Morgan Stanley and Barclays have resulted in substantial losses due to falling stock markets and have dented the credibility of fund managers in Beijing who were responsible for the deals.
In many cases the strategic intent of the deal was widely agreed to be unsound in the post-deal analysis. Better strategic analysis based on in depth assessments of synergies could help to address this.
Chinese acquirers can also benefit from expert advice and support on post-merger integration (PMI) from seasoned professionals. The reality is that the PMI on many high-profile deals has not been strong, with obvious impact on the long-term promise of these transactions. One notable example is Lenovo’s US$1.8 billion acquisition of IBM’s PC division in 2004. While the jury is still out on the deal with Lenovo reporting better than expected Q1 2010 results, the period following the acquisition was riddled with problems.
Another key success factor for large cross-border M&A transactions is the successful handling of both regulatory agencies as well as target stakeholders. Chinese acquirers could benefit from more in-depth due diligence on those parameters so that detailed plans on how to mitigate those challenges can be drawn up.
Perhaps the greatest barrier to the globalization efforts of Chinese companies is a lack of staff with the right experience in international economic environments, the complexities of conducting effective due diligence as well as effective post-merger integrations. Chinese companies continue to face difficulties both in negotiating deals and operating their overseas acquisitions due to this.”
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