Foreign executives facing competition from their Chinese rivals could do with taking some advice from Sun Tzu: “He who knows when he can fight and when he cannot will be victorious.”
Ride-hailing firm Uber had been fighting hard for business with local rival Didi Chunxing for three years, offering consumer rides at below cost in an attempt to win market share. But after losing several billion dollars in the country — and seeing the government ban its subsidy strategy — the tech darling decided it was not the time to fight. It handed over its China business to Didi in exchange for a 5.89% stake in the combined company.
“We had a strong domestic competitor in Didi,” David Plouffe, Uber’s chief adviser and a board member told FinanceAsia.
Uber is not the only foreign company that has retreated in the face of overwhelming odds. Foreign companies are increasingly struggling to justify further investments as the renminbi depreciates or their plans hit regulatory roadblocks.
McDonald’s is set to announce the sale of the franchise rights to its restaurants in China for about $1 billion by end-November, according to a person involved in the process. Yum Brands, the operator of KFC, is spinning-off its Chinese business. BP wants to exit a joint venture. Chevron is planning to sell China assets as part of a wider Asian pullback.
These companies are not the start of a mass exodus from the country. China still offers major opportunities to international firms, and M&A bankers rightly point out that each corporation has its own reasons for reducing its exposure to China. But it cannot be denied that the Middle Kingdom is now a markedly less attractive place to do business for many foreign corporations.
“More of our clients are questioning what the future is going to look like in China as the economy slows,” said Francisco Aristeguieta, the Asia Pacific chief executive of Citigroup, which banks multinationals in the world’s second-largest economy.
The reasons why foreign companies struggle in China are varied. But they are also instructive.
The experiences of some of the largest companies in world as they try to negotiate an exit with a local partner, or extract the value they think they deserve from their China operations, can teach something to other executives finding themselves in the same position — and wondering quite what their next step should be.
No more easy money
China’s growth story is far from sputtering. The economy grew at 6.7% in the first quarter, according to official data, although some question that statistic. But although the picture is still positive, the froth appears to be coming off.
Foreign companies have slowed their investments as a result. Between 1999 and 2010, foreign direct investment into China fell only once on an annual basis. Since 2010, it has fallen in three out of five years. The $249.85 billion of FDI into China in 2015 was almost 15% lower than the country attracted two years earlier.
“The growth story in China is less obvious now,” said Changhong Wang, head of greater China corporate finance and capital markets at brokerage Citic CLSA Securities. “Even though GDP growth is maintaining, it is getting more and more difficult to make quick money in China.”
This is particularly true for some sectors. McDonald’s and Yum are a case in point. Fast-food chains have struggled to grow their profits in China as much as their success elsewhere might have promised, and changing demographics in the country mean the outlook is not as good as it once was.
Dinesh Khanna, a senior partner at Boston Consulting Group, argues that the growth of China’s emerging middle class has peaked — and that success will come not to fast-food companies or low-end manufacturers, but to those foreign companies that are targeting more affluent Chinese looking for quality products.
McDonald’s has stated publicly that its attempt to sell the franchise rights to its Chinese restaurants will put its mainland business closer in line with its global strategy. Yum’s chief executive Greg Creed has said that the planned spin-off of the China business will reduce volatility in earnings, and will “give shareholders the best of both worlds”.
Both companies are trying to emphasise the positives in the changes to their China strategy. That is to be expected. But it is hard to avoid the fact that they are getting out at a tough time for the sector.
“It’s amazing that they are doing it at the same time,” said an M&A banker. “This is the worst time to sell a restaurant business. Have they seen the multiples? Have they seen the market? Have they seen the appetite? It’s the worst time but all of these MNCs are doing it at the same time.”
These are not, however, shortsighted companies. Their long experience of China — Yum entered in 1987, McDonald’s followed three years later — has given them a keen understanding of the positives and negatives in the country. They may have felt that things would have only got worse if they waited, the banker said.
Their shareholders certainly appeared to agree.
Less than six weeks after McDonald’s announced it was looking for strategic partners for its China, Hong Kong and Korea businesses, the stock hit an all-time high. The China decision was not the driving factor of the rally, since the stock had been moving up since September 2015. But neither did it hurt.
Yum Brands, meanwhile, announced it was planning to spin-off its China division in October last year, after a five-month drop had wiped more than 20% off its stock price. This September, it came close to breaking its own all-time high.
To be sure, there are plenty of companies that are still bullish on China. Coca-Cola paid around $400 million to acquire a multi-grain drinks company last year. And McDonald’s, for its part, says it wants to open 1,500 more restaurants in Hong Kong, China and Korea, albeit after its finds a strategic partner to share some of the risks.
Hewlett-Packard, meanwhile, sold a majority stake in its China business not so much to reduce exposure to the country but to maintain it. China is planning to purge foreign technology from state-owned enterprises, banks and the military by 2020. That encouraged the US company to sell a 51% stake in its data network business to Tsinghua Holdings, which paid $2.3 billion and is more likely to win contracts with Chinese businesses.
But for many companies, now appears to be a sensible time to reconsider their China strategy.
In many cases, they fought hard to get in. They could now be forgiven for wondering how to get out.
Go soft or go home
There are several ways for a foreign company to reduce its exposure to China. But the most popular is to take an ‘asset-light’ approach to the country. This allows foreign companies to maintain some exposure to Chinese growth without tying up too much capital at a time of uncertainty.
This is the approach that McDonald’s is taking by selling its franchise rights. It appears to be the rationale behind Yum’s spin-off of its Chinese business. In a sense, Uber’s exit from China can be seen as an extreme asset-light approach. (The ride-hailing firm now has just one China asset — its shares in a former rival.)
“There are different strategies deployed by multinationals with regards to China,” said Brian Gu, co-head of M&A for Asia Pacific at JP Morgan. “Compared with say 10 years ago — when they wanted to invest, build and acquire — they are now trying to identify the most efficient ways to have exposure to China without an intensive demand for capital deployment.”
The difficulty, of course, is finding the right buyer for the assets that they do have.
In Uber’s case, the buyer was obvious. But for most foreign companies paring down their exposure to China, things are made tougher by the fact that the most obvious buyers — Chinese companies themselves — are aggressively shifting capital offshore.
Chinese buyers had announced $164.6 billion of outbound M&A deals by September 5, according to Dealogic. That was already 57.5% higher than they managed throughout all of 2015, despite that being itself a record-breaking year for volumes.
“A lot of the tycoons and the magnates, the people who are sitting on a lot of cash, are trying to find ways to get their money into markets with more promising growth,” said Ellis Chu, head of China M&A at Bank of America Merrill Lynch.
Private equity firms can help here. They have plenty of cash to deploy and are hungry for quality carve-outs from multinational companies.
Yum has agreed to sell part of its China business to Primavera Capital, which invested $410 million, and Chinese online payments company Ant Financial, which took $50 million. (The percentage of Yum’s China business that these investments are worth will be determined at the time of the company’s IPO.)
McDonald’s is in talks with a consortium including Bain Capital and a rival group including TPG Capital about a possible deal, according to people involved.
However the funds are concerned about the strictures McDonald's is placing on the sale including no management changes in the near term and a fatter franchise fee than the one Yum! was demanding, they said.
Private equity firms are also worried about foreign exchange risk. Economists think the renminbi is over-valued, and although there is some debate about how much it will depreciate in the near-term, the direction appears to be one way.
“Global private equity firms have US dollar funds and they remain concerned about renminbi downside risk,” said Mayooran Elalingam, head of M&A in Asia at Deutsche Bank. “To factor this into their acquisitions — while targeting a 20%-plus internal rate of return — makes it difficult for them to make acquisitions work in China.”
The situation becomes even tougher for a foreign company trying to sell down its stake in a joint venture. In that case, outside buyers — whether private equity firms or foreign rivals — would need to trust the local partner.
Both Chevron and BP need the blessing of their Chinese joint venture partners before they can agree a sale, according to people familiar with their partnership contracts.
In many cases, it will simply be easier to sell to the Chinese partner at a cheap price. But this has one obvious problem: the partner needs to be willing.
“If it’s a strong business there’s no reason the local partner won’t want to buy you out,” says Khanna.
“But if you didn’t have a good pre-nuptial agreement, they have more bargaining chips than you’d like them to. We tell our clients that it is really important to think through the exit options when you get in to a JV. Because JVs have a shelf-life.”
This is perhaps the most widespread advice given to foreign companies by the bankers, lawyers, and consultants FinanceAsia interviewed for this article. To get out well: get in well.
Before the global financial crisis in 2008, there was a feeling that foreign companies were in “a great rush to enter China,” according to Shaun Wu, a China outbound disputes lawyer at Kobre & Kim.
“A lot of transactions were sealed very hastily, with very brief contracts, very brief term sheets, and without too much diligence into the China partners,” he said.
That has changed in the last few years. Foreign buyers are now much more cautious about how they structure contracts with local JV partners, said Wu, although another lawyer said it remained easy for them to be cheated by their partners.
In any case, this advice is no help to a company that is already in a difficult joint venture.
One senior M&A banker who is advising a company trying to escape “the headache” of a difficult joint venture said there are “no easy solutions”. In many cases, a Chinese company is going to be looking at the business from a similar angle to the foreign partner — and an attempted sale is unlikely to signal a thriving business.
Bankers and advisors can offer little advice but working hard to sell to the joint venture partner — or praying that another buyer has the appetite to take over.
For some businesses, the best option might be the hardest, especially for publicly listed companies dealing with restive shareholders: wait. The prolonged weakness in the price of oil and the weak demand from China’s big energy companies means BP and Chevron may be best served with a patient approach, according to some bankers.
But for other companies — especially smaller companies — a depressing alternative is simply to walk away, abandoning Chinese assets that cannot be sold but are proving too costly to hold on to.
This is something Dan Harris, a lawyer who focuses on smaller companies entering China, said he has seen in the last few years.
“We got the most calls [at the time] from our clients and other companies that were getting out,” said Harris, a partner at Harris Moure. “I don’t think any of them were able to sell. They just shut down. It’s mostly because they didn’t have businesses people wanted to buy. Things had become tougher for them.”
But whatever option a foreign company takes when attempting to reduce its China exposure, it should take some heart that it is not the only one — and that there is no need to rush what is always going to be a tough choice.
“We made a decision to merge here in China, which is the right decision for the company,” said Plouffe, the Uber board member and former advisor to Barack Obama. “But history will be the ultimate judge of that.”
Additional reporting by Daniel Flatt