China's US M&A woes are only just warming up

The Trump administration is beginning to back up its beligerent words with action, and deals in the biotech and semiconductors sectors are at particular risk.
US Trade Representative Robert Lighthizer has begun an investigation under Section 301 of the Trade Act of 1974, a move seen as firing the first shot in a trade war with China.
US Trade Representative Robert Lighthizer has begun an investigation under Section 301 of the Trade Act of 1974, a move seen as firing the first shot in a trade war with China.

When the tub-thumping campaign rhetoric of candidate Donald Trump was transformed, against all expectations, into a narrow election victory, there was little doubt that the path ahead for acquisitive Chinese conglomerates would be tougher.

Trump, it was speculated, would use the Committee on Foreign Investment in the United States, Cfius, to slow down Chinese dealmaking – and indeed it has complicated the picture for Chinese buyers and seen deals withdrawn, delayed, or failed.

But while Cfius remains a concern, what's preying most on the minds of dealmakers now is the “bigger picture” of tensions over trade as US officials double down on their attacks on China's attitude to intellectual property rights. Particularly vulnerable are deals in the space China craves most: cutting-edge technology.

“We certainly hear talk in the market over the last month that trade relations between the countries are higher up the agenda as parties consider deals and risks around the deals being completed,” said Mustafa Hadi, head of disputes and international arbitration for Greater China and North Asia at advisory and consultancy firm Berkeley Research Group.

“The trade issue is now much higher on the radar for most advisors and investors as a factor to consider when formulating an investment. It is too early to see the impact, but I expect this to ring alarm bells for companies, particularly from China, looking to acquire intellectual property intensive companies in the US,” Hadi added.

Of particular concern in this context are deals involving integrated circuit or software makers, and advanced pharma and biotech firms (see table below). The situation is particularly ironic, because these sectors avoided China's latest crackdown on acquisitions in certain industries – and are therefore prime recipients of financial and regulatory support.

Of the 25 Chinese purchases of US firms that have yet to complete this year as of August 25, eight involve computers or electronics, Dealogic data shows. Those deals are worth some $2.5 billion, out of the $6.3 billion total value of uncompleted deals, as of August 25.

The most recent such deal was the acquisition of US-based image sensor manufacturer OmniVision Technologies by Will Semiconductor Shanghai, a listed voltage-management chip maker, announced on August 22 with no terms disclosed.

In pharma and biotech, Fosun Group and Shanghai Pharmaceuticals Holding are bidding for a stake in Arbor Pharmaceuticals, an integrated pharmaceutical company engaged mainly in research and development of specialty and generic drugs, the bidders said on August 14. No other details were disclosed, with the buyers citing “trading secrets and confidentiality requirements”.

The other case is a $290 million takeover by Chinese polymer and genetic testing kit manufacturer Boai Nky Pharmaceuticals of its US peer BioVision, announced in June.

These deals might just have run into the line of fire.

Game of power

Tensions over China's appetite for American tech know-how have been mounting for years, but the latest escalation was foreshadowed on August 14, when US Secretary of Commerce Wilbur Ross penned an op-ed for the Financial Times.

Under the headline “American genius is under attack from China”, Ross listed several ways in which Chinese companies stole advanced technologies from the US, adding: “The Beijing government and Chinese companies also pursue an investment strategy whereby they identify US start-ups with scientific breakthroughs and then make investments in those companies on better-than-market terms.”

Wilbur Ross: Hit out at Chinese tech deals

Two days later, US trade representative Robert Lighthizer turned words into action. He initiated an investigation into China over theft of US IP, following Trump’s instruction to “look into Chinese laws, policies, and practices which may be harming American intellectual property rights, innovation, or technology development”. China's Ministry of Commerce (Mofcom) fired back on August 21, saying the investigation was “irresponsible” and “not objective”.

It's hard to assess the weight of Ross's argument. Chinese bidders are indeed known for blowing competitors out of the water by offering hefty premiums to get deals done. But that is justified, at least in part, by the vast size of the Chinese market, which greatly increases the commercialisation potential for a price of IP.

Indeed, while Ross argues that “through investments like this, Chinese companies gain access to breakthrough technologies that could create billions of dollars of future revenues without paying royalties,” China is hardly alone in this.

“There’s nothing different than what Japanese, Korean and Taiwanese companies are doing – but those three [countries] are US allies,” said Charles Martin, managing director at East Asia Group, an investment advisory firm covering the East Asia region and the US.

Hadi agrees. “I don’t think the practice of acquiring IP-rich companies and seeking to unlock value by expanding the scope of application of that IP is anything unusual – companies in countries other than China do it, companies within a country do it.”

Take, for example, Google's 2011 acquisition of Motorola's consumer business; even the press release stressed the IP benefits. Apple’s CEO Tim Cook told a conference in 2013 that the company would use its cash stash to buy companies and “we generally do it for skills or IP”. Ironically, Motorola Mobility is now in the hands of China's Lenovo.

“I think it’s the history of trade relations and concerns about IP leakage between China and the US that brings it more into focus and puts the practice pretty much under the magnifying glass,” said Hadi.

Among IP-intensive industries, Chinese forays into healthcare technologies like biotech and high-end electronics and communications technology are facing particular scrutiny. And it’s not hard to figure out why.

A recent report by the Commission on the Theft of American Intellectual Property singled out as suspect China's targeting of biotechnology and quantum communications technology.

Biotech battleground

The Holy Grail of biotech now is genomic data ­– the collection of vast amounts of information on genes, which has the potential to unlock a new era of precisions treatment ... and bio-weaponry. The Financial Times recently reported on the growing concerns of US politicians and law enforcement over the penetration of Chinese capital into US-based genomics assets, either via joint ventures or direct investment.

One key concern for critics of Chinese investment – everyone from Federal Bureau of Investigation agents to key lawmakers – is a lack of reciprocity. In simple terms, this means China does not allow data gathered inside the country to be used outside its borders – even in the case of a Chinese company cooperating with a foreign company in which it has invested.

At present, many biotech deals fall outside the scope of Cfius, which does not look at foreign investments covering less than 10% of a company or investments into start-ups. The committee isn't reported to have blocked any Chinese biotech deals either, although all of its review processes are confidential.

But that could all change. Senior US Senator John Cornyn is working on legislation to expand government reviews of foreign deals to include joint ventures and other structures commonly used in tech acquisitions. If the Texas lawmaker gets his way, the Chinese biotech acquisition trail would likely come to an end.

“That would make many people unhappy,” said an IP litigation lawyer covering US cases, citing the fact many start-up tech companies prefer to sell to the highest bidders while others see partnerships as a way to access the massive China market.

"Most of the anti-China rhetoric is aimed at the domestic US voters,"  said Euan Rellie, co-founder and senior director of BDA Partners, which advises on M&A and cross-border investment in Asia. "Like other elements of the 'populist' agenda, it’s a cheap shot at winning approval in the court of public opinion. China is the single most promising foreign market for US companies. If we can't learn how to work with the Chinese, we will deny ourselves access to that market."

Semiconductor sensitivity

In the semiconductor field – where Cfius has previously blocked the sale of companies that supply the US military – there are also hints of an IP power play in the fate of recent transactions.

For example, Lattice Semiconductor, a chip manufacturer and Portland, Oregon's largest tech company by market cap, wanted to sell to private equity house Canyon Bridge Capital for $1.3 billion. The deal announced in November last year, and has been in the air ever since, with three applications for approval filed to Cfius.

The main issue is that Chinese money is behind the private equity firm, lawyers say, and even though Lattice has completely exited the military defence market, lawmakers fear the deal would give China “too much headway in the chip industry”. With the latest review period about to expire, Lattice executives were pondering options including approaching Trump personally to seek his backing for the deal, according to an August 29 report by Bloomberg.

China set up a $22 billion China Integrated Circuit Industry Investment Fund (CICF) to specifically back chip industry acquisitions. In April, Sino IC Capital, the management company of CICF, agreed to buy Xcerra Corporation, a US-listed manufacturer of semiconductor testing and data communications equipments for approximately $580 million.

The deal is subject to Cfius review and approval, and Cohu Inc, a rival, has launched a quiet campaign to derail the deal, which would grant Xcerra enormous financial backing. According to documents cited by the Wall Street Journal on August 15, Cohu argued “if Xcerra becomes a Chinese state-owned enterprise and obtains top-tier semiconductor companies like Qualcomm, Broadcom and Texas Instruments as customers, it is reasonable to expect transfer of this critical information to Chinese semiconductor companies".

Xcerra issued a statement, saying “the allegations Cohu make are false, as Xcerra does not possess critical [IP] from any customer.”

That use of Cfius is a reminder of the fate that befell China's biggest purchase of an overseas metals processor. Cfius flagged "national security concerns" in its review of China Zhongwang's purchase of Aleris Corporation. But it came amid intense lobbying from a US labour union citing economic concerns

Selected Chinese deals in the US

Announced

Target (US)

Acquirer

Deal value

Deal status

Target industry

Aug 22

OmniVision Technologies

Will Semiconductor Co Ltd Shanghai

Not disclosed

Preliminarydiscussions

Semiconductors

Aug 18

Calient Technologies (51%stake)

Suzhou Chunxing Precision Mechanical

$147.9 million

Pending

Electronics networks

Aug 14

Arbor Pharmaceuticals (20%stake)

Fosun International; Shanghai Pharmaceuticals Holding

Not disclosed

Preliminary discussions

Pharmaceuticals

Jun 07

BioVision

Boai Nky Pharmaceuticals

$290 million

Pending

Life science

May 26

Analogix Semiconductor

Zhejiang Wansheng

$546.62 million

Pending

Semiconductors

Apr 10

Xcerra Group

Sino IC Capital

$580 million

Pending

Semiconductors

Feb 14

Integrated Silicon Solution

Giga Device Semiconcductor (Beijing)

$946 million

Withdrawn

Semiconductors

Source: Dealogic, FinanceAsia research

¬ Haymarket Media Limited. All rights reserved.

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