Chinese outward M&A: next year's big thing?

Is China Netcom''s acquisition of Asia Global Crossing a leading indicator of what''s to come?

On the face of it, Asia Global Crossing's (AGC) decision earlier this week to sell its assets and operations to a consortium led by China Netcom might be viewed as evidence that the advance of Chinese companies into overseas markets is gaining further momentum.

The deal is the latest in a series of tentative forays by Chinese companies into foreign territories, following a general post-deregulation pattern of Chinese companies internationalizing their operations through acquisitions of overseas assets or listings on foreign exchanges. Other recent transactions include the acquisition by CNOOC of oilfields in Indonesia (Repsol) and Australia, as well as Indonesian petroleum assets by PetroChina.

It is tempting to imagine the floodgates opening as Chinese companies pour overseas in pursuit of assets and alliances. However, given the opportunistic nature of the deal, it remains to be seen whether it is truly indicative of a sustainable trend towards real cross-border activity. The agreement could also be perceived as a timely attempt to bolster the international profile of China Netcom, following the IPO of China Telecom.

David Putnam, director at Salomon Smith Barney, advisor to the China Netcom consortium on the deal, suggests that this deal is "to some extent opportunistic but is also indicative of a growing willingness for Chinese companies to consider cross-border transactions as a legitimate component of their overall business development strategy."

He goes on to stress "although emerging PRC bandwidth demand helps justify this transaction in the longer term this is primarily a regional play, not a domestic one."

Others in the industry are inclined to concur with this analysis, edging towards the notion of this deal as being more opportunistic than part of a greater momentum. David Eastlake, ING's Head of M&A, believes that the coming months will see Chinese companies adopting more of a cautious stance with regards to venturing overseas, as opposed to leaping in en masse. Much is likely to depend on the success of recent deals.

"The Chinese market is so vast that few companies need to acquire assets from outside," says Eastlake. "When there is more movement, it is likely to be primarily within Asia, as it generally has been so far."

Like many, Eastlake asserts that the most significant impact on cross-border activity in the wake of recent developments in China will be on the sell-side. Foreign companies, particularly those in Europe, are looking towards China as a source of new and potentially economically priced opportunities. That the period of transition in China appears to have so far been relatively painless will only encourage this development.

Gordon Paterson, Head of M&A at Salomon Smith Barney Asia-Pacific, sees a more balanced picture, pointing out that with China starting from such a low level of cross-border M&A activity, the number of overseas acquisitions can only continue to gradually increase. Whilst the majority of these excursions will remain within Asia, Paterson adds, "there are industries - such as the resources sector - in which Chinese companies may need to make acquisitions outside the region to facilitate development."

The restructuring of AGC, worth over $270 million, represents the first Chinese purchase of a foreign telecoms operator. It also concludes Asia Global Crossing's nine-month search for investors following the fall-out from its parent company Global Crossing's US bankruptcy filing in January this year.

China Netcom, the second largest fixed line company in China, will provide $120 million in equity through a new entity named Asia Netcom, in which other investors are expected to include Newbridge Capital of the US and Japan's Softbank Asia International Fund. The group has also enabled Asia Global Crossing to secure a new $150m credit facility to support the restructuring process.

There are still several obstacles to overcome before the transaction can be completed, with approval required from the US and Bermudan bankruptcy courts. David Putnam confirms, "the signing of the definitive agreement is a critical step but the process is far from over. We still have a number of stages to go through in the chapter 11 process before we can close the transaction." Putnam adds: "Nevertheless, the necessary measures are in place to give the deal the best chance of going through, although until then it is still feasible that other bids may come forward."

China Netcom formed as a result of the regional split of China's former fixed line monopoly, China Telecom, with Netcom operating in the north of the country. This represents about 30% of the network, with the other new company, also known as China Telecom, controlling the Southern regions. The acquisition of Asia Global Crossing's undersea network provides China Netcom with the capacity to develop its data communications service and subsequently the potential to make inroads into the valued corporate market.

For SSB, the accord represents their first M&A deal for a Chinese telecom and the beginning of a potentially productive relationship with China Netcom. A successful venture could give the bank an advantage when it comes to the mandate on any future Asia Netcom listing - and other Chinese telecoms transactions - although Putnam plays down the significance of this as a factor at this stage:

"An IPO is clearly a possibility in the future," he says. "Once the deal is closed the consortium's focus will be on helping management to build profitability. No doubt the investors will be open to the idea of an IPO at some later stage, but that is not a short-term objective.รถ

Other advisors on the deal include Lazard, working for Asia Global Crossing, with legal representation provided by Kasowitz, Benson, Terres and Friedman LLP and Gibson, Dunn and Crutcher LLP. Legal advisor for China Netcom is Shearman and Sterling.

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