China's outbound M&A Rules: Part 1

Teaching China outbound M&A rules: Part 1

Tips from Sanpower, Fosun and Dalian Wanda on how to improve China's overseas M&A record.

China’s companies are expanding overseas. And they’re increasingly doing so through mergers and acquisitions.

President Xi Jinping predicted in September that Chinese companies would splurge $1.25 trillion on overseas assets in the coming decade.  

But the nation’s companies have not had the best track record in M&A. State-owned enterprises, notably, have been big offshore buyers of resources assets, and they have often spent heavily and then struggled to make the deals work. 

So China’s new generation of asset-hungry companies need to pursue smarter acquisition strategies if they are to take full advantage of their buying power.

In 2015 Chinese companies announced 609 outbound M&A deals worth a record $112 billion, according to Dealogic. This year will easily see more; at the end of March the country had conducted 178 deals worth a collective $170.3 billion. That is already an annual record. 

Increasingly SOEs and private companies from a spectrum of sectors want to buy abroad, to produce or sell higher quality products at home.  

“If China wants to be truly prosperous and powerful, it needs a number of first-class multinational Chinese companies that can use the international markets and resources to develop themselves,” said a spokesman for conglomerate Dalian Wanda, which has splashed out on a major US film studio and invested in a Spanish football club, among other things.

Yet Chinese companies have also had to fend off lingering suspicions from their peers and among foreign regulators about their ultimate motives when buying abroad. Such nagging worries include the potential for data theft, intellectual property infractions, industrial espionage, and the uprooting of entire manufacturing facilities. 

These issues, combined with sometime ill-thought acquisition rationales, can have an impact on the success of their M&A ambitions. A September 2015 report by the Boston Consulting Group noted that Chinese acquirers completed just 67% of M&A deals between 2004 and 2014, far lower than the success rates of US, European, or Japanese acquirers. 

There are also concerns that some companies are heavily leveraging themselves to support overly ambitious deal-making. 

China National Chemical Corporation (ChemChina) is borrowing upwards of $30 billion to support its $43 billion tilt at Swiss fertiliser and seed producer Syngenta. Meanwhile, conglomerate Fosun International scrapped two proposed acquisitions in December and February. A debt-to-Ebidta ratio of 17.25 as of June 2015 – a level before it had even concluded of its most recent purchases – seems part of the reason why.  

Most recently, the aggressively acquisitive Chinese insurer Anbang emerged with an unsolicited bid for Starwood Group, the owner of the Sheraton hotel chain. The offer, which it raised to $14 billion on Monday, is meant to gazump Starwood's negotiations with the Marriott Group. Yet it appears slapping more money on the table may not be enough; Starwood continues to say, at least for now, that it prefers Marriott's lower offer.  

So how can Chinese companies improve their chances of success? FinanceAsia garnered the views of three serial overseas acquirers and advisers on how best to do that. 

1) Do your homework 

M&As will most likely succeed when the acquirer has a clear idea of the business opportunity that the target offers. 

That takes preparation, which Chinese companies haven’t always been good at. But this is changing. 

“Over the past 12 months in particular there has been a real change in mindset and behaviour among Chinese companies,” Samson Lo, head of Asia M&A at UBS, told FinanceAsia. “They are becoming more focused and spending more time on a target once they have identified it, rather than just doing fishing exercises.” 

One example is Haier’s $5.4 billion acquisition of GE Appliances. The Chinese company is believed to have monitored the US business for several years.

Guo Guangchang, chairman of Fosun International, told FinanceAsia in written responses to emailed questions that Chinese companies must be especially analytical over international acquisitions. 

“Like domestic investments, outbound acquisitions are detailed work which requires thorough due diligence to know the truth ... There is no shortcut in the process,” he said. “Because you are not familiar enough with the overseas [investment] environment, you have to commit more time and effort.”

Fosun certainly keeps busy looking. It made $6.8 billion in offshore acquisitions last year, from insurance (spending $2.3 billion on Ironshore) to entertainment (buying Cirque du Soleil and Club Med). 

However, it’s become more cautious of late. In December Fosun dropped its interest in European merchant bank BHF Kleinwort Benson Group, while it halted a $460 million bid for 52% of Israeli insurance firm Phoenix Holdings on February 16 after certain pre-deal conditions were not met. Guo said in a statement that terminating the Phoenix acquisition would help in “searching for more suitable investment opportunities around the world.”

The company’s $15 billion debt burden played an important role in this. “They realise they are heavily leveraged and are becoming more cautious,” said a Hong Kong-based adviser. 

Click for full view

Meanwhile, Wanda chairman Wang Jianlin told an audience at Oxford University on February 23 that “the most important thing for [an] acquisition is selecting the right business that fits your business direction.” He added it was important to take a long view, of 10 years at least, when considering acquisitions.

The simplest reasons for companies to buy outside of China are to gain market share in new markets and to access quality products that can be brought home. 

Chinese conglomerate Sanpower is an example. In 2014 the company acquired 89% of UK department store House of Fraser for £480 million ($671.2 million). It now plans to open House of Fraser stores in mainland China, in addition to its existing Nanjing Xinjiekou stores. C.banner, a strategic partner, has bought UK toy store Hamleys and has similar plans. 

“Acquiring outstanding foreign companies and importing advanced operation and management systems is the best shortcut for Chinese companies to transform quickly and overtake [others] in a bend,” Yuan Yafei, chairman of Sanpower, told FinanceAsia in written responses to questions. 

Click for full view

Another advantage for Chinese companies is that there is rarely much production or distribution overlap. Additionally, acquisition targets often find the prospect of direct product access into the Chinese market to be very appealing. Such is the allure that it can even help Chinese acquirers to fend off rivals and potentially get a better purchase price. 

Sanpower’s Yuan said the appeal of accessing the China market allowed him to fend off interest in House of Fraser from UK billionaire Mike Ashley, owner of retail group Sports Direct. 

 “Right ahead of our official signing with House of Fraser, I learnt on the plane [to the UK] that Mike Ashley suddenly wanted to block our acquisitions,” Yuan said. “Once I landed, I visited and talked to HOF’s shareholders one by one. They were attracted by the rosy prospects of HOF’s entrance into China. After restless negotiations for one day and one night, we acquired 89% of the company.”

The dangers of failing to conduct enough due diligence can be very costly. Just ask Japan's Lixil, which makes bathroom fixtures and home supplies. It bought most of Germany's Grohe Group in 2013. But then it emerged that Grohe's Chinese subsidiary Joyou was guilty of widespread fraud

It transpired Joyou had collateralised its factories multiple times, then onlent some of the money through shadow banking, only for banks call in these credit lines over fears about mounting losses in the shadow market. Joyou filed for bankruptcy in 2015, while Lixil was forced to tell investors it faced $560 million in losses.  

2) Start small 

China Inc.’s overseas forays have led to some big deals, such as ChemChina’s planned $43 billion acquisition of Syngenta or conglomerate Haier’s bid for GE Appliances. The appeal is obvious; big companies provide immediate market share and international heft. 

But consultants say corporates with little international management experience are better advised to start small.  

“One of the single biggest forms of value destruction are companies that don’t do much [M&A] for a long time and then make a big single bet,” said Yves Willers, senior partner and managing director for Boston Consulting Group’s Shanghai office. “Companies that make the highest returns for shareholders and get the most from new assets are serial acquirers.” 

It makes sense, especially in view of the relatively low rates of completion for Chinese outbound M&A.  Buying a series of smaller companies gives managers experience in executing synergies and dealing with international executives. And smaller deals are less damaging to a company’s perception or financial health if they go wrong.   

Many Chinese companies have already taken that on board. S&P Capital Intelligence estimates that 378 outbound M&As were announced or completed in 2014 and 2015. Of these, 206 were for less than $100 million.

Chinese banks have also been willing to make small acquisitions in order to learn. China Construction Bank paid $750 million for Brazil’s Banco Industrial e Comercial in 2013, a deal that was worth just 0.4% of CCB’s equity. 

Tomorrow: watch out for watchdogs, consider the culture and make your plans

¬ Haymarket Media Limited. All rights reserved.