Chinese outbound M&A: Unfamiliar territory

The company, best known for its biscuits and crackers, could fetch $750 million including debt, translating to quite the windfall for PEP, which acquired Griffin's five years ago for a reported NZ$385 million. If the whispers are credible, this would be the second food and beverage exit for PEP in recent weeks, following the sale of Independent Liquor to Asahi for NZ$1.52 billion, alongside Unitas Capital.

This time sources tell AVCJ that strategic buyers tracking Griffin's would most likely be Chinese.

Looming large on the horizon is Bright Food Group. The Chinese conglomerate that picked up CHAMP Private Equity's 75% stake in Australian food producer and distributor Manassen Foods last month and the company's chairman, Wang Zongnan, is keen to make more acquisitions in the region.

Bright Food is just one of a host of Chinese firms looking to buy assets overseas. Their objectives are varied: raising exposure to new markets in the interests of diversification; acquiring brands that can be marketed in China; collecting natural resources to meet domestic demand; and accumulating hard assets, intellectual property, technical, process and marketing knowledge that can be used to develop businesses back home.

Unfortunately for the sellers - private equity firms or otherwise - Chinese buyers' exposure and expertise in international dealmaking pales to their M&A motivations. "The Chinese are making some of the classic mistakes that any developing country would be expected to make as it starts to move offshore," says Andrew Thompson, national head of private equity at KPMG Australia.

The irresistible rise

There is no arguing with the numbers. Chinese outbound M&A activity has been sharply rising since 2004, with deal volume exhibiting compound annual growth of 24.4% and deal value rising nearly 10-fold. In the first half of the year, 286 transactions were completed worth a total of $22 billion, according to Dealogic. In 2010, $65 billion was committed to 474 deals compared to $39 billion and 398 deals in 2009.

Of the 164 majority-interest transactions catalogued in the first half of this year, only three were valued above $1 billion, and 21 fell into the $100-500 million category. Well over half were worth less than $100 million. The trend is broadly the same for minority-interest deals and it has stayed consistent for the past decade. Australia and the US are the most popular destinations, followed by Singapore, Japan and Canada.

Big-ticket investments are dominated by natural resources and this is unlikely to change. Manufacturing comes second, with deal activity ranging from Geely's $1.8 billion purchase of Volvo from Ford Motor to $50-100 million transactions in the textiles or machine tool industries, which attract little or no attention. As the Manassen deal suggests, there is growing interest in Western consumer businesses.

"Chinese firms have begun to invest in more than just mine- and mineral-based assets in Australia," says Cameron Buchanan, managing director at CHAMP Private Equity. "Food is a key industry they are interested in. They are comfortable with primary product assets like sugar, protein and dairy as well as consumer goods."

Bright Food is expected to take some of Manassen's brands - which include Jelly Belly Jelly Beans, Margaret River Dairy and Angas Park dried fruit - and launch them in China in the premium segment, leveraging demand for better-quality products among an increasingly affluent consumer class.

However, the Chinese firm may be better known for outbound deals it hasn't done than the one it executed successfully. Last year, it reportedly abandoned a $3.1 billion bid for Britain's United Biscuits, owned by Blackstone Group and PAI Partners, and then in January it walked away from negotiations with US vitamin retailer GNC Holdings over a purported $2.5 billion deal. Last July, Bright Food lost out in the bidding for Sucrogen, CSR's sugar and bio-ethanol business, which was bought by Wilmar International for $1.88 billion. And in March, PAI Partners opted to sell its 50% stake in yogurt brand Yoplait to US firm General Mills for an enterprise valuation of $2.2 billion, despite Bright Food making the largest offer.

It is unclear how far the Chinese company pursued these acquisitions; it's quite possible that the sellers wanted a high price and Bright Food ended its interest at an early stage. In this sense, failing to reach an agreement doesn't necessarily equate to a failed deal. "People show Bright Food many deals because it is a prominent company in China and increasingly outside of China as well," says Rowland Cheng, Shanghai managing partner at Latham & Watkins, who represented Bright in the Manassen deal. "It looks at many transactions we never hear about."

But, taken together, the reports do suggest potential weaknesses in Chinese firms' acquisition strategies, particularly concerning the auctions by which many large assets come to market. These weaknesses - as well as most others that hamper the pre- and post-acquisition process - are ultimately rooted in marked differences in corporate culture.

According to one lawyer who is familiar with Bright Food and Ares Management - which alongside Ontario Teachers' Pension Plan considered selling GNC to the Chinese firm - it would be difficult to find two more different companies. While Bright Food is conservative, has strong ties to the government and pursues strategic interests that go beyond the commercial sphere, Ares is process-oriented, methodical and talks the language of professional US investors.

"Bright Food has people who are familiar with M&A but it doesn't have the equivalent of a business development unit, like Nestle," the lawyer says. "And then there is a Communist Party committee active behind the scenes."

Bright Food didn't secure Manassen through an auction - the company made initial inquiries, then went in pursuit of other assets before returning with a formal approach toward the end of last year - but some of those involved in the transaction, who asked not to be named, recall a slow and frustrating process. They say the internal bureaucracy was so wearing that it is difficult to see Bright Food ever achieving a high M&A success rate when pitched against more sophisticated and nimble rival bidders.

"Chinese companies that get drawn into auctions are often unfamiliar with the target business and they respond slowly," says Anthony Siu, head of Asia investment banking at Robert W. Baird & Co. "They are unwilling to be aggressive and so they lose out in the bidding." He adds that Baird tries to overcome these issues by taking deals to potential Chinese buyers a good year before the assets are put up for sale, giving the companies time to familiarize themselves with the business.

Even then, there is no guarantee that Chinese firms will play by the generally accepted rules. A common complaint is that the country's corporations eschew using transaction advisors because they want to save money and don't fully appreciate how third-party assistance can add value. Unfamiliarity with the auction process leads to confusion. In one instance, a Chinese company added another investor to its bid ticket without informing the selling party. Advisors ultimately found out what was going on through informal channels and the Chinese firm was disqualified because the seller had a conflict with the proposed co-investor.

Commons sense approach?

Transaction advisors also recall regularly eliminating Chinese bidders because their offers were too low, but this is not necessarily a bad thing. Vivian Tsoi, an M&A partner for White & Case in Beijing, thinks companies have learned from past mistakes when large sums were paid for large assets that were hard to digest.

TCL Corp.'s acquisition of Thomson's consumer electronics business in the mid-2000s is probably the stand-out example of a transaction gone wrong. In contrast, prior to acquiring Volvo, Geely's major outbound deal was Drivetrain Systems International, a relatively small-scale Australian auto transmission developer that offered the Chinese company a means of filling a gap in its technological expertise.

"Chinese firms are now using better methodology and moving toward more technical-oriented transactions," Tsoi says.

Exercising due caution is advisable in situations where advisors include the deal originator, who stands to make a substantial financial gain if the transaction goes through, is also serving as an advisor.

One China-based advisor recalls working on a mining resources deal in which the seller refused to disclose information relating to an accident that occurred at the mine. The situation potentially exposed any acquirer of the asset to financial and other penalties. The financial advisor and deal originator played down the situation, but the Chinese firm was spooked and walked away from the deal.

Bob Partridge, head of Greater China transaction advisory services for Ernst & Young, agrees that Chinese firms' slower approach arises, at least in part, from a desire to focus on the details and not be caught overpaying for assets. But he notes that Chinese companies are responding to this by building stronger relationships with target companies. Ernst & Young's Detroit team is currently working with a state-owned enterprise on an auction-based transaction and, although the Chinese party is the least experienced of the bidders in this situation, the US seller is still interested because the SOE submitted a strong long-term strategy for developing the business.

In addition to a buyer's M&A track record, potential holdups created by the need for Chinese regulatory approvals are a headache for sellers. While approvals are usually required from the target country's government as well, the opacity and unpredictability of the Chinese system can cause problems. Partridge warns that companies that fail to engage regulators early on and win support risk disappointment further down the line.

Generally speaking, the Chinese government is uncomfortable with two situations. The first is deals that come out of nowhere and attract considerable public attention, thus putting the spotlight on regulators. This occurred in Sichuan Tengzhong Heavy Industrial Machinery's doomed bid for General Motors' Hummer brand in 2009. The second is situations in which private enterprises compete against SOEs for assets.

"The amount of Chinese outbound we are seeing is just so high - we are seeing acceleration in deals and maybe it's more lasting," says Patridge. "The negative is that regulators are trying to shut out private enterprises."

Sellers can try to protect themselves against these risks by insisting on a break fee clause in the purchase agreement, whereby the Chinese firm agrees to pay compensation if the deal flounders. The M&A participants and advisors who spoke to AVCJ were divided as to the effectiveness of this approach. According to one source familiar with the CHAMP-Manassen deal, the "only way" the PE firm would have agreed to proceed is if a large sum had been deposited in an Australian account that could have been called upon in the event of a breakdown.

Others contest that demanding a break fee may alienate prospective Chinese buyers on future deals as well as current ones. It might also be paltry consolation should a transaction fail. "If you have exclusivity with a Chinese buyer and the deal doesn't go through, you might have the break fee but what happens next?" asks Baird's Siu. "How likely is it that you can go back to the other bidders and get them to pay the same price?"

David Xu, a Beijing-based transactions and restructuring partner at KPMG, notes that any break fee clause must be accompanied by a specific explanation of why it is there. The purchase agreement must be inspected by the Chinese authorities and they would not approve it if the foreign seller cites uncertainty over Chinese regulatory approval as the reason for the clause.

"I have seen so many sellers try and include a break fee clause tied to this reason, and it never works," he says.

PE opportunities

There is precedent for private equity firms participating in Chinese outbound investment. In 2007, Blackstone Group paid $600 million for a 20% stake in China National BlueStar, a subsidiary of China National Chemical Corp., with a view to helping it become a fully fledged multinational. The company had already bought French animal nutrition firm Adisseo Group and, with Blackstone's support, further acquisitions were completed, such as Australian chemical firm Qenos in 2008 and Norway's Elkem earlier this year.

TPG, Newbridge Capital and General Atlantic (GA) managed to participate in what is perhaps still the best known Chinese outbound deal: the purchase of IBM's PC division by Lenovo for $1.75 billion in December 2004. The private equity firms came on board a year later via a $350 million capital injection that was partly used to fund the IBM acquisition.

Ernst & Young's Partridge, who worked on the transaction, describes it as the right move at the right time; Lenovo negotiated favorable terms with TPG, Newbridge and GA and saw added value in having the support of global PE firms as it faced the challenging task of acquiring an asset larger than itself. "You just didn't have the abundance of capital Chinese companies have now," Partridge says.

Although there is much talk of replicating the Lenovo model, there are few examples of deal execution. Industry participants point to the fundamental mismatch between the strategic outlook of a corporate investor and the short-term financial gains-focused approach of a private equity firm.

If there is a prevalent trend, it is PE firms picking up assets that could feasibly be exited to Chinese strategic investors as an alternative to going public. This is particularly apparent in Australia, where investments are being made into agriculture and livestock assets.

In March, Archer Capital purchased Brownes Foods, Western Australia's leading dairy products firm and, four months later, Paine & Partners took 50% of fresh produce firm Costa Group. Wolseley Private Equity and Catalyst Investment Managers both own fruit and vegetable firms, Freshmax and Moraitis Group, respectively. Two years ago, Terra Firma bought Consolidated Pastoral Company, Australia's second-largest beef producer.

"There is a ‘protein' theory - you buy low-cost, high-quality sources of food and build a platform that can be sold to developing nations that need food security. We receive quite a few unusual inquiries from offshore about gaining access to basic food-type businesses," says KPMG's Thompson. "Their number one exit would be China, India or the Middle East. That's what they are writing on their investment proposals."

 

Sidebar: Integration issues

The objective of many Chinese outbound deals is the accumulation of know-how. This is often highly process-oriented: Understanding how to use a German-made machine tool technology in an efficient manner could knock several years off a company's product development timeline and knock millions of dollars off its cost base.

"In one particular case, a private enterprise in Jiangsu province was looking at a small machine tool business in Germany," says David Xu, a Beijing-based transactions and restructuring partner at KPMG. "The Chinese entrepreneur said that if the company developed the processes internally it would take 30 years. But if it acquired the German business, it could apply the processes in China in the space of six months."

If a company's strategy is to replicate a foreign factory in China - for many of the smaller deals that dominate Chinese M&A landscape in terms of deal volume, this is exactly what happens - integration seems easy. But it's not.

Transferring assets overseas may cause problems with local authorities that fear job losses, or it might trigger an international tax event that makes the effort so costly it isn't economically worthwhile. And that is before you get to the staffing issues - retaining and relocating skilled workers that are required to implement the new processes and technologies and then meet the severance and pension obligations of those who are let go.

Josephine Chow, M&A consulting business leader for mainland China and Taiwan at global professional services firm Towers Watson, recalls a deal failing last year because the prospective state-owned enterprise buyer wasn't familiar with the pension commitments involved.

Where the assets being transacted are less tangible, such as brands, standard practice is to keep the existing management in place, often by cutting them into the business or tying bonuses to length of tenure. In the case of China Bright Food Group's acquisition of Manassen Foods, CHAMP Private Equity, the founder's family and company management will hold a 25% stake.

Nevertheless, Marco Kaster, M&A advisory leader for Asia Pacific at Towers Watson, thinks some Chinese companies just don't act fast enough. "I went to see a Chinese company three months ago that had just made an acquisition overseas. After about five minutes they started talking about a smaller acquisition they made three years ago. It was only at this point - three years down the line - that they began to think about how they could make the entity work with their Chinese business."

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• Topics
• Greater China
• Australasia
• Exits
• Investments
• Pacific Equity Partners
• CHAMP Private Equity
• Unitas Capital
• The Blackstone Group
• Newbridge Capital
• TPG Capital
• General Atlantic
• Archer Capital