China M&A: Leaps and bounds

Spearheaded by a burgeoning outbound segment, in turn backed by the support and prodigious resources of the central government, it is rocketing ahead, giving rise to expectations among senior players and market observers that it will shatter the records set before the GFC next year.

As PricewaterhouseCoopers (PWC) Greater China private equity ground leader David Brown put it, “The really interesting thing is the limited effect the global financial crisis has had on China, and as a consequence, M&A activity there. The pace is now about on par with pre-GFC levels. And outbound in particular is ramping up impressively year-on-year.”

Status quo

Overall inbound and domestic activity in 1H10 rebounded by 26% compared to a 3-year low point in 1H09, though unsurprisingly this was mostly due to intra-China deal making.

Significantly, 22 of these transactions were over $500 million in 1H10 compared with 17 over the same period a year earlier. Individual deal sizes (on average) remained more or less constant, however, at around $40 million.

Robert W Baird & Co, long active in the PRC, echoed many of these findings in its own overview of the China market. It detailed a skein of macro factors likely to increas China’s already strong M&A momentum going forward.

The bedrock of these, in an inbound context, remains what it has always been: the country’s phenomenal economic growth story as set against its vast population – now spanning decades – and its still huge future potential for more of the same, after 31 years of GDP expansion with a 10-year CAGR of 9.9%.

Before 2009, China’s allure for foreign investors was proven by years of double-digit growth in inflows. That reversed by 3% across M&A and other foreign investment categories last year. But Baird reports a solid return to the upside, with 27.6% growth seen in 1H10. Nevertheless, most investments are valued at less than $100 million and only 10 transactions valued at more than $1 billion have been announced since 1999. To date, large majority control deals remain rare.

An increasing focus offshore

Unlike the PRC, China’s neighbors have felt the effects of the financial crisis and valuations have followed suit. As a result, outbound investments have become the flavor of the month. “In a broader sense, outbound is really the big story at the moment,” Brown contends. “The number and size of deals in this segment has never been as high.”

From 1H08 through 1H10, there were 59 deals collectively valued at $4.4 billion over the first six months. In the second half of 2008, this expanded to 67 deals worth $5.1 billion. In 1H09, the number of deals backed off slightly to 65; but the aggregate value of these nearly tripled to $14.7 billion. And the second quarter of last year’s numbers again showed strong growth, to 79 deals worth a total of $15.6 billion. And this has only increased in 1H10, with 99 deals valued at an aggregate $23.1 billion – a whopping 52% increase.

The big driver underlying this performance, predictably, is China’s insatiable need to secure long-term supplies of commodities and raw materials. Of the 37 deals following this trend, seven fell into the elite $1 billion plus category in 1H10, compared to just three in 1H09. The blockbuster was Sinopec’s $4.7 billion acquisition of a 9% stake in Canada’s Syncrude, divested by Conoco-Phillips. Materials demand also drove 14 announced deals in Australia, the main target, but also nine in Africa in 1H10, versus two over the course of 2009.

Funds and sponsors in action

Similarly, financial sponsor activity has remained consistent, but with a notable shift towards local RMB and other vehicles, which announced roughly three times as many deals as their foreign counterparts.

The equivalent of $5.1 billion was raised by 30 RMB funds in 1H10, an all-time high. And over the same period, the first domestic deal over $1 billion was completed when Bank of China Group Investment acquired a 14.45% equity stake in Jiyulu Railway for $1.1 billion.

Nevertheless, foreign fund interest in the Chinese market remains high, PwC claims. They acknowledge that such investors still face serious challenges in terms of identifying and closing on compelling opportunities, one reason being the stubborn sticking point of being able to secure approvals.

PwC Southern China tax leader Danny Po adds, “Foreign investment levels are expected to grow, especially in high technology, manufacturing, and those businesses which are likely to benefit from growth in Chinese consumer spending, plus new energy and environmental protection industries.”

Baird confirms that the immediate inbound attractions today are high-tech enterprises and those sectors poised to take advantage of the steady rise in Chinese consumer spending, such as retail, appliances, luxury goods and home improvement-related industries.

“M&A is a viable means of acquiring assets that are very difficult to develop internally, such as workers, brands and distribution capabilities,” the Baird report asserts. “Partnerships with local entities enable entrants to navigate China’s markets – through established distribution channels –and government regulations, which is a key issue in certain areas like renewable energy.”

Factors behind outbound

Other themes are now feeding the outbound stream, though, and not just peripherally.

“Although natural resources continues to be the priority industry target for Chinese investors overseas, a trend that is in line with the nation’s need to support the engine of economic growth, we’ve noted other industries starting to get increased attention. These include high technology, manufacturing and services industries,” David Brown explains. “Chinese investors are broadening their industry interests as well as their target regions to include the US, Japan and the EU.” And he sees no end in sight.

“With Chinese enterprises increasing interest in global markets, technical capability, production and service expertise, plus stable financial returns in mature asset markets, we can anticipate many more outbound transactions,” his colleague Danny Po adds.

These themes are echoed in the 14 high tech, 12 industrial and 7 energy and power deals completed over the same timeframe. Chinese companies are increasingly keen to use their cash surpluses to acquire machinery and equipment manufacturers in mature markets (particularly in the automotive industry). There have been 32 such transactions in North America (19 in the US), 12 in Europe and Russia Wand 27 Asia-wide (including 10 in Japan).

Marquee examples include Hui Heng Medical’s purchase of Portola Medical in the US, BYD’s acquisition of Ogihara-Tatebayashi Factory in Japan, and Geely’s $1.8 billion acquisition of Sweden’s iconic Volvo brand.

Regulation and M&A

In a country where government influence on the economy is hard to overstate, the support for M&A is supporting pre-existing trends. For example, industries previously open only to SOEs have become accessible by private investors as well.

“The ‘New 36’ sets the right tone from the top,” PwC’s Brown observes.
The Baird report notes that in the past, tight regulatory policies often restricted foreign capital M&A in favor of domestic enterprises. More recently, however, government initiatives have reduced regulations and encouraged foreign investment.

“Even with these changes, minority-interest and pre-IPO investments will remain the most viable near-term option for many foreign investors,” it says. “Tax credits and incentives are being offered to investors in sectors viewed as crucial by the government, including high tech and environmental protection. The consumer, power and manufacturing sectors have also been prioritized as growth categories.”

Loosening government controls are also increasing exit routes for offshore investors in Chinese companies. This is an outgrowth of the increasing acceptance of M&A as a tool in strengthening the overall economy, both on a cross border and domestic basis.

New private equity promise

At the same time, foreign private equity firms represent increased demand for M&A targets.

“Recently, China has been more welcoming of foreign private equity funds, not least because of the related job creation issue,” the Baird report details. “Consequently, financial sponsors are likely to find an easier path to approval for public listings of their China-based holdings in the country’s stock markets. If the government relaxes its rules regarding foreign companies directly listing in China (as is widely expected by 2011), newly listed firms could use domestic capital for M&A, enhancing exit options for sellers.”

But they add a cautionary note: targets may be less willing to sell following the decline seen in Chinese equity values. Public company valuations are a key benchmark for M&A transactions there.

In summary, positive macro-economic conditions are seen as very likely to prevail in terms of setting the tone for Chinese M&A market conditions – conditions that are not replicable in any other global market. There’s staying power. 

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• Topics
• Greater China
• Performance