China M&A builds up steam

Paul Chow, partner with international law firm Linklaters in Beijing, observed:

"I think you'd have to consider the inbound and outbound segments quite separately. With the former – meaning foreigners coming in to acquire strategic stakes in Chinese companies – the pace was off substantially earlier in the year. Clients from outside Asia, particularly from Europe and the US, were all dealing with their own problems at home. So nobody was much interested in doing M&A over here. That's changed recently, though. We're starting to get instructions and more inquiries from western businesses again.

"In the outbound segment, however, there wasn't much evidence of a GFC impact. Rather it was the other way round. Valuations went down, making it and much more attractive to invest and make acquisitions overseas. A key driver in this is the big, ongoing imperative to secure natural resource supplies. That's because China's growth story continues: meaning, they are very acquisitive. Also you've got organizations like CIC who are keenly interested in making a lot of overseas investments."

Recent evidence is their $2.2 billion investment in US power producer AES Corp.

All systems go

Other advisors polled by AVCJ took similar views.

Michael Cho, M&A head for Asia with Bank of America Merrill Lynch, is even more bullish.

"The volume of outbound China M&A deals in 2009 is stronger than last year's levels. The energy, power and natural resources sectors have been particularly active. And that trend toward outbound activity from China will continue to be strong into 2010.

"Third quarter M&A volumes in the region were up 26% over the same period in 2008, and that's a pretty good indicator that the trend moving into next year is upwards. There are plenty of discussions going on, and next year will see a more normalized level of activity across the sectors."

His confrere Ed King, head of Asia M&A with Morgan Stanley, concurs:

"In 2008 we saw a significant decline in global M&A due to the financial crisis, but M&A activity in China remained robust as cash-rich Chinese companies, supported by their domestic banks, aimed to secure overseas natural resources. This year, the main theme for China M&A is the resources sector. Overall, China M&A volume YTD is about $90 billion, on par to reach last year's historical all-time peak on an annualized basis," he told AVCJ.

He also notes the strength seen in the natural resources segment of the outbound sector, but adds:

"We've also seen many Chinese corporates making acquisitions to boost branding or to gain access to technology and branding. In the medium-term, similar to Japan's experience as it industrialized and modernized, we will see a greater proportion of deals in sectors relating to consumers, e.g. consumer electronics, automotive, biotech, health care and so on."

On the inbound side, he likewise sees expanded opportunities in infrastructure, clean technology and healthcare.

The statistical evidence

In terms of mainland China, AVCJ's numbers back these views. Back in 2006, aggregate deal value was pegged at $56.4 billion on the strength of 1,419 transactions. By 2007, though actual deal numbers were off by a third to 1,061, value had doubled to $110.2 billion, subsequently rising even higher to $119.4 billion in 2008 via 1,850 deals; but in the first nine months of 2009 it had backed off somewhat to $83.3 billion over 1,149 deals. Still, if the strong finishing kick noted by our sources materializes, there could be little to choose between this year and last in terms of performance.

"We saw a significant increase in China M&A volume in 2008 compared to 2007," King recalls. "But you also have to keep in mind that 2008 was a unique year, because volume was skewed by restructuring among Chinese telecoms and also Chinalco-Alcoa's investment in Rio Tinto. The year 2009 may not top 2008 in terms of volume, but it will still be a great year for M&A. And so over the next six months, with China's economy advancing and the government's continued stimulus effort, as well as a recovering global economy, we expect deal volume to hit new highs in the near future."

Of interest, this same bullish trend is not evident in a Greater China context. Comparably, Taiwan recorded $13.5 billion on 117 deals back in 2006, and virtually the same amount, $13.4 billion via 133 deals the year following, only to drop markedly to $5.7 billion on the strength of 106 transactions in 2008, and slip even further to $3.2 billion via 39 deals so far this year. A similar trajectory is evident in terms of Hong Kong activity: $21.1 billion over 264 deals in 2006, $28.5 billion via 346 deals in 2007; spiking to $41.2 billion through 286 transactions in 2008, then plunging to $11.7 billion via 207 deals so far this year.

Domestic private equity prominence

What is particularly interesting, however, is the degree to which a pair of the bigger transactions reflect the newest development in the Chinese M&A and private equity market, namely the rise of the prominent new domestic players best exemplified by Hopu Investment Management, which counts Goldman Sachs as its most prominent investor and is headed up by their China Partner, Fang Fenglei. The other new player of note is Hony Capital.

Hopu played a leading part in two of the three top PRC M&A deals that figured in the regional top ten.

In May 2009, a group of investors led by the Hopu Fund acquired a 5.8% interest in China Construction Bank (CCB) previously held by Bank of America. Bank of America was under pressure at home to raise capital and so sold the stake at a 14.3% discount to the bank's stock market trading price at the time.

The transaction broke into two parts: A 3.6% stake purchased by Hopu and Temasek Holdings of Singapore for $4.6 billion; and a further 2.13% stake acquired by BOCI Asia and China Life Insurance for $2.69 billion.

Earlier in the year, in January in a similarly opportunistic investment, Hopu Investment Management acquired approximately 30% of Royal Bank of Scotland's $2.3 billion stake in Bank of China (BoC). This amounted to the Chinese firm's second investment after raising $2.5 billion from investors such as Goldman Sachs and Temasek Holdings in 2008. Bank of China's shres had lost some 44% of their market value over the course of 2008.

But an important question is to what extent are these bold moves by domestic Chinese private equity players a harbinger of things to come? Very much so, our sources say.

Comments Linklaters' Paul Chow: "I think there will be more and more of them coming to market, although they might not all be as ambitious as Hopu or Hony, who are very well established with good-pedigree, bluechip investors. The problem with this country is that while there is a lot of money floating around, there are not that many channels for people to invest. You've got the stock market, but that's only been a factor for the last couple of years. And nobody wants to put their money in the bank. So therefore there is a huge and growing demand for private equity."

And that, he reckons, will spawn any number of new private equity players from basic, informal bucket shops with a fund manager and some enticing stories that people basically throw money at, all the way up to the top tier.

Jeanette Chan, partner with US-based international law firm Paul Weiss adds:

"The government has been trying to build up a strong domestic private equity sector to counter the influence of the foreign private equity players. Also, with the economy growing at such a rapid rate for the past two decades, China has a lot of rich individuals who have the RMB to fund these private equity operations."

And where do the foreign private equity players fit in this increasingly complex mix? One hears that they are up against very heated competition, due in no small part to competition from Chinese banks.

Jeanette Chan confirms this is true:

"SOEs tend to prefer domestic loans since they are readily available and no government approval is required for SOEs to borrow from domestic banks. Also the Chinese government's stimulus plans have provided with a lot of funds to lend to SOEs, whereas investments by foreign private equity funds are subject to government approval and that is time consuming and possibly more expensive. That's why the foreign funds are setting up RMB funds so that they can be more attractive to Chinese companies."

Morgan Stanley's Ed King agrees:

"In terms of financing from Chinese banks, SOEs have certainly enjoyed an advantage that has helped them win deals. However, I believe that international private equity firms have many advantages as well – such as brand recognition, management expertise, ability to assist with international expansion, to name a few. And if these firms can leverage those strengths, they can still compete successfully with Chinese SOEs.

Bank of America Merrill Lynch's Michael Cho echoes this view:

"Private equity investments will still be highly competitive, but as the lending markets come back, that will help to ease the pressure."

 

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• Topics
• Greater China
• Hony Capital