PRC M&A in the spotlight

With 2009 M&A levels trimmed from their 2008 heights, but hardly critically so, the omens are good for a full-year China M&A total that could come respectably close to the all-time highs of recent years. Meanwhile, regulatory changes such as the final issuance in July 2009 of the long-awaited regulations on examinations and notifications of mergers by the Anti-Monopoly Bureau of the Ministry of Commerce (MOFCOM) have given greater certainty to M&A transactions. Yet, as doubts rise over the sustainability of China's post-crisis stimulus-engineered recover, questions linger over the present character and future direction of PRC M&A.

Themes and drivers

China certainly continues to enjoy strong international M&A profile. "In China, vast growth potential continues to draw overseas acquirers; local entities continue to be enticing as a way to enter geographic markets; and while the government still has a hand in cross-border M&A, the environment increasingly favors deal activity," maintains Anthony Siu, Managing Director with RW Baird in Shanghai.

Ji Zou, Partner with Allen & Overy in Shanghai cites market consolidation, further expansion of business, and government-orchestrated exercises as major domestic drivers for M&A. The latter, according to AVCJ sources, include consolidations and restructurings aimed at maintaining high employment and social stability, especially in an export sector still reeling from the falloff in demand from the West.

Drivers for outbound M&A include further industry consolidation and acquisition of distressed or undervalued assets, or even insolvent businesses, according to Zou. With many Western businesses in distress or under debt burdens, China's well-capitalized companies, supported by stimulus-driven domestic lenders, are often in a comparatively favorable position for acquisitions.

"China has become one of the most active acquirers in the cross-border M&A arena," adds Siu. "This reflects the underlying strength of Chinese companies and confidence about the markets. China-based companies are likely to pursue cross-border acquisitions that provide access to new markets, valuable resources, technology expertise, and leading brands."

However, problems often arise at the intersection between domestic Chinese and international regulation. In particular, accepted formulae for effective execution worldwide may not work so well in a China context. "Typical commercial terms and arrangements in international M&A may be subject to regulatory restrictions: e.g. the timeline and mechanics of payment of consideration, earn-out, statutory hurdles, etc.," warns Zou.

Sectors of preference

As the data tables show, financial services and utilities have topped the 2009 M&A statistics, sustaining a strong performance from financial services in 2008, but trimming back the predominance of telecoms deals in the previous year. In fact, financial services delivered almost $40 billion from 243 transactions in 2008, and over $25 billion from almost 150 deals in the first three quarters of 2009. Utilities, up from just under $7 billion off 79 deals in 2008, produced almost $19.5 billion from 58 deals in 1-3Q09.

The key drivers in utilities were China's insatiable appetite for new resources and capabilities to support its growth. "In China, the number of mining, utility and energy deals is increasing as industry players attempt to obtain rights to critical natural resources needed for China's extensive industrial operations, energy production, and growing population," as Siu asserts.

Mining and metals, naturally, continue to be another priority focus. "State-owned firms, the central bank, and China's sovereign wealth funds have focused on investments in the resources sector," Siu avers. Also, he adds, inbound investors may find a more favorable reception if they heed the government's sectoral priorities. "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 also have been prioritized as growth categories."

An overall government leaning towards the consumer sector plays well alongside the preferences of international acquirers and private equity investors. "Outside buyers are attracted to the benefits of owning a high-growth Chinese company serving the expanding market for domestic consumption," Siu points out. "For companies targeting successful domestic businesses, China represents a fertile end-market that capitalizes on the growing middle class."

Difficulties in the China environment

Successful practitioners of M&A in China need specific execution skills and market knowledge to navigate this often-challenging environment. "Challenges still exist, including a lengthy approval process, complex integration, fewer financing sources and relative valuation differences," Siu asserts.

Ziu tallies the strengths and weaknesses of domestic advisors in China seeking to bring off M&A transactions. "They have on-the-ground experience. They have easy access to the regulators," she confirms, but among the deficiencies, she lists less network support, problems in managing deals involving more than one jurisdiction, and related to this, a lack of knowledge and experience in cross-border deals.

Key concerns in managing deals in China, she adds, include "managing the client expectations: China is different," and perhaps more critically, dealing with the heavy burden of regulation in China, especially in sectors such as financial services, mining and metals, and telecoms. Finally, the long approval time needed for China deals can create problems in itself.

Siu, however, notes an increasingly favorable regulatory reception for private equity, both on the initial investment and the eventual listing exits. "Recently, China has been more welcoming of foreign private equity funds, due to the related job creation. As a result, financial sponsors are likely to find an easier path to approval for public listings of their China-based holdings in China's stock markets."

Furthermore, the long-expected prospect of international companies listing in China could create a new acquisition currency for global players looking to do PRC deals – domestic stock and domestically-raised capital. "If the government relaxes its rules regarding foreign companies directly listing in China, newly-listed firms would be able to use domestic capital for M&A activities," Siu adds.

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• Greater China