China outbound M&A: Within the rules

A hypothetical checklist for a private equity firm working with a Chinese corporate on an outbound acquisition might include some of the following: 1) Pick a partner you know well; 2) Target an asset that is relevant to the partner’s core business; 3) Make sure that partner has a presence and/or capital overseas so the regulatory approvals process is easier; 4) If unable to fulfill the criteria in point three, establish whether the partner has relationships that can be leveraged; 5) Highlight a One Belt, One Road (OBOR) angle in any submission that needs to be made to Chinese regulators; 6) Have a means of exit.

CITIC Private Equity appears to have checked the first three boxes with its acquisition of Canada-based Therapure Biopharma’s contract development and manufacturing (CDMO) business, which is being executed in conjunction with 3SBio. The GP has been an investor in 3SBio since 2013. The CDMO asset represents a logical addition to 3SBio’s business, which it is seeking to make more international. 3SBio is listed in Hong Kong so its capital is not locked in the mainland. CITIC PE also has a way out: the GP can sell its stake to 3SBio on pre-agreed terms after four years.

Points four and five are therefore less relevant in this case, but they might be worth considering by other private equity firms backing outbound deals, particularly in the light of new guidance on overseas M&A released by Chinese regulators. The guidance reinforces the existing government policy of cracking down on irrational transactions – where companies make lavish bets on assets that have little in common with existing operations – as well as offering insights into which sectors might be favored.

Chinese corporates have committed $82.5 billion to 226 outbound deals so far this year, compared to $204.1 billion across 282 transactions for the whole of 2016, according to Mergermarket. Capital controls remain in place and banks have been warned about supporting deals launched by a handful of profligate companies, but OBOR deal flow continues to increase even as broader M&A activity slows.

OBOR features prominently in the section on “encouraged outbound investments” in the document published last month by the National Development & Reform Commission, Ministry of Commerce, People’s Bank of China, and Ministry of Foreign Affairs. Transactions will also likely be looked upon kindly if they offer exposure to foreign technology and manufacturing expertise, help export Chinese production capacity, contribute to the country’s resources and agricultural needs, or play a role in general industry upgrades.

Other investments are classified as restricted or prohibited. The former category includes sectors like real estate, hotels, cinemas, entertainment, and sports – all of which have received plentiful Chinese capital in recent years. Furthermore, outbound investment funds will be restricted if a specific industry project is not cited. It remains to be seen how widely the net will be cast in bringing supposedly “normal” sectors under the restricted umbrella, how long the approvals process will be, and what documentary evidence must be submitted.

While deals involving New York hotels and English Premier League football clubs are not off limits, strictly speaking, they will be subject to a lot more scrutiny. On the other hand, a logistics transaction in Southeast Asia would likely encounter a smoother approvals process – which is why some prospective buyers might try and play the OBOR card.

For private equity firms partnering Chinese corporates on outbound deals, typically participating in a minority capacity and providing capital and expertise, selection will become a lot more important. They must ask themselves whether their partners have the domestic credibility, the ability to bring capital offshore, and the executional capabilities to get deals done.

Plenty of transactions currently in the pipeline may fall through, but at the same time new opportunities will open up – working with corporates on encouraged deals or going solo elsewhere. A GP with an offshore fund is not subject to the same restrictions as Chinese groups with renminbi-denominated assets, so it may find there is less competition for deals than before. And they still have scope to leverage relationships with Chinese corporates, potentially positioning portfolio companies for future trade sales, if and when the regulatory focus shifts.

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• Topics
• Greater China
• Regulation
• GPs
• China
• M&A