Chinese outbound M&A has had a record year in 2016, with 372 deals worth $206.6bn, according to Mergermarket data. The cumulated deal value has doubled from 2015’s $94.4bn, with the deal volume increasing by some 20%. The surge in deal value primarily relates to significantly larger transactions in North America and Europe, with a 223% rise in Europe and 558% in North America, according to global law firm Clifford Chance.
The increasing flow of Chinese outbound M&A activities is due to Chinese companies’ continued pursuit of technology, market growth and diversification. However, it has become increasingly challenging for Chinese companies to do deals overseas.
Previously, the key challenge was the lack of cross-border M&A experience in handling deal dynamics and complex negotiations. As large Chinese acquirers enlist the services of high-profile M&A advisors, lawyers and accountants, the level of sophistication in deal negotiation and bidding approach has generally been enhanced.
Chinese buyers have also been developing and are starting to demonstrate their ability to manage the acquired companies post deal, which may require restructuring, capital injections or credit rating improvements.
New challenges are now surrounding how the Chinese acquirers can make it to the finishing line post signing, given the heightened regulatory hurdles and market policy restrictions from regulators both in foreign markets and back home. In any case, $35.6bn worth of Chinese companies’ bids failed in 2016, according to Thomson Reuters data. That compares with a mere $2bn of failed bids in 2015.
Growing Protectionism In The West
Foreign regulators have increasingly scrutinised Chinese M&A efforts, often citing antitrust and national security concerns.
The state-owned China National Chemical Corporation’s (ChemChina) proposed takeover of Swiss crop protection and seeds group Syngenta for $43bn, if completed, will be the largest Chinese cross-border deal to date. While ChemChina has recently received green lights from the Committee on Foreign Investment in the United States (CFIUS) and Australia’s Competition and Consumer Commission (ACCC), the high-profile deal is still awaiting for an antitrust decision from the European Commission (EC), due April this year. The EC may rule that ChemChina must divest certain overlapping assets, but given the nature and size of the transaction involving a Chinese state-owned company, if successful, this will be a major milestone for China’s outbound investments.
In addition to antitrust issues, national security concerns are particularly prevalent in deals involving high-tech companies, which attracts a lot of attention given Chinese government’s strategic plan to promote the development and growth of China’s technology industry.
There are cases where governments are influencing deals outside their own jurisdiction over national security concerns. In December 2016, President Barack Obama, following a CFIUS recommendation, extraterritorially blocked Fujian Grand Chip from completing a deal with German semiconductor company Aixtron because the acquirer was backed by a Chinese government-supported investment fund. This executive power has rarely been exercised and thus far, all three of Obama’s presidential actions under CFIUS have involved Chinese buyers.
With Donald Trump’s inauguration as US president and elections being held in the larger European Union member states in 2017, potential populist governments may lead key Western economies into economic protectionism, which may add further scrutiny to inbound M&A activities.
This heightened uncertainty will likely slow Chinese’s outbound M&A activities into these economies.
However, not all hope is lost, since such protectionism effort will require strong, well-financed regulators with expertise in dealing with complex and cross-border deals, these same governments may see challenges in curbing the hugely unpopular bureaucracy that is also often part of their campaign promises.
New Regulation And Policy At Home
The upsurge of Western protectionism is not the only threat to the wave of China’s outbound acquisitions.
Amid the depreciation pressure on the renminbi and the eroding foreign currency reserves, Beijing is taking action to stop Chinese companies from using outbound direct investments (ODI) to move large amounts of capital offshore, especially for financial interests that are non-strategic in nature. A Ministry of Commerce spokesman stated in December that the authorities will put a cap on irrational and non-strategic investment such as real estate, hotels, entertainment and sports.
South China Morning Post also reported in December that the central bank put monetary thresholds on overseas transactions: outbound investments above $10bn, mergers and acquisitions of more than $1bn outside a Chinese investor’s core business and foreign real estate deals by SOEs involving more than $1bn.
In support of the wider government effort, China’s State Administration of Foreign Exchange (SAFE) has begun vetting any overseas transfers over $5m. It has also signalled that it is increasing scrutiny of major overseas acquisitions and will crack down on deals that it deems speculative in nature. Strategic acquisitions in targeted industries as per the government’s strategic plan, or acquisitions that have synergies with the buyer’s business at home, will continue to be encouraged.
It is too early to say how stringently will these measures be enforced. However, these new policies will likely to deter smaller newcomers to the global deal-making scene, especially those aiming to make acquisitions not directly linked to their core business or those who cannot provide satisfactory details on the sources of their funding.
Furthermore, the additional time required to obtain SAFE approvals, which has already increased from two to three months at the beginning of 2016 to four to six months towards the end of 2016, will put Chinese dealmakers at a disadvantage at the negotiation table, especially in auctions.
Outlook For 2017
Chinese companies’ desires to conduct cross-border M&A are expected to continue, although regulatory and policy roadblocks will likely cause delays in the deal process and may reduce the likeliness of successful deal execution, especially for large deals in strategic industries.
Given the increased uncertainty surrounding Chinese M&A bids, overseas sellers are likely to demand higher break-up fees as insurance against deal failure and to ensure the Chinese bidders are confident about their ability to close the transactions. The market is already seeing sellers seeking 10-15% of the deal value as a break-up fee compared to low-single-digit fees in some of the earlier deals.
To reflect the extra risks, the deals that are signed may also require larger premiums and upfront payments. In addition, the deal value will also be impacted by overall funding costs, as Chinese banks will increasingly find it hard to finance large overseas deals.
In 2017, the uncertainty, regulatory roadblocks and potentially reduced returns could deter some of the smaller, weaker Chinese companies from conducting acquisitions overseas. Companies planning to acquire overseas targets in the Chinese government’s designated strategic industries will likely continue to receive strong support from the state.
Through their recent experience in expanding and operating within a competitive global landscape, Chinese companies have shown to be nimble and will no doubt learn to navigate the ever-changing political and financial scene to complete larger and more strategic overseas M&A transactions.