April 1, 2016    8 minute read

Is Chinese M&A Easing Capital Flight?

   April 1, 2016    8 minute read

Is Chinese M&A Easing Capital Flight?

Perhaps we may all have heard about the scenario where China would need to make a hard landing over a soft one. According to the billionaire investor George Soros, “a hard landing is practically unavoidable.” These words are markedly in contrast with those pronounced by Li Keqiang, the Chinese Premier, at the end of China’s National People’s Congress (NPC), which is a meeting of Parliament held every year, reassuring that there will be no hard landing as long as structural reforms continue to be impactful. 

A Way Out?

One possibility of navigating away from a hard landing is through M&A.

“Whether they are big or small, all Chinese companies have high needs of overseas assets”

Ronald Wan, Chief Executive of Partners Capital International

There are some reasons for this. One of which is that investors are scared that the RMB may further depreciate despite the PBOC Governor, Zhou Xiaochuan’s reassurances. Under these circumstances, US fixed assets providing a steady cash flow and foreign property sector are the ultimate choices to survive the volatility that has stricken equities in Mainland China. Although Anbang recently pulled out of the potential acquisition of Starwood, it does nevertheless exemplify the latest example that can explain the trend of the general Chinese investor sentiment. And how much do investors gain out of these offshore deals? 

Several bidders have been reported to finance their acquisitions through an unsustainable debt load. To these observations, it is legitimate to raise questions about whether the activities are part of a genuine plan to enforce ingenious corporate strategies or just a creative method to funnel money out of the country, designing a win-win situation for both the company (hopefully increasing sales and lowering costs) and the PRC government (meeting growth targets). Evidence would point to M&A as an instrument improperly used due to insufficient capital discipline regulations.

Another case that spurred much outrage was the China National Offshore Oil Corporation, better known as CNOOC, takeover of the Canadian oil giant Nexen for about $15 billion in 2013, paying a high premium of 60%. However, synergies have not yet been realised, predominantly due to different corporate cultures and to the steep fall in oil prices.

Italian Sale Period

As if the world was a shopping centre and China was an avid consumer of luxury goods that has to own everything even if it is a small accessory, Italy has naturally come across as a jewelry store in which every piece is just so alluring. State Grid, in fact, acquired 35% of Cdp Reti which also owns 30% of Terna and Snam for €2.1 billion. Bright Food bought the group Salov, famous for its olive oil sub-brands Sagra and Berio and soon after the Italian Strategic Fund gave away 40% of Ansaldo Energia to Shanghai Electric Corporation for €400 million. ChemChina possesses now Pirelli, the world’s fifth-largest tyre manufacturer, for €7 billion. Some necklaces were also bought this time by People’s Bank of China, that has an extensive portfolio containing a 2.1% of Eni (11th largest industrial company) valued at €1.4 billion, 2% of Enel (biggest Italian manufacturer and distributor of electricity and gas) valued at €750 million, €330 million of Telecom, €280 million of Fiat and around 2% of Prysmian (manufactures electric power transmissions and telecommunication cables and systems) valued at €70 million.

The transactions were completed in just one year and since then China has moved on to other shops. According to the Chamber of Commerce of the PRC, only in the first semester of 2015, €32 billion was spent on foreign investments and 75% of these were invested in equities of 2,766 enterprises in 146 countries, which means that the average stake was very small raising again questions on how China Inc would gain from these ventures.

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(Source: Telegraph)

Competitive Field

On a different note, capital flight could also partially explain the reasons behind the current football industry sky-high transfer fees not to mention the highest salary offers that the sector has ever seen. Mario Balotelli, the Italian striker for AC Milan, on loan from Liverpool has been offered €15 million (which would actually place him to be the 8th highest paid footballer of the year) to play for Jiangsu Suning FC, a club backed by one of the largest retailers, B2C Suning Commerce Group, that has an R&D Center in the US. 

More surprising is the transfer of Jackson Martinez, previously with Atlético Madrid, on which occasion Guangzhou Evergrande FC disbursed €42 million.

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(Source: FT)

 

These may all seem legitimate business transactions, but let us take a look at the capital structure of Guangzhou Evergrande FC. The ownership is shared unequally by Alibaba and Evergrande Real Estate, with the latter having 60% of the stake. However, Jack Ma has thought well of getting a minority stake in the Evergrande Group, which would allow him to increase his influence within the football club, winning him a spot in the club’s name: Guangzhou Evergrande Taobao FC. Now, given that all this interest in foreign assets has met the favor of President Xi Jinping, who yearns to see a competitive China in different sectors including football, other than the decadent manufacturing, investors may be presented with the perfect opportunity to exploit his desires and successfully satisfy individual interests. 

According to Deloitte, Chinese Super League (CSL) clubs spent more than $280 million during the winter transfer window, more than in any other league, including England’s Premier League. Raising one more time questions on how the investment is worth the money paid, since many are skeptical already about how to recoup the big money paid by the CSL clubs.

The Escape

The recent stock rout that erased almost $4.6 trillion in market value after a seven-year high on June 19 in combination with a depressed real estate market in Mainland China has not left many choices to the PBOC than to cut rates to boost confidence and sustain an already declining and disappointing the stock market. This monetary expansion can be said to have been successful, just not where the Government wanted it to be.

In fact, Chinese nationals were armed with loads of cash to escape the country together with their capital. The array of destinations that they could choose from is embarrassing. Portugal has been one of the most recent countries to have created a Golden Visa program for individuals who have at least €500,000 of disposable income to invest in exchange of a permanent residence. In Toronto, the most populous city in Canada, they experienced an average property price of $1,963.278 due to extensive real estate purchases by the Chinese, compared to Vancouver’s average price swiftly catching up with a detached home in the city jumping 30% in February from last year’s level which also welcomed Chinese investors.

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Some global cities have resorted to drastic measures to curb this phenomenon such that in San Francisco, HSBC announced that it would deny the request of mortgage to some Chinese citizens interested in buying real estate in the US, given that they have spent $28.6 billion in properties alone. 

Meanwhile in Shanghai, it will be more onerous for non-residents to own property. In fact, if one is not in possession of local residence permits, the buyer will have to wait at least five years after they move to the city to be able to conclude a deal, up from two years as per previous regulations. Additionally, the new rule to prevent a potential housing bubble expects second home buyers to pay a down payment of 50-70% of the home price.

It seems that Chinese capital is not able to find a stable market to stay and grow. The irrational spending that characterises both the retail investor and the Chinese government has to be controlled and limited smartly with tailor-made regulation.

Bottom Line

The peculiarity of Chinese acquisitions is that very often they are state-backed which allows the nonsensical bids, commercially speaking. In fact, the purchase by ChemChina of Syngenta for $44 billion was dubbed as a pre-planned deal between the Chinese state and a Swiss company and not between two commercial companies. In the hope that all the coveted reforms, promised by the Premier Li Keqiang, come to a realisation, large improvements should also be made to change the unhealthy lifestyle that the Chinese financial industry is conducting. This is especially the case as Li Keqiang has pledged that China will invest at least $1 trillion over the next five years, making China the second largest global investors after the US. 

This declaration should make even more impelling the implementation of regulations that impose greater capital discipline to protect the current together with the future acquisitions from unpolitical results. 

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