Key drivers behind the trend
Global mergers and acquisitions (M&A) set a record in 2015 with transaction volume reaching nearly $5 trillion, driven by the globalization of the M&A market and the emergence of Asia Pacific as a key player in it. Asia Pacific companies’ appetite for M&A has increased due to a range of macro factors, with overall Asia Pacific M&A volume approximately doubling from $748 billion in 2013 to $1.5 trillion in 2015.
Chinese buyers are playing an increasing role in Asia Pacific M&A activity, with their volume nearly tripling from $259 billion in 2013 to $735 billion in 2015. In addition, seven of the 10 largest cross-regional acquisitions out of Asia Pacific in the first four months of 2016 were announced by Chinese buyers. Chinese companies are looking to North America and Europe when considering M&A as the slowdown in domestic growth sends ripples across Asia and China’s economy rebalances from an export-driven manufacturing economy to one driven by technology, industrial know-how and consumption by the rising middle class.
China outbound M&A into other regions reached $59 billion in 2015, representing an 18% increase year over year. In the first four months of 2016, Chinese buyers eclipsed 2015 volumes with outbound activity of $96 billion, representing more than a fivefold increase over the same period in 2015.
China’s era of double-digit GDP growth that extended through 2010 was characterized by rapid industrial expansion and urbanization. To fuel it, Chinese state-owned enterprises had to rely on outbound M&A in the energy and resources sectors. As China’s economy matured and growth settled near more sustainable levels, outbound M&A priorities evolved to focus on technology and consumption-focused sectors. Consistent with this shift, the targets of China outbound M&A moved from resource-abundant nations to developed nations that house companies with best-in-class capabilities and technologies.
China is transforming its economy from export-driven manufacturing to one driven by technology, industrial know-how and consumption. The strategic priorities of Chinese buyers have evolved to reflect this shift. Chinese companies are acquiring North American and European companies to enhance technological capabilities and move the nation’s industrial sector upstream, to obtain high-value brands that can be offered to the maturing consumer in China, and to build scale and distribution in strategically important markets and geographies. Chinese companies are looking beyond market share in China to global markets, with their sights set on becoming market leaders globally.
China’s growth engine extended through the global financial crisis, with China posting GDP growth of 10.6% as recently as 2010. China’s economy has since slowed, and the International Monetary Fund pegs the nation’s long-term growth rate at 6% as China’s economy rebalances toward consumption and services. Nevertheless, China’s growth rate remains among the highest globally when compared with other developed and emerging markets. However, Chinese companies have turned to both domestic and outbound M&A to boost slowing organic growth.
A wave of consolidation among small- to medium-sized companies in China has reduced the number of domestic targets for Chinese buyers. Independent companies in China often prefer public market transactions or have high-value expectations, given local valuation benchmarks. This relative valuation gap is encouraging Chinese buyers to look abroad for targets.
The People’s Bank of China (PBOC) has taken a number of monetary easing measures to address China’s economic slowdown. From year-end 2014 through the first quarter of 2016, the PBOC reduced the reserve requirement ratio for domestic banks from 20% to 17% and, separately, reduced the benchmark interest rate from 6% to 4.35%. Increasing numbers of financing sources are available for Chinese buyers, including foreign banks, domestic commercial banks, A-share placements, domestic PE co-investments and support from regional governments and policy banks. In December 2008, the China Bank Regulatory Commission issued a set of guidelines that paved the way for Chinese commercial banks to begin offering M&A financing to domestic buyers. In 2015, it further relaxed its guidelines by increasing the loan-to-value and tenure requirements on such financing.
Chinese buyers pursuing outbound M&A are increasingly able to utilize target-level, non-recourse financing due to the enhanced size and quality of overseas assets being acquired. Certain of the largest China outbound acquisitions involved such target-level financing.
The Chinese government has introduced a number of initiatives and policies to support strategic investment both domestically and overseas. China’s One Belt One Road initiative aims to enhance trade between Europe and Asia through a series of infrastructure investments in road, rail and ports. The Made in China 2025 initiative seeks to move China’s manufacturing sector upstream, with a focus on technology and innovation; it earmarks strategic sectors such as information technology, automation and high-speed rail to support this objective.
The supportive M&A financing environment mixed with overall monetary easing and the strategic imperative to execute overseas acquisitions has broadened the universe of acquirers from China. China outbound M&A historically was dominated by state-owned enterprises with a focus on energy and resources. The recent wave of M&A has been characterized by a wider universe of buyers, including companies with a broader sector focus, domestic private equity firms and A-share listed companies. Domestic private equity funds are actively pursuing larger international acquisition opportunities and are open to forming a consortium or partnering with state-owned enterprises and strategic parties to pursue larger overseas acquisitions. A-share listed companies have an increased appetite for outbound M&A in light of the supportive political and financing environment and the valuation premium that Chinese listed companies receive over their North American and European counterparts, which is conducive to conversations on value creation.
Chinese companies are becoming more comfortable executing public takeovers and arranging acquisition financing. Management teams have become increasingly proactive in evaluating potential acquisitions of overseas targets as M&A becomes a more widely accepted growth strategy. Experienced acquirers are evaluating acquisition opportunities in parallel and have made global headlines in terms of the number, frequency and size of the outbound transactions being executed.
While Chinese buyers have become increasingly receptive to participating in global processes, they may require a longer lead time to prepare for such processes. Chinese companies may need up to six months to prepare for an auction, compared with one or two months for many Western companies, according to J.P. Morgan’s survey1 of M&A leaders across Asia.
Chinese companies view value creation over a longer time frame and often adopt a longer-term investment horizon when evaluating a potential target. Chinese buyers generally use a lower hurdle rate when evaluating a strategic acquisition, compared with North American or European acquirers, and at times do not utilize a hurdle rate, according to J.P. Morgan’s survey. The combination of a longer investment time horizon and a lower hurdle rate can cause Chinese buyers to see more value in an asset, allowing them to pay a relatively higher premium.
Consistent with Chinese culture, Chinese buyers place high importance on building a relationship with management before and/or during the transaction process. Chinese buyers and overseas targets must ensure that this relationship-building complies with any applicable takeover code or other takeover regulations in the target’s jurisdiction.
In outbound M&A, Chinese buyers typically have a strong motivation to retain the target’s management team. Buyers appreciate that they may be less familiar with the dynamics of the overseas market and less capable initially of running the business, and they value the intellectual property developed by the acquisition target.
Western management teams and boards often have a number of concerns when transacting with Chinese buyers, generally stemming from their limited experience with this emerging group of acquirers.
Chinese companies overall have a much shorter track record of M&A execution than many of their Western counterparts. Acquirers with experience will be more knowledgeable and efficient at executing a deal, while new and less-experienced buyers may be less well-versed in typical transaction processes and execution procedures.
The funding of China outbound M&A can be more complex and less transparent than Western M&A financing. The source of funding may involve a diverse array of parties, including government investment vehicles, trust structures, equity syndicates and lesser-known private equity funds. The use of escrow funding and the increase in target-level financing is often helpful in alleviating concerns over fund certainty.
Chinese regulators have taken significant steps to relax the approval process for Chinese buyers seeking outbound acquisitions, which should reduce the perception that Chinese buyers are disadvantaged in a sale process.
Developed nations have strengthened the regulatory review process for foreign investors. For example, the U.S. government established the Committee on Foreign Investment in the United States (CFIUS) and enacted a series of reforms in 2007 and 2008 to review acquisitions. Transactions involving acquirers controlled by foreign governments automatically trigger a longer review period by CFIUS. In the five years ended 2014, CFIUS received 562 notices: 220 were further investigated, 60 of them were withdrawn, and the president prohibited one.
Chinese companies are increasingly open to the use of break-up fees, which may be triggered by events related to foreign investment review, China outbound investment approval and shareholder approval. This illustrates the increasing understanding and flexibility of Chinese buyers in their pursuit of overseas targets.
As Chinese buyers become more active and experienced in these transactions, global M&A practitioners should consider Chinese companies as legitimate partners, buyers and interlopers when evaluating sale transactions, and should expect Chinese buyers to participate in global auction processes. Cross-regional M&A can be a value-enhancing strategy for Chinese companies looking abroad and for the shareholders of Western firms transacting with Chinese buyers. The Chinese buyers and Western sellers who are adept at navigating successful cross-regional M&A will gain a competitive advantage.
1 J.P. Morgan’s Survey of M&A leaders across Asia, titled “Asian Corporates Aggressively Using M&A to Pursue Growth,” was published in November 2015. For more information, please visit https://www.jpmorgan.com/country/US/EN/insights/asiamastudy
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