Samson Lo, head of Asia M&A for UBS, remains bullish about the Chinese M&A market as financial sponsors, SOE restructuring and capital controls continue to shape deals
Samson Lo, head of Asia M&A for UBS, looks beyond the figures at the dynamics in the China and Hong Kong markets. The dominating headlines about Chinese M&A have been the slowdown in outbound deals, but this masks some interesting trends beyond the numbers that may have longer term resonance. For example, the restructuring of Chinese state-owned enterprises, at times explicitly to create entities that can compete on a global field. China Cosco Shipping being one example of this. Although flashy outbound deals may be slowing, corporate activity is not and nor are the prospects for outbound. The much-discussed capital controls have also had an interesting affect on Chinese private equity funds, which find themselves in the position of being able to offer strategics consortium arrangements in which the latter can benefit from offshore financing to avoid local controls. Meanwhile, the capital controls may be beginning to relax.
What is your reading of the M&A market in China and Hong Kong right now? We keep hearing of a slowdown in outbound investment from China, is that really the story to focus on?
Broadly, we have seen two types of deals in the Chinese M&A market: domestic restructuring and outbound acquisitions.
Domestic restructuring has made a comeback over the last 12 months. There isn't any particular catalyst for it but the Chinese government has never deviated from its ambition to reform some of the state-owned entities (SOEs). SOE reform was particularly active between 2014 and 2015; it then quietened down and now the SOEs are back. For example, UBS advised on recent restructurings by China Merchants Group and China Cosco Corporation. Typically, SOEs have sought to merge subsidiaries and streamline their businesses by consolidating assets and we expect this trend to continue. There are persistent rumours of large mergers in the offing, most notably, of a tie-up between ChemChina and Sinochem.
There are persistent rumours of large mergers in the offing, most notably, of a tie-up between ChemChina and Sinochem
Speculation about a slowdown in outbound acquisitions has been in the market for almost one and a half years now, but, in my view, as long as the target is strategic, demand has remained strong. Chinese companies continue to pursue these targets and are structuring deals both to get around capital controls and to cope with the lengthy regulatory approval processes. Although capital controls have been in place since November 2016, over that period we advised China Investment Corporation (CIC) on its €12.25 billion acquisition of Europe-based logistics company Logicor; a consortium of five Chinese companies in its S$15.9 billion ($12 billion) acquisition of Singapore-listed Global Logistic Properties (GLP); and China Cosco Shipping in its $6.4 billion acquisition of Orient Overseas International (a cross-border deal with an SOE buying into a Hong Kong-listed company). While there has been a slowdown, especially on the part of private enterprises, activity among SOEs continues to be robust. Nonetheless, the size of deals has tended to decline and we are seeing more deals with a sweet spot of between $1 billion and $2 billion.
Some private enterprises with little access to offshore funding can get stuck in lengthy regulatory processes but the SOEs continue to be strong in outbound because they have ready access to government funding.
At the same time, structuring has become more innovative. For example, Chinese strategics are, increasingly, willing to form consortia with Chinese private equity (PE) funds. We've seen companies team up with not just one but a number of Chinese sponsors to help circumvent capital controls, meet funding requirements, and secure foreign currency approval. It also seems like capital controls are slowly beginning to relax.
How have capital controls influenced the way deals are being done and the onshore/offshore structures being used?
Capital controls are most onerous for companies with all their cash onshore. The approval process can take a long time; for example, to get the equivalent of $1 billion in onshore RMB, offshore, approvals are likely to come in batches, which has implications for the prospective deal's completion time. As a result, many onshore companies turn to international banks to provide the SBLC (standby letter of credit), which involves taking onshore cash as a collateral for an offshore bridge financing. But it is important to note that such arrangements are well established and pre-date capital controls. Onshore companies are also willing to team up with Chinese sponsors, which are comfortable with onshore cash as equity as well as with being a shareholder in an A-share listed company. Under such arrangements, the PE funds receive collateral or guaranteed returns, in return for providing offshore equity.
What will be the likely impact of the National Development and Reform Commission (NDRC)'s Administrative Measures on Enterprise Outbound Investment?
The measures are aimed at a specific group of industries that are not encouraged by the Chinese government. They include: football clubs, the entertainment/media-related industries and property. But most deals we've been looking at have been strategic – you just don't see many entities looking to buy a football club in Europe any more. The measures are unlikely to have much effect deal flow in the industrial, tourism or logistics sectors. There have also been changes to eliminate the so-called "roadpath" system, an informal process for small deals that preceded the formal approval process. In short, if a company got through the roadpath system the deal was to all intents and purposes approved. Now, all deals need formal approval. But Chinese outbound deals are all quite sizeable and subject to formal approvals anyway, so removing this conduit does not affect timings or deal flow. The Administrative Measures have also made guidelines for the outbound market more transparent, especially in terms of deal size, approvals etc. It is more clear-cut and the new measures allow for online applications which enhances transparency.
What implications does the restructuring of SOEs have and what is behind the restructuring process?
Restructuring has made the SOEs more efficient. Many of the large SOEs are multiple-listed entities; Hong Kong-listed, A-share and even B-share, which means that often their subsidiaries are competing with each other. Merging select subsidiaries helps streamline the business and reduce overlaps and competition between subsidiaries. At the same time, some mergers were designed to create national champions, for example, China Cosco Shipping. China Cosco Shipping was formed by a series of asset restructurings to create a standalone shipping giant that can compete globally and be a consolidator. The company is now capable of competing against other shipping giants around the world.
How have financial investors been influencing the Chinese M&A market?
They've been both a facilitator and a threat to Chinese strategics. They act as a facilitator when a Chinese strategic is short on funding or is getting caught on capital controls; sponsors are an alternative source of financing. They are also user-friendly. Many are Chinese PE funds, so they understand the culture and how to get things done. They can also help carry the strategic, especially the one-timer, through a competitive process. At the same time, they are a threat, and there have been situations where Chinese investors have not needed to team up with strategics because they have the in-house knowledge to compete directly with them. With the flush of capital in the market, Chinese PE funds have also been driving up valuations. For example, funds have been very active in the education and tourism sectors, competing with strategics as well as against other PE funds. Ultimately, the winner pays above and beyond to beat other financial investors. They have reset the valuation benchmarks in some sectors.
The Hong Kong market has also been interesting and we've seen Chinese SOEs buying out Hong Kong competitors or PE funds taking Hong Kong-listed companies private. Hong Kong-listed companies are trading at very low multiples and, for many, their valuation relative to A-share listed companies means that they are unable to compete. The Hong Kong market is rife with privatisations and sales to SOEs. Another theme is the conglomerate carve-out. Many Hong Kong-based conglomerates are more willing to divest than the Chinese SOEs and they are divesting non-core assets to external investors. This has been going on over the past couple of years.
What trends have you seen in inbound M&A into China? Have there been changes to foreign investment rules?
You just don't see a lot of inbound these days. The market has moved from the one of many years ago where foreign companies were seeking to make inroads into China. Foreign investors have been perturbed by a couple of factors. In some cases, the companies acquired were not what they seemed and investors have been burnt. In addition, in some sectors, such as pharmaceuticals, the Chinese government favoured incumbent Chinese companies and put up hurdles to foreign companies. A number of Western conglomerates including McDonalds China, Yum! China, and office supplier Staples, have or are seeking to divest from China inbound investments are now more likely to be via joint-ventures (JV) with an incumbent local company. Foreign investors are willing to take a minority position because it offers an element of safety.
As for inbound investment rules, there are catalogues in certain areas, for example in the automotive sector. For a Chinese international car manufacturer, the catalogue says that they cannot have more than two international JVs. That continues to be the case. There may have been minor tweaks in some catalogues but, broadly, some restrictions remain.
What is your outlook for the next 12 months?
In 2017, the focus was on falling deal flow, and the media was reporting a 35% decline from 2016. But if you look behind the scenes and discount some of the large and one-off transactions, like Syngenta, the decline was really about 15%. In terms of volumes, last year was still the second-highest for Chinese outbound M&A. In 2018, China outbound is likely to remain at the same level as 2017, but whether it will be the second or the third-highest we don't yet know. China may be more cautious towards the US but Europe will continue to be very active. Chinese SOEs will also continue to be very active, whether via asset restructurings or mergers.
|About the contributor|
Samson Lo is currently head of Asia M&A for UBS. Lo joined UBS in 2010 and is primarily responsible for M&A origination and execution in the Asia Pacific region, with a focus in Greater China across many industry sectors. From 2007-2010, Lo was a member of Merrill Lynch Asia Pacific's investment banking team for Hong Kong-based corporations and Macau-based gaming companies. From 2000-2007, Lo was a member of Lehman Brothers' M&A group in New York and led executions for transactions across many industry sectors.
Notable transactions in Asia Pacific include PAG's unsolicited offer for Yingde Gases for $2.6 billion; China Mengniu Dairy's acquisition of China Modern Dairy for up to $1.1 billion; LafargeHolcim's Fr1.1 billion ($1.1 billion) sale of a controlling stake in Sichuan Shuangma Cement to IDG Capital; and sale of Nirvana Asia to CVC for $1 billion.
Lo graduated magna cum laude from the University of Pennsylvania's management & technology programme, with joint undergraduate degrees from Wharton School and School of Engineering & Applied Sciences.
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