IFLR Asia M&A Forum 2017: key takeaways
Chinese outbound M&A: challenges and opportunities
- In recent years sellers in the US, even those from the Midwest, are becoming more familiar with Chinese buyers;
- Termination fees and cash deposits required by foreign sellers of PRC acquirers have been around for years;
- But because of last year’s tightening of capital controls foreign sellers, fearing the Chinese buyer’s failure of obtaining relevant PRC regulatory approval and the Committee on Foreign Investment in the US (Cfius) approval;
- Foreign sellers are now much more worried about their Chinese counterparts’ ability to settle outbound transactions and therefore require them to prove that they have sufficient offshore cash;
- Because of the tightening of capital controls, PRC enterprises are increasingly raising dollar debt offshore and establishing an offshore subsidiary in Hong Kong for acquisition financing purposes;
- Sectors such as consumer brands, telecoms, healthcare have increasingly targeted by PRC corporates;
- But in this environment deals consistent with the One Belt One Road policy have a higher chance of seeking clearance from the National Development and Reform Commission and other PRC regulatory bodies.
Hot topics in healthcare transactions
- The current capital controls imposed on PRC corporates, which are expected to continue, is both a problem as well as an opportunity for funds;
- Since last year, a lot of China outbound M&A had been curbed by capital controls and there have been a number of high profile cases;
- US-dollar funds have an opportunity because previously highly competitive deals are now less so because of a lot of Chinese bidders don’t have the money. In the past some of the highest bidders for US and European assets were Chinese;
- Winning an auction or an asset is not just dependent on how high the bidding price is. Factors such as scepticism, politics and how the money leaves China are also important;
- In healthcare alone, there have been two notable cases where Chinese buyers were the highest bidders but did not get the asset;
- There are no capital restrictions on getting cash out of Japan – the Abe government is actually encouraging domestic investors to go abroad given the declining population and negative interest rates, in various areas including insurance and healthcare;
- In the past year or two, a US seller facing a Chinese buyer will occasionally ask for a ‘China premium’ to compensate for Cfius and internal PRC approval risks;
- There would also be a reverse termination fee triggered by the failure to obtain Cfius approval. Twenty-two percent of deals had failure to seek Cfius approval as a trigger in contracts, and 16% had Cfius-related covenants ready as closing conditions.
- Last year was strong year for M&A in India thanks to the liberalisation and simplification of FDI. Over the past two years, India has been one of the largest recipients of FDI in Asia, matching the investment received by China in 2000;
- The finance minister has recently, in the context of the 2017 budget, announced that FDI would be further streamlined;
- The Foreign Investment Promotion Board (FIPB) is a long-standing government entity put in place to help approvals for overseas companies looking to invest in India;
- The process has been simplified though and the government plans to remove the FIPB this year, hoping to see an increase from 34% to 35% of FDI;
- One of the day-to-day commercial challenges foreign investors face, especially those with a global arm as tied to Indian conglomerates, is that big banks ask for strict warranties on anti-corruption and data privacy. If there’s a US element there will be far more warranties with unlimited caps;
- Often parties don’t get to know the third-party agent hired in many foreign-led transactions in many developing countries in Asia;
- In a place like India, there is only so much available information about the reputation of the agent, such as whether this person has a history of making payments to officials to get deals.
Best practices in resolving Asian M&A disputes
- In the 1990s and 2000s, there was a lot of backlash against and misconceptions about litigating against your local acquisition target or joint venture partners on their home turf;
- When it comes to advising clients on a dispute situation, it is important to look at it from an enforcement standpoint by doing due diligence on your acquisition or joint venture partner: asking what is its business and where its assets are located, and whether they are primarily offshore holdings and operating assets;
- For smaller transactions the foreign investor isn’t advised to consider arbitrating in Hong Kong, Singapore or London, because of the reality of not being able to enforce it in a local market;
- The size of the dispute in question is going to be outweighed by the overall legal process, having to initiate an arbitration proceeding and a large fee;
- In the insurance business in India, no matter what arbitration award and what your rights are, the insurance regulator has a say on the terms of your joint venture agreement. Otherwise there are capital controls, which may prevent parties from paying for the arbitration award;
- Courts have a bad reputation for interfering in the arbitration process. If they don’t then the location of the arbitration can be chosen, but enforcement of the arbitration award often has to occur where the assets are.
- For the first time in Vietnam, the country has a WTO-compliant investment law, and it has the fastest-growing middle class population in any ASEAN country;
- FDI into Vietnam has tripled in the three years since 2013. M&A has also dramatically increased with 658 deals recorded in 2016;
- Most foreign investors in Vietnamese M&A are from Thailand, Japan, Korea, US and Europe. Retail and real estate are the two most attractive sectors to investors in terms of deal value, and Vietnam now has the most liberal real estate law in the entire ASEAN region;
- The new investment and enterprise laws, which are fully compliant with Vietnam’s WTO service-sector commitment for market access and effective from July 1 2016, means that for the first time there is a simple and clear definition of the term foreign investor;
- There is a new negative list in the investment law that lists all sectors subject to conditions or prohibited. In non-conditional sectors 100% foreign ownership is allowed;
- The old law had 386 conditional activities and 51 prohibited activities, but the new law has 267 conditional activities and only six prohibited activities;
- Many transaction counterparties – mid-level corporates and banks – are relatively unsophisticated, perhaps because they haven’t done international deals before and are not familiar with the terms. So the process can sometimes be inefficient;
- Operational-level counterparties often think they can do all the work on their own. This is not a sustainable proposition especially when term sheets are 30 to 40 pages long.
Know before you go – United States edition: the Chinese bidder’s guide to successfully launching and executing outbound acquisitions
- In China outbound M&A is never straightforward. Each local company dealing in outbound investment has to go to their local bank and two government agencies – the Ministry of Commerce and the National Development and Reform Commission (NDRC);
- They will review and evaluate capacity and intention. For every step of the process there are internal checking systems to see whether these outbound transactions are feasible. The foreign seller will ask the Chinese buyer: have you filed the application for outbound transaction?
- The recent tightening of capital controls is widely expected to be a short term measure, as the ultimate goal of the Chinese government is for the Chinese currency to be fully convertible;
- In 2016, private equity investment in China’s healthcare field was RMB56.3 billion ($8.2 billion). M&A investment was around RMB94.2 billion and total investment was RMB150.5 billion. Around 12% of that was offshore;
- Foreign investors have mixed feelings about Chinese buyers. Many are rich in cash and tend not to restructure or divide the target company into different smaller entities to be sold off upon acquisition as some western companies, particularly private equity, do;
- Although PRC buyers also bring greater deal certainty risks, they are usually willing to pay a premium for their targets.
The art of distressed M&A
- There haven’t been mega distressed M&A deals in Asia because of historically low interest rates. The golden age for acquisitions of distressed assets was the Asian financial crisis in the late 1990s;
- During the crisis liquidity was constrained and the size of the economies concerned was smaller and their governments less significant than they are today;
- This made it possible for the IMF and international creditors to exercise strong discipline, and allowed foreign investors to come into distressed jurisdictions, such as Indonesia, Korea and Thailand;
- That only lasted two years though, and after that domestic liquidity took over and led to easy credit;
- Rather than look for distressed M&A targets, which tend to emerge after a long period of protracted slump in the economy, the focus should be on seeking a distressed seller – private equity is key;
- China has become a good source of outbound FDI for picking up distressed assets in eastern Europe such as Istanbul or Bucharest, and politically unstable or uncertain places that western investors tend to avoid;
- Chinese FDI continues to grow in these jurisdictions, and they are keen to partner with locals to pick up assets;
- It was particularly appealing for the Chinese to buy bankrupt assets in the US because to some extent it streamlined the regulatory process.
The impact of tech M&A in the region
- Acquirers’ expectations are changing with them now expecting to generate more data within their platform and user base;
- This is happening for two different reasons: one is the changing Chinese laws around cybersecurity and data security, and because in outbound transactions they will be subject to a different set of rules regarding what data being generated by the platform being acquired;
- China doesn’t have one single piece of legislation regarding data protection, but this year the cybersecurity law will come in and be a game-changer in the area of data privacy;
- Major issues for foreign companies will be that they will be obliged to keep the data collected in China in China, making cross-border transactions very difficult;
- Communication is key and must be done in a way that’s sensitive to Asian culture. Asia is made up of so many countries and cultures, and so messaging that works well in Australia and New Zealand, for example, utterly terrifies and strikes as inappropriate in countries like Japan;
- When acquiring a tech company or intangible assets, while doing due diligence you need to know if buying these intangible assets or data, you are going to have the material rights on it;
- A recent example is an acquisition of a German company that was declared unlawful because the emails, names and phone numbers of the customers were not used by the buyer;
- When doing first stages of M&A it is important that in the data room, no confidential information is disclosed regarding employees;
- Often in non-disclosure agreements there will be confidential information and data, whether it is business information or personal information.
Finding opportunities in Asia-outbound M&A into Europe
- There is a widely-held perception that Cfius [Committee on Foreign Investment in the US] poses a significantly greater scrutiny risk than in Europe, as it focuses squarely on national security;
- But almost every European country has its own version of Cfius and some of them look quite similar to Cfius on paper;
- Cfius has over the past ten years significantly expanded its definition of what comprises national security;
- It reviews transactions not just based on national security per se, but key infrastructure covering real estate and property acquisitions and those of businesses that have nothing to do with national defence but happen to be proximate geographically to sensitive assets;
- There is no question that the perception that Cfius has set high barriers to inbound transactions from a national security perspective has impacted the volumes of deals into the US and has conversely increased the volume of deals into Europe;
- It’s generally perceived that European regulators are less likely to be susceptible to political influence than Cfius;
- China and Chinese investors are in general more sanguine about Brexit and its economic and political implications – Chinese companies are still interested in the UK and are happy to acquire a minority stake in European companies;
- PRC companies have also increasingly formed consortia with overseas institutional investors to maximise deal certainty and gain access to funding from western banks through their foreign partners.
Getting ready for an M&A exit
- In an M&A situation, any inherent risks can be shifted between seller and buyer. But in an IPO context, it must be disclosed in the registration statement and there can be a lot of overlap in the process;
- M&A lawyers are concerned about whether stockholders have built-in protections in the US. For example, they can refrain from going forward with the sale and then exert their appraisal rights and then get a higher value and sale price to be fully compensated for it;
- Stockholders are able to execute and deliver a clean portfolio company and so they can get close to 100%, if not 100% of their stockholders to vote for this transaction;
- There are certain deal protections, such as a drag-along right, giving a majority of stockholders the contractual right to drag the minority shareholders into a sale. This is most often used as a threat;
- Instead of having to get every single stockholder onboard, you could structure a deal differently by conducting a merger and that comes up a lot in hot auctions as nobody has time to wait;
- Before making an investment, there must be an exit plan – if the company says it wants to do an IPO, that is an exit plan to work towards.
How to succeed in post-merger integration
- About 70% of M&A deals have failed because of poor post-merger integration, and so it is important for parties involved to protect their synergies and think of strategic reasons for the integration;
- Usually integration lasts for one year and the next step is optimisation, but it is most important to assess the target company to see whether a targeted integration team will be needed to carry out proper due diligence, as well as to watch out for tell-tale signs of good or bad integration;
- Cultural issues have to be taken into account, including people on the ground and teams who can speak the local language;
- For Chinese buyers to be seen as credible, it is important that they build up the right team that is familiar with integration and local communications;
- Anti-corruption has been very topical in the last five years, with both local rules and the Foreign Corrupt Practices Act (FCPA) risks in this part of the world being a key area of focus.
Navigating corruption risk, due diligence and enforcement in Asia
- Very rarely do people want compliance and to stay away from corruption for their own sake – there is a different culture in Vietnam and China because many people who have ignored these things have done very well;
- Reputation equals value and this is what makes people move towards greater corporate governance compliance. Senior management must also understand this;
- The new cybersecurity law in China is scheduled to come into force on July 1, offering some regulatory guidance on how financial institutions can and should access data and what they can do with it;
- China is an interesting market in that much of the internet activity has complete state ownership or an interest in it;
- This has created problems for foreign business entities as they face protectionism and leverage when seeking to gain access to the Chinese market and consumers.
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