By Andrew McGinty
China ended 2016 as the leading acquirer of foreign companies – the third year in a row that it topped the outbound M&A league table, a ranking of firms involved in mergers and acquisitions.
Chinese companies collectively spent nearly $200 billion buying their foreign counterparts in the first nine months of 2016, with an additional increase in spending expected in the final quarter of the year.
China’s historical emphasis on resources has been replaced with a desire to diversify its risk and asset base, with a host of deals this year across multiple sectors ranging from technology to distribution and agriculture.
China’s appetite for deals in the tech space was highlighted by Ctrip’s £1.5 billion acquisition of the British online travel group, Skyscanner. ChemChina’s $43 billion purchase of Swiss seed and agro-chemicals giant Syngenta, agreed to in February 2016 and expected to close in early 2017, showcases China’s interest in the agricultural industry.
But according to critics, 2017 is likely to see the end of China’s outbound boom with investment in foreign companies coming to a grinding halt.
Critics increasingly point to the seismic shift in global political sentiment as the primary reason for the end of China’s overseas acquisition spree. They argue that the surprise November election of Donald Trump and the Brexit vote in the United Kingdom reflect a rising tide of new protectionism in response to globalization.
With greater focus on domestic concerns, the critics believe regulators will raise an increased number of objections to cross-border deals, including those which would have been waved readily through in the recent past.
The decisions of German regulators and President Barack Obama to block the Fujian Grand Chip Investment Fund’s $750 million acquisition of the technology group Aixtron came as a surprise to many observers. Coming hard on the heels of the New Zealand government’s decision late last year to block the previously approved acquisition of a large cattle and sheep operation by Pengxin Group, these decisions reflect the beginning of a global regulatory crackdown.
While politicians talk tough, emphasizing early stage assessment for “public interest” intervention in relevant jurisdictions, there is little evidence to suggest Western protectionism will stymie Chinese deal-making.
Critics also point to domestic obstacles which they see as preventing cross border deals. Like concerns over Western protectionism, suggestions that the Chinese government’s crackdown on capital flight and the implementation of law which increases the liability of state-owned enterprise executives will curb outbound deal-making seem exaggerated.
Recently, a majority of front-line deal monitoring and supervision has been delegated to the State Administration of Foreign Exchange (SAFE) as it increasingly focuses on macro supervision rather than black letter law and rulemaking. A multi-authority review of “authenticity and compliance” for transactions involving outflows of $5 million or more in RMB or foreign currency has been implemented, with a formal review conducted by SAFE when the threshold of $50 million is reached.
While increased supervision may slow the deal-making process and should be accounted for by transaction planners, it will not halt all outbound business activity.
Despite increased government scrutiny of foreign exchange outflows, Chinese authorities will continue to allow legitimate deals that make clear strategic sense. In the last few years, China has progressively reduced the red tape in the approval process for outbound deals. For the vast majority of acquisition deals, the process is based less on approval and increasingly used as a method of record-filing.
Chinese officials want to better understand the rationale behind a deal. They want to ensure a purchase is made for legitimate business reasons and not simply to shift funds offshore in the absence of a genuine underlying transaction. The recent tightening is a ‘bump in the road’ which will not alter the overall trend towards liberalization of capital accounts.
The transition to liberalization in recent years has helped to diminish the influence of the historical ‘China premium’, a practice in which sellers would price in the uncertainty of the Chinese approval process. The recent crackdown may dent confidence in the short term, particularly in terms of meeting payment deadlines, but this impact will fade once the methods of review become clearer.
In many ways modern Chinese corporations are in a better position than their predecessors, who had to wade through a formal approval process where timing was uncertain. Outbound investment is becoming a much simpler process to navigate and those pursuing legitimate deals that make sense in non-sensitive countries and sectors have little to fear.
The need for China’s leading companies to diversify away from reliance on the domestic market during a period of slower economic growth remains acute. The Peoples’ Republic remains underweight in a number of key sectors. Chinese products continue to suffer from a lack of distribution channels and brands in other markets. And for a country that has the second largest global economy, China has surprisingly few globally recognised brands.
The desire, and need, of leading Chinese companies to diversify, coupled with healthy corporate balance sheets and increasing management sophistication, implies Chinese companies will continue to look outbound in 2017.
There will be some difficulties, delays and setbacks along the road. The regulatory and administrative processes in both China and “target” countries will need to be looked at more carefully and factored into deal-making at an earlier stage. Some deals may not be as easy to close. But fundamentally the arguments and rationale for China to continue to invest huge sums overseas remain as cogent and compelling as ever.
About the author: Andrew McGinty is a partner at Hogan Lovells in Shanghai and is the head of the firm’s corporate practice in Asia and co-head of the firm’s China practice. He can be reached at: [email protected].