July 20, 2016
The world’s fastest growing economy since the turn of the century has often been a focal point as spectators have scrambled to track and understand China’s meteoric rise to becoming a global economic powerhouse.
However, as China’s own internal acceleration tailed off in the past few years, Chinese companies have become much more aggressive in pursuing international investments. There are no signs this will slow as, in under just six months, 2016 has already outgrown a record-breaking 2015 for Chinese outbound mergers and acquisitions (M&A).1
There are a number of reasons why this is happening: concerns about China’s weakening economic growth and the wish to gain access to new markets and technology to satisfy a growing middle class constitute valid reasons for China’s outward view.
The country’s transition to a consumption-driven and service-oriented economy is also hastening the desire for overseas acquisitions. As such, high-technology from mature U.S. and European markets which power many of the products Chinese consumers have grown to depend on, including smartphones and automobiles, have received significant attention from ambitious Chinese companies wishing to fulfil the desires of a middle class growing in influence.
The desire is palpable, the funds are available, the Chinese government is supportive — but as the past year has shown, all the material hallmarks of a successful transaction do not always add up to a completed transaction. China’s reputation continues to prove troubling for officials in the U.S. and, increasingly, in Europe. China’s ultimate objectives with the acquisitions, the reliability of their management teams and the origin of their capital have all come under increasing scrutiny.
With the global economy and capital markets generally stagnating and acting with volatility, cross-border M&A is bucking the trend and has proven relatively resilient under the surrounding circumstances, thanks mainly to a hive of Chinese-related activity in both the U.S. and Europe.
China’s GDP growth in 2015 was the slowest in 25 years.2 The country’s economic growth has appeared to many economists and analysts to be decelerating faster than the government has acknowledged given it is weighed down by debt, excess industrial capacity and an overbuilt housing market.
This doesn’t change the fact the Chinese are still hungry for growth. It’s just what they are seeking is changing. Instead of looking to steel, iron ore and other composites to build their country upon, they are now buying other companies to help accelerate China’s development into a “smart manufacturer.”
As such, Chinese companies are now stepping up and pursuing brands, expertise and intellectual property in order to move up the global value chain. This led to a record-breaking 2015, with 607 deals valued at US$112.5 billion in total.3
Halfway into 2016, this has already been surpassed. With the May 2016 announcement that the Chinese government will remove the need for State Council approval for outbound deals, as well as allowing Chinese companies to bid for the same target, there is no surprise this has occurred and China International Capital Corp expects outbound deals to hit US$150 billion this year.
This growth sentiment is particularly relevant for the Technology, Media and Telecommunications (TMT) industry, as 2015 was the biggest year for global technology M&A. The sector was the second most targeted and accounted for 14% of annual M&A volume over the year, its highest ever.4
It seems like 2016 may easily surpass the levels hit in 2015. Already this year, the highest level of movement since 2000 has been recorded, with global technology M&A standing at over US$71 billion from more than 1,500 deals through to March 2016.5
The technology industry itself is evolving rapidly, driving companies to consolidate and partner with competitors to drive scale and innovation. Manufacturers of smart chips for the Internet of Things industry are increasingly looking to partner up as a result of slower industry growth and emerging competition.6
And much of this change in the direction for Chinese investment and expansion seems to come down to a shift in perception from Chinese citizens. As the expectation for the good life spreads through the middle class, which makes up for hundreds of millions of the country’s inhabitants, corporations are searching for sophisticated R&D capabilities, products, supply chains and technologies to satiate the domestic desire for the latest high-quality — and often technology-driven — consumer goods.
For the first time, China has overtaken the U.S. as the world’s biggest acquiring nation for M&A in the technology industry. With US$34.7 billion invested in 2016 year-to-date (222 deals) and accounting for a record high volume share (49%), the world’s largest population is now the world’s largest acquirer of technology.
Tianjin Tianhai’s proposed US$6.3 billion acquisition of Ingram Micro, announced on February 17 2016, set the tone for China’s ambitions for the year. It stands as the largest Chinese outbound M&A deal in the sector and also the largest cross-border technology M&A deal since December 2015.7
This level of ambition from China should not come as a surprise. In 2014, Lenovo bought IBM’s x86 server business for US$2.1 billion and Motorola Mobility for US$2.91 billion. Further, in 2015, Tsinghua invested US$3.78 billion in Western Digital. The level of interest and investment into the U.S. has always been high.
This can be traced back to when China joined the World Trade Organization in the early 2000s and marked an increased cooperation between China and the U.S. in high-technology. The recent ramp up in activity can also be attributed to the consensus reached between the two countries on the Information Technology Agreement expansion in November 2014, which saw tariffs cut on high-technology products.
Although the U.S. continues to be the apple of China’s eye, European technology innovators have increasingly gained attention from Chinese investors over the past few years. With a strong entrepreneurial spirit, the innovation being driven out of Germany, Finland, Switzerland, Sweden and others has the potential to have a big impact globally but previously lacked the domestic support and local European capital to reach the next step. This opportunity is now very evident to China, as outward direct investment in these sectors into Europe increased by 44% in 2015, and could jump dramatically in 2016.8
With all the ‘highest-ever’ numbers being put forward regarding China’s outward investment, the high-profile deals left incomplete involving Chinese companies stand in stark contrast. In 2016 alone, three major deals within the TMT sector have been subjected to intense media and stakeholder scrutiny, ultimately ending in some degree of failure.
China still lags behind a number of developed countries in the completion rate of outbound M&A deals and in the quality of integration. Although China is more active in the market and there looks to be no slowing down, geopolitics and public perception concerns in the U.S. and Europe continue to pose challenges to Chinese companies looking to acquire overseas assets.
Traditionally, the biggest hurdle in the U.S. has been CFIUS, a government panel that scrutinises deals for national security threats. In recent years, Chinese deals have led the list of those scrutinised by CFIUS.
Some believe the overall shift from fairly run-of-the-mill deals to those involving high-technology such as semiconductors is raising concerns with U.S. authorities due to China’s reputation. A history of espionage by Chinese entities, companies with ties to the state, the extent to which state ownership is unclear and the origins of their financing all come into heavy consideration, not only for regulators but also for the entity being acquired.
This doesn’t necessarily mean the U.S. has a hostile stance toward investment from China although this could be assumed as the number of cases involving Chinese corporations investigated by CFIUS has increased. It should be that noted the number of Chinese deals announced have also grown during the same period.
Europe has perhaps represented a relatively more straightforward investment arena for China as opposed to the U.S. However, the tide seems to be turning. As innovation gains pace in Western Europe and Scandinavia thanks to an entrepreneurial spirit, funds from China are increasingly flowing into the area to compete with domestic investments.
As China aims to move up the global supply chain, Chinese companies realise they can no longer rely on cheap Chinese labour and low-end technology. This has resulted in Chinese bids for European high-technology companies coming in at extremely high levels compared to earnings, such as Midea’s valuation of Kuka at 28 times expected 2016 revenue. The generous bid showed Midea’s strong desire to access Kuka’s world-leading robotics and enhance its own operations.
Although the desire from the Chinese is there, Europe is increasingly casting a more critical eye than before. Specifically, their state-provided subsidies, cheap capital and assistance from the government provide Chinese bidders with a hefty advantage over European companies that are legally barred from receiving “state aid” when bidding for assets within Europe.
As such, Europeans are hitting back by putting Chinese firms under increased pressure for greater transparency with regard to ownership structure, funding sources and corporate governance. As with the U.S. experience, Europeans also need to be ensured the buyers will be good stewards of the business post acquisition.
There have also been calls for a more reciprocal relationship between the two regions. In June 2016, Angela Merkel called on Chinese authorities to grant foreign firms the same “rights and privileges” as domestic ones when operating in China.9 It signifies, perhaps, a subtly impatient sentiment from Europe in response to China’s acquisition of high-technology expertise to make its own corporations stronger and more competitive on the global stage, without similar advantages being afforded the West in China.
However, this line in the sand may not be as strong for a now unsettled region after the British referendum in June 2016 indicated a preference to leave the European Union. Chinese companies may “wait and see before making a move” in any investment or M&A activity in the UK or the region as a whole.10
Governments, businesses and the public naturally fear what they don’t understand. The U.S. and Europe’s understanding of China is clearly cloudy, whether an intentional outcome or not. Chinese companies are not without blame, as their investment objectives in acquiring international businesses are often kept clandestine.
Although the competitive and nuanced environment of global technology M&A has not stopped China from leading deals around the world, Chinese bidders have faced the prospect of trying to be more transparent and convince targets of their reliability. And the U.S. dealmakers are paying more attention to financing and regulatory risk from China.
While some are trying to work harder to push through deals with Europe and the U.S., prominent Chinese businessmen are publicly voicing their anxieties when dealing with these markets. One of the country’s largest conglomerates stated its investment arm would scale back its Western deal-making to focus more on emerging markets such as Russia, India and Brazil.11
Chinese companies have had to take unconventional approaches to deal-making on occasion, either overpaying for assets or offering a hefty break fee to assuage the concerns of their targets. ChemChina, for example, is offering a US$3 billion break fee to Syngenta in the case of a takeover failure.
While the hard finances of a deal can play out quite evidently, effects of the reputational issues are perhaps more difficult to contend with. China, as a mere country of origin out of which the interest is coming, can impact a deal so much that Chinese companies are, on occasion, having to fashion themselves into Western businesses, bringing on international and independent directors.
It is evident there are two sides to the case when considering cross-border M&A involving China, the U.S. and Europe. A look at the environment in the past few years point to a myriad of issues — financial, reputational, operative and regulatory — and that means nothing is as simple as it may seem on the outside.
Having an excess of capital is not the sole driver of success as transparency and communication from both the seller and buyer with stakeholders play an increasingly large role in the success of cross-border M&A.
At the outset, it is important for both parties — an acquirer and a seller — to recognise there will be challenges in completing a deal involving China.
Communication and transparency are important to tackling the widespread misunderstandings and misperceptions of Chinese corporations — particularly China’s State Owned Enterprises — that continue to harm China’s reputation and have triggered political backlash in Washington D.C. and other political capitals.
U.S. concerns about China’s technology capabilities don’t just relate to fear over an economy with the potential to become the world’s biggest. Military power is perhaps the foremost fear in terms of the flight of high-technology from U.S. shores, and proves to be a legacy issue for China since the 20th century.
While regulatory bodies such as CFIUS have the prerogative to stay opaque in their decisions for reasons such as national security, it makes it difficult to understand exactly what the best approach is for Chinese buyers to approach the process of engagement.
However, acquisitive Chinese companies are best placed when they are proactive in all accounts to secure regulatory approval and win over the stakeholders of the to-be-acquired entity. Deal risks need to be addressed early on and actively tackling likely concerns and robustly articulating the benefits of the transaction to all stakeholders can result in a deeper understanding by those who matter.
This can include internal and external communications around details of the transaction and articulating the rationale for the deal and future plans for both sides, thereby resulting in a level of transparency and education that focuses on driving visibility for the positive effects of the acquisition.
Establishing trust and commitment is the necessary link to seeing continued cooperation between the two ends of the globe. As befitting a country as powerfully flush as China, cash has proved king as paying a high valuation for an acquisition has helped show commitment to the cause.
However, healthy funding ability cannot by any means be the only thing that will win concerned parties over. Effective communication with all stakeholders, rather, needs to be a priority. The impact of communicating the strategic fit of the transaction, commitment to the market and the benefits of the proposed partnership might not have an obvious monetary value but is priceless in ensuring China’s continued success in the global transaction market.