December 19, 2016
Also covered in the FTI Journal, November 2016.
Chinese companies are trying to scoop up Western tech companies in M&A mega deals, with big rewards for all. But suspicions on both sides continue to scuttle some of the deals. Here’s why.
Chinese companies have been on an international shopping spree in the past few years. Driven by China’s slowing economy, a flight of capital out of the country and a rising middle class demanding more consumer goods, mainland firms have become more aggressive in pursuing mergers and acquisitions (M&A) around the globe. The trend shows little sign of slowing with the number of Chinese outbound M&As this year having already surpassed the record-setting pace of 2015.
Nowhere is that more evident than within the Technology, Media and Telecommunications (TMT) industry. As China shifts away from steel, iron ore and other composites, Chinese companies are eyeing high-tech brands, expertise and intellectual property to help accelerate the country’s development into a “smart manufacturer.” They’re particularly looking at the mature tech market in the U.S. and European markets—the same ones that power many of the products Chinese consumers have grown to depend on.
Indeed, China has overtaken the U.S. as the world’s biggest acquiring nation for M&A in the tech industry. With USD$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.
That feeding frenzy is catnip to the Western tech industry, which is evolving rapidly and is looking at consolidation, growth capital and partnerships with competitors to drive scale and innovation. But along with all that potential comes some sizeable caveats for those companies who fall under the gaze of Chinese firms looking to acquire overseas assets.
It seems not every Chinese M&A proposal is all it’s cracked up to be.
The Middle Kingdom’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 scrutiny. Three high-profile deals in 2016 alone illustrate this issue, each subject to intense media and stakeholder scrutiny and ending in some degree of failure:
Running afoul of the CFIUS, a government panel that scrutinizes deals for national security threats, is not altogether surprising given the tense relations between the U.S. and China. In fact, China has topped the list of those scrutinized by the CFIUS in recent years. (That might also be attributed to the increase in the number of deals involving China.) A large part of scrutiny can be traced to suspicions of espionage by Chinese entities with ties to the state and the lack of clarity about the state’s role and the origins of financing.
The election of Donald Trump as President of the United States also presents a fork in the road in terms of international relations. On the one hand, the President-elect’s nationalist rhetoric points to even greater resistance to inbound investment, particularly in sectors deemed sensitive to national security. On the other hand, there has been some positive commentary from China following the election result, with some interpreting China’s President Xi Jinping’s congratulatory note as akin to tossing the friendship ball into Trump’s court—provided Trump can deal with the world’s second-largest economy on an equal basis. That ball may very well be thrown back with requests that China open its own market to inbound investment, which has been a point of contention for targeted countries in recent years.
Meanwhile, European high-tech companies have likewise benefited from the Chinese shopping spree as the country’s move away from cheap domestic labor and low-end technology. One example involves China’s Midea Group’s extravagant valuation of Kuka, a German entity, 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. That deal also met resistance as the German Government sought an alternative buyer within the EU. Ultimately Midea’s sound strategic plan and deep pockets prevailed.
Europe is generally casting an increasingly skeptical eye on Chinese companies. Specifically, Europe is looking at state-provided subsidies, cheap capital and assistance from the government that provide Chinese bidders with a hefty advantage over European companies that are legally barred from receiving “state aid” when bidding for assets within Europe. In the UK, Chinese investment into the Hinkley power station project was delayed for review by the new Prime Minister, Theresa May. It was ultimately approved but there is a strong signal that future investments in strategic assets will come with built-in safeguards for the UK. Similarly the German government withdrew its approval for the Chinese takeover of chip equipment maker Aixtron. It was reported that this followed concerns raised by U.S. intelligence.
In reaction, Europeans are pushing back on Chinese firms for greater transparency with regard to ownership structure, funding sources, future strategy and corporate governance. Just as with U.S. companies, Europeans also need to ensure the buyers will be good stewards of the business following acquisition.
Governments, businesses and the public naturally fear what they don’t understand. The U.S. and Europe’s understanding of China is clearly muddled—whether intentional or not. Chinese companies are not without blame, however, as their investment objectives in acquiring international businesses are often shrouded in mystery.
It’s clear that there are two sides to the case when considering cross-border M&A involving China, the U.S. and Europe. There are a number of issues to consider—financial, reputational, operative and regulatory—with nothing as simple as it seems. It’s also clear that having a ton of capital is not the sole driver of success.
How can all parties improve the situation and keep the mutual benefits flowing? By focusing on three strategies: communication, understanding and transparency.
Chinese corporations, particularly those owned by the state, must communicate intentions early and openly. That may help reduce suspicion especially given the concern the U.S. has about the flight of high-technology from its shores to its geopolitical rival. Concurrently, the CFIUS and other government bodies must be clearer in their decision-making so that Chinese companies know how to best approach the process for getting deals done.
Ultimately, deal risks and proposed benefits need to be addressed and articulated early by all stakeholders to promote understanding. China’s willingness to spend lavishly shows its commitment to the cause. But money isn’t the only thing that talks when it comes to such a robust M&A market. Communication goes a long way too.