MERGERS & ACQUISITIONS
Investment Banking Boutique Says M&A Key to Strategic Growth in China
April 24, 2007
Elizabeth Johns

"With regard to new foreign entrants and established foreign players in the domestic market, M&A will be fundamental to driving their China growth strategy." ARTICLE TOOLS Print Version Reprints RECENT ARTICLES Different cities, same customers China is the region's top stop for exporting Improving wire transfers Quantifying your banks' performance

Joanne K. Wood is a co-founder and partner in Capital Eight, an investment banking boutique specialized in corporate finance and headquartered in Shanghai.  In April she spoke to ChinaForum about merger-related trends she is seeing, explaining how M&A will become a fundamental part of corporate activity in terms of how to achieve strategic growth within a three to five year time frame.

In which industries do you typically concentrate?

We cover around 20 industries, with transaction experience in all of these areas, but at the moment, we are concentrating on industries where we see the most active M&A and structured financing opportunities, ie. infrastructure, building materials, construction, logistics, transportation, retailing, financial services, agribusiness, textiles, life sciences, TMT, resources and power/energy.

Are there any industries that are seeing significant merger activity? 

Apart from what I mentioned, it should be noted that all traditional industries in the China market place are in the midst of consolidation and restructuring, due to their historically, highly fragmented nature, eg. garment manufacturing, pharmaceuticals.  Other industries such as brewing have already reduced in number from 10's of 1000's to less than 100 main players over a 25 year period.  However, other industries went through a period of expansion in the 80's and 90's and have now pared down to a relative few in number through forced government mergers eg. aviation companies.  Yet other industries, particularly those related to hi-tech development and telecoms are experiencing a period of rapid growth and are starting to consolidate through merger activity to increase scale and competitiveness. 

In all cases, the increasingly competitive nature of the domestic market is driving companies towards more cost effective operations if they are to survive.  The days of the 'iron rice bowl' which guaranteed government handouts in the form of annual budgets are gone.  Both private and state-owned enterprises are obliged to perform competitively.  As more companies list on domestic and offshore stock exchanges, there is also the added responsibility to the shareholders at large, something which is not yet entirely appreciated by many CEO's, Chairmen and their Boards of Directors. 

How have you seen acquistions typically structured recently?

China's M&A laws and regulations are still in their infancy, so there is little precedent or structure to follow.  Even now, significant mergers between state-owned enterprises are typically 'encouraged" and if this still does not result in a merger of the entities, the relevant government agency/department may issue a directive ordering the restructuring.  In most industries, it makes sense to consolidate, particularly if the goal of the government is to create a number of Chinese companies that can compete on the global stage.

There is less merger activity amongst privately held companies and more acquisition activity, albeit on a friendly basis.  Hostile M&A is very rare because of the untested regulatory framework but also because it would tend to 'go against the cultural grain.'  Direct conflict is always avoided, if possible, and held in disregard by most.
 
Are you seeing any merger-related trends?

M&A activity is definitely on the uptrend in China.  Our view is that M&A will become a fundamental part of corporate activity in terms of how to achieve strategic growth within a 3-5 year time frame.  In the meantime, it continues to be the focus of larger Chinese corporates who are going global and/or undertake M&A as part of their structuring pre-IPO. With regard to new foreign entrants and established foreign players in the domestic market, M&A will be fundamental to driving their China growth strategy.  A new takeover code, anti-trust law and other M&A regulations that appeared during the course of 2006 are also helping to demystify the M&A process and give clarity and thereby added security and comfort to contractual terms that are agreed in negotiations.  

Another important trend is the imposition by the Chinese government at the beginning of 2007 of shareholding restrictions placed on foreign companies seeking to acquire Chinese groups.  Essentially, certain industries that are considered strategic to the national interest or are considered iconic, national brands cannot be wholly acquired by foreign entities.  In some instances, there is either an outright ban or a cap that limits the % of foreign shareholding.  In other instances, a lack of transparency in the approval procedure at the national level in Beijing allows for the flexibility of rejection, revised terms or full approval of a deal.       

Are there any mergers that are particularly noteworthy for you this year?

Come back to me at the end of 2007 and we should have several we can discuss!  It is turning out to be a great year for us....

What is the likely impact of the new M&A regulations in China?

The regulations are having a very positive impact on the M&A industry in China because they continue to clarify and define the procedures for M&A in the market.  There are still some 'grey' areas and definitions that need to be clarified but the surge in M&A activity just this year to date is an indication of how actively companies are now pursuing M&A.

How early in the process should treasurers, CFOs begin thinking about post-merger integration when doing mergers in China?

We cannot stress the importance of post-merger integration planning upfront in the M&A process enough!  Unfortunately, it is still under-appreciated by most companies, both foreign and Chinese, in terms of the impact the planning can have on the probability for success.  We raise the importance of post-merger planning in initial meetings with clients and highlight it as an area of focus from very early in the transaction.  In an environment where HR and cultural issues are supreme challenges and can significantly impact the success or failure of a merger, it is very important to address a detailed approach to integration.

What are some of the merger-related risks prevalent in China and how can treasurers/CFOs seek to mitigate these risks? 

Every industry has its own set of unique risks but those that relate to China transactions range widely and include risks such as cultural issues, miscommunication, insufficient due diligence, poor negotiation strategy and deal rejection by approval authorities.  Chinese companies consider their greatest risk to be mismanagement of the cultural divide.  The use of experienced advisors with the requisite expertise and strong track record in the domestic market are a good way to mitigate the risks.  Just as critical to risk mitigation is the appointment of an in-house team of people who have a good understanding of China dynamics, are familiar with the challenges in executing M&A transactions, have Chinese negotiation experience and are fluent in Mandarin.  Preferably, they are all based in China or are at least prepared to move to China until the transaction is closed or ends. 

What type of advisory services can multinationals seek to assist them in this process?

At a minimum, the MNC should appoint a lead advisor (typically also the financial advisor ie. a corporate finance advisory specialist) and legal counsel.  Where the target under consideration is a manufacturing or production oriented entity, it is wise to consider the appointment of an environmental consultant.  Key issues usually involve areas such as IPR, environmental violation, missing/incomplete legal documentation, messy accounts, un-audited financials, poor corporate governance and HR.  

Is there anything else you would like to say to treasurers and CFOs of multinationals doing business in China?

1. Too often, management will do the minimum due diligence on a target company.  You usually only get one chance to really appreciate what risks you assume when acquiring in China - and that is at the due diligence stage - so it is paramount that you undertake as complete a process as possible to uncover all potential liabilities and risks that could destroy the value of the transaction.
2. Never underestimate the time it takes to conclude a transaction in China.  I was involved in the mid 1980's in a deal that took 5.5years to conclude!  Admittedly, times have changed but as a general rule of thumb, double the amount of time you would allot to undertake the same transaction in your home market.
3.  If your company is new to China and undertaking its first investment, take the time to educate your senior management in the challenges of concluding a successful deal in China.  You need enormous amounts of patience and tolerance.
4. Don't rush the deal!

For those who may not be familiar with your firm, tell us about Capital Eight.

Capital Eight is an investment banking boutique specialized in corporate finance advisory services headquartered in Shanghai.  We offer a complete range of corporate finance services, ranging from M&A, debt and equity public/capital markets fund-raising and private fund-raising, project and structured finance and general strategic advice.  We are not principle investors nor do we operate a fund management activity.  We are a little over 15 months old and are wholly owned by the partners, ensuring a high degree of confidentiality.  To our knowledge, we are the only firm of its type in China.

Although the company is very young, the experience and transaction record of the partners is very solid.  I have just over 20 years of China M&A experience and between us all in the team, we have over 50 years of corporate finance experience.

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