HR Due Diligence

Mergers and Acquisitions in China

ChyeKok Ho, ChinSeng Koh

• Publisher: Chandos Publishing
• Year: 2011
• eBook ISBN: 9781780633282
• Topic: Commerce
• Subtopic: Gestion des ressources humaines

This book examines how to conduct due diligence on mergers and acquisitions for organisations in China written from a management perspective. Aimed primarily at practitioners within the field of International Human Resource Management, it highlights models that appear straightforward and yet are susceptible to oversights and failings. It examines the roles of human resource practitioners from when a target company is identified for mergers or acquisitions through to assessing its risks. The book incorporates adopting human resource management strategies under differing business conditions, negotiating to secure the deal and integrating the new business unit to the merged or acquired organisation. This title gives a fantastically detailed analysis of due diligence, capturing the nuances of the Chinese way of doing things and how this affects a business environment. - Provides practical and realistic solutions to real-world problems - Concisely draws upon the authors' wide-ranging practical and research experience in conducting due diligence assignments in organisations in China - Written by highly knowledgeable and well-respected practitioners in the international Human Resource Management field

1

An overview

Abstract:

The accession of China into the World Trade Organization (WTO) has paved the way for a phenomenal increase in foreign investments into China. As China opens previously closed industrial and service sectors to foreign direct investments by eliminating operating restrictions imposed on foreign invested enterprises (FIEs), the climate for Mergers and Acquisitions (M&A) as a strategic investment vehicle into China is intensely vibrant, and the marketplace increasingly competitive.

Key words

economic reform

harmonious society

Engel coefficient

direct investment

mergers and acquisitions

China and the Chinese

The People’s Republic of China was founded on 1 October 1949 when the Communist Party leader Chairman Mao Zedong proclaimed its conception from the Gate of Heavenly Peace that fronts Tiananmen Square, marking the victory of the Communists over the Kuomintang in the Chinese Civil War. Since then, several significant events have taken place. The years 1956 to 1961 saw the Great Leap Forward Movement, an economic and social campaign of the Chinese Communist Party (CCP) aimed at exploiting its vast population to rapidly transform the country from an agrarian economy into a modern communist society. The movement prohibited private farming and those engaged in it were labelled as counter-revolutionaries and persecuted. As the liberal middle class infiltrated the communist party and society at large to restore capitalism, Mao Zedong launched the Great Proletarian Cultural Revolution to remove the middle class through revolutionary violent class struggle. For ten years from 1966 to 1976, the Chinese people experienced the Cultural Revolution that officially ended with the demise of Mao Zedong. After Mao’s death in 1976, Deng Xiaoping, who opposed the Cultural Revolution, gained prominence, became the leader, and abandoned most of the political, economic, and educational reforms of Mao’s revolution.

In 1978, Deng Xiaoping launched China’s socialist economic reform. Several years later, in 1992, he went on an inspection tour of southern China to revive the economic reform to transform China into a socialist market economy. One of the key statements of Deng Xiaoping’s economic reform is that it does not matter what the colour of the cat is, as long as it is able to catch mice.

Against the fast-growing private sector in the 1990s, large- scale state-owned enterprises (SOEs) were failing. Reforming SOEs was a national agenda. According to Tong (2007), the first phase of the reform was to establish and strengthen profitability-related incentives for the managers, and the second phase was to nurture the big SOEs while letting go of the smaller SOEs. The second wave of SOE reforms resulted in the mass laying off of workers in the urban areas, and the slow and consistent shrinking of the SOEs’ share in China’s industrial sector. Reforming SOEs created social discontent and disharmony among the Chinese people. Many workers took to the streets to demonstrate against the government.

In 1997, China entered a period of administration by Jiang Zemin and Premier Zhu Rongji. Jiang and Zhu oversaw China’s accession to the World Trade Organization (WTO) in 2001. Then, there were fears among some of China’s economic sectors as China opened its domestic markets to the world. Such fears were judged unfounded as the Chinese leadership successfully integrated China into the world economy. Hu Jintao assumed the party leadership in 2002. In addressing income disparity, gaps between urban and rural development, occupational health and safety in SOEs, state corruption and environmental protection, Hu adopted a humane style of leadership and, at the same time, enhanced state authority and control. His balanced approach, Wang and Lye (2007) argue, is embodied in the ‘Three people’s principles’: power to be used by the people; concern to be showered on the people; and benefits to be enjoyed by the people. The ‘three people’s principles’ have eventually been manifested in the concept of an ‘harmonious society’. An ‘harmonious society’, according to Hu Jintao, would contain elements of fairness and uprightness, rule of law, order, democracy and balance between the needs of man and nature. In 2008, seven years after China’s accession to the WTO, Chinese foreign exchange reserves exceeded US$1.9 trillion, boosting China’s confidence in leading its economy in a globalised world. As of 2009, Chinese gross domestic product (GDP) ranked third globally and China overtook Germany to become the world’s biggest exporter.

Geographically, China is the third largest country in the world, after Canada and Russia, with a land area of approximately 9.6 million square kilometres, covering 6.7 per cent of the world’s surface area. As of 2008, its population is 1.328 billion, with more than 90 million Chinese living in the Henan (94.29 million), Shangdong (94.17 million), and Guangdong (95.44 million) regions. In its major cities, there are approximately 17 million people living in Beijing, 19 million in Shanghai, 10 million in Guangzhou, and about 9 million in Shenzhen. The largest municipality/city is Chongqing with a population of 28.39 million. The eastern part of China is more densely populated than the western part. The average household size in 2008 is 3.16 people. The population growth on a year-on-year basis has reduced from 12 per cent in 1978 to 5.08 per cent in 2008. According to Reuters (2008), the Chinese population is expected to grow to 1.5 billion by 2033.

As of 2008, the median age of the Chinese is 34.1 years. There are about 105 males to 100 females. China has about 150 million people aged 60 or above, comprising 11.6 per cent of its population; the old age dependency stands at 10 per cent. According to the United Nations Procurement Division, this figure is projected to increase to 39 per cent by 2050.

The Han ethnicity makes up the majority 92 per cent of the population, with 55 ethnic minorities accounting for the remaining 8 per cent. The major dialects are Beiyu, Minyu, Xiangyu, Yueyu, Keyu and Ganyu. Its diverse population are spread across five autonomous regions (Guangxi, Xinjiang, Tibet, Inner Mongolia and Ningxia); 22 provinces (Hebei, Shanxi, Liaoning, Jilin, Heilongjiang, Jiangsu, Zhejiang, Anhui, Fujian, Jiangxi, Shandong, Henan, Hubei, Hunan, Guangdong, Hainan, Sichuan, Guizhou, Yunnan, Shaanxi, Gansu and Qinghai); and four municipalities (Beijing, Shanghai, Tianjin and Chongqing). The 31 autonomous regions, provinces and municipalities are under the direct control of the central government.

The urban population, i.e. those living in cities and towns, accounted for approximately 45 per cent, so the rural population is 55 per cent. In 1978, the year the reform policy was promulgated by Deng Xiaoping, the ratio of urban to rural population was 17.9 per cent to 82.1 per cent. This ratio increased to 26.4 per cent and 73.6 per cent respectively in 1990. By 2000, the gap between urban and rural was narrowed to 36.2 per cent and 63.8 per cent. The shift in the urban to rural population may not have any historical significance in terms of its sheer numbers in the labour movement. However, the increase in urban population reflected a higher economic growth rate which was sustained over a period coupled with internal labour movements. It was reported that 130 million migrant workers uprooted themselves from their home towns in the rural provinces to the cities in search of work and better earning opportunities; initially drawn to the first-tier coastal cities and subsequently to the second-tier cities. According to China Daily (2009), there are more than 240 million unemployed urban residents in China.

Currently, China has more than 118 megalopolises with a population exceeding 1 million each and 39 super metropolises of more than 2 million residents each. Overall, the standard of living, measured by the Engel coefficient, of the urban and rural population has improved significantly, and the gap between urban and rural Engel coefficient has narrowed over the past 30 years. The Engel coefficient of the urban population in 2008 was 37 per cent, and that of the rural population was 43.7 per cent. In 1978, the Engel coefficient for urban population was 57.5 per cent, and for rural population 67.7 per cent.

According to China Daily (2009), China invests 2.8 per cent of its gross domestic product (GDP) in education as compared to the OECD countries’ investment of 5 per cent of GDP. The literacy rate in China increased from 84.12 per cent in 1990 to 93.3 per cent in 2008, and 72 per cent of the senior school graduates in 2008 went on to tertiary education. Of postgraduate enrolments, 59,764 are doctoral candidates, and 386,658 are studying for a Master’s degree. The disciplines studied by postgraduate candidates are engineering, medicine, management, law and economics. In addition, literature is popular at graduate level. In 2009, there were more than 1.28 million postgraduates and Chinese students studying abroad. Three hundred million Chinese people were reported to be learning English in China and approximately 40 million students were learning Chinese outside of China.

A recent report by IDP Education Australia commented that China is adding 2.5 million domestic tertiary education places annually, representing a 25 per cent compound annual growth rate. However, demand for university places continues to outstrip supply. It is estimated that 350,000 mainland Chinese are studying for degrees in overseas universities and the number is expected to double within the next 20 years. There were an estimated 120,000 Chinese students studying in Australia in 2009 and 23,000 Chinese students were granted British student visas in 2007. Among the international students overseas, Chinese students at overseas universities exceeded all other nationalities. The reason, IDP Education reported, for the large number of Chinese students overseas is the lack of university places in the home country; opportunities for skilled migration; perceptions of improved employment and career prospects for overseas graduates; and the beliefs about better quality education and overseas life experiences.

From the economic data for 2007, the size of China’s economy is approximately US$3.26 trillion, which lags a long way behind the GDP of the US at US$13.84 trillion in 2007. China’s share of global GDP stands at 7.14 per cent in year 2008, compared to 1.8 per cent at the time of the economic reform policy of Deng Xiaoping in 1978. Since then, more than 200 million of the Chinese people have been lifted out of poverty. Fogel (2010), an economics Nobel laureate, predicted that China’s GDP in the year 2040 will increase to US$123 trillion; capturing a 40 per cent share of global GDP, larger than the US share of 14 per cent and the European Union share of 5 per cent.

When Deng Xiaoping took over the leadership from Mao Zedong, China’s foreign exchange reserves stood at US$1.6 billion. Ten years later, in 1997, these reserves were US$139.9 billion, lagging behind the Asian economies of Taiwan, Hong Kong and Singapore. By the year 2001, the reserves exceeded US$200 billion. As at the end of February 2010, China’s foreign exchange reserves exceeded US$2 trillion. With a GDP that is growing phenomenally, China is becoming the world’s largest economy. Huge foreign exchange reserves would have a significant impact on Outflow of Direct Investments (ODI) and/or Foreign Direct Investment (FDI) and Merger and Acquisition (M&A) transactions. Perhaps there will be an increase in crossborder M&A transactions, both from inbound and outbound direct investments of the Chinese and China.

An AT Kearney report on ‘The Rise of Emerging Markets in Mergers & Acquisitions’ concluded that ‘a paradigm shift is occurring [in that] beginning in 2002, deals between developing and developed countries grew at an annual rate of 19 per cent’. In another study on ‘Mergers & Acquisitions: impacts of WTO Accession’, Chen and Shi (2008) observe that ‘among M&A markets worldwide, the Asia Pacific region has normally accounted for only 15 per cent of all M&A transactions worldwide. But in 1H05 [first half of 2005], this figure reached 18 per cent’. AT Kearney reported that of the 2,168 major acquisitions in 2007 between developed and developing countries, almost 20 per cent were driven by companies from developing countries; this trend is growing at an annual rate of 26 per cent. Their study concluded that companies from India, Malaysia and China are at the forefront of M&A activities, accounting for 56 per cent of the deals which took place between 2002 and 2007. Moving away from the region and focusing on China specifically, there were 63 cross-border M&A transactions in 2007 with a value of US$18.67 billion, an increase of 105.4 per cent over the previous year. In 2008, the value of M&A deals increased by 44 per cent, followed by 135 inbound transactions into China totalling US$10.6 billion in 2009. Looking at M&A from a different perspective, the China Foreign Investment Report 2006 commented ‘Mergers and acquisitions have emerged as a common channel for global investments since the 1990s, accounting for nearly 80 per cent of the total worldwide. But they currently account for less than 10 per cent of total foreign direct investments to China’. It appears there is a large amount of scope for inbound M&A into China in the coming years.

M&A activities in China

As of the mid-1990s, M&A transactions in China were relatively unnoticed. At present, the situation is one where mergers and acquisitions are becoming increasingly common and form an integral part of the economic landscape. Two major factors may be responsible for the surge of M&A activities in China. The first is the economic reforms which were promulgated in 1978 by Deng Xiaoping that led to decades of high economic growth, and the second is China’s accession to the WTO in 2001. China’s economic reforms and phenomenal economic growth fuelled the rate of M&A activities, and its accession to the WTO opened its hitherto closed door to foreign investments. The economic landscape was quickly transformed from a centrally-planned to a market-driven economy. In the 1980s, investments were mainly restricted to export-oriented joint ventures with Chinese firms. As the country moved into the early 1990s, foreign enterprises were allowed to produce goods for sale in the domestic Chinese market. By the mid-1990s, the rules and regulations on foreign investments into China were relaxed to permit wholly foreign owned enterprises (WFOEs) to set up their operations locally.

Concurrent with the economic reforms, China also restructured its state-owned assets. In several industrial sectors, the state encouraged its state-owned enterprises (SOEs) to merge into gigantic conglomerates to compete in the global marketplace by exploiting their core business, while in other sectors it sought to reduce its equity holding. As a result, large numbers of SOEs were made available for restructuring and/or partnership with foreign entities. These potential targets therefore represent greater market entry options to foreign investors.

Undoubtedly, China’s entry into the WTO is the catalyst that compelled the Chinese government to open the service sector to the world, thereby paving the way for foreign investors to operate in domestic markets. These developments served to open up previously closed industrial and service sectors to foreign investments by eliminating operating restrictions that were previously imposed on foreign invested enterprises. The opening up of the domestic sectors attracted inflows of FDI exploiting M&A as a strategic vehicle for foreign investors. M&A offers foreign investors a convenient and effective platform to gain knowledge and market share as well as to jump-start and accelerate expansion of their business. An analysis frequently touted is that foreign acquisition of or participation in listed or non-listed enterprises or SOEs, especi...

Table of contents

• Cover image
• Title page
• Table of Contents
• Copyright
• Dedication
• List of figures and table
• About the authors
• Preface
• Chapter 1: An overview
• Chapter 2: Cultivating affective relationships
• Chapter 3: Introducing HR due diligence
• Chapter 4: Conducting HR due diligence
• Chapter 5: Navigating beyond relationships
• Chapter 6: Managing integration
• Conclusion
• Appendix: checklist for conducting a HR due diligence
• References
• Index