Mergers & Acquisitions And Partnerships In China

Olivier Coispeau, Stéphane Luo

• Publisher: WSPC
• Year: 2015
• eBook ISBN: 9789814641043
• Topic: Biological Sciences
• Subtopic: Science General
• Index: Biological Sciences

Mergers & Acquisitions and Partnerships in China provides a fast and accessible framework to external growth in China, and is an attempt to accurately describe the main operative conditions and in particular the most common pitfalls for foreign businessmen. The business cases in this book illustrate real business situations, including different outcomes and a thorough analysis of the reasons for success or failure of the case. The authors provide all the necessary tools to better master the negotiation and transaction process, and provide in particular, detailed explanation on the due diligence process and the regulatory framework to help readers successfully lead acquisitions in China.

Written by well-known experts in finance, law, and management, who all have deep business knowledge of China, the book aims to help practitioners, such as law firms, audit and advisory firms, and entrepreneurs to start or grow their businesses in China through successful partnerships, and acquisitions and mergers by explaining how these aspects are regulated by a complex web of laws, regulatory, and political practices in a context where the state plays a key role in the approval of important transactions.

Contents:

• Introduction (Olivier Coispeau)
• Preparing for an External Growth Operation in China (Olivier Coispeau and Stéphane Luo)
• Initial Approach of the External Growth Operation (Olivier Coispeau, Stéphane Luo and Thierry Labarre)
• Managing Acquisitions Risks (Frank Zheng, Thierry Labarre, Josephine Chow, Steven Yu and Olivier Coispeau)
• Negotiating Effectively (Olivier Coispeau)
• Closing the Transaction (Olivier Coispeau and Stéphane Luo)
• Seven Case Studies of Mergers & Acquisitions and Partnerships in China (Olivier Coispeau)

Readership: Advanced corporate finance students; emerging market students, in particular those working on China; corporate finance professionals, lawyers, auditors, and strategy officials; officers in charge of M&A in international companies and responsible for strategy, with a specific interest in the China market.
Key Features:

• Unique comprehensive and multifaceted vision on how to succeed in negotiating partnerships and acquisitions in China
• Compact and effective book written to deliver the most critical and needed information including related laws from China
• Five case studies to facilitate an in-depth understanding of key issues in M&A and partnerships in China

Chapter 1

Preparing for an External Growth Operation in China

1.1. Mergers & Acquisitions Specificities in China

(1) Approaching the Chinese market in a rigorous way

The size and dynamics of the Chinese market alone are not a sufficient guarantee of success for an M&A operation or a strategic partnership. Local and international competition is fierce, the legal framework still flexible and sometimes soft, and the business name of the game very clear: maximize profitability and reduce time to recoup investment.

Naïve optimism that business will flow through one’s door is not an option, with a few remarkable exceptions (e.g., “dream brands”); nobody is really waiting for your products in this urban jungle, but everybody will be interested to see what you can offer. The emergence of new competitors, possibly from local elites who were yesterday’s partners, can be amazingly quick. Industry consolidation strategies must be assessed in the light of China’s tremendous capacity to self-generate new entrepreneurs trained in the best universities locally or abroad, and capable to adapt and develop faster than foreigners into the Chinese industrial web. However, this can be a long-term objective for a specific and well-defined product range.

The availability of talent, the growing innovation capacity of the Chinese firms, the intimate knowledge of the economics, the political environment, and the availability of funding — encouraging local initiatives — all induce strong competitive pressures. Price and talent wars often occur to tame competition and result in the disappearance of less resistant competitors, especially when this is coupled with rumors or disclosures of improper products shipped on the market or disappointed teams leaving the firm. Preparing a winning entry strategy takes a bit of detailed and rigorous analysis, to know precisely how to position products and develop one’s market share.

Protection of the key “soft” assets — talents, intellectual property (IP) — is often considered a sensitive and problematic issue in China. Damage that can possibly be inflicted on a foreign company due to an unwilling transfer of know-how expertise is huge. Close to the protection of key assets are the risk of internal fraud and the risk of using counterfeit products or releasing improper products⁶ on the market, which may lead to serious losses. This requires a constant monitoring of business operations and the way business is done. In China, conflict of interest may be interpreted in a different way than is the West: doing business with someone I know is actually a way to reduce risk.

It is indeed mandatory to be well organized, constantly monitor the way business is done, be surrounded by loyal local allies, and remain very close to on-field operations. Strategies to protect key assets must be designed, especially the more fragile and volatile assets, such as people and intellectual property. This requires being creative, being respectful of the laws, and exploiting every opportunity offered by the existing PRC laws and the local partners’ network. Of course, this phenomenon is not limited to China and similar problems can be witnessed in all emerging countries.

It is therefore necessary to carefully plan and monitor the Chinese market’s strategic approach, by progressively and relentlessly building a quality position and a foothold. At the same time, as credibility increases, preparing for a well-timed leap is necessary. Progressiveness of the efforts deployed is mandatory and requires a tactical preparation for the key stages of development. Strategically, a company must set ambitious but realistic goals, that take into account the rapid Chinese market growth and the specific appetite of the Chinese market for certain products (e.g., color codes, lucky numbers, positive references to China’s culture and traditions).

The establishment of a presence in China as a simple duplication of a presence in Europe or in the US is just a beginner’s mistake to avoid. Many management books are full of stories which should have worked on paper in China but finally failed, for obvious reasons uncovered after a more detailed analysis. One foreign automotive manufacturer had difficulties in selling its newly produced car in China. Oddly, it was very successful in other countries, and in theory, well suited for the Chinese market. Someone realized that the car was mostly available in metal green. The most educated people will indeed associate the color with health, prosperity, and harmony, but also with nausea. A more serious concern is that a widespread popular tradition associates green hats in China with infidelity, and it is used as an idiom for a cuckold and tends to make Chinese laugh at it. Therefore, buying a green car is not exactly a symbol bringing “face” to its owner; it is no surprise that such cars were hard to sell without a huge discount in China. In essence, China is a country where experimenting and dialoguing is crucial, and any wise organization must be organized and ready for that.

The stakes associated with a presence in China must be pondered, and the companies willing to do so must realize that important opportunities come with a high level of risk. However, these risks are controllable and manageable, provided that the human investments (advisory, consultancy, training, auditing) and industrial investments are meticulously calculated and methodically implemented, with sufficient flexibility to leave a margin for interpretation to local conditions. Those who prefer to systematically use shortcuts and simplistic approaches will probably face bitter setbacks.

(2) Assessing administrative changes

China’s accession to the WTO on December 11, 2001 allowed foreign investors to access many economic sectors previously restricted, thus creating a new wave of international investments. Industrial sectors which were once closed to foreign investors have opened up, although the recent legal evolution has also tightened a few screws, on the grounds of preserving national security. Acquisitions by foreigners of listed companies, following a public take-over bid, have recently been successfully carried out (e.g., acquisition of Supor by Groupe SEB in several steps). However, this reform is still ongoing, and several sectors are still closely monitored or restricted to Chinese majority ownership including media, financial institutions, and airline ticket bookings.

Along with this market reform, China has significantly adapted its state-owned companies created under the communist era to a new market economy with socialist characteristics. This means that China’s government did not wish to support loss making or ineffective state-owned companies, and was eager to confront them with the reality of offer and supply on competitive markets.

In specific sectors, the Chinese government pushed companies to merge and better specialize to form integrated conglomerates having the potential to become world leaders. Moreover, the Chinese state is trying to dispose of its interest in these companies and is looking for private investors to manage these assets.

As a result, the number of state-owned companies, as well as the significant number of offers of partnerships and acquisitions of state-owned corporations made available to foreign investors, is decreasing. At the same time, new forms of partnerships based on foreign technology and domestic financial investments are emerging. Still, the numerous constraints on restructuring operations and partnerships concluded within China are such that many operations are still conducted offshore.

Even though China has become a major economic player and has been ranked from time to time as one of the most attractive destinations for foreign investment, the fact remains that it has just emerged from a planned economy derived from a Marxist approach and intends to move towards a socialist market economy, with all the implied possibly unstable changes and rapid adjustments. This transition confers specific characteristics to its relatively young legal environment, particularly in terms of control of foreign investments.

It should be first noted that the restructuring of complex acquisitions and mergers techniques and possibilities, are much less extensive and developed than in mature economies. One must assess what is feasible and under what conditions, before engaging in operations that may ultimately prove to be impossible or awkward in China, for example, due to potentially conflicting political agendas such as protecting “core” national brands.

Control on foreign exchange in China still remains a source of constraints for cross-border restructuring and M&A operations. The gradual internationalization of the renminbi (RMB) is going to change this in the future. But for now, a duality of regimes is applied to Foreign Invested Enterprises (FIE) and purely domestic firms, even though new regulations tend to bridge these two regimes, notably the Company Law and the Enterprise Income Tax Law. Many special texts, particularly in the field of company restructuring and acquisition, continue to provide specific rules depending on whether the investor is Chinese or foreign.⁷

To date, every foreign investment on Chinese territory systematically requires the Chinese authorities’ approval. Such approval is given at different levels, depending on the size of the envisaged investment and on the industry, which may induce conflicting solutions and requirements depending on whether the relevant authorities are national, provincial, or local, and whether they are in a coastal and economically privileged province, or a more remote and less economically developed district.

Local governments may also have their own interpretation of these laws and regulations. They may even publish implementation guidelines which overlay national laws, which can create complex situations that are always quite delicate to solve and time consuming. Local regulations can be drawn up in terms which may be interpreted differently from the national framework. Convergence towards a viable solution will then be a matter of negotiation and finesse of these texts’ interpretation. From this perspective, China is a pragmatic country, and meeting with people and understanding their concerns are very important at each step of the process. The arrival of a new political leadership in China, under the stewardship of Xi Jinping, has also redefined the house rules, and what could be considered acceptable or even normal in the past to grease the wheels is not acceptable any more, associated with corruption and punished.

(3) China still remains a particular environment for M&A

The lack of accounting transparency is too often responsible for creating a difficult environment to assess a potential target. The underlying management of social, fiscal, and environmental liabilities may entail complex issues in an equity deal, implying a transfer of social and fiscal responsibility from the target to the acquirer.

In the past, the obligation to pay in full the acquisition price of a PRC target company within three months was one of the key differences between M&A operations in China and in Western countries, as it increased the Chinese inbound M&A transaction risk profile.

This obligation limited the possible use of safeguard and protection techniques for the acquirer, such as escrow accounts for a part of the buying price or the inclusion of earn out clauses (additional payment depending on milestones). Ultimately, these constraints limited the options available to legally challenge the seller in the event of the discovery of undisclosed liabilities after the closing. The 2014 reform has abolished this restriction and China’s M&A practices are converging to the world’s best practices.

Acquisition and restructuring strategies can still be delicate to carry out in a fast moving economy and adjusting legal environment. The laws are sometimes drafted in general terms, leaving a lot of room for interpretation. They can be incomplete or even in contradiction with possible interpretations at various administrative levels. It sometimes makes the practice of law look surprisingly flexible when dealing with reference texts. A regular practice of these frequent problems in China, as well as strong interpersonal skills, a good network, and a precise knowledge of what may be a deal breaker will generally indicate whether an external acquisition or partnership is sustainable or not. However, it may take some time to patiently assemble all the pieces of such a jigsaw.

1.2. Typology of Mergers & Acquisitions in China

Before acquiring a Chinese structure, any foreign investor must carefully choose the legal form of the Chinese entity in which its own Chinese target will be incorporated. In addition to the opening of a representation office, which has nowadays become a bit outdated, except for some heavily regulated sectors such as banks, foreign investors can better set up their business in China by using a joint venture (JV) as a host structure, or a wholly foreign-owned enterpr...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Preface
• Acknowledgments
• Contents
• About the Authors
• Disclaimer
• Key Abbreviations and Institutions
• Foreword by Seamus Grimes
• Foreword by Yves Dolais
• Introduction
• Chapter 1. Preparing for an External Growth Operation in China
• Chapter 2. Initial Approach of the External Growth Operation
• Chapter 3. Managing Acquisitions Risks
• Chapter 4. Negotiating Effectively
• Chapter 5. Closing the Transaction
• Seven Case Studies of Mergers & Acquisitions and Partnerships in China
• Appendix
• Conclusion
• Bibliography
• References
• Index