Getting it together

Overcapacity, economic fears, mooted currency liberalization and the market free-for-all promised by the World Trade Organization in 2007 make China rife with takeovers and tie-ups. Deals locally and overseas, are keeping Chinese and foreign consultants busy, and perhaps forging a few champions. Chinese firms, some with government prodding, increasingly hunger for mergers and acquisitions (M&A). Despite years of horror stories, foreign companies are also eager to buy their way in, and replace capacity rather than add to it.

Most industries, especially those dominated by state-owned dinosaurs, are seeing plenty of action, often substantial deals at local or regional levels. "The beer sector has seen a lot of consolidation over the last few years. The best example is Tsingtao going around eating up regional competitors," says Angus Barker, corporate finance group head of UBS Investment Bank in Hong Kong.

For years, China's listed fixed and mobile phone networks have been acquiring provincial networks via asset injections from their state-holding companies. China Netcom led the consortium that bought up bankrupt trans-Oceanic cable network operator Asia Global Crossing in 2002.

China's big three airlines – Air China, China Eastern and China Southern – have been busy swallowing smaller carriers, at least seven on Beijing's orders, over the last few years.

Trouble in the provinces
Typically, provincial arms are under a state-owned parent. Through "acquisition" a firm with nationwide remit, often listed in Hong Kong, acquires these branches. While still common, these deals are increasingly being matched by conventional M&A deals.

"The interesting thing about M&A in China is that it is starting to happen across a range of industries, different segments of markets, and indeed across borders," says Barker.

Consumer electronics manufacturer TCL is now the global king of television production, holding a 67% stake in a manufacturing joint-venture formed with France's Thomson in November 2003. That followed its takeover of Germany's Schneider Electronics for US$10.6m. Then in November 2004, Thomson bought 4.82% of Konka, TCL's archrival, for US$18.9m.

TCL also fused its mobile-phone division with Alcatel's handset operations last year, gaining know-how, brand and a big footprint in Europe. In December, Lenovo agreed to buy IBM's PC design and manufacturing business for US$1.75bn.

Nasdaq-listed online-gaming giant Shanda took control of Korean rival Actoz last November, spending US$91.7m for a 29% share, after grabbing two small Chinese rivals Haofang Online and Bianfeng Software last July. Its bid for Nasdaq-listed Sina, one of China's largest internet portals, resulted in China's first major hostile takeover attempt. Sina came up with a 'poison pill' to make Shanda think twice about raising its stake above the current 19.5%.

Shanghai Automotive Industry Corp snapped up South Korean automaker Ssangyong last year, and despite April's "no deal" announcement, could still take over the sexier parts (like brand and engineering) of now bankrupt British auto-maker MG Rover. In a break from the past, Chinese executives are scouting out firms in the West to manufacture in China, rather than waiting for them to come knocking. That opens the doors to outsourcing, joint-ventures and even takeover. Overseas takeovers not only offer a backdoor into wealthy markets, potentially circumventing tariffs and quotas, but also burnish China's prestige, making otherwise marginal deals acceptable.

"Some of the deals are also egotistical," says Robert Partridge, managing director of Ernst & Young's China transaction advisory services practice in Hong Kong. "It's prestigious in China for a Chinese company to be seen acquiring overseas."

Executives from China's energy firms are sitting on stacks of air-miles after scouring the planet for oil-and-gas deals, stretching from Indonesia to South America via Africa and Canada. China National Offshore Oil Corporation (CNOOC) even bid for US stalwart Unocal, only to see ChevronTexaco snatch the deal. In 2003, it paid US$2bn shopping for gas and oil assets in Australia and Indonesia, while Sinochem paid US$100m for a stake in an Ecuadorean field operated by ConocoPhilipps.

Firms have been raking through Australia and Africa for metals. "We've seen raw materials security as a theme for a while, so we have seen their energy companies or natural resources companies going out to look for joint-ventures or takeovers," says Barker.

China scales up
For China's better-run, outward-looking firms, scale is their only defense against almost unfettered foreign competition coming in 2007. "M&A is becoming much more common," says Duncan Clark, managing director of BDA China, a telecoms consultancy in Beijing. "There are a number of listed companies that need to grow, buying to keep the growth going."

Beijing is pushing consolidation among key firms in strategic sectors like banking, energy and transport for the same reason, which explains why market-driven M&A is making its mark, overshadowing old-style asset injections and restructurings ahead of listings in Hong Kong.

Scale also allows firms to expand into other provinces overnight. "Chinese companies are looking for Chinese domestic M&A to fuel their growth through entering new markets and adding more products," says Partridge. "Likewise, you have Chinese companies looking overseas for acquisitions, fundamentally for the same reasons. As regulations loosen up, we're going to see more domestic and international M&A."

Less so than in the past, expanding domestically can still trap companies in hoops designed to protect local players – so owning what is already there is sometimes the more doable option. Some companies are also shopping to build up brand and design.

Whatever the reason, the new enthusiasm for tying the knot spells boom time for consultants, creating dozens of competent local partnerships that successfully compete against foreign leading lights, yet also work hand-in-hand.

"Mainland enterprises tend to use local consultants to handle local deals and foreign specialists for overseas deals," says Xu Zhi Gang, heading Deloitte & Touche Corporate Finance eastern China in Shanghai. "They each have relative strengths."

Straightforward local transactions are generally the province of local players, like Llinks Law, Junhe, and King & Wood. "We have seen the emergence of a lot of local law firms that have a similar approach to international law firms," says Ernst & Young's Partridge.

With deals that cross borders, foreign lawyers, like Freshfields, King & Wood, and Linklaters, accountants, typically the big four, to global investment banks, the usual suspects, are finding Chinese firms knocking on their doors.

Consulting business grows

As deals involving Chinese firms grow in size and complexity, foreign bankers find themselves more in demand. Goldman Sachs advised Shanda in the bid for Sina, which was advised by Morgan Stanley. "The quality and quantity of corporate dialogue has certainly increased for us and for many practitioners in the market over the last 12-18 months," says Barker of UBS.

Heading overseas can be expensive. "Chinese companies as a rule are spendthrift," says Partridge. "Many want to engage investment bankers who are financial advisers because they don't have to spend much upfront."

But many Chinese firms looking at local mergers still opt to use guanxi (connections) over a phalanx of due diligence specialists – and the results can be horrific, as evidenced by D'Long International's multi-faceted journey to empire, and ultimately, collapse last year. "A lot more companies are stepping up to become serial acquirers," says Partridge, "some for the right reasons, some for the wrong reasons.?

"I hope we don't see too many serial acquirers that are careless like D'Long."

Accountants and lawyers are now sorting through D'Long's wreckage, trying to salvage what they can from a spectacular bankruptcy that threatened China's stockmarkets, forcing the People's Bank of China to step in with a US$1.8bn takeover. D'Long's owners, the Tang brothers, remain under arrest, pending trial.

Chinese firms often approach M&A from the opposite perspective to foreign firms. "When Chinese companies look to do acquisitions they usually look at net asset value, whereas Western acquirers are focused on cash-flow. That's a very fundamental difference and very telling about what a long-term view is," says Partridge.

Asset values do not mean profits, as D'Long found to its cost. Focusing on the parts, rather than their sum, suggests Chinese firms are looking at asset stripping, or betting on asset inflation, or both, to deliver a return.

That said, more than a few Chinese companies are run by skilled management that understands the importance of cash-flow perfectly well. In rare cases, a few are buying out their foreign joint-venture partners. "You will only see that where the foreigner has decided to exit the China market [but] I don't see that being a big area for deals," says Partridge.

Usually it is foreigners, tired of troublesome partners and seeking full management control, buying out their Chinese partners, and regulatory changes allowing that in many industries have unleashed a slew of such deals.

IP security is another incentive for buying out partners. "When they build up their management team, network and reputation, and when they plan to introduce advanced technology, they will consider buying their Chinese partner out to maximize profit and gain autonomy," says David Yu, a partner specializing in distressed assets with Llinks Law in Shanghai.

Distressed assets

Foreign investment banks are focused on the US$200-US$400bn of distressed assets state asset management companies are slowly selling off – making for a steady stream of below-the-radar real estate deals. Venture capital is also pouring into target-rich China, now over US$2bn from an estimated US$5m in 2001. "In the next few years, we'll see a US$5bn market for foreign private-equity venture-capital investment," says Partridge. "The growth rate is most significant – the entrepreneurial development in China is huge."

By some measures, Asian Venture Capital Journal's for one, venture money has already reached US$5bn, but that is still peanuts compared to Europe's annual draws of US$150bn. To maintain fast growth in VC inflows, China needs regulatory changes, most importantly a convertible yuan, and an end to the ban on foreigners listing companies on the stock market – opening a much needed exit for VC investors. Such issues are less important to strategic investors looking to settle down and grow businesses in darling sectors. "We're continuing to see a lot of activity in autos, retail businesses, technology and telecoms, and financial services," says Partridge.

As plenty of blockbuster deals show – Cathay Pacific bought 10% of Air China for US$300m in November. Emerson Electric paid US$750m for Huawei's Avansys subsidiary in 2001, seen by some as the first true M&A deal in China. Anheuser Busch beat out SAB Miller for 29% of Harbin Brewery for US$140m in 2004. That skirmish is a prelude for a battle royale over Tsingtao, China's brewing titan, of which Anheuser owns 9.9% (with an option to raise that to 27%) and Miller 29.4%.

When the WTO liberalizations eliminate remaining investment restrictions, the size and pace of deals will almost certainly rise. That thought has some investors moving in now, not waiting till 2007.

Meantime widespread expectations of a stronger yuan this year are pushing investors to make a deal while the currency still looks cheap. "We're seeing a lot more deals closed, not because they are better deals but because foreigners are willing to take more risk and hurry up deals," says Partridge.

Such deals are really the first wave, introducing M&A to corporate China on the one side, and China to offshore prospectors on the other. "It is very, very early days in China," says Barker.