Published in ICIS Chemical Business, 6-19 August, 2007
Charles Maynard / Business Development Asia
At first glance, the billions of dollars invested in China appear to be paying off: companies can trumpet growth rates of 30-40%, and in their annual reports they describe their foothold in the world’s most exciting market in glowing terms. The reality, though, is often different.
For many corporations, revenues from China remain a tiny fraction of global sales – and growth rates always sound impressive when you’re starting from an almost nonexistent base. Also, their sales in the Chinese market are dwarfed by those of their local counterparts.
This is hardly surprising. How can foreign companies in China, which have traditionally been focused on the export market, compete with the distribution networks that local, state-owned enterprises have had in place for decades? Nor can foreigners compete on price – a long-established Chinese company can almost always make its products more cheaply than a foreign-financed project.
It is for these reasons that many global companies are now on the acquisition trail in China, buying up local competitors to boost their presence in the domestic market. An added side benefit is obtaining the knowledge of the local management team.
Gone are the days when the economy consisted only of Chinese state-owned firms run by clueless bureaucrats. Most businesses, state or privately owned, now have commercially oriented, dynamic local executives who can help outsiders navigate the vagaries of the Chinese market.
The result has been more deals, and bigger deal sizes. Acquisition targets with revenues in excess of $50m (€68m) of enterprise value have become the norm. There’s more liquidity and money looking for targets, and more competition.
It’s not just European and US companies trying to buy companies, but also Indian and Japanese buyers, Hong Kong, Taiwanese and other Chinese strategics, as well as global private equity players.
Buyers also want more of the company they’re buying. Joint ventures with local partners are now far from popular – many companies are spending major resources extricating themselves from such structures. And 100% acquisitions, or majority stakes with staged, earn-out provisions, are the norm.
Increased competition means higher prices for Chinese firms. China’s perennially inflated stock market doesn’t help. No Chinese seller will ignore the massive multiples that his peers are trading at on the local stock exchanges. Equally, as the mergers and acquisitions (M&A) market in China has become more sophisticated, structured sale processes have become more common, making transactions easier to close, but again, a little more expensive.
Yet the process remains fraught with difficulties and disappointments.
UPPING SUCCESS RATES
Acquirers tend to steer clear of the state-owned behemoths listed on stock exchanges in China as well as Hong Kong and New York – the government is unlikely to sell crown jewels such as Sinopec or Sinochem.
But there are more than enough companies in China to find a decently sized, profitable competitor, while avoiding the targets that could cause an uproar in Beijing. It’s only a question of looking in the right place.
Success depends on foreign acquirers taking the time to adjust to the way things work in China (see box) – a process that requires a lot of patience and understanding, but that will pay off in the end.
The key is to build a relationship with the company’s management – and that’s not just a question of picking up the phone and speaking only English or limited Chinese. Neither will managing the deal by simply flying in and out be effective.
Doing business in China requires face-to-face time and focus – and ideally it should be handled in the regional language by dedicated locals who have time to really get to know key people at the target company and push the deal forward on a daily basis. The cost of hiring an adviser experienced in Chinese M&A with a strong local presence will more than likely be offset by the time and money saved in the long run.
There are changes afoot in China’s rapidly reforming economy that bode well for acquirers. With debt funding limited and capital expenditure requirements becoming untenable, many are now looking to rationalize their portfolios by divesting parts.
Also encouraging is the fact that, after three decades of reform, a significant group of middle-market, privately owned companies are finally emerging in China – not just in chemicals but in many industrial sectors. These are attractive companies often owned by entrepreneurs who are increasingly comfortable with M&A.
POTENTIAL ACQUISITION PITFALLS
The Chinese market changes at a lightning pace
You may have gotten to know your top competitors on a trip to China in 2005, but it’s now 2007, and they’re no longer at the top of the pile, or they may already have sold exactly the part of the business you had your eye on. It’s important to continually track a top tier of targets, understand their business and goals, and meet their management and shareholders.
Accounting in China remains a work in progress
These days, it’s easy enough to get information on companies, even on the internet. But it is often patchy – and even misleading – on issues such as shareholder structure and especially financials. It’s worth asking for this information from the company directly, but don’t expect perfect financials early on in the process. After decades of Communism, many Chinese companies are still not used to international accounting and valuation norms. For example, it’s not unheard of for both buyer and seller to spend months agreeing on a price they’re both happy with, only for the deal to fall apart when it transpires that the Chinese party was – out of ignorance rather than bad faith – negotiating equity value, while the foreigner was negotiating enterprise value. Concepts such as earnings before interest, tax, depreciation and amortization (EBITDA) or enterprise value may be completely foreign to them and need to be thoroughly introduced.
Taxes are not optional for foreigners
In a system where the state owned the company and got the profits, tax collection wasn’t so important, and so underreporting by Chinese enterprises remains typical. But it is unlikely that a foreigner will be allowed to get away with it. Address this issue and any questionable sales practices early on.
China is heavily regulated and those regulations will need to be complied with
In China, a person can’t even exchange money to go on holiday, or own a dog without a government license – so you can imagine the number of approvals needed in a large and complex financial transaction. Start thinking early on about what regulatory approvals are needed for your deal, how long they will take to secure, and whether there’s any execution risk entailed.
China’s shareholding structures are often complicated
Try to come to grips with these early on. Once you have figured out who actually owns the company, focus on each key shareholder – and his or her motivation to sell or hold.
Consider earn-outs and succession issues
How motivated will a key shareholder be post-sale? How deep is the management team? How can succession risk be minimized and the management motivated?
You may have to pay a China premium
There’s limited benefit in focusing too much on trading or deal comparables of global leaders in mature markets to price an offer. Chinese target companies may have revenue growth rates ten times higher – and there is increasing evidence of a “China premium” – where buyers are willing to pay a material premium to gain a substantial presence in the Chinese market.
Charles Maynard is cofounder and managing director of Business Development Asia (www.bdapartners.com), an Asian M&A advisory firm that specializes in the chemical industry. He can be reached at cmaynard@bdallc.com
