Just a few years ago, Chinese companies had been the top acquisition targets of foreign investors. Now, many of them are buyers and on an overseas shopping spree. The total value and number of overseas investments made by domestic enterprises in the last 12 months defined 2008 as a landmark year for Chinese outbound M&A.
According to Thomson Reuters’s latest statistics, China outbound transactions recorded a 64.4% growth in deal values from US$29.1bn in 2007 to US$46.2bn, with the natural resources sector taking the lead in terms of deal value.
However, given the uncertainty in the global market and a decline in Chinese companies’ earnings, there is a good chance that Chinese outbound M&A activity will see a slowdown in the months ahead.
“Amid the global financial crisis, China is also experiencing contracting growth. Any notion that China is 'decoupled' to any significant degree from the global recession no longer has any credibility," said Ashley Alder, head of Asia at Herbert Smith. "Over the next a few months, the economic slowdown may well delay Chinese corporations’ ambitions to expand through M&A transactions abroad, although we also expect that China may well come out of the current economic turmoil faster than the US and Europe."
Slow on deal making
With the deepening global financial crisis, many companies in developed countries are suffering financial difficulties and seeing their share prices drop sharply. The turmoil could mean bargains around the world for Chinese investors.
Although cheaper assets overseas are making more domestic companies eager to jump on the outbound M&A bandwagon, legal advisors have reported certain difficulties in closing deals.
“The economic uncertainty has created hurdles, preventing the buyers and vendors from reaching an agreement on the value of targets. Chinese investors remain cautious, as some markets are still searching for the bottom,” said Zhang Shiwei, partner of Kaiwen Law Firm. “Some transactions we are advising on are progressing slowly and a few have come to a halt, due to the uncertainty in valuation.”
Last year, Kaiwen advised Shenzhen Zhongjin Lingnan in its joint takeover bid with Indonesian partner Antam for Australia’s Herald Resources for US$470m.
Vinson & Elkins, which has represented Chinese companies on a number of high-stake outbound transactions in the energy and natural resources sectors, has noticed the same market sentiment. “The large SOEs are proceeding cautiously at this point. We don’t see any immediate moves by our Chinese clients to immediately expand their acquisitions of overseas assets,” said Paul Deemer, co-managing partner of the firm’s Beijing and Shanghai offices.
“However, we do expect that the climate for Chinese overseas acquisitions will improve later in the year, particularly if it becomes clear that the slowdown has bottomed,” Deemer said. “There will be more distressed sellers in the market, and those will need to be carefully vetted to assure the buyer that it is getting what it pays for.”
Opportunities amid crisis
While outbound M&A activity is likely to be slower in the short term, the long-term outlook remains positive. As markets in other parts of the world hit the bottom and financing becomes more readily available, more offshore investment is expected to take place later in the year.
Law firms in the region are hoping that incomes generated from advising on cross-border transactions of Chinese investors would offset the downturns in some of the more affected markets.
“Chinese acquirers have fewer obstacles and frictions now in Western countries, given that these countries are lowering their thresholds for foreign investment to relieve the financial pressure on their companies,” said Zhang. In the years ahead, the firm is looking to represent Chinese clients in an increasing number of transactions in Europe.
While Western attitudes towards Chinese investment are improving slowly, Chinese investors have learned to play it safe by investing closer to home. Investment value for targets in Australasia and South East Asia in 2008 increased significantly compared to the previous year.
International and local firms with strong practices in the resource-rich jurisdictions have found themselves in a better position to win mandates from Chinese investors.
According to Ian McCubbin, lead partner of Deacons China practice group in Australia, his firm’s cross-border M&A work with Chinese companies has doubled over the past 12 months. Half of the M&A revenue is from cross-border deals with state-owned enterprises and most of these have taken place in the resources sector.
In 2008, McCubbin led a Deacons team and advised Sinosteel in its US$1.3bn takeover of Australian mining company Midwest. The deal marked Chinese state-owned enterprises’ first successful acquisition of an Australian-listed resources company.
Driven by clients’ international legal needs, many PRC firms have strengthened their global network and international capacity in the past few years, either through establishing offices overseas, joining global law associations or forming strategic alliances with foreign firms. Latest examples include King & Wood’s New York office and its strategic alliance with Australian firm Gilbert + Tobin, the establishment of Grandall’s Hong Kong office and Wang Jing & Co’s membership in Terralex.
“Lower prices and costs in M&A deals would encourage PRC regulators to continue their policies of backing domestic enterprises in their overseas investment and M&A. Such governmental support will result in an increased number of deals and a better possibility of success,” said King & Wood partner Yang Xiaolei.
In light of a lower level of activity in the legal service market, clients’ bargaining power is greater than a year ago. Many law firms have been offering clients an array of alternative fee arrangements and discounted billing rates. However, general counsel of companies that are not financially challenged insist that quality of service, efficiency and ability to complete deals within tight timeframes are the top selection criteria for external legal advisers.