It was the best of times, it was the worst of times. – A Tale of Two Cities (1859)
So penned Charles Dickens in describing the conflicted relations between London and Paris that preceded the French Revolution. Today, Dickens’ timeless salvo may just as well sum up Washington, DC’s intricate relationship with Beijing. On the one hand, present dealings between the United States and China yield extraordinary potential. Bilateral commercial interconnectedness persists. The combined GDP of the two economies totals US$33.9 trillion, accounting for approximately 42 per cent of global GDP. In 2018, the United States and China represented each other’s biggest trading partners. Cross-border mergers and acquisitions, capital flows, supply chains, logistics systems and digital networks sustain the countries’ economic interdependence.
And yet, new and unprecedented strains complicate matters significantly. A bilateral trade war continues unabated. Historic tariff measures have ensued. The United States has imposed tariffs on approximately US$550 billion worth of Chinese goods, while China, in turn, has responded in kind with US$185 billion in tariffs. In addition, heightened volatility aggravates financial and capital markets in both economies. Compounding these challenges, the United States and China engage in an increasingly tense ‘high technology’ race, seeking advantage in the development of 5G infrastructures and jockeying for edge in fast-growing sectors such as artificial intelligence. Added to these strains are an accumulation of geopolitical flashpoints, including ongoing brinkmanship in the South China Sea and growing sensitivities concerning Hong Kong’s future.
Trends in China M&A tell a tale of comparable paradox. During 2016, China M&A levels skyrocketed, with year-end deal volume totalling 11,409 transactions and aggregate deal value amounting to US$770 billion. In Q1 2017, elevated asset prices and tighter credit spreads generally sustained China M&A activity. While, at the time, trends would have suggested a continued robustness in overall activity, the China M&A market has since soured. During 2018, only 577 cross-border China M&A transactions materialised, with an aggregate deal value of US$189.8 billion – representing a precipitous decline from levels observed in 2016. In addition, in 2018, the number of mega China M&A transactions (ie, transactions exceeding US$1 billion in total enterprise value) remained flat relative to volumes observed in 2017. The relatively stable deal volumes were attributable largely to fewer mega outbound China M&A transactions – with a 29 per cent decrease from levels observed in 2017 and a 60 per cent decrease from levels observed in CY 2016 – offset by a moderate increase in the number of mega M&A transactions undertaken by financial sponsors and domestic strategic players in China. China M&A activity during the first half of 2019 evidenced further a sharp decline in overall levels: a total of 220 cross-border China M&A transactions materialised, with an aggregate deal value of US$45.6 billion.
The current trade impasse between the United States and China contributes to diminished capital flows between the two economies, with the potential of generating long-term deleterious consequences. Further, continued volatility in China’s financial and capital markets complicates the business environment in China for American and European multinational corporations and investment firms that operate in the country. Consequently, greater caution has ensued in corporate and strategic planning in China.
Amid this amalgam of uncertainties, it is essential for senior management teams and corporate boards to understand the key challenges and risks that emerge in connection with M&A transactions in China. Herein, we explore important trends and fundamental issues impacting the strategic decision-making of multinational corporations and investment firms when effectuating M&A transactions bearing a nexus to China.
When a business determines to expand its operations into a foreign country, it generally confronts important preliminary questions regarding the choice of deal structure. Corporate transactions in China assume a variety of structures, and deal structures are especially salient to corporate strategy underpinning M&A dealmaking opportunities in China. Arguably the most common structures have been stand-alone acquisitions and joint ventures (JVs). Direct investments – generally referred to as ‘greenfield investments’ –are also undertaken with some frequency. Taken together, these structures largely represent the bulk of cross-border M&A activity with a nexus to China.
In Chapter 1, we explore and analyse:
- the above deal structures as they relate to the China market;
- considerations impacting both acquisitions and JVs with a nexus to China; and
- recent commercial regulatory developments impacting M&A deal considerations in China.
M&A transactions in China represent complex endeavours that necessitate sound judgement, determination and patience. Significant challenge confronts dealmakers and senior management teams when formulating valuations for Chinese enterprises. While conducting valuations in China generally involves the application of time-tested methodologies, there is often more to this task than meets the eye. Specifically, it is important for M&A dealmakers, senior management teams and corporate boards to understand, and base strategic decisions, in part, on the idiosyncrasies of China’s market when evaluating M&A transactions that implicate the region. Unique characteristics innate to China have the potential of impacting directly the quality of M&A valuations of Chinese enterprises.
In Chapter 2, we explore and analyse key aspects of M&A valuations in China, including discussions on valuations, methodologies and other important considerations. We discuss historical valuation trends in China M&A, including overviews of primary methodological tools in valuing Chinese enterprises listed on the Shanghai and Shenzhen exchanges. Chapter 2 also explores customary valuation techniques and discusses the applicability of enterprise value/EBITDA multiples and other common metrics, including discounted cash-flow analyses, as they relate to China M&A transactions. In addition, we analyse key qualitative drivers of M&A valuations in China, including factors pertaining to market share concentration, source of financing, the location of a domestic enterprise’s headquarters and the role of outside advisers. Finally, Chapter 2 provides an overview of new trends in China M&A valuations and discusses several recent China M&A transactions of consequence.
Antitrust and market competition
China constitutes the world’s largest consumer market and manufacturing base. As such, the country has historically been fertile ground for robust M&A activity. Notwithstanding the current tense trade environment, China continues to introduce new policy measures to reform further and open up its economy. Significantly, China’s new Foreign Investment Law may herald a new era in which foreign businesses are able to navigate within a more level, transparent and predictable business environment in China.
Since the implementation of its Anti-Monopoly Law in 2008, China has evolved into a key competition jurisdiction with increasing influence on global M&A transactions. During the past 11 years, China’s competition authorities have reviewed over 2,700 merger filing cases, with yearly case volume exceeding 350 since 2015. Among these cases, more than 70 per cent involve at least one non-Chinese party. From Q3 2018 to August 2019 alone, over 500 mergers have been reviewed in China, including five conditional clearances (Essilor/Luxottica, Linde/Praxair, UTC/Rockwell, KLA-Tencor/Orbotech and Cargotec/TTS), as well as 13 failure-to-notify cases.
Previously, M&A dealmakers could seek competition approvals in the United States and the European Union and assume that merger clearance from other jurisdictions would be forthcoming. Today, however, China’s competition authorities have determined to exercise independent analysis of an international transaction’s competitive effect on the Chinese market. In doing so, China’s competitive authorities frequently impose separate remedies on the basis of such independent analysis. Accordingly, the ability to manage China’s competition processes can impact significantly the progress and outcome of an international M&A transaction.
Against this backdrop, in Chapter 3 we explore and analyse the China competition aspects of global M&A from the following perspectives:
- the Chinese merger filing regulatory framework, including the regulatory body, filing thresholds, process and timeline, fast-track procedure, failure-to-notify and competition assessment/remedies;
- a review of merger filing cases in China from Q3 2018 to the present; and
- practical notes for effective management of China merger filings for international M&A transactions.
China continues to usher in new reforms to provide greater protection of intellectual property rights in the country. A consequence of this push is that many major Chinese technologies and brands are growing in scale and recognition globally. A concomitant result is that many foreign enterprises seek to acquire Chinese businesses in order to solidify an international footprint and discover new ways to produce innovative products and services for consumers globally. Notwithstanding these developments and China’s ongoing reforms, intellectual property risk remains a serious concern for foreign businesses when executing M&A transactions and conducting post-closing integration initiatives in China. Foreign technology companies especially derive immense value from their unique intellectual property portfolios and assets, which all too often become subject to misappropriation, piracy or theft in China. Chapter 4 discusses salient intellectual property issues that confront foreign enterprises when undertaking M&A transactions in China. Chapter 4 also explores the fundamental tenets of China’s intellectual property rights regime and corresponding regulatory framework. It further provides an overview of current intellectual property protections as drafted by China’s National People’s Congress and discusses patents, copyrights, trademarks, transfer protections and related liability topics.
Cross-border M&A transactions involve considerable risk. Effective risk management becomes especially salient when executing China M&A transactions. While China offers foreign enterprises access to an extraordinary consumer market, low-cost labour and new technologies, ever-present risks – spanning compliance, due diligence, regulatory, financial and geopolitical – often complicate China M&A transaction processes at all stages. Significantly, China has long been associated with high levels of corruption within its business environment. Additional risks derive from China’s complex political and regulatory climate, bribery and financial risks associated with capital repatriation, among other considerations. Chapter 7 examines these and other risk considerations when undertaking M&A transactions in China.
China’s tax system has evolved considerably over the past 70 years. During the mid- and late-1980s, China reformed its tax system and began imposing enterprise income tax on state-owned and collectively owned enterprises. Since then, China also has gradually reformed its indirect taxation of enterprises. Beginning in 2018, China levied VAT on revenue generated by commercial enterprises in respect of the provision of services and the importation or sale of products. China imposes additional taxes on revenues generated from the sale of luxury goods, as well as transaction taxes in the form of stamp duties or deed taxes.
Chapter 6 discusses China’s taxes that impact foreign direct investment and cross-border mergers and acquisitions in China. It also discusses important considerations pertaining to tax structuring.
Employment and labour
China’s employment and labour practices are governed by several key statutes and corresponding regulation: the Labour Law, the Labour Contract Law and the Regulation on Implementation of the Labour Contract Law. The Labour Law and the Labour Contract are designed to govern employment relationships between individuals and enterprises in China. Local employment and labour considerations in China are also subject to detailed measures and rules promulgated by regulatory bodies within China’s provinces, autonomous regions and municipalities. Chapter 5 discusses these and other employment and labour considerations that have the potential of impacting M&A dealmaking and corporate strategic decision-making in China.
While the term ‘revolution’ overstates the deteriorating predicament of US–China economic relations, a ‘new normal’ of tension in the bilateral economic relationship most certainly has materialised. And while, historically, M&A industry participants have generally lauded China’s growing prominence as a stakeholder within the international system, a golden stakeholder era has given way to a new and precarious ‘skirmish era’, the contours of which yield greater market uncertainty and tactical economic brinkmanship between Washington, DC and Beijing. A tale of two cities has summoned a companion ‘tale of two eras’, bearing long-term implications both for international financial and capital markets and for global economic order.
As such, assessing holistically the fundamental challenges, risks and opportunities inherent in China’s M&A landscape enables dealmakers, senior management teams and corporate boards to develop smart strategies in order to thrive in the current environment. Accordingly, a new and pioneering annual review of China M&A could not be timelier.