Since 2018, the ongoing trade war between China and the US has cast a shadow over the outbound investment into the US.  As CFIUS is tightening up its scrutiny, more and more Chinese companies have felt the pain and struggled with pressing their deals through, and even have to give up eventually.  As a result, many Chinese companies turn their eyes to the European market and actively explore investment opportunities in Europe.  As a matter of M&A practice in Europe, controlled auction procedure has proven itself to attract the largest number of potential buyers and realize high selling price and favorable deal terms for the seller.  We will briefly discuss below how the controlled auction is organized and conducted and what main issues Chinese investors need to address.

As compared to the one-on-one negotiated deal, controlled auction is characterized by creating competitive tension among multiple potential buyers, through which a successful bidder will emerge after 2-3 rounds of offers and counteroffers under a timetable set by the seller. Controlled auction procedure is commonly used by international companies for disposal/spin-off of assets and business.  In recent years, controlled auction has also established itself for medium-sized transactions.

Preparatory stage

As s starting point,the seller willengage a financial advisor to act as an intermediary with potential bidders, while the seller would remain anonymous.  The financial advisor will send to each potential bidders an invitation letter together with a teaser briefly introducing the target company.  Meanwhile, the seller will set uponline legal, tax and financing data rooms(the “VDR”) with special access right.  In many cases, the seller’s outside counsels will perform due diligence exercises over the target company (or the seller’s due diligence) and place the seller’s due diligence reports into the VDR. In doing so, the sellers could significantly reduce the amount of confidential information to be disclosed and avoid repeatedly address the same inquiries from different bidders.  Additionally, the seller will promise to offer “stay bonus” to management of the target company having access to confidential transaction information, to incentivize them to stay with the target company until closing.

Round One - From signing of NDA to submission of non-binding offer

As this stage, the seller will circulate the process letter and the Information Memorandum (the “Infomemo”), after signing confidentiality agreement with potential bidders expressing an interest.  The process letter sets out the step-by-step timetable while the Infomemo contains more details of the target company, including the historic financial data and management forecasts, the target company’s business model, corporate structure, market shares and industrial trend, etc.  By assessing the Infomemo, the bidder will prepare and submit its non-binding offer to the seller, setting out its proposed purchase price/valuation, assumptions, deal structure, and scope of due diligence, etc.  The first round of bidding will take 6 -10 weeks and the seller will select 3-6 bidders to enter into the second round of bidding.

Round 2 - From due diligence to submission of binding offer

At this stage, the seller will open up the VDR to allow the selected bidders and their outside legal and financial counsels to perform due diligence.  All the bidders are expected to receive the same set of information and abide by the same timetable set by the seller. No bidder would be treated preferentially absent any special circumstances.  It is worth noting that, since the bidder will obtain from the VDR certain competitively sensitive information (e.g., pricing) of the target company (the “Clean Team Data”), the seller will grant the access to the Clean Team Data to a very small number of the bidder’s employees and outside counsels.  This would avoid the risk of the bidder deriving any competitive advantage from the Clean Team Data in violation of relevant antitrust, competition laws and regulations, given that the seller and the bidder could be market competitors now or in the future.  Parallel with the DD exercise, the seller will arrange management presentation and site visits for the bidders to communicate with the target company’s senior management as a gesture for further cooperation.

In the course of the due diligence exercise, the bidders are advised to fully aware of, and carefully assess, the potential risks embedded in the legal, environment, political, environmental, and foreign exchange regimes of the host country.  For example, in France, the work council plays a powerful role in M&A deals and needs to be thoroughly consulted with prior to signing of transaction documents.  In some eastern European countries, the government has been vested with overarching authority due to historical and political reasons, which could affect deal certainties.  In a Romanianl deal, the entire set of signed transaction documents were renegotiated and re-executed because the Romanian government reopens its civil/criminal investigation against the target company and its senior management for irregularity in privatization of its predecessor.

At the end of the due diligence exercise, the seller will place the draft SPA into the VDR for bidders to review and mark up.  The bidder will submit to the seller the marked-up SPA and its binding offer setting out the proposed purchase price, valuation, conditions precedent, and source of financing, etc.  The price in the binding offer would be deemed as the final offer by the bidder. Please note that some sellers may require the bidder to provide evidence of financing source on a binding basis(such as a commitment letter issued by a bank) at this stage rather than at closing.

Round 3 - From binding offer to signing/closing

At this stage, the seller will generally select one or two bidders to enter into the third or final round of bidding.  The seller will disclose to the bidder more sensitive information not previously made available, based on upon which the bidder will continue to do a confirmatory due diligence over the target company.  After weighing on price and deal terms, the seller will negotiate with the prevailing bidder sometimes on an exclusive basis and sign the transaction documents.  But up to signing, the seller will treat the other bidder (if any) as a back-up and keep it in dark about ongoing negotiation with the successful bidder. 

During the interim from signing to closing, the parties will work to satisfy the CPs,including shareholder approvals, government approvals/clearances, third party consents and financing, etc.  Chinese buyers are required to fulfill filing or approvals with NDRC and MOFCOM or their local counterparts, and registration via local bank.  On the seller side, clearances to be secured include passages of the foreign investment review and anti-trust filing (if applicable).  Anti-trust filing with the EU may be triggered if the target company is a member state, in which case the member state filing would no longer be required. Please note that, on or after October 2020, the EU will implement the FDI screening mechanism, which is essentially an information sharing mechanism with member countries having a final say, as opposed to a mandatory nature of CFIUS review.  Please note that if the target company has a US presence, the transaction may possibly be subject to CFIUS review, especially when the US affiliate engages in any form of collection of personal information of US citizens (e.g., operation of student apartments, production of blood plasma products).  Thus, Chinese bidders are advised to consider early on whether and how to divest the US business in order to work around the CFIUS review.

For Chinese bidders, the seller-friendly nature of the controlled auction poses a couple of challenges.  First, the whole process is time-consuming with each round of bidding taking up to 6-10 weeks.  Second, the lack of visibility of the other bidders weakens one bidder’s bargaining position.  Third, the bidder will bear the costs for advisors and other transaction expenses regardless of the result.  That said, the controlled auction enables Chinese investors to have an equal chance against domestic competitors and to win the bid by presenting the most attractive offer.