Overseas M&A activity by Chinese companies has skyrocketed in the last several years. Virtually all these acquisitions have been for cash, leading to a massive outflow of foreign exchange from China and financing issues for acquirers. Two recent deals suggest that PRC authorities for the first time are experimenting with allowing Chinese companies to use their highly valued public equity as consideration to buy US and other international companies.
Two recent deals signal that PRC authorities are experimenting with allowing publicly traded Chinese company to use their listed equity as consideration to acquire foreign companies. These deals are the acquisition of Home Inns and Hotels Management Inc. (Cayman) (Home Inns Cayman) by BTG Hotels (Group) Co., Ltd. (BTG) (Home Inns Acquisition), and the acquisition of Hiwinglux S. A., a supplier of electronic components based in Luxembourg, by Aerospace Hi-Tech Holding Group Co., Ltd. (Hiwinglux Acquisition). The Home Inns Acquisition has obtained all the governmental approvals necessary to proceed with the deal, while the Hiwinglux Acquisition is still in the midst of the examination and approval process with the Ministry of Commerce (MOC) and the China Securities Regulatory Commission (CSRC).
Technically speaking, for many years PRC laws and regulations appeared to permit Chinese listed companies to use equity as consideration for the acquisition of foreign companies. The legal foundations for this were laid principally by the Rules on Acquisition by Foreign Investors of Domestic Enterprises published in June 22, 2009 by the MOC (Acquisition Rules), the Administrative Rules on Strategic Investment in Public Companies by Foreign Investors published on December 31, 2005 and revised on October 28, 2015 (Strategic Investment Rules), the Scheme for Parallel Examination and Approval regarding Acquisition and Reorganization of Public Companies published on October 24, 2014 (Parallel Approval Rules), the Opinions on Further Improving the Market Conditions for Enterprises Acquisition and Reorganization published on March 7, 2014 by the State Council (Acquisition Opinions), and the Administrative Rules on Approval and Registration of Offshore Investment Projects published on April 8, 2014 by the National Development and Reform Commission (NDRC) (NDRC Approval Rules). However, the Home Inns Acquisition is the first case that has actually obtained all necessary approvals from various government authorities. These approvals include:
- Confirmation Letter from the NDRC (NDRC Confirmation) granting its approval of an offshore investment by the buyer (BTG), as required under the NDRC Approval Rules;
- Offshore Investment Project Registration from the NDRC (NDRC Registration), as required under the NDRC Approval Rules;
- No Action Decision from the MOC after examining whether the proposed transaction may have any anti-competition effect (MOC Clearance), as required under the Acquisition Rules;
- Approval from the CSRC regarding issuance of shares for the purpose of purchasing offshore assets (CSRC Approval), as required under the Strategic Investment Rules and the Acquisition Rules; and
- Approval from the MOC regarding strategic investment by foreign investors in a domestic public company (MOC Approval), as required under the Strategic Investment Rules.
The Home Inns Acquisition signals a momentous and exciting step forward by the Chinese government— most importantly, the MOC—of its previous tight control over offshore investments by Chinese companies, motivated by the draining effect over China’s foreign exchange reserves by offshore investment by Chinese companies using cash. It is also possible that PRC regulators believe that permitting PRC-listed companies to use equity for overseas acquisitions will ameliorate the systemic risks associated with the perceived over-valuation of listed companies in China’s capital markets.
All that being said, it is noteworthy that the Chinese acquirers in both Home Inns Acquisition and Hiwinglux Acquisition are state-owned enterprises. Whether the new practice will be extended only to state-owned enterprises (which undoubtedly have enjoyed more leniency from the government than private companies) or will be applied to privately-owned Chinese companies is yet to be seen.
It also remains to be seen whether the requirements and approval standards adopted by the Chinese government in Home Inns and Hiwinglux Acquisitions will be universally applicable to other Chinese companies, especially Chinese private companies. Under the Strategic Investment Rules, foreign investors investing in Chinese public companies must satisfy several qualification requirements, including that the foreign investor must be an entity (as opposed to an individual) and that the foreign investor must have offshore assets with an aggregate value of at least US$100 million. This requirement clearly does not apply to the stockholders of Home Inns Cayman, who, by reason of the share exchange transaction, became stockholders of, and hence foreign investors in, BTG. Without any further clarification from Beijing, we cannot be certain whether this deal represents a one-off exemption granted by the Chinese authorities to BTG, or that it signals an across-the-board relaxation or even nullification of the requirements under the Strategic Investment Rules.
The Strategic Investment Rules also require that although the investment can be made in installments, the shareholding percentage of foreign investors in the public company after the payment of the first installment shall be no less than 10 percent; and that the foreign shareholders be subject to a 3-year lock-up period unless otherwise permitted by competent government authorities. These requirements have not been strictly followed in past deals, such as the acquisition of New Popular Technology Co., Ltd. by Zhejiang Firstar Panel Technology Co., Ltd., under which two foreign investors only hold 8.51 percent and 2.34 percent, respectively, of the issued and outstanding shares of Zhejiang Firstar after their first payment installment; or the acquisition of Shanghai Haier Integrated Circuit Co., Ltd. (a joint venture among Haier Group and several foreign companies) by Qingdao Eastsoft Technology Company Limited by Shares, under which foreign investors would up with an aggregate 0.24 percent interest in the PRC public company. In the Home Inns and Hiwinglux Acquisitions, the foreign investors received less than 10 percent of the Chinese public company acquirers, and the lock-up period was decreased from 3 years to 12 months. These earlier examples appear to have been case-by-case waivers of the strict language of applicable laws and regulations, so we cannot be sure whether future deals will be able to take advantage of the same lenient approach.
Finally, it is important to note that the examination and approval procedure in China for stock deals is likely to add to the already-long schedule for closing a China-to-US investment. For example, in the Home Inns Acquisition, BTG first approached the shareholders of Home Inns Cayman in June 2015 with a non-binding term sheet. The acquisition proposal then obtained the NDRC Confirmation on September 8, 2015, the NDRC Registration on January 22, 2016, the MOC Clearance on March 8, 2016, the CSRC Approval on July 28, 2016, and eventually, the MOC Approval on September 28, 2016. Of course, now that the ground has been broken, subsequent deals could move through the Chinese approval process more quickly. Without an established timeline for the governmental examination and approval process, timing and completion risk will remain significant issues for parties involved in US-China M&A transactions.
The use of Chinese stock to purchase a US company also implicates US federal and state securities laws, which generally have not been a concern in all-cash deals in the past except in respect of carrying over the benefits of US stock option plans. To the extent stock is issued to US persons in the deals, or the means and instrumentalities of US interstate commerce are implicated in the issuance of the consideration stock, the buyer will either have to register the stock used in the acquisition or satisfy itself that an exemption from registration is available. The US securities issues, as well as US tax issues, become even more complicated if a special-purpose vehicle is placed between the target company stockholders and the Chinese acquirer/issuer in order to address PRC restrictions on individual foreign shareholding in Chinese listed companies. The first few deals of this nature will be breaking new ground and it remains to be seen how the market will decide best to structure similar transactions.
In some ways the complexity of this new structure for US-China M&A transactions is a signal of the increasing sophistication of Chinese international investments. These deals are also yet another signal that Chinese buyers as well as the Chinese government are committed to being active players in international M&A for a long time to come.