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M&As in China: Opportunities and Obstacles

Most global companies want a share of the enormous Chinese market. China has been transitioning to a market economy since 1978, and that transition has accelerated since the country's accession to the World Trade Organization (WTO) in 2001. One way of gaining business access to this large economy is via the merger and acquisition process.

With only one-third of China's economy being nonstate ("China to Strengthen...," 2006), the government is making many of its state-owned enterprises (SOEs) available to both domestic and foreign investment, whether through M&A or sale of assets through bankruptcy. These actions have made the country a prime target for foreign investments.

Both the foreign and domestic M&A market in China are growing considerably, with foreign investment running about half that of domestic M&A. By November 2007, there were 1,700 domestic deals in China worth more than $80 billion. Private equity deals are also increasing in China, with 140 deals valued at $10.6 billion by November 2007 (Yuan 2007).

Li Rongron, minister in charge of the state-owned Assets Supervision and Administration Commission, announced in November 2007 that China will accelerate the listing of eligible SOEs by 2010, as well as the bankruptcy of 2,000 to 3,000 SOEs by 2012 ("China to Accelerate...," 2007). Also fueling the M&A boom are various incentives for foreign investors—incentives so good that some Chinese companies are routing investment through offshore entities, or "round-tripping," to take advantage of them. Many critics within China fear the liberalization will allow too much foreign ownership across too many industries for less than fair market value.

This fear might not be well founded, though. While the opportunities and incentives available to foreign investment seem to be a great advantage, some experts say that the complex rules and regulations surrounding the M&A process actually favor domestic buyers. In response to fears that China is losing control of its economy, as well as to slow down the practice of round-tripping, the Provisions on Acquisition of Domestic Enterprises by Foreign Investors were enacted on September 8, 2006. These provisions, as well as lengthy political approval processes, can make M&A in China a difficult proposition for foreign investors.

There are strict limitations on foreign ownership, set forth in the Guidance Catalogue of Foreign Investment Industries. Some industries are considered prohibited, while others are restricted so that majority ownership remains with domestic Chinese shareholders. Also, while a foreign company may be allowed to acquire the assets of a bankrupt SOE, that company cannot operate those assets directly in China without setting up some sort of enterprise in the country.

Further dampening foreign M&A aspirations, China's National Development and Reform Commission is reportedly compiling a new list of industries and enterprises that are banned from foreign acquisition because they are critical to China's "economic security." Also, a year-long ban on foreign investment in the Chinese brokerage industry just ended in September 2007; it had capped foreign stakes below WTO requirements. Finding a target in China that is truly viable becomes a lot more difficult under these regulations.

When deals are allowed, government approval is involved in almost every aspect. The government not only reviews deals for economic repercussions, it also approves deal specifics, even if it owns one of the entities involved in the deal. As a case in point, makers of construction equipment—whether private or state-owned—must consult with the central government before selling a large stake to a foreign entity (Corne and Hinze 2007).

Mergers are also well regulated. A foreign company cannot directly merge with a domestic Chinese company or even a foreign-invested enterprise (FIE) located in China. The only way foreign investors can conduct a merger in China is if they operate an FIE and merge that with a domestic company or another FIE.

Other Chinese companies are taking advantage of offshore investment to reach a different end. By undergoing what is known as a reverse merger, Chinese firms can become publicly listed without enduring an IPO. A publicly traded U.S. shell company acquires the Chinese company that is looking to get listed. The board of the shell company then resigns and the board of the Chinese company takes over, changing the name of the company and raising millions of dollars by issuing new stock. The process can take far less time than a traditional IPO, and there have been about 150 such deals involving Chinese companies since 2005 (Einhorn and Balfour 2007).

The complaints about the arcane Chinese system are unlikely to disappear soon, but these shouldn't conceal the fact that M&As have already brought large changes to the nation, changes that are far from over. In fact, so far there are few signs that the current M&A wave in China will recede soon.

For more information visit i4cp’s Mergers and Acquisitions Knowledge Center and Corporate Restructuring Knowledge Center.

References:

China to accelerate listing of state-owned enterprises. (2007, November 2). Xinhuanet.
China to strengthen reform of state-owned enterprises. (2006, January 24). ChinaDaily.
Corne, P., and C. Hinze (2007). The current state of M&A in China. The Metropolitan Corporate Counsel.
Einhorn, B., and F.  Balfour (2007, March 5). Going public, Chinese style. BusinessWeek, 40.
State-owned enterprises bankruptcies planned. (2007, August 3). People's Daily Online.
Yuan Yuan. (2007, December 12). Domestic deals fuel China M&As. China Daily.