Successful Outbound Direct Investment by Chinese Enterprises

An Expert's View about Trade Trends in China

Last updated: 22 Mar 2010

Chinese enterprises should seize the opportunity to expand in the international market, such as the United States, and should especially take maximum business acquisition opportunities during the current global economic downturn.

Preparation and Timely Action are Keys to Successful Outbound Direct Investment by Chinese Enterprises April 23, 2009 Author: Anita Y. Tang, Managing Director, Royal Roots Global Inc., With contributions by Robert D. Billow, Managing Director, Billow Butler & Company, LLC In 2007 I put forward a ?Seedling Transplant Model? considering the transfer of a success-proven product or service from one geographic location to another or from one industry to another. Articles I wrote regarding this model were published by China Daily on June 15 and by China Business Times on July 4, 2007. At that time, my firm ? Royal Roots Global ? was consulting with a middle-market investment bank, Billow Butler & Company, which was working to sell a U.S. firm. If this firm had been acquired by the Chinese, it is very likely that it would have been a success case fitting the ?seedling transplant model?. However, the Chinese enterprises did not take action fast enough, and this U.S. company was very quickly acquired by the world leader in its industry. The purpose of the acquisition was to (1) expand the acquirer?s product line and (2) block Chinese players in the industry from gaining access to the market of the developed economies ? a market they repeatedly had tried to enter without success. There is a Chinese saying: to succeed one needs to get simultaneously the right timing, the right locality and the right human factor. There is also a Western saying: there is ?no free lunch?. Here is a concept which I generated from my Asian and Western education, training, and business experience: to succeed, one needs to be well-prepared AND take actions at the right time. Chinese Introduced more Administrative Assistance to Help its Enterprises ?Go Out? In a February 2009 interview with People?s Daily, Zhang Chengwei, Deputy Director, Research Institute of Finance, Development and Research Center of the State Council, made these points: ?We can make the most out of the low value of primary products internationally to build up strategic reserves of energy resources and expand the use of overseas resources; use the global downturn to secure human capital, accelerate the establishment in technology and strategic reserve; and, in an area that drew a great deal of discussion these days ? use the current severe decrease in foreign asset value to conduct overseas mergers and acquisitions.? In early March, Li Ruogu, President of the Export-Import Bank of China, indicated that the Bank would increase its lending support this year to more than RMB 200 billion in new loans. He also expressed his belief that the use of China?s foreign exchange reserves should be diversified, such as by supporting Chinese enterprises? overseas acquisitions or investments. In mid-March, to promote and regulate foreign investment, the Ministry of Commerce (?MOFCOM?) formally promulgated the ?Administrative Measures for Overseas Investment?. This simplified the approval process regarding cross-border deals by delegating significant authority to local authorities where investments starting from US$10 million to up to US$100 million will be reviewed by provincial authorities. Yao Jian, spokesperson of MOFCOM, pointed out that the new measure would further help reform the foreign investment management system, facilitate Chinese 1 Copyright 2009 @Royal Roots Global Inc. and Billow Butler & Company, L.L.C. outbound investment, and support Chinese enterprises to "Go Out" in order to take part in international economic cooperation and competition. A week before this, at a session for parliamentary representatives from Hunan during the National People's Congress, Sany?s Xiang Wenbo expressed his hope that the government might consider providing credit support to Chinese enterprises transacting overseas mergers and acquisitions. He was then asked three questions by Vice Premier Wang Qishan: ?Do you have a good grip of your own management capability? Have you analyzed the cultural differences between the two sides? Do you understand the local labor union relations? If you don?t know yourself and your enemy, this confidence scares me.? As U.S.-China cross-border, cross-cultural business strategists, we recognized quite early on that Chinese enterprises should seize the opportunity to expand in the international market, and should especially take maximum business acquisition opportunities during the current global economic downturn. To this end, Mr. Robert Billow, Managing Director of Billow Butler & Company, and I spent many months planning for a mid-March visit to China this year to explore with both government officials and enterprise executives possibilities for cross-border business and cross-border mergers and acquisitions. Our China visit started right after the closing of the NPC and the CPPCC meetings. The following report includes discussions of our China trip as well as some of our observations and findings. Middle-Market should be the Focus When Chinese Firms Acquire U.S. Enterprises Robert Billow has over 30 years of merger and acquisition experience through his roles as a corporate attorney and as an investment banker. He has participated in more than 150 transactions in a wide variety of industries ranging in size from several million dollars to over one billion dollars. In our March trip to Tianjin, Beijing and Shanghai, we conducted five presentations with government and private entities on cross-border business and merger and acquisition (?M&A?) activities. Mr. Billow, in particular, shared his valuable experience from his career in investment banking. On cross-border M&A, he pointed out that in the past few years deal value of Chinese outbound investment has been experiencing tremendous growth ? from 2003?s RMB 14 billion it increased to 2008?s RMB 308 billion. Dominated by state-owned enterprises (?SOEs?) and Chinese conglomerates, strategic investments in fiscal year 2008 were concentrated in natural resources, energy and power, financials, and infrastructure. The more recent, high profile Chinese M&A deals included minority investments in U.S. firms such as Morgan Stanley and Blackstone. Other announced deals as of the end of this February included: Target Buyer Target Country Transaction Value Aluminum Corp of China Rio Tinto Australia $20B USD Yanzhou Coal Mining Co. Felix Resources Australia $1B USD Hunan Valin Iron & Steel Fortescue Metals Group Australia Not Disclosed China Development Bank Rosneft Russia $25B loan for pipeline China Minemetals Corp. OZ Minerals Ltd. Australia $1.7B USD China Minemetals Corp. 70% interest in Macarthur Minerals Ltds. Australia $81mm USD China Minemetals Corp. Northern Peru Copper Corp Canada $455mm CAD China Development Bank Minority investment in Barclays U.K. 136mm GBP 2 Copyright 2009 @Royal Roots Global Inc. and Billow Butler & Company, L.L.C. Several years ago, some Chinese companies and sovereign wealth funds attempted to acquire certain sensitive foreign targets but encountered either various hurdles, or they were rejected by the host countries on the basis of social and economic interest or national defense reasons. As a result, current Chinese M&A activities overseas appear to focus more on buying ownership stakes instead of full control to avoid political backlash. Advantages of Middle-Market Enterprises Based on the situation discussed above, Mr. Billow proposes that middle-market businesses offer an array of benefits for Chinese SOEs and large enterprises in their M&A activities in the United States. Middle-market enterprises are those defined typically as businesses with revenues of US$10-200 million or RMB 68.5 million to RMB 1.37 billion. They are overwhelmingly private, closely-held or entrepreneurial enterprises; and many are nimble, innovative thought leaders that possess great value inherent in their intellectual property, for example, that confer competitive advantages. However, due to capital constraints commonly imposed by their ownership, these firms often take a conservative approach to business decisions. This conservatism can offer substantial benefits to Chinese suitors. Middle-market businesses are considered the ?lifeblood? of the U.S. economy. There are over 250,000 middle-market businesses in the U.S. reporting revenue between US$10-200 million. U.S. businesses of this size employ over 25 million people and their contribution to GDP, measured by sales, is about US$ 8 trillion. Attraction of U.S. Middle-Market Middle-market businesses often offer niche, non-commodity products or services with above industry-average margins. They have long-standing, rock-solid relationships with blue chip customers. They also have innovative intellectual property, including patents, trademarks, and brand names, as well as professional management with business savvy, operational ?know-how? and a diverse mix of talents that combine to support a high degree of demonstrated high technical acumen. These firms therefore can frequently have the same attributes as large-cap U.S. businesses but be available at lower acquisition cost and at lower U.S. government regulatory risk. As M&A targets, middle-market companies should ideally present less cultural confrontation to an overseas buyer than do large-cap U.S. companies. They may offer greater ability to build an organization with internal talent and management. While they can have the same characteristics as the large-cap target, they are typically available for acquisition at lower valuation multiples and therefore buyers should have a lower risk of overpaying for strategic business value. Further, depending on the size of a transaction, middle-market companies can fly beneath regulatory radar when compared to large-cap acquisitions since these firms may not meet the specific threshold requirements established by certain regulations. Chinese corporations constitute compelling partners for U.S. businesses. They can attain great synergistic value with an acquired U.S. target. Chinese manufacturers, for example, can achieve low-cost manufacturing of U.S. target products, create opportunities to sell Chinese products to the existing customer base of the U.S. target, and can even open up Asian and European markets to U.S. target products. They can also create greater collective buying power. 3 Copyright 2009 @Royal Roots Global Inc. and Billow Butler & Company, L.L.C. Is this the Right Time for Chinese Firms To Accomplish Transactions in the United States? Based on my more than 20 years of foreign exchange and investment experience, any price can be described as ?quite high or quite low". On the question of whether this is the right time to conduct M&A activities in the U.S., my general answer is that it is. However, it also depends on the particular industry and market of the prospective target, as well as the time frame of the Chinese investor. Robert Billow pointed out that deal volumes and values in fiscal year 2008 had fallen to the same levels as in fiscal year 2004. In fiscal year 2008, U.S. deal volumes and values were down 25% and 45% respectively from fiscal year 2007. The current credit environment presents a major obstacle for large-cap buyouts ? lenders reinstituted collateral-based formulas and terms which led to leverage multiples shrinking to significantly lower levels in fiscal year 2008 than in fiscal year 2007. As a result, private equity firms are often forced to substantially or even fully fund deals and then recapitalize them post closing. Currently, many U.S. strategic businesses are investing only in core assets. However, with lessened competition, good deals are still getting accomplished, though at lower multiples. Mr. Billow asserted: ?We already have seen the ?watermark? in pricing for this past M&A cycle; yet whether it is the best time now to conduct M&A activities in the U.S. is a matter of opinion since prices may not have reached the bottom.? He added that it will take many months to source and negotiate a deal, and that buyers also will have more targets from which to choose at this point before the market resumes its upward move, when prices will also accelerate along with increased activity. Some people asked us: ?If this is a buyers? market in the U.S., then why are sellers willing to sell their businesses?? Business owners sell their businesses because of many different motivations. From a business perspective, owners are motivated to sell in order to satisfy capital needs for growth, or because they own a dynamic business that has outgrown their ability to manage it, or due to competition, or any of a range of other reasons. From a personal perspective, it can be retirement, diversification of assets, achieving liquidity, estate planning, tax planning, or for health or other personal reasons. Data showing fiscal year 2008 multiples being lower in all transaction sizes demonstrate the current compelling value proposition to Chinese buyers. Based on the above-mentioned market environment and the different situations that business owners encounter, many owners of U.S. middle-market businesses are becoming more receptive to joint ventures or collaborative partnerships, and sales to others, including overseas parties. Seize the Current Prospect To Expand Business Globally Even if this is in fact a golden opportunity for Chinese enterprises to conduct outbound investment and M&A activities, we should still be very cautious as cross-border business is full of challenge. As a Chinese person who has lived and worked in the United States for 16 years, I am perfectly aware of the different perspectives we get looking at matters from different viewpoints; for example looking into the U.S. from the outside, looking at the U.S. from within, and looking from the U.S. to the outside. Consider for instance how differently the Chinese government and the U.S. government function in supporting the development of their respective domestic industries and enterprises: the Chinese government is currently promoting ?government-escort cultural diplomacy? while the U.S. government, consistent with its philosophies, supports business strategies that are initiated and developed by American companies. 4 Copyright 2009 @Royal Roots Global Inc. and Billow Butler & Company, L.L.C. To ?Go Out?, a Chinese business should first assess its own attributes and capabilities. An appropriate manner in which to approach this is for the company to conduct a ?SWOT? analysis ? assessing its strengths, weaknesses, opportunities, and threats. Through this evaluation, the Chinese business can set the curve for formulating its overseas business strategy as a part of the company?s overall strategy. Be it investing overseas or finding foreign business partners, hiring employees or securing distribution channels, we need to bear in mind the golden rule of conducting due diligence. Carefully Select a Route to Achieve Your Goal In our presentation at TEDA, Tianjin, questions from meeting participants mostly related to finding business partners overseas. Mergers and acquisitions appeared useful to them but yet, they appeared to view this as very new concept. However, in our three public presentations in Beijing and Shanghai where participants had more experience dealing with companies overseas or foreign companies in China, they were extremely interested to learn more about the M&A process and post-merger integration. As shared in our meeting by one of the participants, he unknowingly disclosed his company?s business model to someone who turned out to represent a potential foreign acquirer. This Chinese entrepreneur said: ?I did not know that his firm wanted to buy my firm, but I already ?stripped? in front of him!? Robert Billow explained: ?It is not easy to dance a good M&A dance ? you need to follow the beat, only when the other side pulls up her skirt a little, you pull yours up a little. When you have more of those things the other side desires, you will have stronger bargaining power.? Since every case is different, therefore, there is no one set rule for negotiation. Accordingly, if you can get assistance from someone with vast experience in this area, then in any particular situation you will have a much better opportunity to prevail on the best possible terms. Two other companies also shared their unsuccessful overseas investment experience. One case was about an entrepreneur who took the recommendation of a friend of 10+ years who resided overseas and invested in a foreign project. The friend later disappeared and the investment went with him. The other case was about post-merger integration where the Chinese company not only lost the initial investment in the overseas company but also wasted a great deal of time, money and effort trying to handle trade union and labor issues before it could get out. Once again, the conduct of due diligence and the wise counsel of seasoned advisors can be most critical to avoiding these hazardous outcomes. To support these advisory efforts, we have observed numerous and ongoing openings of global law and accounting firms in China to strengthen the services that facilitate Chinese outbound M&A activities. Build a Strong Foundation to Secure Long-Term Benefits Robert Billow offered a quote from Warren Buffet in his presentation: ?Be fearful when others are greedy and be greedy when others are fearful.? This may reflect that the current buyers? market may very well be the right time in which to get great deals done. Again, caution and fear among financial investors and strategic corporate buyers limits competition and consequently lowers pricing for assets. Nevertheless, brand names, distribution channels, and the intellectual property of U.S. middle-market businesses are assets that likely are not impaired by the current economic environment in regard to the long-term values they represent. 5 Copyright 2009 @Royal Roots Global Inc. and Billow Butler & Company, L.L.C. In one of our Beijing public presentations, one of the companies had already completed a small investment in North America and gained some experience, and is now considering increasing its investment in the continent. The key concern of this entrepreneur is the same as that of the large SOE for which we conducted a close-door internal presentation ? post-merger integration. First, waiting to acquire bankrupt businesses is not an option for Chinese buyers because of the potential for a loss of sales, management, customers, and other goodwill, which can only exacerbate post- closing difficulties. Second, even though a Chinese firm can manage to acquire an overseas business with synergistic value at a good price, it is as crucial as ever to succeed in post-merger integration such as assimilation of culture, gaining buy-in and support from key executives, cultivating good labor union relations, as well as continuing strong working relationships with customers, suppliers, distributors, bankers and more. If successful on all these fronts, there is a good chance that the Chinese buyer can build a strong foundation and secure long-term benefits from its acquisition by preserving intact and enhancing the assets, goodwill and other value drivers of the U.S. target. Looking Ahead Robert Billow and I gained a great deal from our March trip. Besides the four public presentations and the private presentation, we also met with experts in many different disciplines ? professional service providers, members of think tanks, government officials, and senior executives of state-owned enterprises and private enterprises ? to share market intelligence and exchange viewpoints. Globalization for Chinese enterprises is bound to happen. Here is a quote from Premier Wen Jiabao who observed that in the current tough times: ?One needs confidence, because with confidence comes courage, and with courage things can be achieved.? Royal Roots Global and Billow Butler & Company are looking ahead and see that there is a growing need to help Chinese enterprises with their increasing overseas investments. We strongly believe that knowledge brings the confidence with which Chinese enterprises will have the assertiveness to ?Go Out?. With the right tools and right mindset, Chinese entities can take timely actions now. Two years ago I proposed that Chinese entities begin to consider outbound M&A transactions, but except for a few prominent transactions these did not happen with any scale. I am highly confident that today the U.S. middle-market provides a fertile opportunity for Chinese companies to expand overseas. - 0 - 6 Copyright 2009 @Royal Roots Global Inc. and Billow Butler & Company, L.L.C.
Posted: 22 March 2010, last updated 22 March 2010

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Presenting the contributor
Royal Roots Global Inc.

Royal Roots Global Inc.

U.S.-China Business Strategist

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