Mergers & Acquisitions Alert | 12.21.16
Chinese outbound foreign direct investment ("ODI") has grown rapidly in Europe. 2016 was no exception, and Chinese enterprises are constantly presented with new opportunities to expand overseas. China's footprint as a global investor is expanding at a rapid pace, and the entire world is taking notice. 2016 certainly contains many success stories of Chinese investments in Europe, most notably the UK's approval of China General Nuclear Power Corporation ("CGN"), EDF Group's project to build a new £18 billion nuclear reactor in the UK, Midea's successful acquisition of publicly listed German industrial robot manufacturer Kuka, and Portugal's approval of Fosun's purchase of 17% of the shares of Millennium BCP Bank. However, some tales of caution are also emerging, notably the Swiss government's review of the China National Chemical Corporation ("ChemChina")-Syngenta transaction, the German and the U.S. governments' review of Aixtron transaction, which ultimately resulted in Fujian Grand Chip Investment Fund LP ("Fujian Grand Chip") rescinding its voluntary takeover offer in December 2016, and the German government's review of the Osram transaction.
In addition, as outbound investment is facing tighter foreign exchange controls within China with the State Council announcing new restrictions since late November 2016, it is especially important for Chinese enterprises to be well prepared when they are ready to capitalize on investment opportunities in Europe. These types of preparation may be especially important to ensure success of the ODI in light of the new investment climate on both sides of the transaction, whether in China or in Europe.
Before a Chinese enterprise, fund or entrepreneur embarks on an investment in Europe, it may be helpful to consider the following points. These points are the accumulated observations of evolving themes over recent years, based on the actual investment experiences of Chinese ODI into Europe.
1. Start with an informed investment strategy. While this may seem to be a self-evident statement, there are several aspects to this in practice. Structurally, there may be a range of investment hurdles to overcome in order to successfully negotiate, close and integrate the proposed transaction: from regulatory and legal through business integration to counterparty communication issues. The regulatory hurdles may arise from many sides of the transaction, as evidenced by Beijing's plan to lower thresholds and formulate new restrictions on certain types of ODI, the EU decisions on the Syngenta, Aixtron and Osram deals and the U.S. block of the sale of Aixtron's U.S. operations in December 2016. All of these can impact the proposed deal timetable, and a plan for addressing known regulatory approval risks should be built into that timeline in a realistic way. A good strategy will take these issues into account in terms of the cost and advisory impact and will thereby build trust in the process with the European party.
2. Incorporate the PRC investment approvals into the timetable early. It is understood by European counterparties that there is a domestic process supervision and approval authority process for the Chinese bidder to go through. There has been ample press about China's recent plan to limit certain types of ODI, but the European counterparties are not typically aware of the exact details of these limitations, nor would they typically keep abreast of updates on any changes to China's rules on ODI. As the rules within China may be reformulated, it will be important to convey any changes or updates to the European counterparties. In some cases, European counterparties may ask for more definitive PRC regulatory information before spending management time and advisers' fees on advancing a transaction.
In addition, the dynamics between provincial and national authorities and the delays that can be caused by changes to the approval sought are already less well understood by European counterparties. Explaining this will obviate the possibility that the deal dynamics change unnecessarily due to such delays or that the European party mistakenly believes such delay is a negotiating strategy.
3. Consider what deal documentation strategy is appropriate. Europe-China deals can be document‑heavy, not least because of the need for translation. In some deals, it might be more appropriate to develop detailed term sheets for approval purposes before moving on to principal documents that are then developed in fewer drafts. Too many turns, each translated, can be an expensive and time‑consuming process that appears inefficient, and even indecisive, to the European counterparty.
The perceived value of this to the European counterparty should not be underestimated as, where this process more closely resembles their own, they will view it as being more decisive. This is the case even where, in actual fact, the PRC process may mask other layers of considered review and value addition in the quality of decision‑making.
4. Have a solid understanding of European regulation before starting. The European Union is the most complex, and heavily regulated, free trade area in the world. When looking to invest in a project, it is not just a case of competition law and foreign investment approvals but also of internal market rules. In addition, keep abreast of the recent developments in Europe. The European investment landscape is also evolving as foreign investments are increasing at a brisk pace. For example, infrastructure may be governed by third‑party access rules. Sales by joint ventures can invoke merger rules, investigations of pricing or a need to seek approval for distribution and marketing agreements. A failure to have a good understanding of this first is a common reason for deal delay and deal failure.
5. Be prepared to disclose a PRC company's ultimate beneficial ownership ("all the way up the chain"). European disclosure and transparency standards are fairly rigorous, and a PRC company should be prepared to respond to these types of questions and requests for supporting documents. The queries and diligence on the true beneficial ownership of the PRC company could likely extend to any affiliate that becomes a party to the transaction.
6. Localization and Integration. Consider the extent to which local employees are a key part of the business continuity based upon financial adviser's advice and as modeled. Consider the extent to which the securing of their commitment to the business during the transaction period requires further understanding by them as to how the business and their roles will be integrated post-completion. Key employees will have an understandable apprehension about the commitment of the new business owners to them.
7. In an active bidding process, or with any coveted target, it is important to ensure that the funds are available at the time of closing or when the final bid is submitted. This timing/delay/lack of clarity is one of the largest stumbling blocks between Chinese and European partners. The delay is often viewed with suspicion because a certain date is never provided.
8. In an active bidding process, we are seeing with some frequency a request for the PRC company to place some of its funds for the acquisition in a large European/international bank, as opposed to a Chinese bank. Companies that are involved in one of these bids might want to think about initiating contacts with the China branch of a selected European/international bank early on in the process.
9. While there may be a tendency to focus on investing in/purchasing high‑profile large targets, it should not be viewed as a defeat to invest in/purchase a medium‑sized target when investing in a European country for the first time. This may be especially relevant given Beijing's recent plan to limit certain ODI above €1 billion. In addition, as mentioned above, Europe is generally heavily regulated and relatively complicated to navigate. By investing in a medium‑sized project in the first instance, it would allow a PRC company to build up its name in the local market, meet local experts and gain the operational experience in the local market. Then the PRC company could be in a better position to successfully manage any of the investments, large and small, in the local European country. The German authorities' withdrawal of the approval and reopening of the review of Fujian Grand Chip takeover of Aixtron in October 2016, the U.S. authorities block of the sale of Aixtron's U.S. subsidiary in December 2016, and Fujian Grand Chip's withdrawal of its voluntary takeover offer in December 2016 have arguably damaged all parties concerned.
10. Consider hiring some local professionals to assist the PRC company in integrating the business and navigating the local business climate post-investment. This will assist the PRC company immensely in terms of efficiency and having its own "set of ears" in Europe. We would recommend hiring locals with various levels of experience and in different operational roles so that the PRC company can receive direct feedback on its European investment on multiple levels.
In summary, while Chinese companies will still be presented with a plethora of attractive investment opportunities in Europe in 2017, given the rapid changes in today's investment climate and regulations and the increasing competitions between bidders, the difference between a well‑prepared investor and one less prepared could be the determining factor in the success of a transaction.
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