Trends in Mergers & Acquisitions: the Restructuring of Domestically Listed Chinese Companies

COMMON ASSET RESTRUCTURING MODELS

Often, the aforementioned restructuring techniques may be used in tandem. Wang Mingfu in his book Touzi Yinhang Binggou Yewu analyzes common asset restructuring models employed by listed Chinese companies during the years 1997 through to 1999.3 The following is a summary of these models.

Model 1: Asset Swap between a parent company or controlling shareholder and a listed Chinese company.

This model generally entails a Chinese holding company or a large Chinese group company (qiye jituan) swapping viable assets for non-performing assets of a listed subsidiary. The Chinese holding company or group company then revitalizes the non-performing assets or disposes of the assets through an asset sale or bankruptcy. The listed subsidiary is then able to raise additional funds by issuing new shares on the strength of the asset injection. The listed subsidiary can use the additional funds to purchase more assets from the parent company. The parent company can, in turn, use the additional funds raised by selling assets to the subsidiary to engage in new business ventures and, thereby, acquire additional assets to inject into the listed subsidiary.

Model 2: Sale of a controlling interest and acquisition of a listed Chinese company (backdoor listing).

In this model, an economically viable Chinese company purchases a controlling stake in a non-viable listed Chinese company. The controlling shareholder then sells all or some of the assets of the listed company. The listed company then uses the proceeds from the sale and/or debt to acquire viable assets from the controlling shareholder.

Model 3: Allocation of State shares and injection of State assets into a listed company.

This method is often employed by Chinese government holding companies or government departments holding State shares in Chinese companies. The government holding company or government department will allocate State shares in a non-performing listed Chinese subsidiary to another viable non-listed Chinese company in its portfolio, often in a different industrial sector. The healthy Chinese company will then swap good assets for non-performing assets and/or debt in the non-performing listed Chinese company.

Model 4: State-owned Share Trust Arrangements

This model involves a kind of trust arrangement whereby a shareholder, often a Chinese government entity or assets management company, entrusts its shares (usually State owned shares in a listed company) to a viable company or a financial institution to manage on its behalf.

Model 5: Repurchase of State Shares

This method involves a listed Chinese company purchasing shares held by the principal shareholder (usually a Chinese government-affiliated entity). The listed company uses its non-performing assets and debt to set up a limited liability company. The principal shareholder will then use funds derived from the original share repurchase to acquire the newly created limited liability company.

This is an important method used by China's four asset management companies for restructuring State-owned enterprises.

Model 6: Issuance of New Shares

This method usually involves either the issuance of new legal person shares that are subscribed for by a new controlling shareholder. Alternatively, it may involve the issuance and listing of new shares on a Chinese stock exchange. The new controlling shareholder injects new viable assets into the company in exchange for the shares in an asset swap arrangement. Often the target will also divest itself of non-performing assets by asset sale or bankruptcy of a newly formed company into which the non-performing assets are injected.

Model 7: Merger by Absorption

In a merger by absorption scenario, a company will issue new shares, which it will exchange for the shares of another company. The shares are exchanged according to a ratio agreed to by the parties.

Model 8: Debt Restructuring

Debt restructuring in China can take a variety of forms, including:

a) reduction of interest on loan repayments;

b) restructuring of loan repayment schedules and repayment methods;

c) partial debt forgiveness; and

d) debt-for-equity swaps.

In addition, in cases where a listed Chinese company is bankrupt, the government may intervene to bail out shareholders. Usually, this will involve the Chinese government instructing a government affiliated company to make a tender offer to buy shares at a low price after news of the listed company's bankruptcy has been released and the share price has collapsed. Funds for the tender offer often come from the government's "market adjustment fund".

In other cases, the Chinese government may divide a bankrupt Chinese listed company, Company A, into two new companies: Company B, formed using viable assets of its predecessor; and Company C, composed of the predecessor's non-performing assets. Following the division, Company B preserves its listing, while Company C files for bankruptcy.

RESTRUCTURING IN THE FUTURE

China's equity markets, for a variety of reasons, do not currently operate as a mechanism for reorganizing Chinese listed companies. Most restructuring of listed Chinese companies does not involve the buying and selling of listed shares. Rather, most restructuring of listed Chinese companies consists of share transfers by private placement and the buying and selling of assets and asset swap arrangements. In addition, debt-for-equity swaps have recently become more commonplace. Notwithstanding their importance as a source of financing, China's equity markets have yet to develop into true market-oriented instruments for reallocating assets.

This phenomenon is a consequence of two fundamental factors: First, only approximately one-third of the capitalization of listed Chinese companies consists of freely tradable A shares (and B shares). Roughly two-thirds of the equity in listed Chinese companies is composed of non-freely tradable State shares and legal person shares. As a result, only in exceptional situations can a company acquire a target company by purchasing shares listed on Chinese equity markets. Second, since most Chinese companies have not been restructured into joint stock companies, China's pool of assets has not yet been converted into equity that can be transferred. The upshot of this situation is that the transfer of tangible and intangible assets is usually undertaken by a straight asset purchase or via asset swaps.

The current condition of domestic Chinese companies relates largely to the underdevelopment of China's capital markets. However, as China implements its policy of reducing the State shares and legal person shares held by Chinese government-affiliated entities, China's stock markets, in the years ahead, will become a more viable mechanism for acquiring interests in Chinese companies. In addition, as more and more Chinese companies are corporatized into joint stock companies, a greater variety of methods for acquiring and disposing of Chinese equity will develop.

Since China has promised to eventually open its capital markets fully to foreign participation, foreign investors and foreign investment enterprises alike will in the future predictably play a much more important role in the restructuring of Chinese companies.

ENDNOTES

1 Wu Xiaoqiu, Zhubi <> Beijing: Zhongguo Caizheng Jingji Chubanshe, 2000, pp. 115-116.
吴晓求，主笔《中国资本市场未来10年》北京：中国财政经济出版社，2000，第115-116页。
2 Wang Wei, Kang Rongping, Zhubian <> Beijing: Zhongguo Wuzi Chubanshe, 2001, pp. 20-84.
王巍，康荣平，主编《中国并购报告》北京：中国物资出版社，2001，第20-84页。
3 Wang Mingfu, Zhubian <> Beijing: Qiye Guanli Chubanshe, 1999, pp. 107-119.
王明夫，主编《投资银行并购业务》北京：企业管理出版社，1999，第107-119页。