A defiant message

Carrying a value of US$2.4 billion, the deal would have been the largest foreign takeover of a Chinese company. As such, it was always contentious – with the outcome uncertain to say the least.

But while accusations of protectionism and concerns over future M&A deal activity were understandable … and even predictable, equally certain was the notion that Mofcom and the Chinese government (like other governments around the world before them) would use such a high-profile case as a vehicle to issue a statement of intent.

W ith the benefit of hindsight, there were plenty of clues in the build-up to the decision on March 18 as to which way the verdict would go.

Competition

In addition to concerns over the survival of existing small-scale juice manufacturers, Mofcom's justification to block the Huiyuan takeover seems to centre on its premise that Coke could leverage its market power and take advantage of its dominant position in the soft drinks market.

“Presumably Mofcom was concerned about Coca-Cola linking the sale of its Coca-Cola products with the sale of the Huiyuan juice products,” says Mallesons Stephen Jaques Shanghai-based partner Martin Huckerby.

Although it is too early to predict whether such reasoning represents a fundamental difference in the application of competition law to regulators elsewhere, on first appearance it does seem to be in marked contrast to policy in the US. Regulators there rarely block mergers on the basis of potential future anti-competitive behaviour. Not wishing to deprive consumers of the benefits of unions, they rely on post-merger enforcement to restrain any anti-competitive conduct.

But Mofcom appears to have placed considerable significance on bundling and tying theories in justifying blocking the Coke deal. In its announcement, Mofcom mentions two rounds of informal negotiations with Coke over remedies that would have made the merger more palatable. While the substance of these negotiations was not released, unconfirmed reports say that Coke was asked if it would be prepared to relinquish its rights to the Huiyuan brand after the acquisition. Coke refused.

Yet the imposition of conditions should not have caused surprise as such a request had a precedent. In the AML's first – and only other – significant test case, Belgium-listed brewer InBev and US-listed brewer Anheuser-Busch were granted a conditional approval to merge by Mofcom back in November 2008.

Unlike the Coke deal, the conditions related solely to future transactions rather than the merger itself, which Mofcom found would not have the effect of excluding or restricting competition in China's beer market. But like the Coke deal, it seems likely that non-competition issues may have played a part in the decision to impose conditions.

At the time of the Anheuser-Busch / InBev decision, Nicholson said: “It would not be unreasonable to assume that national security issues were relevant.”

While it is difficult to liken the juice business to national security concerns, it does seem clear that – with the Coke decision at least – Chinese antitrust officials have relied on broader definitions of anticompetitive harm than those used by their counterparts in the US.

Yet the Mofcom review process is actually more straightforward than many people realise, with this part of Chinese law fairly westernised. Peter Wang, partner-in-charge of Jones Day's Beijing office, says: “Going into the review, I don't think they had a predetermined outcome in mind. Mofcom truly does think that there are competition concerns.”

He adds: “The real question is 'do they have the evidence?' Mofcom has raised profoundly legitimate competition reasons for blocking the deal – but are they supported by the facts of the case?”

Protectionism

By blocking a transaction that would likely have been cleared in the US or Europe, Mofcom has shown that it is willing to chart its own course when it comes to maintaining the independence of Chinese firms and protecting domestic competitors from foreign rivals.

“It does send a clear, early message that Mofcom will use its powers to block mergers if it thinks this is necessary,” says Nicholson.

Mofcom's request for Coke to dispense with the Huiyuan brand was effectively a deal breaker as it knew this would be unacceptable to Coke given the premium it had paid for the brand.

“The problem came from the fact that Coke was trying to acquire a major Chinese brand in addition to a business,” says Wang.

With its shares traded on the Hong Kong stock exchange, Huiyuan is 23%-owned by France's Groupe Danone, with US private equity firm Warburg Pincus holding 6.8% and the company's founding chairman Zhu Xinli possessing 36%.

But although defining the nationality of brands is becoming increasingly difficult, public sentiment in China was firmly against allowing the Huiyuan brand to fall into foreign hands. A poll by the Web portal Sina.com showed that nearly 80% of the half-million participants opposed the sale.

“In the current climate, I suspect the complaints of smaller companies were given greater weight. Mofcom wouldn't want to approve a transaction that could cause people to lose their jobs, and potentially create social unrest,” says Huckerby.

“Whether the complaints had any merit is neither here nor there. Mofcom may have been concerned about upsetting the community if it were to approve a contentious deal based on a pure competition analysis,” he adds.

A statement by Mofcom sought to deflect accusations of protectionism. “[The] decision to block the acquisition was neither affected by disturbing external factors and nor was it protectionism.”

And the anti-monopoly regulator could be forgiven for considering such accusations as somewhat hypocritical, particularly those emanating from the US.

China National Offshore Oil Corporation was forced to withdraw its 2005 bid for US oil company Unocal after a political backlash in Washington DC. And in March the following year, Dubai firm Dubai Ports World had to agree to cede control of US ports acquired in its takeover of P&O to a US entity after US Congress threatened to block the takeover on security grounds.

Although the juice business is not a strategic industry like defence or energy, Mofcom's decision to reject the Huiyuan takeover could be interpreted merely as a sign that the Chinese government wants China's companies and brands to compete in global markets.

Future M&A activity

It has been suggested that the failure of what would have been the largest foreign takeover of a Chinese company will be seen as a blow to multinational companies seeking to make acquisitions in China. But should it?

“It will take a lot of deals where multinationals look to buy high profile Chinese companies off the table,” says Huckerby, “or cause multinationals to look at smaller targets that are less likely to attract criticism and focus more on their regulatory strategy.”

But deals will continue to happen, and certainly involving Coke. After all, China is Coke's fourth largest market and a key battleground with rival PepsiCo Inc.

And most deals do not have the same ingredients as the Coke deal – where a very famous foreign brand is trying to acquire a very famous Chinese brand – argues Wang. “I don't think the Coke decision will have a significant effect on deal activity. Potential investors might be a bit more careful, but what they would prefer more of is greater transparency. Even if the rules were tighter, at least then they could plan ahead.”

A Chinese government adviser has claimed that it is unfair to criticise China for rejecting the Coke deal because the government has approved more inbound deals than it has blocked – Mofcom has investigated 29 proposed acquisitions under the AML since August last year and approved 24 of them. As the Coke decision represents only one such review, Nicholson says it does not necessarily represent a general trend against international companies by Chinese authorities.

Of more concern to the Chinese government is the prospect of authorities in other jurisdictions retaliating. It is not in Beijing's interests for China to be perceived as hostile to foreign investors, which could in turn hurt the prospects of Chinese companies looking to take advantage of cheap prices to invest abroad. This is particularly the case with natural resources that are critical to sustaining Chinese economic growth.

Already in Australia, for example, shares in mining company Rio Tinto plummeted as speculation increased that the Australian government could reject the mining company's US$19.5 billion funding deal with Aluminum Corp of China. Even before the Coke decision, Australians have been increasingly concerned with Chinese companies buying up domestic mining resources – the Australian treasurer even blocked Minmetals' US$2 billion offer for debt-ridden Australian miner OZ Minerals on national security concerns.

In the past two years, the value of deals struck by Chinese companies shopping overseas has exceeded the value of deals done by foreign companies in China, according to Thomson Reuters. Chinese firms completed US$76.6 billion in deals abroad last year, compared with US$18.6 billion in completed deals by foreign companies in China.

Such investments have escalated since the global downturn started to bite late last year – and the Chinese government is looking to loosen the reins further, recently issuing new rules (Measures for Administration of External Investment) that lower regulatory hurdles for Chinese companies looking to invest abroad [see Outbound unbound? on page 18].

Reasons to be cheerful

When Coke and Huiyuan first embarked on their regulatory journey with Mofcom, most commentators were confident the deal would go through but with conditions attached. The fact that it hasn't has provided ammunition to those eager to criticise.

So was the Chinese government's rejection of the Coke deal retaliation for previous acts of protectionism by the US government? Only Mofcom and the Chinese government can truly answer that question.

Unlike in the US and the EU, China's anti-monopoly regulator is not an independent agency and therefore not immune to political pressure. Exacerbating the problem further is the lack of detail on the competition analysis.

“As with the InBev decision, this decision could have formed the basis for some really helpful guidance for parties to future transactions in China,” says Nicholson. “But the decision is so lacking in detail that its helpfulness is limited.”

But Wang points out that in both cases Mofcom has provided some level of detail – and a lot more than it had to. “The law merely requires them to publish the decision,” he says. “Although it is not as much as some people hoped for, you don't get much more elsewhere.”

The InBev decision showed Mofcom taking the deal seriously even though it was an offshore transaction. “And the Coke decision takes it to a whole other level,” adds Wang. “It's says: if you're dominant in one market, we will watch you very closely in everything else that you do.”

For its part, Mofcom has stated that its ruling represents big progress and that investors should be encouraged by the fact that laws are properly enforced. In addition, investors have been furnished with further clarity on Mofcom's AML review process:

Calendar days will be used for the timeline of Mofcom's pre-concentration anti-monopoly reviews; a case-specific factor not enumerated in the AML has influenced the final decision to a greater or lesser extent; and time spent on hearings will not delay the overall review timetable.

The likely outcome of the Coke decision is that companies will think even harder about acquisition strategies that avoid the need for Mofcom approval. This may involve taking a minority interest, staying below control and turnover thresholds, or a carefully structured joint venture.

“We'll see a lot of offshore transactions taking place that are structured without acquiring domestic approval and which are done at high speed,” says Huckerby. “But companies must remember that if they do trigger the thresholds, they have to notify, or face penalties.”

The alternative is to engage with Mofcom early on and to immediately start to resolve attacks on a deal and thereby make it easier for the regulator to clear the transaction. In addition to provisions under the AML for pre-filing consultation, Mofcom has set up a process for early consultation. “It may not get you a better result, but it at least gives you visibility,” says Wang.

In rejecting the Coke deal, Mofcom turned to the AML. In doing so, it at least couched its objection in business terms – unlike the US over Unocal, where 70% of Unocal's energy reserves were in Asia.

“The AML is at a very early stage,” says Wang. “It's easy to criticise, but I get the sense that Mofcom is working very hard and that greater transparency will come.”

Additional reporting by Tom Young and Rachel Evans