On the receiving end of Chinese outbound investment

A very prominent example of how things can go wrong came with Sichuan Tengzhong's attempted acquisition of the Hummer brand from struggling US car-maker GM. In this case, the deal had been announced without final approval being obtained from the NDRC. The companies' failure to understand the approval process resulted in financial loss and damage to their reputations, perhaps particularly significant for the Chinese domestic company in this case.

Most lawyers say it is essential for both parties to have a continuing dialogue with the government in order to smooth the approval process. Although it is ultimately the Chinese company's job to obtain the necessary approvals, an overseas target company with good connections may be able to assist the deal approval process by talking to the relevant regulator.

“This would typically only be for the purpose of providing more information and general comfort,” says Mallesons Stephen Jaques partner David Olsson.

This information could be more valuable than it first appears: it will familiarise the regulators with the transaction, which in turn can help reduce the time required for formal post-filing review and help identify any concerns that the regulators may have in advance of signing the definitive transaction documents.

“Communication with the PRC government should be ongoing, not just on one or two occasions – both formally and informally,” Tom Chau, a corporate partner of Herbert Smith in Beijing, told CLP at the time the Hummer deal was under consideration.

Relationship-building is particularly important in China, as the government is more directly involved in outbound deals than foreign investors may be used to at home.

“The Party line is to encourage outbound investment,” Chau said. “But on the other hand, the government has advised PRC enterprises to be cautious and careful because they are afraid of the fact that PRC outbound investors may not have sufficient knowledge … to manage an asset overseas.”

You make it easy
To help ease the process, foreign target companies should do their best to understand the way Chinese companies do business. As Peng Yuan, director of the Valence Group, explained to the audience at a recent conference on Chinese outbound investment, they may, for example, ask for certain information at a much earlier stage in the process than Western companies are used to.

“This is not the Chinese company trying to embarrass the foreign company,” she said. “It's more that it's coming from a less mature position.” Market-oriented M&A deals have only been happening in the PRC for about 10 years.

On the regulatory side, foreign companies must also try to grasp how approvals are conducted in China.

“It is important that a target company understands the regulatory environment in China to understand the Chinese approval process, as that will impact on completion of outbound transactions,” says Sam Farrands, a Hong Kong partner of Minter Ellison and head of the firm's major projects and infrastructure practice in Asia.

Any of the four regulators mentioned earlier may be asked to comment either on the transaction itself or on who may be required to give a statement about the situation in the target investment's jurisdiction. Complicating matters further, in certain industries other ministries or even quasi-governmental consultative bodies may need to get involved. In mining, for example, bodies such as the Chinese Chamber of Commerce for Metals and Chemicals or China Mining Association must give the Chinese company advice on the legal and investment landscapes of the target country before an investment application is made

Of course understanding the roles of these bodies may not be straightforward for foreign companies.

“Some of these organisations are unique to China without any analogous counterparts abroad,” Farrands says. “Therefore their specific role and requirements need to be considered by both the acquirer and the target company.”

Companies should also consider what they can do on the home side to assist the regulators. Olsson says his firm has seen “at least one situation where the target also made representations” to the local regulator in support of the Chinese acquirer's proposal. This happened in a deal where the target was at risk of being put into liquidation by its bankers unless a new financial proposal or capitalisation arrangement was put in place.

The way an acquisition is structured can also make or break a deal. In sensitive industries, Farrands says Chinese companies should follow the approach that was used by Japanese and Korean companies in the 1980s and '90s in West Australia: purchase at the asset level rather than equity in companies.

“Often it is easier to push through a deal where the Chinese side takes no interest in the target company itself, but an underlying asset or project, thereby also achieving its goal of securing supply of a particular resource.”

The right pricing is also key, says Olsson. In a competitive bidding situation a Chinese investor may be at a disadvantage to another international bidder if it is not able to submit an unconditional bid.

“The risk of PRC approvals not being obtained may mean that a less financially attractive but unconditional bid may be preferred by the target.”

Taking things over
Many Chinese outbound acquisitions are strategic, and take the form of a minority stake holding plus add-ons such as a seat on the board, rights to enter into other future projects, offtake agreements, and so on. But incidences of takeovers and majority acquisitions are increasing and are likely to continue to do so as Chinese companies become more experienced and bold.

In a non-hostile investment or takeover situation, the foreign target should work with the Chinese acquirer to try to make the terms of the deal more favourable to the PRC purchaser and the regulators on both sides. This can be done by trying to develop, agree and implement a suitable strategy which addresses the timetable for obtaining PRC approvals, as well as the legal and regulatory issues in the target's jurisdiction.

Where the Chinese company is taking a full or majority stake, cultural awareness becomes vital, as well as awareness of the legal and regulatory issues which apply in the particular sector. It will need good external counsel – and this can extend beyond the usual financial and legal advice. Most specialists say it is very important for a foreign acquirer to engage a PR company during the bidding phase and beyond.

It might seem that the management of the target company can not hope to add much in this situation, and has no place in discussions with the regulator. But experienced advisers say that, at least in the Australian context, agreeing that senior management and key staff will remain in the same position after the acquisition will help smooth the deal

“This is a very significant part of the proposal to be put to the Foreign Investment Review Board – we've seen requirements that there's an ongoing Australian element to the acquisition,” says Olsson.

This provides another advantage for the incoming Chinese company in that it can help improve public perception.

For many companies overseas, an approach from a PRC company may provide a welcome lifeline. But it should not end there; the target company must do all it can to help the deal go through. In reality this will mostly take place at the home end, but the foreign target should not ignore the needs of the Chinese company and the regulatory environment from which it is coming. As Chinese companies spread their wings, an understanding of the PRC regulatory environment is becoming more and more relevant to companies and their legal advisers overseas.