Going outbound: What private companies can learn from SOEs

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SWOT analysis

Compared with SOEs, POEs tend to be smaller and more flexible in international transactions. POEs must know their strengths and weaknesses and appreciate the coexistence of opportunities and threats (SWOT) when pursuing global strategies (see figure 1).

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Integration planning

This goes to the top of the list because the deal execution team is often not the same as the operational team, and their objectives and motivations are not always aligned. This is typically seen in the large SOEs as their M&A team or new project development team at the group company level or in a special overseas investment flagship unit will usually lead on the transaction side. Many such units are active global market players with employees that have internal commercial, legal and financial experience and an international education or working background and are familiar with cross-border acquisitions and projects. However, the negotiation team will probably not become the management team after the completion of the transaction.

In some cases, decisions regarding the management or operational team may be made at a later stage of negotiation (or even after signing). This may cause a particular issue if a foreign target is not being acquired in its totality, where a shareholders' agreement or joint venture agreement would usually be required. Early involvement and input from the future on-the-ground management or operational team when designing the joint venture structure, corporate governance and shareholder oversight power is highly desirable from commercial, as well as legal perspectives.

Giving the future management team input at the negotiation stage may be more manageable for POEs given their relatively smaller management pool. Nevertheless, clear corporate strategies, a carefully considered integration plan, as well as the talent level of the management team are strong indicators of the readiness of Chinese POEs to invest abroad. In addition, an early consideration of the integration plan may suggest changes to the deal structure, for example, post-deal management considerations may result in taking a minority stake before investing further.

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Aligning with stakeholder interests

There are lessons to be learned from past experiences of some early entrants into the host countries. For example, some of the early entrants have been criticised internationally for their poor environmental record, labour violations and lack of social responsibilities, particularly in African or Latin American jurisdictions. The sectors most affected by such criticism have been energy, mining and infrastructure construction. On the other hand, a number of early entrants complained about unforeseeable cost increases or delays caused by difficulties in dealing with the local government, residents and communities in the host countries.

The Chinese government has since pushed for companies investing abroad to pay particular attention to environmental and social factors. MOFCOM and the Ministry of Environmental Protection (MEP) jointly released the Guidelines on Environmental Protection for Outbound Investment and Cooperation (对外投资合作环境保护指南) on February 18 2013 – the first of its kind for Chinese enterprises. The Guidelines have no teeth, but do contain several prominent features.

As a fundamental principle, the Guidelines go beyond (although are focused on) requiring Chinese enterprises to fulfil their environmental protection responsibility and also aim to guide and help them to shoulder more general corporate social responsibilities (CSRs), respecting religions, cultures and customs of the host countries, protecting legitimate rights and interests of local labourers, providing training, schooling and job opportunities, and achieving win-win results.

The Guidelines also encourage Chinese enterprises to apply for environmental management certificates and other International Organisation of Standardization (ISO) certifications and to adopt principles, standards and norms of relevant international organisations. Adopting international industry standards and best practice and setting up transparent and accountable reporting practices could help Chinese enterprises to improve their corporate image, and strengthen their core competiveness and soft power in the global arena.

Another more recent effort is the issuance of the Provisions on Regulating Competitive Acts in the Sector of Outbound Investment and Cooperation (规范对外投资合作领域竞争行为的规定) by MOFCOM on March 18 2013. The Rules, among others, call for Chinese enterprises to comply with the relevant regulations, require expatriates to obtain employment quotas approved by host country governments, and fulfil local content requirements in accordance with the relevant local laws, and not to obtain overseas projects through depressing labour costs.

Corporate social responsibility has become a worldwide trend. Many major Chinese enterprises (especially SOEs) have begun to publish CSR reports and to promote transparency and accountability in their local activities and compliance. On the other hand, smaller private enterprises may still lack understanding of the local laws and practices related to taxation, environmental protection, land acquisition, labour protection and functions of trade unions, as well as a well-developed plan to confront local challenges and to support local development projects through philanthropic activities.

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Complex deal structures

The $15.1 billion Nexen acquisition by CNOOC was no doubt the most significant deal in 2012. Not only was the Nexen takeover by far China's largest overseas acquisition to date, but the complexity of the transaction and the approval processes from Canada, the US and the EU has put the deal under the global spotlight.

In addition, more overseas deals by Chinese enterprises (notably including not only major SOEs but also large POEs) have been reported involving hostile take-overs, schemes of arrangement, complex debt restructuring and refinancing arrangements, leverage buyouts, and deal protections such as reverse break fee structure favourable to the target to increase the buyer's chance to secure the deal. Financing partners such as commercial banks, private equity firms and government-backed funds have become unavoidably active players in such transactions. The contribution of experienced external legal, financial, tax, technical, environmental and insurance advisors, consultants and specialists involved in the investment decisions and processes is also indispensable.

The completion of head-line transactions demonstrates the ability, sophistication and confidence of those Chinese enterprises to pursue their international strategies and their astute understanding of the rules of international M&A. However, most Chinese POEs, especially SMEs, including those that are leaders in their region or industry, still have little overseas experience. Their experience is lacking both in terms of the sophistication of their management and in-house legal and financial teams, and their appreciation of quality intermediary assistance.

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Thorough due diligence

Many issues and problems discussed above might have been identified, mitigated or even avoided, if there had been thorough due diligence before the investment was made. The large Chinese SOEs have been paying increasing attention to the importance of high-quality due diligence, but there is still a tendency for Chinese enterprises to rush into a deal with only quick inspection of the target for obvious problems and without a clear acquisition strategy. The usual excuse is that no opportunity can wait. This, however, is likely only to be half of the truth.

Due diligence is an investigation of the target's business, assets and liabilities, mainly through review of the documents provided by the seller or the target. It also includes a review of information that is publicly available, information collected during site visits, management presentations and interviews. Figure 2 clearly outlines the key issues and risks POEs should be aware of during international transactions.

Throughout this process, the level of information the buyer may get access to is key. However, the seller or the target can be reluctant to hand over commercially sensitive information until it is clear a deal is likely to proceed. In practice, the seller would need to weigh whether the buyer's interest is serious or not. If a buyer has not involved external advisers, its intent is generally seen as less serious and a Chinese investor may struggle to access the information they need to conduct proper due diligence. Figure 3 provides an outline of the timelines and stages of an acquisition, including due diligence.

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Government support

Although the government does not create wealth, it can help provide an environment for wealth creation. For Chinese ODI, policy support from the Chinese government has been and will continue to be instrumental in the growth of outbound investment from Chinese POEs.

Chinese governmental policies have been a significant driver of ODI trends by encouraging and guiding Chinese POEs to invest overseas. The most recent and prominent policy is the Implementing Opinions on Encouraging and Guiding Private Enterprises to Actively Engage in Overseas Investment (关于鼓励和引导民营企业积极开展境外投资的实施意见) (2012 Opinions) jointly issued by 13 departments of the State Council, including the NDRC, on June 19 2012. The 2012 Opinions set out 18 major measures (or rather principles) on five aspects and are known as the first comprehensive policy document encouraging ODI by private enterprises. More specific measures and detailed implementing policies are also expected, which are likely to improve government support to Chinese POEs' outbound investment in all aspects, including tax, finance and insurance, customs, foreign exchange as well as the approval process and regulatory supervision.

The necessity of PRC regulatory approvals is often viewed as a way out of a deal post-signing, especially for Chinese SOEs given their state-owned nature. The announcement made in January this year that CNOOC has been unable to obtain the final PRC governmental approvals for its stake in Exoma Energy has fuelled speculation that PRC regulatory approvals represent a free option to renegotiate the price or walk away. This may be less of a concern for POEs but the current time-consuming approval process could make their offers less attractive.

Perhaps with these difficulties in mind, various Chinese regulators, including the NDRC and MOFCOM, have made an effort to streamline the approval process and reduce the amount of red tape required. Notably, a consultation paper was published by the NDRC on August 16 2012 on the Measures for Administration of the Check and Approval of Overseas Investment Projects (Draft for Comments) (境外投资项目核准管理办法（征求意见稿）), which replaces the Tentative Measures for Administration of the Check and Approval of Overseas Investment Projects (境外投资项目核准暂行管理办法), issued by NDRC in 2004. However, the timetable for the issuance of these regulations remains unclear.

An important aspect of Chinese ODI is the learning curve: the more deals that are sealed, the more Chinese companies will be aware of the issues and difficulties they may face in the future. Lessons learned from previous investments will make them increasingly sophisticated and mature their approach to ODI.

Monica Sun, Herbert Smith Freehills, Beijing