Not quite letting go

China wants its companies to play on the global stage. But larger firms still can’t wrest themselves from the government’s grip, writes Andy Thomson.

The Chinese government apparently decided that the nation’s companies should “go global” in the mid 1990s. It seems unlikely that anyone noticed however, given that a decade passed before the first overseas acquisition was approved when TCL, the Chinese electronics manufacturer, purchased its French rival Thomson.

Since this landmark deal, things have speeded up dramatically – culminating in the $56 billion of foreign direct investment made by Chinese companies last year. This year, many expect the value of Chinese acquisitions abroad to be worth more than the value of Chinese companies being bought by foreign firms – for the first time ever. 

On the face of it, amendments to existing overseas acquisition rules that came into force at the beginning of this month appear to aid the ambition to go global. For example, Chinese companies making overseas investments worth less than $10 million are now the beneficiaries of a fast-track procedure which does not require either provincial or central government approval of the investment.

Meanwhile, deals worth $10 million to $100 million require only provincial approval. This means a large number of companies that had to seek lengthier central government approval under the old version of the rules need do so no longer.

Good so far. 

For deals worth $100 million or more, however, a green light is still required from central government. These larger deals only become effective once approval has been obtained in China – and not upon execution of the deal. This, say legal experts, creates a real headache in trying to ensure that key contractual provisions retain their enforceability pending receipt of approval. When selling to a Chinese buyer, can a vendor know that the buyer is good for the money? At the very least there is room for doubt – and this uncertainty can be crippling.

There are at least three ways in which private equity firms might find themselves affected by this (all three examples below apply to deals over $100 million): 

One: any China-based private equity-backed portfolio company will find it as hard as any other Chinese company to expand internationally. If cross-border acquisitions are not off the agenda, they are at the least made considerably more difficult.

Two: any private equity firm wanting to do a deal alongside a Chinese partner – think of last year’s attempt by Bain Capital to buy US software firm 3Com in partnership with Huawei Technologies, for example – has to think seriously about that partner’s ability to enter a meaningful contract. The ultimate nightmare in this scenario would involve the joint venture jumping through hoops to get the deal signed in the first place, only to find that it subsequently unravels when approval from China is withheld.

Three: a private equity firm thinking of selling a portfolio company to a Chinese buyer has to tread carefully and consider whether the deal is worth doing given the uncertainty of execution – even if the Chinese bidder is offering the highest price.

A briefing by law firm Norton Rose says the new rules indicate that “the Chinese authorities wish to retain a firm grip in shaping the destination and nature of overseas investments, especially those in the energy and mineral sectors”. For larger Chinese companies, “going global” is still not as simple as it sounds.