China special: New government controls on outbound deals

If global M&A markets have been busy over the last two years, you need only look to the flow of capital from China for one of the reasons. Indeed, 2016 in particular saw unprecedented levels of interest from Chinese buyers for overseas assets – China outbound activity doubled last year to reach $185 billion, according to Mergermarket.

While the $43 billion acquisition of Syngenta by ChemChina accounted for a large share, the fact that the number of deals was up by 45 percent to 906, according to Thomson Reuters, suggests the appetite was strong for overseas companies and assets last year. Many of these buyers were corporates, although some were private equity-led, such as the deal that saw Hua Capital, CITIC Capital and Goldstone acquire OmniVision Technologies.

Many deals also included some element of private equity capital – the acquisition of printer business Lexmark for $2.54 billion was completed by Apex Technology and PAG Asia Capital, and in Germany Osram sold its lamps business to strategic buyer MLS in a €400 million deal backed by IDG Capital and Yiwu State-Owned Assets Operation Center.

As John van Rossen, head of transaction services, UK & Ireland, at EY, says: “It can be hard to distinguish Chinese private equity investment from conglomerate M&A activity as financial and strategic investors often team up.”

The acquisitions provide access to valuable assets and know-how. “Many Chinese companies are looking for established and valued brands that they can bring back to the Chinese market,” says Jie Gong, partner in Pantheon’s Asian investment team. “They are also looking for technology that can boost productivity or help their product command premium pricing. The other strand is gaining access to engineering know-how – Germany in particular is seen as a stronghold in this area.”

This was one of the rationales behind the creation of private equity firm Asia Germany Industrial Promotion Capital (AGIC) in 2015 by ex-Deutsche Bank executive chairman Henry Cai. Its debut fund hit its $1 billion target in February 2017, with sovereign wealth fund China Investment Corporation an anchor investor. Investments include a €925 million deal to buy German manufacturer KraussMaffei in conjunction with ChemChina and the acquisition of Italian robotics business Gimatic for €100 million in June 2017.

The strategy is to help European businesses expand in Asia, particularly China. AGIC’s links should ensure that trade sales to Chinese companies are a natural exit route.
While many of the new Chinese private equity funds invest mainly domestically or across Asia, some, such as the $500 million European Environment & Energy Fund raised by Hong Kong-based A Capital, have a European mandate.

This flow of capital from China has clearly affected European and US private equity deal markets. A recent MVision and London Business School survey of GPs found that 83 percent had noticed an rise in Chinese acquisitions in 2016 and two-thirds said they had come up against a Chinese buyer more frequently in 2016. Over a quarter (29 percent) said they had lost out in a deal to a Chinese bidder and 76 percent said Chinese activity was having an inflationary impact on valuations.

“There has been exponential growth in Chinese M&A over the last few years,” says Calum Paterson, managing partner at Scottish Equity Partners. “I think that has driven up valuations and made it more difficult for private equity to compete. But there is a lot of capital out there more generally – corporate and institutional – and China is only part of the story.”

The flip-side, of course, is that the exit market has been equally buoyant, a trend also noted by respondents to the MVision/LBS survey. Over four-fifths (86 percent) said they expected Chinese buyers to provide them with more exit opportunities. Those benefiting in 2016 included Scottish Equity Partners, which sold online flight booking business SkyScanner for £1.4 billion ($1.8 billion; €1.7 billion) to Chinese travel company Ctrip and Bain Capital which secured a £1.21 billion sale of British manufacturer of blood plasma therapies Bio Products Laboratories to Chinese investment firm Creat Group Corporation.

US and European private equity firms may find themselves more in demand over the coming year as Chinese corporates seek out partners to circumvent more stringent controls on outward foreign direct investment.

Reacting to the rapid outflow of capital over the previous two years, the Chinese government announced last November that it would increase scrutiny of overseas investments, including megadeals over $10 billion, and acquisitions in sectors outside an investor’s core business.

The result was a sharp drop in outbound deals to $23.8 billion in the first quarter of 2017, down from the more than $80 billion in Q1 2015, according to Thomson Reuters.
As a recent White & Case report says: “Beijing’s new stance on outbound acquisitions is unlikely to bring dealflow to a halt, but it will slow down certain types of transactions.”

Some will respond in much the same way as Ping An, the insurer, which said that it intends to team up with foreign private equity and property funds for its outbound deals.

There are other advantages to teaming up with US and European funds. “Private equity firms in Europe and China have a role to play,” says Gong. “There is a clear cultural barrier that strategic buyers have to grapple with when doing outbound M&A. They need to be well-informed, understand what their target pool looks like and be able to identify which companies have what they are looking for. That usually requires local knowledge and contacts. Private equity houses therefore make great partners for strategic buyers from China.”

The other factor that may slow Chinese outbound investment is the rise of protectionism in some markets, with technology key among the more sensitive areas when it comes to Chinese buyers.

US authorities, for example, prevented Philips from selling its lighting business last year to GSR Ventures, Oak Investment Partners, Asia Pacific Resource Development and Nanchang Industrial Group.

There are also concerns among US and European governments about a lack of reciprocal arrangements for inbound M&A in China, leading to accusations of an unequal playing field. “Protectionism may well be on the agenda in 2017 and 2018,” says van Rossen.

The deep pool of capital residing in China bodes well for the world’s big private equity funds, says MVision CEO Mounir Guen. “China has some significant institutional investors and most of them currently focus on domestic funds that are able to run local currency structures,” he says. “Yet they are one cycle away from becoming international in their approach to alternatives.”