Part 1: Understand Your Father-in-Law
Amidst economic uncertainty and volatility in 2014, recently high M&A activity in China has brought a silver lining to the dark clouds. Chinese M&A deal values have reached a record high in the first half of 2014 and are expected to heat up in the coming years, driven by forces of both East going West and West going East. China is becoming more sophisticated and stands in the middle of a planned and market system. This hybrid dynamic shows in the current M&A environment as the Chinese government remains a major player in reshaping the M&A landscape in China.
If we look at acquiring a Chinese partner as entering into a marriage of convenience in China, multinational companies (MNCs) are the foreign son-in-laws. And the first thing they should learn is how to understand their father-in-law, or in this case, the Chinese government. So, how can they do this?
Firstly, MNCs should be prepared to compete with more formidable state-owned enterprise (SEO) players. To change an unsustainable pattern and make SOEs more effective and competitive, the Chinese government announced its plans to permit non-state-owned capital to take equity stakes in projects with investment by state-owned capital in a form of IPOs of unlisted state-owned assets, forming a joint venture with private capital.
This has mixed impact for MNCs – on a negative side, domestic competition will increase and on the other hand, MNCs will have more sophisticated companies to partner with. While the central government aims to reduce state shares in competitive industries and pillar industries it remains the major shareholder in key strategic industries.
SOEs show lower returns than foreign-invested companies in almost every industry, yet their revenues are extremely dominant in strategic industries with restricted access to foreign investors (see below).
The second shift is around growing industry consolidation. Many local competitors are getting bigger in scale. The industry consolidation initiative specifies quantitative consolidation goals in key sectors including pharmaceutical, auto, electrolytic, iron and steel, red earth, metal, agriculture, cement, shipbuilding, and baby formula.
Thirdly, the antimonopoly law requires foreign investors that will take a controlling stake or the actual controller of a domestic enterprise to submit applications to the Ministry of Commerce for a separate review process, creating an additional regulatory hurdle for foreign companies. It has created growing concern that the control provision of the AML could become a new tool to discriminate against foreign companies, and the protectionist overtones of this ruling may have a chilling effect on foreign investment in China.
The future competitive landscape between multinationals and local players is poised to change. Perhaps a more interesting age of further liberalization of the market is coming. As a multinational company, are you brave enough to embrace that?