The Art of Mergers & Acquisitions in China

Professor Shen Wei

White & Case

September 13, 2006

Topics

1. Preparation and Strategy

2. The On-the-Ground Reality
3. Closing a Deal and Achieving an Exit

Preparation and Strategy

A. Overview of the M&A practice in China
-

China is definitely on the radar: internationally and domestically

Moving from greenfield projects to more M&A transactions

More industry sectors open to foreign investors

Hot industries include telecoms, financial, energy, mining, retail,

pharmaceuticals, machinery, automobile

Two-folded policy concerns

Preparation and Strategy

B. Some basic concepts in the M&A practice in China
-

Inbound M&A vs. outbound M&A

public company vs. private company

asset deal vs. equity deal

transaction modes: share purchase, share swap

various targets: SOEs, FIEs, pure domestic entities

Preparation and Strategy

C. Recent Developments in the M&A practice in China
-

Increasing number of private equity led deals

Protection of key industries from foreign takeovers a case of

deja ru?

Share reform of listed companies

C, G and legal person shares

Using stock for acquisitions

How do these changes affect the market?

What are the implications?

Box 1 - Alphabet Soup

One share
class
denominated
in RMB

Domestic
Exchange

Foreign/Hong Non-tradable
Kong
Exchange

Domesticinvested

Traded in
RMB A Shares
G Shares

Not possible

C Shares

Foreigninvested

Traded in
foreign
currency B
Shares

Traded in
foreign
currency:
H Shares
Hong Kong
N Shares
New York
T, S, L etc.

Not possible

Preparation and Strategy

D. Recent Regulatory Developments in the M&A practice in China
-

New Company Law 2005

New Securities Law 2005

Rules for Mergers with and Acquisitions of Domestic Enterprises by

Foreign Investors 2006

Takeover Rules of Listed Companies 2006

Administrative Measures on Strategic Investment in Listed Companies by

Foreign Investors 2005

Others i.e., infamous SAFE Notices

Preparation and Strategy

D. Recent Regulatory Developments in the M&A practice in China (cond)
-

China is evolving towards a more sophisticated legal regime for

M&A transactions

Good news:
Clearer approval requirements and procedures
More experienced local players and government authorities
Adoption of new transactional tools such as share swap

Bad news:
More new limitations and restrictions imposed
Approval authorities now have more discretionary powers

Box 2 MOFCOM

MOFCOMs discretionary power

-

Any deal involving a key industry or well-known brand, or may affect

national economic security shall be filed with MOFCOM (Article 12 of the
M&A Rules 2006)

Possible key industries include

Nuclear power
Military
Machinery
Power generation/transmission
Shipbuilding
steel

Box 2 MOFCOM

MOFCOMs discretionary power

-

MOFCOM may stop a deal if it has grounds to believe that it will affect
national economic security similar to US CFIUS Review

Vagueness in rules escalates uncertainty in deals

Coca-cola & Huiyuan

10

Preparation & Strategy

E. Winning Strategies
-

Keep abreast of new developments

Cultivate local partners

Understand the counterparty

Cultural sensitivity not cultural blindness

Adjust time lines (forward or backward) and manage expectations with

home office

11

Box 3 Cultivate local partners

Watch out for Foreign Corrupt Practices Act issues

-

many commercial entitles have State-owned links

Companies may keep different sets of accounts

12

The On-the-Ground Reality

F. Navigating the Chinese Regulatory Regime and doing deals in heavily
regulated industries
-

Investing in heavily regulated industries

The Encouraged, Restricted, Permitted and Prohibited or The Good,

Bad and the Ugly

Foreign ownership caps

Good nominee structures, bad nominee structures

13

Box 4 Foreign ownership caps

Strategic
Investor
Individual
cap?

Strategic
Investor

Financial
Investor

Foreign sub of
PRC company
Outside China

Foreign consortium cap ?

Public
shareholders

PRC anchor
investor

China

Impact ?

Domestic Bank

14

Box 5
Bad Nominee Structure telecom CCF arrangements
Foreign telco

China
Unicom

Provincial Subsidiary

Cooperation
Joint Venture

local
network
Operation Agreement

15

Box 6 I got your number

Foreign
Publishing
House

Copyright Cooperation

PRC
company

Magazine
Name

Brand Name

Cannibalisation

(publication
number)

16

Box 7 Valueadded telecoms

Founders
Investment Vehicle

Public

Listco

Founders

Nominee
contract

License holder
Regulated
Business

China

Operating Vehicle
Security and
Cash
Extraction
Contracts

Unregulated
Business
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The On-the-Ground Reality

G. Regulators

MOFCOM

SASAC

CBRC

SAIC

NDRC

CIRC

SAFE

CSRC

MII

Customs

SAPP

EPB

18

The On-the-Ground Reality

G. Regulators (cond)

Central
MOFCOM

Local
MOFCOM

19

The On-the-Ground Reality

H. State-Owned Enterprises
-

Recent developments
- Xugong, Chenming

Deal drivers
- Which member of the group?
- Dealing with the Hong Kong listed member
- Parent guarantee?
- State-owned assets valuation (mandatory, licensed appraising firm, methodology,
SASACs confirmation)
- Payment terms (90% rule)

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10

The On-the-Ground Reality

H. State-Owned Enterprises (contd)
-

Special considerations
- Diligence
- Procedure (involvement of the asset exchange centre)
- Timing
- Documentation
- Social obligations
- Cross-provincial consolidation
- Sovereign immunity

21

Box 8 The Hong Kong listed member

HK listco

Foreign
investors

SOE
Onshore
Operating Vehicle
- Hong Kong Stock Exchange issues

Connected
transactions

- Disclosure of interests
- Hong Kong Takeovers Code issues
- Insider dealing issues
- Pricing issues and the halo effect
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11

The On-the-Ground Reality

I. The Public Company
-

Share reform
- The good news, the bad news
- Theme is convergence

Special considerations
- Investor qualification
- Public bid process
- Lock-up
- Diligence insider trading issues
- Timing pricing and approval process(es)

23

The On-the-Ground Reality

I. The Public Company (contd)
- Trading restrictions
- Disclosure of interests
- Connected transactions

Listed Company Takeover Rules

- Mandatory Offers
- Partial offers
- Stock as acquisition currency

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12

The On-the-Ground Reality

J. The Private Company
-

M&A Rules 2006

- Multi-agency effort
- Approval for acquisitions of key industries, famous Chinese brands
- Deals affecting state economic security
- Stock deals
- Merger Control
- May be inconsistently applied across China

25

The On-the-Ground Reality

J. The Private Company (contd)
-

Special Considerations
- If privatized, was it privatized properly?
- Offshore control vs. onshore control using a holdco

26

13

The On-the-Ground Reality

K.

Investment Funds, Hedge Funds and other Alternative Investors

-

Meeting investor qualification criteria

Prejudice against financial investors?
Opportunities and risks

27

Closing a Deal and Achieving an Exit

L.

M&A Roadmap for M&A Transactions in China

Important Milestones in an M&A Transaction

MOU
Pre-deal restructuring
Due Diligence
Reps and warranties
Pre-closing conditions
Closing
Post-closing matters

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14

Closing a Deal and Achieving an Exit

L. M&A Roadmap for M&A Transactions in China (cond)
Negotiation
Identify the target
Sign a Term Sheet/LOI/MOU/Heads of Agreement
Commercial/legal negotiation
Due Diligence (legal, financial, commercial, technological)
Prepare definitive agreements

29

Closing a Deal and Achieving an Exit

L. M&A Roadmap for M&A Transactions in China (cond)
Approval
MOFCOM approval
Approval by the industry watchdog(s)
SASAC approval
Anti-trust filing
New business license
SAFE approval
Others

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15

Closing a Deal and Achieving an Exit

L. M&A Roadmap for M&A Transactions in China (cond)
Closing
Clear up key findings in due diligence
Prepare the disclosure letter
Pre-closing audit (financial due diligence)
Conditions precedent (to be satisfied or waived)
Payment of consideration
Post-closing integration

31

Closing a Deal and Achieving an Exit

M.

Critical Factors in Structuring M&A Deals

Structure-out problems
Structure for growth
Structure for new problems

When planning the marriage, consider the divorce

Structure for Exit
Structure for Taxes/Dividends
Structure to satisfy the regulators

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16

Box 9 Structure for growth

Foreign Investor

Holding Company

Operating
Company

Operating
Company

Operating
Company

Operating
Company

- building a brand
- centralized distribution, procurement and infrastructure
- floating cash layer
33

Box 10 Structure for exit

The case of the Crown Jewel
Foreign Investor

Foreign Investor

HK SPV

JV Crown
Jewel

JV

JV

JV to be retained

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17

Closing a Deal and Achieving an Exit

N.

Due Diligence
-

Legal due diligence (not an exhaustive list)

Incorporation of the target (approval and registration, transfer of equity)
Capital verification of all contributions to registered capital
Legal rights in respect of land and buildings
Environmental survey in respect of the relevant land and facilities
Tax status including any preferential benefits enjoyed with respect to both
income tax and imported equipment
Existence of any business relationship with third parties such as suppliers,
franchisees, customers, banks, lessors, etc. which may prevent or hinder
proposed investment
Identify key employees whose continued participation in the relevant
business would be of strategic importance, employee settlement plan,
labor related costs, labor redundancy, etc.
Status of IP rights, e.g., trademarks, patents, know-how, copyrights,
software, enterprise names, domain names, licenses, etc.)
Assets (SOE assets, ownership, encumbrances or third party claims)

35

Closing a Deal and Achieving an Exit

N.

Due Diligence (cond)

-

Non-compliance is widespread
No target company (in particular in China) is 100% clean
Risks shall be properly assessed from both legal and practical perspectives

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18

Closing a Deal and Achieving an Exit

O.

Instruments to Lower Legal Risks

-

Closing conditions corrective measures to tackle due diligence findings

Payment of consideration
escrow account, holdback, earn-out, buy-back (?)
default payment timeframe: 3 months of the issuance of a new business license,
extendable to 1 year, provided 60% is paid within 6 months

Reps and Warranties

Indemnity
Unilateral termination
reasonable/practical triggers
Exit

Post-closing covenants

37

Closing a Deal and Achieving an Exit

P.

Current Exit Strategies

-

Trade sale
IPO
Domestic
NY, London, HK, SG
MBO/LBO
Private Equity
MBO
LBO
recycled deals

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19

Closing a Deal and Achieving an Exit

Q. Critical Post-Closing Issues
-

Protect IP

Employment / Labor Issues

Confidential information risks

Foreign Exchange

39

Closing a Deal and Achieving an Exit

Q. Critical Post-Closing Issues (contd)
-

Relationship with other investors

Business risks

Regulatory risks

Dividends

Expansion

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20

Closing a Deal and Achieving an Exit

R. Anti-trust Filing
-

Most anti-trust filings have been procedural but it is expected to have more
teeth

Thresholds for the anti-trust filing are rather low

Turnover of a party to the transaction in China exceeds RMB 1.5bn during the year
The foreign party has cumulatively acquired more than 10 domestic enterprises in one year
Current (pre-M&A) market share of a party already exceeds 20% in China
Post-deal market share of a party will exceed 25% in China

Anti-trust review may be requested by domestic competitors, relevant

organizations or industrial associations

41

Closing a Deal and Achieving an Exit

R. Anti-trust Filing (cond)
-

Watch out: offshore M&As may also be subject to anti-trust filing in China if
certain thresholds are met
Any offshore party holds assets in China of over RMB 3 bn
Volume of business in China of any offshore party is over RMB 1.5 bn
An offshore party has reached a market share in China of 20%
The transaction will result in an offshore party attaining a market share of 25% in China
The result of the transaction will make an offshore party have direct and indirect ownership
in over 15 FIEs in the relevant industry or area

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21

Closing a Deal and Achieving an Exit

R. Anti-trust Filing (cond)
-

Problems
Relevant market (Articles 51 and 53 of the M&A Rules)
Affiliate (Article 51)
Offshore acquisition (Article 53)

43

Closing a Deal and Achieving an Exit

S. National Security Review
-

the Notice on Establishing National Security Review Mechanism for Mergers

and Acquisitions of Domestic Enterprises by Foreign Investors [Guo Ban Fa
[2011] Circular 6], issued by the General Office of the State Council on 3
February 2011

the Interim Rules on Issues Related to the Implementation of the Security

Review System for Mergers and Acquisitions of Domestic Enterprises by
Foreign Investors, issued by the Ministry of Commerce on 4 March 2011

the Regulations on the Implementation of the Security Review System for

Mergers and Acquisitions of Domestic Enterprises by Foreign Investors,
Announcement [2011] No.53, issued by the Ministry of Commerce and effective
as of 1 September 2011
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22

Closing a Deal and Achieving an Exit

S. National Security Clearance: the targets subject to national security reveiw
Category A

Category B

Where the target is a military industry

enterprise

Where target involves agricultural

products

A supporting enterprise for military

industry enterprise

Where target is related to energy

sources & resources

An enterprise located close to

sensitive military facilities

Where target is related to

infrastructure
Where target is related to
transportation services
Where target is related to
technologies
Where target is related to equipment
manufacturing
45

Closing a Deal and Achieving an Exit

S. National Security Review: the target subject to the review
-

BUT still uncertain whether all foreign investors in all M&A transactions
must file an application with the MOFCOM or whether it is only those
transactions that fall within the scope of the security review circular
a list of considered factors in Circular 6
any other scenarios which would cause the rights to exercise actual control over
operational decisions, financial personnel and technological affairs of a domestic
company
practical meaning is that the list can be further extended

Small transactions exempted? Cf. Australia FIRB

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Closing a Deal and Achieving an Exit

S. National Security Clearance: procedure
Step

Timing

Notification to MOFCOM

(not specified)

MOFCOM notifies the Ministerial Panel if the

transaction falls within the scope of the security
review

5 working days

Ministerial Panel general review:

Request opinions from other departments
Opinions from other departments
Decision (either dismissing or proceeding to a
special review)

5 working days
20 working days
5 working days

Ministerial Panel special review

60 working days

47

Closing a Deal and Achieving an Exit

S. National Security Review: A Paper Tiger??
-

Injecting another layer of uncertainty

Who can initiate the procedure?

Review measures will be used as frequently as the AML

Requires substantial disclosure and may cause more delays

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