Chinese companies are showing themselves to be a major force in global mergers and acquisitions (M&As). M&A in China in the year 2010 spiraled up due to international economic resurgence and the country’s non-stop growth, according to a report by Zero2IPO Research Center.
In 2010, Chinese companies effectuated 622 M&A cases, year-on-year growth of 111.6 percent. Of these, there are 57 cases of overseas M&As, an increase of 50 percent in comparison with 2009. Foreign counterparts in China accounted for 44 cases, lifting the growth figure to 33.3 percent on a year-on-year basis. Real estate, energy and mining industries comprised the majority of the M&As activities.
While there are more internal acquisitions during the past three years, the next five years should witness more cross border deals for Chinese companies. Chinese companies will be driven to undertake cross-border deals for many reasons, with some of the most common ones including access to resources, expertise and brand building. Access to resources is a clear and well-known driver.
Beyond that, Chinese firms use mergers and acquisitions to move up the value chain. One example is Lenovo’s acquisition of IBM’s laptop business, which allowed it to gain global distribution, operational expertise and brand value. Could we fathom similar acquisition that could propel a Chinese firm to the top league of the logistics play as well?
Another key driver influencing outbound M&A activity lies in the fact that Chinese monetary authorities are pushing state-owned enterprises to acquire resource, mining and energy companies abroad, to secure the basic necessities to feed the country’s growing appetite for just about everything. The other key benefit of course, is to diversify away from declining US dollar-denominated government securities.
According to JP Morgan’s forecast, by the year 2020, China will have US$16.4 trillion in aggregate domestic savings. If only 5% of these savings are deployed abroad, China will export US$822 billion of capital annually. This may essentially imply a tectonic shift in M&A activity in the coming decades.
With this shift, which will be the most likely industry targets? For the short term, investments will likely focus on sectors such as automotive, mining and resources, agriculture and financial services. From the medium to long term, we can expect Chinese investments to search for targets that will strengthen its global supply chain foothold, to ensure that it continues its manufacturing and distribution dominance.
Geographically, China will continue its acquisition spree in places such as Africa and Latin America, where there are abundant natural resources available. The national security concerns and caution that Chinese companies often face in the European Union (EU) or the United States, often take a back seat to official desires for capital. In May 2009, the China Development Bank announced a loan of US$10 billion to Petrobras, the state-owned Brazilian oil company, in exchange for a guaranteed supply of oil over the next decade. We can expect many similar deals to come.
However, more work need to be done for the Chinese investment to succeed in global M&As. Over the last few years, there have been several poorly executed investments whereby the Chinese acquirers could have benefitted from better pre-deal planning of cross-border M&A strategies. In addition, Chinese acquirers can also benefit from expert advice and support on post-merger integration (PMI) from seasoned professionals in the industry.
The reality is that the PMI on many high-profile deals has not been strong, with obvious impact on the long-term promise of these transactions. One notable example again was the Lenovo’s US$1.8 billion acquisition of IBM’s PC division in 2004. While the jury is still out on the deal with Lenovo reporting better than expected results over the last 2 years, the period following the acquisition was riddled with problems.
Perhaps the greatest barrier to the globalization efforts of Chinese companies is a lack of staff with the right experience in international economic environments, the complexities of conducting effective due diligence as well as effective post-merger integrations. Chinese companies are expected to continue to face difficulties both in negotiating deals and operating their overseas acquisitions due to these factors.
However, while Chinese resource firms often have government directives for going overseas, evidence suggests that once an overseas M&A deal is consumed, profit trumps imperatives. For example, about 75% of the oil from China’s overseas holdings does not get sent back to China. Rather, it is sold in the global marketplace at spot prices. Gasoline prices in China are capped, so oil refineries in China tend to operate at a loss, unless the Government subsidizes them.