Chinese outbound M&A boomed in 2016, but then macroeconomic imbalances and a growth in potentially speculative investment sparked regulatory tightening to contain flows. So how is the market faring in 2017? Stefania Palma investigates.

China outward M&A

Chinese outbound mergers and acquisitions (M&A) enjoyed a record year in 2016, with the volume of announced outbound deals more than doubling in just 12 months to $221.57bn. The growth in completed transactions was as explosive, with volumes almost doubling to $145.11bn in 2016. 

A slowing economy at home, ambitions to expand internationally and the need to upgrade corporates via technology or consumer brand acquisition all contributed to this boom. But as volumes skyrocketed, Chinese regulators grew nervous about the capital outflows and weakening renminbi resulting from this new trend. What is more, while strategy underpinned many of these deals, some transactions targeting the hotel, sports clubs and entertainment sectors were perceived as irrational investments. 

So, in late 2016, Chinese regulators started rolling out tighter capital controls and strengthened the scrutiny of outbound deals. Though these directives were never formally announced, they were enough to slow down the cascade of international M&A. So where does that leave the market in 2017?

Regulatory crackdown

The boom in Chinese outbound M&A was a natural progression in the country’s growth path. Acquiring foreign technology or consumer brands helped upgrade China’s industrial base at a time when the country started moving from an investment-driven to a consumption-driven economic model. And after decades of breakneck growth, Chinese corporates were ready to expand abroad as their domestic economy was slowing down. 

But the speed of growth in outbound investment also led to near-record capital outflows and put pressure on the renminbi, forcing the government to burn through nearly $320bn of foreign exchange reserves in 2016 to prop up the currency. As a result, Chinese regulators clamped down on capital outflows. 

“The government could not afford such an exodus of foreign exchange reserves in [such a] short timeframe. It was not surprising to see some reasonable control on foreign exchange,” says Zilong Wang, head of M&A at Chinese investment bank China International Capital Corporation (CICC).

None of these regulatory changes have been announced publicly, making it hard for market participants to map the new directives. “In China, control is often exercised through eyebrow regulation [where market participants discover where they stand vis-a-vis regulation after authorities tighten policy directives], and not just through formal, published regulation,” says Timothy Gee, a partner at law firm Baker & McKenzie.

Mr Wang agrees, saying: “You need an on-the-ground team to communicate with regulatory parties. There are usually no clear directives.”

Non-core investment

Chinese authorities also tightened scrutiny on outbound M&A deals after a spike in potentially speculative investment in sports clubs, hotels and cinemas, and the entertainment industry.

At €2.15bn, China accounted for more than half of global investment in football clubs between 2014 and 2016, according to M&A adviser ThinkingLinking. The average size of a football club deal involving a Chinese buyer was five times the global average, at €126m. “I don’t think Chinese buyers are different from any other buyers of football clubs. These are mostly trophy assets with no industrial logic,” says Mr Gee.

According to the Financial Times, in June the China Banking Regulatory Commission (CBRC) asked domestic banks to probe Zhejiang Rossoneri Investment – the vehicle Rossoneri Sport Investment Lux used to buy Italian football club AC Milan – for “systemic risk”.

The CBRC also asked Chinese banks to review relationships with the conglomerates HNA and Dalian Wanda, consumer group Fosun and insurer Anbang, which have been some of the most active Chinese buyers in the past three years. HNA and Anbang stand out for their investments in the hotel and entertainment sectors, two industries flagged by Chinese authorities for non-core investments.

Anbang came close to buying Starwood Hotels & Resorts, but dropped out of the bidding in March after failing to demonstrate the financing backing its $14bn offer, according to the Financial Times. “We advised Starwood to move forward with its deal with [competing bidder] Marriott,” says Colin Banfield, head of M&A, Asia-Pacific, at Citi.

CBRC’s prudential concerns particularly apply to insurance companies, which are meant to match assets to long-term liabilities. “There have been concerns that some [insurance companies’] investments were not likely to lead to good matches,” says Mr Gee.

Chinese authorities detained Anbang chairman Wu Xiaohui in June, according to financial magazine Caijing, although his detention has not been officially confirmed. Anbang said in a statement that Mr Wu was “unable to perform his duties”.

Meanwhile, in 2016 HNA bought up stakes in hotel groups Hilton and Rezidor and purchased eight golf clubs in Washington state as well as 850 Third Avenue, a 21-storey building in New York City. HNA’s 2016 M&A activity also stands out for the array of companies it targeted, from hotels to real estate to a fine jewellery firm (Hong Kong’s KTL International Holdings), a tech accelerator for start-ups (RocketSpace in the US) and airline catering (Servair, a subsidiary of Switzerland's gategroup).

Towards sustainability 

Since rolling out these tighter regulations, the volume of newly announced Chinese outbound M&A deals has dropped. But market participants stress this decrease does not mean the international Chinese M&A story is over. Growth in 2016 was exceptional and unlikely to continue long-term. And at $82.64bn, the 2017 volume of Chinese outbound M&A approvals as of July 11 is already close to annual numbers for 2015 ($97.22bn).

“Contrary to what others may have stated, I remain bullish about China outbound M&A. The volume of outbound activity continues to grow year on year and deal size and complexity continue to get more sophisticated and ambitious. This trend is here to stay,” says Mr Banfield.

Andrew Bell, chairman at DealGlobe, an M&A advisory firm focusing on cross-border Chinese deals, says: “I see this slowdown as a maturing of the M&A market, a natural process. Growth will be more sustainable.”  

Market participants believe the volume of completed deals will remain high in 2017, as an overhang from the previous year. And some bankers say their deal pipelines remain unaffected. Mr Gee, however, disagrees. “It’s the pipeline that is really being hit. Bankers will tell you that conversations that had started have cooled, and new conversations are not starting,” he says.

But Mr Bell believes smaller deals are likely to be less affected compared with the multi-billion dollar headline transactions. “Large deals that are highly leveraged will have a harder time this year,” he says.

China outbound M&A

Maturing market

The China outbound M&A story, however, is not just about volume, as Chinese companies are now targeting increasingly sophisticated sectors. Before 2010, energy accounted for more than half of all Chinese investment abroad as the country needed to secure energy supply and security. In 2016, the story was no longer about extractives. Industrials accounted for more than half of investment, followed by technology, media and telecommunications at 18% and consumer business at 12%. Energy was nowhere, says Mr Gee.

What is more, state-owned enterprises are no longer the only players in the market. Chinese private equity firms, A-share companies and privately owned companies have also joined the outbound M&A race. 

China’s privately owned tech giants, such as e-commerce platform Alibaba or internet firm Tencent, are part of this trend. So far in 2017, Tencent has bought a 40% stake in Indonesia’s scooter taxi app Go-Jek, joined a consortium to invest $1.4bn in India’s e-commerce giant Flipkart and acquired a stake in Hong Kong financial services company Futu Securities International.

Alibaba has also been busy. In Asia, it has invested in a clutch of e-wallet and payment companies: Mynt in the Philippines, Kakao in South Korea, Ascend Money in Thailand and Paytm in India, and is in the process of acquiring money transfer company MoneyGram International. The deal, which is set to close before the end of 2017, will help expand its cross-border remittance business.

Squeezing premium

More disciplined pricing is another sign of China’s maturing outbound M&A. When the wave of outbound deals began in 2007, Chinese corporates were known to offer hefty premia – going as high as 20% – to ensure their success as newcomers. “Perhaps in the past some Chinese [investors] were prepared to pay crazy prices. Now, they pay economically driven prices. They are dealing with markets they have access to and they bring in a lot of value,” says Mr Bell.

According to Mr Gee, it is a generalisation to say all Chinese corporates pay 10% to 20% more than the market price. “Chinese investors don’t like overpaying for an asset any more than anyone else does,” he says.

It also depends on the deal. If it is a strategic transaction for China, the likelihood of a premium is higher. This is the case with state-owned chemical company ChemChina, which has tendered about 95% of the shares in Swiss seed and pesticide maker Syngenta, at a premium over a previous bidder. “[ChemChina] is definitely paying a generous price,” says one market participant. 

But this $44bn deal could create the largest chemical group in the world. “Syngenta is transformational for ChemChina, which will become a top three player in the agro-chemical sector. They recognise the strategic value of this opportunity,” says Citi’s Mr Banfield.

“[The Syngenta deal] shows Chinese investors can do mature deals and that they don’t crash about with big boots and a large cheque book. There has been good management of the broader stakeholder group and of the deal’s public image,” adds Mr Gee. The transaction should be completed in 2018.

Execution risk 

Chinese buyers may still offer attractive pricing, however, to offset higher execution risk versus their competitors. Sellers typically worry about Chinese corporates’ ability to meet deadlines in a Western market competitive auction, to secure approval for the transaction and about the type of finance backing the deal. 

To assuage these worries, Chinese buyers have started offering reverse break fees, or payments in case deals fall through; non-refundable deposits; or escrows that can be drawn down if the buyer cannot complete the transaction on time.

Execution risk tends to drop with smaller, more nimble buyers, according to DealGlobe’s Mr Bell. Most of DealGlobe’s clients – listed companies with the entrepreneur still owning a significant minority stake – fall into this category. “[In this case] sellers are not dealing with multiple layers of decision-making and these firms have access to capital markets if they need financing for the deal,” he says.

In addition to dealing with regulatory risk at home, Chinese corporates also face tight scrutiny by target countries’ regulators. Indeed, 2016 was as much a boom year for outbound investment as it was for deals cancelled – a record $74.5bn, with the US accounting for a whopping $59bn of the total, says a report by Baker & McKenzie and Rhodium Group.

China investment in Europe vs US

Barriers abroad

Although Chinese firms still consider the US a top M&A market, its regulators are perceived to be the toughest. The US considers Chinese companies acquiring hi-tech firms such as semiconductor businesses, whose products are used in weapon systems, as a threat to national security. State-controlled Tsinghua Unigroup cancelling its bid for data storage group Western Digital after US authorities flagged the investment for investigation is just one example of the tech deals blocked in 2016. Many market participants feel the US definition of national security, however, is broadening.

US pressure even helped block a Chinese deal in Germany. In October 2016, German authorities withdrew approval for Fujian Grand Chip Investment Fund to take over German chip equipment maker Aixtron, which has a substantial Silicon Valley division.

Despite this, however, Europe is still perceived as more welcoming than the US. Markets such as Germany, Switzerland and Austria offer strong established businesses, brands and technology, says Mr Banfield. “These markets become even more attractive if [Chinese firms] find the doors for acquisition closed in the US,” he adds.

Down the Belt and Road

Besides Western markets, Chinese companies will be looking at countries along the Belt and Road project, a Chinese initiative that aims to rebuild the ancient Silk Road trade and investment route to Europe.

Most markets along this path do not host the hi-tech or consumer brand companies that Chinese buyers are currently targeting; most economic activity in these developing countries focuses on infrastructure projects. “But in the next five to 10 years, these markets will have generated new target companies for Chinese firms,” says CICC’s Mr Wang.

“Transactions that support the [Belt and Road] initiative are likely to receive strong Chinese government support,” adds PeiShen Chou, co-head of M&A, Asia Pacific, at UBS.

As with many aspects of China’s growth experience, the boom in outbound M&A was as extraordinary as it was unbridled. A stress scenario brought regulators to reckoning, followed by tighter directives, which seem to be normalising outbound M&A flows. But the 19th National Party Congress later this year could affect the market.

“To the extent that [Communist] party policy continues to prioritise economic expansion, further restructuring of Chinese industry will be required, and overseas investment is a central part of that,” says Mr Gee. The congress will at least clarify policy direction; at best, it might make regulators more permissive.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter