China and the M&A boom

Alysha Webb discovers that different corporate cultures are not always the only hurdles foreign companies need to overcome in bringing about successful merger and acquisition deals in China

In early January, a group of Citibank and Pudong Development Bank executives sat together under the chandeliers in the opulent lobby of the Shanghai Pudong Development Bank to announce to the press that they were now strategic partners. Citibank took a 5% stake in the Chinese bank because, said Stephen Long, head of North Asia for Citibank, �greater opportunities lie in co-operation than competition� for foreign banks in China.

Co-operation didn�t come easily, though. The two financial firms spent a year-and-a-half hashing out the details of the agreement, which will start with Citibank helping to manage Pudong Development Bank�s nascent credit card business. Both sides hope the co-operation will become a stand-alone credit card joint venture, when regulations allow. Though Pudong Development is listed on China�s domestic A-share market, the Shanghai Municipal Government is still the majority owner. So, learning to work with US based, NYSE-listed Citibank wasn�t easy, admits Pudong Development�s chairman, Zhang Guangsheng. �The biggest hurdle was cultural differences,� he says. �That, and dealing with the lawyers.�

Get ready for more cultural differences, and lots more lawyers! Already in line for 2003: Japan�s Nissan is finalising 50% interest, US$1.03bn investment, in Dongfeng Motor Corporation. The Government also hopes a new policy allowing foreign parties to buy so-called legal-person shares - non-tradeable shares owned by state institutions, government departments and state-owned enterprises in listed and unlisted companies - will boost M&A in China. And not all the money is flowing into China. A small but growing number of Chinese companies are going shopping overseas. As M&A activity grows, however, so do the problems.

Valuation will be a major stumbling block for any foreign investor. Citibank�s investment was valued at RMB400m (US$72m), though Long was loath to reveal exactly how that figure was arrived at other than saying �a combination of assets and profitability and the quality of the organisation and management�. However, the price of Citibank�s legal-person share purchase is already being challenged by retail investors in China. They claim Citibank bought the shares at a deeply discounted 1.5 times the forecast price to book for 2001, just a third of the 4.4 times price to book retail investors were asked to pay for a new batch of tradeable shares issued recently.

Then there is what Johan Leven, head of mergers and acquisitions for Asia ex-Japan at Goldman Sachs, calls China�s �housekeeping rule� - that state-owned assets cannot be sold under net asset value. Apparently influenced by the rule, a high share price delayed attempts to list China Telecom in New York and Hong Kong last year. When it did debut, in late November, investor reaction was lacklustre. �Valuation can be a challenge in China,� concludes Leven, whose bank worked on the Nissan-Dongfeng deal.

Even more challenging is China�s unique valuation method, says Oliver Hua, general manager of corporate finance and management consultant, Stern Stewart�s China office. �They take the net book value as the basis for valuation, which is derived by subtracting the book value of debt from book value of assets,� he explains. �Normally firms use discounted cash flow type of approaches - the future ability of a firm to generate cash flow. That is the fundamental difference between Chinese valuation and the international method. One is backward looking and one is forward looking.�

That didn�t seem to slow down M&A activity in China much in 2002. According to Thomson Financial, there were 766 transactions targeting a Chinese company last year, accounting for 24% of all transactions in Asia, for a total of US$25.07bn. Though one deal stood out - Hong Kong-listed China Mobile�s US$10.34bn purchase of eight subsidiaries from its parent, China Mobile Group, in Beijing - there were plenty of other examples.

The finance sector was especially attractive to foreign investors, who were no doubt eyeing the more than US$1 trillion in savings locked away in Chinese savings accounts. In 2002, Newbridge Capital paid US$1.8bn for nearly 20% of Shenzhen Development Bank, and HSBC paid US$600m for 10% of Pingan Insurance. With a passenger car market which grew 52% in 2002 to 1.1m units, China�s auto sector was also a hot area. In November, General Motors took a 34% stake in mini-van maker Liuzhou Wuling for more than US$30m, and in December bought Yantai Body Co along with partner SAIC for US$108m, among other deals.

Numbers notwithstanding, basic misunderstandings underlie some agreements. When Morgan Stanley sought to form a domestic investment bank together with China Construction Bank in 1994, the US investment bank thought the new entity - called China International Capital Corp - would simply be an extension of Morgan in China. Only when it recognised that the Chinese side wanted to form an independent entity did co-operation really start. Now, Nissan and Dongfeng Motors are having the same problem, says a source close to the deal. �The more we negotiate, the more we have divergent views of what this JV is supposed to achieve,� says the source. The two companies �got engaged in November but, now that they are planning for the wedding, all these issues are coming up�. The disagreement will likely drag finalising the deal out for several months.

Not all M&A activity comprises foreign companies looking to buy into Chinese firms. A small but growing number of Chinese companies are now looking to buy overseas assets, to gain access to natural resources, markets and management skills. They face their own problems. �Most Chinese aren�t sophisticated global managers,� says Goldman Sachs managing director, Fred Hu. Valuation is a problem in these deals too, says Shanghai based David Zou, a lawyer with Tongda Law Offices. He worked with a Chinese biomedical company that was acquiring a Californian firm. �The Chinese companies are not familiar with the valuation, and the technology stuff can be very hard to value,� he says.

China�s baklava-like layers of bureaucracy can change the shape of an agreement, says Jia Baoluo, managing director of Best Development Investment Co, an investment arm of mainland steel conglomerate Shougang. Any decision of an overseas subsidiary often must be filtered through many departments back at the China headquarters. Like a story that is retold many times, the agreement can change. �You have to go through a lot of procedures and argument, and the final decision comes out maybe not how you want,� says Jia. �The local manager has to have his freedom to make decisions.�

Of course, some deals go smoothly. For example, in October, TCL Overseas Holding, part of the Hong Kong-listed arm of China based electronics group, TCL Holdings, paid e8.2m for Germany�s Schneider Electronics AG, including Schneider�s brand name, production facilities, inventories and some of its marketing network. �TCL�s vision is to become a world-class company; for the realisation of this vision we have been looking for a world-class brand name and technology,� explains Ahn Myung Jun, managing director of TCL Overseas Holdings. TCL and Schneider encountered �quite normal� barriers, such as a high initial price and what to do with previous employees. �They were resolved in a reasonable and amicable manner,� Ahn asserts.

Alysha Webb is a business journalist based in Shanghai.