May 2014 Issue
On a global scale, M&A activity has remained listless in recent years. Although blockbuster deals have been announced periodically, global M&A activity is still relatively depressed overall. This is particularly evident in comparison with the boom years of the pre-financial crisis era.
China has not been shielded from the gloomy M&A environment. Total M&A activity in the country decreased in 2013 due to a number of factors including the extensive change seen in the Chinese government, the slowing of China’s GDP growth rate and the general weakness in international commodity prices. Yet despite the local economic slowdown, China’s appetite for outbound M&A has showed no sign of stopping. In fact, unlike other regions, it appeared to gather pace in 2013.
In recent years PRC government policy has encouraged domestic manufacturers and investors to increase their focus on longer term value creation, as well as on domestic investment to develop and expand consumption. The government is extremely supportive of companies’ overseas expansion, particularly in areas that will move the Chinese economy further up the value chain in terms of technology, resources, market positioning and brand value.
While Chinese firms have always been aware of the growth potential of overseas development, there has been some caution about the associated challenges. However, the government has taken concrete steps in practical areas such as finance. These include allowing commercial banks to support outbound M&A and working to streamline its regulatory process.
Overall, 2013 saw Chinese outbound M&A involving both state owned and privately owned enterprises perform strongly, with transactions soaring in volume and continuing to rise in value. Throughout the year Chinese firms were involved in 220 global M&A deals valued at a cumulative total of $68.9bn. This represents a 37 percent and 17 percent increase in volume and value respectively over 2012. The most notable deals focused on the energy and power sector, accounting for 64 percent of the value of total outbound investment. However, the consumer goods sector is increasing its profile in terms of overall value, receiving a boost from the $7.1bn acquisition of US-based Smithfield Foods by China’s Shuanghui International Holdings in September 2013.
“Europe’s telecoms sector remains fragmented, divided among
approximately 150 major operators which crisscross national lines.”
The spate of acquisitions completed by Chinese outbound acquirers stands in sharp contrast to the slowdown in M&A seen in many other global regions. We may be seeing the emergence of the next wave of Chinese outbound M&A. Rather than state owned enterprises acquiring foreign energy and mining assets to feed and sustain the budding export juggernaut of China, the next phase of Chinese outbound M&A seems to be driven increasingly by private companies. Technology companies such as Lenovo Group Ltd and conglomerates such as Fosun International Ltd are leading this phase of international expansion and investment. Private companies accounted for approximately one-third of the total value of outbound deals that exceeded $1bn in 2013.
The second half of 2013 saw Chinese outbound M&A increase sharply. There were more deals announced during this time than in any earlier half year period. The majority of outbound deals involving Chinese firms last year remained focused on traditional regions. Mature, established markets such as North America, Europe and Asia were the chief focus of Chinese outbound M&A activity, with firms targeting the usual, conventional sectors for investment.
The strong showing from Chinese companies last year should be replicated through 2014 and beyond. Private enterprises will continue to drive Chinese outbound M&A efforts, especially as the country has placed a greater emphasis on the role of private firms in its future economic development. In November, at the third full plenum of the Communist Party’s 18th Central Committee, President Xi Jinping laid out the Party’s plans for the broadest changes to the Chinese economic system since the 1990s. Most notable among the revisions was the Party’s decision to increase the emphasis on private companies, providing them with a significantly greater role in the Chinese economy.
However, there is a feeling that with a new wave of Chinese outbound M&A underway, 2014 and beyond will see a shift in the destination of transactions. The Middle East, for example, is growing in popularity. Increased foreign capital has flowed into Africa and the Middle East in recent years. The focus on these regions is a response to decelerating growth in other emerging markets such as Brazil and India.
In support of this theory, a new survey has been published by Deloitte. According to the survey the Middle East is expected to witness a considerable amount of outbound M&A activity from China throughout 2014 and beyond. The report noted that “respondents are more optimistic about the China outbound M&A landscape than they were 12 months ago. A cumulative 74 percent of respondents believe that activity will increase over the coming 12 months, whereas when interviewed the same time last year, just two-thirds of respondents answered similarly”.
Other factors may be at play, however. While there is a strong demand for acquisitions in the US, Chinese firms have found the regulatory obstacles to be considerable, particularly in the technology sector. Instead of outright acquisitions there have been a number of significant joint ventures, strategic licensing agreements and joint development deals – a trend likely to continue. As a result, although Chinese companies will remain interested in outbound acquisitions, they will probably be implemented and completed in substantial part through investment vehicles other than traditional M&A.
Regarding the structure of deals, the Deloitte report found that the composition of Chinese deals in the Middle East in H1 2013 remained broadly similar to previous years. According to Deloitte’s report, outbound deal flow was focused within the energy and resources and consumer business industries in the regiom. During the first half of 2013, outbound deals in these two sectors accounted for 53.1 percent of total deal volume, valued at $29bn. This represented an increase from 50.5 percent, or $17bn, during the same period in 2012. Chinese companies have shifted their attention to other emerging markets due to the significant cost advantages those nations often provide to investors. Not only are the markets less mature and the opportunities more plentiful, there are also lower labour costs for firms invested in these regions.
As a location for large scale investment, the Middle East is beginning to thrive. 2013 marked its best full year total for M&A since 2010. Activity in the area was greatly strengthened by the $7.5bn merger of two UAE state owned aluminium producers in June. The materials sector was the most targeted industry, accounting for 23 percent of all activity. Deals involving the energy and power and telecoms sectors also helped to drive activity, accounting for 21 percent of overall M&A.
China’s burgeoning interest in the region was demonstrated last year as Chinese investors registered the highest value of inbound M&A deals targeting the Middle East. According to Deloitte, Chinese companies are most likely to invest in areas such as energy and resources, real estate, construction and financial services.
In the financial services sector, 52 percent of respondents to Deloitte’s survey said they expect the Middle East to see a considerable amount of Chinese outbound M&A activity through 2014. The region ranked second only to Asia among respondents, placing it ahead of Europe and Africa, for anticipated investment in financial services. Forty-seven percent of those surveyed expected to see an increase in activity in those regions as well as South America and North America, where 44 percent and 18 percent of respondents respectively expected to see an increase in M&A.
Overall, the M&A landscape in the Middle East has been relatively stable over the last few years. However, 2013 saw the best full year total recorded since 2010. Moreover, the value and number of deals targeting the Middle East reached the highest level in six years by value, and five years by volume. The 90 completed deals had an aggregate value of $15.6bn – a 21.9 percent increase on the $12.8bn generated by 73 deals in 2012. Last year was also the second consecutive year of increased M&A deal value and volume. The materials sector was the most targeted industry, accounting for 23 percent of all M&A activity. Energy and power and telecoms deals also helped drive transactions, with each sector accounting for 21 percent of activity in the region.
An increase in investment in the Middle East is not without precedent. In 2013 China outbound M&A deals targeting the Middle East registered the highest value compared to all other nations. In the first six months of last year, 98 outbound deals were completed involving Chinese firms for a total value of $35.3bn. During the same period in 2012, a similar number of deals were completed but only $22.9bn was contributed by Chinese firms. The majority of those deals focused primarily on the energy and resources sector and consumer business industries, which accounted for more than half of all deals. The decision by Chinese oil giant Sinopec to acquire a $3.1bn stake in the Egyptian operations of the Apache Corporation, has been highlighted as an example of China’s growing interest in the Middle East and its abundant energy resources.
Around 63 percent of respondents to Deloitte’s survey expected the consumer and transportation sectors in the Middle East to receive a generous number of Chinese M&A investments in the months ahead. The real estate and construction industries are also expected to see a notable increase, with 45 percent of those surveyed expecting a sizable increase in M&A deals.
However, not all sectors are expected to attract as much Chinese investment in the year ahead. Less than 10 percent of those surveyed expected to see any notable investments in the technology, media and telecommunications sector. The life sciences, healthcare and manufacturing sectors in the region are also likely to miss out.
The Middle East is not without its problems. Yet, despite political, social and economic issues, many dealmakers expect 2014 to be the year M&A flourishes in the region. Furthermore, with Chinese foreign direct investment expected to rise to around $150bn per year by 2015, the Middle East presents fertile ground for many Chinese companies, both state and privately-owned.
Chinese acquirers will have to remain determined and dedicated. No matter the region they are entering, their success depends on navigating the challenges and restrictions of both domestic and target markets. However, this should not pose a particular problem for Chinese firms which, in the past few years, have reached out into global markets with increasing success.
© Financier Worldwide
BY
Richard Summerfield