Mergers and acquisitions in China (with special focus on the financial industry)

Table of Contents

List of graphics

List of tables

List of abbreviations

1. Introduction

2. Mergers & Acquisitions

3. Chinese M&A market
3.1. Chinese economy
3.2. Overview of Chinese M&A market
3.3. M&A regulations and restrictions
3.4. M&A advisory and Investment Banks

4. Current FDI and M&A activity
4.1. Current M&A activity in China
4.2. Current FDI activity in China

5. M&A and the importance of the stock market

6. Industry Example: Financial industry
6.1. Overview and problems
6.2. Reasons for foreign investors
6.3. M&A activity and evaluation

7. Conclusion

Bibliography

List of graphics

Graphic 1: Tender offer vs. merger

Graphic 2: The world’s largest economies

Graphic 3: Approval Authorities

Graphic 4: Selected Outbound Deals

Graphic 5: M&A deals

Graphic 6: FDI Confidence Index

Graphic 7: Size of equity market

Graphic 8: Reduction of NPL

Graphic 9: Growth of Chinese banking industry

Graphic 10: World’s largest IPOs

List of tables

Table 1: Inbound and Outbound Deals

Table 2: FDI

Table 3: M&A activity

Table 4: Foreign investments in the Big Four commercial banks in China

List of abbreviations

illustration not visible in this excerpt

1. Introduction

This paper is the final paper for the course Chinese Financial System. China is a fast growing economy. Therefore a lot of companies intend to enter this market. Mergers & Acquisitions (M&A) are a useful tool to do so.

First of all, it is important to understand the key principles of M&A. Therefore chapter 2 gives a summary of the most important aspects of mergers and acquisitions in general. Chapter 3 gives an introduction to the Chinese M&A market, while chapter 4 will focus on the current situation of M&A activity and foreign direct investment (FDI) in China. FDI is another method for entering a market and is a competing tool to M&A. Chapter 5 deals with the importance of the stock market for M&A activity. After that, the most important aspects of M&A activities in the Chinese financial industry will be shown. The paper will end with a conclusion in chapter 7.

2. Mergers & Acquisitions

Generally, M&As refer to traditional mergers and acquisitions, takeovers, corporate restructuring, corporate control and changes in the ownership structure of companies in general. It is usually distinguished between mergers and tender offers respectively:

Graphic 1: Tender offer vs. merger

illustration not visible in this excerpt

Source: own graphic

Mergers are negotiated deals between the members of the two boards of the companies, while tender offers are direct offers to the shareholders of the target company (the company, which makes the offer is called bidder) and are usually hostile. These offers can either be conditional (bidder requires a minimum amount of shares) or unconditional and restricted (bidder says a maximum amount of shares he is willing to buy) or unrestricted. It could be a two-tier offer, where the bidder first buys a bit more than 50% of the target company to get control and buys the rest later on. Another possibility is a three-piece suitor, which is similar to a two-tier-offer, however, before buying 50%, the bidder just buys a few shares to get a toehold.

M&As are generally made because of strategic and financial objectives and are driven by several forces, which usually work together. Technology (e.g. internet), globalization (e.g. WTO, EU) and deregulations (e.g. liberalisation in European postal markets) may be the most important ones. Mergers can be horizontal, vertical or conglomerate. Horizontal mergers occur between companies in the same business activity, in order to reach synergies and economies of scale and scope. As these kinds of mergers could result in a loss of competition, governmental antitrust regulations have to be considered. Vertical mergers occur between companies in different stages of production, like for example the acquisition of a supplier. These kinds of mergers happen due to increasing information and transaction efficiency, as information can flow quicker within a company after a merger and no time for contracting is being wasted any more. Conglomerate mergers are mergers between companies in unrelated types of businesses.

There are lots of regulations and laws concerning M&As (like rights for minority shareholders, insider trading, antitrust policy etc.), which will not be covered in this paper. Several reasons for M&As exist. Managers assume better efficiency through economies of scale (a decline of average costs when producing more), economies of scope (e.g. using the waste of one product as the input for another product), organization capital (i.e. the ability to produce at lower costs), organization reputation and human capital resources. In general, M&As are useful, when the two companies together are performing better than the two companies on their own (2 + 2 = 5). This is usually reached through synergies, like increased efficiency, as mentioned above. Other points could be better growth opportunities, a reduction in the variability of cash flows or tax advantages.

As a result of globalization and technology (technology is portable and can be transferred to other countries easily) more and more international takeovers take place. This is because companies want to combine complementary capabilities, find new markets and achieve critical mass. In cross boarder M&As exchange rates play an important role and managing risks concerning this topic is essential.

Like for every other investment a M&A is favourable if it has a positive net present value. To reach this, it is important for management not to overpay and to integrate the acquired company. The post-merger phase is the most important part of any M&A, especially different company cultures can lead to problems.

3. Chinese M&A market

3.1. Chinese economy

China is one of the world’s fastest-growing economies. The GDP growth rate is at about 10 per cent. After the accession to the WTO, Chinese government has undertaken reforms. Especially the banking system is going to be reformed in order to reduce non-performing loans. Furthermore China is investing in infrastructure, which should boost productivity. As seen in graphic 2, China is the second largest economy in the world using purchasing power parity. In 2020 it is expected that China will be the world’s largest economy.

Graphic 2: The world’s largest economies

illustration not visible in this excerpt

Source: The Economist (2006)

3.2. Overview of Chinese M&A market

With that booming economy in the back, also Chinese M&A activity has been booming in the last years.

Table 1: Inbound and Outbound deals

illustration not visible in this excerpt

Source: Own table using data from Morgen, Evan & Company, Inc. (2006)

Both, inbound and outbound deals increased from 2003 to 2004. In the first half of 2005 a small decrease is registered. However, experts estimate that the M&A activity will increase in future.

In addition, also foreign direct investment (FDI) is very strong. China ranks number one in receiving FDI.

Table 2: FDI

illustration not visible in this excerpt

Source: Own table using data from Morgen, Evan & Company, Inc. (2006)

3.3. M&A regulations and restrictions

All acquisitions of companies operating in China are reviewed by the local, provincial or central government. Regulations, restrictions and required time depend on the type of the acquisition target, transaction size and the impact on the industry or sector involved. Deals can only be completed when all government approvals have been issued. The following table gives you an overview of the involved approval authorities.

Graphic 3: Approval Authorities

illustration not visible in this excerpt

Source: Morgen, Evan & Company, Inc. (2006)

3.4. M&A advisory and Investment Banks

Historically, investment banks play an important role in M&A activities. Investment banks are wholesale financial institutions, which assist organizations in raising funds in the capital market and provide strategic advisory services for M&A activities and other types of financial transactions.

The Chinese M&A advisory market is a very dynamic sector, which for example increased in 2003 by 158.3%. Therefore more and more companies try to enter this market. The Chinese investment banking sector is dominated by the China International Capital Corporation (CICC) with a market share of 32% in 2003. The next two largest investment banks, Bank of China Investment Bank (BOCI) and CITIC International Financial Holding (CIFH), have a combined market share of about a third that of CICC. The CICC is China’s first joint venture investment bank. It is owned by China Jianyin Investment Limited (43.35%), Morgan Stanley International Incorporated (34.3%), China National Investment & Guaranty Co., Ltd. (7.65%), The Government of Singapore Investment Corporation (7.35%) and Mingly Corporation (7.35%). Until September 2004 CICC’s largest shareholder was the China Construction Bank. At that time China Construction Bank was demerged into China Construction Bank Corporation and the current largest CICC shareholder, China Jianyin Investment Limited, which now holds the ownership in CICC and is state-owned. It can be concluded that the Chinese State is the largest shareholder of CICC. The other important player is Morgan Stanley, one of the biggest investment banks in the world. Since 1997, CICC is offering financial M&A advisory. Renowned clients are China Mobile, China Telecom, Alcatel or Unilever.

4. Current FDI and M&A activity

This chapter deals with the current FDI and M&A activity in China in more detail.

4.1. Current M&A activity in China

The volume of M&A activity has increased significantly in China in the past. For foreign companies M&A are a quick way to build up market presence in the local market. Acquiring a local competitor is a quick way to get a known local brand (without investing much money in promotion), to get access to the local distribution system and local factories. As Thomson Financial pointed out, Chinese companies were Asia’s most preferred takeover target in 2005, mainly because of the rapid growing economy pointed out in the previous chapter.

As seen in table 3, the M&A activity in the last years is pretty high. Especially in the year 2005 the transactions worth increased considerably. It is expected that this number will decrease in 2006, as in 2005 a series of important investments in the financial sector occurred, as China’s big four state-owned commercial banks sought strategic investors prior to their IPO.

Table 3: M&A activity

illustration not visible in this excerpt

Source: Own table using data from Morgen, Evan & Company, Inc. (2006)

The most active sectors were utilities and mining, energy, financial services, telecommunications and logistics. Also other sectors like industrial manufacturing in general, pharmaceuticals, automotive and brewing were quite active. M&A activity in the retail sector is expected to grow as the top 100 retail companies in China only account for 10 per cent of the market share. A recent example is Wal-Marts one-billion Dollar acquisition of Trust Mart.

Many foreign companies acquire Chinese companies as the Chinese market is seen as the market of the future. So getting a foothold into this strategically very important market is vital for some companies. For example Amazon, Yahoo or Kodak bought Chinese companies. M&A is getting to an alternative for traditional joint ventures for foreign companies to enter the Chinese market. It has the advantage that they can control the company on their own and are not dependent on a partner. The Chinese M&A market is characterized by a relative high number of deals with low average transaction worth.

In recent years, M&A activities involving Chinese companies have predominately been inbound deals, meaning foreign companies were buying local companies. These foreign companies were using cheap Chinese labour and saw the opportunity to enter a big, booming market. In the last years, however, Chinese companies started to acquire foreign companies. It started in July 2005 with the US$18.5 bn bid of China National Offshore Oil Company’s (CNOOC) to buy Unocal and Haier’s bid to acquire Maytag in June 2005. However, both bids failed. The Unocal deal even led to political disputes with the United States. In future, it is expected that Chinese companies will acquire more and more companies abroad. The trend in the last few years confirms this expectation. A key industry for outbound deals is the energy sector, followed by the financial services sector. The largest cross-border deal in 2006 is China National Petroleum Corp’s (CNPC) acquisition of PetroKazakhstan. Other important Chinese outbound deals are listed in the following graphic:

[...]