By Frank Sun
Chinese acquirers are playing an increasingly important role as buyers of private equity sponsored companies — nearly 200 portfolio companies were sold to Chinese entities in 2016. However, in our view, measures taken by the Chinese government to scrutinise transaction fundamentals more closely and slow capital outflows have impacted deals. The number of deals completed so far in 2017 has fallen to 63, compared to 109 at the same point last year. With Chinese deals now facing higher abort risks, we consider what buyout firms must know and do in order to achieve a successful exit.
Why Do the Deal?
Chinese regulators are focusing on the authenticity and commercial purpose of deals by Chinese companies. Acquisitions with a solid rationale that benefit the Chinese economy are unlikely to be rejected outright. So-called “irrational” deals (outside of a Chinese buyer’s core sector, particularly in the real estate, media, sports or hospitality sectors) will face greater regulatory hurdles. Private equity firms and their advisers need to factor this into any approach from a Chinese buyer.
Who Is the Buyer?
Deal teams need to understand whether they are dealing with a private company, a publicly listed company or a state owned enterprise (SOE). Acquisitions by SOEs, with links to government departments, are less likely to be hindered by the rule-tightening. Deals worth less than US$300 million should also be safe, as smaller deals have a streamlined approval process. Overseas subsidiaries of Chinese parents with sufficient assets and financing capacities, offshore Chinese heritage companies and US$ funds managed by PRC based firms will generally not be affected.
Where Is the Money Coming From?
Chinese investors typically raise all or a portion of the purchase price within China, whether on balance sheet, via an existing or new bank facility, through a private placement of equity and/or from co-investors. The People’s Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) have directed Chinese banks to more closely monitor any remittance of funds, and banks have slowed FX remittance out of China. Banks are also under pressure to scale back their provision of cross-border security and onshore deposit-backed offshore lending.
Deal teams should seek, at an early stage, to ascertain the sources of funds. Buyout firms may prefer to deal with an offshore entity affiliated with a Chinese buyer, which holds cash overseas (either in escrow or with a supporting standby letter of credit for the purchase and break fee costs) and is able to sidestep FX difficulties.
How Long Will the Deal Take?
Deal teams and Chinese buyers should engage early in deal timetable planning as Chinese buyers must file a significant amount of information, which will take time to prepare. Work on obtaining state approvals should begin as quickly as possible, even if on a no-names basis.
What has Changed?
- Certain transactions will not benefit from streamlined filing processes, including:
- Transactions of ≥ US$10 billion
- Transactions of ≥ US$1 billion involving overseas targets
- unrelated to the Chinese buyer’s core business
- Outbound minority investments in overseas listed companies
- Chinese buyers now need to:
- Provide more information to the National Development and Reform Commission (e.g., financial statements, sources of funding and target due diligence reports)
- Conduct supervisory interviews with the PBOC or SAFE. Before a Chinese bank can process the transaction, SAFE must review the authenticity and compliance of transactions involving the purchase of foreign currency, payment of foreign exchange or outward remittance of funds over US$5 million