Deal-Hungry Chinese Buyers Hit a Wall After Record M&A Spree

Industry:    July, 2016

Chinese companies have gone big game hunting this year. Yet that record run is threatened by a rising set of challenges — not to mention the Brexit shock.

It took less than six months for the volume of announced Chinese outbound deals to surpass last year’s total of $120 billion — itself a milestone. But now, Chinese buyers are facing tougher regulatory opposition abroad, while at home they must grapple with a government keen to stabilize a yuan pressured by outflows from $148 billion of overseas deals this year.

“Chinese outbound M&A is likely to slow down in the second half of the year,” said Zilong Wang, head of mergers and acquisitions at China International Capital Corp., which is advising China National Chemical Corp. on its proposed purchase of Syngenta AG. “Mainland companies may face greater scrutiny in transferring funds offshore for acquisitions.”

Would-be Chinese acquirers are being hindered by government opposition in Europe, which until now had remained friendlier territory than the U.S. On top of that, there are skeptical target boards and difficulties getting funds offshore. For bankers and lawyers, the plateauing in China deals threatens one of the few bright spots in global dealmaking, which is down 13 percent from this time last year and reeling from a number of high-profile blowups.

The trend illustrates the bind facing President Xi Jinping’s government, which continues to encourage Chinese companies to use acquisitions to gain know-how while seeking to limit the currency moves that could accompany a string of big-ticket purchases.

For a quick guide on China’s outbound deal spree, click here.

Domestic Scrutiny

China’s dealmaking ambitions face increased scrutiny at home. The commerce ministry, one of the several regulators with a say in acquisitions, last month publicly warned of the pressure of outbound investment on the country’s foreign exchange reserves. The currency supervisor, no longer the rubber stamp it once was, has also held up some landmark transactions including the $9.3 billion buyouts of Qihoo 360 Technology Co.

A key concern for Chinese authorities is the stability of the yuan, which is on track for a third annual loss versus the dollar, even after central bank support that’s led to an $800 billion decline in the nation’s foreign-exchange reserves over the past two years. China’s currency has depreciated 1.6 percent over the past two weeks to the lowest level since 2010. China’s State Administration of Foreign Exchange is scrutinizing deals to ensure they fit into a strategic priority for the country, according to Chen Lin, a finance professor at the University of Hong Kong.

The Qihoo buyout consortium, leading the largest ever take-private of a U.S.-listed Chinese firm, is among investors bearing the brunt of the supervisor’s scrutiny. The group eventually agreed to the Chinese regulator’s request to transfer the buyout funds offshore in several batches, after trying unsuccessfully for approval to send the money overseas in a single go, people with knowledge of the matter said earlier. That further delayed a deal that’s still pending more than a year after an initial announcement.

Coming Home

Another source of Chinese deals is set to dry up as the nearly $50 billion wave of attempted privatizations runs into trouble. Online-chat platform YY Inc. said in June that a group of executives pulled a $2.5 billion takeover proposal. 21Vianet Group Inc., a Beijing-based data center operator, announced the same month that a potential bid for the company valued at $1.7 billion wouldn’t proceed.

Chinese investors planning to acquire overseas firms and then relist them on the Shanghai or Shenzhen exchanges have been given pause following moves by the securities regulator to restrict their route back to the domestic market. The government is planning new curbs on backdoor listings as it seeks to discourage more buyouts, people familiar with the matter said in May.

And that’s just at home. Chinese acquisitions this year have become increasingly high-profile, drawing the attention of officials in the U.S. and Europe too. ChemChina has resubmitted its $43 billion Syngenta purchase to the Committee on Foreign Investment in the U.S., which can recommend transactions be blocked if they pose a risk to national security, people familiar with the matter said last month. At least two other recent China deals have unraveled amid CFIUS reviews.

“We could be close to the peak in outbound Chinese deals,” said Severin Brizay, head of European M&A at UBS Group AG. “But I expect activity will continue until a major deal gets blocked.”

Government Attention

Such stumbles threaten the bonanza for investment banks, which earned a record $230 million in fees from Chinese buyers of overseas assets in the first half of the year, according to New York-based consultancy Freeman & Co. Goldman Sachs Group Inc. was the No. 1 adviser on China outbound deals with a 49 percent market share, followed by Beijing-based CICC and Credit Suisse Group AG, data compiled by Bloomberg show.

Even China’s foray into Europe has faced opposition, with an offer by the nation’s biggest appliance manufacturer for a stake in German industrial robot maker Kuka AG drawing criticism. The deal by Midea Group Co., with funding from Industrial & Commercial Bank of China Ltd., has triggered concerns from the German government about the longer-term intentions of state-backed Chinese investors.

“No matter if it’s a U.S. or European regulator, it’s become more and more likely that they will challenge these deals,” said the University of Hong Kong’s Lin. Chinese companies “are going for technologies. And that means they’re on their way to becoming direct competitors with European and U.S. firms.”

Sudden Collapse

Companies must also contend with wariness from boards that have seen a number of large Chinese acquisitions collapse — sometimes with a scant warning. Beijing-based Anbang Insurance Group Co. had topped a rival bidder, Marriott International Inc., for the owner of the Sheraton and Westin hotel brands before it abandoned its offer with little explanation. At least $21 billion of announced deals from Chinese buyers this year have been terminated, the most since the first half of 2009, according to Bloomberg-compiled data.

Some Chinese firms saw deals fail when they stumbled near the finish line. Health-care investor Luye Group Ltd. lost the bidding for French drugmaker Ethypharm despite offering a higher price than the eventual winner, people with knowledge of the matter said. Luye left out a crucial clause in its financing documentation that would have offered stronger payment security, according to one of the people, who asked not to be identified as the information is private.

China’s KingClean faltered in its bid for German coffee machine maker WMF when it couldn’t transfer enough funds offshore by a deal deadline, according to people with knowledge of the matter. Though KingClean was one of the final two bidders, KKR & Co. decided to sell the business to France’s SEB SA in a deal valued at about 1.6 billion euros ($1.8 billion) because it wanted the greater certainty of closing the sale, one of the people said.

Representatives for Astorg Partners, the private equity firm that was selling Ethypharm, and KKR declined to comment. A spokeswoman for Luye Group said she doesn’t have any relevant information on the matter. A representative for KingClean’s Shanghai-listed arm, KingClean Electric Co., said the bid was pursued by the chairman’s private company and declined to pass on a request for comment.

Greater Challenge

Brexit will also bring pause to Chinese acquirers. Buyers that took for granted the role of the U.K. as a platform for expanding into Europe will have to carefully assess the implications of the British vote to leave the European Union, said Christopher Chua, the head of China M&A at Credit Suisse.

To be sure, Chinese companies are still seeking to gain technology and will pursue acquisitions in the healthcare, automotive and financial services industries, according to Bill Curtin, a partner and global head of the M&A practice at Hogan Lovells.

“The momentum continues to be strong, but I would say that there are only so many low-hanging fruits,” Credit Suisse’s Chua said. “The easy deals get done, and the harder deals become more of a challenge.”