M&A

in China
Webinar
June 25, 2009
10 am EDT
New Challenges and
Opportunities

Organized by Sponsored by

&
M&A
in China
Webinar
June 25, 2009
10 am EDT
New Challenges and
Opportunities

Godfrey Firth
Chief Representative, Shanghai Office
US-China Business Council

Barry J. Chen
Corporate Practice Director
InterChina Consulting
 The USCBC
The US-China Business Council is
the principal organization of US
companies engaged in trade and
investment in the People's Republic
of China. Founded in 1973, the
Council serves more than 250
corporate members through offices
in Washington, DC, Beijing and
Shanghai.
http://www.uschina.org
CONTACTING THE COUNCIL:
Washington, DC:
John Frisbie, President
T: (202) 429-0340
F: (202) 775-2476
Beijing:
Robert Poole, Vice President
T: (86-10) 6592-0727
F: (86-10) 6512-5854
Shanghai:
Godfrey Firth, Chief
Representative
T: (86-21) 6288-3840
F: (86-21) 6288-3841
 USCBC Services
• Government Advocacy
• Business Advisory Services (BAS)
• Publications
– China Business Review
– China Market Intelligence
• Programs
 Table of Contents

• The Appeal of China M & A

• The Post-Crisis Environment – Positives and

Negatives

• Legal and Tax Background

• The Merger Filing Process and MOFCOM’s Track

Record

• The Wild Card: Media and External Affairs

 USCBC 2008 China Operations Survey

China's Prominence in Overall

Company Strategy

Top priority 21%

Among top 5 priorities 67%

One of many non-key

priorities 10%

Not a priority 2%
 USCBC 2008 China Operations Survey

Company Resource Commitment

to China over Next 12 Months

Will accelerate compared to

last year 73% Will remain unchanged 26%

Will be curtailed 1%
 USCBC 2008 China Operations Survey

Company Objectives in China

26%

Access or serve Export platform Export platform Other

the China market to serve markets to serve US
In Asia market
 USCBC 2008 China Operations Survey

Impact of New M&A Legal Framework on

M&A Opportunities in China
Positive 2%

Negative 14%

Too early to tell 45%

No impact 39%
 Post-Crisis Environment – The Negative Side

• 1Q 2009 – Bloomberg reports 44% drop in deal activity

• “Digestion” issues for companies closing acquisitions in

2008

• Lack of financing options (although this may be easing)

• Slump in demand makes capacity expansion less urgent

• Larger target companies able to access significant

government support – bank loans, subsidies, etc.
 Post-Crisis Environment – The Positive Side

• Valuations becoming (somewhat) more reasonable

• Targets more willing to consider relinquishing control –

“going it alone” less appealing

• China emerging first – recovery appears to be on track

(although very sector-specific)

• Strong desire from local and provincial governments for

increased FDI

• Little practical assistance to Chinese SMEs from

government policies (stimulus, bank loans, etc.)
 Snapshot of Laws & Regulations Covering M&A
• Regulations on the Mergers & Acquisition of Domestic Enterprises by
Foreign Investors (MOFCOM, Sept. 2006)

• Filing Guidelines for Mergers with and Acquisitions of Domestic

Enterprises by Foreign Investors (MOFCOM, Mar. 2007)

• Draft Circular on Tax Treatment of Enterprise Restructuring &

Liquidation (SAT, June 2008)

• Antimonopoly Law (NPC, Aug. 2008)

• Regulation on the Notification Thresholds of Concentrations

(MOFCOM, Aug. 2008)

• Notice on Certain Questions Regarding the Enterprise Income Tax

Treatment of Enterprise Reorganizations (MOF and SAT, May 2009)
 New Tax Regulations and Enforcement
• Overseas acquirers need to consider “substance over form” and “main
purpose” tests, in accordance with the Enterprise Income Tax Law’s
general anti-avoidance provisions (GAAR)
• Two cases, one in Chongqing and one in Xinjiang, involved
challenges to the use of special purpose vehicles (SPVs)
• Local tax bureaus have significant latitude to investigate whether
capital gains are China-sourced and thus subject to withholding
tax, and then apply to national SAT

• New enterprise reorganization regulations provide criteria for

structuring transactions to meet the requirements for “special tax
treatment”
• Able to defer recognition of loss and gain
• Imposes a 12 month lock-up period on receiving entity and a
restriction on changing the “key business activities”

• Questions remain regarding interpretation and implementation

 Merger Control Filings: New versus Prior Thresholds

Antimonopoly Law (2008) M&A

New thresholds Regulations
(2006)
Old thresholds
Turnover Threshold #1 Combined worldwide At least two business
turnover of operators have China
>RMB10 billion turnover of
(US$1.4 billion) & >RMB400 million
(US$57 million)
One party’s
turnover in China
Threshold #2 Combined turnover At least two business >RMB 1.5 billion
in China of operators have China (US$214 million)
>RMB2 billion turnover of
(US$286 million) & >RMB400 million
(US$57 million)

Market nil ≥25%

share

©2008 Baker & McKenzie 13

 Schematic – Antitrust Filing Process

Determine No
whether any Discretionary
filing Yes
threshold met Suspensory
obligation
(Article 4 of Draft
(Article 3 of Draft Concentration
Concentration Regulations)
Regulations )

Yes

Submit Merger Waiting

merger control Clearance
Filing period /
control report review
receipt decision
(Article 23, AML/ Article 9 of (Article 27, AML) (Articles 25 and (Articles 25 and
Draft Concentration 26, AML) 28, AML)
Regulations)

©2008 Baker & McKenzie

 Useful Tips: Merger Filings

• Ensure that you budget sufficient time for merger filing and waiting
period

• Never too early to start preparing report

• Market information has to be collated from diverse sources
(marketing, finance departments, consulting firms, client/target)
• Difficulties of obtaining China data

• Very demanding in terms of amount of information/level of analysis

• Typical report ~ 100+ pages (including attachments)

• “Clock” (30-day waiting period) does not commence until MOFCOM

deems report complete
 Notable Transactions since the AML

Approved, with conditions (May

• InBev / Anheuser-Busch not raise stake in Tsingtao or
Zhujiang, or acquire stakes in
two other domestic breweries)

• Coca-Cola / Huiyuan Blocked

Approved, with conditions (divest

• Mitsubishi / Lucite significant China production
capacity )

No approval required (non-

• Yum! Brands / Little Sheep controlling stake)

• Pfizer / Wyeth Application not yet made

• Tengzhong / Hummer (GM) Application not yet made

 Lessons to Date

• Define the market at the national level, as “China”, but be prepared to

look at provincial market share and product-specific or granular
markets – e.g. “pure fruit juices,” not “beverages”

• Expect to be asked for detailed descriptions of distribution channels

and relationships, including contracts

• Be prepared to discuss potential remedies or changes to address

potential concerns (divestitures, etc.); do not expect an opportunity to
review and challenge the methodology used by MOFCOM

• Expect MOFCOM to be familiar with any previous US and EU cases in

the same industry and to cite or utilize those arguments

• Acquire strong local counsel – Foreign law firms are still not permitted
to directly represent clients before MOFCOM

• Prepare a rapid, effective, and strong media/external affairs strategy

 Yangcheng Evening News

XinhuaNet

West China City Daily Xin Kuai News


“Foreign investment threatens a
sound Chinese economy by
controlling market and nibbling native
brands.”
外资正在控制中国市场，外资正在蚕食中
国的民族品牌，外资恐怕已经严重威胁到
中国经 济的健康发展了
Xinhuanet, Sept. 5, 2008
“Those supporting the Coca-Cola/
Huiyuan deal are economic traitors.”
支持汇源收购的人都是经济汉奸
People’s Daily, Sept. 15, 2008
Evolution of the Debate
“The Coca-Cola acquisition of Huiyuan
faces three main difficulties; first,
excessive media speculation interferes
with MOCOM’s administration….”
林哲莹说，可口可乐收购汇源果汁面临三大困
难：第一个困难是媒体过度炒作对商务部行政
形成一定干扰
Lin Zheying, Deputy Director, Foreign
Investment Administration Dept., MOFCOM,
Securities Times, Feb. 10, 2009
“MOFCOM is reviewing the Coca-Cola/
Huiyuan acquisition case in accordance
with the Antimonopoly Law and will not be
influenced by any external factors.”
商务部正在根据反垄断法依法审核可口可乐收
购汇源案，不会受任何外部因素的影响
MOFCOM Minister Chen Deming, Xinhua,
March 20, 2009
 Conclusions

• M & A continues to increase and remains a viable strategy for

expansion or market entry – most companies stick to “tip-toe” M&A
consisting of small, targeted deals

• There are significant advantages to looking for deals in the current

post-crisis environment

• If necessary, plan well in advance for the merger filing and approval
process

• Carefully evaluate policy, media, and external environment before

getting too far along in a deal

• Get professional help

Strategic Growth Through M&A
Challenges and opportunities during a time of
uncertainty

Presented by: InterChina Consulting

Date: June 25, 2009

What’s Happened So Far?
Better than average

China GDP 2004-2008 (Current Dollars) Q1 2009 Quarterly GDP Growth Rates
1.6%
[USD trillion] $4.22
$3.25
U.S. Japan Germany France U.K.
$2.64
$2.27 China
$1.92
-1.2%
-1.6%
-1.9%

2004 2005 2006 2007 2008 -4.0% -3.8%

Source: World Bank, CIA Fact book, Economist Source: OECD Figures, China Daily

[USD billion] China FDI (1995-2008E) Corporate Profits Comparison

Weighted AVG EBIT

Median EBIT Margin
Margin
China U.S.A. China U.S.A.
Cons. Products 8.43% 3.16% 9.10% 7.18%
Energy 15.70% 5.35% 10.46% 10.59%
Financial Services 26.15% 14.14% 23.88% 6.76%
Healthcare 10.71% -16.53% 9.81% 8.25%
Industrials 8.99% 3.81% 6.52% 8.05%
IT 9.23% -3.77% 7.50% 9.19%
Materials 7.33% 3.81% 5.89% 4.28%

EBIT margin for 2008, listed companies by sector – InterChina Analysis

© InterChina Consulting 2
2009-2020: Where Is China heading?
There will be a significant change in China’s economic model

There will be a
dramatic change
over the next 10
years...

... from a an
investment and
export-driven
economy...

... to a consumption
based economy

.. Growth drivers:
continued
urbanization

© InterChina Consulting 3
2009 Economic Scenario: multiple aspects
…. Where corporate strategies vary greatly

Multiplicity of Faces in China

Stressed Areas Business as Usual Booming China

1. Coastal regions
and export-
focused areas
2. Chemicals, steel,
and textile-related
sectors
REACTION OF MNCS
• Shifting resources to
local market
• Waiting for better
times
1. Regions focused on 1. Western / Interior
production for domestic
regions
markets
2. Consumer goods, 2. Infrastructure, logistics,
services, and food & healthcare, and other
beverage sectors major focus sectors of
the stimulus package
REACTION OF MNCS REACTION OF MNCS
• Still view China as • Aggressive
strategically important investments
in medium/long term

© InterChina Consulting 4
Crisis has put pressure on growth in China
Pursuing acquisition for different reasons

Case 1 – Balanced Portfolio Case 2 - Catching Up Case 3 – Quick Entry

• A strong multinational company
entered the Chinese market a
few years ago but has failed to
generate significant revenues
• Chinese F&B Company – China • Accelerate the deal timeline –
Profits Growth establish a material presence in China
CAGR: 40% • WOFE will take 6-8 years to have a
material presence

• Acquisition will accomplish it in two

US$20 bil years

2005 2006 2007 2008

• Foreign F&B Company – China
Profits Growth

US$30 mil CAGR: 10%

Worldwide revenue
China revenue
1 2 3 4 5 6 7 8
Years in China

Organic growth
Acquisition
2005 2006 2007 2008 © InterChina Consulting 5
As a consequence, M&A remains active in China
Less deals, bigger size, slightly lower valuation multiples.

Average Deal Size / # of Deals Average Revenue Multiples /

Shanghai Composite
1188 1091 1199 (USD millions)
971

$76 $78 1.54x

$73 1.24x
$66 $65 1.01x 0.91x 1.04x

2005 2006 2007 2008 YTD 2009 2004 2005 2006 2007 2008
Average Transaction Size # of Transactions Revenue Multiple Shanghai Composite
Note: 2009 June 9 YTD # of deals: 289 Note: 2009 YTD rev. multiple: 1.26x

Average EBIT/EBITDA Multiples

• Average deal sizes are still increasing
19.30x (2009 YTD average deal size is $78 mil)
17.14x 16.80x
• Valuations have not continued downward
13.39x this year compared to 2008 (2009 YTD
12.06x
11.40x 11.03x 9.64x average EBIT multiple is 16.8x, and 2009
9.04x revenue multiples have not changed
8.05x
significantly)
2005 2006 2007 2008 YTD 2009
• Strong company price expectations still
EBITDA EBIT
remain high
Source: Thomson Financial
© InterChina Consulting 6
And there is a clear trend towards domestic consolidation
Driven both by government policy and aggressive domestic players

Deal Volume and Type by Sector, 2008

44 44 19 132 64
Ratio of Cross-border / Domestic Deals
21 8
25 42% 81 38
48%
57% 60% 59%

23 11
55% 19 58% 51 26
61% 52%
74% 69% 43% 40% 41%
87%
Food & Chemical Transportation & Consumer Healthcare
Beverage Infrastructure Products &
Services

39% 45%
26% 31% Deal Value and Type by Sector, 2008
13% US$ million 2,515
2,125
2004 2005 2006 2007 2008

Cross-border Domestic 1,472

1,202 1,105
Source: Thomson Financial

The ratio of domestic to cross-border

deals has steadily increased since 2005 Food & Chemical Transportation & Consumer Healthcare
Beverage Infrastructure Products &
Services

* Source: Thomson Cross-Border Domestic

Financial © InterChina Consulting 7
The M&A Environment is changing in 2009
…. As a whole, improving

Improved environment Challenges

• Availability of candidates (POE have • Facing stronger local competition)

reached certain scale)
• Chinese entrepreneurs are getting
• Appetite for sale is going up more confident

• Approval could be easier (for • Decreased competitive

smaller deals) differentiation for some foreign
companies
• Valuations are more practical in
some cases due to lack of IPO
market

© InterChina Consulting 8
Chinese sellers’ motivations are also changing
Understanding them will become critical for a deal success

Discourages M&A Motivates M&A

• Getting Stronger and

confidence of going • Succession issues
alone

• Competitive
• IPO dream
pressure

• Not accustomed to
foreign transaction • Liquidity
and decision process

• Prolonged transaction
process w/ foreign • Tie up with a
companies diminishes stronger player
confidence

© InterChina Consulting 9
Things which have not changed: valuations remain an issue
Variations industry by industry

Case: Automotive
Sector
Global Auto Parts Companies - Weighted
Average Trading Multiples • Peer multiple of home country vs. China

14.33 • China growth factor

9.56 China
1.24
• For stronger companies, valuation
0.39 expectations remain high
0.23 Germany
0.03
• Widespread belief that the downturn is
1.46 temporary
0.87 U.K.
0.09
• Controlling premiums remain high
2.75
1.49 USA • However, terms and price can be negotiated
0.1
(clear room for opportunity that did not exist
2.17 in 2008)
1.72 Japan
0.17

Revenue Multiple EBITDA Multiple EBIT Multiple

Source: Thompson Financial © InterChina Consulting 10

Transaction Length remains the key deal breakers
Average of 15 months (vs. 6 in the west). Why does the process take so long?

Process Issues/efficiency/time wasters

• Lack of commitment
Strategy
• Expectation does not fit reality

• The candidate pool is too thin

Target Search
• Unqualified candidates
• Not the right gauge of intention

• Managing the Chinese seller’s expectations

Valuation • Whether acquirer is willing to pay a “China
premium”
• Inexperience in managing the diligence process
Due Diligence
• Incorrect assessment of deal issues

• Irreconcilable issues / not willing to budge

Negotiations
• Mismatch of pace

© InterChina Consulting 11
Critical Success Factors
under time of uncertainty

• Keep M&A as a part of growth strategy

• Crisis, a window of opportunity
Strategy
• Broader range of strategic parameters
• Higher level of flexibility

• Align expectations
• Widen the pool of candidates
Speed /
• Judge deal feasibility early, and materiality of issues
Efficiency
• Understand seller’s expectations and secure commitment
• Sequence events in a non-linear way

• Do not expect bargains

Valuation
• “China premium” in a strategic context

© InterChina Consulting 12
© InterChina Consulting 13