2.1 Review of Trends
2.1.12 China
China's M&A activities involving both domestic and cross-border consolidations have tremendously increased over some decades now. Several reasons have been given to explain these substantial increases in M&A transactions.
One important reason is the steady and gradual development of the Chinese capital markets coupled with the impact of the global economic environment which has also contributed significantly. Specifically, firms in China have been able to consolidate and restructure their businesses through acquisition activities to protect themselves against the entry of robust competitors from abroad as a result of its agreement in 2001 to the World Trade Organisation (WTO). Second, due to high levels of profits Chinese firms generate, together with the country’s high growth rates, strategic M&As in the form of outward and inward investments have given firms from China the opportunities to seek other synergies or economies of scale to improve their competitive advantage. Third, because of the reduction in barriers and regular modifications to regulatory and taxation framework associated with M&As approval process, its execution has become easier for Chinese firms. Fourth, State-owned companies in China have been using M&As to restructure their assets. For example, important SOEs (state- owned enterprises) in particular sectors such as defense, aerospace, telecommunication, energy, utilities, basic material have been advised for conglomerates to compete globally.
Others have been asked to reduce their shareholdings to improve competition and enhance efficiency. As a result of this, other investors have obtained the opportunity to enter the M&A market (Devonshire-Ellis et al., 2011).
Since the early 2000s, the government of China has used various policy measures like low interest rates, subsidised insurance, favourable exchange rates, and reduction in taxes to encourage outward foreign direct investment (OFDIs) such as M&As. Evidently, several firms from China have taken advantage of these introduced incentives and invested outside of China (Khoury & Peng, 2011; Meyer et al., 2009).
Cross Border Mergers & Acquisitions (CBMA) has become an important vehicle for Chinese companies drive to seek different forms of assets globally (Boateng, Qian, & Tianle, 2008).
International merger deals for China are likely to rise in terms of volume and value in the future and the impact of it will be great on international political and economic affairs (Chen
& Tan, 2011). In 2012 for instance, China’s CBMA value was $ 37111 million compared to
$185 million in 1991 (Du & Boateng, 2015). Further, in 2015, China played a significant role
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in $5 trillion global increase in mergers and acquisitions. A considerable percentage of these transactions were driven by the emergence of Asia Pacific firms, of which the value of transaction by Chinese acquirers alone stood at $735 billion. Indeed, China’s acquisition activities over the years continue to rise as is clearly depicted in Figure 2.12.
Figure 2.12: Mergers and Acquisitions transactions in China from 1993-2018 Source: IMAA INSTITUTE, 2018.
Despite the over 30 years of privatisation, the Chinese economy has substantially been affected by the intervention of government, and a considerable portion of firms are controlled or owned by the state and its agencies. For instance, almost 80% of the listed firms in China in 2010 were owned by the state, and several domestic acquisition deals, particularly in the energy, industrial and natural resources sectors were also led by state-owned companies (Szamosszegi & Kyle, 2011). The government of China provides the required assistance such as financial support and tax incentives to its acquiring companies to pursue potential target firms under strict government control. For example, Zhou, Guo, Hua, and Doukas (2015) find that, public state-owned companies in China are in a better position than non- government- owned companies in acquiring private state-owned targets. Further, Sun et al.
(2012) also indicate that, the Chinese government offers numerous incentives in the form of preferential benefits to SOEs for them to easily access production inputs and bypass certain regulatory processes. If the state-owned companies can take advantage of the opportunities given to them by having quick access to funds, get reliable M&A counterparts, approve deals quickly, it will enable them to execute M&A deals at relatively reduced costs. This makes
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government acquirer firms experience considerable long-term improvement in their performances relative to their counterparts that are not government-owned.
These policies of discrimination in China’s market for M&As significantly have influence on the motivations and results of acquisition deals which usually put non-government-owned enterprises at disadvantaged positions compared to government-owned enterprises. For example, Shanxi Province in 2018 decided to reduce the number of coal mines by embarking on reconstruction of a coal mine scheme. Virtually all privately-owned coal mine firms were asked to accept merger bids of state-owned enterprises (SOEs), where deal valuations provided by the government were not based on negotiated or market prices (Zhou et al., 2011).
However, political security has arisen in China because of the massive decline in its foreign exchange reserve as a result of the increasing capital outflow. This has made Chinese authorities adopt measures to control outbound flows. Outbound M&A activity in China in 2015 and 2016 increased, reaching a total value of $59 billion and $208.6 respectively over these periods (Gao, 2010). Acquisitions are not the only mode of entry for Chinese multinational enterprises; exports are also used (Gao, 2010) even though the primary entry mode is that of acquisitions (Sun, Peng, Ren, & Yan, 2012).
China’s outbound M&A drive is attributable to several factors including the availability of capital, quest for growth from external sources to support its slowing economy and the desire to meet the growing demands for the many middle and affluent classes. As a result of this, acquisitions by China relating to consumption activities went up to almost $13 billion in 2013.
Companies from China focus on Europe and North America when deciding on acquisition transactions. This is due to the slowdown in growth domestically which has affected other Asian countries adversely as the economy of China reposition itself from an export-driven manufacturing economy to a technology driven one, because of the rise in consumption by the middle class (JPMorgan, 2016). The growth in China’s acquisition activities has been motivated by a host of factors.
First is China’s desire and quest for sustainable long-term growth. After 2010 when its GDP growth was 10.6%, the economy of China stagnated. Due to that, several Chinese firms since 2010 ventured into both foreign and domestic acquisition transactions in large numbers to improve on its internal growth.
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Second is the availability of funds together with the favourable regulatory frame work for firms in China. There has been an introduction of many monetary easing instruments by the People’s Bank of China (PBOC) to tackle the slowdown of China’s economy. From 2014 to the first quarter of 2016, the bank (PBOC) was able to reduce the benchmark interest rate from 6% to 4.35% (JPMorgan, 2016) as illustrated by Figure 2.13 below.
Figure 2.13: PBOC Benchmark Interest Rate Source: JPMorgan, 2016.
Many sources of finance are available to Chinese acquirers, including local commercial banks, foreign banks, domestic private equity co-investments, A-share placements and support from policy banks and regional governments. The China Bank Regulatory Commission in 2008, provided guidelines that requested commercial banks in China to offer financial support to local acquirers. Further in 2015, it made its guidelines less strict by increasing the tenure requirements and loan-to-value on such financing.
A third factor is China’s change in direction from export-oriented manufacturing economy to an economy tailored towards technology, consumption and industry. Firms from China focus on the acquisition of firms from North American and Europe in order to advance their technological capabilities to push the country’s industrial sector forward, to attract reputable and valuable brands to the growing consumer base in China. Firms from China have resolved to look beyond their local market to include the international market also, in their efforts to become global leaders.
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Fourth motivating factor is empire building and managerial hubris by managers of Chinese companies. In fact, the compensation of managers of several Chinese firms depends on the complexity and the size of the firm they manage. For instance, The Economist (2010) reports that, the Chief Executive Officer (CEO) of Industrial and Commerce Bank of China (ICBC), received just under $134,000 in 2009 compared to his counterparts in the Western world. It is prohibited to demand substantial pay raises within state-owned enterprises in China.
However, by expanding the size of the firm considerably and the company’s complexity through large-scale acquisitions, then a manager can make a strong case for pay increases.
This may be a key reason for ICBC’s 2007 acquisition of 20 per cent of standard bank of South Africa valued at $5.5 billion, which was the largest OFDI deal of China during that period (JPMorgan, 2016).
The fifth factor is the urgency for fast market entry by firms from China, particularly into natural resource endowed areas (Deng, 2009). Indeed, M&As in China has for a long time been focused on acquisition of natural resources. This has included mining investments in Canada and Australia as well as acquisitions of copper, iron ore and steel. The country’s acquisitions in the mining sector were valued at $ 30 billion in 2008 but decreased to $20 billion in 2009.
The sixth motivating factor is the scarcity of attractive domestic assets. A recent development in M&As by small and medium-sized firms from China has led to a reduction in the number of domestic target firms for Chinese acquirers. Privately-owned firms in China usually opt for public market transactions because of domestic valuation benchmarks. This kind of valuation difference motivates acquirers from China to pursue targets abroad.
The seventh factor relates to the large number of acquirers from China. The favourable funding climate for M&As together with the overall monetary easing and the strategic importance to undertake foreign M&A deals has increased the number of Chinese acquirers.
The country’s outward transactions have historically been dominated by government-owned companies who concentrate on resources and energy. The current acquisitions wave is characterised by a wider universe of acquirers, consisting of firms with a broader sectoral focus, A-share listed companies and domestic private equity firms.
The eighth factor relates to the politically supportive environment, which plays a major role as far as M&A activities in China are concerned. The Chinese government has introduced several policies and initiatives as incentives for certain local and foreign investments.
Examples of these initiatives include the Belt One Road project designed for improvement of trade between Asia and Europe by means of investments in ports, rail and road infrastructure.
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Another example is the Made in China 2025 initiative aim to push the country’s manufacturing sector forward, with emphasis on innovation and technology. This programme focuses on specific sectors like automation, information technology and the high-speed rail to provide support for this initiative.