China may be in for subdued pace of M&As amid trade row, capital curbs

Beijing, China. Photo: Raj Eiamworakul/ Unsplash

Beijing’s stringent capital controls and the trade frictions between China and the United States have significantly dampened mergers and acquisitions (M&A) activities in the mainland this year.

According to data compiled by global consultancy Duff & Phelps, overall M&A deal value in China declined by more than a third from the year before to $334 billion in 2019. Deal volume was down 29.1 per cent to 4,169 transactions this year.

Despite first-stage trade deal

China’s M&A activities slumped against the backdrop of a bitter, protracted trade spat with the US. New points of disagreement keep emerging despite a limited agreement sealed earlier this month in what is seen as the first-stage trade deal between the world’s two largest economies.

Although the US agreed to put the brakes on new tariffs scheduled to come into force on December 15, the atmosphere surrounding the trade talks soured after Trump approved legislation to back protestors in Hong Kong. In October 2019, the US also blacklisted 28 Chinese technology companies from purchasing products from U.S. companies, citing human rights violations of Muslim minority groups in northwestern China’s Xinjiang province.

Outbound M&A activities between China and the US tumbled this year, with the M&A deal value between the two countries dropping almost one third to $11 billion across 183 transactions, from $16 billion across 279 transactions in 2018, according to Duff & Phelps.

“From a mid-and-long term perspective, the first-stage trade deal reached between the two countries can hardly shore up confidence among Chinese investors and boost M&A transactions into America,” said Sun Qiang, managing director and head of M&A at China Renaissance.

China Renaissance, established in 2005 by former Morgan Stanley and Credit Suisse banker Bao Fan, has invested in and advised on a number of high-profile mergers and acquisitions by Chinese technology start-ups, including those between Meituan and Dazhong Dianping, Didi and Kuaidi, as well as the acquisition of Mobike by Meituan.

“Outbound M&A activities between China and the U.S. have almost come to a standstill in 2019 due to [increased foreign investment reviews made by] CFIUS,” said Sun. CFIUS, fully known as the Committee on Foreign Investment in the United States, is an authority that reviews the national security implications of foreign investments in U.S. companies or operations.

Regulatory uncertainties

China’s overall outbound mergers and acquisitions also fell more than one fifth, from 998 deals in 2018 to 732 deals in 2019. The aggregate deal value decreased by about 26.1 per cent to $68 billion during the year. This, says Duff & Phelps, is attributable to “capital control measures by China to curb large outbound deals, in addition to other political or regulatory uncertainties.”

“The main challenge that Chinese firms are already facing – regarding high-tech acquisitions – are formal and informal restrictions by host country governments, and that will certainly increase,” Steven White, associate professor at School of Economics and Management, Tsinghua University, wrote in an email reply to DealStreetAsia.

Besides restraints imposed by foreign authorities, the State Administration of Foreign Exchanges (SAFE), the foreign exchange regulator in China, has introduced stringent capital controls in recent years to stem capital flight and prevent a sharp depreciation of yuan. To discourage companies and individuals’ attempts to hedge against a gloomy domestic economy, each Chinese citizen is only allowed to buy up to $50,000 worth of foreign currency per year.

China registered $3.096 trillion in foreign exchange reserves in November 2019, down from $3.105 trillion one month earlier, according to official statistics on the SAFE website. The regulator has maintained that cross-border capital flows were stable between January and September.

Regulatory uncertainties from Beijing on outbound mergers and acquisitions “remain high” in the following year, said Sun, although he observed that China is slightly relaxing control over the country’s outbound direct investment (ODI).

Beijing’s capital curbs, the country’s intense relations with the U.S., as well as other geopolitical uncertainties including Britain’s plan to leave the European Union, contributed to a much less vibrant global M&A market in 2019. Global M&A deal value stood at $3 trillion with over 39,000 transactions in 2019, compared to $3.7 trillion across more than 46,000 deals in 2018, as per statistics from Bloomberg.

Avert poor investment decisions

“Rather than amount, I think it’s much more interesting and informative to look at the composition and changes [of China’s M&A activities] over time,” White wrote. “The Chinese government is clearly encouraging some types of M&A (technology, internet/services/e-commerce, scarce resources) and discouraging others (leisure, trophy properties, etc.).”

“That actually makes sense from a national development and finance point of view,” White explained, “They [the government] should keep some controls as many of the companies would otherwise make poor investment decisions – defined as for prestige or to shift assets to foreign currencies, in effect, rather than to create new value and capture profitable investments.”

Overall speaking, the industrial sector led the Chinese M&A market in 2019 in terms of the deal volume, with a percentage of 20.6 per cent. However, the financial sector was the dominant industry and captured the largest share of overall deal value at 23.8 per cent. Mergers and acquisitions in the technology field accounted for 11.6 per cent of the total deal volume and 8.8 per cent of the total deal value in 2019.

White pointed out that Chinese ODI into the United States in 2018 was majority health/biotech-related, which was more than real estate, transportation and infrastructure – the largest proportion in the few years before that.

Regardless, several notable deals took place in 2019. The largest investment was made by state-owned China Huaneng Group, the nation’s largest power producer. The company announced in early September to pay over $8.85 billion for all shares in its wind power unit Huaneng Renewables and delist the affiliate from the Hong Kong stock exchange.

In another transaction of equivalent significance, Alibaba-backed home improvement chain Easyhome agreed to sell 100 per cent shares in its new retail unit to Chinese state-backed listed retail conglomerate Wuhan Zhongshang Commercial Group. The deal, which is worth up to $5.65 billion, would result in a so-called backdoor listing of Easyhome New Retail on the Shenzhen bourse.

Third, state-owned China Telecom teamed up with a consortium consisting of Dennis Uy’s Udenna Corporation, and Philippine passenger and cargo shipper Chelsea Logistics to ink a $5.4-billion investment deal to finance Mindanao Islamic Telephone Company, the third major telecom provider in the Philippines.

China Renaissance’s 2020 M&A outlook:

There are both challenges and opportunities faced by investors looking at M&A opportunities in mainland China-listed companies.

The China Securities Regulatory Commission (CSRC), the country’s securities regulator, issued a series of policies to “warm” M&A deal activities for companies listed on domestic bourses, creating “a relatively ideal policy environment” to activate the market.

However, quality assets will become more inclined to go public independently – which will lead to the scarcity of investment targets – as China’s STAR market fast tracks listings of companies and Shenzhen’s Nasdaq-like ChiNext submarket steps up reforms to pilot the registration-based initial public offering (IPO) system.

Top-level assets and investors to become more dominant in the market

Top-level assets and investors will become more dominant in the market. In comparison, assets that are less superior yet still exceptional might not be able to attract buyers, and investors who do not have an ample capital pool and large enough cheques might also become increasingly passive.

At the same time, the frequency of M&As among companies in the same sector will decrease since oligopolies have very much formed in most industry segments.

Cross-border M&As to continue to be affected by geopolitical uncertainties

From a mid-and-long term perspective, the first-stage trade deal reached between the two countries can hardly shore up confidence among Chinese investors and boost M&A transactions into the US.  Meanwhile, regulatory uncertainties remain high although Beijing is slightly relaxing control over the country’s ODI.

Buyout deals led by PE funds and specialized M&A funds to become the new normal 

Undoubtedly, future M&A deals will not be confined to the new economy space. But businesses that integrate online and offline services will still remain as the mainstream of M&A deals amid consumption upgrade and rising consumption ability in China’s lower-tier cities.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.