PJ SOLOMON's Head of M&A Execution and Cross-Border, Jeff Jacobs, speaks with Peter Adams of Vermilion Partners, the Chinese affiliate firm in the Natixis M&A network. They discuss the outlook for US-China cross-border M&A.
PJ SOLOMON's Head of M&A Execution and Cross-Border, Jeff Jacobs, speaks with Peter Adams of Vermilion Partners, the Chinese affiliate firm in the Natixis M&A network. They discuss the outlook for US-China cross-border M&A.
Assuming the logistics of doing M&A deals between these two countries resumes in relatively short, or at least medium term order, we expect continued M&A deal flows and trade flows, both from China into the US and from the US into China.Jeff Jacobs:
I'm Jeff Jacobs , Head of M&A Execution and Cross-Border at PJ SOLOMON. Thank you for listening to our podcast, PJ SOLOMON Presents. I'm joined by Peter Adams, a partner in the Beijing office at Vermilion Partners, part of our Natixis M&A network. Vermilion offers a range of cross border and domestic investment banking services into and out of China with a keen understanding of policies and government in China, enabling it to advise on transactions in highly regulated sectors. Before we begin, I want to give a bit of background. The last 10 years have been interesting as an evolution for cross-border M&A from China. In 2016, the US government strengthened oversight of inbound Chinese M&A through CFIUS, the Committee on Foreign Investment into the US. Despite the increased political scrutiny, China appears to continue to have strong ambitions to pursue external growth through acquisitions, a topic we wrote about in PJ SOLOMON's fourth volume of our Cross-Border Bulletin published last year. Today, the geopolitical issues are complicated by the damage brought on by the recent coronavirus, impacting the world's supply chains, hindering Chinese cross border M&A. Recently, it seems that US-China cross border M&A may be in the early stages of recovery. We saw Popeye's opened its first location and expects to open up to 1500 more. Costco opened its first store in Shanghai and is preparing to open more. Tesla built a factory in Shanghai and got a loan from the state-run Industrial and Commercial Bank of China to fund further expansion. Exxon is in talks to build a chemical plant in China. And, Universal has been in talks to open a theme park in Beijing. Fundamentally, we're seeing US corporations continue to bet that China's long term growth potential outweighs the challenges stemming from recent geopolitical and health risks. So, Peter, first off, thank you very much for joining us. To start, tell us about the current state of M&A in China. Have you seen your clients start to explore acquisitions post-COVID as recovery takes place?Peter Adams:
Jeff, thanks for having me on. And, as usual, you sound as knowledgeable as any full time practitioner of cross border M&A in China. It has been a bit of a slow period, as you can imagine. Just in terms of travel logistics, it's basically impossible at the moment to have principal-to-principal meetings. On the other hand, China is, I think, fairly far ahead of the rest of the world in terms of coming out of the virus and is, from our perspective, fully back to work with the exception of the fact that the borders effectively remain closed. So, we have seen some big Chinese SOEs participating by remote in auctions of, for example, European assets. That's number one. And number two, we've also seen on the part of some of our foreign clients coming into China that they've relinquished operational control of their execution teams, or handed that over to their teams here in China. So anecdotally, we have deals that really haven't missed a beat, both inbound and outbound, and we're fairly encouraged to see that activity is still going on at the moment.Jeff Jacobs:
Yeah, I think likewise, we've seen - in step with the rest of the world - people trying to execute deals remotely , and having more success than I think people would have anticipated otherwise, given the lack of in-person meetings. So that seems to be fairly standard course these days. What sectors are attracting investment in China today, specifically for key sectors China may be focused on into the US?Peter Adams:
So I guess there's two ways to answer this question. Number one, the sectors in which China has interest, not just in the US by the way, but globally, are primarily technology, which is very sensitive around the world now, but also obviously in the US with CFIUS. And secondarily, healthcare. So these have been prioritized by the state and any Chinese, particularly state owned companies, but even private companies that w ant to do outbound acquisitions, these sectors will likely get state support, not just in t he form of Chinese regulatory approvals, but sometimes also in t he form of financing. And sometimes actually be given a nudge to, y ou k now, act proactively to look for acquisitions in these sectors. Given the fact that technology i n t he US - deals i n t he technology companies in the US typically come under the scrutiny of CFIUS as you mentioned earlier. You know, Chinese companies have now figured out that they need to pursue deals in the US that are not going to typically raise questions from US regulators. If you looked back a couple of years, you saw some really big deals being done out of China into the US i n sectors that were much less sensitive, including, for example, for Smithfield, the pork producer, which was bought by a Chinese company. The GE appliance division was bought in about 2016 by the Chinese company Haier. So the big deals I think in the past and in the future from China into the US w ill be in sectors that are not necessarily those of primary interest to China.Jeff Jacobs:
That's interesting; it does make sense. It is challenging, I think that the sectors that are of the highest interest are also the ones that are most difficult to get transactions completed these days because of the government regulatory issues and constraints. When you think about multinational corporations, how do you think that they are looking at global supply chains after the recent COVID crisis? In 2019, we saw US tariffs increase the cost for many companies that manufacture in China. I know several of our clients began evaluating new manufacturing facilities in other parts of APAC or exploring the potential to bring manufacturing back to the US, and then at the start of the virus, restrictions on international travel, limitations on shipping, even further reinforced the benefits of having a domestic supply chain. But on other hand , a diversified supply chain, especially outside the US, has been a benefit for companies during coronavirus as other less affected n ations have been e arlier to recover. Peter, what's your view on the impact to global supply chains today?Peter Adams:
Yeah, it's a really good question and something that, you know, you hear everybody talking about. So completely agree, diversification is sort of the first word that comes to mind in the minds of a lot of these multinational companies that have supply chains here in China on the one hand. On the other hand, you know, you hear some people say that in some cases, supply chains, if you were really to want to move them entirely out of China, and depending on the industry it would take 25 years. So for those in industries or at companies where somehow it's easy to move supply chains in short order, you're right, you are seeing investment. For example, in Southeast Asia, Vietnam specifically will be a big beneficiary, I think in the end of this, you actually see amongst some of our clients, and some of what's keeping us busy at the moment, is some divestitures of multinational-owned assets in China, as they do aim for diversification. But I think we're just at the start here. We haven't yet anyway seen the deluge that some people are predicting. You know, let's see how things play out, but I think this could be a very long term trend. In the short term, things will probably remain somewhat similar to the way they are I think in most industries.Jeff Jacobs:
I take your point. I know we've had conversations with clients and frankly, it's an education. I think folks anticipate that moving supply chains is faster than it otherwise is, but 25 years is not an unrealistic timeline. And , for many industries, the complexity around the supply chains and manufacturing process really does take a long time if you want it to move or pivot to another geography, they're fairly entrenched where they are. In our first ever edition of the Cross-Border Bulletin back in 2018, we wrote about China's Belt and Road Initiative, which at the time was driving outbound investment. There are economic investments in developing nations; they were used to build infrastructure and help garner influence in other regions. In an effort to increase its global ambitions, the Chinese government frequently offered favorable sovereign loan packages to emerging markets, which often I think after the global recession caused by the coronavirus pandemic could potentially trigger a series of defaults. Peter, as the Chinese government works through these loans, what do you think will happen to the program going forward and do expect the Chinese government to make a push into these key emerging markets on a continued basis?Peter Adams:
Yeah, another great question. Yeah, I do. Belt and Road, although it's not mentioned so much by name anymore, is a signature policy of the Chinese government. And really, as you sort of mentioned in your question, it was originally meant to address Chinese surplus capacity and some of its own infrastructure industries. So they were looking essentially for work overseas, which is sort of how the name came to be and the policy started. But it's since been made flexible so that it can be adapted to sort of almost any policy or geography. And it really, you know, in the end, at this point, refers probably just to Chinese outbound M&A, in general into really some fairly developed countries, including just to give you an example, even, even Poland is considered a Belt and Road geography in China's view of the world. So, you know, despite the fact that you now see stories about China potentially having overextended itself in some specific cases, which I think is what you're talking about when you're talking about default on loans, we don't see in the near term that this policy is going away. We think it will continue.Jeff Jacobs:
That's interesting. Yeah. We have seen quite large numbers estimated about the amount of lending that's gone into other regions over the last several years, but I think it's an initiative, I would agree with you, that it's here to stay.Peter Adams:
Maybe it makes sense to actually look back, not just in terms of Belt and Road, but in terms of the Chinese outbound acquisition history. Chinese outbound acquisitions didn't really become sort of a formidable thing if you will, until only five or six years ago. This didn't necessarily have, at the time, to do with the Belt and Road Initiative exclusively. What happened, it was sort of an incredible confluence of events where number one, the Chinese state, whether it was through Belt and Road, or just general policy, wanted to see its companies going out into the rest of the world and buying foreign companies. The Chinese foreign investment stock as a percentage of Chinese GDP is extremely low compared to more developed countries. So China number one had a lot of catching up to do. And number two, had some interests in specific sectors. But what you saw was sort of cheap financing for everybody, and you saw deals really in any sector, including some that were not priority for the state - airline companies doing deals for technology companies; you saw investments into sports clubs, for example, one of which we did - West Bromwich Albion, which was the first ever takeover by a Chinese company of an English Premier League football, as they call it in that country, team. But, that was sort of right around the time that Belt and Road was becoming a stated policy. What has happened since then is number one, the Chinese regulators were concerned by the end of 2016 already at the rate of capital outflow and they moved very quickly to establish what's now referred to as currency controls, whereby if you are now a Chinese acquirer who wants to go out, you have to make sure you get Chinese regulatory approval to do it, which is not nearly as easy to come by as it used to be. And that's not to say that there won't be any activity, it's simply that the state wants to make sure that the activity that there is, is in the sectors of the high priority, whether it's , for example , it's technology or healthcare , as we just talked about. So Belt and Road is part of that. Belt and Road, as you know, originally as we, as we talked about, is geography driven, but again, deals for Belt and Road in the Belt and Road geographies, particularly in infrastructure were supported back then and continue to be supported now by the state.Jeff Jacobs:
What's interesting is we've also seen Chinese investment be a big driver of US venture capital flow . You know, there was a number of record years. It seemed that VC investments into the US from China finally slowed, you know , in part due to coronavirus, but the activity has been increasing as recently as in March. Chinese firms, I think inked nearly 70 VC deals, the highest since mid-December. What are you seeing in terms of activity in the region related to some of these early stage investments?Peter Adams:
I can tell you anecdotally, that we know business people in China who can very easily raise venture capital money because they have very good VC track records, including in the West. And that some of those people who were originally raising funds for investment in the US have now turned to raising funds for investment in China, because a lot of these funds obviously focused on technology and those deals have become much harder to do in the US. I'm encouraged to hear from you that there is still a good flow into the US. I can only imagine that it's into, again, less sensitive sectors and let's see how it plays out.Jeff Jacobs:
So the US recently claimed that Hong Kong is no longer autonomous from China - this in response to Beijing's plan to impose a national security law on the territory. So let's talk about the practical implications for business and finance. For the US and the rest of the world, Hong Kong has always been a conduit for US investment in China. In fact, Hong Kong channels about sixty percent of foreign direct investment and half the capital flow raised through Chinese IPOs into China. Furthermore, just under ten percent of China's exports came to the US through Hong Kong. And the currency is obviously pegged to the dollar acting as a bridge between China and the global capital markets. But that said, you know, lately Chinese leaders have reacted negatively to what is perceived as the US crossing a red line and interfering in matters related to national security laws in Hong Kong. Do you expect the increased political tension could negatively impact either cross border trade, or more relevant to our conversation, M&A going forward?Peter Adams:
Probably not in the short term is our view. So finance in Hong Kong rests on the rule of law and the freedom of capital exchange and those fundamentals have not yet been affected, politics aside. So in our view, it will still remain a major offshore financial center. To answer your question about how it might affect M&A to or from Hong Kong, I was on a call recently where somebody asked whether CFIUS is now going to take a closer look at deals from Hong Kong into the US and the answer from the lawyers on the call was the fact is that CFIUS has always taken a very close look at deals from Hong Kong simply because it's really part of China. So politics and emotions aside, our sense is that in the short term, there's not likely to be a huge effect on cross border business.Jeff Jacobs:
Last year, Beijing erased ownership restrictions on foreign groups' investment in China, some of the ownership restrictions. Have you seen US companies consolidating JVs in China as a result? For example, we saw Exxon Mobil and Tesla and others build wholly -owned plants. Which industries do you think are poised for consolidation today?Peter Adams:
This is a very timely question. One of the real positives we think in the US-China relationship is the fact that China, a few years ago, committed to erasing, as you say, or releasing some of the restrictions on foreign ownership in specific sectors in China; the financial sector and the automotive sector. So in the financial sector, depending on whether you were, for example, a securities company like Goldman Sachs or Morgan Stanley, who wanted to have an operation here in China, where the limitation was, was effectively very low on the order of probably a third of your JV could be owned by you, the foreign company, and the other two thirds needed to be owned by your Chinese partner. And secondly, in automotive, which famously has been limited to fifty percent foreign ownership for a very long time. So the answer is, you know, given that these restrictions have now just this year come off, particularly on financial services and in the automotive industry, yes, you are seeing - I think you were talking just now about wholly owned entities being established, and I think that will be a trend. But we're also seeing some of the existing joint ventures, whether it's in securities or asset management, for example, we're seeing deals generated by originally the minority foreign JV partners - Goldman, and I think Morgan Stanley have recently taken majority stakes i n their securities JVs. I think JP Morgan h as set up a hundred percent owned futures company. I think JP Morgan Asset Management has now acquired a majority stake in its asset management company in China. Previously, the cap on that was forty-nine percent. I think that's g one up to fifty-one percent this year. In short order will be completely released where you will see foreign companies able to own a hundred percent of their asset management companies in China. In the automotive sector, BMW went from fifty percent to seventy-five percent in its JV w ith Brilliance Automotive in 2018. By the way, Brilliance was one of the very first Chinese - speaking o f US capital markets - was one of the very first Chinese companies ever to list in the US back in the mid-nineties. So here we are full circle with BMW now raising it s s take in its JV here with Brilliance. And I think that's going to be, yo u k n ow, a trend in automotive. Tesla, as you know, es tablished a hundred percent Tesla-owned factory in China. That, by the way, was a little bit of a special circumstance because there was a separate set of rules th at c o vered e lectric vehicles that didn't apply to traditional automotive. But yeah, those are the two sectors where we see ac tivity a s a result of easing Chinese restrictions on foreign investment.Jeff Jacobs:
I think that's an incredibly interesting development and certainly eliminating some of those restrictions alleviates some of the forced technology transfer concerns for some of these companies. Let's talk about access to capital for Chinese corporations and how your clients are thinking about access to US capital markets. We know, in May 2020, the US Senate passed legislation known as the Holding Foreign Companies Accountable Act and it required US-listed companies to comply with US information sharing, regulatory and audit standards. Interestingly, some of these standards may be in fact, in breach of Chinese law, but failure to comply would lead to Chinese companies being delisted in the US. Do you see the new legislation impacting your clients or their access to capital and do you anticipate that selected Chinese companies may start to seek alternative country listings, either in Europe or even potentially domestically in China?Peter Adams:
Another very good and timely question. So, you know, our sense is that for the most part, Chinese companies have stopped thinking about access to, for example, US capital markets. China itself is not short of capital and many companies get much better valuations domestically and, for example, in Hong Kong, if they're able to list there. The one sector again which still has interest in listing in the US is the technology sector and that's a function of the fact that to get listed domestically in Shanghai or Shenzhen or in Hong Kong, you need to have a track record of profitability, which some technology companies don't have, which is what's driven them in the past to NASDAQ. What the trend there is going to be is there will be sort of a relaxation of at least some of the profitability standards in favor of, for example, revenue standards on these exchanges that will allow these Chinese companies to list closer to home.Jeff Jacobs:
Lastly , let's talk about technology. Technology has been a critical industry for both the US and China, we've hit on some of the points already. Not all investments have gone without scrutiny, but, what's your view globally on if there will continue to be technology cross border M&A going forward? And I know you suggested that there are certain pockets that may be more likely to experience volume or flow of deals versus others, but are there any ones that we think could be areas to focus on or areas to watch in the near future?Peter Adams:
You know, you have the world's two largest economies in the US and China and technology investment is not going to be stymied entirely. Yes, there will be continued technology M&A, and whether that happens earlier stage at the VC level, like we were talking about just a minute ago, or sort of around the fringes of more critical technology , such that it's not subject to the kind of scrutiny that more critical technology deals have been more recently. That's perhaps the trend there.Jeff Jacobs:
And certainly we've seen an appetite and eagerness to expand and invest in technology globally; I mean, not just within China specifically, but we saw Facebook invest in Jio in India, we see the race to 5G and everyone across the world focused on that, so I think there is a continued interest and eagerness from companies to expand, and I expect we'll see it between the US and China, as well. Thank you again to Peter Adams from Vermilion Partners for joining us on this podcast. I'm Jeff Jacobs from PJ SOLOMON. Thank you for listening to PJ SOLOMON Presents. We hope you found this helpful. For more information, please visit pjsolomon.com.