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Has China put the Brake on M&A?

As featured on CNBC, Roberto Bottoli, manager of GAM’s merger arbitrage strategy, discusses the significance of new capital controls measures imposed by China, namely restrictions on outbound mergers and acquisitions, and whether the political standoff between China and other countries on cross-border M&A is likely to be resolved.

Tuesday, January 17, 2017

If you’ve been listening to Germany’s economy minister and deputy chancellor Sigmar Gabriel recently, you might be under the impression that China is about to take over Europe and the industrialised world.

However that’s all changed. In December, Beijing announced new capital controls measures, including curbs on international renminbi payments and gold imports and, crucially, restrictions on outbound mergers and acquisitions.

The volume and number of Chinese acquisitions in the US, European Union and Japan has been accelerating in recent years. In the first three quarters of 2016, Chinese acquisitions in the US, Western Europe and developed Asia totalled USD 208 billion. This compares to USD 97 billion in the same period in 2015, USD 44 billion in 2014 and USD 30 billion in 2013.

The driver behind this trend has been China’s need to acquire know-how to close the gap with more advanced economies. Crucially, China needs processes and technology to improve productivity that would take too much time to develop on its own, leaving it with little choice but to buy them outside.

However, the downside to this flow of money out of China has been downward pressure on the renminbi, which Chinese authorities want to reverse.

The impact of the new measures

It is too early to say how stringent the measures will be. Outbound mergers and acquisitions are likely to be scrutinised in terms of whether the deal fits China’s strategic goals. Deals above USD 10 billion are likely to be reviewed most carefully whilst those under USD 1 billion will receive less scrutiny. How highly leveraged the firm is will also be considered, given China’s desire to control its level of indebtedness.

It is, however, unlikely that Chinese acquisitions will come to a halt, especially those with strategic significance. The approval by the Chinese authority SAFE (State Administration of Foreign Exchange) of the USD 5.8 billion acquisition of Ingram Micro by Tianjin Tianhai is a positive signal.

Growing protectionism

Arguably, western governments will welcome the measures, given growing protectionist tendencies. In November, the German government surprisingly withdrew its approval for the takeover of chip equipment maker Aixtron by Chinese investors. Just days later, Gabriel accused China of “foul play” and hampering investments into China by European companies.

A number of deals involving a Chinese bidder for a US target were called off last year over objections from the Committee on Foreign Investment in the United States (CFIUS). In December, President Barack Obama blocked the sale of Aixtron US assets, upholding a recommendation by CFIUS and thus causing the collapse of the deal.

The protectionist attitudes of President-elect Donald Trump could have a negative impact on cross-country transactions, particularly those involving a US target and a Chinese buyer, and could affect the review process of key authorities, including the CFIUS, which rules not solely on deals where the target is domiciled in the US, but also on transactions where the target has operations in the country.

The increased uncertainty surrounding Chinese deals is already driving up the M&A arbitrage spreads --the difference between the market price of a target company’s shares and the offer price. That means they can also be more rewarding for an investor who makes the right assessment of the risks involved.

Can differences be resolved?

The political standoff between China and other countries on cross-border M&A is likely to be resolved as both parties have means to exert pressure on one another. China is a highly motivated buyer of western companies: It needs know-how in value-added sectors, its companies seek revenues in hard currencies and, over the long term, China needs market diversification. Conversely, western companies need access to the Chinese market, given that they lack growth.

These strategic drivers should lead to a compromise of mutual satisfaction. This could take time and will not be smooth, but sub-optimal growth on both sides is likely to trigger further negotiation if a solution isn’t agreed sooner.

Sources: Bloomberg, GAM

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