Deal certainty trumps best price in China transactions

Chinese private equity firms and strategic buyers eyeing overseas assets will continue to face more rigorous scrutiny and outcomes for these deals will become much harder to predict, private equity practitioners from international law firm White & Case said.

As a result, certainty is the new price in cross-border deals.

“On the sell-side, we’ve seen more companies go with the lower-priced bidder because it offers more deal certainty and they are seen to have fewer regulatory hurdles,” Christopher Kelly, a Hong Kong-based partner at the firm, said in a media briefing on China M&A.

When sellers select a bidder, they want to know the deal will close within a minimum amount of time and that it will not be blocked by a regulator, Kelly added. “That affects deal certainty and that affects the willingness of people to do transactions with certain counterparties.”

In 2016 China became the second-largest global investor behind the US. According to data from Mergermarket, Chinese dealmakers – including private equity firms and strategic investors – engaged in 258 deals outside of Asia worth $185.3 billion, nearly quadruple 2015’s tally of $49.1 billion across 177 deals.

As the number of Chinese investments increases, so does regulatory scrutiny. According to industry sources, the Committee on Foreign Investment in the United States (CFIUS), an intergovernmental agency that vets foreign acquisitions of US businesses, is facing an unprecedented number of cases before them. Latest published data from CFIUS revealed 147 reviews in 2014, a 52 percent increase compared with 2013, and a 33 percent increase over 2012. For the third consecutive year, China had the highest number of inbound transactions: 24 were reviewed in 2014, up from 21 in 2013.

While CFIUS's mandate is to assess national security risks, “national security” isn't defined.

“What we do know is that CFIUS has a very wide remit. National security is not defined, critical infrastructure is not defined,” Kelly pointed out. “That means a whole range of businesses that previously we might not have thought to have anything to do with national security, for example, businesses nowhere near military installation or semiconductors – there might be pipelines, dam projects and utilities – all these things are fair game now.”

Chinese companies have been treated with suspicion by CFIUS because of their governance and ownership structures, which may be tied with government, Alex Zhang, a Beijing-based partner at White & Case, said.

He noted that Chinese buyers are getting more sophisticated in dealing with US regulatory issues, are better informed and are increasingly engaging advisors to help them from pre-deal analysis through CFIUS review.

“Another interesting trend we see is private equity firms working with Chinese strategic buyers in deals. In any event, if the private equity firm is a US dollar-denominated fund, it is better positioned to work with a strategic in dealing with the currency issues,” Zhang said.

Chinese buyers are also facing regulatory hurdles at home. In November Beijing reinstated limits on overseas investment. The Chinese government is also closely monitoring “irrational deals” in areas such as real estate, hotels, entertainment and sports. China also plans to introduce its first regulation on outbound direct investments later this year to clarify and define the range of overseas investments, as well as listing prohibited investment areas.

“The positive way of looking at what regulation has done around the world is that it’s weeded out the field and reduced silly money chasing a small number of assets,” Kelly said.

“This is going to mean a shift and focus on the right buyers who will make a positive impact in the US economy and in China’s case, buyers who are going to advance the national interest by doing a proper strategic deals.”