Transactions

Mergers and acquisitions activity has scaled up dramatically

in China. A Plus looks at the Mainlands corporate hunters
and their targets as well as how Institute members can
smooth the deal process

32 July 2014

Mainland
matchmaking
I
ts not just Chinese tourists who
are heading overseas on exotic
shopping trips. China Inc. is on the
march again, as Mainland compa-
nies swoop in on foreign targets like
never before.
From resources to retail, Chi-
nese companies are scooping up a host of foreign
brand names. And unlike in the past, there is less of
a bogeyman attitude to mergers and acquisitions
by Chinese entities, as many distressed companies
in Europe and North America look to cash-rich sav-
iours from the Mainland.
There are compelling reasons for Chinese com-
panies being more active in undertaking cross-bor-
der M&A transactions, says Derek Lai, Managing
Partner of Deloitte China Southern Region and a
Hong Kong Institute of CPAs member, citing re-
cently loosened Chinese government restrictions,
a stronger yuan and a desire to diversify their
markets.
The shopping binge often involves Hong Kong
entities as an intermediary, which means more
business for local accountants as well as bankers,
lawyers and management consultants. Hong
Kong is a very good platform for Chinese compa-
nies going overseas, says Judy Tsang, Transaction
Advisory Services Partner at EY in Hong Kong and
an Institute member.
Chinas outbound M&A volume reached
US$14.3 billion in the first quarter of 2014, accord-
ing to the London-based data provider Dealogic,
A PLUS
Illustrations by Harry Harrison
which tracks global M&A. That marks the highest
first-quarter total since 2008 and is nearly 27.7 per-
cent higher than the US$11.2 billion recorded in the
same period last year.
Chinese acquisitions in the United States
reached an all-time record of US$5.8 billion in
the quarter, thanks to Lenovo Groups successful
US$2.9 billion bid for Motorola Mobility. Other
high-profile deals include the MMG-led consor-
tiums takeover of the Las Bambas copper project
in Peru and the purchase by Sanpower of Scottish
department store House of Fraser.
The potential windfall for accountants is huge
as they fulfil several fee-earning roles, notes Louis
Leung, President of Wing On CPA & Associates and
an Institute member. CPAs can be a reporting ac-
countant, an internal control expert or a member of
the investment banks deal team.
While many of the largest deals involved en-
ergy or natural resources, mega-mergers worth
more than US$1 billion have become less common
than they were as Chinas economic growth slows.
There were seven transactions of at least that size
recorded in the first quarter, compared with 10 in
the same period last year.
Members step up
Chinese companies are likely to continue to turn
to Hong Kong as the first step in an international
M&A deal. Chinese companies going overseas
usually want to set up an offshore company and
Hong Kong is one of the best platforms for that,
July 2014 33
Transactions
notes Tsang. Many want to be listed here
because having a Hong Kong-listed vehicle
makes it easier to get financing.
Hong Kongs financial professionals es-
pecially CPAs play a crucial role in helping
Chinese companies acquire the necessary
data and information to transact such huge
deals. Tsang says their roles begin at the out-
set of the deal, with the valuation of assets
and the development of a business plan.
A lot of these overseas [target] compa-
nies are loss-making and may suffer from
very high gearing, she says. The acquir-
ing company needs to have an investment
strategy about how to turn it around. (See
CPAs tread with care across M&A minefield on
page 36.)
Some Chinese companies find an appar-
ent bargain in Europe and are still surprised
to discover that it can comes with heavy
legacy costs, such as pensions and other em-
ployee-related expenses.
Institute members can work with human
resources specialists to quantify such costs,
she says, as well as perform other due-dil-
igence measures that Chinese companies
more readily seek than previously. Main-
REFORMS FUELLING are those that create a combined entity with no
more than a 15 percent market share.)
DOMESTIC ACTIVITY Mega-deals are also emerging, such as
Domestic mergers and acquisitions Chinese
companies investing in each other also set
a first quarter record this year, according to
Dealogic, with US$49.6 billion in transactions
recorded.
The Chinese government has been actively
encouraging mergers to weed out smaller, less
profitable enterprises, especially in sectors
such as chemicals, cement and steel, while the
Ministry of Commerce has been simplifying its
M&A approvals mechanism.
One example is Shanghai-listed Shaanxi
Qinling Cements recent acquisition of a group
of renewable energy and waste recycling
companies for US$304 million.
The government is conscious of [the
need for] streamlining efforts and we expect
simple mergers to be cleared at a quicker
rate, says Angie Ng, Senior Associate at the
Clifford Chance law firm in Hong Kong. (Simple
mergers, as broadly defined by the ministry,
34 July 2014
land companies are now more diligent about
analysing the profitability of foreign compa-
nies, Tsang adds.
Managing and executing due diligence,
according to Tsang, would include analysis of
the operating results, balance sheet, pro forma
earnings and net assets, as well as projec-
tions and a review of audit working papers.
Analysis of potential spinoffs and carve-outs
would also be performed.
Eugene Liu, Partner and Head of Trans-
action Advisory Services at RSM Nelson
Wheeler and an Institute member, notes that
Chinese investors are still fairly inexperi-
enced at outbound investment. They often
under-estimate the time required for the due
diligence process and underrate its impor-
tance, he says.
In addition, outbound M&A has signif-
icant tax considerations for Chinese com-
panies, especially in the field of acquisition
structuring, debt funding and foreign tax
credit. Tsang points out that certain sectors,
such as information technology, are subject
to varying tax regimes.
The differences between national corpo-
rate tax regimes are another point of conten-
Shanda Games; and
 Internet giant Tencents investment in China's
largest digital mapping company, the Shen-
Shanghai Jinfeng Investments asset-swap with
Shanghai Greenland Group for US$10.6 billion
to facilitate a back-door listing for Greenland on
the Shanghai Stock Exchange.
Domestic M&A is expected to remain vi-
brant into the second half of 2014, according to
Derek Lai, Managing Partner of Deloitte China
Southern Region and a Hong Kong Institute
of CPAs member. Fuelled by state-owned
enterprise reforms, government support and re-
covering equity capital markets, large Mainland
enterprises have been and will continue to drive
consolidation in sectors such as telecommuni-
cations, media and technology, he says.
Significant deals, he adds, include:
A libabas US$1.2 billion acquisition of a 23.54
percent stake in Youku Tudou, the main
online video provider in China;
Perfect
 World, a developer of massively mul-
tiplayer online video games, paid US$100
million for a 5.61 percent stake in its rival,
tion, and one area where CPAs can work with
legal professionals. The tax issues discov-
ered by CPAs have legal implications, which
the lawyers must address, and the legal is-
sues discovered by lawyers may also have tax
implications, which need further input from
the CPAs, says Bee Chun Boo, M&A Partner
at the Baker & McKenzie law firm in Beijing.
Other common challenges for CPAs, Lai
at Deloitte says, include bridging the gap
between accounting systems and ensuring
regulatory compliance. Another issue is
transaction structures, as the financing of
outbound deals usually requires significant
capital or cross-border financing.
Accountants can help with some of the
more complicated matters encountered, says
Leung at Wing On CPA & Associates. Good-
will has been a hot discussion point in the ac-
counting field when it comes to M&A, he says.
Negative goodwill does exist in practice.
Promising outlook
The M&A boom is expected to accelerate over
the next five to 10 years, according to Chad-
bourne & Parke, a U.S. law firm, citing Chinas
announcement in February that it would ease
zhen-listed NavInfo.
Chinas food and beverage industry is also
seeing a transformation, Lai points out, citing
deals such as:
 Beijing Huiyuan Food and Beverages acqui-
sition of Shanghai-based Suntory Foods; and
 Starway Bio-technologys acquisition of a
majority stake in Luoyang Yzong Islamic Food.
Kenneth Yeo, Director and Head of Special-
ist Advisory Services at BDO and an Institute
member, expects an increasing number of
deals will keep Hong Kong CPAs and other
experts on their toes. For domestic Chinese
deals, common due diligence issues include
unreported earnings, non-compliance with
accounting standards, complexity of related
party transactions, tax-related issues, under
provisions for social security and poor corpo-
rate governance and disclosures.

red tape for acquisitions of overseas compa-
nies that cost less than US$1 billion.
The National Development and Reform
Commission said Chinese firms would no lon-
ger need explicit approval for such transac-
tions from 8 May. Both Chinese enterprises
and their foreign partners will have far more
transparent and predictable procedures, Ed-
win Lee, a Beijing Partner at the law firm, says
of the new M&A rules. The measures will
speed up the transaction process and save
costs for related parties.
Foreign authorities are also more recep-
tive to Chinese buyers, even in countries
where they were less welcome, such as Aus-
tralia and the U.S. In May, the Australian
government cleared a A$1 billion bid by
state-owned Baosteel Resources for iron ore
miner Aquila Resources. In February, a U.S.
judge declared a unit of Wanxiang Group
Corporation, Chinas largest automotive
parts company, as winner of a bankruptcy
auction for the assets of sports car manufac-
turer Fisker.
Ghislain de Mareil, Co-founder of Shang-
haivest, an M&A consultancy in Shanghai,
says there is a growing realization that Chi-
nese companies are not seeking to dominate
foreign markets but use them to obtain tools,
technology and knowhow. Outbound M&A
is a way to acquire means that will help them
compete in the Chinese market with Chinese
and foreign competitors, he says.
There are pitfalls, however. Chinese com-
panies have a reputation for overpaying for
foreign assets. J.P.Morgan noted in a 2013
report that Chinese acquirers paid an aver-
age 33 percent premium in acquiring assets
located in North America in 2012. As an ex-
ample, Lenovos US$2.9 billion purchase of
Motorola Mobility was widely criticized.
There are generally two ways that Chi-
nese companies buy assets in the West,
says Bruno Bensaid, another Co-founder
of Shanghaivest. Either they buy it as very
distressed and get it for a relatively small
amount or they get it overpriced.
Sometimes, however, shareholders be-
lieve a Chinese offer is too low, such as the
Italian financier Andrea Bonomi who is
blocking the sale of the Club Mditerrane
resort group to a joint venture led by Fosun,
Chinas largest private-owned conglomerate.
As some developed economies recover
notably the U.S. and the United Kingdom
asset prices will rise and targets in those
countries can be expected to drive harder
bargains. Chinese companies can expect
A PLUS
fewer fire sales. The recovery in certain ju-
risdictions has led to a greater discrepancy in
terms of valuation between Chinese buyers
and foreign sellers, says Boo at Baker & Mc-
Kenzie. This means that it is harder to suc-
cessfully sign a deal.
Chinese companies still sometimes throw
in the towel when it comes to sealing an over-
seas M&A deal. Angie Ng, a Senior Associate
at the Clifford Chance law firm in Hong Kong,
estimates that about half of all Chinese M&A
bids fail. This is usually either after due dili-
gence is performed or because a contractual
agreement cannot be reached.
Dealmakers concur. There is a very high
failure rate, says Bensaid at Shanghaivest.
There are many factors, he adds. Perhaps
there hasnt been enough lobbying, or there
hasnt been a proper understanding of local
stock exchange rules, or the shareholders
are suing.
Deals of the future
Although total foreign direct investment in
China dwarfs the countrys outbound invest-
ment US$21.6 trillion vs. US$508 billion
the latter is growing much more rapidly, ac-
cording to Douglas McWilliams, Economic
Adviser to the Institute of Chartered Accoun-
July 2014 35
Transactions

CPAs TREAD WITH CARE

ACROSS M&A MINEFIELD
CPAs play an integral role in shepherding mergers and
acquisition deals through a sometimes-tortuous process,
says Louis Leung, President of Wing On CPA & Associates
and a Hong Kong Institute of CPAs member.
Leung, who is also President of the Hong Kong
Chinese Industry and Commerce Association and an
economic consultant to the Shaanxi provincial govern-
ment, notes that some M&A deals will involve a listed
Hong Kong company. Because of the introduction of
the SFC Sponsor Liabilities Rules, accountants should
pay more attention to their due diligence work in M&A
deals, he advises.
Derek Lai, Managing Partner of Deloitte China South-
ern Region and an Institute member, says outbound and
domestic M&A transactions have differing processes and
pitfalls.
For outbound transactions, common due diligence is-
sues include understanding the business and operational
complexities of the foreign target and its market, employ-
ment and pension provisions, tax regimes and transac-
tion structures required. Other drawbacks include:
 Disparity in accounting principles;
 Compliance with regulatory requirements at local,
provincial or national level (environmental regulations,
export and import controls, antitrust laws);
Long approval process and different requirements in
both bidder and target countries; and
Financing of outbound deals, which usually require
significant capital or cross-border financing.
Typical domestic M&A issues include:
Internal control and corporate governance adequacy
issues, such as weak segregation of duties rules;
 Compliance with Mainland accounting principles;
 Non-bona fide transactions, such as fictitious
third-party transactions and supporting documenta-
tion; and
 Issues with related party transactions for example, a
lack of basis and transparency (e.g. they are not sup-
ported by reasonable transfer pricing methodologies);
off-balance sheet liabilities or guarantees provided to
subsidiaries or affiliates; or manipulation of profit and
loss to minimize taxes on a group basis.
Lai also points to a general low reliability of financial
information. It is not uncommon for Mainland compa-
nies to keep several sets of books for specific purposes,
such as the initial public offering, tax filings, bank bor-
rowings or other financing, he says.
Cultural differences and language barriers can be a
major issue, says Kenneth Yeo, Director and Head of Spe-
cialist Advisory Services at BDO and an Institute member.
Given the negative publicity in overseas media that
sometimes accompanies Chinese investments, particular-
ly in the United States, Chinese investors can be forgiven
if they feel like an in-law that is only welcomed for their
money, Yeo observes.
tants in England and Wales. It is clear that the Chinese are
increasingly keen to reap the benefits of investing abroad, he
told an Institute seminar last month.
William Yuen, Director of Transaction Services at Ascent
Partners, a Hong Kong consultancy, expects China to continue
to secure access to natural resources but also express increased
interest in consumer products and industrial technologies. Food
and beverages will be a particularly important sector, he fore-
casts. Like in other countries, food security is a national prior-
ity, says Yuen.
He also expects Chinese companies to make more high-pro-
file purchases of iconic international brands, following the ac-
quisition of Swedish carmaker Volvo, British cereal manufac-
turer Weetabix and American cinema chain AMC. As Chinese
manufacturers move up the value chain, purchasing interna-
tional brands and technology is pivotal, Yuen says.
Observers forecast that some Chinese companies will con-
tinue to look for targets in sectors outside their core competencies.
Bensaid says one Chinese aeronautical industry client is seek-
ing to buy hotel properties as part of a diversification strategy.
He also cites the recent acquisition of the five-star Paris
Marriott Hotel Champs-lyses by a Hong Kong company con-
trolled by Du Shuanghua, Chief Executive Officer of Rizhao
Steel, one of Chinas largest private steel manufacturers.
There is a bit of soft-power encouragement, he says. Some-
times, you just want to get that China sticker up in London or
New York or Paris.
The Chinese corporate juggernaut will continue to bring
opportunities for Institute members. Hong Kong CPAs will be
very important from an adviser perspective, says Tsang at EY.
A lot of Chinese companies engage Hong Kong accountants to
help on their outbound transactions because of their exposure
to international markets. We have the capacity and, from a pro-
fessional services perspective, Hong Kong has a competitive
advantage.

36 July 2014