Riding The Dragon – Chinese M&A Overview
Chinese M&A activity remained broadly steady over 2011 with deal volumes and values holding up over the year despite wider market downturns. Indeed, over the latter six months, when the Eurozone crisis was in full swing, Chinese M&A transactions remained in line with H1 metrics in terms of volume, and actually rose in terms of cumulative deal values.
Nonetheless, while overall deal flow remained stable over the two halves of 2011, this was only due to a subtle shift in terms of deal types coming to market. Perhaps unsurprisingly, inbound acquisitions over H2 2011 dropped off in terms of intensity, with volumes falling some 15% compared to the previous six month period. Meanwhile, domestic and outbound activity made up for this decline, with domestic and outbound deal volumes rising by around 10%.
However, it would have taken a minor miracle for markets to remain resilient over the first quarter of 2012 as the associated effect of the Eurozone crisis (as well as the requisite time-lag) hit home. As a result, deal flow over the first three months of 2012 dropped off sharply compared to the same period the year prior. Just 189 transactions, worth a total US$36.5bn came to market over the quarter, down from the 277 deals, worth US$41.1bn, that were announced over Q1 2011. And it was within the inbound space that the majority of this slowdown took place, with inbound M&A inflows by value dropping a massive 83.1% in Q1 2012 compared to the same period the year before. Meanwhile, volumes fell by more than half. In stark contrast to this however, both domestic consolidation and outbound M&A activity by value rose over the two periods in question.
Inbound M&A Activity
Over 2011, inbound activity became more restrained, primarily because of the onset of the Eurozone crisis, with M&A markets witnessing a fall in the number of announced inbound M&A deals, according to mergermarket, an independent provider of M&A data and analysis. Compared to the first half of 2011, H2 inbound M&A volumes dropped by more than 20%, reinforcing the perception that prospective acquirers of Chinese assets were beginning to prioritise the upkeep of their own houses, as opposed to buying into others towards the latter half of the year.
However, while the volume of inbound transactions declined over the latter half of 2011, the total amount spent rose by 75%, chiefly due to the November 2011 acquisition of an implied 3.05% stake in China Construction Bank by Singaporean sovereign wealth fund Temasek, among other investors, in a deal which was worth a total of US$6.6bn. The deal heavily skewed the overall valuation figures and perhaps a truer figure emerges when this particular transaction is discounted from the overall metrics – in which case, second-half inbound valuations rose by a much more modest – but still not inconsequential – 19%.
Nonetheless, preliminary figures for the first quarter of 2012 perhaps indicate that inbound deal-making is at its inflection point, at least in terms of volumes, with 31 transactions having been announced over Q1 2012 – the same number that came to market in the previous quarter. Although it would seem that foreign corporates are beginning to re-engage with the China marketplace once again, they are only doing so cautiously – only US$1.1bn was spent by overseas buyers on Chinese companies over the quarter, down significantly from a figure of US$11bn in Q4 2011.
Reading the tea-leaves from one particular angle, inbound M&A activity into China could gradually pick up over 2012, with deal flow primarily driven by cash-rich US corporates and first-tier private equity firms hoping to move beyond the difficult downturn caused by the Global Financial Crisis and instead look towards the future for profitable opportunities in China. Their European counterparts will also look to emulate them but to a lesser extent - wider macroeconomic fundamentals indicate that the US is now on the road to a recovery of sorts, while parts of the Eurozone are still mired in debt.
Indeed, such a story is evident when looking at Q1 2012 metrics, which show that inbound investments from the US into China increased by 13 percentage points in terms of volume compared to the previous quarter – this rise being coupled with a corresponding decline in the proportion of inbound acquisitions emanating from Europe. Indeed, over the same two periods, European M&A volumes dropped 16 percentage points to account for just 29% of the total figure for inbound investment.
Nonetheless, the converse could also play out, with another picture emerging if one were to take the view that a recovery in the US would result in US corporates and private equity firms taking an increasingly bullish view on the US economy – and keeping their investments at home as a result. With US manufacturing orders up in March, and with consumer spending having recent hit a seven-month high, could it be first-tier European corporations and private equity firms who end up driving the bulk of Chinese inbound M&A activity over 2012? Either way, inbound activity is likely to increase over the next twelve months.
Meanwhile, domestic M&A plays in China continue to be driven by the strategy outlined in the government's 12th Five Year Plan (2011-2015) published in March 2011. The plan broadly aims to create a more "inclusive" growth model whilst maintaining strong GDP growth. The focus is to build a more equitable society by smoothing out income disparities at both the individual and collective levels, as well as improving access to jobs, education and healthcare, among other social services and public goods.
In terms of the implications for domestic M&A activity, the most recent five-year-plan will broadly encourage (among other goals), the upgrading and modernisation of industry, and thus the continuation of domestic consolidation in key industries such as the mining, light manufacturing, automotive, industrials, and processing industries to name a few. Particular focus will be placed on those industries that are labour and/or resource intensive, highly polluting or plagued by over capacity.
And it was this process of technical upgrading that continued to drive the bulk of Chinese domestic M&A activity, with some 617 local deals, worth US$118.1bn, coming to market over 2011. Furthermore, such flows were equally-spread over the two halves of the year, with H2 domestic takeovers by value (US$62.8bn) actually exceeding investments over H1 (US$55.5bn). However, as financial markets held their breath over Q1 2012, acquisitive domestic bidders seemingly lost their nerve with just 126 domestic deals coming to market over the quarter – the lowest number since Q1 2006.
Nevertheless, given the global economy's fragile recovery since then, a growing number of industry insiders now believe that domestic M&A activity will rebound over the remainder of the year, with this resurgence being dominated by manufacturing sector tie-ups. Indeed, over 2011, such deals comprised around one-quarter (24%) of all domestic deals by volume and 21% of domestic M&A activity by value. Consumer Business transactions are also likely to proliferate, as many fragmented sectors, such as the Food & Beverage space, continue to see consolidation occurring. Deals such as Guangxi Royal Dairy's acquisition of a 55% stake in Dalilaisier Dairy, the Chinese manufacturer of yogurt-and milk-based products, for US$15.1m in mid-2011, are a recent case in point.
Furthermore, domestic activity could also increasingly shift inland over 2012, with industry players reportedly showing strong interest in growing their national market share by acquiring in regions such as Sichuan, Yunnan and Tibet, chiefly due to the greater comparative market potential of these areas. At the same time, powerful government incentives to shift investment away from developed coastal regions and towards such inland provinces, will also act as a significant draw for potential acquirers.
In summary, while the emergence of further deal-making opportunities in these sectors is certainly not a new trend, it is important nonetheless. Domestic consolidation plays that are now taking place, or are likely to come to market in the near-future, are set to be the ones that result in the creation of tomorrow's market leaders and national brands, and ultimately re-shape the future of Corporate China.
The Greater China outbound story is no longer a new one. Over 2011, Chinese outbound acquirers undertook 183 deals, worth US$64bn – a large jump from the 148 overseas acquisitions, worth a total of US$56.2bn, that were announced over the previous year. As a result, over the wider 2007-2011 period, outbound deal flow rose steadily in terms of both volumes and values, growing by an average of more than 10% per year in terms of volumes, and increasing by an average of more than one-fifth by values per annum over the same timeframe.
However, the slowdown that befell China's inbound and domestic M&A markets over Q1 2012 also impacted the outbound market, with deal flow slowing to just 32 deals, worth US$10.4bn over the quarter (down from a total of 41 deals in Q1 2011). Although, the pace of decline was the slowest of the three market types, with y-o-y volume declines of just 22%, with deal values actually appreciating over the two periods in question.
Interestingly, the Chinese outbound M&A story continues to be one that is very much focused on Energy & Resources transactions. Over the 2007-2009 period, close to one-third of all outbound deals were of foreign Energy & Resources assets by volume – a proportion which fell slightly over the subsequent two years. Having said that, investments by value of such assets located abroad jumped from making up 62% of total outbound M&A by value over the 2005-2007 timeframe, to accounting for more than two-thirds of the overall figure.
Yet while Chinese bidders continue to focus on acquiring overseas Energy-related targets, they are also increasingly focusing their intent when it comes to where they are buying. Over the 2007-2009 period, 38.5% of all Chinese outbound acquisitions by volume were of Western European & North American targets. Yet over the subsequent twenty four months, this proportion rose to just under 45% of all deals – although this shift conceals an apparent swing in preference from North American assets towards purchases within Western Europe over the latter period.
Looking forward over 2012, expect to see some groundbreaking shifts in terms of bidder focus as Chinese bidders increasingly move up the value chain. From a sector perspective, infrastructure-related plays could become more commonplace. Such a move could take two forms – the first being the more familiar, traditional project-based infrastructure investment as part of a wider resource-extraction deal. The second type are those pure infrastructure bids – often defensive plays to control large foreign assets overseas in order to ensure steady cash-flow generation. For instance, in one of the very largest outbound transactions of 2011, Cheung Kong Infrastructure Holdings (CKI), an investment vehicle owned by Hong Kong tycoon Li Ka-shing, made a successful bid for the UK's Northumbrian Water, for a total consideration of US$7.9bn.
Outbound buys in the Consumer Business & Transportation sectors will also continue to see steady growth over 2012. In 2011, for instance, deals in these sectors accounted for more than 22% of outbound transactions by volume, and this is unlikely to start falling off anytime soon. These acquirers are not simply looking to buy abroad to access international markets, nor simply to introduce a reputable brand home. In fact, they have a much more holistic strategy in mind, particularly in the tourism and leisure spaces. Chinese tourism is increasingly becoming a carefully choreographed, door-to-door experience – with companies from airlines to cruise operators to theme park developers looking to control each dollar (or Yuan) flowing from a Chinese tourist's wallet. That's why tie-ups between seemingly unrelated entities in this space will be making headlines in 2012.
A final trend in outbound M&A in 2012 could be a rising prevalence of intra-Asia deals, especially as the RMB becomes an increasingly predominant currency throughout the region as a result of loosening cross-border capital controls. Buys in Asia reduce exposure to flagging markets elsewhere, and provide the cultural and linguistic comfort of markets and people closer to home. Financial services, mining, and agribusiness plays are expected to lead outbound deal-making across the region over the next 12 months.
Eric Leung is the M&A Transaction Services Leader for Deloitte China. Over the last 20 years, he has been supporting major corporate and private equity clients in their M&A due diligence. In addition to his extensive experience in transactions in China, he also supported many of the major Chinese companies in their overseas acquisitions.
Eric Leung can be contacted by calling +852 2852 1600.