Both buyers and sellers were affected. The value of outbound deals declined to US$2.42 billion, down 83 percent from a year ago, while outbound deal volume dropped 28 percent. During the same period, inbound transactions fell 44 percent in value to US$6.37 billion, while the number of inbound deals fell by 23 percent.
Beijing-based Hogan Lovells Corporate partner Liang Xu discussed these recent trends in the context of longer-forming shifts in the policies of China’s government and those of key trading partners.
Before the COVID-19 pandemic hit, what were the biggest factors contributing to the slowdown of cross-border M&A deals led by Chinese companies?
One inhibiting factor is the U.S.-China relationship. It’s not only about trade disputes or the trade relationship; it’s more on the investment side. In the United States, we have seen tightening oversight of transactions involving Chinese buyers by the Committee on Foreign Investment in the United States (CFIUS). A Chinese company that wants to acquire a U.S. business has to go through a CFIUS review process, and if the agency believes the transaction will impact U.S. national security, it will simply deny the transaction. If a company is not confident about passing that review, or it wants to acquire a company in a particularly sensitive sector or one that involves sensitive technologies, then it is basically a non-starter.
The second inhibiting factor has to do with funding. Whenever a Chinese company wants to do a deal outside of China, it will have to convert its Chinese currency into U.S. dollars or another foreign currency and get the money out of China. Back in 2016, China had very serious concerns about money leaving the country. The Chinese government realized it was losing too much of its foreign reserves and, in late 2016 and early 2017,it issued new rules, limiting anything above the equivalent of US$5 million from leaving the country. Deal activity came to a complete stop.
That has become less of an issue over the past few years, as China has grown more comfortable and confident in terms of supplying the money. Chinese companies have been given more freedom to do deals outside of China, particularly in relation to the Belt and Road Initiative. While that is becoming less of an issue, though, the CFIUS restrictions continue to be increasingly problematic.
How has the COVID-19 crisis altered the near-term M&A outlook, and what are the intermediate-term prospects for Chinese companies looking to expand?
Some deals are being postponed or cancelled. In the short term, all of the uncertainty around the outbreak is having a very negative impact on dealmaking involving both Chinese acquirers and foreign buyers in China.
But we could very well see Chinese companies respond to this crisis like it did after the 2008/2009 global financial crisis. At that time, many Chinese companies were ready to acquire cheap assets while the market was down outside of China, and there is a chance that Chinese companies could see similar opportunities emerge soon. They’re not actively engaged right now because we are still seeing huge fluctuations in the markets. But if the markets stabilize a little bit, let’s say after three or five months, and if Chinese companies start to conclude that the markets have bottomed, then they could very well try to grab assets on the cheap, particularly in commodities, energy and natural resources, and technology sectors.
What regions do you think Chinese companies will likely target?
In light of the CFIUS restrictions, we are seeing Chinese companies increasingly shift their attention from the United States to Europe, in an attempt to acquire technologies in more advanced economies in Western Europe, such as Germany, France, and the United Kingdom. But those countries are also beginning to follow the U.S. example in instituting more rules around technology-focused deals in particular. For instance, in recent years, Chinese companies have made a few high profile acquisitions in Germany, involving companies such as Kuka, a major robotics company in Germany. This created some concern on the part of some of the German market participants. Those kinds of sentiments could make it more difficult to acquire companies in Western European markets going forward.
If this trend continues, we expect to see Chinese buyers shift more of their attention to infrastructure assets in Eastern Europe and to emerging markets in Asia, the Middle East, Latin America, and potentially Russia, as part of the Belt and Road Initiative, which was designed to promote trade and investments between China and emerging markets around the world. China has been increasingly active in those markets from the perspective of infrastructure and natural resources. The Belt and Road Initiative is also politically significant as it is backed by the Chinese government. Leaders of state-owned enterprises have extra incentive to do deals outside of China to help the country achieve its objectives.
What about in the United States?
While transactions in the United States are likely to remain subject to strict regulatory scrutiny, we could see Chinese companies that are listed on the U.S. stock exchanges look to take those interests private now that share prices have dropped significantly. It used to be that Chinese technology companies, in particular, looked to list in the United States because the exchanges there are more recognized for tech startups and it was seen as good for a company’s reputation.
Historically, Chinese companies needed to wait for months or even years to get listed in China. But China’s capital markets are now undergoing significant reforms and Chinese companies may be able to access capital markets at home, in the not-too-distant future.
The markets are relatively more stable now because China has already started to emerge from the COVID-19 outbreak. So, we may see the founders of Chinese companies look to buy out their U.S.-listed companies at attractive prices and then relist them in China at much higher valuations, particularly against the backdrop of still-uncertain U.S.-China trade relations.
What’s likely to contribute if we see a similar uptick in foreign investment in Chinese companies?
There are a couple of reasons why we are not seeing a lot of deals coming into China right now. The top one is the U.S.-China relationship. When U.S.-based clients want to invest in China, they’re worried about what is still a significant level of trade uncertainty. Yes, China has signed Phase One of the trade agreement, but several issues still remain. And now there’s another fight emerging between the two nations around who is responsible for COVID-19. Companies are not confident about what will happen next should they make a big investment in China.
That said, China is really trying to liberalize its markets and give more access to foreign investors, which could yield benefits after this near-term uncertainty eases. China published a new foreign investment law in 2019 in order to liberalize and protect foreign investments, and it also recently issued its related implementation rules in the beginning of January this year. With the new law already in effect, it’s certainly a positive sign for the future.
We’re seeing signs of loosening restrictions elsewhere, too. For example, in 2018, BMW increased its stake in its main joint automotive venture in China, from 50 percent to 75 percent. This was a groundbreaking deal because China’s rules once stipulated that foreign automakers could not have more than a 50 percent interest in joint ventures in China. Two years ago, the rules were changed for automotive companies and the new rules provide that all such limits be lifted by 2022. This is just one example.
The Chinese government publishes a Negative List on an annual basis, which sets out all of the industry sectors that are restricted or prohibited from foreign investment. This Negative List is becoming shorter and shorter. The 2020 version will come out soon, and will further shorten the list and open more sectors to foreign investment, in order to boost the Chinese economy amidst the impact of COVID-19.
Authored by Liang Xu