Chinese Companies Step Up to the Global M&A Game

Wanhua Industrial Group is a product, and a part, of China’s incredible growth story. Over the past three decades, the company, based in the coastal city of Yantai, some 800 kilometers (500 miles) north of Shanghai, has transformed itself from a small regional manufacturer into Asia’s biggest maker of polyurethane, a plastic used in everything from automobiles to carpets. Looking to sustain that growth, CEO Ding Jiansheng has set his sights on Europe, which represents about one third of the global market for isocyanates, the raw materials for making polyurethane.

In late 2009, Ding found a target in BorsodChem, a Hungarian maker of chemical foams and plastics with a strong European distribution network. BorsodChem had gotten into trouble following a €1.6 billion ($2.1 billion) leveraged buyout in 2006 by U.K. private equity firm Permira Advisers and Vienna Capital Partners. When the global financial crisis hit, sales plummeted, losses mounted, and the firm risked collapsing under the weight of its €1.47 billion in debt. BorsodChem snubbed the first overture from Ding and Wanhua Industrial, hoping instead to refinance its debt with 60-odd lenders, so the Chinese fashioned an alternative strategy. Wanhua Industrial quickly bought up €200 million of the company’s debt to get a seat at the restructuring table. It was the first time a Chinese company had used this tactic, a staple of hedge funds and private equity investors seeking to gain corporate control.

“This was a secret strategy,” says Joseph Tse, a Beijing-based partner at Allen & Overy, the law firm that advised the Chinese company. “It was not without its risks or challenges.” Wanhua Industrial, a state-owned enterprise, needed to win approval from government regulators to pursue its gambit; the strategy also could have left it holding loans in a failing business. But in a three-day session in Frankfurt and Budapest, the company opened negotiations that eventually allowed it to convert its debt into a 38 percent stake in BorsodChem; it also provided €140 million in financing in exchange for the right to buy full control. By February 2011 the company had completed a €1.24 billion takeover, becoming one of the world’s three biggest producers of isocyanates, alongside Germany’s BASF and Bayer. Ding, who took over as chairman of BorsodChem in January, said the merger would turn the two outfits “from two regional players into one global company.” He called the deal a “beacon” for other Chinese companies looking to invest in Europe.

China, the world’s biggest export economy, is going global. After years of sporadic and often unsuccessful forays into the takeover business, Chinese companies are emerging as big buyers of offshore concerns. Oil and gas companies and metals and mining conglomerates continue to be the biggest actors, seeking to secure natural resources to feed the country’s industrial machine. Increasingly, however, Chinese manufacturing, transport and even financial companies are looking for overseas deals to acquire technology, world-class brands and global distribution. And in their pursuit of such assets, Chinese companies are approaching the M&A game with a sophistication unimaginable only a few years ago.

Chinese enterprises spent $61.2 billion in 2011 to buy offshore companies and assets, up 20 percent from a year earlier and a threefold increase from 2006, according to data provider Dealogic. The number of Chinese overseas acquisitions jumped 24 percent from 2010, to 403. The country ranks fifth by deal volume, behind the U.S., the U.K., Japan and France, according to Allen & Overy.

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“This is the start of a greater and longer-term trend,” says Yan Lan, head of Greater China investment banking at Lazard’s Beijing office. “China has a need to grow abroad, its companies have the money, and its ability to conduct transactions has been accelerated by the global financial crisis.”

A glance at China’s overseas buyouts in just the past six months illustrates the breadth of the country’s ambitions. In January, Sany Heavy Industry Co., a Hunan-based construction machinery giant, teamed up with Citic Private Equity Funds Management Co. to acquire Putzmeister Holding, a German concrete-pump manufacturer, for €360 million. Also that month Shandong Heavy Industry Group Co. spent €178 million for a 75 percent stake in Ferretti Group, an Italian luxury-yacht maker. And in October 2011, China National Chemical Corp. completed the purchase of a 60 percent stake in Makhteshim Agan Industries, an Israeli agrochemicals producer, for $1.44 billion.

The upsurge in China’s global acquisition activity is only just beginning. The country’s stock of foreign direct investment reached $298 billion in 2010, representing just 1.5 percent of global FDI stock, about the same as Sweden’s, according to the United Nations Conference on Trade and Development. By contrast, China accounted for 9.2 percent of world trade that year and 9.3 percent of global gross domestic product, according to Unctad and World Bank statistics.

The country’s direct overseas investment is set to surpass FDI coming into China before 2015, according to the Ministry of Commerce. That would represent a dramatic change for a country that has been the biggest magnet of foreign direct investment for most of the past two decades. China has attracted more than $1 trillion in FDI since 1978, when then-leader Deng Xiaoping broke with decades of communism and launched market-oriented reforms; the vast bulk of those funds has flowed into the country in the past 20 years. Now that tidal wave of money is set to reverse course, according to Rhodium Group, a New York–based economic and political consulting firm. China could directly invest between $1 trillion and $2 trillion offshore by 2020, the firm estimates.

CHINA’S HUNT FOR NATURAL RESOURCES — ESPECIALLY oil and gas — dominates the country’s offshore acquisition activity, and it’s not hard to see why. In 2010, China became the world’s biggest energy consumer, accounting for 20.3 percent of global use, surpassing the U.S.’s 19 percent, according to the “Statistical Review of World Energy,” published by British oil giant BP. A fast-growing middle class has turned China into the world’s largest automobile market, adding to demand from an energy-hungry industrial sector. The country now buys roughly half of its oil — more than 5.5 million barrels a day — on world markets. “China is very interested in establishing a supply of energy for growth. That means both resources and technology,” says William Owens, Hong Kong–based Asia chairman of private equity firm AEA Investors and a vice chairman of the U.S. Joint Chiefs of Staff in the 1990s. “China has a great interest in energy storage technology, clean coal technologies, shale gas and deep-ocean drilling.”

In last year’s biggest announced deal, China Petrochemical Corp., or Sinopec, paid $4.8 billion to acquire a 30 percent stake in Petrogal Brasil, the Brazilian subsidiary of Portuguese oil and gas company Galp Energia. It was the latest in a string of deals by the petrochemicals giant to secure access to crude supplies. In 2010, Sinopec bought 40 percent of the Brazilian unit of Spain’s Repsol YPF for $7.1 billion. One year before that Sinopec completed an $8.99 billion acquisition of Geneva-based oil exploration company Addax Petroleum Corp.

Chinese companies have spent $136.9 billion on overseas companies in the oil and gas and metals and mining sectors over the past six years — more than half of all foreign M&A activity during the period, according to Dealogic. Seven of the ten largest deals were in these sectors, led by the joint $14.3 billion purchase of a 12 percent stake in Anglo-Australian mining company Rio Tinto by Aluminum Corp. of China and Alcoa in 2008. Chinalco bought out Alcoa’s share the following year.

Resource deals are an obvious first step for China’s budding takeover artists. They meet a pressing economic need, and they pose fewer managerial obstacles than the average corporate acquisition.

“Generally, you’re buying assets, and assets are a lot easier to buy than a business,” explains Gordon Paterson, head of Deutsche Bank’s M&A business for Asia-Pacific. “With resources, you’re digging a hole in the ground, sticking in a pipe, getting it to port and shipping it out.”

The new surge of Chinese M&A activity is extending far beyond resource plays, though. Both state and private entities are looking overseas to acquire technology and powerful brands, and to extend their own supply and distribution networks. As Michael Weiss, head of China M&A at Morgan Stanley in Hong Kong, puts it, “The trend is slowly moving from what China needs to what China wants.”

Driving this transition is Beijing’s desire to go up-market. A key plank of the government’s long-term development plan is to shift enterprises from the low-end, labor-intensive manufacturing that has driven China’s economic success over the past three decades into higher-margin activities. Pulling off that trick is critical to sustaining growth in coming years and avoiding the so-called middle-income trap whereby many economies stall when per capita incomes hit about $15,000 a year. The strong growth of wages in recent years and the rise of the renminbi, which combine to render Chinese goods more expensive overseas, makes the transition all the more important. The renminbi has gained 40 percent against the U.S. dollar in real terms since 2005, according to a December report by the U.S. Treasury Department, while China’s current five-year plan calls for the minimum wage to go up by 13 percent a year through 2015.

“Chinese companies are fundamentally adjusting their business models,” says Rhodium research director Thilo Hanemann. “Domestic economies of scale in manufacturing are maxed out, so they must capture a greater share of the production chain, both upstream and downstream.”

That ambition explains Chinese companies’ appetite for technology. In 2010, Zhejiang Geely Holding Group Co., parent of China’s seventh-largest automaker, bought Volvo Car Corp. from Ford Motor Co. for $1.8 billion. Geely hopes Volvo’s technology will help it compete more effectively against the Chinese subsidiaries of foreign automakers such as General Motors Co. and Volkswagen. Chinese brands saw their share of the domestic market fall by nearly 2 percentage points in 2011, to 29.1 percent, according to the China Association of Automobile Manufacturers.

Just as China is gaining a bigger appetite for foreign acquisitions, Europe’s economic crisis is providing plenty of opportunities for cash-rich buyers. It’s no surprise, then, that Chinese companies have turned to Western Europe for some of their most significant recent purchases. The country’s direct investment in Europe rose to about $9 billion last year from $3 billion in 2010 and an average of about $1 billion a year before 2008, estimates Hanemann.

“There are manufacturing industries in Europe facing stalled growth and eroded competitiveness,” says Yang Chang-po, a managing director at Goldman Sachs Gao Hua Securities Co. in Beijing. “Many manufacturers are looking to sell themselves, and China in particular gives a higher premium for their assets, their technology and their production know-how.”

Many of these deals are aimed as much at bolstering the domestic businesses of Chinese companies as conquering foreign markets. Shandong Heavy hopes its acquisition of Ferretti will facilitate the Italian company’s yacht sales in China, where the number of millionaire households reached 1.11 million in 2010, according to Boston Consulting Group. In April 2011, China National Bluestar (Group) Co., a joint venture between state-owned China National Chemical Corp. and the U.S.’s Blackstone Group, paid $2.17 billion for Norwegian silicon materials producer Elkem. The deal gives Bluestar access to raw materials and technology to upgrade its Chinese plants.

Chinese companies have been quick to take advantage of the distress of some of Europe’s most debt-ridden states. In December, China Three Gorges Corp., operator of the world’s largest hydropower project, outbid E.ON, Germany’s largest electric utility, and Centrais Elétricas Brasileiras, Brazil’s state-owned power company, to acquire a 21.35 percent stake in Energias de Portugal from the Portuguese government for €2.7 billion. As part of the deal, Three Gorges will also help arrange a €2 billion long-term revolving credit facility for EDP and invest another €2 billion by 2015 for minority stakes in Portuguese power projects. Portugal’s government was required to sell the stake as part of a €78 billion bailout agreement with the European Union, the European Central Bank and the International Monetary Fund. That agreement also obliges the government to privatize other assets. In February, State Grid Corp. of China bought a 25 percent stake in Portuguese electric utility Redes Energéticas Nacionais for €387 million.

In 2009, Cosco Pacific, the Hong Kong–listed subsidiary of China’s state-owned shipping and logistics conglomerate China Ocean Shipping (Group) Co., paid $4.2 billion to secure a 35-year concession to operate two of the three container berths in Piraeus, Greece’s biggest container port.

CHINESE COMPANIES STARTED investing overseas as far back as the 1980s as state investment enterprises started buying real estate and industrial assets, including stakes in Hong Kong’s flag carrier, Cathay Pacific Airways, and Hong Kong Telecommunications. Activity stepped up following the country’s entry into the World Trade Organization in 2001, an event that signaled China’s arrival on the global economic stage and lowered barriers to trade and investment. Taking advantage of China’s new trade status, then-Premier Zhu Rongji launched a “go global” policy in the country’s tenth five-year plan that encouraged Chinese enterprises to expand overseas. In effect, the government adopted the South Korean model of encouraging the country’s biggest and most strategic industrial companies to become multinational conglomerates capable of developing global brands and competing around the world.

The more than 150 large state-owned enterprise groups under Beijing’s direct control account for about 70 percent of China’s foreign direct investment, and the country’s 20 biggest overseas investors are all state-controlled conglomerates, led by China National Offshore Oil Corp. (Cnooc), China National Petroleum Corp. and China Petroleum Corp., according to Ministry of Commerce statistics.

In December 2004, China made a breakthrough when Beijing-based Lenovo Group agreed to buy IBM Corp.’s personal computer business for $1.75 billion, thereby gaining control of the iconic brand that launched the PC industry. The deal signaled the desire of Chinese companies to join the top ranks of the world’s multinational elite rather than simply working as low-cost, low-margin manufacturers.

Yet Chinese efforts met with as much failure as success in the first half of the previous decade. In 2000, D’Long Group, a privately owned auto-parts and food conglomerate, bought U.S. lawn mower and garden equipment maker Murray for $400 million, seeking to combine Murray’s design and distribution capabilities with China’s low-cost manufacturing. Instead, quality problems with Chinese components led to product recalls and declining sales, and just four years later Murray filed for bankruptcy protection. U.S. engine maker Briggs & Stratton Corp. bought most of Murray’s assets in 2005.

Other notable setbacks included Shanghai Automotive Industry Corp. (Group)’s 2004 acquisition of a 49 percent stake in Ssangyong Motor Co., then South Korea’s fourth-biggest automaker. Ssangyong had been making headway in export markets — particularly, in selling sport utility vehicles in the U.S. — but rising gasoline prices and the global financial crisis hit it hard. The company filed for receivership in January 2009, forcing SAIC to write off practically all of its $618 million investment.

China’s most significant failure occurred in 2005, when Cnooc made an $18.5 billion bid for U.S. oil company Unocal, sparking massive political opposition on Capitol Hill. Cnooc withdrew its offer a month later, allowing Chevron Corp. to sweep up Unocal.

Those early failures resonated in China’s state-led economy. Top corporate executives hold political responsibilities that include leading Communist Party committees within their respective companies. These executives routinely move among roles in industry, regulatory agencies and the government. They have to consider the political implications of a deal going badly, not just whether a purchase will be accretive or dilutive to shareholders. The result is an inbuilt caution toward takeovers. “Chinese companies tend to spend more time building consensus with regulators,” says Goldman Sachs Gao Hua’s Yang. Cheng Li, a research director at the Brookings Institution, a Washington think tank, echoes the point. “There is no doubt that Chinese business leaders want to go overseas, but they worry about whether foreign policy objectives may conflict with the go-global efforts,” he says.

Recent appointments underscore the nexus between industry and the state. In October, Guo Shuqing, chairman of China Construction Bank Corp., and Xiang Junbo, chairman of Agricultural Bank of China, resigned to head the China Securities Regulatory Commission and the China Insurance Regulatory Commission, respectively. They were replaced by Wang Hongzhang, a deputy governor at China’s central bank, and Jiang Chaoliang, chairman of Bank of Communications and former president of China Development Bank Corp.

Would-be acquirers also have to run a gauntlet of bureaucratic obstacles. Although the authorities clarified procedures in 2009 and provided for greater sources of funding, getting approvals is still a challenge for Chinese companies, especially in a bidding process, says Lazard’s Yan. Companies must obtain approval from the Ministry of Commerce for any offshore investment exceeding $100 million; deals worth more than $10 million require a nod from provincial authorities. Offshore investments also require approvals from the National Development and Reform Commission; the State-Owned Assets Supervision and Administration Commission, which wields the government’s authority as shareholder; and the State Administration of Foreign Exchange, the central bank arm that manages China’s currency reserves.

These hurdles cause uncertainty and delays that can impede deals. In January, China Development Bank lost its bid to acquire the aircraft-leasing business of Royal Bank of Scotland Group to a consortium led by Sumitomo Mitsui Financial Group. Although CDB reportedly bid more than the Japanese group’s $7.3 billion offer, concerns about the Chinese approval process undermined its efforts.

Yet in spite of the obstacles, more and more Chinese companies see foreign takeovers as essential to their future growth.

One of China’s leading serial acquirers is HNA Group Co., owner of Hainan Airlines; the company has used M&A to create an aviation, logistics and tourism conglomerate. In December the group acquired GE SeaCo, a maritime-container-leasing unit of General Electric Capital Corp., for $2.5 billion. HNA did the deal with Bravia Capital, a Hong Kong–based private equity company that has coinvested with HNA on six deals in the past five years. “We are looking at bolt-on strategies, allowing us to leverage our Chinese arm with non-Chinese businesses and raise revenue at a much faster rate than costs,” says Bravia CEO Bharat Bhise, who has worked closely with HNA since 1995, when he helped arrange an investment in the airline by a vehicle controlled by George Soros. HNA has already secured $500 million in new business for SeaCo operations, 60 percent of it from Chinese companies.

In October 2011, HNA teamed with Bravia to buy ACT Airlines, an Istanbul-based cargo carrier they rebranded as MyCargo Airlines. A year earlier the two companies had purchased MyTechnic, a major, Istanbul-based aircraft maintenance and repair concern. Terms of the deals weren’t disclosed. With its airline and servicing operations, HNA is in a prime position to profit from the fast-growing trade between China and the Middle East and Eastern Europe. Acquisitions have expanded HNA’s footprint and helped sales grow by 35 percent last year, to more than 100 billion yuan ($15.9 billion). “We have a breakneck strategy, and we’re growing very fast,” says Bhise.

Other Chinese groups are also using takeovers to acquire consumer brands, often with a main goal of strengthening their competitiveness at home. Fosun International, a Shanghai-based pharmaceuticals, steel and property conglomerate, bought a 7.1 percent stake in French resort operator Club Méditerranée in 2010. Last year Club Med opened a ski resort in Yabuli, near Harbin in northeastern China. The company plans to open a second resort in the southern tourist city of Guilin later this year. “We only invest in those companies which value our participation in their strategy in China,” says Guo Guangchang, Fosun’s chairman, in an e-mail response to questions.

In 2010, Shanghai Jin Jiang International Hotels (Group) Co., China’s biggest hotel group, joined Annapolis, Maryland–based private equity outfit Thayer Lodging Group to acquire Interstate Hotels & Resorts, the largest U.S. independent hotel management company, which operates 232 properties. Interstate is the only U.S. publicly listed company that’s been taken private with the backing of a Chinese state-owned enterprise. The deal not only provided Jin Jiang with a platform for extending its brand internationally, it also gave the company access to Western management practices to strengthen the group domestically, chairman Yu Minliang said at the time.

Management skills are a key concern for many acquirers. Some Chinese executives struggle to bridge the culture gap and comply with legal and regulatory standards in overseas markets. Chinese Vice Premier Wang Qishan underscored the challenges three years ago when he cautioned Xiang Wenbo, president of Sany Heavy Industry, about hunting for overseas companies. Sany, often referred to as China’s Caterpillar, employs more than 70,000 workers and earned 8.65 billion yuan on sales of 50.5 billion yuan in 2011.

“Do you have a handle on your own management capabilities?” Wang was quoted as asking Xiang at a meeting with the Hunan delegation to the National People’s Congress, China’s Parliament. “Have you analyzed the cultural differences of the two sides? Do you understand the relationship between unionized labor and management in that place? If the other side’s engineers resign, are you going to send people from Changsha and make the whole company speak Hunanese?”

At Putzmeister, its latest acquisition, Sany has decided to leave the company’s German management, led by CEO Norbert Scheuch, in place. “Putzmeister will remain as an independent brand with its own management within the Sany group,” said Liang Wengen, Sany founder and chairman, in announcing the merger. Similarly, China National Agrochemical Corp. said in October that it planned to keep the existing management at Makhteshim Agan and maintain the company’s Tel Aviv headquarters.

China National Bluestar, which needed 18 months to complete its buyout of Elkem, raised management issues at the start of its negotiations to ensure that Elkem’s senior executives would remain in place after the acquisition, according to Kit Chan, one of the RBS bankers who advised Bluestar on the deal. “Bluestar planned how the future management team would look and how they would manage the business moving forward,” says Chan.

In Kazincbarcika, Hungary, Wanhua Industrial has spent the past year turning BorsodChem into its European beachhead. CEO Ding has integrated the Hungarian company’s sales force into Wanhua Industrial’s global network and invested €200 million in a new plant to make toluene diisocyanate, a raw material for producing flexible polyurethane foams used in upholstery and automotive seats. Next, Ding plans to introduce Wanhua’s energy-efficient technologies at BorsodChem. Notwithstanding Europe’s economic woes, the executive believes his enlarged company will profit from reconstruction and insulation projects across Europe. “We are strategically positioned in Central Eastern Europe, and we think growth will return to the whole of Europe, so we are optimistic,” Ding was recently quoted as saying.

With such confidence brimming in corporate China, the country’s foreign takeover spree may be just beginning. • •