Presentation Transcript

1. PRC M&A, JV Buyout Seminar Mark Schaub February 13, 2008 China M&A
2. What’s happening Source: Thomson Financial 3
3. Why is M&A a hot topic for foreign investors? China definitely on the radar internationally. Move from green-field projects to M&A activities. RMB Appreciation viewed as a given New sectors opened to foreigners under WTO commitment HOT areas include: Automotive Machinery Pharmaceuticals Financial sector Retail Real Estate Construction materials Energy Mining 4
4. Why a hot topic for Chinese authorities? Chinese government increasingly fear that foreign companies are taking over the manufacturing base of the country. Worries exist that Chinese brands and ability of domestic companies to innovate will gradually disappear. Concerns of local industries that foreigners enjoy monopoly in many industrial sectors, such as light equipment, skincare, beverages, packaging etc. Resentment over CNOOC's failed bid for Unocal. Stalled projects include Carlyle, Caterpillar, Schaeffler Group 5
5. I. Legal Framework 6
6. Legal Framework for M&A and JV Buyout M&A regulations Foreign M&A Rules (08/08/2006) Takeover Rules of Listed Companies (07/31/2006) Foreign Strategic Investment Rules (12/31/2005) Foreign investment laws and regulations Laws and Implementing Rules on CJV, EJV, WFOE Revised Foreign Investment Industrial Catalogue (10/31/2007) NDRC Foreign Investment Projects Approval Procedures 7
7. Legal Framework for M&A and JV Buyout—Cont’d JV buyout regulations FIE Merger and Division Provisions (11/22/2001) Investor’s Equity Change Provisions (05/28/1997) FIE Liquidation Measures (07/09/1996) 8
8. New Milestone - M&A Rules Mostcomprehensive M&A regulations in China to date. Endorsed by 6 Chinese regulatory bodies: MOFCOM, SASAC, SAIC, STA, CSRC, SAFE Good news Approval requirements and procedures clearly spelt out. Chinese government and companies more experienced in M&A transactions. Opens the door to acquisition by share swaps. Not so good news New limitations and restrictions imposed. Approval authorities granted with wide discretionary power. 9
9. National Economic Security Concerns Any deal involving a key industry or famous brand, or may affect national economic security shall be filed with MOFCOM (Article 12) Broad scope of applicability may have sweeping impacts. Possible key industries: nuclear power machinery shipbuilding military power generation/transmission steel MOFCOM may stop a deal it has grounds to believe that it will affect national economic security – similar to US CFIUS review. Vagueness in rules escalates uncertainty in deals. 10
10. Share Swap Share swap is permitted as a M&A tool for the first time in China. All share swaps subject to approval by MOFCOM Offshore entity must be listed in stock exchange. MOFCOM approval is valid for 6 months only - share swap must be completed in the specified time period. Onshore share transfer will be reversed if the MOFCOM approval lapse. SPV may be used to list PRC assets offshore – “small red chip” A number of PRC governmental approvals required: MOFCOM, CSRC and SAFE “small red chip” became much more restrictive if not impossible Proceeds of offshore listing must repatriated. 11
11. Negotiation Approval Closing Identify target Signing term sheet Due diligence Contract drafting Negotiation Definitive agreements SASAC approval Industrial departments MOFCOM approval Anti-trust filing Business license SAFE approval Conditions precedent Pre-closing audit / due diligence Closing / Payment Post-closing integration M&A Roadmap 12
12. 2007 Foreign Investment Catalogue The Foreign Investment Catalogue lists industries that are encouraged, restricted or prohibited for foreign investors and is updated by NDRC and MOFCOM from time to time to reflect government policy. The 2007 Catalogue has been effective as of 1 December 2007. Encouraged sectors expanded to include more high-tech, energy-saving and environmental friendly industries. Service sector further opened to foreign investment: such as financing services, logistic and service outsourcing industry . Exploration of mineral resources and raw materials of strategic importance is more restricted. Export oriented manufacturing no longer encouraged. Foreign investment in real estate more restricted. Media and broadcasting (incl. news website, news agency, internet entertainment etc.) totally prohibited. 13
13. II. Due Diligence 14
14. Types of Due Diligence Legal - carried out by law firms checking the legal status of Chinese target’s i.e. 1) ownership structure; 2) assets; 3) operation; 4) staff and personnel Financial - carried out by accountancy firms to check compliance with accounting and financial requirements (some overlap) Investigatory - carried out by investigation firms to check bone fides of other side Environmental - carried out by expert consultants 15
15. Due Diligence - Procedure Meet with client Understand project Draft strategy paper Preparation for field work Field work Draft report Follow up Draft transaction documentation
16. III. Structure 17
17. M&A Transactions in China China is still highly regulated in M&A transactions. Share/Asset transfer effective only upon approval NOT signing Governing law for transfer agreement must be PRC law Price must be based on appraisal by independent valuator Payment terms shall comply with mandatory terms: 60% within six months Remainder within one year Major forms of transaction: Share Acquisition Assets Acquisition 18
18. Share Deal Buyer will take over all business, assets, liabilities of the target. Careful due diligence is a must - pre-closing restructuring may be required. Share deal may be achieved through: share purchase from current shareholders subscribe to an increase in equity of the target share swap Seller Foreign Investor Share transfer Target 19
19. Case Study (I) Background: A foreign energy company (“Foreign Co.”) intends to acquire the retail energy business of a domestic energy company in eastern China (“China Co.”) . China Co. has 2 subsidiaries and over 50 branches over 3 provinces. Factors considered after due diligence: 20
20. Case Study (I)—Cont’d Factors to be considered based on the due diligence: Final decision—client decided for Share Deal because: The existing liabilities of China Co. were found to be at an acceptable level. Pre-issuance of license would lead to massive disruption of the business. Payment in installment against milestones to reduce risks. Share pledge by Chinese partner as security Chinese partner would need to stay in the JV 21
21. Diagram of Share Deal Share transfer 50% Foreign Co. Chinese Partner 50% shareholder China Co. Business continued Closing much easier Operational license remained in place Liabilities remained in company Branch Branch Branch Subsidiary A Subsidiary B Branch Branch Branch 22
22. Buying the Assets An onshore vehicle is required to own and operate asset in China. Complication in transfer all business, customers, contracts, assets and employees - notification to creditors is required. Encumbrance will need to be discharged before the transfer. Recommended if: The target has high level of exposure / noncompliance Only part of the business is desired. Foreign Investor Chinese Target Investment Asset Transfer Investment Vehicle 23
23. Case Study (II) Background: A foreign machine company (“Foreign Co.”) intends to acquire a domestic machine building company in North-eastern China (“China Co.”) Factors to be considered based on the due diligence: 24
24. Case Study (II)—Cont’d Factors to be considered based on the due diligence: Final decision—Asset Deal because: The existing liabilities of China Co. were found to be large in the due diligence, including loans, land, employees. Not difficult to re-apply for new operational licenses. 25
25. Diagram of Assets Deal Asset Purchase Agreement Foreign Co. China Co. China Investors Various other agreements i.e. land, patents, transfer of business, key employee contracts WFOE No inherited liabilities Clean start Difficult and time consuming closing Destroyed sense of co-operation between parties 26
26. Structuring the Deal Share Deal Asset Deal VS. + - Generally reduce risks of legal liabilities tracking back to newco Inherit all debts and liabilities of target More difficult to spin-off undesired assets or liabilities + Possibility to cherry pick assets or liability - + - New operational licenses required Noneed to transfer operational license Ownership of all assets and contractual agreements need to be transferred - + No need to transfer title of assets Higher risk that Chinese party will carry on competing business Less risk of Chinese party continuing business as competitor - + More favored by lawyers and accountants because less exposure to hidden liability Favored by business people because less disruption to existing business ! ! 27
27. JV Buyout in China A JV buyout may be realized through the following ways: Buy out the Chinese partner and transform the JV into a WFOE Buy out a large proportion of the shareholding of the Chinese partner, with the Chinese partner remaining as a minority silent shareholder Sell shares in the JV to the Chinese partner/other company Liquidate the JV Sue the Chinese partner for breach of contract Walk away, i.e. cease the cooperation 28
28. Summary of Different Options In summary, the pros and cons of the various options are as follows: 29
29. Summary of Different Options—Cont’d In summary, the pros and cons of the various options are as follows: 30
30. Case Study (III) Background: A foreign company intends to buy out the Chinese partner and transform the JV into a WFOE. Factors to be considered: Whether a WFOE is permitted under the Industry Guidance Catalogue Relocate the WFOE Call option in the JV Contract Price determination Restructuring of personnel 31
31. IV. Being Aware of Problems 32
32. Common Problems in M&A How to deal with non-compliance? Evidencing ownership of assets State-owned assets requirements Labor issues Anti-trust review Intellectual property rights protection 33
33. How to deal with non-compliance Almost all Chinese companies have variant level of non-compliance. Chinese companies are more used to informal arrangements. Non-compliance is widespread: labor, tax, social contribution, licenses, IP etc. Risks shall be assessed from both legal and practical perspectives. Not surprisingly foreign invested companies are subject to more stringent scrutiny of Chinese government than their local peers. Regular internal audit is recommended post transaction. 34
34. Corporate Governance New Company Law improves fiduciary duties but much the investor can do: Build in Safeguards/Set Guidelines Management By-Laws Employment Contracts Non-Competition covenants Employee Handbook On-Going Involvement 35
35. Fraud Prevention Not a priority for most companies, but a serious and growing problem in China: Ensure HQ involved and exercises oversight Safeguards/Set Guidelines Internal audits Active board Avoid ethical blindspots Management guidelines 36
36. Evidencing the Assets Ownership of assets and properties are often in question. Land use rights and real property are often problem areas. Granted land vs. allocated land In most cases assets are subject to encumbrances or third party claims. Connected party transaction may result in intermingling of company assets. 37
37. State-owned Assets Rules Disposal of state-owned assets is subject to complicated approval procedures. Mandatory valuation by licensed appraiser firms Commonly used valuation methodology – replacement value Appraisal results must be confirmed by SASAC Transaction price cannot be lower than 90% of the appraisal results. Target must be listed in Asset Exchange Center Substantial delay in the closing schedule Risk that a potential bidder may crash the party Standard contracts of the Exchange Center must be used 38
38. Labor Issues Settlement of staff and workers may cause substantial costs to the transaction. An employee settlement plan must be prepared for M&A deal. Lay-off is to be negotiated with local government. Labor related costs should be considered in valuation: Severance pay to laid-off workers Compensation for change of status Should be considered in the valuation 39
39. Anti-Trust Filing So far most anti-trust filings have been procedural, but it is expected to have more teeth. Threshold for anti-trust is rather low: Turnover of a transaction party in China exceeds RMB 1.5 billion. The foreign investor has cumulatively acquired more than 10 domestic enterprises in one year. Current market share of a party exceeds 20% in China Post-deal market share of a party will exceed 25% in China. Anti-trust review may also be requested by domestic competitors, government agencies or industrial associations. Offshore M&A may also be subject to anti-trust filing in China if meeting certain thresholds. 40
40. Intellectual Property Rights IP protection in China is better than its reputation. IP due diligence necessary to assess risks of IP infringement: Targets using technology to which they are not entitled Particular risks in export market Trademarks/patents not properly registered in China Risk of technology leakage Chinese partners, employees, competitors Measures to be installed to avoid technology leakage and protect IP 41
41. Instruments to Lower Risk Due Diligence – investigate ownership and title over assets, business, compliance Closing Conditions – correction measures on basis of due diligence results Payment – installments within the mandatory frame Reps & Warranties – ownership and compliance Indemnity – any undisclosed liabilities Unilateral termination – set out triggers, exit 42
42. V. Summary 43
43. Main Points to Note “Make it as simple as possible but not any simpler” - Albert Einstein M&A is becoming increasingly popular in China. BUT also becoming increasingly complicated. Structure the transaction to suit your needs. Due diligence is a must before any commitment. Transaction documentation is a key way to limit exposure 44
44. Q&A Mark Schaub Partner in the Business Group of King & Wood, specialized in foreign direct investment, M&A, compliance, intellectual property and private equity investment in China. Mark has advised foreign investment projects in major sectors including retail, power, media, internet, renewable energy, transportation, automotive and manufacturing, etc.  Tel: 0086 21 2412 6300 Email: schaub@kingandwood.com Website: www.kingandwood.com www.china-artoflaw.com 45
45. Mergers & Acquisitions in China Seminar – February 13, 2008 Clarence Kwan, the National Managing Partner of the U.S. Chinese Services Group for Deloitte & Touche USA LLP moderates the seminar 46
46. Mergers & Acquisitions in China Seminar – February 13, 2008 Felix Chang and Harvey Cohen of Dinsmore & Shohl LLP listen in on the conversation 47