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Restructuring Options for Foreign Investment Enterprises in China

Explore the three main restructuring categories for foreign investment enterprises in China: Turnaround of JV, Equity Structure Restructuring, and Withdrawal. Learn about the implementation methodology, pre-selection criteria, and key considerations for each option.

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Restructuring Options for Foreign Investment Enterprises in China

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  1. D. Restructuring options

  2. D1. General options and pre-selection

  3. In China, as far as foreign investment enterprise is concerned, there exist three main restructuring categories Turnaround of JV Equity structure restructuring Restructuring of investment projects in China Withdrawal

  4. On the basis of favorable results of market and competitive analysis, option category I and II are most commonly used for companies’ long-term development Option 2: Equity structure restructuring Option 1: Turnaround of JV Option 3: Withdrawal Charact-eristic • Performance improvement with equity structure change • Buyout • Withdrawal from existing investment projects • Sell out equity • Termination • Bankruptcy • Freezing (walk away) • Performance improvement without changing the equity structure Examples • Dinova • BOSCH Thermo Technik • Linde forklifter • Whirlpool’s refrigerator JV in Beijing • Peugeot Guangzhou • Liebherr • Siemens • Bosch Siemens • Siemens • Bayer • Henkel • ABB

  5. Restructuring alternatives Implementation The general methodology is to filter options with killer criteria and hard criteria to screen out restructuring alternatives Potential options Procedure Pre-selection Killer criteria • Solve key problems • Secure future success Hard criteria In-depth evaluation • General • Cost • Time • Risk • Integration (GSHA-GDAI) • Sales & marketing • Management • Others Conclusion

  6. At pre-selection stage, turnaround, sell out equity and freezing can be eliminated with killer criteria • Pre-selection Killer criteria Chinese Partner in? Pass? Remarks Solve key problems Secure future success I. Turnaround Yes No No No • It’s very hard to implement future integration and consolidation without full control the board of directors • II. Equity structure restructuring • - Equity buyout • No • Yes • Yes • Yes • Geberit gains full control • III. Withdrawal • (1) Sell out equity • (2) Termination • (3) Bankruptcy • (4) Freezing • Yes • No • No • Yes • No • Yes • Yes • No • No • Yes • Yes • No • No • Yes • Yes • No • It’s almost impossible to find a buyer • It opens the way for a new start • It opens the way for a new start • Freezing will ruin Geberit’s relation with local government, thus causing potential hurdle for future presence and trouble to GDAI

  7. To file bankruptcy and liquidate the JV. If the creditor is JV’s foreign parent company, to file bankruptcy by creditor is theoretically possible but practically infeasible in China Bankruptcy Back-up • To buyout the equity ownership from Chinese partner, thus turning the JV into a wholly foreign owned enterprise (WFOE) Buyout • Withdraw all foreign management team and expatriate employees and leave the JV to Chinese partner without file termination or bankruptcy. It‘s an illegal but widely adopted practice in China Freezing Termination • To cease operation and liquidate the JV • Definition of some options

  8. Back-up Some key problems of GSHA are closely linked to the Chinese partner. A clean break can only be assured by a separation • The VGM of Lida maintains an unofficial network consisting of former Lida-employees. He often uses this network to secure his personal interests • Since this VGM has direct access to personnel files (Fuehrungszeugnis) some employees were blackmailed if they didn’t cooperate with him • In context with the Nanxiang production site the VGM should have accepted a considerable amount of kickbacks, said some former GSHA’s employees

  9. Back-up Key statement from some former GSHA employees on Mr. Cai (1) • There is no cooperation between two partners from the very beginning. Mr. Cai said " we make this joint venture bankrupt in 3 years. We can restart again by ourselves." " It does not matter that Geberit is losing money in China. It took Geberit 10 years to make profits overseas, it needs the same time in China as well. Anyhow, it is Geberit's money. " Mr. Cai has extensive network in the industry but he does not use it for Geberit products. In contrast, he introduced the business for other companies that have close relationship with him. • All the important decisions regarding personnel recruiting are made by Mr. Cai. Mr Schuette does not and is not able to influence these decisions. Some of these decisions are against Geberit's interests, for example, some Chinese employees intend not to do the work properly and some key persons in key positions are not qualified, such as production, stock control, CCS etc. • The control system in the company is totally scrapped. At the beginning of the joint venture, about RMB600K machines and 100 moulds were lost without any record. The warehouse only checks the book records rather than real goods. As a result there is difference between the book number and the real amount. This is especially serious on the incoming raw materials. They suspect that some financial accounts, especially done by Mr. Chang daohua, are false. The so-called scrapped products and the waste raw materials are sold in a not transparent way, i.e. no specific price and no invoice. The responsible person is appointed by Mr. Cai. Due to the poor control system in all areas waste is high. Auditing is extremely necessary.

  10. Back-up Key statement from some former GSHA employees on Mr. Cai (2) • Geberit products' technological know-how is obtained by Lida. Mr. Cai assigned one person in CCS (Ms. Ying Hua) and has obtained relevant technological information. It is possible for Lida to produce similar products if Geberit withdraws from the joint venture. More seriously, it is believed that the know-how of Duofix has been released to TOTO. • The business original plant location is 100 meters further north, without any work involved for the new location. More than RMB100k has been spent on work mentioned above. And Mr. Cai insisted on contracting the electricity supply system to one local electric engineering company with a cost of RMB 1560K. • The former manufacturing plant of Lida in Chang ping Road was leased to another company with annual rent of around RMB1 million which is handed to Mr. Hong/SBMC • In year 1998, Mr. Cai used company’s money to buy 5 Peony cards (debit cards) with value of RMB 30k each and sent to five key persons as presents, including Mr. Hong and himself

  11. Back-up Although Lida’s products account for 52% of GSHA’s total sales volume, their actual gross profit margin is -7%. Meanwhile, Lida products’ sales volume sharply declined 60% from 1999 to 2000 GSHA sales volume (2000) Lida products’ sales volume Actual gross profit margin: 4% Unit: RMB ‘000 Gross profit margin 36% Gross profit margin -7% Imported Lida GSHA’ products Gross profit margin -7% Watertank Pipe & fitting

  12. The original policy that required all welfare residential building to have sanitary ware (low end) included at construction stage is invalid • Welfare house allocation system is disappearing • House decoration becomes a popular consumption trend • Medium and high end sanitary ware products’ brand awareness improved which increase brand sensitivity substantially • Consumers with growing purchasing power are turning to medium and high end sanitary ware products Back-up The reason behind Lida products’ sharp decline is the change in government policy on residential building construction and the shrinkage in low end sanitary ware market Government Shrinkage of low end market

  13. D2. In-depth evaluation

  14. Hard criteria Cost, time, risk and potential impact on future integration constitute hard criteria in determining which option to choose Cost Time Options Inte-gration • Equity buyout • Termination • Bankruptcy Risk

  15. D.2.1 Equity buyout

  16. Cost Time Risk Integration • Buyout price: USD 149,0001) • Employee dismissal fee: USD 80,000 ~ USD 340,0002) (90% of employees will be dismissed) • Audit firm: USD 20,000 • Negotiation period- max. 2 months • Execution time- 1 month • Lida is not willing to sell out equity • Lida asks for too high price, and price negotiation breaks down • Government’s concern on unemployment • Nanxiang disagrees to sell out equity • Geberit has full control over its China operation • Free choice of how to restructure and consolidate the operations in China • No need to close Shanghai’s operation 249,000~509,000 USD Max. 3 months - to -- +++ Buying out Lida’s equity is favorable to future integration but the buy out price have to be agreed by Chinese partner Criteria Explana-tion Total 1): Under the premise that the Chinese partner agree with this price 2): Whether to take Lida employees’ service time in Shanghai Lida into account results in different amount of employee dismissal fee

  17. The investors of an FIE1) (and the third parties) agree on the equity change (or transfer) • A written agreement must be signed by all parties 1 Back-up • The FIE submits the application for equity change to the local Foreign Investment Commission (FIC) • The FIC must reply within 30 days after submission 2 • Upon approval the FIE must complete all registration procedures at the Administration for Industry and Commerce and other related Governmental bodies within 30 days 3 Providing Lida and Nanxiang agree on equity transfer, the whole transfer procedure consists of 3 major steps and last for 2~3 months 1): Foreign Invested Enterprise

  18. Back-up An equity transfer agreement must cover the following contents • Equity transfer agreement • Name, address and legal representative of both the transferor and the transferee • Shares and price of the transferred equity • Date and way of equity transfer • Right and responsibilities of the transferee • Consequences in case of violation • Applicable laws and conflict resolution • Validation period and termination of the agreement • Date and place of the agreement singing

  19. Bankruptcy Back-up Buyout • Dismissal fee: USD 360,000 • Audit firm: USD 20,000 • law firm: USD 20,000 • Tariff return: USD 19,000 • Total: USD 419,000 • Dismissal fee: USD 250,000(90% of employees dismissed) • Audit fee: USD 20,000 • Buyout price: USD 149,000 For Geberit, the bottom line of buyout price could be determined on the basis of financial comparison analysis

  20. D.2.2 Termination

  21. Cost Time Risk Integration • Employee dismissal fee: USD 100,000 ~ USD 360,0001) • Audit firm: USD 20,000 • Tariff return: USD 19,000 • Personal incentive • Negotiation period- max 2 months • Termination period- within 4 months • Lida is not willing to sell out equity • Dismissal fee dispute • Government’s concern on unemployment • Under current situation, providing Chinese partner agrees, termination can be the most favorable option for Geberit but it’s very hard to reach agreement with Chinese partner without incentive terms 139,000~399,000 USD 3~6 months - to --- ++ Generally speaking, termination is unfavorable to Chinese partner, however, it can be used in some cases to achieve the foreign partner’s objective very quickly (personal incentive) Criteria Explana-tion Total 1): Whether to take Lida employees’ service time in Shanghai Lida into account results in different amount of employee dismissal fee

  22. Initiate party • Joint venture (Board of directors) • Joint venture (Board of directors) • Liquidation procedure • Time • 3~6 months • Regular liquidation • 6~18 months • Bankruptcy liquidation • Board of directors • Other cost • Government • Court • Audit firm • Law firm • Audit firm cost • Law firm cost • Other cost • Liquidation committee • Liquidation cost Compared to bankruptcy, termination generally has lower cost, shorter execution period and more simple procedure in liquidation Termination Bankruptcy

  23. D.2.3 Bankruptcy

  24. Cost Time Risk Integration • Employee dismissal fee: USD 100,000 ~ USD 360,0001) • Audit firm: USD 20,000 • Law firm: USD 20,000 • Tariff return: USD 19,000 • 6~18 months (Although the China’s Bankruptcy Law provision that the liquidation should be completed within 6 months, many cases actually last for more than 1 year • Can’t get government approval • Lida’s opposition • Dismissal fee dispute • Negative press • Lose everything including: investment loan, account receivable and staffs • Complicated process to keep the business running • To transfer equipment to Daishan or Ningbo could be very difficult 159,000~419,000 USD 6~18 months --- - In view of cost, time, risk and future integration, bankruptcy should be the last choice for Geberit Criteria Explana-tion Total 1): Whether to take Lida employees’ service time in Shanghai Lida into account results in different amount of employee dismissal fee

  25. Back-up Bankruptcy procedure in case of the decision made by board of director • Liquidation procedure 1 • All the members of BoD1) agree to bankrupt the company. • The BoDand the supervising body of the Chinese partners in case of JV agree to dissolve the FIE2) • The FIE applies to the local Foreign Investment Commission in order to formally begin the liquidation procedure 2 • Upon approval the BoD must organize a liquidation committee within 15 days of the beginning of liquidation 3 • The FIE must provide written notification of the name and address of the FIE and reasons for liquidation to customs, tax authority, banks with whom the FIE has an account, and etc. within 7 days from the start of the liquidation 4 • The liquidation committee must dispose of assets and the credits and debts of the FIE • Priority for paying out debts: liquidation expenses; wages and social insurance premiums; state taxes; other debts 5 • After completing all the liquidation work the liquidation committee must submit a final liquidation report to the BoD for approval • Upon approval the report must also be submitted to the supervising body and the local Foreign Investment Commission 6 • The liquidation committee goes through all the cancellation procedures with the customs, the tax bureau, the local Administration for Industry and Commerce and makes and Announcement 1): Board of Directors 2): Foreign Invested Enterprise

  26. Back-up The liquidation value (market price) of GSHA would be USD 2.51 million Items Devaluated total assets after liquidated Devaluted property, plant, equipment: USD 2,142,000 x 0.6 = USD 1,285,000 • Property, plant, equipment: USD 2,142,000 Non-current assets USD 1,002,000 x 0.6 = USD 601,000 524,000 x 0.8 = USD 419,000 208,000 X I = USD 208,000 • Inventory: USD 1,002,000 • Account Payable: USD 524,000 • Total cash and security: USD 208,000 Current assets • Total assets (Book value): USD3,951,000 Liquidation value (Market price): USD 2,510,000 Total assets

  27. D.2.4 Comparison of the alternatives

  28. Equity buyout is clearly the best choice for Geberit. Termination can be very attractive if both parties can achieve mutual understanding Cost Time Risk Integration Equity buyout - to -- +++ • USD 249,000 ~USD 509,0001) Max. 3 months Termination • USD 139,000 ~USD 399,000 • + Personal incentive - to --- ++ 3~6 months Bankruptcy --- - • USD 159,000 ~USD 419,000 6~18 months 1): Under the promise that the Chinese partner agree and the figure already include redundancy restructuring cost

  29. Buy out is not only the most beneficial option to Geberit, but also to the rest of parties as well Buy out Termination Bankruptcy o to ++ o to ++ ++ ++ + +++ + to +++ + to +++ - - / ++ - - / ++ - - - + - - - - - - - - - - - - - - - o Mr. Cai Mr. Hong / SBMC Nanxiang Government Municipal Government GSHA employees Geberit 1) 1) 1) 1) 2) 2) +++ : best - - -: worst 1): Personal incentives 2): Re-investment

  30. D3. Feasible scenarios

  31. Geberit should start the negotiation quickly. If no agreement can be reached, bankruptcy could be the last outcome with the consequence of losing everything (investment, loans, machines, staff etc.) Scenario I: Buyout Min. time 3 months Agreement Implementation 1 month Start Scenario II: Termination Min. time 5 months Agreement Negotiation Implementation 2 months 3 months Fall-back: Bankruptcy Min. time 8~20 months No agreement Execution 6~18 months

  32. Each scenario will result in different organizational restructure Scenario I: Buy out Scenario II: Termination Fall-back: Bankruptcy • Termination of GSHA • Rep office of GDAI • Sales & Marketing • CCS • Headquarters and import • Production • Bankruptcy of GSHA • Rep office of GDAI • Sales & Marketing • CCS • Headquarters and import • Production • Buy out of SBMC • Headquarters • Sales & Marketing • CCS • Production • Closed • Production Shanghai Ningbo Daqu • Dismissal fee (90% employee) • Buy out Lida • Closing cost (Ningbo) • Location • Machine • Potential higher margin • Synergy • Price too high • No agreement with Lida • Uprising of employees, sabotage • Finding management team • Dismissal fee (all employees) • Write-off investment • Lower operating cost • Logistic • Management team • Lay-off easier • Longer than buy out • Loss of all loans and account receivable • Negative press • Sharp drop in business • Dismissal fee (all employees) • Write-off investment • Transfer cost • Management team • Logistic • Lower operation expenses • Potential higher margin • Much longer than buy out • Loss of all loans and account receivable • Negative press • Drop in business Cost Benefit Risk

  33. However the organizational structure for scenario I should be aimed for as Geberit’s future structure in China GSHA Fall-back No agreement Scenario II Re-open Agreement on termination Re-open Scenario I Agreement on buy out GDAI Close Ningbo Ningbo as headquarters

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