Q&A: What's Next for China Inbound M&A?
By DAVID LIVDAHL, JENNY SHENG, & LISA LI
China remains a compelling story for global firms in the hunt for investment opportunities. As China’s global economy has moved to center stage, these opportunities have expanded into new sectors and new technologies. To provide context for these changes and challenges, Paul Hastings partners
What industries are most active now in terms of inbound M&A by foreign investors? What’s the driving force behind this activity?
In 2012, the most active industry sectors included energy and mining, manufacturing and chemicals, financial services, Internet/ecommerce, and pharmaceuticals, and healthcare.
Several factors drove this shift in focus, including:
Large companies are increasing their control over natural resources and centralizing production to maximize profits. With concerns about energy security so paramount in China, the energy and mining industry is experiencing constant M&A activity.
The Internet/ecommerce industry is growing, and has developed very quickly in China over the past two years. Recent high-profile M&A activity in the sector is attracting an increasing number of foreign interest and investors.
China’s need for medical and health care services is increasing due to the rapid growth of China’s elderly population and its relatively undeveloped health care system.
Moreover, the Chinese government is specifically encouraging private investment in the medical industry. Taken together, these elements provide ample opportunities for cross-border integration of the pharmaceutical and health care industry.
The inbound investment story is a well-established one. A final factor that is spurring recent investment trends is the need to expand existing business channels in China and enhance profit and other sales/service fee income from China.
What particular issues should foreign buyers be aware of in structuring their M&A deals?
Based on our experience representing clients in inbound M&A transactions, there are three key issues that should be carefully considered when structuring deals:
Exit Strategy. Foreign investors should consider exit strategies before entering into a deal. We often recommend that a foreign investor acquire a Chinese target company through an offshore special purpose vehicle (SPV). These are established by the foreign investor in certain tax-friendly jurisdictions, such as Hong Kong, the Cayman Islands, or the British Virgin Islands. With this structure in place, when the foreign investor transfers its shares in the offshore SPV to exit from the deal, the transfer – as an offshore deal – avoids having to undergo the lengthy approval process with the Chinese authorities.
Dividend Repatriation. Dividend repatriation is key for a foreign investor to obtain profits generated by its investment in a Chinese company. The withholding tax for dividends varies, depending on the tax treaties between Mainland China and the home country of the investor’s parent company. As such, investors should carefully consider the tax jurisdiction of the direct parent that will acquire the Chinese target company.
Policy Change. Chinese governmental authorities change or update their policies on foreign investment from time to time. A key guide is the Catalogue of Industries for Foreign Investment. The National Development and Reform Committee (NDRC) and the Ministry of Commerce (MOFCOM) update the Catalogue periodically to reflect the Chinese government’s attitude toward foreign investment in certain industries. We regularly monitor these policy updates for our clients. All foreign investors should stay abreast of such changes and work with their professional advisers to determine their investment strategies and deal structures accordingly.
What is your perspective on MOFCOM’s recent practice of antitrust and national security reviews? In your opinion, have recent cases proved positive or negative for these reviews?
MOFCOM is playing a more active role in its antitrust review. MOFCOM received 201 filings in 2012, with 186 cases accepted for review. As of December 26, 2012, MOFCOM had reviewed 154 cases, of which 142 cases were approved without conditions, six cases were approved with conditions, and six cases were withdrawn.
MOFCOM is making greater efforts to publish information related to its antimonopoly review. Previously, MOFCOM only published, on its website, cases that were blocked, or were approved with conditions. However, on November 16, 2012, MOFCOM voluntarily published information on all reported concentration transactions (458 in total) that were approved without conditions from August 2008 to September 2012. Since then, MOFCOM has published such information for all approved cases on a quarterly basis.
On April 3, 2013, MOFCOM published a draft Interim Regulations on Applicable Standards for Simple Cases regarding Concentrations of Business Operators (the “Draft Simple Case Standards”). It is likely that the Draft Simple Case Standards aim to facilitate MOFCOM’s drafting and promulgation of the proposed fast-track rules, to increase the efficiency of MOFCOM’s antitrust review. However, the Draft Simple Case Standards do not address the review procedure and timeline regarding a simple case, nor do the Draft Simple Case Standards address the procedures and timeline regarding MOFCOM’s review of other (non-simple) cases.
The most recent case reports issued by MOFCOM in April 2013 relate to MOFCOM’s conditional approvals of the acquisition of Xstrata by Glencore and the acquisition of Gavilon Holdings, LLC by Marubeni Corporation. Based on our review of such reports, we found that MOFCOM did not complete the review of both cases within the maximum statutory review timeline (e.g., 180 days). It claimed that the proposals submitted by the applicants did not resolve the anti-competition problems involved. In both cases, the companies withdrew their applications and re-submitted them later re-initiating the review. We hold the view that these two cases reveal negative signals showing that MOFCOM may require more time to review cases it thinks are complex and important.
In contrast to developments in antitrust review, so far there are no published national security reviews which have attracted public attention. However, while there are no specific cases in which MOFCOM has required a national security review, we note that in certain antitrust cases reviewed and approved by MOFCOM, its officials have taken economic and national security concerns into consideration.
What is your view on the NDRC’s current practice of foreign investment approval? How should project investors approach compliance with the NDRC?
Due to the vagueness of certain provisions in the NDRC regulations and the uncertainty in their implementation, for many years no one has understood what projects must be approved by the NDRC. In practice, project investors try to avoid seeking the NDRC’s approval unless the other approval and registration authorities for a project – such as MOFCOM and the State Administration for Industry and Commerce (SAIC) or its local counterparts – required NDRC approval before the investor submits the applications to MOFCOM and SAIC.
On August 16, 2012, the NDRC issued its draft Administrative Measures for the Approval of Foreign Investment Projects (the “Draft Measures”) for public comments. However, after reading the language of the Draft Measures, it is still unclear what kind of projects must obtain NDRC’s approval. Nonetheless, the Draft Measures demonstrate increased determination of the NDRC to be involved in the regulation and administration of all types of foreign investment projects.