Tuesday, March 30, 2010

All Eyes on M&A in China

Strong recent growth momentum in mainland China mergers and acquisitions (M&A) is only set to continue. The number of M&A deals jumped from 388 in 2003 to 824 in 2006, with deal value increasing similarly by almost 30% a year on average from US$29 billion to US$62 billion. Private equity deals have been the fastest growth area, up 75% per year, followed by domestic strategic deals (42%) and venture capital deals (28%).

China's Housing Bubble Is Inflating Faster Than Ever

China's Housing Bubble Is Inflating Faster Than Ever
Posted Mar 10, 2010 09:46am EST by John Carney in Housing, China
From The Business Insider, March 10, 2010:

The latest report on the property market in China is truly frightening. Despite measures taken by authorities to reign in the price explosion in Chinese real estate, prices rose at the fastest clip in nearly two years in February.

Unless you have faith in the ability of China's central planners to perfectly negotiate a soft landing, you should be preparing for a rough crash.

From the official Chinese news agency:

China's property market grew at the fastest pace in 20 months in February, with housing prices rising at a double digit rate, despite the government's cooling-down moves, according to data released Wednesday by the National Bureau of Statistics (NBS).

Housing prices in China's 70 large and medium-sized cities increased 10.7 percent in February from a year earlier, and were up 0.9 percent compared to the previous month, said the NBS.

Prices of new homes in February rose 13 percent year on year, up 1.3 percent from January, and were mainly pushed up by soaring home prices in Hainan Province as the state government decided to build the island into an international tourist resort in December.

Haikou, capital city of Hainan, ranked first among other major cities in new home price growth, which soared 58.4 percent year on year in February. Sanya, the second largest city in Hainan, saw its new home prices up 56.1 percent.

Prices of second-hand homes climbed 8.5 percent in February from the same time last year, up 0.5 percent from the previous month, according to the NBS.

Sanya topped other cities in second-hand home prices, with a rise of 42.2 percent in February year on year, and was followed by Haikou, with a 41.7-percent-growth, according to the NBS.

The figures were announced during the annual session of the National People's Congress (NPC), the top legislature, when Chinese Premier Wen Jiabao reiterated determination to curb the excessive growth of home prices in major cities and satisfy people's basic need for housing.

China's central and local governments rolled out a series of measures to dampen the overheated property market at the end of last year, including reimposing a sales tax on homes sold within five years of their purchase and raising the down payment requirement for families buying a second house or more with bank loans.

In another move to cool the property market, the People's Bank of China, the central bank, raised the deposit reserve requirement ratio in January, and in February for the second time.

For additional coverage, see: It Begins: China Cracks Down On The Shadow Banking System That Is Inflating Its Real Estate Bubble

Thursday, March 18, 2010

Business Sours on China

Business Sours on China
Foreign Executives Say Beijing Creates Fresh Barriers; Broadsides, Patent Rules

By ANDREW BROWNE And JASON DEAN

BEIJING—Foreign businesses say their relationship with China is starting to sour, as tougher government policies and intensifying domestic competition combine to make one of the world's most important markets less friendly to multinationals.

Interviews with executives, lawyers, and consultants with long experience in China point to developments they say are making it much harder for many foreign companies to succeed. They say the changes suggest Beijing is reassessing China's long-standing emphasis on opening its economy to foreign business—epitomized by the changes it made to join the World Trade Organization in 2001—and tilting toward promoting dominant state companies.

In the latest broadside against foreigners, authorities in a wealthy province near Shanghai Tuesday assailed the quality of luxury clothing brands from the West, including Hermès, Tommy Hilfiger and Versace.
(Related article, page B2.)

Next week, the American Chamber of Commerce in China is coming out with a new survey of its members that is expected to document a downturn in sentiment.

Technology executives say they are highly concerned about government procurement rules issued late last year that would favor local suppliers who have "indigenous innovation." The rules, if implemented, could limit foreign access to tens of billions of dollars in contracts for computers, telecommunications gear, office equipment and other goods.

Patent rules imposed Feb. 1 threaten to increase costs in China for foreign innovators in industries such as pharmaceuticals, and let authorities force foreign drug companies to license production to local companies at state-set prices.

Executives in several industries say the liberalization spurred by China's WTO entry is stalling. Foreign makers of wind turbines and solar panels say they are being shut out of big renewable-energy projects.
Regulatory barriers effectively cap participation in insurance: Foreign companies had just 4.7% of China's life-insurance market as of June, and 1% of its property and casualty market, according to PricewaterhouseCoopers.

"I am pro-China and I am in favor of doing business in China, but I have some serious concerns about what has been happening in the last year,"
says Fraser Mendel, an attorney with U.S. law firm Schwabe, Williamson & Wyatt.

Chinese officials dismiss complaints that the environment for foreigners has worsened, but there are signs top leaders are noting their concerns.
Commerce Minister Chen Deming called top China executives from more than 20 multinationals to a meeting this month billed as "a chance to listen and hear issues of concern," said one participant. Mr. Chen pledged China would "resolutely continue" to open its markets, but he also criticized protectionism in the West.

On Sunday, Premier Wen Jiabao vowed China will "unswervingly implement its opening-up policy." He conceded that his "contacts with foreign investors haven't been close enough," and pledged to increase interaction.

Many foreign executives say they see an upsurge in economic nationalism, accelerated by China's world-beating performance during the recession and a new disdain for Western economic management.

"The economic crisis and downturn emboldened those who had been pushing back" against efforts to liberalize markets, says Duncan Clark, chairman of BDA, a Beijing-based consulting company.

Signs of nationalism are evident in the grooming of state-owned companies to dominate their industries as "national champions," often at the expense of private Chinese companies as well as foreign firms. From airlines to coal mining to dairy products, government policies are expanding the state's role.

A year ago, in a move foreign critics called protectionist, Chinese regulators rejected a bid by Coca-Cola Co. for China Huiyuan Juice Group Ltd., saying it could crowd out smaller companies and raise consumer prices. The two combined held just a fifth of China's juice market.

In July, four executives of Anglo-Australian mining giant Rio Tinto were detained, initially accused of stealing "state secrets," amid tense negotiations between global miners and China's steel industry over iron ore prices. Rio Tinto denies wrongdoing by the men, who await trial on reduced charges of bribery and theft of commercial secrets.

Google Inc.'s woes highlight the angst. The search company, long troubled by Chinese censorship rules, threatened Jan. 12 to depart China after it said a Chinese hacking attack penetrated its computer network.
Related attacks hit dozens of other multinationals. Google is expected soon to close its Chinese site, Google.cn., leaving local companies dominating an Internet market of 400 million users.

"The Google issue has had a crystallizing effect," says Lester Ross, managing partner in Beijing for U.S. law firm Wilmer Cutler Pickering Hale and Dorr. "It raised the consciousness of government and of the boardrooms and other stakeholders" about the difficulties of doing business in China, he says.

Foreign investors have long complained of China's haphazard legal system and regulation. These were mere annoyances when China was an emerging market. Today, the huge Chinese market is fundamental to the health of large Western multinationals. Lose here, say Western executives, and multinationals are weakened globally.

The new patent rules providing for what is called compulsory licensing aren't unique to China. But China's pharmaceuticals industry is dominated by state-owned firms, and Western lawyers worry the rules will favor them. One provision requires companies to pay Chinese employees at least 2% of profit derived from their inventions in China unless the employees explicitly waive that right.

The law "imposes significant new requirements on multinationals operating in China," says Mr. Mendel, the attorney. "You no longer have absolute control over what comes out of your R&D facility."

Executives interviewed for this article declined to comment publicly. In December, a group of 34 business organizations from North America, Europe and Asia sent a letter to three Chinese government ministers blasting the indigenous-innovation preferences for procurement as "discriminatory" against foreigners.

Beijing denies the rules are discriminatory, yet governments are taking note. "Recent events...have reminded us of the continued challenges faced by foreign and U.S. companies operating in China," U.S. Commerce Sec. Gary Locke said in a January speech. "China needs to continue making strides to be more transparent, predictable and committed to the rule of law."

Some are more upbeat. A U.S.-China Business Council poll of members last year showed 93% were "optimistic" or "somewhat optimistic" about their future in China over five years. Robert Poole, head of the council in China, says it "is really concerned about some of these policies," but "the broad themes of continued openness and reform continue to be there."

Some sectors haven't been much hindered. Car makers like Volkswagen AG and General Motors Co. benefited hugely from China's booming market last year. But state-run media have reported government plans to increase domestic brands' share to over 50% of passenger vehicles by 2015, from 44% last year.

For many multinationals in China, today's profits follow years of investment, much of it encouraged by government policies designed to lure capital. Now, at the point when their dream of access to a giant market is becoming reality, China is so prosperous that it has less need for foreign funds. Foreign investment has grown much slower than the rest of China's economy, amounting to 1.8% of gross domestic product in 2009, down from a peak of 6% in 1994.

Beijing has long harbored suspicions the West wants to hobble its economic rise. Analysts say lately, such insecurities have strengthened the hand of leaders who want to limit foreign presence in the economy.
There are backers of openness, says Mr. Ross of WilmerHale, but "there are louder voices pushing China to be more protectionist and to be more nationalist."
—Loretta Chao contributed to this article.Printed in The Wall Street Journal, page A1

Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

Thursday, March 11, 2010

China export rebound continues

China's exports surged ahead in February, in an indication of revived global demand in the wake of the global financial crisis.

According to Chinese customs data released on Wednesday exports were up 45.7 per cent over a year earlier, the fastest growth in three years.
Imports also rose by 44.7 per cent, reflecting a recovery in Chinese domestic demand as consumers' worries over the financial crisis ease.
Chinese export data is being closely watched by analysts looking for clues as to the strength of the world's number three economy third-largest economy and for signs of recovery in crisis-hit export markets such as the US and Europe.
February's exports growth was boosted by comparison with last year's weak trade amid the global downturn and came despite the week-long Lunar New Year holiday, when many factories and offices shut down.
Overall China's global trade surplus for the January-February period narrowed by
50.3 per cent from the same time last year.
The reduction reflects a resurgence in China's demand for imports while the US and other key export markets are still struggling.


The latest data could lead China to relax its peg on the value of the yuan [AFP]
According to government figures China's economy sped up in the final quarter of 2009, growing by 10.9 percent on the strength of massive stimulus spending and bank loans.
That in turn spurred Chinese demand for imported iron ore and other materials used in stimulus-financed construction projects.
The strong export figures could make Beijing more comfortable with letting the value of the Chinese currency, the yuan, appreciate.
The value of the yuan, which has effectively been pegged to the US dollar since mid-2008, has been a source of friction with China's Western trading partners, who say Beijing is keeping it artificially low to give an unfair boost to exports.
Beijing has been under intense pressure from Washington in particular in recent months to allow the yuan to rise.
On Saturday the governor of China's central bank, Zhou Xiaochuan, said Beijing would will be "very cautious" about easing exchange-rate controls because the global economic outlook is still uncertain.
However, he added that the peg was temporary and would be removed "sooner or later" once the global recovery was on a firmer footing.

Friday, March 5, 2010

Seller Due Diligence

"When the economy plummeted in 2009, the M&A landscape changed quite dramatically," says Hector Cuellar, president of McGladrey Capital Markets LLC. "Transactions were being retraded at an alarming rate, and due diligence data requests skyrocketed." Further, he adds: "Our average days to close a deal [from letter of intent signing to deal close] increased from 95 days in 2008 to 125 days in April 2009."
For deals to close in this environment, the gap between buyer and seller expectations needs to be bridged―allowing buyers to maintain their confidence level and protecting sellers against eroding values and retrading sales prices.
Value retention and surety of close. If value retention and surety of close were key goals of a transaction before, they are even more significant considerations for the foreseeable future.
This article takes collective input from transaction stakeholders—including strategic buyers and sellers, investment bankers, private equity groups and lenders―to check the street’s pulse about business sellers’ need to have their financial house in order when going to market.
Higher thresholds of scrutiny and diligence by buyers and lenders are now the norm. As a result, sellers can no longer go to market with less than optimal financial transparency and expect to attract a willing and able buyer and, at the same time, retain their perceived value.
Seller due diligence: Bridging the deal health gap. A key remedy to building confidence and maintaining trust is the clarity and transparency delivered through seller diligence. In seller diligence, a business owner hires a third-party due diligence firm to substantiate and prepare supporting documentation for the company’s financials before offering the company for sale. Since seller diligence teams often work on buy-side transactions, they can anticipate the buyer’s concerns. As a result, the seller’s diligence team proactively prepares the company to address requests and concerns head-on rather than being reactive to diligence issues a buyer may raise.
According to Thomas Dollhopf, principal at Marwit Capital, "Purchase-price reductions during buyer due diligence are common if inaccuracies or financial irregularities are uncovered. Sellers can eliminate the risk of this happening and greatly improve their credibility by hiring a firm to help them get prepared for all aspects of due diligence."
Other antidotes are available in the seller diligence process. Assisting the seller with data-room preparation alleviates a significant burden. Optimal tax structuring and tax diligence generally becomes a major part of the transaction diagnosis. Additionally, as transaction closings are taking significantly longer, having someone on the team who can regularly update the financial health of the company is value-added. Assistance in customizing the accounting language around earnouts, working capital and certain accounting definitions can be highly valuable. Finally, a working capital true-up is a regular deal negotiation point that can be easily addressed.
These remedies serve to increase the likelihood of a successful and timely transaction.
"Seller diligence reduces the risk of surprises surfacing in diligence," says Cuellar. "The result is increased surety of close and value retention. Companies that cannot defend their numbers get retraded, destroying value for the seller."
A senior M&A executive of a Fortune 50 company agrees: "You want the opportunity to position the issues before the buyer finds them―and they will find them," he emphasizes. "Positioning of issues becomes very important in retaining value. If issues are identified early in the process and positioned well with the buyer, it takes away the buyer’s negotiating power. Not doing this can give the buyer a reason for walking away from the deal or retrading the purchase price."
When seller diligence makes sense. Buyers often back away from a transaction when inadequately addressed red flags appear. Red flags―big or small―that are not addressed in a timely and satisfactory way create uncertainty and can cause an otherwise willing and able buyer to step away from the deal. Broken deal costs alone justify meaningful preparation by the seller.
Cuellar and Sun Capital Partners Inc. principal Matthew Garff agree that a prime candidate for seller diligence likely has at least one of the following characteristics:
Poor financial management, accounting infrastructure and financial reporting systems (many times caused by an inexperienced CFO or controller, or even a lack of one)
Lack of internal resources necessary to provide adequate attention to document preparation and to a buyer’s diligence requests; this is typically where the internal staff is stretched and only has time to focus on the day-to-day business
Closing a deal or not closing a deal may be the difference between a seller with less than optimal financial transparency and a seller with transparent financials. "It comes down to confidence in the financials," explains Cuellar.
The Fortune 50 M&A executive introduced above also encourages seller diligence in the following situations:
When multiple divisions or business units are being sold as a single asset, requiring pro forma financials, consolidation and elimination of intercompany transactions
Division or product line carve-out or spinoff
Companies that operate well, but want to keep an eye on the business and ensure no surprises come up in diligence
Businesses with complex accounting structures, systems and confusing internal jargon
"Value retention is at the heart of the issue. Clarity in the presentation of the carved-out entity is critical to optimizing value," this executive says.
Don’t misunderstand the role of an investment banker. A frequent misconception exists that an investment banker’s role is to be a one-stop shop for all financial aspects of the transaction. On the contrary, "an investment banker’s role is to position the company in the market place, help prepare a sellable forecast and develop the deepest buyer pool possible," says Cuellar. "When it comes to putting supporting details behind the numbers, an investment banker does not replace the role of an accountant."
Rob Wendell, also a principal at Marwit Capital, agrees. "A good investment banker is typically focused on presenting an opportunity to a buyer universe in the best light possible―not necessarily focused on compiling professionally prepared due diligence information like an experienced accounting due diligence firm."
When everyone’s role on the deal team is properly identified and aligned, the seller begins to realize in tangible terms―surety of close, value retention, time savings, reduced stress―the value of having the right players for the transaction.
An ounce of prevention is better than a pound of cure. Seller diligence is preventative medicine for your transaction’s health. Says Garff: "You don’t want to go down the road six to eight months with imperfections that may cause the deal to fall apart. This incurs significant costs, such as missing add-on acquisitions you could have performed, management distractions and effort, and fees paid to lawyers, accountants and others." He adds, "Seller diligence is an insurance policy against the risk that the buyer will find issues that erode value."
Marwit’s Dollhopf says, "When running a sale process, sellers need to stay focused on their core business, or they risk losing significant value. If Ebitda drops off because the seller is distracted with issues relating to the sale process that could be managed by others, the value lost [Ebitda change multiplied by the transaction multiple] may far exceed the cost of engaging a firm to perform seller diligence." He further emphasizes, "If Ebitda is already declining, the problem is compounded. Seller diligence pays for itself."
Cuellar adds, "You don’t want to pay for seller diligence in a retrade based on multiples. You want to pay for it by the hour."
Value retention: At the heart of the matter. The prevailing theme conveyed by transaction stakeholders interviewed for this article is value retention and surety of close are at risk if sellers are not well prepared for a transaction.
Each stakeholder agrees―buyers are looking for reasons to reduce price or identify issues that will cause them to walk away. With careful preparation, sellers create a defensible position to retain value and gain the buyer’s and lender’s trust, resulting in more deals getting done.
This article was written by Milton Marcotte, managing director and Dan Solomon, manager with RSM McGladrey's national Transaction Support Services practice, and originally appeared in The Deal.