k ing & w ood. prc m&a, jv buyout seminar mark schaub february 13, 2008 china m&a
Post on 26-Mar-2015
217 Views
Preview:
TRANSCRIPT
KING & WOOD
KING & WOOD
PRC M&A, JV Buyout Seminar PRC M&A, JV Buyout Seminar
Mark SchaubMark SchaubFebruary 13, 2008February 13, 2008
China
M&A
China
M&A
3KING & WOOD
What’s happening
Completed M&A Deal in China
Year No. of Deals Rank Value (US$m)
2005 668 18,512
2006 616 27,150
2007 715 28,148
Source: Thomson Financial
4KING & WOOD
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:
Why is M&A a hot topic for foreign
investors?
• Automotive
• Machinery
• Pharmaceuticals
• Financial sector
• Retail
• Real Estate
• Construction materials
• Energy
• Mining
5KING & WOOD
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.
Stalled projects include Carlyle, Caterpillar, Schaeffler Group
Resentment over CNOOC's failed bid for Unocal.
6KING & WOOD
I. Legal Framework
7KING & WOOD
Legal Framework for M&A and JV Buyout
Foreign M&A Rules (08/08/2006)
Takeover Rules of Listed Companies (07/31/2006)
Foreign Strategic Investment Rules (12/31/2005)
M&A regulations
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
8KING & WOOD
Legal Framework for M&A and JV Buyout—Cont’d
FIE Merger and Division Provisions (11/22/2001)
Investor’s Equity Change Provisions (05/28/1997)
FIE Liquidation Measures (07/09/1996)
JV buyout regulations
9KING & WOOD
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.
New Milestone - M&A Rules
Most comprehensive M&A regulations in China to date.
10KING & WOOD
Broad scope of applicability may have sweeping impacts. Possible key industries:
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)
• 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.
11KING & WOOD
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.
Share Swap
Share swap is permitted as a M&A tool for the first time in China.
12KING & WOOD
Identify target
Signing term sheet
Due diligence
Contract drafting
Negotiation
Definitive agreements
Negotiation
SASAC approval
Industrial departments
MOFCOM approval
Anti-trust filing
Business license
SAFE approval
Approval
Conditions precedent
Pre-closing audit /
due diligence
Closing / Payment
Post-closing
integration
Closing
M&A Roadmap
13KING & WOOD
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.
14KING & WOOD
II. Due Diligence
15KING & WOOD
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
Due Diligence - Procedure
Meet with client
Understand project
Draft
strategy paper
Preparation for field work
Field work
Draft report Follow up
Draft transaction documentation
17KING & WOOD
III. Structure
18KING & WOOD
M&A Transactions in China
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
China is still highly regulated in M&A transactions.
19KING & WOOD
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
Share Deal
Target
Foreign Investor SellerShare transfer
20KING & WOOD
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:
Case Study (I)
Purchase Share Purchase Assets
• No need to re-issue operational licenses.
• New operational licenses will need to be issued to the New Co.
• No need to change existing contracts
• Existing contracts should be re-entered by the New Co.
• Inherit existing liabilities of China Co. • Liabilities limited to the purchased assets.
21KING & WOOD
Factors to be considered based on the due diligence:
Case Study (I)—Cont’d
Purchase Share Purchase Assets
• Accept the existing employees • Select accepted employees, trigger severance
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
22KING & WOOD
Diagram of Share Deal
Foreign Co.Foreign Co.
China Co.China Co.
Subsidiary ASubsidiary A Subsidiary BSubsidiary B
Chinese PartnerChinese PartnerShare transfer 50%Share transfer 50%
50% shareholder50% shareholder
BranchBranch
BranchBranch
BranchBranch
BranchBranch
BranchBranch
BranchBranch
• Business continued
• Closing much easier
• Operational license
remained in place
• Liabilities remained in
company
• Business continued
• Closing much easier
• Operational license
remained in place
• Liabilities remained in
company
23KING & WOOD
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.
Buying the Assets
Chinese TargetForeign Investor
InvestmentAsset TransferInvestment
Vehicle
24KING & WOOD
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:
Case Study (II)
Purchase Share Purchase Assets
• No need to re-issue operational licenses (not many).
• New operational licenses should be issued to the New Co.
• No need to change existing contracts
• Existing contracts should be re-entered by the New Co.
• Inherit existing liabilities of China Co. (large loans)
• Liabilities limited to the purchased assets
25KING & WOOD
Factors to be considered based on the due diligence:
Case Study (II)—Cont’d
Purchase Share Purchase Assets
• Unpaid land grant fee • Not to purchase land
• Accept the existing employees (more than 1,000)
• Select accepted employees; trigger severance
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.
26KING & WOOD
Diagram of Assets Deal
Foreign Co.Foreign Co.
WFOEWFOE
China Co.China Co. China InvestorsChina InvestorsAsset Purchase AgreementAsset Purchase Agreement
Various other agreements i.e.
land, patents, transfer of
business, key employee
contracts
Various other agreements i.e.
land, patents, transfer of
business, key employee
contracts• No inherited liabilities
• Clean start
• Difficult and time consuming closing
• Destroyed sense of co-operation between parties
• No inherited liabilities
• Clean start
• Difficult and time consuming closing
• Destroyed sense of co-operation between parties
27KING & WOOD
No need to transfer title of assets
No need to transfer operational license
More difficult to spin-off undesired assets or liabilities
Structuring the Deal
Generally reduce risks of legal liabilities tracking back to newco
Ownership of all assets and contractual agreements need to be transferred
New operational licenses required
Possibility to cherry pick assets or liability
More favored by lawyers and accountants because less exposure to hidden liability
Inherit all debts and liabilities of target
Favored by business people because less disruption to existing business
Asset Deal Share Deal
++
--
Higher risk that Chinese party will carry
on competing business
Less risk of Chinese party continuing business
as competitor
--
++
++
++
--
--
!!
-- ++
!!
VS.
28KING & WOOD
JV Buyout in China
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
A JV buyout may be realized through the following ways:
29KING & WOOD
Summary of Different Options
In summary, the pros and cons of the various options are as follows:
Option Pros/Cons
Foreign investor converts the JV into a WFOE
Clean break +
Possibility to move to a better location +
Improve IP protection +
Foreign investor buys
large majority of
shares
Chinese partner is a silent partner only +
Foreign investor improves control +
Chinese partner retains influence –
No clean break –
Possibility for later problems remains –
Possibly delaying inevitable split –
30KING & WOOD
Summary of Different Options—Cont’d
In summary, the pros and cons of the various options are as follows:
Option Pros/Cons
Chinese partner/other company buys foreign investor out
Probably very low purchase price –
High risk to IP rights –
Foreign investor liquidates
the JV
Clean break, foreign investor can start
again +
Difficult, time-consuming procedure –
Destruction of current business –
Foreign investor sues Chinese partner for breach
Difficult and time consuming –
Destroys current business –
Foreign investor walks away Unlikely to be practical –
Involves risks of breach of contract –
31KING & WOOD
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
Case Study (III)
32KING & WOOD
IV. Being Aware of Problems
33KING & WOOD
How to deal with non-compliance?
Evidencing ownership of assets
State-owned assets requirements
Labor issues
Anti-trust review
Intellectual property rights protection
Common Problems in M&A
34KING & WOOD
How to deal with 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.
Almost all Chinese companies have variant level of non-compliance.
35KING & WOOD
Build in Safeguards/Set Guidelines
Management By-Laws
Employment Contracts
Non-Competition covenants
Employee Handbook
On-Going Involvement
Corporate GovernanceNew Company Law improves fiduciary duties but much the
investor can do:
36KING & WOOD
Ensure HQ involved and exercises oversight Safeguards/Set
Guidelines
Internal audits
Active board
Avoid ethical blindspots
Management guidelines
Fraud PreventionNot a priority for most companies, but a serious and growing
problem in China:
37KING & WOOD
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.
Evidencing the Assets
Ownership of assets and properties are often in question.
38KING & WOOD
State-owned Assets Rules
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
Disposal of state-owned assets is subject to complicated approval
procedures.
39KING & WOOD
Labor Issues
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
Settlement of staff and workers may cause substantial costs to the
transaction.
40KING & WOOD
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.
Anti-Trust Filing
So far most anti-trust filings have been procedural, but it is expected to have more teeth.
41KING & WOOD
Intellectual Property Rights
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
IP protection in China is better than its reputation.
42KING & WOOD
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
43KING & WOOD
V. Summary
44KING & WOOD
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
Main Points to Note
“Make it as simple as possible but not any simpler” - Albert Einstein
45KING & WOOD
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 6300Email: schaub@kingandwood.comWebsite: www.kingandwood.com
www.china-artoflaw.com
Q&AQ&A
46KING & WOOD
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
47KING & WOOD
Mergers & Acquisitions in China Seminar – February 13, 2008
Felix Chang and Harvey Cohen of Dinsmore & Shohl LLP listen in on the conversation
top related