china newcomer opportunities

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The Dbriefs China Issues series presents: Doing business in China: opportunities for newcomers Clarence Kwan, Managing Partner, U.S. Chinese Services Group, Deloitte LLP Warren Clark, Partner, Deloitte & Touche LLP Shelley Chia, Partner, Deloitte & Touche LLP October 14, 2010

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Emerging China market opportunities.China\\’s 12 5yr plan.Key Success Factors in China.Case studies highlighting pitfalls.

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Page 1: China Newcomer Opportunities

The Dbriefs China Issues series presents:

Doing business in China:

opportunities for newcomers

Clarence Kwan, Managing Partner, U.S. Chinese Services Group, Deloitte LLP

Warren Clark, Partner, Deloitte & Touche LLP

Shelley Chia, Partner, Deloitte & Touche LLP

October 14, 2010

Page 2: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Agenda

• Emerging market opportunities

• Key success factors for doing business in today’s

China

• Case studies of typical market entry pitfalls in China

Page 3: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

What is your company’s China investment plan over the

next 6 to12 months?

• Pursue new investments in China

• No new investments in China

• Scale-back investments in China

• Pull out of China

• Don’t know/not applicable

Poll question #1

Page 4: China Newcomer Opportunities

Emerging market opportunities: new industries and services

Page 5: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Sources: PRC National Bureau of Statistics, IMF, U.S. Bureau of Economic Analysis

$0

$1

$2

$3

$4

$5

US

$ t

rill

ion

s

China’s nominal GDP growth

(1978-2009)

China’s rapid economic ascent

From 1978 through 2009, China’s average annual GDP growth

rate was 9.8% - 3x the global average

$0

$200

$400

$600

$800

$1,000

$1,200 Exports (US$B)

(1980–2009)

Launch of China’s Open Door Policy

China joins WTO

Deng Xiaoping’s ―Journey South‖

1

Page 6: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

U.S. investors have grown with China

After investing US$64 billion through 2008 (7.5% of China’s cumulative total

FDI) U.S. investors continued to favor China in 2009

4.4

4.9

5.4

4.23.9

3.1 32.6

2.9

3.6

0

1

2

3

4

5

6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

U.S. FDI into China last year was US$3.6 billion — a 24% increase

over 2008 despite the economic crisis and the best showing since 2004

Flow of U.S. FDI in China

(2000–2009)U.S.$ billion

Sources: PRC Ministry of Commerce

2

Page 7: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

U.S. SMEs are finding success

Despite less time on the ground than larger U.S. investors, many U.S. SMEs

reported profitable China operations during 2009.

How can this success be replicated, especially with more uncertainty ahead?

SMEs Large companies

> 20 yrs.

10-20 yrs.

6-9 yrs.

2-5 yrs.

< 2 yrs.

SMEs Large companies

Large loss

Break even, small lossProfitable

Very profitable

Source: American Chamber of Commerce 2010 White Paper – survey of 388 U.S. companies with investments in China

SMEs = Small and medium-sized businesses, defined as those with fewer than 500 employees

Profitability of China operations (2009)Length of time in China

3

Page 8: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

To create (and preserve) value in China, successful foreign

investors:

1. Seek to understand China’s business environment and anticipate

the direction of change

2. Adapt their strategy, structure, people and processes to the China

environment

Navigating risk in a land of opportunity

4

Page 9: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

• A shift to a more sustainable development model

– Lessen dependence on exports by spurring domestic demand

– Promote service sector as an engine for job creation alongside

manufacturing

– Strive for “inclusive growth” (包容性增长) – spreading benefits more

evenly across urban-rural, provincial and regional divides

– Green, green, green

• Respond to the Chinese people’s desire to see China

achieve global standing commensurate with its growing

economic leadership

What does China’s leadership want for China?

5

Page 10: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

• Consensus-building – Harness the Five-Year Planning (FYP)

Cycle to build consensus around a sustainable growth path

• Targeted industrial policy – Revitalize old strategic sectors

while spurring the competitiveness of Chinese enterprises in

new ones

• Accelerated urbanization – Shift residential patterns to

improve access to employment and social services

• Recalibrated role in the global economy – Inbound FDI more

carefully vetted for alignment with balanced growth goals;

outbound FDI encouraged

How will Chinese leaders try to get there?A few examples

6

Page 11: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Consensus - buildingChina’s 12th Five Year Plan takes form

Drafting

March 2011

Final approval at 4th

Plenary session of 11th

NPC

2009 20112010

Research

October 15-18, 2010

Review and approval of draft at 5th

Plenary Session of 17th the CCP

Central Committee

Review & approval

Implementation

October

2008

2nd National

Economic

Census

launched

March 2010

Premier Wen

submitted guidelines

to 3rd Plenary

Session of the 11th

NPC for approval,

allowing drafting to

move to next phase

November 2009

NDRC announced

that drafting of the

12th FYP is under

way, drawing on input

from across China

Early 2010

NDRC submitted

guidelines for

State Council

approval

November 2008

Planning division of NDRC

released draft outline of 12th

FYP

7

Page 12: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

12th FYP Policy Thrust Potential 12th FYP Targets

Accelerated urbanization Increase national urbanization rate from 47% to 52%

by 2015

Create an energy-efficient, low-carbon society 2015 interim goal to China’s public pledge to reduce

carbon intensity by 40-45% from 2005 levels by 2020

Reduce income disparities through regional

integration & specialization

Increase urbanization rate of Central China from

40% to 48%; reduce energy intensity of Central

China’s economy by 25% from 2008 levels by 2015

Extend social safety net Universal basic healthcare coverage by 2020

Lessen reliance on global markets for growth;

achieve economic rebalancing

Increase domestic consumption to 50% of GDP from

36% now

What we expect to see emerge this week

Consideration of the 12th FYP is the sole agenda item for this week’s four-

day annual meeting of China’s party leadership (Oct. 15-18)

Source: State Council, NDRC, Chinese media, ACMR

8

Page 13: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

• Alternative Energy

• Biotechnology

• Information Technology

• High-end Equipment Manufacturing

• Advanced Materials

• Alternative Fuel Cars

• Environmental Protection

Targeted industrial policySeven new strategic sectors unveiled in September 2010

Detailed industry support plans - similar to the 2009 revitalization

plans for 10 old strategic sectors - are expected before January 1st

9

Page 14: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Meeting the challenge of faster urbanization

•Although cities account for just 3% of global surface area and 51% of the world’s

population, they consume 75% of energy and emit 80% of greenhouse gases

•China has 622 million urban residents today but is still just 47% urban - plans to

urbanize an additional 280 million Chinese by 2030 will place tremendous strains

on sustainability

Sources: Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2009 Revision

and World Urbanization Prospects: The 2009 Revision, Chinese Academy of Social Sciences, China Daily

0

10

20

30

40

50

60

70

80

90

100

1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

Pe

rce

nta

ge

Urb

an

(%

)

Year U.S. China Global Average

47%

51%

82%

Urbanization rates (1975-2030)

10

Page 15: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

“Inclusive growth” – narrowing regional disparities

Sources: National Bureau of Statistics, MOFCOM and local trade & investment promotion agencies

―Rejuvenate the Northeast‖

(October 2003)

―Go Inland‖

(September 2006)

Heilongjiang

Jilin

Liaoning

Hebei

BeijingTianjin

Inner

Mongolia

Shandong

Zhejiang

Fujian

Guangxi

Hainan

HunanJiangxi

AnhuiHubei

Henan

Guizhou

Yunnan

SichuanChongqing

Gansu

Ningxia

Shaanxi

Shanxi

Qinghai

Xinjiang

Tibet

Jiangsu

Shanghai

Guangdong―Go West‖

(September 1999)

―Open Up and Reform‖

(December 1978)

2008 East Northeast Central West

Population (m) and

as % of total

480

(37%)

109

(8%)

355

(27%)

365

(28%)

GDP (US$B) (% of

total)

2,555

(54%)

406

(9%)

909

(19%)

838

(18%)

Average Per

Capita GDP (US$)

5,908 3,665 2,551 2,405

FDI inflows

(US$B), and as %

of total*

86.2

(70%)

12.0

(10%)

16.5

(13%)

7.9

(6%)

The 12th FYP is expected to strongly emphasize regional development

11

Page 16: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Has your company begun to look at the implications of

the 12th Five Year Plan for its future plans to invest in

China?

• Yes

• No

• No, but we intend to

• Not applicable

Poll question #2

Page 17: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Recalibrated role in the global economyChina as a major source of capital

Sources: PRC Ministry of Commerce (MOFCOM), NBS, State Administration of Foreign Exchange (SAFE)

0

10

20

30

40

50

60

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

US$ billions

Overseas FDI in financial sector Overseas FDI in non-financial sectors

Chinese outbound

FDI flows

(2002-2010)

(Jan.-May)

US$60 billion

projected

By the end of 2009, China's cumulative overseas investment had exceeded US$230 billion, up from just US$28 billion at the end of 2000

12

Page 18: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

How will you leverage China’s future development

to achieve your business objectives?

• Where does your product/service fit in the 5-year

plan?

• Are you in one of the seven new strategic sectors?

– If not obvious, could you at least support these sectors?

• Will you invest in an “encouraged” region?

• Will you collaborate with a Chinese company to

expand your global footprint?

– Leverage partner’s local knowledge, financial strength, R&D

capabilities, and distribution network to expand market

coverage

– Relationship goes both ways

Align China’s objectives with yoursShare the same bed, and the same dreams

13

Page 19: China Newcomer Opportunities

Success factors and examples of typical market entry failures into China

Page 20: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Poll question #3

Which of the following best describes the likely mode of

entry for your next investment in China?

• Wholly-owned greenfield/organic entry

• Minority stake acquisition

• Majority state acquisition

• Other forms of strategic alliance (joint venture etc)

• Not applicable

Page 21: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Deal-making in China - creating lasting value

• At what point should we walk away from a deal?

• What is an acceptable price to both parties?

• How should the deal be structured?

• Does the deal present a compliance risk?

• How can the acquisition be integrated in to the global organization?

Five Questions Companies Should Ask

14

Page 22: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Potential deal breakersWar stories from our colleagues on the ground in China

• Lack of integrity on the part of target’s

management

• Disagreements over management

control

• Inability to establish clear title to assets

• Diverging expectations over price

• Conflicting stakeholder obligations

At what point should we

walk away from a deal?

• What is an acceptable

price to both parties?

• How should the deal be

structured?

• Does the deal present a

compliance risk?

• How can the acquisition

be integrated in to the

global organization?

• Case: A U.S. manufacturer acquiring an operation in Southeast

China realized that the target’s managing director had been making

large payments to a “non-existent” overseas consultant

– It was revealed that the “consultant’s” offshore account belonged to the

managing director

15

Page 23: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Pricing considerations War stories from our colleagues on the ground in China

• Availability of basic financial information

• Conflicting valuation

procedures/methodologies

• Contingent/hidden liabilities

• Redundancies and non-core assets

• Sustainability of sales

• At what point should we

walk away from a deal?

What is an acceptable price

to both parties?

• How should the deal be

structured?

• Does the deal present a

compliance risk?

• How can the acquisition be

integrated in to the global

organization?

• Case: A European chemical company seeking to acquire a privately-

owned manufacturer in China found that no social security payments

had been made for its 3,000-strong sales support staff. This would

have potentially resulted in huge un-accrued liabilities for the acquirer.

16

Page 24: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Structuring and compliance considerations War stories from our colleagues on the ground in China

Remember the “3 Cs” of Deal Structuring

Contain: Insulate the investment from hidden or

contingent liabilities associated with previous

operations or from potential liabilities created

during the transaction itself

Comply: Ensure that the terms of the deal and

subsequent operations are in compliance with

pertinent regulations from the outset, both in China

and in the home country

Compete: Create a sustainable business model

that minimizes the net global tax position and

maximizes the flexibility of cross-border capital

deployment

• At what point should we

walk away from a deal?

• What is an acceptable

price to both parties?

How should the deal be

structured?

Does the deal present a

compliance risk?

• How can the acquisition

be integrated in to the

global organization?

17

Page 25: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

• Failure to detect legacy liabilities and adjust structuring

accordingly

• Failure to uncover improper related-party transactions

• Assuming unnecessary risk in a seller’s market

• Over-reliance on personal relationships

• Failure to assess the consequences of offshore payments

Common containment mistakes War stories from our colleagues on the ground in China

• Case: A U.S. firm purchasing a majority stake in a Chinese

consulting company was pleased with the three years of financial

data presented by the seller, but due diligence advisers found the

virtually flawless financial statements suspicious and recommended

searching further in the past

– It was revealed that the seller had enhanced the most recent accounts

and buried significant unpaid taxes in the preceding years

– The buyer avoided the tax liability by executing an asset deal rather than

an equity deal

18

Page 26: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Common compliance mistakes War stories from our colleagues on the ground in China

• Following common business practices without a full understanding of

their legal basis

• Failure to recognize the potential for inconsistent regulatory

interpretation between local and state-level officials

• Failure to anticipate and adapt to changes in the regulatory

environment

• Ignoring industry-specific regulations

• Violation of foreign exchange rules

• Misunderstanding of circumstances under which a license can or

cannot be transferred

• Case: A Canadian enterprise sought to acquire the exploration rights

from a gold and platinum mining facility in southwest China

– After making payment, the buyer was informed by the central government that

the exploration rights were non-transferable

– The buyer was forced to invest an additional US$8 million to set up a joint

venture with the Chinese company

19

Page 27: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Common competitive positioning mistakes War stories from our colleagues on the ground in China

• Failure to use an offshore intermediate holding company or

forming one in a sub-optimal jurisdiction

• Giving insufficient consideration to exit strategies

• Using legal entities that are incompatible with the business model

• Failure to capture specific tax incentives

• Failure to correctly estimate the long-term capital needs of the

China operation

• Inability to repatriate cash in excess of dividend capacity

Case: A U.S. firm acquired a contract manufacturing facility in Shenzhen to

do final product assembly for export

– The company’s structure was intended to minimize the Chinese tax burden but

they were precluded from selling directly in to the Chinese market

– As local demand products grew, the firm sought to sell domestically but to do so

they had to export and re-import its products, incurring customs and shipping

costs, thus making their prices uncompetitive vis-à-vis local Chinese competitors

20

Page 28: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Poll question #4

Which of the following issues strikes you as the most

significant challenge to pursuing a deal in China?

• Lack of transparency

• Legacy liabilities

• Management/Control issues

• Difficulty agreeing on price, including the valuation

method

• Regulatory/licensing issues

Page 29: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Potential deal-breakers

• Lack of integrity on the part of target’s management

• Disagreements over management control

• Inability to establish clear title to assets

• Diverging expectations over price

• Conflicting stakeholder obligations

Pricing considerations

• Availability of basic financial information

• Conflicting valuation procedures/methodologies

• Contingent/hidden liabilities

• Redundancies and non-core assets

• Sustainability of sales

Deal-making in China - creating lasting valuePeople issues dominate the list of transaction headaches

21

Page 30: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Putting people first - before the dealUnderstand the stakeholder environment

1. Find out not only

who can make the

deal but who can

break it.

In China, these

individuals can be both

inside and outside the

company.

2. Learn everything

you can about the

stakeholders in

advance.

Lack of management

integrity is one of the

most frequent deal-

breakers in China.

3. Secure a firm

mandate from your

top management,

including clear

“go/no go” decision

points.

This will help you to

negotiate with

confidence in China’s

unpredictable and less

than transparent M&A

environment.

At what point should we

walk away from a deal?

What is an acceptable price

to both parties?

• How should the deal be

structured?

• Does the deal present a

compliance risk?

• How can the acquisition be

integrated in to the global

organization?

22

Page 31: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Putting people first - during the dealEstablish trusting relationships

4. Negotiating in China

is not just about

getting the best deal

possible but also

building lasting

relationships.

Strong-arm tactics can

be effective but should

be applied judiciously.

5. Trust takes time but

once you have it,

nothing moves a

deal forward faster.

If they trust you, you will

get the information

needed to support your

decisions.

6. You do not need to

be Chinese to get

what you want in

China.

Be creative – Look for

occasions where acting

like an American

advances your cause.

7. Better to

communicate too

much than too little.

But more importantly,

make sure you can trust

your translator.

0

• At what point should we

walk away from a deal?

• What is an acceptable price

to both parties?

How should the deal be

structured?

Does the deal present a

compliance risk?

• How can the acquisition be

integrated in to the global

organization?

23

Page 32: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Putting people first after the dealTransform relationships into lasting China value

8.Signing the

contract is often

just the beginning

of real negotiations

in China.

Use the relationships

you have established to

protect your China

value.

9.Loyalties in China

are more often to

individuals than to

companies.

The best way to retain

critical employees,

customers and

suppliers is to retain

key leaders.

10.Anything is

possible in China,

but nothing is easy.

Without the right

people, nothing is

possible.

• At what point should we

walk away from a deal?

• What is an acceptable price

to both parties?

• How should the deal be

structured?

• Does the deal present a

compliance risk?

How can the acquisition be

integrated in to the global

organization?

24

Page 33: China Newcomer Opportunities

Question and Answer

Page 34: China Newcomer Opportunities

Join us on November 11 at 11 AM ET as our China Issues series presents:

China Tax and Regulatory Update

Page 35: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Contact info

Shelley Chia

[email protected].

+1 213 688 3232

Warren Clark

[email protected]

+1 215 246 2503

Clarence Kwan

[email protected]

+1 212 436 5470

Page 36: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

Thank you for joining

today’s webcast.

To request CPE credit,

click the link below.

Page 37: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

This presentation contains general information only and is based on the experiences and

research of Deloitte practitioners. Deloitte is not, by means of this presentation, rendering

business, financial, investment, or other professional advice or services. This presentation is not a

substitute for such professional advice or services, nor should it be used as a basis for any

decision or action that may affect your business. Before making any decision or taking any action

that may affect your business, you should consult a qualified professional advisor. Deloitte, its

affiliates, and related entities shall not be responsible for any loss sustained by any person who

relies on this presentation.

Page 38: China Newcomer Opportunities

Copyright © 2010 Deloitte Development LLC. All rights reserved.

About Deloitte

Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee,

and its network of member firms, each of which is a legally separate and independent entity. Please see

www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and

its member firms. Please see www.deloitte.com/us/about for a detailed description of the legal structure of

Deloitte LLP and its subsidiaries.

Page 39: China Newcomer Opportunities