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When East Buys West: The M&A Deals of Chinese Companies

by Bennett Voyles

October 27, 2015

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How Chinese companies can win the foreign acquisition game.

First China, now the world: Chinese companies’ appetite for cross-border acquisitions is growing, and there’s no end in sight. Whether the aim is to find new customers abroad or simply to gain greater leverage at home, many companies are now looking overseas for their next big opportunity.

In this series, we look at why Chinese companies are going abroad, why so many of them are likely to fail—and how to make sure that your company isn’t among the casualties.

Going Abroad

Outbound Chinese direct investment now exceeds $100 billion a year according to a recent report by the Rhodium Group in partnership with the Mercator Institute for China Studies (MERICS) of Berlin, and over the next five years these investments are expected to grow significantly: total foreign assets held by Chinese companies are expected to rise from around $6.4 trillion today to nearly $20 trillion by 2020.

So far, roughly a quarter of that investment has been spent in outbound M&A transactions, according to recent PwC figures, although outbound M&A deals still represent a fraction of the total Chinese M&A market, according to an August report of the global consultancy. Of the 4,559 deals completed in the first six months of 2015, only 174 were outbound. In the first six months of 2015, $352 billion in M&A deals were completed, but only $27.2 billion of that went abroad. Enthusiasm is growing, however. Analysts say that the number of deals grew 17% compared to the same period in 2014, and total deal value rose 24%.

In Europe, Chinese investments have grown dramatically in the past seven years, from a value of €2 billion in 2009 to more than €14 billion in 2014. All told, China has invested more than €46 billion in Europe between 2000 and 2014, at least 90% in M&A deals, according to the Rhodium/MERICS report. Twenty-eight percent was invested in energy, and over 40% split roughly evenly between automotive, agriculture and food, real estate and industrial equipment.

State-owned enterprises led the first wave of deals, mostly mining and resource assets in emerging market companies. “Now companies from industries as diverse as internet, automotive, insurance, chemicals, consumer electronics are all expanding outside of China,” says Joel Backaler, Vice-President at Frontier Strategy Group and author of China Goes West, a book about Chinese companies’ expansion into international markets.

Interest in outbound targets is growing equally among all kinds of Chinese companies—large enterprises, including state-owned enterprises (SOEs), large private companies and small and mid-sized companies. “There is continued momentum for outbound deals, which is now expanding downwards from SOEs and large Chinese companies to SMEs,” says Russell Brown, Managing Partner of LehmanBrown, a Chinese accounting firm headquartered in Beijing. Most are “seeking to expand internationally, to reduce their single market dependency, and to seek out new growth opportunities.”

Reasons to Go

Chinese companies are going abroad for several reasons, according to Jagdish Sheth, a marketing professor at Emory University’s Goizueta School of Business and a corporate strategist:

1) To counter foreign competitors who are encroaching on their home turf, he says: Dell Computers goes into China; Lenovo buys IBM’s PC unit. “That’s a typical pattern,” Sheth notes.

2) To find new markets, now that their domestic market is maturing. “You go after the markets where the growth opportunities are,” he says.

3) To take their place as China’s global champion. Most global markets have three leaders, Sheth says. Winning demands a strong presence not just in the home market, but in at least one major foreign market as well.

4) To follow the government’s wishes that companies become more global. “The Chinese government has publicly announced that they would like their companies to be globalized, not as much for economic growth but to make Chinese corporations much more transnational in their mindset,” Sheth explains.

Rhodium/MERICS analysts also see the government as a key driver of outward investment, and point to a deregulation of administrative controls and new incentives for firms and individuals to invest abroad.

Nor are companies likely to become more conservative in the next few years. “With the domestic economy cooling, more companies are likely to look abroad for growth,” predicts Backaler.

“In general as China’s economy slows, more Chinese firms will need to look out in order to either identify new opportunities for their business overseas, or to acquire advanced capabilities (talent, IP, tech processes) that will improve their competitive positioning back home in China,” writes the Los Angeles-based executive in an email.

The Odds are Bad

On paper, buying abroad may make sense, but from strategy to execution, a lot can go wrong. For every company that buys the right asset at the right time for the right price, handles the regulators of its industry in the right way and manages the integration with just the right touch, as many as four others flounder. Many studies have found that 50-80% of mergers fail to create any additional value, and that in fact a bad acquisition can cost the new company dearly.

However, some experts say companies can buck the odds if they know what they’re doing. “It is a risky business,” acknowledges Robert Sher, author of Feel of the Deal: How I Built a Company through Acquisitions, “but think of this: if you and I and two brain surgeons, all four of us, decided to do brain surgeries, and we took the average success rates, I bet you we would have more than a 50% failure rate.”

Chinese acquirers do not always have an easy time in developed markets. Currently, most have to pay as much as a 33% premium over the market price to close a North American deal, according to Backaler, due to regulatory complexity in China and unfamiliarity with western markets.

But a few companies are learning. Backaler says two firms, Lenovo and ChemChina, have both already begun to apply the lessons of past mistakes. “Each post-merger integration has gone smoother than earlier deals,” he observes.

“What we’ve found in our research, more than anything else, is that if people on average just didn’t do the really stupid acquisitions… if they just cut off the stupid 20 or 30%, that number that’s published and in truth accurate would be very, very different,” says Sher, who is also founder of CEO to CEO, a San Ramon, California-based consultancy to mid-sized companies.

The odds may be particularly high for Chinese outbound companies. A recent report by A.T. Kearney, the global consultancy, concluded that “most outbound deals have not created value because Chinese companies had to overpay or were not able to capture operational synergies…. In the pursuit of expansion outside of China, many are failing to avoid the most common pitfalls.”

Edward Hess, a professor of business administration and Batten Executive-in-Residence at the University of Virginia’s Darden School of Business, believes six factors are the most common reasons for failure: poor due diligence, bad valuations, over-estimates of cost savings synergies, bad integration, incompatible cultural values, or making an acquisition for the wrong reason, such as a CEO deciding to merge because CEOs of bigger companies tend to make more money.

On top of the ordinary risks, Chinese companies face the challenge of learning to do business in a foreign market not just as an exporter but as an active participant.

Regulations are one potential pitfall. In the US, for example, companies must comply with unfamiliar accounting standards, labor laws and environmental standards, or face serious penalties, according to William J. Carney, a professor emeritus of Emory Law School. “Noncompliance can leave the buyer with disastrous unexpected liabilities,” he says.

If the acquisition is western, to retain talent the acquirer must also cope with Western stereotypes that Chinese companies are tough employers, warns Paul Seigenthaler, a London-based merger integration expert.

But the Potential is Attractive

Despite the pitfalls, the potential rewards are high enough that many companies can’t help but try it.

“Growing organically is hard,” explains Sher. Uber and other fast-growers may fill up the newspapers, but they are the exception. “The truth is, for most businesses, it’s hard slogging,” says Sher.

This can make an acquisition tempting, particularly if the goal is to enter an unfamiliar market. “You say, wow, if we can buy something… not screw it up too badly, it can be a much faster way to grow—you learn things, you bring on talent, you get a fast start,” he says.

It’s also generally easier to expand an existing business than a start-up, Sher adds. “You just can’t pour money into a start-up fast enough to scale it quickly, but if you’ve got capital, $10 million, and you can buy an existing business, and then infuse more capital into it, you get a much bigger result much faster.”

To read all the articles in the When East Buys West series, please click here.

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