A decade-long trend of the China government encouraging Chinese businesses to expand globally by acquiring resources, advanced technologies, and distribution channels overseas is hitting a speed bump.
Chinese direct investment into the U.S. hit a record $45.6 billion in 2016, nearly tripling the amount in 2015, including $36 billion invested by private investors. The average deal value rose sharply from $90 million in 2015 to $321 million in 2016 although the total number of completed investment projects by Chinese investors decreased from 169 to 142.
China transactions in the US in US$ million according to Rhodium Group.
Some eye-catching deals included Haier’s $5.4 billion acquisition of GE’s appliance business, Lexmark for $2.5 billion, and Vizio for $2 billion. Some of the transactions involved an unprecedented level of leveraged financing among Chinese buyers.
The dramatic increase in the Chinese interest in U.S. assets caused political concerns in the U.S., especially in the semiconductor industry. In 2016, several deals were either blocked by or abandoned due to the pressure from the Committee on Foreign Investment in the United States (CFIUS).
A proposed acquisition of Royal Philips NV of an 80.1 percent interest in its Lumileds light business to a Chinese private equity consortium was blocked by CFIUS in January 2016 due to concerns about Chinese control over dual-use semiconductor technology involved in making LEDs. Fairchild Semiconductor International Inc. rejected an offer from a consortium, comprised of China Resources Microelectronics Ltd. and Chinese private equity firm Hua Capital Management Ltd. citing CFIUS concerns. Former President Obama blocked the proposed acquisition of the U.S. business of German semiconductor company Aixtron SE by Chinese investor Fujian Grand Chip Investment Fund LP for $752 million, leading to the termination of the entire transaction.
The strong growth of offshore investment did not come without political risks in China either. The sudden outflow of foreign currency through outbound acquisitions put some pressure on China’s foreign currency reserve, which is closely monitored by the Chinese government with wary eyes.
Starting from the second half of 2016, it has become clear that the Chinese government is poised to tighten its reins on outbound investments. Many investors started to receive interview requests and the filing process to obtain foreign currency slowed down significantly.
In a Q&A statement published in late November 2016, China officials announced offshore M&A transactions are subject to additional governmental scrutiny. They include outbound investment by limited partnerships which are popular with private equity and VC finds in China as well as investments by newly set-up companies with recently received capital contributions.
Various local government agencies also implemented rules restricting capital outflow through overseas acquisitions. The recent actions at local level indicate that all overseas acquisitions going forward must meet the new criteria. For example, the investment needs to be seen as strategic and aligned with the Chinese investor’s core business.
We expect formal rules will be released in the near future to provide legal support for case-by-case reviews. Officials also announced additional reviews over exchanges of more than $5 RMB million versus $50 million in the past. Starting July 1, 2017, all financial institutions in China also must report any cash transactions over 50,000 RMB (approximately US$7,200) or overseas transfers over 200,000 RMB (US$29,500).
Many U.S. companies with recent experience working with potential Chinese investors in M&A deals have shared the same frustrations. After several months of conference calls, a deal seems to be going smoothly until all of a sudden, the Chinese investor calls to say that the promised signing or closing has to be delayed due to some new restrictions on currency exchange or a notice from CFIUS.
Given the recent uncertainties, potential sellers or targets should take a number of steps. For example they can protect themselves by conducting a quick due diligence on the potential buyer and negotiate a binding agreement, requesting a small earnest deposit before engaging a legal counsel or investment bank.
Most analysts believe that the current restrictions are temporary, merely aiming at preserving China’s foreign currency reserve and discouraging speculative transactions without commercial substance in light of the current economic uncertainties. In the long run, those restrictions could either be modified or lifted when the foreign currency reserve in China or the RMB’s exchange rate stabilize.
--Ning Zhang is a JD/MBA at MagStone Law a law firm specializing in China related transactions.