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Making sense of Chinese outbound M&A

The past year saw Chinese companies spend $227 billion on acquiring foreign companies—six times what foreign companies spent acquiring Chinese firms. These “outbound” M&A volumes have grown at 33 percent per year for the past five years though regulatory controls on foreign exchange have slowed growth in 2017. Chinese companies were among the ten largest deals worldwide in 2016 (for example, the current ChemChina/Syngenta acquisition, which is going through the regulatory-approval process) and were involved in some of the most controversial transactions of the year, such as Anbang Insurance’s high-profile battle for Starwood Hotels & Resorts, which added $0.4 billion to the price that Marriott eventually paid.

Despite all the media attention, a number of myths around Chinese outbound acquisitions persist. Let’s discuss them one by one.

First myth—the ‘wave of money’

China, the theory runs, is awash with cheap capital, and that is now fueling a global shopping spree. It has almost $3 trillion in foreign reserves, the world’s second-largest sovereign-wealth fund, and four of the world’s largest banks by assets—all of which are extremely well capitalized. Chinese companies therefore have almost unlimited firepower for overseas acquisitions, and that makes them willing to pay unrealistically high prices for high-profile megadeals.

It’s important to put this supposed wave of money into context. The total amount of China outbound acquisitions has grown dramatically, from $49 billion in 2010 to $227 billion in 2016. However, the absolute level is still very low. For example, in 2015, Chinese companies spent around 0.9 percent of GDP on outbound acquisitions; EU companies spent 2 percent, and US companies spent 1.3 percent. We are still relatively early in a long growth trend.

The big-ticket deals that make the headlines are also not representative of the majority of transactions. These are mostly middle-market deals: the median deal size over the past three years was only $30 million. And for the most part, the valuations paid were not significantly above normal market levels. However, a Chinese company may have a legitimately different perception of valuation from their European or US peer. Nonstate firms listed in Shanghai had an average price-to-earnings ratio in 2016 of 60 times. If a Chinese acquirer is able to raise equity capital at this valuation, this will naturally make prices paid for overseas assets look much less irrational.

Moreover, the source of the funding is often not even Chinese. Many of the deals with very high leverage were financed enthusiastically by Western banks. The financing of many of the largest deals in recent years was done by foreign-led syndicates of banks. Of course, the Chinese acquirers accepted high levels of leverage for some of these deals, such as in ChemChina’s acquisition of Syngenta, where $33 billion of the $47 billion purchase price was financed by debt. But from a Chinese firm’s perspective, this is not a significant leap of faith. The Chinese economy has for many years relied heavily on bank debt more than on public-equity markets, and most Chinese companies are more comfortable with high levels of leverage than their Western counterparts. Moreover, high-leverage megadeals led by financial sponsors are hardly unusual in Western markets.

Second myth—the invisible hand of the Party

There is a persistent suspicion that somewhere in Beijing resides a collective brain that directs Chinese companies’ actions—and that the recent outbound acquisitions have been directed by this pervasive government planning.

The government does like making plans: the extent to which it drives corporate decisions, however, is greatly overstated. The central government sets an overall policy framework, and managers of state-owned firms are rewarded in career progression for advancing it, but they are acutely aware that they are responsible for their own decisions. With very few exceptions, acquisitions are identified and pursued by management teams for commercial reasons.

Being aligned with policy can, however, bring help in executing the deal. Approvals arrive faster, loans are more readily available, and at times the government will quietly tell other Chinese bidders to drop out of auctions so that only one is contesting a deal. In some sectors—notably semiconductors, in recent years—there is active pressure on companies to find acquisitions. The deals they pursue may align with industrial policy, but mainly because policy reflects the interests of the firms in the first place, and the larger state-owned enterprises (SOEs) participate in shaping major policy instruments such as the five-year plans. But the responsibility for sourcing and executing deals remains firmly with the companies, and they are also responsible for their failures.

The role of government—or lack thereof—can also be seen in how companies use the government-linked investment funds. There is a very substantial amount of capital available to investment funds controlled by central government, such as the Africa Fund, China Investment Corporation (CIC), and the Silk Road Fund. If there really were an invisible hand directing acquisitions, the government would be using these to coinvest with corporates. In practice, this rarely happens. The Silk Road fund, for example, has only invested in one company to date, compared with dozens of project-financing deals.

The only government-linked fund that has done numerous investments into foreign companies is CIC. However, these deals are portfolio investments, done purely in pursuit of CIC’s commercial remit to make returns and not in pursuit of any policy objective; moreover, a significant portion of CIC’s portfolio is deployed into fixed-income securities and funds.

Third myth—it’s all capital flight

Between 2005 and 2014, the renminbi had only strengthened against the dollar, and a generation of managers came to take that as given. From 2014 onward, however, the renminbi has progressively weakened, and growth continues to slow. Many managers found themselves looking for ways to move capital offshore, and acquisitions provided a quick way to do that in large quantities. Are the acquisitions of prestige assets—hotels and property in major cities, often at relatively high prices—simply companies getting money out of China into “safe” assets?

Capital flight is unquestionably happening through multiple channels, of which overseas acquisition is only one: through 2016, the government worked hard to close these loopholes, which in the first quarter resulted in a significant drop-off in deal volumes. The question is whether it was a major driver of the growth in outbound M&A. Between 2015 and 2016, outbound deal volumes grew by 125 percent: this was clearly an acceleration compared with the growth rates in the preceding five years, ranging from 7 to 41 percent growth. Some of the deals done—real-estate deals in particular—made little apparent sense for the acquirers beyond simple financial diversification. Yet the growth in outbound M&A had started long before 2014: the capital flight of the past few years has contributed, but it was never the primary driver.

Fourth myth—crazy gamblers

For many sellers, having Chinese buyers participate in an auction can be a frustrating experience. Their decision making often appears opaque and irrational, with limited visibility into their funding, priorities, or intention to actually complete a transaction.

What appears to be irrationality, however, is often decision processes that aren’t fully transparent to the sellers. A Chinese buyer, particularly a state-owned company, has to work with a complex set of stakeholders both inside and outside the company, and the person communicating with the seller may not be able or willing to explain these considerations.

Among many Chinese buyers there is also a suspicion that the standard M&A sales process does not play to their strengths. It is designed to place buyers in competition on equal footing and limit their access to the target company; this is exactly the opposite of the one-on-one negotiation and closer relationship building with the counterpart that they would prefer. Moreover, many management teams remain unfamiliar with the process itself and do not understand how to navigate it. This is changing fast, particularly among the private companies that have business-development staff with international experience and among the more sophisticated SOEs with experienced deal teams, but there is still far to go.

This impression often masks a genuine desire, even need, for some of these transactions. For Chinese companies that are approaching the limits of growth in their domestic markets, access to technology, brand, and distribution networks abroad can be critical to their growth plans. Hence sellers often receive extremely mixed messages that can be challenging to decode; they frequently write these off as cultural differences, when in fact they reflect the unique circumstances of these buyers.

Fifth myth—integration isn’t important to these buyers

In many deals, there is relatively little discussion of what will happen postdeal apart from securing the management team—and often the acquired managers are pleasantly surprised by the degree of autonomy they enjoy after the deal. This has led to the perception that Chinese companies aren’t particularly interested in integrating their acquisitions into the parent companies to the same degree that a US or European acquirer would want to.

It’s certainly true that Chinese companies are more likely to take a “hands off” approach to managing acquisitions postdeal than would most Western companies. However, this is largely because in the past, they lacked the capabilities to integrate: they simply didn’t have enough managerial bench strength that could function in the acquisition’s region. It’s not that they didn’t want to integrate: they doubted their ability to do so. The lack of focus on integration is one of the reasons that over the past ten years, the track record of success by Chinese acquirers has been extremely mixed.

Consequently, the integration models used look quite different. In most Western countries, there’s a fairly well-understood approach to postmerger integration—speed is critical; companies eliminate overlaps and pursue synergies aggressively. Many Chinese integrations chose to prioritize stability first, keeping the company separate and looking at one or two major areas of synergy, such as R&D sharing or localization of product manufacturing in China to reduce cost.

As the track record shows, the approach to integration made a significant difference in the success of these deals. Those companies that had an organized and systematic approach to integration, on average, showed much better results than those that kept the asset at arms’ length, managing through the board and treating it essentially as a financial investment.

There is, in most cases, a solid logic behind these acquisitions, be it acquiring capabilities, building a footprint outside China, or buying brands or technology. However, without a plan, potential synergies are simply numbers on paper. Increasingly, Chinese companies are recognizing this and developing more concrete integration plans earlier in the deal process. The bottleneck for most is building the resources to execute those plans—developing a cadre of managers with experience both operating abroad and in integrating acquisitions that they can deploy. This is easier said than done. Often deep functional experience is required—engineers and technical staff to support technology transfer or procurement, marketing teams to support cross-selling, IT staff to support platform consolidation—and the teams need to be able to function in the acquisition’s language and working environment as well as the acquirer’s. There are not, for instance, many Italian-speaking Chinese aerospace engineers available on the job market.

We are still at the beginning of a long growth trend, and the persistent myths surrounding these deals reflect this. Chinese companies will in time be an important part of global cross-border M&A, and that means levels of activity substantially higher than what we have seen to date. This will require some adaptation on both sides. However, Chinese companies need the brands, channels, technology, and relationships that these transactions can bring; and the investee companies benefit from access to the rapid innovation, scale, and cost advantages of the China market. In the long run, everyone gains from China’s participation in the global deal market.

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Ropes & Gray rebuilds in Hong Kong with Simpson Thacher hire

Ropes & Gray has hired Simpson Thacher & Bartlett finance lawyer Jackie Kahng as a partner in its Hong Kong office.

Kahng, who is dual-qualified New York and Hong Kong and was an associate at Simpson Thacher, focuses on borrower-side financing work, advising private equity funds and their portfolio companies.

The co-head of Ropes & Gray’s global finance practice Byung Choi said: “Jackie’s experience will enhance our global finance offering and we expect that she will play a key role as we continue to expand our acquisition and leveraged finance practice. Her appointment is a further step in building an integrated global finance practice that allows us to offer cross-border expertise across financing products.”

Ropes’ 2020 strategy, which it unveiled in 2015, has an emphasis filling in the gaps and creating links between London, New York and Hong Kong.

The firm opened in Hong Kong in 2008 and first began offering Hong Kong law advice in 2012, hiring Julian Chung and Gary Li from Norton Rose and Paul Weiss Rifkind Wharton & Garrison.

The office suffered a blow in April 2017 with the loss of four partners, including office managing partner Paul Boltz, to Gibson Dunn & Crutcher. Private equity partners Scott Jalowayski and Brian Schwarzwalder, and banking partner Michael Nicklin, also departed.

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Baker McKenzie partner accused of sexually assaulting associate

A partner at Baker McKenzie allegedly sexually assaulted a female associate, it has emerged.

The alleged assault, first reported by RollOnFriday, is understood to have occurred after a work event.

The associate received a payout from the firm and entered into a confidentiality agreement before leaving.

The firm said the incident referred to by RollonFriday took place several years ago and was reported by the HR team. Baker McKenzie immediately launched an investigation into it.

It subsequently imposed sanctions on the partner concerned, who has remained at the firm.

A Baker McKenzie spokesperson said: “We take any allegations of inappropriate behaviour or misconduct extremely seriously. This incident occurred several years ago and was reported by our HR team at the time. The firm treated the allegation very seriously and immediately carried out a thorough investigation, including obtaining both external and internal advice.

“On completion of the investigation, the firm imposed sanctions on the partner concerned. A confidential settlement was then reached with the employee, which we are not in a position to discuss. Our Code of Business Conduct reflects the values of our organisation, and we expect all of our people, whether partners or employees, to abide by the principles and standards of behaviour set out in that Code.”

The revelations come as law firms are facing increasing scrutiny about what they do to prevent and respond to sexual harassment and discrimination in the workplace.

In the wake of the Presidents Club male-only charity dinner scandal, research undertaken by Advisory Excellence demonstrates a disparity between how men and women partners feel about male-only networking events.

Eighty-six percent of respondents to the survey – which gained responses from more than 250 partners – say law firms need to make corporate networking activities more inclusive, including almost 50% who think firms must try “much” harder.

Earlier this month, Dentons suspended a male partner in response to allegations of inappropriate behaviour.

The firm has launched an internal investigation into the claims, which refer to behaviour by the partner when he was at legacy Scottish firm Maclay Murray & Spens, which merged with Dentons in July last year.

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West Palm lawyer takes helm at Florida’s largest law firm

A West Palm Beach trial lawyer, David Spector, became chairman and CEO this month at Akerman LLP, one of the nation’s largest law firms.

Spector, 46, a Palm Beach County lawyer since he got his law degree at the University of Miami, said he hopes to continue the client-centered strategy that has seen the firm grow to more than 650 lawyers nationwide.

“Many people in the industry talk about disruption in law firm industry and how to overcome those disruptions. We think about the disruptions in our clients’ industries now, about what the changes there are going to be in the next phases of their lifespans, and about focusing our business around them rather than around our industry,” he said in an interview Tuesday.

Akerman, founded in Florida, is the biggest law firm in the state and 76th biggest in the U.S., by number of lawyers. The firm has 24 offices, including eight and its operations center in Florida. In 2016, the latest year for which figures were available, the firm reported net income of $127 million, on gross revenues of $349 million.

On a growth curve for at least a decade, within two weeks Akerman will announce acquisition of another firm in Texas, where it already has offices in four cities, Spector said. Another acquisition will come shortly thereafter in South Florida, “which we will be exceptionally proud of,” he said. “A great group of lawyers you will know.”

Spector earned his B.S. at Syracuse University in 1993, his J.D. at UM in 1996. He and his wife and four children live in Boynton Beach.

He litigates complex fraud schemes and unfair and deceptive practices on behalf of property and casualty and health insurers, financial institutions and self-insured retailers, according to the firm website. Before replacing Andrew Smulian at the firm’s helm, Spector founded Akerman’s Fraud and Recovery Practice Group, an team “dedicated to the investigation and eradication of fraud.”

Smulian, an urbane Yalie who spent a decade as chair and CEO, will remain a partner, focused on special projects.

Among Spector’s cases, he represented the nation’s largest property and casualty insurer in the first attempt by an insurer to sue a medical legal referral service for alleged fraudulent claims in violation of Florida self-referral laws. He defended an international law firm in a bench trial for alleged malpractice and fraud claims arising out of an oil and gas venture representation in which damages were claimed to be $1.15 billion.

Spector, speaking from Jacksonville and on his way to Houston and Chicago next week, said that as Akerman’s leader he expects to be traveling frequently but will maintain an office in West Palm Beach, splitting his South Florida time between there and the firm’s largest office, in Miami’s Brickell City Centre, where Smulian was headquartered.

He plans no strategic changes but will maintain the nimble footing of “a fifth generation law firm with first generation thinking,” he said. “We’ll continue our investment in technology and innovation, such as the use of data analytics to align our needs with those of our clients. We continue to see our core strengths in the middle market (of corporate work), and real estate and financial services.”

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Magic circle law firm acquires Carillion’s legal arm

Clifford Chance today announced it has acquired collapsed construction giant Carillion’s ‘managed legal services’ offering. Carillion Advice Services (CAS) will be ‘fully integrated’ with Clifford Chance.

Uncertainty hung over the future of CAS when Carillion declared insolvency last month.

The legal arm was set up in 2011 to support Carillion’s in-house legal team from Newcastle. It has provided over 30,000 hours of support to the Carillion in-house team, which the company said saved the business around 15% in external legal spend in 2016. CAS’s team of 60 paralegals in Newcastle and 10 in Telford handles high-volume work of low-to-medium complexity, such as confidentiality agreements and legal research. CAS also provides contract management, document review and litigation support, corporate due diligence, unbundling and project support services.

Clifford Chance said the CAS team will continue to be led by director Lucy Nixon and it will continue to be based in Newcastle. The team will report to Clifford Chance managing partner Michael Bates, and Oliver Campbell, the firm’s global head of client services solutions, who is also responsible for the legal support centre in India.

Bates said: ‘Our priority is always to ensure that we are best placed to provide the optimum service to our clients. By working with the CAS team, we will enhance our ability to provide extremely cost-effective, efficient and high-quality service on a range of low complexity legal tasks as an integral part of our overall client offer.

‘To date, we have delivered this work either through our legal support centre in India, or through working with other third parties including legal outsourcers. The addition of the team in Newcastle, with their well-recognised expertise in unbundling, developing processes and applying the latest in legal tech, will enable us to provide clients with another option from within the firm.’

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Legal team gets top ranking by Chambers Global 2018

The dispute resolution team at Bermuda law firm MJM Limited has been given a Band 1 ranking by Chambers Global 2018.

The global law firm rating agency said the team is known for being a “distinguished, independent Bermudian firm that is widely respected in the jurisdiction”.

It noted that it maintains “a very strong reputation for domestic Bermudian cases and is regularly instructed by the Government of Bermuda on a variety of constitutional and public law matters”.

Chambers said some of MJM’s highlights were acting for Bermuda’s Ministry of Home Affairs in a long-running land compensation claim against the Corporation of Hamilton concerning Hamilton Waterfront, and that it “successfully represented the Electricity Supply Trade Union in a breach of contract dispute against the Bermuda Electric Light Company. This case related to the provision of free healthcare to union retirees and was reported as the first class action to be heard by Bermuda’s Supreme Court”.

Alan Dunch, Andrew Martin and Fozeia Rana-Fahy were mentioned as notable practitioners. Mr Dunch was praised for “superlative litigation skills”, while Mr Martin was described as “gentlemanly, calm and measured advocate” with “a keen understanding of Bermuda’s legislative, regulatory and political environment.”

Sources quoted by Chambers regarded Ms Rana-Fahy as “knowledgeable, responsive and pragmatic”.

Chambers Guides have been ranking the best law firms and lawyers since 1990 and now cover 185 jurisdictions throughout the world.