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Foreign fears may hamper China's 'rational' M&A drive


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Foreign fears may hamper China's 'rational' M&A drive

China is trying to favor "rational" overseas investments by its companies as it cracks down on capital outflows and irresponsible borrowing, but its attempt to push them toward real economy acquisitions comes just as foreign governments turn protective of strategic manufacturers and technologies.

Concerned that foreign acquisitions were draining foreign reserves and putting downward pressure on the yuan, Chinese authorities began late in 2016 to apply more scrutiny to cross-border purchases, acting most recently to limit companies' use of collateral in China pledged to local banks in order to obtain foreign currency loans from their branches abroad. After a record $170 billion in foreign takeovers in 2016, according to official data, Chinese companies have slammed on the brakes so far this year, with investments plummeting 82.1% in overseas property markets and 82.5% in culture, sports and entertainment.

Spending in these areas had often been risky and "irrational," according to the Ministry of Commerce, which said in late July that companies should concentrate their purchases on the real economy. Outbound direct investments in manufacturing industries have declined 18.3% in 2017, far less than the all-sector 42.9% decline in the first half from the year-ago period, ministry data show.

But, while the government seems content for Chinese companies to keep snapping up high-tech manufacturers, such purchases not only tend to be subject to higher regulatory requirements but are also meeting with increasing resistance in Europe and the U.S.

"Purchasing overseas manufacturing and high-tech companies requires stringent regulations," said Xia Le, chief Asia economist at BBVA Research in Hong Kong. "Combined with capital outflow curbs in China, we have seen a significant decline in overseas investments."

Earlier this month, Alibaba Group Holding Ltd. affiliate Ant Financial Services Group had to refile its application to buy MoneyGram International Inc. with the Committee on Foreign Investment in the U.S. after failing to obtain clearance within 75 days, Reuters reported. In April, Anbang Insurance Group Co. Ltd. dropped its bid for U.S. insurer Fidelity & Guaranty Life after the Chinese insurance giant failed to satisfy inquiries from state regulators on its shareholding structure. Anbang, also under pressure in China over its sales of wealth management-type insurance products, hadn't had to disclose such information when acquiring hotels and buildings.


More profoundly, there are signs of a backlash against what some foreign governments see as a pattern of buying companies with useful technology and then transferring it to China. Reacting to the 2016 takeover by a Chinese firm of industrial robot maker Kuka, Germany in July issued a directive to allow ministers to block deals involving "critical infrastructure". In December 2016, China's Fujian Grand Chip Investment had to withdraw its offer to buy German chipmaker Aixtron SE after security concerns raised by both German and U.S. officials. The European Commission also reportedly wants mandatory screening of some mergers and acquisitions, following €75 billion in Chinese purchases in 2016. And technology transfers to China could be at the center of the first significant trade action against Beijing by the Trump administration.

Chinese companies have long had a culture of making real estate investments, which can generate good returns and are subject to less rigorous standards of approval by overseas regulators, said Paul Guan, Hong Kong-based partner at Paul Hastings, a law firm advising cross-border M&As in and out of China. But property developers will not be the only Chinese firms to see their foreign opportunities reduced as a result of the new policy: insurance companies often invest in hotels and buildings as long-term assets against their long-term liabilities.

"Investing into the real estate market is relatively simple," Guan said. "Investing into the real economy may face foreign countries' scrutiny and blocks."

In addition to foreign regulatory suspicion, Chinese companies on the acquisition trail will also face tougher controls on transferring their money offshore, as the authorities staunch capital outflows. This will make it more difficult for them to complete deals quickly, BBVA's Xia said.

"In the short term, foreign companies may doubt Chinese buyers' seriousness if Chinese companies failed to move money out of China to complete the deals," he said, although he added: "In the long run, foreign sellers will have reasonable expectations on the issue."

Some Chinese companies have already found it harder to transfer money out of China. HNA Group Co. Ltd. had to delay two pending deals while it sought approval to move capital offshore, Reuters reported.

For years Beijing had moved towards liberalizing its capital account, but it become alarmed by capital outflows which, according to the Institute of International Finance, reached a record $725 billion in 2016, almost five times 2014's level and helping to drain foreign exchange reserves by $320 billion. The yuan depreciated by 6.5% against the dollar in 2016, the most ever.

Excessive foreign investment could also end up hurting China's financial system if foreign bets go bad and leave Chinese buyers struggling to keep up with their domestic obligations, Xia said.

AMC Entertainment Holdings Inc., in which Chinese developer Dalian Wanda Group Co. Ltd. owns a 68.83% stake, recorded a net loss of $176.5 million in the quarter ending June 30. In June, China's National Audit Office found 20 audited state-owned companies had made 38.5 billion yuan in risky overseas investments due to poor management, CGTN reported.

Risks to Chinese banks

"Increasing debts and risks will eventually fall on Chinese banks," Xia told S&P Global Market Intelligence, adding that the Chinese government, as the biggest shareholder of state-backed lenders, might end up footing the bill.

Foreign exchange reserves recovered to $3.08 trillion in July, the highest since December 2016, and the yuan has appreciated to the highest level against the U.S. dollar since October 2016. But the crackdown on outflows comes as the authorities are especially keen to guarantee financial stability in the lead-up to the 19th National Congress of the Communist Party of China, expected to be held early November, which will endorse the country's top leadership and set out development plans for the next five years.

"The trend (in foreign reserves) can be reversed at any time," said Hong Hao, managing director and head of research for BOCOM International Securities in Hong Kong, adding that from June 2014 to January 2017, China had lost US$1 trillion, or 25% of its foreign exchange reserves. "Foreign exchange reserves can shrink in a very fast way."

Nonetheless, with prices for some local assets, including real estate, at levels some argue are in bubble territory, Chinese companies still have incentives to buy abroad and diversify risks.

"It would be difficult for Chinese companies investing overseas in the next few months," said Guan at Paul Hastings. "But I am optimistic that in the long term, increasing overseas investments is a trend that can't be reversed."

As of Aug. 11, US$1 was equivalent to 6.67 Chinese yuan.