Earlier this year, I did a post entitled, Buying A Chinese Company? Why China Deals DON’T Get Done.  In that post, I talked of how a very high percentage of the China deals on which my law firm represents the foreign buyer simply never happen. In our experience, a Chinese M & A deal is maybe five times less likely to go through than a deal in a developed country.  This is due mostly to the lack of transparency of Chinese companies, the differences between how Chinese and Western companies operate, the differences between how Chinese and American companies can operate in China, and to inexperience with such deals on the China side.

I thought of that post today when I read “Why Chinese Firms’ Cross-Border Deals Fall Apart” in the Harvard Business Review, written by Laurence Capron and Will Mitchell.  That article talks of a soon to be published study that concludes that “cross border deals involving Chinese companies are almost twice as likely to break down (15% of the time) as deals involving companies from other BRICS countries (8%) and three times as likely as those involving Western multinationals (5%).  Those numbers “seem” about right to me in that if you tease out the pecularly China reasons for incoming China deals to fail, I’d probably reduce my “five times less likely to go through” to three times less likely to go through.

The HBR article sets out some of the reasons for the low follow through rate on China deals:

Chinese companies are relatively new to the M&A game, governments in many target markets are quick to detect a political agenda, Chinese companies sometimes struggle to obtain financing or face unexpected political opposition at home, and many acquiring Chinese firms operate in particularly dynamic — and volatile — global markets.

But Chinese companies nonetheless need to start stepping up their game and becoming more sophisticated in choosing their deals and in setting up mechanisms for following through. The calls on Chinese companies to improve in four things:

  1. Make sure that acquisitions are aligned with strategy. Companies jump to an acquisition out of fear of missing an expansion opportunity. This is a recipe for failure and acquirers need to make sure that their M&A strategy is aligned with a well thought-through broader strategic plan. Obviously, this requires that you have a robust strategic planning process to begin with, which is not always the case in China.
  2. Assess the political attitude in the target country. Governments in most countries will review major foreign investments. As noted, several high profile deals involving Chinese firms, such as CNOOC’s 2005 attempt to purchase Unocal in the U.S., have been blocked, either formally or by delaying the negotiations to the point that the buyers withdraw. Before going too far with your acquisition process, Chinese acquirers need to assess how the target’s local government is likely to react.
  3. Make sure there is no opposition at home. Although some deals may be blocked in the target countries, others fail because of opposition at home. Tengzhong’s 2010 attempt to buy Hummer from General Motors, for instance, fell apart because of opposition from the Ministry of Commerce in China. Before embarking on deals that are likely to be controversial inside China, Chinese acquirers should first make sure there is a clear path for approval.
  4. Consider sequential engagement. When there is high uncertainty about the value of the combination or how you will be able to work with your foreign target, you may want to start out with a more focused partnership. You can start with a specialized alliance or undertake an initial equity stake and gradually deepen your relationship.

It then sets out what it (and I too) see as the “bottom line” reason for so many Chinese merger failures:

Bottom line, too many Chinese companies are opportunistic dealmakers.They need become more sophisticated in their M&A processes and should explore more carefully less headline-grabbing ways of acquiring new resources and capabilities, along the lines we set out in our book, Build, Borrow, or Buy. If they do so, their cancellation rates will fall and they will be seen as more reliable M&A counterparties, which will open up more opportunities for them.

Very true.

I cannot tell you how many times we have been called in to represent an American company that is selling itself or some aspect of its business to a Chinese company and for the life of us, we do not see how the deal makes sense on the China side.  We have had a couple of such deals where the Chinese company has put down real money as a non-refundable deposit and then walked away shockingly early in the deal, presumably because they then realized that the deal made no sense.  I have often thought imagined that in those situations the Chinese company had some sort of mandate from somewhere to move forward with “a deal” and pretty much picked one at random.  “Let’s see, we are a very successful clothing company in China so let’s buy an American airplane parts company” or we have a lot of money from our successful mining operations in China so let’s buy a United States consumer software company.”  I have made up these examples, but trust me when I tell you that they are very much similar to what we have seen.

So what do you think?

China recently issued a new mandate requiring the Supreme People’s Court approval for all executions. I see this boding well for strengthening China’s judiciary.

A year or so ago, I was on Fox News to discuss international jurisdiction issues arising from the Natalee Holloway murder case in Aruba. Before accepting this “gig,” I made very clear to Fox that I knew almost nothing about criminal law and even less about Aruba criminal law. The “show people” assured me I would not be asked to discuss either of those topics.

So I go on LIVE TV before ten million people and the first question I am asked is on Aruba criminal law. My mind races for a second and I then answer (without really having any clue) as though I had been handling criminal cases in Aruba for the last twenty years. I had no choice.

I have a choice now so please forgive me for not delving terribly deeply into the criminal law implications and going right to its overall impact. I see this new law as just another effort by Beijing to strengthen its hand against the provinces. Consolidating the right to execute means only Beijing has the power to kill. It also means Beijing’s control over the courts has increased.

This is not to say real good will not come from this change, because I think it will. Those on China’s death row can expect to get a fairer shake from China’s highest court than from the judges in most of the provinces. But, as pointed out on the Moderate Voice blog, this will not always be the case:

In December 2003, a purported gang boss who said he was tortured into confessing to corruption charges was executed in the northeastern city of Shenyang in an anti-graft crackdown.

A provincial court had issued a reprieve, citing the possibility that the torture claims might be true, but the Supreme People’s Court overruled that decision and ordered his immediate death.

The BBC had this to say:

But it is unclear whether this will involve a full appeal hearing or, as it is at present in lower courts, simply a review of the paperwork from the initial trial.

Jerome Cohen, a US expert on the Chinese legal system, called the move a “step in the right direction,” which shows the country’s top judiciary is increasingly concerned by the death penalty system.

But he said more fundamental reform of the death penalty legislation is needed to change the way such cases are tried and appealed.

China’s chief justice Xiao Yang called it “an important procedural step in preventing wrongful convictions”.

“It will also give the defendants in death sentence cases one more chance to have their opinions heard,” Mr Xiao said in comments carried by state media.

In a sidebar, the BBC article noted the following:

  • China is believed to execute more people than rest of the world combined
  • Non-violent crimes such as tax fraud and embezzlement carry death penalty
  • Other crimes include murder, rape, robbery and drug offenses
  • China does not publish official figures on executions
  • Many cases are based on confessions and trials often take less than a day, observers say

The Paper Tiger Blog, whose writer has been deeply involved with China for more than 25 years “wonders if this [new law] is another part of the Central government’s efforts to reign in unruly and disobedient local governments. The optimist hopes that it marks a further strengthening of a rule of law in China with a foundation of justice, as opposed to the whims of authority.”

I actually wrote the above portion of this post at the end of October, but decided it lacked enough of a business angle to run it. I revived it after reading an article in the most recent “China Law Reporter” that does an excellent job of tying the change in China’s execution laws to the big picture of China governance and business. China Law Reporter is put out by the China Committee of the American Bar Association’s (ABA) section on International Law and the article was co-written by the committee co-chairs, Amy Sommers of Squire, Sanders & Dempsey and Michael Burke of Williams Mullen.

Like me, Ms. Sommers and Mr. Burke see the change in China’s execution laws as part of “an effort by the national government to exert greater control over, and prevent abuse by, local officials.” They also see this same dynamic at work in China’s new M&A regulations applicable to foreign-invested acquisitions and in Beijing’s recent crackdown on corruption and economic crimes.

According to Sommers and Burke, China M&A regulations “grant greater supervisory powers to MOFCOM (the national body responsible for overseeing foreign investment), such as in the case of proposed sales of companies in strategic industries or projects having a bearing on ‘national economic security.'”  Sommers and Burke see Beijing as wanting to crackdown on corruption for fear it could threaten social stability and eventually lead to increased challenges to party control.

I agree.

I see Beijing’s increasing strength, particularly in the courts, as generally good for foreign companies doing business in China, at least in the short term. Beijing has a better understanding of the importance of such things as enforceable contracts and IP protection than most of the provinces. The more control Beijing asserts over the provincial courts, the more those courts will begin to resemble Beijing in their law enforcement. I am much more wary of the long term implications of centralized power, but I will leave that discussion to the political theorists.

I recently discussed Beijing’s battles for control in “Shanghai Corruption, Beijing Battles And The Fight For China Leadership” and in “Unsafe Mines And China IPR” and I urge those who want more on these issues to check out those posts.

If you are doing business in China and you are not reading Andrew Hupert’s Diligence China Blog [no longer exists], you are making a mistake. Plain and simple. Andrew Hupert is one of the best versed and straightest talking China business writers in the blogosphere and his China focused business blog is essential reading. He just did a post on an issue I had been wanting to post on for weeks:  a recent influx of what I call conservative United States companies seeking to go into China. His post is called, “China Business: The Learning Curve has just gotten much Flatter.”

I had a conversation on this topic a few weeks ago with Jeremy Gordon of China Business Services and the China Business Blog. During our conversation, we discussed how we were both seeing increasing in business from old-line companies (mostly American in my case and mostly British in Jeremy’s case) looking to manufacture or sell in China. We talked about how these companies had previously taken a wait and see position towards China, but were now ready to move in. As Jeremy put it (this is a very rough quote on my part), “five years ago, China was on everyone’s mind. Two years ago, China was on everyone’s agenda. Six months ago, China was placed on everyone’s desk.” There is a certainty about China now that was not there even one year ago. Immediately after I got off the phone with Jeremy, I started a post on this topic, but abandoned it after realizing I had nothing more to say than what I have said in this one paragraph.

Thankfully, Mr. Hupert just wrote the blog post I should have written. Hupert sees the same “shift” of which Jeremy and I (and countless other China service providers) were discussing:

China business has just shifted again. It’s a little hard to tell because it was subtle, but the last few weeks have seen some powerful trends confirmed. US companies’ 06 China operations threw off 50% more profits than in the first half of 05. Starbucks is buying back their JVs and running their China stores independently. Wal-mart has unveiled plans to become the #1 foreign retailer in China.

US corporations, who have largely been waiting on the sidelines during the Great China Opening, are finally ready to start moving into this market.

Hupert then goes beyond merely seeing the trend to explaining it.  He sees the following as driving the trend (my comments are in italics):

  1. International MNCs [multinational companies] have officially learned how to do business in China. “China is still hard and unpredictable, but now it’s possible. Expensive, bureaucratic, and slow” but that’s what legal departments are for. There are enough roads and wires and regulations in place for the US giants to execute their large-scale, integrated plans. The Americans are coming.” He is absolutely right.  There are still risks, of course, but they can be calculated.

  2. Chinese bureaucrats have officially learned how to do business with the World. “They have a good idea about what is possible, what is not possible, and what works. Again, he is absolutely right.  Just by way of example, we are now able to fairly accurately predict the minimum capital requirements for various businesses seeking to form in the Shanghai area and in various other China locales.  There is actually pretty good consistency there.

  3. Private Chinese and ex-pat’s have learned where the opportunities in China really lie. “While not always successful, they are a lot more savvy and sophisticated about how to attack the China market. They know that if they go with the flow, they will find tremendous opportunities. But anyone who bucks the trends or looks to get rich quick will get destroyed by the big forces in this environment.” This does seem to be the case, though we are still seeing many Americans seeking to do business in China without enough of a real plan.

Hupert then sets forth the two basic rules of China’s opening to business that all must “take to heart: 1) China’s policy of economic opening is essentially a conservative attempt to safeguard the long-term security of the Party. 2) China’s intent was always to interact with the West as little as possible while securing maximum possible gain in terms of technology, knowledge, process and intellectual property.

He then goes on to say that an accommodation has now been reached between the Chinese government and foreign business: Westerners get access to the China market so long as they act to support the bureaucracy.  The Chinese get to hold on to manufacturing, but are to “back-off [from] the notion of Chinese consumer branding.” For the most part, Chinese brands have not taken hold either inside or outside China  and the “lion’s share of the Chinese domestic economy will be engaged in OEM [original equipment manufacture] manufacture for western companies or servicing international brands.”

I agree with Hupert regarding Beijing’s goals in opening its economy and I also agree that Beijing, at least to a certain extent, will continue favoring foreign companies over domestic ones because it sees big money in the hands of its own people as a potential threat to its own power.

Hupert then discusses how American companies (rightfully so) do not like to partner; they like going it alone. China has been “a scary and unfamiliar place,” but that all changed last month when Starbucks bought out its Beijing joint venture (JV) partner and Wal-Mart made clear its plans to go full bore into China.  Hupert sees much “more US style business entry into China, with US based companies establishing a toe-hold in Shanghai or Beijing and then rolling-out new locations as part of a systematized, scheduled plan.” Hupert sees “new energy in M&A and buy-out activity as US firms look to collect assets, brands and marketing territory.”

He sees development in China’s second tier cities exploding as US companies radiate out from Shanghai. US investors will scour for under-utilized assets and inefficient competitors ripe for consolidation. They will take the brand and customer lists, shut the factory, and centralize production and operations in an efficient, high-volume facility. Hupert concedes all this has been going on for years, but on a much smaller scale than he anticipates going forward.

Hupert sees a difference in how American and European companies approach developing markets:

The new competition in China will be between the market-dominating US brands and the market-building Europeans. Europeans tend to get in early and try to slowly change the rules of the game in their favor. Americans like to wait until the regulatory and physical infrastructure is on the ground, and then move in force. There is still time for some Chinese private brands to emerge, but companies like Wal-mart and Best-Buy tend to be category-killers that discourage new competitors from entering the market.

I do not know enough about European companies to concur in Mr. Hupert’s comparison, but his description of American companies perfectly coincides with what I see with my firm’s mostly American clients.

China is becoming less exotic and more doable for American business.

the Organization for Economic Co-operation and Development’s (OECD) just released a report on foreign investment in China.  The OECD report focuses on China’s policies regarding cross-border mergers and acquisitions (M&A) and notes that though “some progress has been made” in easing the rules and regulations for cross-border mergers and acquisitions, still “more needs to be done.” The report calls on China to “make its rules and regulations for cross-border mergers and acquisitions more open and transparent to attract more and better foreign investment.”

The report specifically calls on China to do the following to improve foreign M&A in China:

  • Streamline the approval process for cross-border M&A and make it more transparent;
  • Put in place a sound competition framework;
  • Further open capital markets to foreign investors;
  • Encourage Chinese companies  to increase corporate transparency and provide more up to date and accurate financial information to make it easier to value a potential acquisition, especially regarding a firm’s liabilities;
  • Relax foreign ownership restrictions. In particular, revise existing catalogs that list the type of firms that can or cannot be acquired by foreign investors.

The report also recommends China pilot test these recommendations in the North-East of the country before rolling them out nationwide. The report states that this region, China’s historical industrial heartland, has a high concentration of state-owned firms needing restructuring and technological upgrading, as well as high unemployment and low productivity. The report contends  that cross-border M&A could help rejuvenate the region’s economy.

One of the biggest problems facing private Chinese businesses is finding money to grow.  These companies are essentially cut off from both bank loans and the Chinese stock exchanges and, as set forth in the OECD report, China’s M&A laws make foreign acquisitions relatively difficult.  In the next few years we foresee a big influx of western venture capital (VC) firms providing secured and unsecured funding to dynamic Chinese private companies in return for equity stakes and other compensation.