[Financial Times] Chinese State Owned Enterprises put the brakes on outbound M&A

By Lisha Zhou in Shanghai, Yumin Wang and Olia Wang in Beijing

Published: July 13 2011 16:00 | Last updated: July 13 2011 16:00

Chinese State Owned Enterprises put the brakes on outbound M&A

By Lisha Zhou in Shanghai, Yumin Wang and Olia Wang in Beijing

Published: July 13 2011 16:00 | Last updated: July 13 2011 16:00

This article is provided to FT.com readers by mergermarket—a news service focused on providing actionable, origination intelligence to M&A professionals. www.mergermarket.com

Chinese state-owned enterprises [SOEs] are slowing down the pace of overseas deal activity, sources at these entities told mergermarket.

According to data recently compiled by mergermarket, Chinese bidders have been significantly less active in M&A this year, with the total value of deals announced by Chinese companies (USD 46.3bn) 17% less than at the same point last year. SOEs tend to account for the bulk of outbound deals, noted a Chinese government official.

Sources told this news service that reasons for the slowdown include diminishing acquisition opportunities, high commodity prices, more regulatory oversight on outbound deals and tightening credit.

Diminishing opportunities

A major factor for the slowdown is the decreasing number of quality opportunities, a source at Sinopec explained. In the traditional energy and resources sectors, the price discrepancy between the vendors and the buyers is significant, which is deterring the Chinese bidders.

“When global commodity prices are high, it is not a good timing to make outbound acquisitions,” Jiemin Jiang, the head of China National Petroleum Corporation [CNPC] and PetroChina [601857: SH, 00857: HK], told public shareholders at PetroChina’s mid May annual shareholders’ meeting this year. Jiang said the turmoil in North and West Africa did not cause CNPC to review its overseas M&A strategy because CNPC had already evaluated the risks before entering the region. However, the high oil prices would influence CNPC’s overseas acquisitions, he was quoted.

A source at CNOOC also told this news service that Chinese energy giants would focus more on the operation and consolidation of the overseas assets they bought in the past three years, rather than move out to buy new ones. Hence he was not surprised to see that outbound M&A deals in the energy and resources sector declined this year, the source added.

In the mining sector, where Chinese suitors were very active in recent years, few decent targets remain, said a source at Wuhan Iron and Steel Group [Wisco]. Only a few small-sized direct shipping ore deposits, or hematite deposits with grades in excess of 60% Fe, are available now in Western Australia, where many Chinese SOE steel makers such as Baosteel, Sinosteel and Anshan Iron & Steel have already acquired assets. Now Chinese investors are mostly limited to low-grade magnetite mines, and most of them have transportation difficulties, the source said.

Stricter SASAC regulations

Encouraged by the State-owned Assets Supervision and Administration Commission [SASAC] to go outside China when the global financial crisis hit the world in 2008, Chinese SOEs used to be more eager to seal a deal than to worry about the price. A successful outbound M&A deal added more points to an SOE head in its performance review with the SASAC, and could directly result in promotion. But after most of the outbound M&A deals done by Chinese SOEs in the past three years turned out to be loss-making, the SASAC started to strengthen its oversight on outbound deals.

Senior SASAC officials indicated several times since the beginning of 2011 that SASAC would require heads of SOEs to take responsibility for the failures in SOEs’ overseas investments. In late June, the indications became true. SASAC ruled in two regulations that SOE’s overseas investments will be registered, monitored, audited and reviewed by SASAC starting from 1 July 2011. The heads of SOEs will now be investigated should the overseas investments incur losses.

Although SASAC didn’t clarify what consequences an SOE head would face, the new policy did create psychological pressure on Chinese SOE bidders to make them more price sensitive in dealing with targets.

A source from CNPC said SOEs will have to carefully evaluate investment yields of their overseas acquisitions before it can get the green light from regulators. Added a source at Shanghai International Port Group [SIPG]: “We only look at opportunities with annual investment yield no less than the Chinese bank loan interest rate, which is above 6.56% now.”

Compared with the National Development and Reform Commission [NDRC], which usually has minimum investment yield requirements on an outbound deal, SASAC is even stricter, said an SOE internal banker who oversees outbound M&A deals. “SASAC once had asked two third-party assessment firms to evaluate our potential overseas acquisition before they gave green light,” he said. And if the two firms got different views on the potential target, SASAC would not support the deal, he added.

“Price and profitability of a deal is more important than ever,” the CNPC source said. In fact, price concerns have already caused many Chinese bidders to walk away from potential targets this year.

The China Guangdong Nuclear Power Corporation [CGNPC] would rather wait for another three months to come up with a 20p-less offer for Kalahari Resource [KAH: LN]. Minmetals, which had twice raised its offers in the previous takeover of OZ Minerals [OZL: AU], withdrew from the bidding war for Equinox Minerals [EQN: CN; EQN: AU] because it couldn’t afford a higher rival bid. Yanzhou Coal, Sinopec and CNOOC also pulled out of talks with Whitehaven [WHC: AU] and OGX [OGXP3: BZ], respectively, due to the extremely high asking prices. Even the negotiations between Bright Food and GNC lapsed at the last minute because of a price discrepancy.

Lack of funding

Another reason why Chinese SOE bidders’ outbound acquisition fever has cooled is that the tightening credit supply has made once cash rich SOEs now short of funding. A source at China Development Bank [CDB], the major funder in SOEs’ overseas acquisitions, said the total credit supply will be cut by 30-40% this year. Even large SOEs are finding it difficult to get funding from Chinese banks to close deals, let alone local-level SOEs or private companies.

A trend this year is that Chinese companies are rushing out to raise funds in offshore markets. Instead of going out and spending money, domestic-listed SOEs are pursuing dual listings in Hong Kong or issuing bonds offshore. It would not be a surprise if these SOEs become more conservative now, said the CDB source.

Management changes

Most Chinese SOEs are facing or experiencing senior management changes this year and next. Uncertainties surrounding management team changes usually results in SOEs reluctant to make deals. The Sinopec source agreed that this has caused Chinese bidders to be less active in making outbound acquisitions. And even after the management changes, SOEs would need time to digest the change and figure out future strategies for the new leadership before warming up, said the CNPC source.

It seems Chinese SOE bidders are going to be quiet for some time, said the Sinopec source.


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