Special report: China’s business landscape75China’s track record in M&AChina’s companies are expanding the focus of their outbound M&A, but so far they have struggled to create value. Thomas LuediChinese companies have been slower to expand abroad than many in the global business community had expected, but some evidence suggests that the long-awaited expansion is now under way: in the rst quarter of , they announced foreign direct investments of almost billion ( bil- lion renminbi)—nearly twice as much as during the same period last companies are in a good position to make an impact in the global M&A market. At the very moment when the valuations of their foreign counterparts are falling as a result of turmoil in the world economy and global capital markets, many of them are sitting on large cash balances built up over the past few years of quick and pro table growth. Others are responding to the convergence of high domestic liquidity levels (including the money that Chinese banks have to lend and the state’s foreign reserves), global exchange-rate adjustments, political support for overseas expan- sion, and the need for access to raw materials and new raises eyebrows in many Western countries, where uncertainty over the source of the capital and fears of political interference in strategically important industries are generating signi cant opposition to otherwise solid business ventures. There is also concern about whether some of these overseas deals will create value for investors.
76The McKinsey Quarterly 2008 Number 3To develop a clearer understanding of the globalization strategies of Chinese companies, we assessed all of their cross-border deals from to and examined some of their more recent large-scale M&A ventures in greater detail. We found that these companies have diverse motives for acquiring foreign ones and that not all of the acquisitions are aimed primarily at creating value for shareholders. Indeed, few have actually done so, at least in the short explosion of M&AThe acquisition of foreign assets by Chinese companies is a relatively new phenomenon. As recently as , their foreign direct investments, in both organic growth and M&A, came to only . billion ( . billion ren- minbi). Since then, the level has risen tenfold, to . percent of GDP in —still far below the levels of France, Germany, and the United Kingdom, for example (Exhibit ). Some megadeals (with a combined capital market value of more than billion, or billion renminbi) have certainly caught the world’s attention. Top of sand backgroundA recent phenomenonBaseline for unit of Outbound deals as share of real measure/subtitle1GDP, 2007, %Chinese outbound foreign direct investment (FDI), $ billion3Organic CAGR, %United & of = renminbi. For – , includes deals with nal stake of > %. Compound annual growth rate. Estimate based on M&A deal value ( . billion) from Dealogic, plus organic outbound investments ( . billion), assuming % growth in organic investments over previous year; and data include nancial investments; data include China Investment Corporation's (CIC) billion acquisition of . % stake in Blackstone. Source: Dealogic; Ministry of Commerce of People’s Republic of China; McKinsey analysis
Special report: China’s business landscape77 Top of sand backgroundLooking for deals1Baseline for unit of Outbound Chinese M&A by destination and sector, 1995–2007measure/ = $ billion <$ billion $ billion–$ billion(x) = number of deals$ billion–$ billion>$ billionNorth (9) (3) (1) (2) (5) (3) (1) (1)AmericaWestern (4) (1) (2) (1) (2) (1) (2) (20) (36) (7) (2) (5) (3) (5) (16) (12) (11)Latin (3) (1) (2) (5) (1) (2) (5) (2) (2) (10) (8)High techFinancial Food and Health MachineryMetals and MiningOil and gasTelecomTranspor-servicesbeveragecaresteeltation All deals with value > million; major industries account for > % of total outbound deal value in each country. = renminbi. Source: Dealogic; McKinsey analysisWhere the deals are In the past, Chinese outbound M&A deals were concentrated in Asia, except for natural resources such as metals, oil, and gas, which Chinese com- panies have sought all over the world. This dual focus is understandable given the facts of geography and China’s need to obtain access to minerals and energy resources because of its own limited recently, leading Chinese companies have pursued growth and a global presence more actively, announcing deals across all geographies and in many industry sectors. Most of these deals are the rst of their kind for the companies involved, and many of them are small and focused—for example, aimed at gaining access to a speci c market—rather than large and transformative. Many companies, lacking the ability to conduct cross-border transactions and the experience to maximize the value from large ones, seem risk averse. Not coincidentally, China’s domestic M&A and indus- try consolidation activity are still often mandated by the government and executed on a net-asset-valuation basis rather than on market value (in par- ticular, when assets of state-owned enterprises are involved). These deals tend not to be very , we expect the number and size of cross-border deals to increase as Chinese companies build the capabilities they need to identify, capture, and conserve value (Exhibit ).
78The McKinsey Quarterly 2008 Number 3The strategy behind the dealsChinese companies have many strategic rationales for cross-border deals—and the rationales vary among industries (Exhibit ). The rst transactions aimed primarily to gain secure access to supplies of critical raw materials. That strategy remains an important driver for metals and energy companies to make acquisitions in resource-rich locations such as Central Asia and Africa. It does, however, raise some questions for investors in these companies. Finance theory suggests that it may be good for the country of the acquirer to obtain natural resources, but not, perhaps, for its share- holders. At this point, the size of the sample is too small to draw any- thing but the most general conclusions. Clearly, some of the resource deals create value for shareholders; others clearly do cross-border deals outside the natural-resource sector have been increasingly strategic in nature. Some, such as Lenovo’s acquisition of IBM’s personal-computer business, aim to help Chinese companies globalize. Other companies do cross-border deals to enhance their operating capa- bilities; Chinese auto companies, for example, have successfully acquired brands and technology from ailing UK companies and used them to launch brands in China—for instance, Shanghai Automotive Industry Corporation’s (SAIC) Roewe brand, based on technology from Rover. Many manufacturing companies have acquired foreign businesses to gain access to new growth markets, to lower the cost base by globalizing supply chains, and to consolidate manufacturing in large-scale facilities in China, thus bene ting from its lower capital and operating costs. Chinese Top of sand backgroundStrategic rationales1Baseline for unit of Chinese outbound deals by strategic rationale, 1995–2007 (n = 214)measure/subtitle2Primary rationaleNumber of dealsTotal deal value, $ millionSecurity, access to natural resources6827,083Access to new markets4815,753Financial investment/diversification4315,055Access to capabilities314,026Gaining scale101,448Access to financing5184Government influence5448CEO’s personal ambition3577Export of capabilities 114 All deals with value > million. = renminbi. Source: Dealogic; McKinsey analysis
Special report: China’s business landscape79banks and insurance companies have used their investments in foreign nancial institutions to diversify their product portfolios and gain access to risk-management, credit-rating, and other critical performanceAt best, the outcome of outbound Chinese M&A deals has been mixed. They have underwhelmed the market by the standard of value creation measured through share price movements around the time of announce- ment, namely, deal value added (DVA) and proportion overpaid (POP). Although drawn from a relatively small sample, our analysis suggests that Chinese acquirers tend to overpay in a little more than half of all deals and that the capital markets on average discount the value of the combined entities. Although the low number of deals—very few of which include two public companies—makes comparisons with global POP and DVA levels problematic, evidence suggests that the deals of Chinese companies from to performed less favorably than those of Western ones did (Exhibit ).There is some indication that Chinese companies do much better, in terms of both POP and DVA, in transformational deals than in nontrans- formational ones. The reason could be a more careful selection of Top of sand backgroundUnderwhelming the market1Baseline for unit of Chinese outbound deal performance, 1995–2007 (n = 56)measure/subtitleAverage 3DVA to acquirer Average deal size, Number of 2(median), %$ milliondealsType of dealPOP, %Resource 56– 55– ––34,7001,229Global All deals with value > million and nal stake of > %, – ; average deal size ~ million; = renminbi. POP = proportion overpaid; de ned as proportion of transaction in which share price reaction, adjusted for market movements, was negative for acquirer from days prior to days after announcement of deal. DVA = deal value added; de ned as acquirer’s change in market capitalization, adjusted for market movements, from days prior to days after announcement, as % of transaction value. Data from to ; average deal size ~ billion. Comparison with global data is useful and representative but not exact. Because few deals in China involved two publicly listed companies, China’s DVA and POP indexes re ect movement only in acquiring company’s share price. Global DVA and POP numbers, by contrast, were calculated using only deals where both acquirer and target are public, and these numbers re ect share price movements for both companies. Source: Dealogic; McKinsey analysis
80The McKinsey Quarterly 2008 Number 3targets, a signi cant enhancement in the overall operating and manage- ment capabilities of the combined companies, or the availability of transformational synergies that improve overall operating ef ciencies rather than merely capturing cost the capital comes from China has enjoyed strong economic growth since the start of economic reforms and the transformation of state-owned enterprises into listed cor- porations. Unlisted state-owned enterprises, listed ones, and privately held companies all enjoy large cash balances that allow them to acquire assets overseas. For now, a majority of the companies Related articles on cross-border Governing China’s boards: An interview with deals are publicly traded John Thorntonstate-owned enterprises How to make M&A work in Chinathat used to be wholly state Creating value from mergersowned. While at this point the state is still a major shareholder in many of these companies—often with as much as to percent of their total equity—managers must operate them as corporate entities and follow the disclosure rules of the exchange on which they are listed. Because they Top of sand backgroundUnusual suspectsBaseline for unit of 12005–07, $ billionmeasure/subtitle2Total Chinese outbound M& by sovereign-wealth by private-equity by government-controlled M& = renminbi. All deals with value > million. Listed or unlisted companies under direct supervision of either China’s State-owned Assets Supervision and Administration Commission of the State Council (SASAC) or Central Huijin Investment Company. Includes listed and partially listed companies—ie, a group company with some of its subsidiaries listed (a common phenomenon in China). Source: Dealogic; McKinsey analysis
Special report: China’s business landscape81rank among China’s largest companies, it’s understandable that they have so far been in the forefront of the country’s corporate globalization , the government’s stake in these enterprises continues to fall; McKinsey estimates that it will be almost entirely sold off by . Meanwhile, their shareholders will increasingly hold them accountable for the value created (or destroyed) by their overseas acquisitions. That will further reduce fears that they might act on behalf of the government. It will also make them obtain access to funds through conventional channels, such as market-rate equity issuance or debt (Exhibit ).The China Investment Corporation (CIC), a sovereign-wealth fund, has funds of some billion ( . trillion renminbi), and it too is expected to make selected cross-border forays. It is more likely to do so, however, as a minority investor aiming for capital gains consistent with its mandate and stated intentions than as an active shareholder. Separately, China’s wide range of nascent private-equity funds tend to focus on domestic investments, in view of the large number of opportunities and the greater ease of executing these deals and managing the portfolios they create. QThomas Luedi is a principal in McKinsey’s Shanghai of ce. Copyright ' McKinsey & Company. All rights welcome your comments on this article. Please send them to quarterly_comments@.
