Investment law must address M&A lacunae

Though the draft of the proposed new Foreign Investment Law aims to significantly reduce the barriers for foreign investment in China, foreign companies are still apprehensive about the provisions relating to mergers and acquisitions, said a report released on Tuesday by global consulting firm, the Boston Consulting Group.

"From a commercial perspective, foreign acquirers have a batch of things to consider besides regulatory approval like: how to add value to justify the purchase price, and how to do post-merger integration. So we cannot expect the number of foreign M&As to increase overnight," said Jeff Walters, partner and managing director of BCG.

According to the draft, when the law comes into effect, most foreign investment, including setting up a new company, will no longer need pre-approval from the State Council. The only exception is where a foreign party intends to invest in one of the restricted industries on the negative list－likely to be based on the Catalogue of Restricted and Prohibited Industries for Foreign Investment.

The previous case-by-case approval process would be replaced by a requirement to submit reports on each phase of the investment. A national security review framework will be established with the authority to veto a proposed deal. Applicants cannot appeal the veto decision, the draft said.

"Any move to help clarify the regulatory approval process and simplify it would help create a better environment for foreign M&As, as regulatory approval is a major hurdle for foreign acquisitions in China. The transition to a negative-list management would also help remove several uncertainties," said Walters.

However, the exact reductions to the previous "restricted" and "prohibited" industry list are still not clear, and that makes it difficult for observers to accurately assess the specific impact. But Walters cautioned that even if some industries, such as finance and Internet, opened a larger door, it would require additional conditions for foreign acquirers to actually consider buyouts, because there are few precedents.

The immense challenges posed for foreign M&As prompted BCG to produce a report, he said. Noting existing challenges, however, the report said investors should not be intimidated by them. Value-adding through synergies could be realized, as long as "you do things right".

"Prospective multinational acquirers are frequently deterred by the misperception that value-generating acquisitions are nearly impossible in China. They believe they cannot attain majority control; while this is true in a few industries, it is more the exception than the rule.

They see the regulatory process as opaque and painstaking to navigate without deep existing personal connections. They believe that asking prices are too high and can be justified only by realizing a degree of synergies ... Our experience with numerous multinational acquirers of Chinese companies has demonstrated that these hurdles can be overcome. They don't have to be scary," the report said.

For example, one important lesson is that starting post-merger integration planning near deal completion is too late－the earlier it starts the better. It is much better for the acquiring company's management to sit down as soon as possible with the target company's CEO to engage in an assessment of senior executives.

Veronique Yang, a principal with BCG and an author of the report, said attention should be paid from the earliest stages on whether the company and its target management share the same high-level vision for the combined entity. They should be able to walk away from a deal if the target management does not come to terms and it is better than painfully working out the disagreements after the deal is done.

Understanding the landscape

Common misperceptions about M&As in China:

· Westerners often misinterpret the impact of the Chinese cultural phenomenon of guanxi, which they misconstrue as a murky system of "connections" or "relationships", on the regulatory approval process. Guanxi is actually rooted in empathy－the concern for someone else's interests when taking an action of one's own. Thus, each regulatory body will be looking for signs that an acquiring company understands, and has a plan for addressing, the social as well as economic considerations that fall within the parameters of the regulator's authority.

· The acquiring company should not think that it can fully delegate the management of the approval process to a third party. The authorities will want to see that the company is actively involved in the deal.

· Leaving critical decisions until late in the acquisition process. By this time, the acquiring company has already missed important opportunities to work with the target company to build consensus on such questions as company vision, achieving synergies, and the approach to merging operations.

· Majority-share ownership confers control. This is not always the case in China. A majority share may win more board seats, but in reality the board may exert very little influence over the company's operations. The managing director and the general manager often have the authority to dictate operations