USCBC M&A in China Webinar, 2009

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New Challenges and Opportunities

M&Ain ChinaWebinar June 25, 2009

10 am EDT

http://www.uschina.org

http://www.chinabusinessreview.com

http://www.interchinaconsulting.com/en/index.php

http://event.on24.com/r.htm?e=150304&s=1&k=4620C1255187D0FBEE0AA353FF0B4F5E

New Challenges and Opportunities

M&Ain ChinaWebinar June 25, 2009

10 am EDT

Godfrey FirthChief Representative, Shanghai OfficeUS-China Business Council

Barry J. ChenCorporate Practice DirectorInterChina Consulting

The USCBCThe US-China Business Council is the principal organization of US companies engaged in trade and investment in the People's Republic of China. Founded in 1973, the Council serves more than 250 corporate members through offices in Washington, DC, Beijing and Shanghai.

http://www.uschina.org

CONTACTING THE COUNCIL:Washington, DC:

John Frisbie, PresidentT: (202) 429-0340F: (202) 775-2476

Beijing:Robert Poole, Vice PresidentT: (86-10) 6592-0727F: (86-10) 6512-5854

Shanghai:Godfrey Firth, Chief RepresentativeT: (86-21) 6288-3840F: (86-21) 6288-3841

USCBC Services

• Government Advocacy• Business Advisory Services (BAS)• Publications

– China Business Review– China Market Intelligence

• Programs

• The Appeal of China M & A

• The Post-Crisis Environment – Positives and Negatives

• Legal and Tax Background

• The Merger Filing Process and MOFCOM’s Track Record

• The Wild Card: Media and External Affairs

Table of Contents

USCBC 2008 China Operations Survey

Among top 5 priorities 67%

Not a priority 2%

One of many non-key priorities 10%

Top priority 21%

China's Prominence in Overall Company Strategy


Company Resource Commitment to China over Next 12 Months

Will remain unchanged 26%Will accelerate compared to last year 73%

Will be curtailed 1%


Company Objectives in China

Access or servethe China market

Export platformto serve markets

In Asia

Export platformto serve US

market

Other

26%


Impact of New M&A Legal Framework on M&A Opportunities in China

Positive 2%

Negative 14%

No impact 39%

Too early to tell 45%

• 1Q 2009 – Bloomberg reports 44% drop in deal activity

• “Digestion” issues for companies closing acquisitions in 2008

• Lack of financing options (although this may be easing)

• Slump in demand makes capacity expansion less urgent

• Larger target companies able to access significant government support – bank loans, subsidies, etc.

Post-Crisis Environment – The Negative Side

Post-Crisis Environment – The Positive Side

• Valuations becoming (somewhat) more reasonable

• Targets more willing to consider relinquishing control –“going it alone” less appealing

• China emerging first – recovery appears to be on track (although very sector-specific)

• Strong desire from local and provincial governments for increased FDI

• Little practical assistance to Chinese SMEs from government policies (stimulus, bank loans, etc.)

Snapshot of Laws & Regulations Covering M&A

• Regulations on the Mergers & Acquisition of Domestic Enterprises by Foreign Investors (MOFCOM, Sept. 2006)

• Filing Guidelines for Mergers with and Acquisitions of Domestic Enterprises by Foreign Investors (MOFCOM, Mar. 2007)

• Draft Circular on Tax Treatment of Enterprise Restructuring & Liquidation (SAT, June 2008)

• Antimonopoly Law (NPC, Aug. 2008)

• Regulation on the Notification Thresholds of Concentrations (MOFCOM, Aug. 2008)

• Notice on Certain Questions Regarding the Enterprise Income Tax Treatment of Enterprise Reorganizations (MOF and SAT, May 2009)

New Tax Regulations and Enforcement

• Overseas acquirers need to consider “substance over form” and “main purpose” tests, in accordance with the Enterprise Income Tax Law’s general anti-avoidance provisions (GAAR)• Two cases, one in Chongqing and one in Xinjiang, involved

challenges to the use of special purpose vehicles (SPVs)• Local tax bureaus have significant latitude to investigate whether

capital gains are China-sourced and thus subject to withholding tax, and then apply to national SAT

• New enterprise reorganization regulations provide criteria for structuring transactions to meet the requirements for “special tax treatment” • Able to defer recognition of loss and gain• Imposes a 12 month lock-up period on receiving entity and a

restriction on changing the “key business activities”

• Questions remain regarding interpretation and implementation

©2008 Baker & McKenzie 13

Merger Control Filings: New versus Prior Thresholds

Antimonopoly Law (2008)New thresholds

M & A Regulations (2006)Old thresholds

Turnover Threshold #1 Combined worldwide turnover of>RMB10 billion (US$1.4 billion) &

At least two business operators have China turnover of>RMB400 million (US$57 million) One party’s

turnover in China >RMB 1.5 billion (US$214 million)

Threshold #2 Combined turnover in China of>RMB2 billion (US$286 million) &

At least two business operators have China turnover of>RMB400 million (US$57 million)

Market share

nil ≥25%

©2008 Baker & McKenzie

Schematic – Antitrust Filing Process

Discretionary filing

(Article 4 of Draft Concentration Regulations)

NoYes

Yes

Determine whether any

threshold met

(Article 3 of Draft Concentration Regulations )

Submit merger

control report

(Article 23, AML/ Article 9 of Draft Concentration

Regulations)

Filing receipt

Merger control review

(Article 27, AML)

Clearance

(Articles 25 and 28, AML)

Waiting period / decision

(Articles 25 and 26, AML)

Suspensory obligation

Useful Tips: Merger Filings

• Ensure that you budget sufficient time for merger filing and waiting period

• Never too early to start preparing report• Market information has to be collated from diverse sources

(marketing, finance departments, consulting firms, client/target) • Difficulties of obtaining China data

• Very demanding in terms of amount of information/level of analysis

• Typical report ~ 100+ pages (including attachments)

• “Clock” (30-day waiting period) does not commence until MOFCOMdeems report complete

Notable Transactions since the AML

• InBev / Anheuser-Busch

• Coca-Cola / Huiyuan

• Mitsubishi / Lucite

• Yum! Brands / Little Sheep

• Pfizer / Wyeth

• Tengzhong / Hummer (GM)

Approved, with conditions (May not raise stake in Tsingtao or Zhujiang, or acquire stakes in two other domestic breweries)

Blocked

Approved, with conditions (divest significant China production capacity )

No approval required (non-controlling stake)

Application not yet made

Application not yet made

Lessons to Date

• Define the market at the national level, as “China”, but be prepared to look at provincial market share and product-specific or granular markets – e.g. “pure fruit juices,” not “beverages”

• Expect to be asked for detailed descriptions of distribution channels and relationships, including contracts

• Be prepared to discuss potential remedies or changes to address potential concerns (divestitures, etc.); do not expect an opportunity to review and challenge the methodology used by MOFCOM

• Expect MOFCOM to be familiar with any previous US and EU cases in the same industry and to cite or utilize those arguments

• Acquire strong local counsel – Foreign law firms are still not permitted to directly represent clients before MOFCOM

• Prepare a rapid, effective, and strong media/external affairs strategy

Yangcheng Evening News

XinhuaNet

Xin Kuai NewsWest China City Daily

Evolution of the Debate

“Foreign investment threatens a sound Chinese economy by controlling market and nibbling native brands.”

外资正在控制中国市场，外资正在蚕食中国的民族品牌，外资恐怕已经严重威胁到中国经济的健康发展了Xinhuanet, Sept. 5, 2008

“Those supporting the Coca-Cola/ Huiyuan deal are economic traitors.”

支持汇源收购的人都是经济汉奸People’s Daily, Sept. 15, 2008

“The Coca-Cola acquisition of Huiyuan faces three main difficulties; first, excessive media speculation interferes with MOCOM’s administration….”

林哲莹说，可口可乐收购汇源果汁面临三大困难：第一个困难是媒体过度炒作对商务部行政形成一定干扰Lin Zheying, Deputy Director, Foreign Investment Administration Dept., MOFCOM, Securities Times, Feb. 10, 2009

“MOFCOM is reviewing the Coca-Cola/ Huiyuan acquisition case in accordance with the Antimonopoly Law and will not be influenced by any external factors.”

商务部正在根据反垄断法依法审核可口可乐收购汇源案，不会受任何外部因素的影响MOFCOM Minister Chen Deming, Xinhua, March 20, 2009

Conclusions

• M & A continues to increase and remains a viable strategy for expansion or market entry – most companies stick to “tip-toe” M&A consisting of small, targeted deals

• There are significant advantages to looking for deals in the current post-crisis environment

• If necessary, plan well in advance for the merger filing and approval process

• Carefully evaluate policy, media, and external environment before getting too far along in a deal

• Get professional help

Strategic Growth Through M&A Challenges and opportunities during a time of uncertainty

Presented by: InterChina Consulting

Date: June 25, 2009

© InterChina Consulting 2

What’s Happened So Far?Better than average

China FDI (1995-2008E)[USD billion]

$1.92

2004

$2.27

2005

$2.64

2006

$3.25

2007

$4.22

2008

[USD trillion]

Source: World Bank, CIA Fact book, Economist

China GDP 2004-2008 (Current Dollars)

Corporate Profits Comparison

1.6%

-1.6%

-4.0% -3.8%

-1.2%-1.9%

China

U.S. Japan Germany France U.K.

Q1 2009 Quarterly GDP Growth Rates

Source: OECD Figures, China Daily

Median EBIT Margin Weighted AVG EBIT Margin

China U.S.A. China U.S.A.

Cons. Products 8.43% 3.16% 9.10% 7.18%

Energy 15.70% 5.35% 10.46% 10.59%

Financial Services 26.15% 14.14% 23.88% 6.76%

Healthcare 10.71% -16.53% 9.81% 8.25%

Industrials 8.99% 3.81% 6.52% 8.05%

IT 9.23% -3.77% 7.50% 9.19%

Materials 7.33% 3.81% 5.89% 4.28%

EBIT margin for 2008, listed companies by sector – InterChina Analysis


2009-2020: Where Is China heading?There will be a significant change in China’s economic model

There will be a dramatic change over the next 10 years...

... from a an investment and export-driven economy...

... to a consumption based economy

.. Growth drivers: continued urbanization


2009 Economic Scenario: multiple aspects…. Where corporate strategies vary greatly

Multiplicity of Faces in China

1. Coastal regions and export-focused areas

2. Chemicals, steel, and textile-related sectors

REACTION OF MNCS

• Shifting resources to local market

• Waiting for better times

1. Regions focused on production for domestic markets

2. Consumer goods, services, and food & beverage sectors

1. Western / Interior

regions

2. Infrastructure, logistics,

healthcare, and other

major focus sectors of

the stimulus package

Stressed Areas Business as Usual Booming China

REACTION OF MNCS

• Still view China as strategically important in medium/long term

REACTION OF MNCS

• Aggressive investments


Crisis has put pressure on growth in ChinaPursuing acquisition for different reasons

Case 1 – Balanced Portfolio

Worldwide revenue

China revenue

US$20 bil

US$30 mil

• A strong multinational company entered the Chinese market a few years ago but has failed to generate significant revenues

2005 2006 2007 2008

CAGR: 10%

• Foreign F&B Company – China Profits Growth

• Chinese F&B Company – China Profits Growth

Case 2 - Catching Up

2005 2006 2007 2008

CAGR: 40%

Case 3 – Quick Entry

• Accelerate the deal timeline –establish a material presence in China

• WOFE will take 6-8 years to have a material presence

• Acquisition will accomplish it in two years

Organic growth

Acquisition

1 42 3 5 6 7 8Years in China


As a consequence, M&A remains active in ChinaLess deals, bigger size, slightly lower valuation multiples.

1.01x 0.91x 1.04x

1.54x1.24x

2004 2005 2006 2007 2008

8.05x

12.06x

9.04x

13.39x11.40x

19.30x

11.03x

17.14x

2005 2006 2007 2008 YTD 2009EBITEBITDA

Revenue Multiple Shanghai Composite

Source: Thomson Financial

Average Revenue Multiples / Shanghai Composite

Average EBIT/EBITDA Multiples

Average Transaction Size # of Transactions

Average Deal Size / # of Deals

$66 $65$73

$76 $78

1188 1091 1199971

2005 2006 2007 2008 YTD 2009

(USD millions)

9.64x

16.80x

• Average deal sizes are still increasing (2009 YTD average deal size is $78 mil)

• Valuations have not continued downward this year compared to 2008 (2009 YTD average EBIT multiple is 16.8x, and 2009 revenue multiples have not changed significantly)

• Strong company price expectations still remain high

Note: 2009 June 9 YTD # of deals: 289 Note: 2009 YTD rev. multiple: 1.26x


And there is a clear trend towards domestic consolidationDriven both by government policy and aggressive domestic players

74%

26%

87%

13%

69%

31%

61%

39%

55%

45%

2004 2005 2006 2007 2008

Source: Thomson Financial

Cross-border Domestic

Ratio of Cross-border / Domestic Deals

The ratio of domestic to cross-border deals has steadily increased since 2005

Cross-Border Domestic

Deal Volume and Type by Sector, 2008

2557%

2148%

842% 81

60%38

59%

1943%

2352%

1158% 51

40%26

41%

Food & Beverage

Chemical Transportation &Infrastructure

ConsumerProducts &Services

Healthcare

44 44 19 132 64

Food & Beverage

Chemical Transportation & Infrastructure

Consumer Products &Services

Healthcare

Deal Value and Type by Sector, 2008

1,202

2,515

1,472

2,125

1,105

US$ million

* Source: Thomson Financial


The M&A Environment is changing in 2009…. As a whole, improving

Improved environment

• Availability of candidates (POE have

reached certain scale)

• Appetite for sale is going up

• Approval could be easier (for

smaller deals)

• Valuations are more practical in

some cases due to lack of IPO

market

Challenges

• Facing stronger local competition)

• Chinese entrepreneurs are getting

more confident

• Decreased competitive

differentiation for some foreign

companies


Chinese sellers’ motivations are also changingUnderstanding them will become critical for a deal success

• Getting Stronger and confidence of going alone

• IPO dream

• Not accustomed to foreign transaction and decision process

• Prolonged transaction process w/ foreign companies diminishes confidence

Discourages M&A

• Succession issues

• Competitive pressure

• Liquidity

• Tie up with a stronger player

Motivates M&A


Things which have not changed: valuations remain an issueVariations industry by industry

• Peer multiple of home country vs. China

• China growth factor

• For stronger companies, valuation

expectations remain high

• Widespread belief that the downturn is

temporary

• Controlling premiums remain high

• However, terms and price can be negotiated

(clear room for opportunity that did not exist

in 2008)

Global Auto Parts Companies - Weighted Average Trading Multiples

0.17

0.1

0.03

0.09

1.72

1.49

0.23

0.87

2.17

2.75

0.39

1.46

Japan

USA

Germany

U.K.

Revenue Multiple EBITDA Multiple EBIT Multiple

1.249.56

14.33China

Source: Thompson Financial

Case: Automotive Sector


Transaction Length remains the key deal breakersAverage of 15 months (vs. 6 in the west). Why does the process take so long?

Target Search

• The candidate pool is too thin

• Unqualified candidates

• Not the right gauge of intention

Strategy• Lack of commitment

• Expectation does not fit reality

Valuation

• Managing the Chinese seller’s expectations

• Whether acquirer is willing to pay a “China premium”

Due Diligence• Inexperience in managing the diligence process

• Incorrect assessment of deal issues

Negotiations• Irreconcilable issues / not willing to budge

• Mismatch of pace

Process Issues/efficiency/time wasters


Critical Success Factorsunder time of uncertainty

• Do not expect bargains• “China premium” in a strategic context

Valuation

• Align expectations• Widen the pool of candidates• Judge deal feasibility early, and materiality of issues • Understand seller’s expectations and secure commitment• Sequence events in a non-linear way

Speed / Efficiency

Strategy

• Keep M&A as a part of growth strategy• Crisis, a window of opportunity• Broader range of strategic parameters• Higher level of flexibility


Documents

USCBC M&A in China Webinar, 2009