Chinese Cross-border M&A: Motivations and Reactions

After a record-setting 2016, Chinese outbound M&A slowed considerably in 2017. The world experienced a colossal -31% year-on-year decline in Chinese outbound investment. Fittingly, the most significant announced deal of the year— the $1.2bn acquisition of Moneygram by Ant Financial — was blocked by the US government in January of 2018 after failing to close in 2017, capping off an already disappointing year.

A new delicate flashpoint in US-China relations has emerged in this M&A battleground. China has experienced an explosion of economic growth, creating conditions in which massive amounts of capital have been freed up for outbound investment. Even in the supposed down year of 2017, the total value of all deals was almost US$700bn, with outbound deals totaling around US$160bn.

This investment boom can be credited to a few Chinese government policies and attitudes in particular. At the root, the increase in foreign M&A stems from the rapid economic growth China has experienced for the past four decades. This economic transformation was brought on by Deng Xiaoping’s economic reforms and opening of China to foreign markets; Deng’s reforms launched the incredible growth story that we see in China today. With economic growth came wealthier Chinese individuals and firms with much more disposable income than before, creating massive amounts of capital for investment. At the same time, China’s active state apparatus encouraged domestic company growth and foreign expansion. In response, China’s deal making exploded. The declining return on domestic investments at that time also motivated investors to seek international targets instead. As Bloomberg states, “As China grew, so did its appetite for foreign acquisitions. They’ve shifted focus to acquiring the brands and technology China needs to transition to an economy driven by domestic consumption more than exports, labeled here as the new economy.”

The United States has met this new development with caution – a caution centered around legitimate cyber-security risks.

Nowadays, the words “China” and “cyber-security” often appear in the same sentences, and usually in a negative light. The U.S.-China Economic and Security Review Commission (USCC) said in its 2009 annual report that “there has been a marked increase in cyber intrusions originating in China [that target] U.S. government and defense-related computer systems,” and that China posed “the single greatest risk to the security of American technologies.” It is now 2018, almost a decade after the Commission’s report, and cyber-security risks in regards to China have only become more alarming. Companies from Google to Northrop Grumman have since alleged (with strong evidence in some cases) that Chinese groups and even the Chinese government itself have directed cyber-attacks against them. Perhaps the most incriminating incident was in September 2014, when a Senate Armed Services Committee probe found that “hackers associated with the Chinese government have repeatedly infiltrated the computer systems of U.S. airlines, technology companies and other contractors involved in the movement of U.S. troops and military equipment.”

These cyber-security risks can be pointed to as reason number one for the recent collapse of high-profile and high-value deals such as the proposed $1.2bn acquisition of Moneygram by Ant Financial and Huawei’s recent 2017 attempt to partner with AT&T to enter the US market. The risks, understandably, make US companies as well as US regulators wary of engaging in M&A activities with Chinese companies, particularly in sectors that affect technology or national defense.

But the decline in Chinese outbound M&A is not caused merely by American action – Chinese policy has depressed outbound M&A as well. Beijing is taking a more proactive role in making sure that outbound investments are not, as the Chinese government puts it, “irrational.” This comes in light of the massive shopping spree that Chinese companies have had from 2009-2016. Frivolous deals that were characterized by Beijing as “irrational” flooded the market. For example, Chinese companies would routinely buy luxury resorts and spend millions on soccer clubs — activities that offered little long-term value towards China’s overall economic growth vision. As a result, the Chinese government has increased oversight on certain investment activities; namely, Chinese companies who invest through overseas subsidiaries, a method which circumvents some of China’s capital outflow restrictions, will be watched more closely. There are now strict rules on what kind of acquisitions and deals are acceptable, and what kinds would be restricted. There are even whispers of the government seeking to repair damage done by the wasteful shopping spree by forcing the fire sale of non-performing assets. History has also shown that megadeals of over US$10bn will generally be blocked by Chinese regulators.

The effects of these Chinese policies have been clear and tangible. In the first half of 2017, Chinese overseas direct property investment – the prime area for “irrational” luxury spending sprees – fell by a whopping 82%. The focus has been diverted towards areas like technology, which China has made a national priority.

Looking forward to the upcoming year, a rebound in outbound M&A from the nadirs of 2017 can be expected, especially in sectors vital to Chinese growth and national security. It is unlikely that Chinese outbound M&A will reach the profligate heights of 2016, since the Chinese government has taken explicit action to prevent this. Although the overall deal volume will decline as China cracks down on wasteful deals in “irrational” areas, money will flow in a more targeted fashion towards more important industries that are tied to China’s growth and development goals such as software, semiconductors, telecom, electronics, and energy. Across the Pacific, the increase in these types of capital flows may be inhibited by cautious and prophylactic Western governments, as these are the very industries that are most at risk to cyber-attacks.

Michael Tan is a sophomore at Duke University. Contact him at michael.tan@duke.edu.

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