Quarterly update on the M&A market in China

Voice from China - 4th edition 2019

First, it’s a trade war, then it’s a tech war, and now the prospect of a currency war, as Trump and the US trade hawks move to weaponize the dollar. If you ask any economist, he or she will agree that the dollar is the United States’ most powerful weapon, and China is preparing for them to deploy it.

Just last month, the Chinese government began promoting blockchain technology as a first step towards digitalizing China’s currency. Why? Because if the RMB is digitalized like Bitcoin, then China will be very happy to dump SWIFT. Unlike Bitcoin, a digitalized RMB will be neither anonymous nor decentralized from the Chinese central bank, but it creates a sure-fire way for China to avoid the dollar system. In other words, we will be living in a divided world once again, only this time the division will not be due to religion, culture or ideology. It’s the Thucydides Trap, as Graham Allison so rightfully put it, and it’s human nature that’s propelling us there.

How would this decoupling change the dynamics of Chinese M&A activity?

We are already seeing different trends and directions compared with one or two years ago. Chief among them, inbound transactions are increasing and we expect this trend to continue. Since 2014, inbound transactions lagged outbound dealmaking. The main reasons for this were:

1. Inflated price/earnings (P/E) multiples for Chinese companies compared with foreign concerns. For China’s public companies, in 2014, this stood at around 56 — considerably higher than that of the rest of the world.
2. Poor internal controls and accounting at small and mediumsized Chinese companies
3. Chinese government restrictions on foreign investment and official policies that impeded investment from abroad.

The situation, however, is becoming more favorable as:

1. In an about-face, the Chinese government has begun instituting policies more conducive to foreign direct investment (see sidebar).
2. The Chinese stock market has become more subdued, and in 2018 the PE multiple for listed companies fell more in line with international averages at around 36.1
3. The management of Chinese enterprises is becoming more sophisticated, and a significant number of companies are now led by a new generation of executives who were educated abroad.
4. Small and medium-sized Chinese businesses are actively seeking strategic partners from abroad that can provide them with additional expertise.
5. In recognition of the above, foreign investors are increasingly seeking to enter the Chinese market through mergers or acquisitions, rather than greenfield investments.

Outbound transactions, on the other hand, are decreasing as a result of the trade war and Europe’s General Data Protection Regulation (GDPR), which inhibits investment from outside the European Union. ANGELA CHEN, MANAGING DIRECTOR, OAKLINS, CHINA

The slowing global economy is also depressing outbound Chinese M&A, although there is still considerable activity among small and medium-sized companies, especially in regions where protectionist measures have been more muted.

While total outbound activity fell during the first three quarters of 2019 by 31% year-onyear, the number of transactions closed during the third quarter exceeded that of the second quarter, possibly hinting at some degree of recovery and geopolitical normalization.

The conflicts between China and the United States are viewed by both countries as a long-term issue. But in the near term, following October’s visit to the United States by Liu He and the Chinese trade delegation, we don’t see the trade war intensifying further. In the meantime, Chinese outbound M&A activity will continue to increase in Asia under the Chinese government’s One Belt One Road initiative.

Author and industry specialist

Angela Chen Shanghai, China
Managing Director
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