Welcome to Censere Group
Censere is a transaction support and strategic advisory group with extensive coverage across Asia Pacific. We combine our valuation, forensics, research and advisory skills to provide unique and comprehensive services to our clients.
Our clients include SME's, multi-national corporations, banks, insurance companies, investment funds, financial advisers, audit firms and legal advisers - in fact, anyone who requires quality, independent advice.
Following is an interview of our CEO, Brett Shadbolt, by Quamnet in relation to Censere being awarded the 2012 Outstanding Services Award for Business Appraisal and Valuation. This provides a good insight to our history, service focus and values.
We look forward to helping you achieve your objectives.
China Outbound M&A – How to solve the equation?
China Outbound M&A – How to solve the equation?
China’s economic rise has entered into an interesting phase from a historical perspective. While China is still logging 7+% growth a year, many regions in the world economy are growing 1% or less and in some cases, even contracting. As a result China needs to rebalance their economy from an export led growth model to a domestic consumption driven model. At the same time, Chinese companies flushed with cash are looking for value acquisitions in countries currently facing more acute economic challenges. China is well positioned to acquire some interesting assets and companies all over the world to compliment the needs of their domestic economy.
Evidence points to a pickup of pace for Chinese outbound M&A activity in the recent years. According to Mergermarket, overseas acquisitions from China have tripled since 2005 to a total of 177 M&A transactions in 2012, and the total value of these outbound transactions have increased nearly five-fold to US$63.1bn in 2011. In terms of sector, energy and resources continue to account for the lion’s share of transactions accounting for 70% of value and 30% of volume in 2012. Industrials and chemicals is a close second in terms of volume, accounting for 21%, however in terms of value it was dwarfed by the energy and resources sector accounting for only 11% of transaction values. Geographically, Western Europe proved very popular for Chinese buyers accounting for 29% of volume and 31% of value, mainly due to its industrials and chemical companies. North America however, was the biggest outbound market for Chinese companies in 2012 due to the abundance of energy and resources, accounting for 20% of volume but 35% of value.
From our perspective, China’s outbound M&A activity seem to be focused around three key areas: 1.) Securing access to raw materials. 2.) Acquiring industrial companies with cutting edge technology, Intellectual Property (IP), or production know-how. 3.) Consumer focused companies that have a strong brand. Often an acquisition may present an opportunity in more than one area, such as Lenovo’s acquisition of IBM’s personal computer business in 2005 as well as their recent attempt to acquire part of IBM’s server business. However many factors can complicate these cross border M&A deals, and from our experience there are a few problems that many Chinese enterprises encounter repeatedly.
Chinese Outbound M&A Issues
Government regulatory issues
One of the major factors that can cause problems for Chinese companies acquiring assets overseas is governmental approval and requirements, both domestic and foreign. This is especially true for large transactions or transactions in strategic industries. Typically, a Chinese domestic firm making overseas acquisitions will need approval from at least these three key ministries:
1.) National Development and Reform Commission (NDRC)
2.) Ministry of Commerce (MOFCOM)
3.) State Administration of Foreign Exchange (SAFE)
In addition State Owned Enterprises (SOEs) may also need the approval of the State-owned Assets Supervision and Administration Commission (SASAC), and “special projects” often require the approval from the State Council as well. There is also a distinction between central or provincial level approvals. For example central level NDRC approval is required only for investments of $300 million or more (resources sector) or $100 million or more (non-resources sector), anything below this threshold requires provincial NDRC approval. Before any acquisitions are made, companies must know which departments need to approve the deal, what is their criteria/procedures, and the time frame for approval.
Certain foreign governments have proven reluctant to approve certain acquisitions in strategic industries such as natural resources or technology. The pressure exerted by the US government which led to the failure of CNOOC’s acquisition of Unocal in 2005 as well as Huawei’s bid for both 3Com and 3Leaf Systems on national security grounds are examples of this trend. Though the environment seems to be improving, this is still something that Chinese companies need to take into account, for political winds change constantly and can prove unpredictable.
Issues with securing technologies, IPs, brands and intangibles
Another problem which Chinese companies run into when they acquire assets to secure IPs and technology is that they often assume simply acquiring the patents and technology is enough. However the actual key is talent retention. Even with the right IPs, processes, and technology if the line staff, technicians and researchers with the know how to operate these technologies do not remain after the acquisition, then the effectiveness of these technologies and any synergies that can be derived with parent company technologies and processes will be greatly reduced. Production quality may also be negatively impacted as a result, affecting the brand value of the company. Retaining organizational knowledge is therefore just as if not even more important in the acquisition of IPs and technologies.
Strategic investors that acquire companies for synergies and technologies especially should keep in mind the potential integration issues that will lead to an exodus of key staff after acquisition. Ambiguity, culture clashes, lack of communication, unclear reporting lines, responsibilities, and remuneration may lead to the loss of key employees. Strategic acquirers should have a clear integration plan that is well communicated to all employees if they want to reduce these risks.
A related problem is that some companies act like IP collectors, in that they acquire enormous quantities of IPs, yet cannot effectively leverage them. Quantity is no substitute for quality and a company should consider how any IP portfolio they may pay for as part of an acquisition is valued, especially if they do not immediately fit with the processes and technology of the acquiring company. It goes without saying that companies need to consider exactly how the new acquired technologies will compliment or synergize with their existing technologies and processes.
A recent example of the importance of IP integration can be found with Microsoft’s acquisition of Skype for USD$ 8.5 Billion. Up to now Skype has retained its autonomy, and it’s one of the most popular apps on the Android and iPhone platforms, which are competitors of Microsoft. It’s no secret that Microsoft ultimately needs to integrate and embed Skype more deeply in its own platforms such as Windows 8, Windows based phones, the Xbox game console, etc and provide a superior Skype experience on its own products to justify this price. How they will be able to do this and if this will lead to adequate additional value for the firm remains to be seen.
For consumer based companies thinking of acquiring overseas brands both as a way to enter foreign markets as well as to increase domestic competitiveness, the value of the brand is crucial. Since the majority of the value of these companies come from intangible assets, determining their fair value and hence the price paid for them becomes the most important part of the deal. Often times it is unclear how the value of a brand should be measured, so external experts should be utilized to prevent overpaying.
Brand perceptions are also often culture and region specific, and hence brand value can vary widely in different regions. Perception of the same brand varies significantly in different countries, for example the IKEA brand occupies a much more premium space in China compared to North America and Europe. Coach the handbag brand also occupies a more premium segment in Asia compared to North America. Acquiring companies should be aware of how their target brands are viewed and valued in the different target regions which the company may want to operate in before making a deal to ensure a fair value paid.
It is a “buyer beware” market out there, and there have been many cases where companies overpaid for a M&A deal resulting in later write-downs. On the other hand some run into problems or issues that derailed the transaction which could have been prevented. However, there are a few things acquiring companies can do in order to reduce or eliminate these risks and prevent huge write downs down the road.
Securing pre-approvals and starting out small
The simple way to approach government regulatory issues is to secure pre-approvals with the appropriate authorities during the early stages of the transaction process. Often bodies like the NDRC will give out conditional pre-approvals which will speed up the formal approval process unless the details of the transaction have materially changed. In addition securing approval from bodies like the NDRC will usually also speed up approval of other relevant government bodies such as the MOFCOM or SAFE.
In terms of opposition from local authorities to strategic or resource based acquisitions by foreign firms, an increasingly popular method is to start small and build on the relationship first or acquire non-controlling stakes. For example Sinosteel started by entering in a joint venture with Midwest Corporation of Australia in 2005, before taking over the Australian company in 2008. China Investment Corporation (CIC)’s 2009 investment in Canadian company Teck Resources of 1.5 billion USD resulted in only 17.2% ownership of the company, which dampened the criticism that China was taking over one of the few remaining large Canadian owned resource companies.
Know the value of your IPs and intangibles
For issues relating to IP and other intangibles, working with relevant legal, valuation, and technology experts is key. More and more investors have realized the importance of IP, intangible and brand valuations and have started to utilize independent legal and valuation experts to advise on these issues for their M&A transactions. Though there is an upfront cost to hiring outside experts, experience has shown that reducing the chance of overpaying and determining the fair value of any potential investments before deals are prime considerations for many strategic as well as financial investors.
Determining the value of intangible assets can be tricky. The different approaches to valuation including cost, market, and discounted cash flow can yield very different results, and choosing the appropriate method is critical. Key considerations include: 1.) Determining whether the asset in question will in fact have future economic benefits at all and if so how do you quantify it 2.) Determining whether there is an actively traded market for the asset in question and what is the market price. 3.) What exactly are the costs of developing this asset and can it be replaced? On top of that IPs in different stages of research, development, and commercialization may need different methods of valuation at different points in time. Having the correct expertise to correctly determine intangible asset values is especially important to ensure a fair price is paid in any cross border deal.
In order to fully monetize your IP, you must first understand where the value of your IP comes from. The value of the IP at different stages of its life cycle will be different and the value may be drastically different for strategic investors versus financial investors. An IP in early stages before commercialization for a strategic investor who can develop and shepherd it to monetization stage will have a much higher value than a pure financial investor. Knowing where the value of the IP is derived relative to your organizational capabilities and aims are therefore very important.
Engaging with the right local partners
For cross border acquisitions, engaging with partners that have local market knowledge, experience, and presence can prevent a lot of problems. Whether it’s knowledge of the local market that can affect brand valuation, understanding local culture and values to reduce integration issues, knowledge of local government regulations and processes, as well as local networks and connections, finding a partner with these critical competencies can make all the difference between a deal that goes smoothly or one that goes awry. Many cross border transactions in the past have encountered problems because the acquiring companies assumed that the local environment worked in the same way as their own domestic markets, or failed to read the changes in the local environment correctly. Language and cultural barriers can cause additional problems.
In choosing partners it is important to keep in mind their motivations. Some parties may have a vested interest to secure the deal at the highest possible price in order to increase their success fees, and their advice may be skewed as a result. Hence engaging with independent partners with local knowledge who do not have these conflicts of interest is often needed to get a clearer picture of the deal.
When in doubt, engage an independent third party for a pro-forma valuation
In the midst of a transaction, when dealing with different parties with vested interests, it is difficult to gage the accuracy and true value of the assets and companies that are being represented. Are the sales forecasts optimistic or in line with industry standards? If they are above industry rates are they justified? Are the production numbers presented by the seller or their representatives reasonable and technically feasible? The risk is especially high on cross border deals where you may not have local market knowledge. On top of that sometimes the relevant technical experts who can perform the technical due diligence required may not be available in house. There may also be resource constraints in terms of the amount of people available to properly research the market, the business, and the company as well as build a proper valuation model based on this research. A few overly optimistic numbers can lead to overpaying for a deal by the millions of dollars.
Even for sellers in the market there are increased pressures from buyers who are more and more sophisticated and require an increasingly level of transparency and accuracy in the numbers of forecasts presented.
In cases like these, it might be useful to engage an independent valuation expert early in the transaction who has the local market knowledge, in house research and technical expertise, and experience in M&A transactions to perform a pro-forma valuation. An independent valuation report can give you valuable insights, establish trust and provide a third party review which your internal models can benchmark against. There are some costs associated with this, but for transactions worth tens if not hundreds of millions of dollars where any small error can result in multi-million dollar impacts this is worth the relatively small cost.
The Future Looks Bright
There are a lot of opportunities right now on the international stage for Chinese companies to acquire good assets and good companies at great value. This is indeed a historic moment of opportunity for Chinese firms looking to expand. Though there are great opportunities out there, there are also great risks. However for companies that keep a vigilant eye out for these issues and engage the right parties, there are still a lot of great potential deals out there. Good luck!