September Insight - Acquiring public companies as a path to real revenue growth in China

The increasing percentage of the Hong Kong, Shanghai and Shenzhen exchanges as a percentage of world capital markets is no secret.  There are also numerous listings of China focused companies on all of the world’s major stock exchanges.

Intercedent predicts the number of international companies that acquire and delist or purchase controlling interests of publically traded companies with a majority of their revenues derived from within China will increase dramatically over the next 2 to 5 years.

Short term, the bloom appears to be coming off the Chinese economy, stock valuations in Hong Kong, Shanghai and Shenzhen are waffling and Muddy Waters’ negative company analysis has gutted the value of many listings off-shore that derive their revenues in China. The PE ratios for China listed companies that were once over inflated are falling to reasonable levels.

The long term commitment to sell off state owned companies in the public market or exit strategies through IPOs of private companies by China’s wealthy families will present the transactions that multi-nationals and niche SMEs can consider as platforms for further market penetration in China.

Intercedent advises that international companies buying out public companies whose assets are in China be done in partnership with China experienced capital groups.  These groups can help manage the transition from a publically listed company to a private one, provide government relations support and also on going operational knowledge about doing business in China.

The initial rejection of the Coca-Cola interest in acquiring the HKSE listed Huiyuan Juice Group in 2009 suggested that the Ministry of Commerce was not supportive. Recently, however, the final approval of Diageo’s purchase of publically listed Shuijingfeng, Nestlé’s acquisition of Singapore listed but China based Hsu Fu Chi and Yum’s acquisition of Little Sheep Group are signs that China is more prone to approve  foreign takeovers of listed assets.  

China is also facing increasing pressure within the G-20 for expanding foreign participation in its capital markets. This is a reaction to China’s own interest in acquiring control of firms abroad. One example is the debate in Canada about the importance of reciprocity as part of the approval of CNOOC’s bid for Nexen that was started by the Dean of the Rotman School of Management.

These pressures are likely to increase given the political power that investment banks carry in Washington, London and Tokyo. Slow capital markets in Europe and North America have refocused the investment banks attention on Asia. This, along with the fact that it is increasingly harder for non-western investment banks to get the IPO mandates to list Chinese firms internationally, will focus their efforts on assisting international firms acquiring assets that are listed in China, Hong Kong or Singapore.  

The business motivation for acquiring industry leaders and also small cap companies to expand revenue growth in China is rational for a number of reasons.  These public companies are potentially more transparent M&A targets than private companies, operate ideally on market principles and are less immune to the subjective influences of that cripple state and family owned firm’s management culture.

European, North American and Japanese companies are cash rich and once the economy stabilises will be under pressure to grow again. Limited opportunities in their core markets due to sluggish GDP growth, consumer debt, aging demographics will make Asia and China more attractive place to invest.  This will be especially true for consumer and luxury goods companies that will want to purchase distribution and retail capacity.

It will also be the case for companies that focus on selling infrastructure and business to business goods and services.  These acquisitions will be supported by a shift of portfolio investment from Europe and North America to Asia and a healthy supply of local savings capacity that is keen to migrate to solid management with the value added that intellectual property and brand provide.

In the small cap market companies outside of China that have complementary product lines, niche private businesses in North America or Europe may want to comb the ASX, TMX, AIM and DAX to identify well run but undervalued small caps that have distribution and revenue in China. These vehicles could be taken over to provide liquidity for the private company, a vehicle to raise growth capital and a platform to expand revenue growth through the newly acquired operations in China.

Oddly enough, if this trend develops in the large cap and small cap space it may address a number of systemic problems and reground public markets by permitting them to return to their original function  of creating value by raising money and creating new markets for companies by going public.

These types of transactions will permit international companies to develop new revenue growth within China and in return the Chinese economy will get a contribution to the globalization of its currency and positive impact on market transparency and natural capital flows that it seeks.  

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