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Tectonic Shifts: Chinese Outbound M&A in 1H 2017

At the end of 2016, China tightened administrative reviews for capital outflows, including outbound foreign direct investment. These changes have slowed down the pace of new Chinese outbound M&A activity

At the end of 2016, China tightened administrative reviews for capital outflows, including outbound foreign direct investment (OFDI). These changes have slowed down the pace of new Chinese outbound M&A activity in the first half of 2017 and re-shaped the composition of deal flow in terms of investors, industries and other characteristics. This note summarizes the most important trends.

China’s Global Dealmaking Has Dropped Sharply in 1Q But Stabilized Lately

Following Chinese regulators’ crackdown on “irrational” OFDI in November and December of 2016, new deal activity slowed sharply. The number of newly announced outbound M&A transactions by Chinese companies fell by 20% in the first six months of 2017 compared to the same period in 2016.

The drop was particularly steep in the first quarter of the year but activity has rebounded in recent months. After reaching a low point in February, March and April saw a return to double digits for new deals. In each of May and June, Chinese companies publically announced more than 20 new overseas M&A transactions with a value of $5 million or more, around levels seen near the 2016 peak.

Chinese Buyers Strike Smaller Deals

After a blockbuster year with a record number of megadeals, the average deal size in the first six months of 2017 has contracted dramatically compared to 2016, which is a direct consequence of Beijing’s greater scrutiny for large transactions.

Whereas 2016 saw on average one deal per month worth at least $3 billion, so far 2017 has only seen two such transactions (State Grid’s purchase of the outstanding shares of Brazilian electric utility CPFL and CIC’s acquisition of UK-based Logicor).

The smaller average deal size is also having a big impact on the total value of Chinese outward M&A flows; the value of announced acquisitions averaged more than $15 billion per month during 2016, but less than $8 billion per month from January to June 2017.

State Investors Are Staging a Comeback

Another trend is that sovereign and state-owned companies are back in the driver’s seat. The 2016 M&A boom was largely driven by private companies. With the exception of ChemChina’s massive Syngenta takeover announced in the first quarter of 2016, most large deals were undertaken by private sector buyers.

These large private deals have mostly disappeared in the first half of the 2017. State-related companies accounted for nearly 60% of the total deal value from January to June. While the State Council has recently tightened risk control measures for outbound investment by state-owned companies, it seems that experienced sovereign and state-owned investors are able to better navigate the current political environment to get capital out of China.

Activity is Down in Most Sectors But Materials and High-Tech Are Most Resilient

Capital controls also had a significant impact on the industry composition of outbound M&A. Activity has fallen across all sectors in 1H 2017, but there are marked differences as to the patterns and magnitude of the declines.

Basic Materials, Energy, & Utilities has been one of the most resilient sectors, with only a small deceleration of deal-making in recent months from a relatively high base. Five out of the top 12 deals announced since January have state-owned acquirers ofoverseas Basic Materials, Energy, & Utilities assets (State Grid, Sinopec, Three Gorges, Shandong Gold and Yancoal).

Deal flow in high technology and modern service sectors (Telecom, Media & Computing) has also been more resilient through 1H2017. However, in contrast to materials, all of the largest deals announced in this sector so far in 2017 have private acquirers and a much smaller average deal size. Private firms still seem to be better able get government approval for outbound transactions that boost their innovation capacity (or those that are in line with Beijing’s industrial policy goals).

Deals Take Longer to Close But Most Still Make It to Completion

A number of failed transactions (such as the termination of the $1 billion sale of Dick Clark Productions to Wanda in early March and the collapse of LeEco’s $2 billion acquisition of TV manufacturer Vizio in early April) have highlighted that Chinese capital controls have increased the closing risk for pending transactions.

Indeed, the completion time for deals with a Chinese buyer has increased substantially since 2015, reflecting the increased regulatory scrutiny and funding stresses Chinese buyers are facing.

However, most transactions are still moving towards closing even with capital controls. Recent examples include HNA’s $10 billion purchase of the CIT aircraft leasing business, China Oceanwide’s $1 billion International Data Group deal and ChemChina’s $43 billion acquisition of Syngenta.

Outlook: Beijing Is Unlikely to Re-Open the Floodgates in the Second Half of 2017

There are rumors that Chinese regulators have already given their nod to a gradually less restrictive interpretation of outbound FDI rules following a stabilization of balance of payments pressures in 1Q 2017. Some observers have also speculated that Beijing may return to a liberal OFDI policy after the Party Congress in the fall.

These hopes will likely be disappointed as the Chinese macroeconomic outlook remains fragile. Monetary growth is slowing as the central bank is trying to prevent further expansion of a credit bubble; historically such slowdowns in credit growth impact the real economy. The recent US rate hike may place additional pressure on the USD/CNY exchange rate, which could trigger fresh rounds of capital outflows.

Given these realities, we expect Beijing to remain wary. A wholesale removal of capital controls on outbound FDI is unlikely to happen soon. Rather, we expect Beijing to work towards a new formal OFDI regime that provide greater clarity to market participants while maintaining a system that allows Beijing to intervene in outbound deals based on macroeconomic and deal-specific considerations.

Last week’s news that the China Banking Regulatory Commission (CBRC) is assessing potential risks related to loans for several large private firms’ overseas M&A activity is an example of this type of approach and a reminder that Chinese authorities have multiple levers to tinker with deal activity. CBRC’s move will force banks to rethink credit lines for Chinese outbound investors, which will further aggravate uncertainty for sellers considering Chinese offers.

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