Secrets of making acquisitions work

Chinese companies are no longer content to wait for overseas firms to offer them a deal

For years foreign companies have been reaping the benefits of combining their brands, product development, intellectual property and distribution with Chinese businesses in the fastest-growing market in the world. But with an increasing number of Chinese groups searching for such opportunities, it is no longer a one-way street.

Government encouragement, compelling business logic, an abundance of opportunities and weak competition from Western buyers are turning a trickle of sizeable natural resource deals into a growing stream of Chinese companies looking at buying businesses overseas in sectors from auto, aviation and rail to food and beverage and branded consumer goods.

The business theory is compelling and often stands on what the acquisition can offer at home for the Chinese buyer. But Chinese industry is just starting out on internationalization, so how can it avoid the mistakes of the Japanese in the 1980s and turn theory into practical success? How can a Chinese buyer get what it pays for and capture all of the value that it sees?

The key is to value the intangibles, and here are three ideas:

1. Understand the market

While Africa, Australia, and the Americas are the markets for natural resource assets, Europe offers many well-invested medium-sized businesses with deep heritage and intellectual property. It depends on the specific sector, but being international and open-minded is in the DNA of most European businesses.

Britain has an open-door policy and is a very easy place to do business. It does not have the regulatory restrictions of the US, where the Committee on Foreign Investment has led to deals failing because of national security concerns, including CNOOC's attempted acquisition of Unocal and Huawei's bid to acquire 3Com. In Germany and Italy there are many family businesses that need to resolve succession issues and at the same time recognize that the center of gravity in their industry is moving to China. This is particularly true in Chinese pillar industries such as auto, aviation and rail, but also true of some branded goods and other consumables. With Western buyers focusing their expansion in the BRICS economies, opportunities in the West abound, especially in Europe but also in non-strategic sectors in the US and other geographies.

Despite these overall themes, all too often acquisition targets are considered on an opportunistic basis, with only a superficial knowledge of the overseas marketplace and the target in question. For instance, in TCL's acquisition of Thomson, TCL underestimated the speed of change in the Western marketplace once new technologies were adopted and the restrictions on their ability to respond quickly. The speed of the switch from cathode-ray-tube TVs to flat screen technologies cost TCL millions.

Sometimes the ability to leverage a company's assets in China is not enough. There is great value to be gained in investing in the resources to acquire the knowledge to enter the right market through the right vehicle. Industry insiders, trade shows, customers, suppliers, local government, potential partner investors and advisers should be considered essential sources of knowledge rather than optional ones.

2. Follow local practices

While Chinese buyers have a distinct advantage in being able to extract the enormous synergies available from the China market, this alone will not win the deal.

Almost all good Western assets are sold by advisers, and to be taken seriously one needs to engage and work in harmony with an adviser working for a potential buyer. This is the local practice, with many international companies using advisers to ensure they make a sensible deal or step away from a flawed transaction, despite possessing their own resources in the local market.

For a would-be Chinese buyer there is a further practical issue to overcome: whatever the commercial rationale, Western vendors have a growing perception that the chance of a Chinese acquirer completing an acquisition is low. One Western adviser said recently: "Many Chinese buyers move so slowly that we don't deal with them unless they have decent advisers." He went on to cite the example of a Chinese group coming back with strong interest to buy a company that was being sold about six months after receiving the initial information, having had no communication in the interim. "Sadly that deal was already in the process of completion, although it offered more commercial logic for the Chinese buyer."

A Chinese buyer needs to come across as professional in the context of the local market or it will have to offer substantially more to be taken seriously.

Choosing an adviser with in-depth local knowledge of both China and the Western market is critical to getting the most from an adviser. Unlike China, Western markets offer many options for structuring and protecting an investment. These can be used to mitigate risk and align interests. An adviser will look at the dynamics of the deal and consider many angles, including raising local debt to fund the acquisition, obtaining grants for new investment, structuring to mitigate tax, giving incentives to managers, hold-backs, earn-outs, initial minority positions/step-up agreements, differentiated shareholder rights/classes of shares, spinning off unwanted assets, partnership deals and so on.

Often a Chinese company with limited international experience or resources may wish to consider taking an initial stake that can be increased over time. This provides valuable insight and lower risk, enabling the buyer to cross the river by feeling the stones. Another strategy is to team up with a financial sponsor, as Lenovo did with great success in buying IBM's PC division. Though it can be difficult to marry trade and financial investors, it can lend credibility and provide savvy resources in the local market.

In China, the regulatory regime requires experience to navigate, with approvals from the National Development and Reform Commission, the Ministry of Commerce, the State Administration of Foreign Exchange and potentially the State-owned Assets Supervision and Administration Commission all required. Support from an adviser who understands the workings of these bodies, as well as China's policy and commercial banks, is critical to completing a transaction in an acceptable time.

These are the harder factors, but more important is the cultural compatibility of the adviser to both client and target.

Those advising buyers can be worth many multiples of their fee by optimizing a deal and saving their client from making a mistake. This is not a tangible contribution, but it is more than words - it is knowledge.

3. People make business

Over the past 20 years of Vermilion's engagement in Sino-foreign transactions, the critical success factor when the ink dries on the legal documents is not the number of machines or land values or number of patents or any of the tangible assets; it is the people.

The intangible art of identifying, assessing, motivating and building a trusting relationship with the critical people in a target company is the single most important success factor in the long-run. Taking the time to establish these relationships and selling the idea of the acquisition to the management team as a positive step for the company and for them personally is critical. In Sany's successful acquisition of Putzmeister, the German cement pump manufacturer, the fact that Sany had previously committed 100 million euros to a greenfield research and development center in Cologne demonstrated its commitment to the market and played well with Putzmeister's management team. It is often the case that there is limited overlap between the organizations of a Chinese buyer and Western target. Selling this message and the likely corollary that it will mean no redundancies and could lead to expansion provides a strong incentive to go with a Chinese buyer, to both founding vendors and incumbent management.

The focus on management should also extend beyond the top team, especially for struggling companies, where the senior team is often part of the problem. In these cases releasing a talented middle management or changing the top can be highly successful strategies.

A critical role for someone advising a buyer is to assess the strength of the management team and help the client establish good relationships so it can make the deal work in the long-run. With the accumulated knowledge of the history and conclusion of the transaction, it is critical that the advisers' knowledge and relationships are not lost and that they are prepared to stay on hand to help in the 90-day plan and longer-term integration after the transaction. A merchant banking approach, in which an adviser works with a client over many years, is required, rather than deal makers who instantly move on to the next deal with little thought for the long-term success of their earlier client.

The people and the way the organizations interact are intangible, yet critical, for success.

The author is a founding partner of Vermilion Partners, an investment banking advisory and private equity firm focused on China. The views do not necessarily reflect those of China Daily. (China Daily 09/20/2012 page9)