Last week’s unsolicited US$18.5 billion bid by China National Offshore Oil Corporation for Unocal Corporation is further evidence that China’s state-owned corporations are emerging as serious bidders for North American companies. This bid is the largest foreign acquisition ever attempted by a Chinese company.
It is the latest in a line of recent transactions involving Chinese companies, which include the proposed purchase of Maytag Corporation for US$1.12 billion, the acquisition of IBM’s personal computer business for US$1.75 billion and two investments in Canada’s oil sands (the purchase of 40% of Synenco Energy Inc.’s Northern Lights Project for C$105 million and the purchase of 17% of MEG Energy of Calgary for US$123 million). In the fall of 2004, a Chinese state metals trading company was in exclusive (but ultimately unsuccessful) negotiations to buy Canada’s Noranda Inc., the world’s third-largest zinc and ninth-largest copper producer, with a market capitalization of about C$7 billion.
The emergence of Chinese companies as credible bidders for U.S. and Canadian companies has attracted significant attention from politicians and the general public in North America. In the United States, the mechanism for reviewing and potentially blocking foreign acquisitions that affect national security is the Exon-Florio amendment to the Defense Production Act of 1950, introduced in 1988 amid concerns about Japanese foreign investment. In Canada, the Investment Canada Act has long been a means for the Canadian government to assess whether foreign acquisitions of Canadian businesses would be a "net benefit to Canada".
Last week, the Canadian government introduced a bill (C-59) that would amend the Investment Canada Act to provide for review of foreign investments in Canada that could threaten national security. The bill was introduced following public allegations of widespread Chinese corporate espionage activity in Canada and is regarded, in part, as a government response to China’s pursuit of Noranda.
Exon-Florio provides authority to the President of the United States to suspend or prohibit any foreign acquisition, merger or takeover of any entity engaged in commerce in the United States that is deemed to threaten the national security of the United States. It does not define "national security" and gives wide latitude to the President to review almost any foreign investment in the United States.
Over 1,500 transactions have been considered under Exon-Florio, in the computer, telecommunications, aerospace, electronics, advanced materials, chemicals, semi-conductors and mining industries. Very few of these have been formally reviewed and only one has been blocked by presidential order—in 1990, a state-controlled Chinese company was ordered to divest its interest in a Seattle aircraft-components maker. A formal review under the statute, however, is credited with leading to the demise of Hong Kong–based Hutchison Whampoa Ltd.’s proposed purchase of Global Crossing Ltd. In other cases, a review has led to the imposition of conditions. The U.S. government is reported to have approved the Lenovo acquisition of IBM’s personal computer business only after Lenovo agreed to move the operations to a building separate from other IBM operations.
An Exon-Florio review of the China National bid for Unocal would be significant because of its focus on the ownership of significant oil and natural gas resources.
In Canada, the proposed Chinese acquisition of Noranda prompted much parliamentary and public debate about whether national security and human rights concerns should be taken into account during the regulatory approval process. Canadian government officials deny that the proposed amendments to the Investment Canada Act are intended to obstruct China’s acquisition of Canadian natural resources and have stated that the legislation simply fills in gaps in the Act and brings Canada in line with other G-8 countries by providing for government review of foreign investments that might affect national security.
The proposed amendments broaden the purposes of the Investment Canada Act to explicitly recognize the importance of protecting national security, and provide for the review of investments in Canada by non-Canadians that could be injurious to national security. Although the Act presently allows the government to review direct investments in excess of C$250 million (about US$200 million) by a World Trade Organization member, the amendments would establish a review regime of any investment in Canada by a non-Canadian—regardless of the dollar value of the acquisition—if national security issues are raised. The Canadian government could ultimately prohibit the completion of any proposed purchase of a Canadian business by a non-Canadian because of national security concerns or impose conditions on the completion of the transaction. "National security" is not defined in the proposed amendments.
Heightened government scrutiny of foreign acquisitions of U.S. and Canadian companies will affect bidders and targets alike. As politicians and the general public pay greater attention to foreign investment issues, we can expect governmental review of transactions to take place with an increasing focus on foreign policy and national security.
The President’s response to China National’s bid for Unocal will be an interesting test, bringing the focus of the Exon-Florio provision squarely to natural resources rather than the traditional areas of concern, such as defence contractors and technology companies. Assuming that China’s acquisitions continue, natural resource–rich Canada will likely face its own challenges in striking the right balance between free markets, foreign investment and political considerations.
Market participants and their advisers need to factor national security ramifications, broadly framed, into their transaction planning and develop proactive strategies early in the process to consider regulatory risk to merger and acquisition transactions.
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