China has been a magnet for foreign direct investment (FDI) in recent years, however the investment environment has become somewhat more complex as China’s economy has developed and attitudes to foreign investment have changed.
Carlyle-Xugong: US Carlyle’s China Trials
After a year-long public auction, Carlyle, the US private equity group (Carlyle), agreed in October 2005 to pay $375 million for an 85% stake in Xugong Construction Machinery (Xugong), a listed company whose parent is controlled by the local government of Xuzhou city.
Critics complained that such deals might threaten China's economic security, as selling off such a major firm in a key sector (the machinery sector) for foreign investors concerned China so much that it focused significant attention on the local industry. In October 2006, after a year of being blocked by the government, Carlyle was forced to reduce its proposed stake to 50%. This revised deal was approved by the state-owned Assets Supervision and Administration Commission (SASAC), the government body that monitors state-owned assets. However, this deal was rejected by superior regulators, the Ministry of Commerce (MOC), on the grounds that the sector was of 'strategic' importance.
In March 2007, Carlyle agreed to reduce the size of the stake it was trying to buy to a minority 45% share. Upon executing a 55:45 joint venture agreement, the deal finally concluded with Carlyle relinquishing their majority shareholding.
China's existing attitude for foreign acquisitions in key sectors
Despite Carlyle’s problems, not all foreign investment is likely to be given such a grilling. In November 2006, the MOC approved the $325m acquisition by Rotary Vortex, a consortium formed by Goldman Sachs and Chinese private equity house CDH, of a 100% stake in Shineway Group, the biggest state-owned meat processor. In addition, a 25% stake in Shineway Group's listed subsidiary was approved. The key difference between Carlyle's and Rotary's deal seems to be whether the target is seen to be a strategic asset in a 'key' sector.
With the Regulations on Foreign Investors' Mergers and Acquisitions of Domestic Enterprises (Regulation) coming into force on September 8, 2006, this marked the first time a regulation was jointly adopted by six ministerial departments and orchestrated by the MOC. The regulations are a response to the increasingly greater number of M&A transactions in China. This development reflects the government's concern of protecting perceived 'key' industries and those associated with national security from being acquired by foreign investors.
According to the regulations, possible key industries include: nuclear power, machinery, shipbuilding, military, power generation/transmission and steel. M&A transactions touching upon these concerns are required to declare the transaction with MOC and will be subject to strict MOC scrutiny. Failure to satisfy the declaring requirement may cause the block of the transaction by MOC. In addition to that, MOC may block a deal when it has grounds to believe that it will affect national economic security – similar to the US CFIUS review.
Potential foreign investors would be well advised to include policy risk in pre-acquisition due diligence and to manage any approaches with sensitivity.
Recent case of Blackstone-BlueStar: Shareholding is still an issue
Following China’s $3 billion investment in the U.S. private-equity fund via its IPO, Blackstone Group (Blackstone) is poised to buy into the country’s largest petrochemicals maker, state-owned China National BlueStar (BlueStar), with parties currently in initial negotiations.
A report in The Wall Street Journal Asia suggested Blackstone would purchase between a 20% and 40% stake in BlueStar for $400 million. This is the latest variation on a June 20 scoop by The South China Morning Post, speculating on Blackstone's possible purchase of a 30% stake in BlueStar for $500 million.
In a public notice issued by its three domestically-listed units, Shenyang Chemical Industry, Blue Star Cleaning, and Blue Star New Chemical Material on June 21, BlueStar confirmed that it was in talks with unidentified buyers for 'strategic cooperation'.
However, it is still uncertain whether Blackstone will purchase more than one–third of BlueStar, which would enable Blackstone to defeat any special resolution. In light of the Carlyle deal, approval of the Blackstone acquisition is bound to be another challenge for SASAC.
Minter Ellison will keep you updated on further developments to the Blackstone deal in the future.
Latest update: proposed national security screening for foreign acquisitions
China is tightening controls on foreign acquisitions of Chinese companies by adding a requirement for national security reviews to the draft of its proposed anti-monopoly laws.
Currently, foreign investors acquiring Chinese companies in deals worth US$100 million or more are subject to MOC approval.
However, the draft, submitted to the 28th session of the Standing Committee of the National People's Congress (NPC) for a second reading, proposes that all cases of foreign investment be checked for national security clearance before approval by the MOC.
This development is indicative of the changing complexities of the Chinese investment environment resulting from ever-increasing foreign investment deals.