By Ken Koo, Managing Director at Citigroup and Deputy General Manager at Orient Securities Investment Banking Co.; with an introduction by Patrick Dransfield, Consultant at Asia Law Portal

I first met Ken Koo when he delivered the Key Note Address at the ABA Section of International Law’s Asia Pacific Forum in Hong Kong in October, 2019.

Ken addressed the conference topic from both the lawyer’s and the deal maker’s perspectives as his illustrious career has straddled both roles and, in what seems another life time now, explored with conviction and insight the external factors that were affecting M&A patterns in an Asia caught in the cross-hairs of the continuing US-China trade frictions.

Thanks to China Going Global Thinktank Service (CGGT) for sponsoring this post.

Fast forward to the present: with only 2% of companies in SE Asia actively engaged in post-Covid-19 initiated acquisitions, a sense of ‘wait and see’ permeates the corporate world of Asia. I can think of no-one better placed to advise in-house counsel on the complexities of trade patterns that impact M&A strategy in the ‘New Dynamic’ of this Covid-19 world.

Ken Koo is the Deputy General Manager at Orient Securities Investment Banking Co.; and manages the Cross-Border M&A Department.  Ken has over 25 years of experience in investment banking in Asia and the U.S.  Prior to joining Citi, was an Executive Director in Goldman Sachs IBD in Hong Kong and New York; was and also Deputy Head of the Listing Division at The Stock Exchange of Hong Kong Limited (HKEx), and Head of the China Listing Affairs Unit.  Prior to that, Ken practiced banking & finance with two major law firms in New York. He holds B.A. and J.D. degrees from the University of Pennsylvania and the University of Pennsylvania School of Law.

“Asia Pacific M&A and Corporate Strategy amidst Global Market Dislocation”

As the world wrestles with the Covid-19 pandemic, many economists, political analysts and pundits continue to speculate about permanent changes to business patterns and consumer behavior.  But even before Covid-19’s bolt out of the blue, the confluence of rising trade frictions, growing de-globalization, tightening geopolitical tensions and daring central bank monetary policies already was pushing countries’ economies akilter.  Corporations, credit lenders and institutional investors are all facing complex, new challenges to their business strategies, and ultimately to their competitive positions.   How deeply will supply chains reconfigure?  Which Asian countries are resourceful and agile enough to weather the volatile international changes?  Which internet models and players will prevail?  Will the financial markets help or hinder? Which countries, which industries and which specific companies will financial capital favor, or penalize?   Views on these kinds of issues should precede a discussion on whether and how M&A should be employed; and the best in-house counsels should be front and center with the rest of senior management in re-evaluating, revising and honing their companies’ strategic planning during these complex times.

              Very often, people perceive M&A as a proactive tool — whether or not to use, when and how to use.  But even if your company is intent on pure organic growth, M&A by your competitors, or by {deletion} technology-emboldened upstart companies crossing over into traditional industries, could threaten and disrupt your company’s prospects.  It therefore pays to be watchful of M&A trends.

M&A activity by corporates (whether acquiring businesses, forming joint ventures, taking minority positions, or divesting assets) is always, everywhere, a part of business strategy.  A preeminent Cold War scholar defines grand strategy as “the alignment of potentially unlimited aspirations with necessarily limited capabilities.”①  This definition certainly applies to ambitious corporates, of whatever size, and of whatever operational longevity or brevity.  The dynamics of business competition and, increasingly, inter-regional competition, ensure that M&A activity will endure.  And we all should be prepared for M&A that could herald ever faster changes in the Asian business landscape.  Why this may happen in Asia will be examined below, along the key themes of (A) current market dislocations; (B) financial markets as catalyst; and (C) China’s inevitable impact on the region.

What are some of the key market dislocations?  The confluence of the several forces mentioned in the opening paragraph is indeed creating significant uncertainties which, for the time being, are stymieing M&A deal making.  While online due diligence and video conferencing are sensible workarounds under restricted travel conditions, most bidders and investors refrain from closing or pursuing new transactions when face-to-face familiarization with counterparts is absent.  At least in the corporate and institutional arena, their human agents still view their intangible sensory antennae as critical to final judgments about the other side’s sincerity, veracity, compatibility and credibility. 

The pandemic indeed has damaged many companies, especially those whose balance sheets are over-leveraged.  In China, the pandemic came at a very inconvenient time for many private-sector enterprises, which already were suffering under domestic banking reforms since 2017 aimed at reining in opaque shadow banking and its high-cost borrowing channels.  Distressed M&A should be one market solution for such companies, and indeed some owners hope strategic or financial investors will alleviate their business and financing pressures.  However, China’s regulatory environment is complex and often too daunting for all but the most committed foreign investors.

Presumably, the pandemic’s disruptions will pass, hopefully sooner rather than later.  Then we can re-evaluate Asia’s future prospects, including an assertion once made by Lee Kwan Yew, Singapore’s insightful founder and leader:  

“The 21st century will be a contest for supremacy in the Pacific, because that is where the growth will be.  That is where the bulk of the economic strength of the globe will come from.  If the U.S. does not hold its ground in the Pacific, it cannot be a world leader.”

Lee Kwan Yew never was one to mince words.  Today, his bold assertion must be evaluated against new uncertainties such as economic decoupling, supply chain reconfigurations, bipolar ecosystems in technology, traditional industries versus New Economy as engines of growth, and last but not least, geopolitics.  The Financial Times warns that as a new multipolar world takes shape, we are seeing more trade disputes, higher tariffs, and broader geopolitical uncertainty.  Changes in global supply chains are predicted to speed up dramatically, according to McKinsey Global Institute.  Yet worryingly, global trade with countries in the bottom half of the World Bank’s political stability assessment rose from 16% in 2000 to 29% in 2018; and almost 80% of trade involves nations with declining scores in political stability.③

Beware that while many companies dither over such imponderables, the forces underlying these many uncertainties are accelerating, not slowing, changes in many markets – such as a faster adoption of e-commerce, online healthcare and fintech.  Flush with funds from venture capital and private equity, some upstart newcomers are seizing opportunities in other industries and other geographies.  Be reminded that even before the pandemic’s grip tightened, rapidly developing technology already began threatening traditional business operating models in traditional sectors, chiefly from a new generation of players in e-commerce, m-commerce, fintech, robotics, AI, cloud services and new energy transportation.  Some long-dominant leading companies in Asia already had started to re-evaluate their futures against new technology’s disruptive potential, and to strategize about avoiding becoming casualties in the next round of Schumpeter’s creative destruction.  Some continue to study how best to adapt to this spawning industrial mutation, including possibly resorting to M&A acquisitions or strategic investments in disrupting tech companies (“If you can’t beat them, buy them”).  However, some of these targets may also be in the cross-hairs of larger tech companies.  To wit, the expansion of Chinese internet companies, such as Alibaba and Tencent, into Southeast Asia where already there are some 300 million digital consumers.

Aside from technology’s disruptive energies, the reconfiguring of supply chains to diversify country risks and/or to minimize exposure to growing tariffs also brings new business strategy challenges.  Across Southeast Asia and its heterogeneous cultures, with each country presenting its own infrastructure and logistics challenges, does one patiently build or proactively acquire a local company’s platform to jump-start operational scale?  Can companies replicate elsewhere anything like the efficient supply-chain ecospheres created in China, some of which involved dozens or hundreds of other companies?

Aside from new market dislocations, are there other reasons to expect more M&A in Asia?  Another force for change comes from a long-standing global phenomenon, namely, the inexorable pressure within most industries for companies to dominate by size, to boost market share, to build scale and thereby create, capture and exploit more “operating leverage,” more “revenue synergies” or “more efficiencies” – more benignly called industry consolidation.  There is scarcely an industry exempt from this economic law, whether in Western OECD countries or in the rest of Asia Pacific.  In fact, many corporates in China cite as their strategy the shorthand mantra “Get big, become strong” (“做大做强”), even if this entails go-for-broke high debt leverage.  Apart from outright national protectionism of home champions, the only other effective check on industry behemoth-ism comes from countries’ antitrust laws (if any, or rather, if applied with earnestness).  

Furthermore, members of the legal community often fail to appreciate fully the various ways in which financial market conditions can drive greater M&A activity.  Many people do understand that newsworthy mega-deals tend to happen when stock markets are buoyant, when corporate bidders are underpinned by their own high stock prices and so can raise capital easily, and when confident CEOs can expect supportive market reactions to announced acquisitions. 

Today’s markets, however, face a handful of highly unusual conditions, such as:  a robust US stock market with a lop-sided bullishness towards tech companies, stoking investor fears of over-valuation; a global bond market with near-zero interest rates and as much as $15 trillion worth of OECD bonds trading at negative yields, implying very low or no economic growth for years to come; a world awash with financial liquidity, including private equity firms with as much as a record $1.5 trillion of “dry powder,” or funds ready to deploy into new investments; and a rising China with a $13 trillion GDP economy, and the world’s 2nd largest domestic bond market and 2nd largest stock market.  Corporate strategists should ask themselves how these unusual financial conditions might motivate or empower other players (both corporates as well as financial investors) to acquire or divest businesses of relevance to, and possibly to the detriment of, the strategies of their own companies. 

Just to point out two such ways:  One, in the world of private equity, many PE fund managers are exiting more and more of their portfolio companies in trade sales, i.e., M&A transactions in which the buyers are corporates or even other PE funds.  Two, in the Chinese onshore A-share stock market, when secondary market valuations are high, listed companies become more acquisitive (as we have seen in the past decade), especially of attractive, unlisted private companies whose owners decide to sell rather than wait for their own IPO listing.  Currently, companies listed on the Shanghai Star Market are trading at average of 90-100x price-earnings ratios, while several hundred other A-share listed companies in IT, healthcare and consumer staples are trading at 40-50x P/E multiples.  To put it simply, if investors are willing to back a company and own its stock at a price of, say, 50x the company’s EPS (earnings per share) — which implies that the market expects its net income will grow at a 40-50% CAGR – that company may well be tempted to BUY some of that expected earnings growth by paying just 10-20x for the earnings of decent target businesses (onshore or overseas), provided that the target’s financials are consolidated with the company’s financial statements.  For many Chinese listed companies, this math can be compelling.

Might China’s cross-border M&A activity resume to any significant degree?  The general perception is that inbound M&A into China has slowed for several years, along with lower yet steady FDI levels, and outbound M&A has run aground since 2017 when China began regulating outbound M&A and tightening controls on capital outflows.  On the latter observation, there is no debate.  Let us look at some less obvious points and their contradictory signals.

First, inbound M&A.  On the one hand, China’s formal economic plan includes an emphasis on Made in China and on promoting homegrown innovation; on the other hand, China is opening more industry sectors to foreign investment by winnowing down the negative list of prohibited sectors, and by promulgating a new Foreign Investment Law.  For many multinational companies, across many industry sectors, one cannot be a leading global company without a strong presence in China’s domestic market.  The auto industry for traditional passenger cars and now New Energy Vehicles is just one example, as exemplified by Volkswagen AG’s announcement a few months ago of a deal to invest more than one billion euros (EUR1 billion) into Gotion High-Tech, a Chinese electric battery company listed on the Shenzhen Stock Exchange.  In capital markets, China continues to implement policies welcoming foreign monies into the onshore bond and stock markets, including allowing international institutional investors to set up onshore and raise RMB funds from local investors.  There is also a domestic peculiarity:  As more and more Chinese entrepreneurs age and retire (with only one child as a result of China’s decades-long one-child policy), many of them will opt to sell their companies to a new owner, rather than bequeath to an uninterested 2nd generation. 

Second, outbound M&A.  After a spate of splashy overseas acquisitions during 2014-2016 by several Chinese companies in the private sector ($40 billion worth by just HNA alone), the Government called a time-out.  There now is a regulatory approval process segmented into three channels of green (encouraged), yellow (conditional) and red (discouraged).   Besides the regulatory screening of outbound deals according to the parties’ industries and strategic purposes, separate approval must be obtained from SAFE (State Administration for Foreign Exchange) to remit funds outside China; many market participants believe China fears destabilizing financial risks from any significant capital outflow, so SAFE is very sparing in granting such approvals.  Nevertheless, outbound M&A is occurring in situations where China sees the strategic logic of the Chinese bidder, such as an investment to promote the bidder’s vertical integration.  More profoundly, despite the pandemic, trade tensions and concerns over capital outflow, one fundamental has not changed at all – namely, that in the long term China’s economy must continue to go abroad, to gain new markets and to deploy her abundant financial capital.  Failing to do so would mean her companies will not develop fully and cannot aspire to become global leaders, and capital rigidly trapped onshore will tend to create serial asset bubbles.

On the ground in China, one hears of two trends which sound contradictory.  Some Chinese companies are slowing international expansion to concentrate on a domestic market which is being spurred by China’s Made in China policies; demand for some locally made products is expected to soar (think, technology hardware).  The controlling shareholders and CEOs of other companies, primarily in the private sector, dread an inwardly focused market where even more Chinese private enterprises will focus and compete, usually fiercely, and only on the basis of price-cutting, thereby destroying everyone’s profit margins.  (Note, China’s stock markets are not yet developed enough to mete out market discipline and punish listed companies which engage in ruinous competition and destroy shareholder value.)  To escape being in the thralls of such vicious domestic competition, some companies are saying they now need to accelerate, not stop, their international expansion.  There also is the incentive to set up more production outside of China as a way to escape further tariffs on Chinese exports.  Some of this overseas expansion will be organic growth, some will be via M&A – subject to SAFE’s permission to remit funds offshore, that is.  Of course, outbound expansion will and should vary by industry, by company.  Chinese companies in social media may own a platform and business model for which overseas markets and accessing new customers requires only incremental investment.  5G telecoms, e-commerce, consumer internet and O2O are areas in which China has started to be a global contender, or even an outright leader, and are already spilling over into some Asian markets (think, Bytedance/TikTok, or Tencent/WeChat).  Chinese companies in capex-intensive businesses, however, may be dissuaded from international expansion, at least in the short-term until geopolitical and economic uncertainties subside, unless they are receiving official strategic encouragement.  

If your company is Chinese, and you worry that investments into some Western countries will be rejected or undergo lengthy regulatory obstacles, then other geographies may be more welcoming; and Asia is closer to home.  If your company is global or regional, you need to continue to calibrate the optimal balance of resources in China, rest of Asia or outside of Asia.  In all cases, for Chinese and non-Chinese companies alike, the business strategy and risk analysis will drive the decision on whether to engage in M&A, as well as whether others’ M&A can threaten your company’s prospects. 

That this article chooses to close with a discussion about China is deliberate.  Every businessperson in Asia should strive to comprehend China’s economic, trade and financial impact on the rest of Asia, and on the rest of the world.  She currently is the largest trading partner for over 130 countries, including all the major Asian economies (15% of ASEAN’s total trade in 2015, versus US’s 9%).  China is already at an economic scale and degree of development that her policies and actions can act like a magnetic vortex on the rest of the region.  The Newtonian forces from this vortex feature both centripetal (inbound) and centrifugal (outbound) economic, trade and business consequences.  Once again, Lee Kuan Yew:

“The size of China’s displacement of the world balance is such that the world must find a new balance in 30 to 40 years.  It is not possible to pretend that this is just another big player.  This is the biggest player in the history of the world. ④ ⑤

He said this in 1993, so by his reckoning . . . the world, and our companies, have until 2023 to 2033 to rebalance and secure our footing. 

Thanks to China Going Global Thinktank Service (CGGT) for sponsoring this post.

That the reader has this volume in hand implies an ambition to be (or remain) a master of the nuts & bolts of M&A, an essential capability to ensure flawless corporate M&A execution.  Although this article serves as a Forward to a technical volume on many important aspects of executing M&A transactions, the complicated panorama outlined herein underscores the need for (nay, beckons) smart legal counsel to apply their professional and intellectual training — which is inherently and fundamentally rooted in multi- and inter-disciplinary thinking — at the level of strategic thinking and management, and to own and deserve a seat at the uppermost management discussions.  The best legal minds know the micro workings and also see the big picture; these are the lawyers who can and should have significant business influence within their companies.  I trust that my confidence in the reader is not misplaced.

Kenneth H. Koo
Shanghai, 10th September 2020

①  John Lewis Gaddis, On Grand Strategy (Penguin Books, 2019), p. 21.
②  Graham Allison and Robert Blackwill with Ali Wyne, Lee Kuan Yew, The Grand Master’s Insights on China, the United States, and the World, p. 35 (The MIT Press, 2013).
③  Rana Foroohar, “The great trade unwinding,” Financial Times, 9 August 2020.
④  Allison and Blackwill, Lee Kuan Yew, The Grand Master’s Insights, p. 42.
⑤  Quasi-disclaimer:  For the avoidance of anyone’s doubt, I have no family, social or business connection to the Grand Master or the State of Singapore; I quote him twice, sheerly out of my respect for his consistently articulate and often prescient opinions on China.  I do, however, have a dear brother and sister-in-law who live and work in Singapore, both successfully.  Any indiscretions or nonsequitors expressed in this Article are wholly the author’s.

Posted by Patrick Dransfield

Patrick M. Dransfield is Client Relations Director at Alsuwaidi & Company, Principal of Clearway Communications and Co-Founder of the Managing Partners’ Club.

Leave a Reply