Review and outlook for Sino-German cross-border M&A – by Nan Ju

The following content was published on Investment Platform China/Germany January 2019 Issue

Review and Prospects of the Sino-German Cross-border M&A Market

Review of the Sino-German Cross-border M&A Market in 2018

In 2016, the Chinese company Midea Group acquired German KUKA Group through a tender offer, which drew unprecedented attention from the business communities and media in both countries, even raising concerns among the Germans. It was in this year that the volume of Chinese-German mergers and acquisitions reached its historical peak.

However, in 2017 and 2018, the volume of Sino-German mergers and acquisitions did not continue to grow. Based on our experience in Sino-German M&A consulting and our observations of this niche market, we believe that the decline in M&A volume in 2018 was influenced by the following factors:

1. Under the impact of China's deleveraging policy, liquidity has tightened, manifesting as restricted financing quotas and significantly higher financing interest rates. This has particularly affected Chinese private enterprises, including private listed companies. The certainty of financing is the foundation of transaction safety and is the primary concern for German sellers. If the Chinese party cannot provide sufficient guarantees or collateral to the German party in terms of transactional aspects, the likelihood of the Chinese party winning in the acquisition process is extremely low.

2. Expectations of a downward macroeconomic trend and the Sino-US trade war have led more companies to adopt a cautious wait-and-see approach. So far, China's macroeconomic easing monetary policy has not met expectations in driving GDP growth, resulting in weak economic performance. Additionally, the external shock from the Sino-US trade war starting in 2018 has further dampened confidence in the Chinese economy, affecting participants in the M&A market.

3. The German M&A market is a seller's market, with active participation from overseas investors. PwC predicts that overseas investors completed more than 800 M&A transactions in Germany in 2018, with American companies maintaining strong momentum in the German M&A market. The valuation levels of the Chinese stock market continued to decline in 2018, making overseas assets relatively less attractive to Chinese investors compared to previous years.

4. The German Federal Cabinet approved a more stringent amendment to the Implementation Regulations of the Foreign Trade and Payments Ordinance last year. Additionally, the German Federal Ministry for Economic Affairs and Energy (BMWi) has become more stringent in its review of investments from non-EU investors. China State Grid's attempt to acquire a 20% stake in German grid operator 50Hertz and Yantai Taihai Group's attempt to acquire Leifeld Metal Forming Company were both obstructed due to government intervention. Overall, the introduction of these new regulations directly reduced the safety of Sino-German transactions, inevitably leading to a decline in the attractiveness of Chinese investors in the bidding process.

Although the decline in Sino-German merger and acquisition (M&A) transactions is a result of various factors, we believe that liquidity tightening and the uncertainty surrounding the recent economic outlook are the most significant underlying causes. In comparison, the strengthening of Germany's controls on overseas investments has had a limited impact on the current Sino-German M&A market. Additionally, although the Chinese government's foreign exchange regulations designate real estate, hotels, and entertainment as sensitive sectors for overseas investment and have frozen Chinese companies' overseas M&A activities in these fields, the focus of Sino-German M&A has always been on the manufacturing sector, so this measure is not the main cause of the decline in the Sino-German M&A market.

Of course, we also observed positive changes in Sino-German mergers and acquisitions, mainly manifested in:

1. Looking back at 2018, the number of inquiries from Chinese companies seeking investment opportunities remained stable. After several years of development and consolidation in Sino-German mergers and acquisitions, many classic M&A and post-merger integration cases provided market participants with excellent references and positive role models. Chinese investors paid more attention to the synergy between their core business and acquisition targets in their M&A strategic considerations, and had a more thorough psychological preparation for the difficulties they might encounter in post-merger integration. Chinese investors became more professional in their M&A operations.

In Sino-German mergers and acquisitions, Chinese strategic investors are the absolute main force; seeking common sustainable development with German enterprises is the firm driving force behind their overseas acquisitions. For many acquisition cases, we also conduct post-acquisition tracking. Apart from a few negative cases, the majority of Chinese investors have achieved long-term sustainable development for both Sino-German parties. After a period of adjustment, the strategic thinking of both sides gradually aligns.

2019 Expectations and Prospects for the Sino-German Cross-border M&A Market

We expect that the issue of liquidity tightening will gradually ease in 2019. In fact, the People's Bank of China has already cut reserve requirements four times in 2018 and implemented a larger-scale cut in reserve requirements in January 2019, hoping to channel liquidity into the real economy, which is in urgent need of funds. We have observed that the highest decision-making levels in China continue to release positive fiscal (such as tax cuts) and monetary policy stimulus signals to encourage the business sector to regain confidence. The implementation and effectiveness of these measures will still take time, so we believe that whether the confidence of Chinese businesses can be restored within 2019 remains a big question mark. Negotiations on Sino-US trade relations are ongoing, and a reduction in the trade war and an increase in mutual trust would be very beneficial for boosting market confidence. There are already signs that Sino-US trade friction may see a phased easing this year. Based on the above analysis, and without considering the case of Geely's acquisition of equity in Daimler, we predict that the volume of Sino-German mergers and acquisitions will see a recovery in 2019, but returning to the levels of 2017 will still be challenging. Of course, there is also a high degree of uncertainty regarding the development of US and European stock markets in 2019, which may present opportunities for Chinese investors in the German M&A market.

Germany and China are the two countries that have benefited the most from globalization, with their industrial divisions being more complementary than competitive. We are also pleased to see that the Chinese government continuously introduces new policies, gradually opening up the Chinese capital market to foreign investors, which sends a positive signal to the German government and business community. Under President Donald Trump's America First principle, Germany and China have even more reason to strengthen mutual trust and cooperation, and to promote international capital cooperation. Guided by the national strategy of Made in China 2025, the Chinese government encourages enterprises to upgrade their technology, shifting from quantity improvement to quality improvement. Through overseas mergers and acquisitions, Chinese enterprises can simultaneously achieve technology upgrades, market expansion, and management improvements, accelerating the realization of quality improvement. Germany, with its high-quality investment environment and innovative enterprises, is bound to attract the attention of Chinese investors.

After 40 years of reform and opening up, China has grown into the world's second-largest economy. An increasing number of Chinese companies have become indispensable parts of the global industrial value chain and are becoming increasingly irreplaceable. Currently, the total number of Chinese acquisitions in Germany accounts for only about 5% of the total number of overseas investor acquisitions in Germany, far behind the levels of developed countries such as the United States. However, from a long-term perspective, we are confident that the market share of Chinese acquisitions in Germany will rise.

Author Profile

Nan Ju, CFA, Partner at Eurasian Consulting GmbH Since 2013, Nan Ju has been a senior executive at Eurasian Consulting GmbH. Prior to that, he worked in the transaction advisory department of PwC Germany. His areas of expertise include merger and acquisition consulting and enterprise valuation. He has successfully advised on numerous cross-border M&A projects between China and Europe in the fields of intelligent manufacturing, automotive, consumer goods, and construction machinery.