First

Things

First:

ClarifyingStrategyandCommercial

GoalsPresented

By:JohnJ.Evans,ManagingDirector

TractusAsia

Ltd.M&AinChina–

AnEssential

Skills

Series

17

Jan

2002

Hotel

Inter-Continental,

SingaporeWhy

China?252%of world’s

populationIs

a

4.5

hour

flight

from

Hong

Kong3“China

Fever”vs.

Reality:What

toExpect4Economic

Growth

8%

peryr.WTO

levels

theplaying

fieldHuge

upside

for

FDILow

cost

production

baseIfeveryChineseboughtone

more

of

our

product?SOE’s

a

bargainWork

force

eager

to

learn

&

prefer

foreigncompanies7.3%

‘01,

can

it

be

sustained?Implementation

slowSteep

learning

curvesCosts

do

not

equal

efficiencyCanyoucompetewithlocal

companies?Overvalued&inexperiencedMostemployeeslack

experience

and

skillsBut

youcan’tignoretheworld’s

largest

countryand

fastest

growing

economyAre

your

investment

decisions

being5driven

by

perception

or

reality?Lawyers,

consultants

and

“guanxi”

are

no

substitute

for

a

commercially

sound

dealWe

can

only

help

you

do

your

homeworkBepatientandtakeyourtimetounderstand

the

market,

opportunities,

and

competitorsAreyoulookingatanewmarketorareyou

already

established?If

somethingsounds

toogood

tobe

true,it

isDon’t

overestimate

your

own

abilitiesDon’t

underestimate

the

investment

costsHowdoesChinafitintoyourglobal

or

regional

strategy?SellSourceProduce6STAGE

6Evolution

of

FDI

into

ChinaSTAGE

1STAGE

2STAGE

3STAGE

4STAGE

5Opportunistic

exportsSource

raw

materials

&

productsGain

control

on

import

&

exportsSet

up

branch

or

representative

officeMake

a

small

investmentDevelop

market

knowledgeMake

a

larger

investment

(M&A)Set

growth

goalsTarget

best

management

practicesMore

investment

and

expansionImprove

management

and

systemsFocus

on

business

fundamentalsWhat

are

your

M&A

goals?8Market

entryChina

demand

for

your

products

or

servicesCompetitive

export

baseChinese

domestic

growthIncrease

market

presence

and

geographic

coverageBuy

competition

to

consolidate

sectorDoes

a

merger

or

acquisition

in

China9make

sense

for

your

business?Does

a

merger

ever

make

sense

given

the

lack

of

business

transparency?What

do

you

know

about

the

market

and

competition?Who

are

they

and

what

is

thelevel

of

sophistication?What

are

the

obstacles

to

entry?Can

you

afford

to

buy

them?Don’t

befooledbypastmergerscenariosPartner

selection

was

limited

and

often

politicalSales

and

marketing

capabilities

were

exaggerated“Guanxi”

was

considered

most

importantPartnerships

often,

“same

bed

different

dreams”Chinese

Co.Foreign

Co.ObjectivesShort-termprofits

IP

&

tech.

transfer

Foreign

exchange

Exportmarkets

Pay-out

profits10Long-termgrowthQualityproductionIncreasemarketshare

China

customer

access

Re-invest

profitsPath

to

a

leading

global

economyoesatioDDoooorrOOppeenniningg

LLibibeeraralilsisaatitoionnSStatabbiliilsisaatitoionnNNoormrmaalilsisaatitoionnMModdernrni

isationnSOE’s

dominateSevereinvestment

&

trade

restrictionsLimited

FDIRapid

GDP

growth,key

sectorsboomTraderestrictionsrelaxNewplayers

enter

marketEconomyover-heatingOversupplyin

manysectorsGovernmentattempts

toslows

thingsdownChina,

global

economyMarketsand

financialsystems

more

transparentChinese

conglomeratesemerge1980’s1990

-

19951995

-

19971997

-

20002001

on

…Growth

managedSOE’s

start

to

restructureProfitable

FDI

emergesFDIexits&

new

entries11What

are

the

alternatives

for12achieving

your

commercial

goals?SourceSellthrough

distributors,

agents,

or

directlyContract

manufactureLicense

or

franchiseInvest

in

a

WFOEGreenfield

or

BrownfieldPotential

acquisition

targets13Listed

CompaniesState

Owned

Enterprises

(SOE)Foreign

Invested

Enterprise

(FIE)Equity

joint

ventures

(EJV)Contractual

joint

ventures

(CJV)Wholly

Foreign

Owned

Enterprise

(WFOE)Private

Chinese

CompaniesListed

Companies14ProsStockmarketrestricted

tolargeandwell

performing

companies– Most

are

SOE’sCompaniesabideby

standardaccounting

proceduresMostlyrestructuredSOE’snowpursuing

profitConsSevereregulations

on

purchasing

State

sharesForeigners

restricted

to

purchasing

B

sharesHostiletakeoversnot

allowedAllsharepurchases

need

State

approvalState

Owned

Enterprises

(SOE)15ProsSOE's

needing

capital

can

sellequitytoforeignersGov’tmandatetoconvertmostofthe305,000SOE’s

toForeignandlocal

investorsGov’thasselected1,000SOE’stobecomeChina’s

modernconglomeratesConsGov’tcontrolof“pillar”

industries;telecomm,

petrochem,high-tech

electronics,

steel,

aviation,

and

autoDifficultytostrikedealsand

sometimes

gain

approvalMay

be

selling-off

non-

performing

divisionsSOE’saccountfor80%of

loanstoStatebanksandmost

oftheNPL’sHard

to

know

who

is

the

decision-makerForeign

Invested

Enterprise

(FIE)16ProsFlexibility,FIE’scanbe

acquiredby;holding

companies,foreign

entities

or

other

FIE’sAnopportunitytobuya

foreign

investmentSeveralmethodsof

structuring

deals– Both

off-shore

or

on-

shoreConsToughrestrictionson

holding

companiesFIE’sdivided

into

categoriesbyMOFTEC;

encouraged,permitted,

restricted,

prohibitedToacquireFIEassets,

requires

a

local

legal

entityRapidlychanginglawsLocalpartnerconsenton

managementTransparencyWholly

Foreign

Owned

Enterprise

(WFOE)17ProsMostlikelyadheresto

internationalaccounting

andmanagement

standardsTransparencyOpportunitiesforsector

consolidationInvestmentgroundwork

has

already

been

doneConsWhyaretheyinterested

inselling?Profitablesuccessful

companieswilldemanda

premiumSubjecttoWFOE

regulationsInvestmentincentives

may

have

expiredPrivate

Chinese

Companies18ProsMostoftenmore

professionally

managedTiming

of

a

deal

can

be

fasterAllowed

tomergewith

\Assetorequitypurchases

can

be

structuredCreationofanFIEand

eligibilityforincentivesentitiesConsWhy

are

they

selling?Savvyandtougher

negotiatorsSomecompaniesdonothavetherightstoenterinto

contracts

withforeignM&AwillcreateanFIEor

WFOEandbesubjectto

approvals&restrictionsTransparencyCommercial

due

diligence19Do

your

homeworkWhat

knowledge

do

you

already

have?Where

to

access

market

info?Use

your

internal

knowledge

baseWhat

is

your

current

distribution/supply

network?Do

you

have

any

existing

industry

relationships?Access

local

government

assistanceChinese

&

ForeignCommercial

due

diligence20The

role

of

background

checksDon’t

neglect

background

checksbecauseofalackofinformationordifficultyingathering

accurate

dataGoodcompaniesarehappytosharetheirsuccess

storiesInexperienced

companies

don’t

have

anyResearch

and

understand“Guanxi”M&A

targetsSuppliersCustomers“Guanxi”21What

is

it?Does

it

work?Is

it

legal?Does

it

have

a

role

in

your

business?Are

you

building

it

and

is

it

worth

it?Cantheywalkthewalkorarethey

blowing

smoke?How

do

you

verify

influence?The

changing

weight

of

GuanxiCentral

control

of

resourcesState

owned

productionCapitalflowsbasedonpolicy

directivesRegulating

by

policy

changesWelfarebystatesubsidiesto

society,

guaranteed

employmentTarget

based

production

goalsCentrally

controlled

product

pricesGovernment

regulated

marketsControlled

Economytransfers22Supply

&

demand

allocate

resourcesPrivate

ownership

of

manufacturingInvestmentflowsbasedonefficient

employmentofcapitalRegulation

by

lawWelfare

through

direct

governmentDemandbasedandprofitdriven

productiontargetsMarket

driven

pricingCompetitive

marketsMarket

EconomyMerger

&

Acquisition

targets23TransparencyWillingness

to

share

information– Convincing

them

it’s

a

deal

breakerBusiness

licenses

&

authorizationsLiabilities

and

debt

on

and

off

the

booksHistory

of

shareholders

and

principalsProven

track

record

of

operating

successSuppliers

&

Customers24Chase

and

vet

referralsScrutinizeestablishedbusinessrelationshipsand

historical

performancePayment

history

and

credit

termsMeeting

contractual

obligationsQuality

control

and

certificationsResponsiveness

and

professionalismPersonal

relationshipsAvailability

of

M&A

financing25Public

listing

everyone

wants

it,

but

not

a

realityMost

SOE’s

expect

you

tobring

all

the

moneyPlan

well,

you

don’t

want

togo

back

to

theBoardBe

prepared

to

investmore

than

your

estimatesFIE

partner’susuallyunable

to

financegrowthOn-shore

acquisitionsDebtfinancingavailablebut

D/Eratio

limitedby

lawsOff-shore

acquisitionsLendersnotwillingtolendonanon-recoursebasisParent

companies

asked

to

guarantee

local

loansNext

Steps26Put

together

an

action

plan

with

milestonesEvaluate

internal

resources

and

capabilitiesDevelopabudgetwithrealisticcostsand

expected

returnsRetain

external

expertise

as

necessaryTaking

the

plunge27Plan

for

successLearnfrompastmistakesManage

your

expectationsUnderstand

the

Chinese

perspectiveDevelop

a

negotiating

strategySet

realistic

timetables

and

budgetsAllocate

appropriate

resources

to

the

start-up

andimplementationBuild

and

train

a

China

teamTo

succeed

you

have

to

understand28why

mistakes

are

madeNot

having

a

policy

of

engagementMisunderstandingthegoalsofpotentialpartner’soracquisition

targetsFailure

to

manage

partnership

relationsLettingpartnersorthegovernmentdictateyourinvestmentor

location

decisionsOver

or

under

estimating

market

sophisticationOver

estimating

your

own

abilitiesNottakingthetimetounderstandChinaandtheChinese

perspectiveChinese

Perspective29Closed

for

50

years

created

a

different

development

curveLack

of

global

business

experiencePlaying

on

the

same

field

but

don’t

yet

know

the

rulesIsolationismandcreatedanideologythatistruly

ChineseChina’s

regional

differencesEveryone

over

35

grew

up

in

an

era

where

the

state

providedeverythingWithoutfinancialdriversdecisionstraditionally

were

based

on

power

and

relationshipsManaging

Expectations30Understand

your

corporate

goalsCan

you

afford

to

invest

in

China?Can

you

afford

not

to

invest

in

China?Take

your

time

and

do

your

homeworkPrivate

sector

and

public

sector

are

different

animalsSet

appropriate

goals

and

be

flexiblePatience

and

one

step

at

a

ti