China is reining in its record deal-making spree. According to Bloomberg, Chinese regulators will bar overseas investments of $10 billion and above, while leaving room for some strategic deals. They will also restrict overseas investments of more than $1 billion in industries outside a buyer’s core business, as well as foreign property deals of $1 billion or more by state-owned enterprises.
The moves come in the wake of unprecedented merger and acquisition (M&A) activity in the Asia-Pacific region led by China. So far in 2016, outbound deals by Chinese companies have doubled to $218.23 billion from last year.
So, what is the underlying rationale behind the moves? According to experts, it is part of an effort by Chinese authorities to keep China’s money supply within China.
“Investing offshore in USD from China is a real problem. Further, the challenges multiplied in the past few weeks culminating in the SAFE (State Administration of Foreign exchange) directive to banks on additional exchange control this Monday, making it hard to convert RMB (Renminbi) into USD and invest in USD out of China. The authorities want to discourage capital flight which will weaken RMB-USD exchange rate,” said a veteran investor, who has had deep links with Chinese funds over a long period of time.
Now, with China applying the brakes on deal-making, it puts the spotlight on some of the large deals in the making by Chinese companies in India. In July, China’s Fosun Group agreed to buy a controlling 86% stake holding in Gland Pharma Ltd from shareholders including KKR & Co. for up to $1.26 billion. The deal was termed as China’s largest takeover of a firm in India. The deal, though signed, is yet to receive approval by the foreign investment promotion board (FIPB) and has not been completed yet.
On 5 May, Mint reported Asia’s largest film group and theatre operator Wanda Group Co. Ltd is in talks with Ajay Bijli, the promoter of PVR Ltd, to buy a controlling stake. Wanda Group has also agreed to spearhead a $10 billion project to build an industrial park in Haryana, in what could become one of the biggest development projects in India, Bloomberg reported in January.
Do China’s moves to rein in deal-making mean these transactions are dead?
Not necessarily. “It depends upon how influential an investor is in China. The more influential institutions can actually push through some of these things with right networks and relationships, especially for large deals”, added a China expert.
“To be fair, some of these companies have operations outside China earning offshore revenue, and these regulations will not affect them,” the expert said on condition of anonymity. For instance, Fosun has spent about $30 billion in the past two decades outside China, mainly acquiring insurance and real estate assets in Europe and the US.
Besides M&As, the moves would also potentially impact fund-raising by private equity and venture capital funds. “One of the significant trends in the recent past has been the fund-raising activity tapping LPs (limited partners) from China. It would become extremely difficult unless they have dollar capital, which is rare,” said a partner at a law firm very active in the India-China corridor.
The clampdown on deal-making will have an impact on all international recipients of capital.
Indian start-ups are mostly tapping the capital of global venture capital firms that have set up shop in India. While some start-ups like Paytm Payments Bank Ltd and Snapdeal have been funded by Chinese e-commerce giant Alibaba, investment from Chinese companies is relatively uncommon. However, fund-raising options for these large start-ups could potentially shrink.
Overall, the impact could be more pronounced for large companies and a few unicorns. However, it raises a bigger question.
We have been arguing that the world is getting flatter. Flow of information and ideas is almost unstoppable. Flow of people and capital has seen less lowering of barriers but has not as much as we would have liked.
So, how does this move change the story? Is it a knee-jerk reaction likely to fade away? Or does it show that national boundaries are harder to ignore than we first thought?
Such restrictions not only affect companies outside China, but could also deprive Chinese companies of growth opportunities, and access to labour and technology through M&As. This columnist, for one, would love to see freer flow of capital and people. So here is a shout to the proponents of ‘The world is flat’.
Shrija Agrawal is Mint’s deals editor. Due Diligence will run every week and cover issues in India’s venture capital, private equity and deals space.