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Mainland M&A M&A concerns are magnified when it comes to doing deals in China, where there is less familiarity with due diligence. “You have to be more careful when internal controls are not as good, corporate governance is not as well developed and there is a longer time to discover data,” warns Stephen Law, an Institute Council member who worked on many M&A transactions when he was a managing director of private equity group TPG. There were about 3,000 reported M&A transactions in China during 2011, of which 80 percent were domestic transactions. The remainder were inbound deals from overseas, which have slowed in the wake of downturns in the European Union and United States. However, outbound deals by Chinese companies are proceeding apace. In October, China saw its biggest foreign acquisition when the state-controlled oil company CNOOC struck a US$15.1 billion blockbuster deal to acquire the Canadian energy producer Nexus. “It is a particularly strong market at the moment,” says David Brown, who leads PricewaterhouseCoopers' M&A transaction services business in the Mainland and Hong Kong. After a spate of high- profile scandals, M&A due diligence in China in recent years is much more focused on looking out for fraud, Brown says. “There are more forensic due-diligence procedures in place,” he says. There are also lessons for Hong Kong businesses involved in M&A deals with Chinese companies. It was the HK$418 million acquisition of Hong Konglisted Omnicorp in 2010 that put Sino-Forest Corporation in the spotlight when it was found that some of Omnicorp’s logging licences had expired. Sino-Forest filed for bankruptcy in 2012. There can be many hidden obstacles when conducting M&A due diligence in China, or on Mainland-invested entities, experts warn. These include: Complex corporate structures Acquiring a minority interest in a business or entering into a joint venture are common ways to invest in Chinese companies, as is the use of cross holdings, offshore entities and shell and holding companies, but some set-ups may not be entirely legal under Chinese law. “Make sure you are in fact buying one company and not 30 companies,” adds Velisarios Kattoulas, chief executive of Poseidon Research, a consultancy that advises on M&A. Multiple sets of books It is common for Chinese private companies to have multiple sets of books and it is essential to understand why this is and the differences between books. “Frequently the ‘tax books’ will understate income in order to reduce the tax liability,” says Barry Tong, transaction advisory services partner at Grant Thornton in Hong Kong and an Institute member. “[This] may result in a potentially large contingent liability for a buyer.” Revenue recognition and cash reconciliations Experts recommend reconciling cash deposits from bank statements to revenue. “There is often an early recognition of revenues and inclusion of one-off gains as recurring revenue,” observes Jack Clipsham, a partner and head of Asia Pacific corporate finance at Mazars and an Institute member. Owners’ compensation and personal expenses These are among the most common causes of adjustments to earnings. “Look for signs of inappropriate expenses,” advises Law at TPG. Related-party transactions Relatives of the owners or managers may be on the company’s payroll, customers may include related or affiliated companies and key suppliers may be related or affiliated by common ownership. “The due diligence process needs to determine if there is contractual employment, sales or purchase agreements that will survive [the] closing [of the deal],” Tong says. Last but not least, make sure all parties understand the documentation, especially if it requires a translation. “Language itself can also be a challenge – both oral and written,” Clipsham warns. “The Chinese language does come from one of the world’s oldest cultures and possesses an eloquent tradition rich in ambiguities.” A PLUS January 2013 19
of the target’s electricity bill. “Find out the bank balance – that’s harder to falsify than bank statements,” he advises. However, a new stumbling block that many carrying out due diligence are increasingly facing is sellers that give critical information only to certain suitors. “It is becoming very difficult to get the more valuable commercial information before entering an exclusivity phase when a preferred buyer gets access to management,” says Jack Clipsham, a partner and head of Asia Pacific corporate finance at Mazars and an Institute member. Such a preferred-party system might require a phased approach to the due diligence, Clipsham adds. Initial due diligence might ensure key concerns and potential risk areas are covered, but full due diligence wouldn’t be engaged unless the parties were seriously involved, enabling potential acquirers to control associated costs. Teamwork is the key While accountants are essential to an M&A due diligence exercise, other input is necessary. “Accountants tend to look at what information they have. You need other people to look at what information you don’t have,” says Law. That, he adds, means hiring lawyers, business consultants and, if necessary, private investigation companies. Lawyers are there to examine documents, company structures and other legal and regulatory aspects of the target company. “You will need to develop a sense for what aspects of non-compliance or non-conformity are deal breakers and which can be fixed,” says The good and bad of M&A Ten notable global transactions of the past 15 years for the right – and wrong – reasons. Despite the occasional stinker of a mega-deal, the Americans are generally very good at mergers and acquisitions. Large markets, technological knowhow and effective due diligence have made them the masters of the art. It’s no surprise that some of the most successful multi-billion dollar partnerships involve both acquirers and targets from the United States. Exxon Corporation (U.S.) and Mobil Corporation (U.S.), 1999, US$82 billion This merger formed the largest company in the world and reunited John D. Rockefeller’s Standard Oil Company of New Jersey (Exxon) and Standard Oil Company of New York (Mobil), which had been merged in 1870 and broken up by the U.S. Supreme Court in 1911. “You have to ask: ‘Can I trust these people, and do they have the wherewithal to execute... their business plan?’ ” SWEET DEALS Chase Manhattan Corporation (U.S.) and J. P. Morgan & Co. (U.S.), 2000, US$28.6 billion The ultimate evocation of the idea that “big is beautiful,” the deal that resulted in JPMorganChase maximized the synergies of consumer banking (Chase) and investment banking (Morgan) through a largely seamless transaction. A PLUS Mark Schaub, a partner with the King & Wood Mallesons international law firm in Shanghai. One common hiccup is focusing on the commercial matters at stake without thinking of the wider regulatory environment that could affect a deal. “Due diligence should also examine the increasingly complicated approval road map, including anti-monopoly and national security clearances being required in some cases,” Schaub says. That is even more important when one or both of the companies concerned is in China, he says, adding that the Chinese regulatory environment has many grey areas. Working together, everybody needs to Broken Hill Proprietary Company (Australia) and Billiton (U.K.-Netherlands), 2001, US$57 billion The biggest mining industry deal to date was agreed to not by market dictates but by the personal desires of then-CEOs Paul Anderson of BHP and Brian Gilbertson of Billiton. The resulting BHP Billiton is a behemoth in an industry where size matters. DBS Group Holdings (Singapore) and Dao Heng Bank Group (Hong Kong), 2001, US$10 billion DBS was criticized for overpaying Guoco for Dao Heng, but a decade later the acquisition looks smart. No longer dependent on Singapore for the bulk of its revenues, the deal catapulted DBS into the major regional leagues. The Walt Disney Company (U.S.) and Pixar Animation Studios (U.S.), 2006, US$7.4 billion Widely hailed as one of the shrewdest Hollywood deals in memory, this merger brought together the resources, access and history of Disney and the cuttingedge innovation and risk-taking of one of the greatest animation and special effects studios. January 2013 21
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Page 3 and 4: President’s message “ I look fo
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Page 10 and 11: NEWS GREATER CHINA Economic policie
Page 12 and 13: Mainland may adopt IFRS de facto co
Page 14 and 15: OW UR GET George W. Russell finds o
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Page 22 and 23: PHOTO: SAMANTHA SIN the hard work p
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Page 26 and 27: Constant adaptation in fashion-cons
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