MERGERS &ACQUISITIONS IN CHINA IN THE 21ST CENTURY A Comparison Study between Strategically Acquired and Financial- Sponsored Investments Ruilin Xu Advisor: Professor Shannon Mudd 04/28/2011 Ruilin Xu Abstract This study compares the differences in the market perceptions and the actual performances of strategically acquired firms and of financial-sponsored firms in China from 2006 to 2009. Two main hypotheses here are: 1) A merger & acquisition (M&A) activity creates value for acquired firms, regardless of the types of investors; 2) Strategically acquired firms create less value over the same time period compared to the financial investor-backed firms due to the differences in the acquirers’ motivations. In order to prove these hypotheses, standard event studies that look at the cumulative abnormal returns of the acquired firms over periods of [-20, 20] and [-120, 80] are used. Our results confirm that mergers & acquisitions do create market values for the acquired firms. Our results also show that while in the short term the market perceives M&A activities involving strategic investors to be slightly better, this difference diminished after the 07-08 financial crisis. In the long run, the financially sponsored firms have gradually performed better than the strategically acquired firms, especially after 2007. 2 Ruilin Xu Acknowledgements I would like to express my sincerest gratitude to my advisor and mentor, Prof. Shannon Mudd: this paper could not have been written without your constant guidance and support. Many thanks to the Haverford Economics Department: it is my huge privilege to learn from and work with all the professors and students. Special thanks to Mr. Michael Kim’85 and Mr. Takaaki Tsubaki of PanAsia Partners. And to my parents, Feng Li and Junqian Xu. 3 Ruilin Xu Table of Contents I. Background Information & Hypotheses ..................................................................... 8 II. Empirical Methodology ............................................................................................. 17 1) Standard Event Study ............................................................................................. 18 2) Nonparametric tests for actual performance during [-120, 80] .............................. 21 3) Multivariate Regressions ....................................................................................... 22 III. Data Overview .......................................................................................................... 25 IV. Results ........................................................................................................................ 27 1) Standard Event Study ............................................................................................. 27 2) Nonparametric tests for actual performance during [-120, 80] .............................. 31 3) Multivariate Regressions ....................................................................................... 33 V. Conclusion................................................................................................................... 36 VI. Appendix ................................................................................................................... 39 References ..................................................................................................................... 46 List of strategically acquired transactions .................................................................... 47 List of sponsor-backed transactions ............................................................................. 52 4 Ruilin Xu Two different types of investors engage in mergers & acquisitions (M&A) activities: strategic investors and financial investors. Both are active investors in emerging markets like China. Strategic investors entered China first in a wave of M&As that occurred within a limited number of cities in 1987. Due to China’s need both to reform its state-owned enterprises (SOEs) and to develop its stock market, a second wave of acquisition activities (the majority of which were cross-border) occurred, between 1991 and 1996 (Chen, 2009). The third wave came when China joined the World Trade Organization (WTO) in 2001 as many Chinese firms realized that M&A provided a useful way to expand and better compete in the global arena. While in recent years, the overall number of M&A deals in China has been increasing by an impressive 20% annually (China Business, 2005), that number hides a shift in the type of investors coming into China. According to a recent report from Bain & Co (2009), private equity (PE) deals in China grew at a compound annual rate of 45% in 2000-2007(pre-crisis).1 The period of 2006 to 2007 was the height of the deal frenzy, when credit was affordable and money was readily available. Total debt during this period was six times cash flow, nearly doubled what it had been in 2001 (Finkel, 2010). After 2007, as people became more cautious about easy credit, leverage buyouts were no longer “in fashion”, and the market went back to basic values and growth-oriented investing. Nevertheless, this growing trend continued through the first half of 2009, as deal volume topped $7.2 billion, nearly matching the total for all of 2008 (for the overall 1 This percentage increase here includes all types of investments (e.g., M&A, private placement) done by private equity firms. However, the deal data I use in Graph A1 (in Appendix) as well as for the rest of the paper comes from the transactions that are listed as “Mergers & Acquisitions” in Capital IQ. Although a fair number of transactions listed as “Private Placement” can be considered as M&A activities in terms of transaction size and acquired percentage to my discretion, in order to simplify the data-collection process and avoid further confusion, only the “Mergers & Acquisitions” deals are used here. Hopefully this explains why Graph A1 does not show the 45% annual increase as mentioned in the Bain report. 5 Ruilin Xu trend from 2000-2010, refer to Graph A1). China is now on par with the region’s mature economies such as Japan and Australia / New Zealand as a destination for new investment. Both types of investors continue their investment interests in China in the 21st century (see Graph A1). From the graph, while strategically acquired investments are still the major type in China’s M&A activities and have been growing exponentially in terms of number of deals, the number of acquisitions involving financial sponsors is growing steadily as well, although at a much slower rate. Both types of acquisitions were affected by the global financial crisis, but have shown signs of recovery. While both provide capital to the acquired firms, there are important differences between strategic investors and financial investors. Strategic investors are generally firms that operate in the same industry as their acquired firms. Beyond basic capital, these investors provide the acquired firms with know-how, technology, management skills, marketing techniques, intellectual property and clientele. Financial investors,2 on the other hand, consist of private equity firms, venture capital firms and other financial institutions whose primary goal is to supply investment capital to firms that require this capital to grow. The investment is made with the expectation of earning a profit from the capital investment. While these firms may choose to become involved in general management decisions, it is less likely they will have the specific experience and knowledge of the industry to add more than this. The strategies of the different types of financial investors vary somewhat. Private equity (PE) firms are investment managers 2 In this paper, the terms “financial investor” and “financial sponsor” are often interchangeable. The firms that are invested by financial investors may sometimes be referred as “sponsor-backed”. 6 Ruilin Xu that provide capital for a company through a variety of modes including leveraged buyout and growth capital. Venture capital (VC) firms specifically target early-stage, high- potential, start-up companies which usually have a novel technology or a unique business model in high technology industries, such as biotechnology, IT, software etc. Due to the fact that most VC-invested firms are private start-ups with very limited public information attainable to analyze, in this study, we will be mainly focusing on the PE- backed firms, which are more likely to acquire public firms whose financial data are readily available to us. Given these two types of investors, the question arises which type of investor contributes more (as measured by changes in market values) to the acquired firm. Investors may add value either through improved performance of the firm or simply by affecting market perceptions. If there is a difference between the two types of investors, it is also helpful for us to think about the reasons why one investor is able to create more values for their acquired firms than the other. The remainder of the paper is organized as follows: in Section I, I will review the previous literature, summarize the motivations of both types of investors and examine how they might differ in their impact on acquired firms’ value creation. I will also state the main research question and the hypotheses. In Section II, I will introduce the empirical model. In Section III, I will provide an overview of the data. In Section IV, I will present the results of the empirical investigation. In Section V, I will present