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November/December 2016 ▪ Volume 20 ▪ Issue 10
RECENT TRENDS AND nese M&A into the U.S. remains strong, a LAWYER ISSUES IN OUTBOUND number of countervailing trends persist. Along with the increase in Chinese acqui- ACQUISITIONS BY sitions of U.S. companies, there has been CHINESE COMPANIES a concomitant increase in withdrawn bids. In the first half of 2016, 15 deals were By Fang Xue, Yuefan Wang and Qi withdrawn by Chinese buyers, represent- Yue ing a total value of $24 billion, up from Fang Xue is a partner and Chief Repre- 10 withdrawn bids representing $1.6 bil- sentative of the Beijing office of Gibson, lion in 2015.3 Indeed, by the estimate of Dunn & Crutcher LLP. Yuefan Wang and Qi Yue are associates in Gibson Dunn’s the Boston Consulting Group, Chinese Beijing office. Contact: buyers complete just 67% of announced [email protected]. outbound deals, far fewer than peers in the Chinese outbound M&A activity con- U.S., Europe, and Japan.4 This high inci- tinues its breakneck pace in 2016. In the dence of failed transactions has led many first three quarters of the year, the total observers to question the commitment of value of deals announced exceeded $218 Chinese buyers to follow through on deals, billion, already almost double the total for even when Chinese buyers propose higher The M&A the entire previous year and putting China purchase prices. on pace to be the number one cross-border While this problem may be attributed acquirer in the world for the year.1 Chinese in some cases to relative inexperience acquisitions of U.S. companies are a key with cross-border deals, there are a num- part of this significant growth, amounting ber of factors unique to Chinese buyers to well over $30 billion in the first half of that play a larger role—CFIUS review, 2016, representing a sevenfold increase PRC regulatory requirements, Chinese from the same period last year and ac- financing, and Chinese acquirers’ often counting for almost 30% of China’s total opaque ownership structures. Because of outbound M&A.2 The drivers of this these risks, foreign sellers often ask for a record-breaking outbound M&A activity “China premium” on prices as well as re- continue to be a combination of slowing verse termination fees and additional cov- domestic growth, supportive government enants to provide more comfort that deals policies, consolidation among small-to- will be completed. medium-sized potential domestic targets, growth potential in foreign markets, at- CFIUS tractiveness of foreign firms, and the fun- The Committee on Foreign Investment damental changing of the Chinese in the United States is an inter-agency economy. committee of the U.S. federal government However, while overall outbound Chi- authorized to review, investigate and November/December 2016 | Volume 20 | Issue 10 The M&A Lawyer
block transactions of investments that could CFIUS is perceived by Chinese acquirers as a result in the control of a U.S. business or assets major barrier to U.S. acquisitions as they are by a foreign person that may raise national secu- concerned that CFIUS may either block a trans- rity concerns. action or impose significant regulatory and opera- tional costs on them as a means of mitigating CFIUS is focused on areas of particular na- perceived national security risks. Sometimes the tional security concern, including foreign control mere threat of CFIUS review can still cause buy- of U.S. businesses that: ers to withdraw offers and sellers to reject bids. E Provide products/services that could expose E Lumileds. GO Scale Capital’s $2.8 billion national security vulnerabilities, including bid for an 80% stake in Philips NV’s Lu- cyber-security concerns or vulnerability of mileds subsidiary was blocked by CFIUS supply chain; on national security grounds; even though E Implicate critical infrastructure; Philips and Lumileds are both based in the Netherlands, CFIUS found that Lumileds E Are involved in activities related to weap- had a large U.S. patent portfolio and siz- ons and munitions manufacturing, aero- able manufacturing and R&D presence in space and radar systems, or that otherwise the U.S. do business in defense, security or law enforcement sectors; E Western Digital. Unisplendour Corp. Ltd terminated its $3.78 billion offer for a 15% E Engage in R&D, production or sale of tech- stake in Western Digital Corp. after a deci- nology, goods, software or services subject sion by CFIUS to conduct an investigation. to export controls; E Fairchild Semiconductor. Fairchild Semi- E Produce advanced technologies useful to conductor International Inc. rejected a top- national security, including “dual use” ping bid (a bid offered by a third party for a technologies that have both commercial and target that has already signed a merger military applications; or agreement with another buyer) by China E Create potential espionage concerns, for Resources Microelectronics Ltd. and Hua example by nature of a business or asset’s Capital Management Co. Ltd. after Fairch- proximately to military locations. ild’s board concluded that the bid, which included a proposed $108 million CFIUS CFIUS pays particular focus on the acquisition reverse termination fee, was not superior to of control by foreign persons that are controlled another bid with a lower purchase price by a foreign government or from a country with because CFIUS review posed an “unaccept- nonproliferation or other security concerns. able level of risk.” CFIUS, which is not a judicial court, reports directly to the U.S. President. It is often viewed E Strategic Hotels & Resorts. Anbang In- as political in nature and is especially sensitive to surance Group entered into an agreement the prevailing political environment. worth $6.5 billion with Blackstone Group
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LP for 16 hotels. While 15 of the 16 hotels The “Hell or High Water” covenant is particu- ultimately were sold to Anbang, Blackstone larly harsh for buyers, and less than 5% of deals kept the iconic Hotel Del Coronado in San surveyed had such a covenant. Additionally, a Diego amid objections from CFIUS be- number of agreements do not have specific cause of the hotel’s close proximity to a ma- CFIUS covenants but rather covenants related to jor naval base. “governmental approvals” or similar language.
Merger agreements between Chinese buyers There are a number of reasons why RTFs tied and U.S. sellers address CFIUS risk in two poten- to CFIUS approval are far less common. Chinese tial ways: reverse termination fees (RTFs) and buyers are understandably hesitant to pay a covenants. RTFs are, as the name implies, the op- breakup fee for a condition over which they have posite of a traditional break-up fee: the buyer little control; while arguably U.S. sellers would pays the seller a fee if a deal does not close due have a better understanding of their domestic to the failure to satisfy a particular closing regulatory regime. Chinese buyers are also wor- ried that RTFs conditioned on CFIUS approval condition. Sellers may specifically ask for pay- would provide a disincentive for sellers to take ment of an RTF related to CFIUS. In our survey full action to ensure such approval. Indeed, based of recent deals and bids, less than 25% had an on our survey, Chinese buyers who agreed to RTF specifically triggered by failure to obtain RTFs for CFIUS approval appeared to be either CFIUS approval. in a competitive auction setting or in connection Agreements also typically include covenants with submitting a topping bid. For example, related to mitigation measures imposed by HNA Group Co. won its bid for Ingram Micro CFIUS or the buyer’s efforts in obtaining CFIUS Inc. in part because it offered Ingram a $400 mil- approval. Breach of these covenants may trigger lion CFIUS RTF where its two closest rivals did 5 payment of the RTF as well. In our survey of not. recent deals, almost 70% had covenants related PRC Regulatory Approvals to CFIUS. Of these, the vast majority provided that the buyer is responsible for mitigation mea- While PRC outbound investment regulations sures related to CFIUS, as long as such measures are generally trending toward deregulation, the do not have a “material adverse effect” on, or an regulatory requirements can still be unpredict- “adverse effect that is material to,” the buyer or able, with little or no advance notice of changes. seller. Other less common covenants include: In general, all outbound investments by Chinese companies involve a filing with, or, in certain cir- E “Reasonable best efforts” standard for miti- cumstances, approval of, the following regula- gation measures; tory bodies: the State Administration of Foreign Exchange (SAFE); the National Development E Ceilings and floors for divestitures; and and Reform Commission (NDRC); and the Min- E “Hell or High Water” covenants where istry of Commerce (MOFCOM). Public compa- buyer bears full responsibility for CFIUS nies listed in China that wish to use equity financ- risk, including unlimited divestitures. ing in connection with a major acquisition will
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likely require the approval of the China Securi- be as committed at signing as compared to a typi- ties Regulatory Commission (CSRC) as well. cal U.S. deal. Indeed, local Chinese banks may State-owned enterprises (SOEs) will also need be unable to produce U.S.-style debt commitment the approval of the state-owned Assets Supervi- letters. Chinese buyers also typically do not agree sion and Administration Commission (SASAC) to be subject to an obligation to enforce funding for outbound investments. obligations of Chinese banks. Whether direct or Sellers often negotiate for payment of an RTF indirect, real or perceived, financing issues have due to a failure to obtain PRC regulatory dogged a number of high-profile deals: approvals. Of recent deals and bids surveyed, E Terex. Zoomlion Heavy Industry Science almost 70% had RTFs with such a trigger. Ad- ditionally, merger agreements often have cove- & Technology Co. Ltd.’s topping bid for nants requiring the seller and/or the target to file Terex Corporation may have failed partly for, and to cooperate in obtaining, PRC regula- due to financing issues; in a public dispute, tory approvals. Nevertheless, the chief concern is Terex claimed that Zoomlion was not able usually not uncertainty over whether PRC regula- to arrange for committed financing. How- tory approvals will be obtained, but rather when ever, Zoomlion said the issue was ulti- they will be obtained; parties should therefore mately the parties’ inability to agree on provide for sufficient termination dates in their price. merger agreements. Of recent deals surveyed, E Pericom Semiconductor. Montage Tech- initial termination dates ranged from as short as nology Group’s topping bid for Pericom three months to as long as nine months, with Semiconductor Corp. was rejected by about half having initial termination dates of six Pericom. In another public falling-out, months, with options to extend. Pericom said that the deal fell through in Recently, there have been signs that moving part due to regulatory concerns and also as- money out of China is becoming a challenge for serted that Montage was “unable or unwill- Chinese acquirers, including longer approval ing to obtain committed financing,” while periods. The merger agreement in the recent take- Montage alleged that Pericom was merely private of Trina Solar allocated three months employing “scare tactics.” specifically to obtain the required foreign ex- change approvals, a heretofore unseen clause. E Starwood. Anbang Insurance Group’s failed bid for Starwood Hotels and Resorts Financing Worldwide, Inc. is likely the most notori- U.S. sellers often cite buyer financing prob- ous example of a failed bid by a Chinese lems as the cause of withdrawn bids, while Chi- acquirer. Anbang’s high-stakes bidding war nese buyers usually point to other reasons. One with Marriot International, Inc. eventually reason for the confusion may be that Chinese ended with Anbang abruptly withdrawing buyers and U.S. sellers often view the sufficiency its offer three weeks after it unveiled a non- of funding differently. Chinese financing may not binding bid.
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Credit Support for Reverse Termination both an onshore and offshore escrow account, or Fees both a guarantee and an escrow account).
Sellers typically request RTFs for two reasons. Conclusion First, sellers typically want Chinese buyers to bear regulatory risks, as described above, by ask- Though the past few years have seen Chinese ing for an RTF triggered by the failure to obtain buyers join the ranks of the most prolific cross- required PRC regulatory approvals. Second, border acquirers, a number of high-profile with- judgments against Chinese buyers in U.S. courts drawn bids have highlighted and reinforced the impose enforcement issues, particularly where idea that Chinese buyers are sometimes unable or such buyers do not have any assets in the U.S., unwilling to close deals. While inexperience is and RTFs may provide more reliable recourse to partly to blame, Chinese buyers still face particu- ensure the buyer has real incentive to perform. lar challenges that U.S. and other foreign acquir- Sellers also typically ask Chinese buyers to ers do not face. As is often the case, perception provide some form of credit support for the can become reality; the danger is that this percep- obligation to pay the RTF, and sometimes the tion may unfairly bias U.S. companies against purchase price. Of recent deals surveyed, ap- selling to Chinese buyers. Indeed, the real casu- proximately75% had some form of credit support alty may ultimately be U.S. shareholders who are for RTFs. The following are the common types unable to capture the higher purchase prices often of credit support mechanisms used: offered by Chinese buyers. The solution may lie E Requiring a cash deposit into an offshore in experienced advisors, better communications escrow account located outside of China and a fair allocation of transaction risks—while (approximately 55% of recent deals sur- the road may be bumpy, the destination offers veyed with RTFs); promising rewards for Chinese buyers, U.S. sell- ers, and, ultimately, shareholders on both sides. E Requiring a cash deposit into an onshore escrow account located within China (ap- ENDNOTES: proximately 20% of recent deals surveyed with RTFs); 1China Deal Watch, Bloomberg.com, Octo- ber 24, 2016. E Parent or shareholder guarantee (approxi- 2Dealogic.com. mately 20% of recent deals surveyed with 3“China Inc. Tries to Buy the World, with RTFs); or Impeccable Timing,” Wolfstreet.com, May 11, 2016. E Letter of credit (approximately 15% of 4“Gearing Up for the New Era of China’s recent deals surveyed with RTFs). Outbound M&A,” The Boston Consulting Group, September 24, 2015. Note that a small number of deals surveyed 5Definitive Proxy Statement filed with the had more than one form of credit support (e.g., SEC by Ingram Micro Inc. on May 19, 2016.
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