There's a joke a U.S. corporate M&A executive likes to share when describing the perils of negotiating an emerging-markets acquisition. Two businessmen, an American and Chinese, are sitting together on a plane. The U.S. dealmaker conveys a brief point to the translator, who talks at much greater length to the Chinese executive. Puzzled, the U.S. official asks, "Did I say that?" To which the translator responds: "No, but you should have."
Welcome to the plight of a U.S. corporate dealmaker trying to land a deal in a market where little is familiar -- from food, culture and language to political and regulatory rules. Seemingly everyone who goes to China to buy a company or seek a joint venture has cautionary tales to tell. Those who have succeeded, at least by their own reckoning, say they've done so by adapting to local culture, cultivating connections and developing copious amounts of patience.
For most U.S. companies, it would be easier to stay at home, but that's not where the growth is. Although China's torrid growth has cooled from its prior 10% pace, it's still around a none-too-shabby 8%. That compares with the 2% the U.S. has been eking out. Emerging-markets countries still offer one of the only true growth stories around. The level of dealflow has reflected this, notably in China. In the first half of this year, China was the only BRIC nation where deal volume rose, up 6% over the same period last year to $91.6 billion. And it still claims the lion's share of overall deal activity among these nations, accounting for 47% of targeted volume so far this year, according to Dealogic.
Still, a closer look at the roster of U.S. acquirers shows that few corporates have made notable inroads in China yet. Of the top 20 U.S. acquirers since 2008, most are financial or private equity firms. There's just a handful of corporates that factor among the most active, either by volume or number of deals, including Joy Global Inc., Caterpillar Inc., Yum! Brands Inc. and General Electric Co., Dealogic data shows. Even the majority of U.S. multinationals that have telegraphed plans to expand haven't done a whole lot yet, relative to their overall M&A activity. Take Johnson & Johnson, which over the past 17 years, according to Dealogic, has done some $80 billion in acquisitions: Only about $500 million of that has been in growth markets, including two in China -- in 2008 and 2011 -- and one in Russia this year.
Aileen Stockburger, vice president of business development at J&J from its New Brunswick, N.J., headquarters, says the company will continue to look for opportunities in China and that now "at least we feel more comfortable with the process."
Part of that comfort has come from spending lots of time on the ground in the country. J&J established its first joint venture there -- Xian-Janssen Pharmaceutical Ltd. -- in 1985 and a number of domestic affiliates in following years. Stockburger, who says she prizes a common-sense approach to tackling deals, found ample opportunity to explore this skill when she took on the purchase of Chinese state-owned Beijing Dabao Cosmetics Co. Ltd., a deal that took five years to do and closed in 2008. Although the company did not disclose the purchase price, analysts say it cost around $300 million. Not only was this J&J's first acquisition in China, it was also the first time the government had sold off a state-owned company -- and to a U.S. multinational at that. Stockburger realized that imposing a strictly U.S. way of doing things wasn't the best idea.
"There are corporate standard practices and then practical standards," Stockburger says. The trick was figuring out which standards to follow and how to go about it. Local sensitivities were running particularly high because Dabao was a well-known cosmetics brand that was a social welfare company oriented around providing life-long employment, not generating profits. Many employees, moreover, were physically handicapped.
"It was a well-known name, so it was an emotional process in the China press," Stockburger recalls. J&J wanted Dabao because it was one of the leading Chinese skin-care companies, but it required walking a political tightrope. J&J wanted to expand its presence among China's middle- to upper-middle-market consumers, which were already buying Johnson's Baby, Neutrogena and Clean & Clear products. Dabao was attractive because it came with brand recognition and a vast distribution network. But to make changes while preserving the overall value of its purchase, J&J had to proceed cautiously.
The company knew, for instance, that job cuts were needed. The government had already admitted that Dabao required roughly only a third of existing employees. J&J also had to make clear that it wanted to run the company as a for-profit enterprise. Both parties addressed the attrition issue through a deal that let J&J keep existing employees until it figured out how many it actually needed. It then hired that number while the government helped place the rest elsewhere. The job arrangement was one of the reasons the transaction took so long to close. The company brought in a J&J manager to manage the company because Dabao's leaders were Chinese Communist Party officials who didn't want to stay.
Language was another problem. "The people [at Dabao] didn't speak any English, so they were nervous we were going to come in and [impose] rules and regulations. You had to figure out how to manage this," Stockburger says.
The group dealt with the issue by allowing Chinese to remain the main language of the company. Although a seemingly subtle point, the new owner wanted to make clear it would find ways to adapt to the existing culture rather than demanding the reverse. It's a solution management cooked up, along with other changes, to narrow the vast divide between the two cultures.
Her team also tweaked traditional practices. For instance, J&J typically supplies new employees with Dell computers. But not all Dabao employees needed computers other than for checking on human resource benefits periodically. So J&J set up a shared workstation.
There have also been accounting lessons, which will be familiar to other Western companies used to working with transparent, standardized rules. "It was a while before we realized that the advertising expense wasn't in the P&L statement but was in the balance sheet," Stockburger says. Salaries and expenses were also mixed together, further complicating the books. Stockburger, who makes a point of using in-house due diligence expertise for most of J&J's M&A, but who isn't fluent in Chinese, turned to a local accounting firm to help work through Dabao's financials. "I determined we needed help doing due diligence, [as] there were a number of things we didn't expect ... and we needed people who knew what to look for."
It's a common issue. "You find all kinds of crazy things -- people approving their own bonuses, stuff where there's no control," says a senior M&A executive at a U.S. conglomerate that has done a number of joint ventures and a handful of acquisitions in China. "Sometimes there's a tax claim and the company's going to court, and you just find out about it that day, or you discover the company's about to take a huge write-off for inventory."
As for J&J, this May it closed on other China deal, Guangzhou Bioseal Biotech Co. Ltd., which makes a protein sealant used to control bleeding during surgery. Stockburger didn't work on this deal because she was involved in completing the $19.7 billion acquisition of Swiss medical devices maker Synthes Inc. -- the biggest transaction in the company's history (and one that took only a year to close). Bioseal was very different from the Dabao transaction. Bioseal was a private company and didn't present the same high-profile issues. Also, J&J was better prepared because it had already been through the traces of a local deal. Today, Stockburger says, the company is "meeting expectations."
Mostly, she says, such deals require those leading them to persevere and innovate -- whether it's a huge purchase like Synthes or a complex one in the emerging markets. "These kinds of transformational deals require dedication and [involve] a lot of roadblocks put up in front of you. The answers aren't always easy -- you have to be willing to hang in there. You get internal hurdles, and you have to think of ways of doing things differently."
Patience is also key. Call it the three-month wait. That seems to be the average time a number of lawyers and dealmakers say they sit around waiting for the government to give approval for cross-border deals -- a process that normally takes closer to three weeks in the U.S. for a relatively straightforward transaction. For U.S. dealmakers used to working on tighter, more transparent schedules, this is enough to set their teeth on edge, especially when it's a multinational deal that's already won regulatory approval from other countries. It doesn't help that in China the regulatory filing threshold is considered fairly low compared to other jurisdictions. That just means many more companies tend to fall into its regulatory net than elsewhere.
In 2008, China's Ministry of Commerce, or Mofcom, enacted an antitrust law stipulating that if a combined company has more than $60 million in Chinese sales and $1.5 billion in global sales, it requires China's regulatory blessing. Google Inc. recently emerged from the country's regulatory cross hairs after announcing last August that it was buying Motorola Mobility Inc. for $12.5 billion. The deal required regulatory approval from a number of jurisdictions, including China, which is Motorola Mobility's second-largest market after the U.S. Although Google won approval from every jurisdiction by February, it had to wait until late May for China's nod.
Such delays worry companies that have no way of fathoming what's happening in the review process. It doesn't help that nobody really knows when the waiting period even begins. In the U.S., when a company makes a regulatory filing, the clock starts immediately for review. In China, a filing with Mofcom isn't activated until the regulator formally accepts the filing. That can take weeks. Once the government has accepted, it can take several more weeks to communicate any issues.
One executive from a U.S. company that did a large acquisition requiring Chinese approval says this kind of uncertainty "throws your whole process into chaos." During the four months he had to wait, a vacuum developed around what was happening with the review at Mofcom. "The feedback loop is a black box," he says. "You don't know what the problem is. And when your attorney comes back from meetings and you ask, they say they're not really sure either."
Barry Genkin, chair of Philadelphia-based law firm Blank Rome LLP's Asia practice, says U.S. firms need to be realistic. "When you go into China and assume it's going to be the same as in the U.S., that's a recipe for disaster. In the U.S., we take for granted that what we do in business here is the same as in China." That approach, Genkin says, has led to many failed deals. In reality, he says the regulatory process is heavily political and can't be fathomed by memorizing regulatory handbooks. Rules change or are not clearly defined, while overall, there's a lot of individual discretion involved. "It's like sausage making," Genkin says of the regulatory review. "You see the end product, but you're never really sure how it's made."
This is where local connections become so important -- as well as making sure those connections really have access to all-important government officials. "In China everyone will say I have a relationship with so-and-so," Genkin says. "By definition, if you breathe the same air, you have a relationship." He says it's important to work with local lawyers who have experience with U.S. companies so they can understand what the buyer is trying to accomplish. To limit the potential for endless government holdups, Genkin says he requires that everything that's agreed to be documented. That way, he says, "They'll change their mind on a few of the issues, but instead of having 10 or so changes, maybe there will be three. This gives execution certainty."
Ulrike Glück, a China-based managing partner with CMS Legal Services -- a European legal and tax services provider -- says negotiating difficulties vary depending on sector, with some tied to national interests and others in areas China would like to mine for expertise and resources. For instance, automotive deals were once encouraged. Now, China looks more favorably on Internet technology, new energy and environment-friendly industries.
"In all of these areas, protections have been eased a little. In the past, joint ventures were mandatory. Now that's so only in a few industrial areas," Glück says.
U.S. advisers say China tends to look favorably on acquisitions that help the country upgrade the level of its workforce and provide local employment, but conversely, it is worried that big foreign companies will dominate at the expense of nascent domestic businesses. In the U.S., antitrust laws are oriented around ensuring fairness to competitors vying for the same pool of customers. In China, advisers say, officials are still afraid of getting squashed by outsiders.
|Slow boat to China|
|Just a handful of U.S. corporates have made M&A inroads in China|
|acquirer||Deal value ($mill.)||No. of deals|
|Bank of America Corp.||$8,922||2|
|Silver Lake Partners LP||1,740||3|
|Capital Group Cos.||1,629||1|
|Goldman Sachs Group Inc.||1,553||10|
|Joy Global Inc.||1,445||2|
|Yum! Brands Inc.||685||4|
|Fairholme Capital Management LLC||620||1|
|Capital International Private Equity Fund||600||1|
|Blackstone Group LP||600||1|
|General Electric Co.||536||3|
|Bain Capital Partners LLC||485||6|
|Cardinal Health Inc.||470||1|
|Precision Castparts Corp.||355||1|
|International Finance Corp.||350||12|
|Top 20 U.S. acquirers by volume, 2008 through July 2, 2012.
Corporates are highlighted in purple.
In a recent regulatory review involving a major U.S. acquisition that had sales in China, a Mofcom official told the U.S. executive in charge that he was concerned about the size of his company post-acquisition. The comment was startling. "Part of our problem in China was that they thought we were getting too big. But [antitrust] has nothing to do with size. It's about the impact to the customer," he says. Approval finally came, but four months after the review process started and well after other countries had signed off.
A senior U.S. executive at a large tech firm, who has done a number of China deals and has a deep bench of contacts there, puts it this way: "They're nervous; they're new to the global business. They're very good at exporting out of China, but nervous doing business in other countries. They're always worried people are trying to take advantage of them."
He says he tries to establish trust by playing golf with Chinese counterparts and spending time getting to know who's involved in his deals.
"That's more important than studying Chinese culture or everything about the Chinese legal system," he says. "At the end, the only thing that's going to enforce a contract is the relationship."
That may ultimately be the best word of advice for U.S. corporates looking to expand into China. Because anyone waiting for China to adapt their mergers and acquisitions legal process to Western standards may find such demands lost, literally, in translation.