China Still Has Appetite for M&A

China's new year's resolution: Buy more overseas assets, especially resources.

Sound familiar? It's the same resolution China made last year, and the year before.

China's outbound mergers and acquisitions totaled $43.39 billion in 2009, according to Dealogic. That was down from $50.33 billion in 2008, but only because China's most ambitious deal of the year, Aluminum Corp. of China's proposed $19.5 billion alliance with Rio Tinto, was thwarted when Rio opted for a tie-up with BHP Billiton instead.

The results of China's overseas buying binge, which first went into overdrive in 2008, are astonishing. Total outbound M&A in 2008 and 2009 alone surpassed all China's outbound M&A for the previous eight years

Don't expect the action to let up soon.

"We believe this trend is very likely to continue given the size of the Chinese economy relative to other economies in the region, and the desire for Chinese companies to expand internationally," says Ed King, head of M&A for Asia Pacific at Morgan Stanley. The main area of focus, he adds, will be resources, which accounted for two-thirds of all China's deals overseas last year.

Iron ore, copper, coal, natural gas and the like are critical to fuel China's growth, and Beijing has made it clear investments abroad that secure access to these resources will get the green light. Potential buyers have had no problem lining up financing from China Development Bank and other state-owned lenders.

As Joseph Gallagher, head of M&A for Asia Pacific at Credit Suisse, puts it: "The only limitation is on the sell side. Are there enough assets to buy and will regulatory authorities in the target markets allow the investments?" Two of last year's biggest outbound deals involved the acquisition of mining assets in Australia, but Chinese investment in Australia remains a politically sensitive issue. Targets in other countries such as Argentina, where bankers say Chinese oil companies have previously looked at acquiring assets of Spain's Repsol YPF SA, could be even more sensitive.

Price and competition could slow China's efforts as well. A rebound in commodity prices has made resource assets more expensive, and competing buyers from India, South Korea and elsewhere mean China isn't the only game in town.

Some foresee a pickup in China's investment in manufacturing, such as the automotive sector.

"I think they will look at areas where they can add capability and brand," the latter being a traditional area of weakness for Chinese manufacturers, says David Chin, co-head of investment banking for the region at UBS AG.

Chinese companies are already picking through the wreckage of failing U.S. and European car makers for potential deals. In what could be a landmark sale, Ford Motor Co. hopes to reach a definitive deal to offload its Volvo division to Zhejiang Geely Holding Group Co. for about $2 billion by early 2010.

A key force in such deals is the lure of taking a foreign asset and exploiting it at home, where the growth potential is more attractive than in mature developed economies.

For Geely, Mr. Chin says, "the driving motive wasn't to buy Volvo and conquer the world, but to buy Volvo and conquer the China market." He and others sees this potentially happening in other sectors, such as technology.

China's investments in Western financial-services companies haven't been terribly popular at home, and few expect more big moves in that direction soon. Still, some selective investment in financial services might be possible next year. Two areas to look out for include nonbank financial companies such as asset managers that have an expertise China lacks, and banks abroad but closer to home, in Southeast Asia for instance.

For all the excitement about outbound Chinese investment, inbound Chinese M&A remains an area where expectations have dropped considerably. One big reason is the lingering chill from last March, when the Chinese government quashed Coca Cola Co.'s $2.4 billion offer for juice maker China Huiyuan Juice Group Ltd. over concerns about its impact on domestic competition.

But beyond that, in a highly liquid environment like China's, good companies just don't need foreign investment like they used to. A revival in Chinese public stock offerings this year has also made it tougher for foreign buyers to offer a price that looks competitive.

Any company that earns even $10 million to $15 million in income a year is going to aim for an IPO, explains one banker, rather than do a deal with a foreign strategic buyer.

"It's just hard to see that there will be a lot of big deals," he says.

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