European dealmakers are reaping the benefit of the United States’ trade war with China. While the volume of global merger and acquisitions slipped for the first time since 2010, according to research from Mergermarket, Chinese bids for European companies skyrocketed 81.7 percent to US$60.4 billion from $33.2 billion last year.
Meanwhile, Chinese M&A action in the U.S. fell 94.6 percent to $3 billion after cracking a record $55.3 billion in 2016.
“Intensifying trade tensions, political instability, and increased regulatory scrutiny took their toll on the number of deals struck over the year, though deal values remained relatively high.”— Elizabeth Lim, Mergermarket’s research editor for the Americas
2018 saw some massive deals from Chinese companies including state-run power company China Three Gorges Corp.’s $27.5 billion purchase of a 76.7 percent stake in Energy de Portugal, while private equity firm Orient Hontai paid $1.5 billion for a 53.5 percent piece of Spanish media company Imagina.
China has been vocal about its pursuit of an efficient trading network with Europe, Asia, and Africa, under the banner of its One Belt, One Road infrastructure goal.
“China is actively courting the EU with offers of reciprocal market access in an attempt to show foreign investment is not a one-way street, while trade relations with the US continue firmly on a downward path.”— Thomas Gilles, chair of Baker McKenzie’s EMEA-China Group, told the South China Morning Post.
One Belt, One Road… Many Roadblocks
The Trump administration’s hardline rhetoric towards China has proven the Asian behemoth is sensitive to perceived government resistance. And while Europe looked like an open market last year, the European Parliament trade committee’s endorsement of a new EU-wide foreign direct investment screening mechanism in December 2018 does signal the potential for some roadblocks going forward for China.
“Whilst it does not introduce an independent regulatory body capable of issuing binding decisions or a comprehensive screening mechanism, the new regulation does introduce a framework aimed at fostering cooperation and information-sharing between member states and sets minimum standards for national regimes,” write Christian Ahlborn and Paul Lignières of Linklaters LLP in a recent summary for Lexology. Member states retain sole responsibility for screening incoming foreign direct investment on the grounds of security and public order, but the impact shouldn’t be dismissed.
“While some member states that are heavily dependent on FDI may continue to refrain from introducing any review mechanism, it can also be expected that other member states will, over time, align their practices,” write Ahlborn and Lignières. “Whether this will ultimately lead to a Union-wide review mechanism remains to be seen, but further change seems likely.”
It’s a bit of a tug-of-war between countries like Germany, France, and Italy, which already signalled moves to veto foreign investments – like China’s proposed bid for German toolmaker Leifeld which didn’t even make it to table – and countries like Cyprus, Greece, and Portugal, which were hit hard by the Eurozone debt crisis and are looking for outside support to get infrastructure projects off the ground.
And it doesn’t seem like the new FDI screening plan is going to slow things down for Portugal. A week before the EU endorsement of the framework, Chinese President Xi Jinping visited Portugal, and the two countries aimed to sign 19 co-operation agreements ranging from energy and infrastructure to science and technology.
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While European nations banter over FDI screening and its impact on the mega deals that marked last year, the middle market has a tendency to be where the dealmaking between China and Europe is taking place, write David Cogman, Paul Gao, and Nick Leung in a McKinsey article dispelling some of the myths surrounding Chinese outbound M&A .
“The big-ticket deals that make the headlines are also not representative of the majority of transactions,” they say. “These are mostly middle-market deals: the median deal size over the past three years was only $30 million. And for the most part, the valuations paid were not significantly above normal market levels.”
They point out that part of the perception of valuation between Chinese companies and their European or US peers stems from the fact that “Nonstate firms listed in Shanghai had an average price-to-earnings ratio in 2016 of 60 times.”
“If a Chinese acquirer is able to raise equity capital at this valuation, this will naturally make prices paid for overseas assets look much less irrational,” says the article.
According to the 2018 EY Growth Barometer, one-third of Chinese mid-market companies cite new international markets as a strategic priority when it comes to growth, while 27 percent say that overseas expansion is “central to evaluating new business ventures.”
An Attractive Place to Grow
Despite the pushback – or at the very least, increased scrutiny – from major European countries, the protectionist rhetoric in the EU is still dimmer than the aggressive trade war the country is embroiled in with the U.S. And that alone should be enough to entice outbound M&A from China.
There’s no denying China’s dealmaking pendulum has inertia when it comes to Europe. A recent analysis of 678 completed or pending deals in 30 countries since 2008 found that Chinese companies have been involved in approximately 360 takeovers, and now own or partially own four European airports, six seaports, wind farms in nine countries and 13 professional soccer teams.
On the one hand, it’s certainly time the EU takes a closer look at FDI screening practices, after all, a good portion of the major players in the global economy already do so. But it’s worth noting, China’s persistent creep into Europe is part of a long growth strategy, one that is already proving itself an important part of building out the Eurozone. And as the U.S. has already shown, protectionism in the face of globalization has its consequences.
Illustration by Christy Lundy