Money-movers try new legal levers

An unfamiliar Chinese name has been appearing in merger and acquisition deals across Europe. Shougang Group, a state-owned steel company that was once one of China’s largest steel producers, has been prowling developed markets for assets outside its core business.

The Beijing company began working with bankers and lawyers months ago to look at Q-Park, a Netherlands car park operator that could fetch more than $2.4bn. Shougang’s name has also been linked with Indigo, a French car park company expected to fetch $4.3bn.

The steelmaker is an outlier because few state-controlled metals companies have sought M&A outside their core expertise. A buyout in Europe, however, is likely to cost Shougang more than initially expected because of esc­alating legal fees and offshore financing rates from banks. Recent regulatory tightening in China has led to top-notch legal advice being highly prized by groups looking at foreign markets.

It has also put pressure on lawyers to innovate with regard to how to pay for deals, often with little cash crossing the Chinese border.

“Regulations can change rapidly in China. There have been lots of changes over the past six months,” says Jay Ze, a partner at Eversheds Sutherland and head of the law firm’s corporate practice in China. “At the start of a transaction, you need to be able to fully inform the clients on what regulation looks like and what their options are.”

Recently, the options for Chinese groups have thinned out. Since late November, regulators in Beijing have sought to hold back the amount of capital draining out of the country, partly in the form of outbound acquisitions during the record year for cross-border deals in 2016. That has meant greater difficulty in gaining approval from the State Administration of Foreign Exchange, or Safe, for exchanging local currency into dollars or euros.

Deals in which companies consider scooping up assets outside their core competencies, such as Shougang’s Q-Park bid, have experienced an outright clampdown. Regulators, experts say, fear that such deals are no more than expensive ways to move wealth overseas.

More than ever, there is a premium on legal advice to ensure deals can proceed without inadvertently breaching fast-changing rules aimed at controlling the scale of Chinese outbound investment.

As of mid-May, Chinese groups had an­nounced $37.7bn in outbound M&A deals so far in 2017, according to data from Thomson Reuters, the media and information company. This compares with about $101bn in just the first three months of last year.

Several high-profile buyouts have also collapsed, such as Dalian Wanda’s $1.1bn takeover of Dick Clark Productions in the US. Tycoon Wang Jianlin, founder of Dalian, confirmed that Chinese currency controls had sunk the deal.

But the more than halving of overall deal value this year has been countered by a rise in offshore finance for Chinese acquisitions, lawyers say. Instead of looking to onshore Chinese banks for loans, the most aggressive Chinese groups are seeking pricier offshore financing from global banks.

One means of offshore funding, called non-recourse financing, allows banks to lend against the acquisition target. For that part of the financing, no renminbi needs to be exchanged onshore. Companies that have already made several overseas acquisitions can also pledge securities in those assets as collateral for loans, a practice known as margin finance.

Sophisticated Chinese groups, such as HNA, which has spent $40bn on acquisitions in 30 months, have shown high demand for such services.

Over the past six months, most of the financing HNA has received has been far removed from the regulatory perils of China. The company used margin finance to drive its $6.5bn purchase of a 25 per cent stake in US hotel group Hilton Worldwide.

Regulations can change rapidly in China. There have been lots of changes in just six months

But even offshore lending is proving challenging for some Chinese companies, their banks and lawyers, says Philip Li, a partner at Freshfields Bruckhaus Deringer in Hong Kong. “The target companies being pursued by Chinese companies are often not investment grade,” says Mr Li. “Those Chinese buyers who are used to the terms of investment grade financing in China can struggle to cope with the terms of western-style acquisition finance and high-yield products.”

Another popular tactic is finding cash-rich partners overseas. Many Chinese groups have tied up with private equity funds that have capit­al offshore. Last year, China’s Apex Technology pioneered the strategy when it formed an investor group with PAG Asia Capital in order to pull together $3.6bn for US printer maker Lexmark International.

“The capital controls may give Chinese [strategic buyers] more incentives to partner with sponsors that have offshore resources on some of these deals, which often requires creative structuring,” says Charles Ching, head of Weil, Gotshal & Manges’ China practice.

For many lawyers with more than a decade of experience advising on Chinese deals, the curbs on moving capital are nothing new. Owen Chan, managing partner of Hogan Lovells in Hong Kong, points out that strict foreign ex­­change controls for most Chinese companies have been the norm and it has only been in the past few years that regulators have started to create a system for private Chinese companies to invest overseas.

The regulatory restrictions have pushed many buyers to return to a traditional offshore financing structure, where companies ob­tain funding from syndicates of onshore banks with an offshore facilitating agent, says Mr Chan.

“In theory, any genuine, strategic deal that does not trigger any policy red lights should be possible if you have enough time to go through the approval and registration processes with regulators,” Mr Chan says. “The practical issue is, how many buyers can afford to sit out this process . . . and how long will sellers be willing to wait before pulling the plug on the deal?”