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Red-hot valuations and new regulatory regimes are contributing to rapid changes in the investment climate in China. How are foreign investors adopting new approaches to scope?
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Capital Agenda Insights
March 2011
Boardroom issues
• DoyouplantoinvestinChina,butareconcernedaboutchoosingtherightChinesepartner?
• HowdoyoudealwithdifferencesinobjectivesandaspirationsbetweenyouandyourChinesepartner?
• AreyouconcernedaboutmaintainingtheChineseauthenticityofthepartnershipwhenyouareeitheramajorityorminorityowner?
• DoyoufacethechallengeofchoosingtherightteamtoworkinChinaandselectingthebestcandidatesforkeyofficerpositions?
• Howdoyoumaintainalignmentwiththelocalpartneronintegrationpriorities?
• Howdoyouensurethatthepartnershipcreatesthevaluethatwasanticipated?
Investing in China: mapping JV integration to deliver valueThe dynamism of the Chinese market remains a compelling story for western companies, as many continue to vie for stakes in Chinese companies. Yet, red-hot valuations and new regulatory regimes are contributing to a rapid change in the investment climate, and foreign investors need to be agile enough to consider different approaches and adapt their strategic options in China accordingly.
Tenyearsago,therewerenumerousopportunitiesformultinationalsseekingtoacquireChinesecompanies,althoughatthattime,thestrategicintentformostinvestmentswasaccesstolow-costmanufacturing.ManyChinesecompaniesinneedofwesterntechnologyandcapitalwerewillingtoenterintopartnershipsinwhichthewesternbuyerwouldhaveacontrollingstakeinthebusiness.However,theinvestmentclimatehaschangedrapidlyoverthepastfewyears.
RisingvaluationshavebeenoneofthekeyfactorshelpingtotransformtheinvestmentenvironmentinChina,asthecountryhasbecomeoneofthemostdesirabledestinationsforinvestorsinemergingBRICmarkets.Chinesebusinessesaremorecash-richandhaveevolvedrapidlyoverthepastdecade.Drivenbystrongeconomicgrowth,manylistedChinesecompanieshavebecomeincreasinglysuccessful,makingthemmoreexpensiveforpotentialforeignbuyers.
Atthesametime,newgovernmentregulations,includinganti-monopolylawsandlegislationongovernmentprocurement,aremakingdealsmorechallenging.Thisisinpartbecausethenewregulatoryclimatehasincreasedthebargainingpoweroflocalplayers,forcingpotentialamendmentstothetermsandscopeofacquisitionsofChineseassetsandreducingthebenefitsformulti-nationalcorporations(MNCs)lookingtoacquirelocalcompanieswithgovernmentcontracts.
Overall,Chinesecompaniesandpolicymakersarebecomingmoresavvywhendealingwithwesterninvestorsthantheywere10yearsago.Many,ifnotall,areasking,“Whydoweneedyouinourownmarket?”
Theaveragetransactionlifecycleis12to24monthsinChina,comparedtoaroundthreetosixmonthsinmaturemarkets.Theseprotractedtimetablesforconcludingdealsareclearlytakingatoll;in2007,just3outofevery10Chinesetransactionsweresuccessfullycompleted,andthosenumbershavechangedlittleintheinterveningthreeyears.
Giventhislongertransactionlifecycle,investorsneedtoremainpatientandmanagetheirheadquarters’expectations,whileatthesamesettingtherightexpectationsduringinitialJVdiscussions.Webelievethatforeigncompaniesneedtogetseveralcrucialstepsrightduringthepre-dealplanningstageinordertosetthetransactiononareasonablepathtosuccess.
Forallofthesereasons,multinationalsneedtorethinktheirinvestmentapproachesinChina,whethertheyarenewentrantsordabhandsatthemarket.Investinginminoritystakesorformingjointventures(JVs)isnotuncommonthesedays,especiallyinsectorslikeconsumerproducts,pharmaceuticalsandretail.Suchnewapproacheshaveimplicationsnotonlyfortheformationofinvestors’inorganicgrowthstrategiesinChina—namely,howthetargetcompanieswillfitintotheirexistingbusiness—butalsofortheirsubsequentapproachtointegrationanddecisionsonhowbesttoextractvaluefromthesetransactions.
Planning for value: getting the initial steps right
Theportfolioinvestmentstrategyisgainingpopularityasmanyforeignbuyersfocusonaseriesofsmalleracquisitions,partnershipsorJVsinsteadofonetransformativedeal.OneforeigncompanythathasadaptedtoconditionsonthegroundinChinawhileatthesametimepursuingalong-terminvestmentstrategyisaBelgium-basedglobalbrewer,whichtookequitystakesrangingfrom20%to71%inaseriesofChinesecompaniesoveraperiodof20years.
Determining the strategic intent of the JV and objectives from both sides
ForeignandChinesecompaniescometothetablewithverydifferentaspirationsandperspectivesononeanother.ThereisanoldChinesesayingthataptlydescribesthechallengesofapartnershipbetweenaChinesecompanyandaforeigncompany:“samebed,differentdreams.”Thishighlightstheoftenlargedivergenceinobjectivesbetweenforeignandlocalpartners.Inordertosettheinitialdiscussionontherightpath,eachsideneedstomaintainaclearviewofitsownobjectivesforthepartnershipanddeveloparealisticassessmentofthelikelyunderlyingobjectivesofitspartner.
InarapidlychangingmarketlikeChina’s,partners’objectivesarelikelytochangeaswell.Therefore,itisalsoimportantforbothpartnerstothinkstrategicallyabouthowtopreemptorinfluencetheotherwhenonepartychangesitsobjectivesfortheJV.ThinkingcreativelyaboutreshapingtheJVand(or)developingrobustcontingencyplanswillbeimportantevenatthisearlystage.
2 Capital Agenda Insights
Appointing key officers
Whileminorityshareholders’influenceovertheboardislikelytobelimited,theabilitytoexercisemanagementcontrolofoperationsisimportant.Iftheminoritypartnerisabletonamethechieffinancialofficer,theyarelikelytoendupwithacandidatewhoismoreattunedtoWesternstylesofrunningacompanyandbetterabletofulfillcompliancemeasures,bothduringtheintegrationphaseandoverthelongerterm.
TheCFOcontrolsallfinancialmatters,fromsettingtheannualbudget(especiallyimportantforcompanieswithhighcapitalspend),tofinanceandmanagementreportingandinternalcontrols.
AsuccessfulCFOwillholdbroaderresponsibilityfortheoperationalsideofthebusinessandwillalsohavecomplianceofficersreportingtohimorher.
Anotherkeypositionthatmostforeigninvestorsplanforisinmanufacturingoperationsorqualitycontrol.Whilelocalemployeesoftenhavevaluableknow-howinthisarea,Westernleadingpracticesarefrequentlyneededtobringmanufacturingandqualitycontroltothenextlevel,especiallywhentheJVisseekingtoexportitsproductstooverseasmarkets.Bycontrast,salesanddistribution,whichtendtobemorelocalized,arebetterleftinthehandsofthelocalpartner.
In1996,aleadingChinesefastmovingconsumergoods(FMCG)brandformedaJVcompanywithaFrance-headquarteredglobalfoodandbeveragecompany.TheChinesecompanyowned49%oftheJVwiththeWesterncompanyowning25.5%.Twoyearslater,theWesternJVpartnerbecamethemajorityshareholderafterbuyingouttheinterestofanotherinvestmentpartner,takingcontroloftheJVanditstrademark.However,thischangeinownershipwasnotrecognizedbytheChineseJVpartner,whichcontinuedtomaintaincontroloftheJV’sday-to-dayoperations.TheChineseJVpartnerclaimedthatithadnottransferredownershipofthetrademarktotheJV,justitsexclusivelicense.By2000,theChineseJVpartnerhadestablishedothercompaniestosellthesameproductsastheJVandusedtheChinesetrademark,settingoffaseriesofarbitrationandlawsuitsonthepartofbothparties.
HavingwonthebattletohavetherighttoelectaCFOfortheJV,manyforeigncompaniesthenfacethechallengeofselectingtherightcandidate.Inarecentlycompletedtransaction,aUSindustrialproductscompanyelectedanexpatCFOfortheJV.AhighlyregardedveteranwithseveralyearsofoperatingexperienceinChina,theCFO-electhadthedilemmaofdecidingwhethertorelocatetoathird-tiercitywheretheJVisheadquarteredorattempttorunthebusinessfromShanghai.Inaddition,duetoalackofChinese-languageskills,theCFO-electcannoteffectivelycommunicatewiththelocalfinanceteamwithoutaninterpreter,makingitharderforhimtoforgeastrongrelationshipwiththelocalteams.
3Capital Agenda Insights
Protecting intellectual property (IP) and other rights
ForeigninvestorsneedtoensureadequatemeasuresareputinplacefromDayOnetoprotectIPrights,whetherforthetechnologyorforthemanagementprocessesandknow-howthatWesternpartnersareintroducing.Suchmeasuresmayseemunusual,butChineseJVshaveadefinedlifespan;therefore,itisincumbentupontheWesternpartnerstoensurethattheirIPisnotmerely“transferred”totheChinesepartner’shands,butinsteadreflectssomeofthevaluethattheWesternpartnercontributestotheventure.
Mapping out a clear path for the future
Finally,foreigncompanieswillalsoneedtoanticipatetheendgamefortheJV.Dotheyseeaneventualincreaseintheirequitystakesorabuy-outoftheChinesepartnerthatwillallowthemtobecomethemajorityowneroftheJV?DotheyanticipatelistingtheJVonthepublicmarket?Alternatively,dotheyexpecttoformsimilarJVsinotherproductcategoriesorgeographies?
MappingoutthepotentialevolutionoftheJVtheyaregettingintoisasimportantas,ifnotmoreimportantthan,settingtherightsetofobjectivesattheonsetofpartnershipdiscussions.Whileitwillbeextremelydifficulttoanticipatepotentialend-gamescenarios,foreigncompaniesinvestinginChinaareencouragedtoplanrigorouslyforsuchoutcomesandfortheirpotentialtriggers.ThishasimplicationsduringJVnegotiations,whethertheyinvolvethevaluationofthebusinessatatimeofsaleornon-competeclauses.Developingandrigorouslytestingasetofkeyassumptionswillhelptoshapedecision-makingandtrade-offsduringJVnegotiations.
InarecentlycompletedJVinametals-processingbusiness,theWesternparty’scontributionincludedtheir“know-how”aroundefficientprocessingsystemsdeemedleadingintheirindustry.InformingtheJV,theWesternpartnerinsistedthataportionofthefinalprocessingbecompletedbyoneoftheirwhollyownedfacilities,therebyallowingthemtoensurethatnotallaspectsoftheirhighlyvaluedsystemsweresimplygiventotheChinese-controlledJV.
Capital Agenda Insights4
Focusing on JV value creationBothpartiestoanegotiationarelikelytoagreeonvaluecreationasacommonbusinessobjectiveforanyJV.Chinesecompanieslookforforeignpartnersformanyreasons:toachieveaglobalprofileinascalablewayandgainaccesstomassiveexportmarkets;todevelopbrandingexpertiseandgainaccesstonewtechnologiesortolearnnewwaysofovercomingqualityissuesthatcanrestricttheirabilitytoexport.
Foreigncompanies,meanwhile,mustprovetotheirChineseshareholdersthattheyareactiveminorityinvestors;theyneedtoensureeffectivetransferofknowledgeandbusinesspracticestotheirlocalpartners.TheJVwillcreatevaluebyleveragingtheforeignpartner’smanufacturing,technologyandmarketingcapabilitiesandthelocalpartner’slocalmarketandregulatoryknowledge,marketaccessanddistributioncapabilities.
Successfulvaluecreationrequiresbothsidestoagreeonasetofintegrationprioritiesandrapidlytranslatetheseintospecificinitiativeswithineachfunctionalarea.Thisprocesswillalsoalloweachfunctionalareatodeeplyunderstandthecapabilitiesoftheotherandworkoutfeasibleplansthroughassignment
ofresponsibilities.Ifdonecorrectly,thiswillalsogivetheforeignpartyagreaterdegreeofmanagementcontrolandinfluenceinthespecificareasoffocus.
However,ourexperiencetellsusthatthisisoftennotastraightforwardprocess.
Watching your language
Let’sstartwithwhattocalltheintegrationproject.InChinese,anintegrationplanis“”(zhenghejihua),whichcolloquiallymeans“aplantofixthingsup.”WhileChineseseniormanagementwillunderstandthegoaloftheproject,linemanagers,whoareoftenproudofthehistoryandachievementsoftheenterprise,frequentlyreactnegativelyordefensively.China-savvyforeigncompanies,therefore,willrefertotheintegrationprojectas“”(xiaonengtigaojihua),whichmeans“performanceimprovementplan.”ThisislikelytogodownwellthroughouttheorganizationasthecentralgovernmenthasoftencalleduponallenterprisesinChina,betheystate-ownedorprivatelyowned,tocontinuethedrivetowardperformanceimprovementintheirrespectivesectors.
5Capital Agenda Insights
Getting behind a common plan
Nextcomesthechallengeofagreeingwhatintegrationprioritiesshouldbe.Bothpartiesoftenhavedifferentviewsastowhatisavalue-creationpriorityandwhatisnot.Evenwhenbothsidesagreeonprioritiesattheonset,thesemaychangeveryquicklyaseachsideabsorbstherealitiesofthepartnershipandthechangesthatarenecessarytomakeitsuccessful.Focusiscritical,giventhefast-changingcompetitiveandregulatoryenvironmentinChina.
MNCsoftenfocusonthecontrolelementsintheirintegrationplans.Forexample:checkingandensuringexistingsuppliersandcustomershaveproperlydocumentedcontracts,thereiscompliancewiththerelevantregulatoryandhealthandsafetyexecutive(HSE)requirements,checkingandensuringemployeesandcompensationaremanagedthroughastructuredappraisalsystem,cashmanagementhastheproperinternalcontrols,amongothers.
Chinesemanagers,bycontrast,sometimesdonotseethesecontrolprioritiesassoimportant;afterall,theyhaveachievedsuccesswithout“fixing”theseareas.Theyaremosteagertoseetheirproductsexportedoverseasandtheirplantsupgradedsotheycanstartproducingtheforeignpartner’sproducts,increaseutilizationandallowtheirsalesforcetoscaleupquicklyandsellmoreproductsinthedomesticmarket
—evenifgapsstillexistbetweenqualityrequirementsandimplementationoftheCustomerRelationshipManagement(CRM)system.
Agreementonintegrationprioritiesforbothsideswillrequirethemtoworkouttheirshort-termandlonger-termvaluecreationpriorities,whichunfortunatelymaymeananotherroundofnegotiations.Settingrealisticexpectationsaboutwhatcanbeachievedintheinitialperiodisimportantandwillrequireafinebalancingactbetweensecuringcontrolandaddressinglonger-termvaluecreationneeds.AnotherproblemisthatforeignpartnersoftenmakethefirstassessmentofwhatskillstotransfertotheChineseJVonthebasisofaWesternviewofwhatisneededinChina.Thisusuallyisdrivenbyamultinational’sexperienceinitshomemarketanddoesnotnecessarilytakeaccountoftheChinesecontext.Leftunchallenged,thesesortsofassumptionscanpotentiallyleadtoapooruseofresourcesandwastedmarketopportunities.
InarecentlycompletedJVinSouthernChina,theEuropeanheadquartersoftheforeignpartnerquicklyassembleda“firststrike”multifunctionalteamarmedwithacomprehensiveintegrationplan.Theessenceoftheplanwasriskmitigation,fromensuringthelicensingandHSEcomplianceoftheChinesefactory,toputtinginplaceasetofrigorouscontrolsandbudgetinginthepartner’sfinancedepartment.TheintegrationkickoffinChinadidnotgowell.Therewasstrongresistancefromlocalmanagement,whowereexpectingtheroll-outofplanstoupgradetheirfacilities,prepareproductsforexportandshiftsomeproductioncapacitytoChina,henceincreasingtheChinesepartner’sfactory’sutilization.Bothsidesultimatelylearnedtheimportanceofinvolvingbothsidesindecision-makingaboutintegrationpriorities.Reachingacommonunderstandingofwhatareprioritiesandwhatarenotduringintegrationisthefirststepofasuccessfulpartnership.
6 Capital Agenda Insights
Choosing the right team to back you up
Finally,bothsideswillfacethechallengeofimplementingvalue-creationinitiatives.ForeigncompaniesfacethebiggerchallengeofselectingagroupthatcanparachuteintothenewlyformedJVwiththeappropriatemixoftechnical,businessandChina-savvymanagerstoaccelerateknowledgetransferandoperationalimprovements.Withoutproperpreparationandincentives,membersofthisteamoftenseetheircurrentassignmentastheir“dayjob”andcanlacksufficientfocustoworkwiththeJVpartner.OntheChineseside,theremaybealimitednumberofmanagerswiththerequisiteinternationalexperiencetoworkeffectivelywiththeincomingpartner.SuchamismatchofexpectationsandcapabilitiesoftencausethefirstchallengesintheJVrelationship.
7Capital Agenda Insights
Cont
act Yew-Poh Mak
OperationalTransactionServices—Asia-PacificT:+862122283002E:[email protected]
ThedealenvironmentinChinacontinuestobeadynamiconewithstrongappealtoforeigninvestors,butinternationalcompaniesneedtorecognizetheextenttowhichtermshaveshiftedandadapttheirstrategiestotakeaccountofthesenewrealities.StartingandmanagingJVswillincreasinglybecomepartofanymultinational’swinningChinastrategygoingforward.However,thiscontinuestobeacomplex,uncertainandattimes,emotionalprocess.
PreparationismorecriticalthanevertothesuccessofaJVorsimilaralliance,andinvestorsneedtounderstandthestepsthatarekeytothisprocess,includinghavingaclearvisionoftheoverallstrategybehindthedealandwhatbothsidesviewastheobjectivesofthepartnership,choosingtheexecutiveswhowillhaveresponsibilityovermajorfinancialoperationsandenvisioningtheultimateendgameforthealliance.Successrequirescontinuedengagement,pragmatism,andfocus.Duetothedifferencesinculture,experienceandmanagementpractices,eachsideneedstopaysystematicandexplicitattentiontoclarityofcommunicationandtrust-buildingbetweenthepartners.Bepatient!
PartnershipsthatexcelintheChinesemarketplacearethosethatrelentlesslyfocusonmarketopportunities,remainalerttotheevolvingobjectivesofthepartnershipandfocuspost-JV-formationeffortsontheopportunitiesthatwillcreatethehighestvalue.Thosewhoseinitialpartnershipsfailtodevelopaccordingtoplanalsohavethepotentialtobecomewinners,solongastheyapplytheexperiencetheyhavegainedtonewopportunitiesinChina,eitherontheirownorwithnewand(or)existingpartners.Whatevertheroute,theChinesemarketcontinuestooffersignificantopportunitiesandrewardstothosethattakealong-termview,maketheeffortandperseveretotheend.
Conclusion
8 Capital Agenda Insights
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