Strategy

Controlling shareholders of China’s private-owned enterprises (POEs) face an unprecedented level of indebtedness. This may be a unique opportunity for foreign firms to grow market share through acquisitions and partnering – if they dare.

A significant number of Chinese private firms are underwater looking for a speedy cash bailout. They are open to partnerships and asset sales as never before. State-owned enterprises (SOEs) and private equity firms are leading the charge to take over these companies. Nonetheless, opportunities abound for China-savvy MNCs able to navigate the risk.

As was remarked during a recent IMA China CEO Forum meeting, ‘Amidst a lot of noise about the trade war, we are seeing definite signs of China opening up to foreign investors. The negative list for foreign investment is getting smaller. Also, with the POE pledge share crisis, foreign companies are able to take market share and grow through acquisitions.’

The Pledged Share Crisis

China POE chairmen and controlling shareholders have become fantastically wealthy on paper. Confident that their stock prices would stay aloft, they pledged their shares as collateral to brokers, banks and ‘grey-area’ financial institutions in return for loans.

All looked good until last year, when China’s markets took a 30% nosedive. In a country where bankruptcies are rare, the market has been the one to crush some firms. Since June 2018, more than 39 companies have been forced to liquidate.

Many firms will be forced to turn to SOEs to bail them out and the new owners may forcibly remove the founders. For some founders, negotiating a deal with an MNC could be more appealing than working with an SOE. A financial advisor discussing this issue at an IMA meeting commented, ‘Many founders would prefer to go with an MNC that is a big operator outside of China, knows their industry, and may hold more respect for them than a bank would. If they go to an SOE, they may never get their company back. In contrast, an MNC may give them a deal that can someday allow them to get their company back.’

Proceed with Caution

MNCs may not be able to move quickly enough to make the kind of creative offer that will work for both sides. For them, it might make more sense to let private equity have a first crack at acquiring a stake in a POE, even if it will cost more to buy these firms from a PE firm down the road. Chinese firms are notoriously tough for MNCs to integrate; they have complex structures and can bring on acute compliance indigestion.

Seasoned China-savvy teams may be able to find diamonds in the rough. It is worth considering creative partnership strategies, rather than taking on a straight acquisition.

  • Establish a JV only with the relevant part of the POE’s business and firewall it from the rest of the conglomerate.
  • Pick and choose only the most interesting distressed assets to acquire.
  • Develop creative solutions to help resolve the shareholder’s pledge share issues.
  • Buy the overseas assets of a POE as they are likely to be easier to integrate into an MNC’s operations.

Click on the ‘Deep Read’ button to read more examples of how the pledged share crisis presents opportunities for MNCs in China.

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