Chances and challenges of M&A of SOEs for foreign capital

The reform of state-owned enterprises is a pending issue which is of significance on the way of China to the market economy. The country's sustained economic growth depends much on better performance of these SEOs.

As rules of foreign investment in China will be relaxed gradually in the years to follow, it is expected that direct buy out will replace the old practice of roundabout buyout. State-owned listed companies with their dominance in the industries will be the first targets of foreign investors.

However, the influence of acquisitions of state-owned enterprises by foreign capital arouses concerns. First, existing supply chains will be changed after the buyout, which will affect the industry the enterprise is in or even its upstream and downstream sectors. Second, such initiatives will give rise to monopoly which reduces market efficiency and waste of social resources. Third, loopholes in policy can drain the state-owned assets away in the process of the buyout.

Most foreign direct investment in China has gone to the second sector especially industrial sectors while only a little part has flowed to the tertiary industry. But the country still has much potential to be exploited in attracting more foreign capital influx as the service sector is open wider and the policy of cross-border mergers and acquisitions of SOEs has been adopted. China's economy is merging into the surge of the globalization with a faster pace and is making progress on investment policies, market access and national treatment. Foreign investors will find more better chances of taking over China's SOEs and breakthrough of the scale of their acquisitions is expected.

Buyout moves of SOEs by foreign capital are affected by multi-fa?ade factors. The capital market, small and not international enough, is not mature. The reform of financial system lags behind and there are very few choices of financial products and risk prevention tools. The non-integrated policy package adds difficulties to more direct, faster and larger scaled mergers and acquisition by foreign investors. Costs and risks of such cases are hence higher. At present, foreign investors do not launch many M&A initiatives due to limited ways of payment and the absence of a flexible exit system.

State shares still dominate Chinese listed companies. There are strict restriction on the transfer of state shares and corporation shares to foreign investors from state-owned listed companies. For those which have not gone public, the property rights of enterprises which are responsible for their gains and losses have not been identified. This is a barrier for foreign capital interested in buying SOEs. The risk of such deals dampens the enthusiasm of foreign capital.

In addition, mergers and acquisitions normally lead to restructuring of the control of the enterprises. Management and government agencies, which hold and benefit from the control of the enterprises, will be deprived of such control after the M&A. Managers may even step down. So government agencies and executives of enterprises are resistant to such deals to protect their own interests. This shows that core problems that must be solved in the reform and development of SOEs are also the biggest tumbling stone on the way of foreign capital to the take-over of SOEs.

Another barricade is the inadequate legal and systematic support. A case of M&A by foreign investors involves corporate operation, social insurance, securities transaction and bankruptcy which need to be defined by relative laws. But in China, the lack of specified operation process adds to the difficulties and uncertainties in these M&A deals. The system also does not offer protection to the rights and interests of shareholders, creditors and employees. There is no well-defined rules on anti-monopoly and assets appraisal. Most of the cases are planned and undertaken by enterprises involved and no participation of intermediaries. This reduces the efficiency of the operation of M&A deals by foreign capital.

It is a pressing task to improve the legal system governing the deals of M&A by foreign capital, ranging from formulation of laws of counter-monopoly and review of cross-border M&A cases, having detailed instructions of process in place, and making sure these deals are completed within the legal framework. There should be less government intervention but more participation of intermediaries.

By People's Daily Online