Angela Liang
Partner,
Vermilion Partners
In March of 2020, it was inconceivable that we might still be discussing the ongoing effects of Covid-19 in 18 months’ time. But as we stand today, the Covid-19 pandemic has fundamentally changed many people’s lives and continues to create challenge worldwide. Even with increased vaccination rates in many countries, Covid will likely be something that we have to coexist with in the long run.
In the business world, cross-border investment and M&A activities have been particularly impacted by this pandemic. Although thanks to technologies that enable people to see each other while they talk, exchange information and data virtually, not being able to physically meet to evaluate the investment and M&A opportunities and build trust/relationships with the transaction counterparties makes a transaction both difficult to initiative and also execute.
We have witnessed unprecedented challenges for cross border M&A involving China since the onset of the pandemic. Outbound M&A by Chinese investors had a YoY decline of 40% in value in 2020 and was only 1/5 of the peak seen in 2016. We have witnessed Chinese buyers erring on the side of caution in a number of deals, their primary concerns relating not only to deal execution but also the impact of Covid on the prospects of the target asset/business. In some global sale processes, we have seen clients eventually chose to suspend or cancel the process, as a result of this conservative ‘watching’ mode.
That being said, challenges often bring opportunities. Although global FDI activities, including cross-border M&A, has declined dramatically during the pandemic, FDI into China grew by 4%, reaching USD163bn in 2020. According to the Global Investment Trends Monitor issued by the United Nations Conference on Trade and Development (UNCTAD) in January 2021, China exceeded the US to become the world’s largest FDI inflow country in 2020. For certain industries, such as ICT and pharma, FDI inflow via in-bound M&A grew by over 50%. This was mainly due to the fundamental dynamics within China and the fact that the pandemic was largely under control. China’s issuance of various policies to stabilize the economy and encourage investment also helped businesses get back to ‘normal’.
Since the second half of 2020, we have seen a trend by which Multinational Corporations (MNCs) are reactivating their China projects and, in some cases, resuming M&A activities which were suspended due to the pandemic. Several MNC clients have indicated that they were encouraged by China’s prompt and effective control of the pandemic and the resilience of China’s economy.
Under the current pandemic situation, how do we best assist our clients in cross border M&A transactions? We recently completed an in-bound acquisition for a UK FTSE250 company. This transaction was initially suspended after the outbreak of the Covid-19 but resumed in late August 2020. With most of the transaction execution taking place during the pandemic, it provided invaluable experience when it comes to doing a deal remotely.
Providing services beyond the normal M&A advisory scope
As our client was not able to travel to China, they relied heavily on Vermilion for all matters related to the transaction, not just those that would ordinarily be within the remit of a lead financial advisor. Daily communication during the pandemic was largely through Vermilion, which required us to be involved in all the discussions between our client and the vendor/target regardless of subject and nature. We effectively coordinated projects such as site/property improvement, fire safety inspections and remediation and various other pre-completion improvement requirements. This required us to also deploy our local relationships to bring high-quality local expertise to bear on various areas, as well as assisting in their management and resolving difficult issues
Anticipating issues/challenges and making plans
In cross-border transactions, challenges normally surface as a result of differences between regulatory environments, cultures, language, and the mentality of the transaction parties, among others. When it comes to China, certain local practices might not be fully understood by western buyers, who may initially deem that they are not standard or even that they are incompliant. As a result of travel restrictions during the pandemic, our client was not able to physically come to China to meet and see things tangibly. As such, they were (naturally) more inclined to raise questions and concerns that would be relatively easily addressed through an in-person meeting with the relevant authorities or people.
One good example of this is the identification of unauthorized/unlicensed structures on site. The unauthorized structures in questions were auxiliary structures; a roof shield connecting two manufacturing buildings to prevent products from getting wet in the rain, and sun shields to shelter employees’ cars in the parking lot. Not only useful structures, but also common place at manufacturing sites across China. More importantly, they are usually accepted by the regulatory authorities. Not being in-country, and not having the in-person relationship to provide that reassurance, our client remained concerned requested the vendor obtain official building certificates. We eventually received an official notice from the local government confirming the legitimacy of the use of the structures, such a notice would not ordinarily be provided but it was important to our client to receive comfort over the structures
Finding creative solutions
For this deal, there were more challenges than can usually be anticipated in execution. For instance, in due diligence, not being able to physically visit the site and see the manufacturing facilities, made it difficult for our client to understand the full extent of the detailed manufacturing process, to assess the quality and condition of the manufacturing equipment and evaluate the environment, health and safety (EHS) conditions of the target. Not being able to meet the management in person also made it difficult for our client to form a fully informed view on the quality of the management team and to identify certain potential HR issues.
To avoid such difficulties, we involved external specialists to assist with the field work, take pictures and videos wearing a ‘GoPro’, to give our client with an ‘in-person’ view of the workshops, while at the same time conducting a real-time Q&A. This provided our client with a lot of comfort on the operational due diligence. We also enlisted the help of an HR manager from another China business belonging to our client, to help with the HR due diligence. They were able to provide useful insights into our client’s global HR standards and perceptions. Situations such as this require a high degree of creativity and flexibility without lowering the quality of our work or undermining our client’s position.
Maintaining relationships between deal parties is challenging but critical
In most deals we advise on, we assist our clients in managing their relationships with the counterparties. Sometimes we act as the main conduit of communication between our client and the vendor/target, due to cultural and/or language differences, but we always encourage our clients to meet the other side in person as much as possible, so that relationships and trust can be built. This was not possible during the pandemic. In the deal we just completed, we spent a lot more time making sure that positions, views and thoughts were clearly and fully communicated to the other side to avoid any ambiguity and larger issues merging later. For this particular vendor it was also important to manage their emotions carefully when the two sides entered into difficult discussions/negotiations.
Although thanks to today’s technology, our client was able to conduct video conferences with the vendor/target, not being able to physically meet did, inevitably, make communication less straight-forward, especially as the vendor involved had no experience in dealing with international companies.
There is no doubt that the pandemic has made cross-border M&A transactions a lot more difficult to manage. In some circumstances, clients choose to press the pause button, but for clients with projects that are determined to carry on, we, as an M&A advisor, must be prepared to face and resolve more challenges and issues, to ensure that good decisions are made with respect to a deal. It has always been our ethos to advise ‘as principal’; this is even more important when you necessarily step into a broader role.
