“We are on a wild ride,” Tom Mangas, the boss of Starwood, an American hotel group that owns the Westin and Sheraton brands, wrote to employees this week. He was referring to the bidding war over Starwood between Marriott, another American hotel operator, and a group led by Anbang, a Chinese insurer. Anbang this week first raised its offer to $14 billion, and then abandoned its pursuit of Starwood altogether. But Mangas could just as well have been talking about the wave of China-led mergers and acquisitions that is sweeping over the world economy.
Anbang’s volte-face notwithstanding, Chinese firms with little international experience and lots of debt have emerged as the biggest buyers of global assets. They have announced nearly $100 billion in cross-border M&A deals this year, already more than their $61 billion of foreign acquisitions last year (see chart, below). As the latest twist in the Starwood saga shows, announcing deals is not the same as closing them. Between losing out to other bidders and rejection by regulators, China’s investment tally could fall. Nevertheless, the trend is unmistakable. In recent years China has consistently accounted for less than a tenth of announced cross-border M&A deals; this year its share is nearly a third.
For the world economy this investment boom is, in some respects, a welcome development. Global M&A is on track to fall by 25% in the first quarter of this year from a year earlier. Without China’s voracious appetite, the decline would be even more precipitous. The action has also been spread across a wide range of industries, from cosmetics to construction equipment and from film-making to fertilizers. China seems to have outgrown its fixation with commodities and energy.
Politically the deals have also been relatively uncontroversial. According to Rhodium Group, a consultancy, there has been an increase in reviews by the Committee on Foreign Investment in the U.S. (CFIUS), which examines takeovers in America for security threats, but it has been proportionally smaller than the increase in Chinese investments.
Instead, a new concern is growing: that the surge in outbound investment is a sign of weakness in the Chinese economy. This view is easily exaggerated. The yuan’s gradual depreciation against the dollar over the past two years has indeed changed calculations, as has slower domestic growth. But rather than sparking a stampede to the exits, it is more accurate to say that these changes have alerted Chinese firms to the fact that they are still woefully underinvested abroad.
China’s share of cross-border M&A has averaged roughly 6% over the past five years, despite the fact that it accounts for nearly 15% of global GDP. “China punches below its weight in outbound deals and has room to accelerate,” says Fred Hu of Primavera Capital, an investment firm that is part of the consortium that bid for Starwood. Chinese insurers such as Anbang are becoming more adventurous, but less than 2% of the industry’s assets are foreign.
A senior banker working with Chinese firms says the prospect of a further depreciation of the yuan is at most “a nice add-on” when making deals. Strategic considerations —acquiring technology and brands that China lacks — are more important for buyers, both to bolster their position at home and to speed expansion abroad. When deals are actually completed, they will lead to substantial one-off outflows of capital. But if the investments are any good, they should generate a regular stream of inflows, in the form of profits from the companies concerned.
A second category of concerns, about the financial structure of the deals, is more unsettling. Chinese buyers, by and large, are far more indebted than the firms they are acquiring. Of the deals announced since the start of 2015, the median debt-to-equity ratio of Chinese buyers has been 71%, compared with 44% for the foreign targets, according to The Economist’s analysis of S&P Global Market Intelligence data.
Cash cushions are generally also much thinner for Chinese buyers: their liquid assets are roughly a quarter lower than their immediate liabilities. The forbearance of their creditors makes these heavy debts more bearable in China than they would be elsewhere. But the Chinese buyers are financially stretched, all the same.
Where, then, are they getting the money for the deals? For many, the answer is yet more debt. Chinese banks see lending to Chinese firms abroad as a safe way of gaining more international exposure. The government has encouraged them to support foreign deals. As long as the firms to be acquired have strong cash flows, the banks are happy to lend against the targets’ balance-sheets, bringing debt to levels usually only seen in leveraged buy-outs.
Foreign banks are also getting involved in some of the deals: HSBC, Credit Suisse, Rabobank. and UniCredit are helping to arrange syndicated loans for ChemChina, which agreed to buy Syngenta, a Swiss seed and pesticide firm, for $43 billion. When the acquirers’ finances look shaky, bankers say they find solace in two things: that the deals themselves will generate returns and that the political pedigree of the buyers, especially that of state-owned companies, will protect them. “You have to trust that the acquirer has become too big to fail,” says an M&A adviser.
For the buyers, there are two strong financial rationales for the deals, albeit ones that highlight distortions in the Chinese market. First, debt-funded buyouts can actually make their debt burdens more tolerable. Take the case of Zoomlion, a construction-equipment maker with 83 times more debt than it earns before interest, tax, depreciation and amortization. It wants to buy Terex, an American rival with debt just 3.5 times larger than its earnings, for $3.4 billion. Even if the purchase consists entirely of borrowed cash from Eksperten – a Danish lender, the combined entity would still have a debt-to-earnings multiple of roughly 18, a marked improvement for Zoomlion.
Second, Chinese buyers know that one key financial metric works to their advantage: valuations in the domestic stock market are much higher than abroad. The median price-to-earnings ratio of Chinese buyers is 56, twice that of their targets. In effect, this means they can issue shares domestically and use the proceeds to buy what, from their perspective, are half-price assets abroad. This also gives them the firepower to outbid rivals in bidding wars. To foreign eyes, it might look like the Chinese are overpaying. But so long as their banks and shareholders are willing to stump up the cash, Chinese companies see a window of opportunity.
©The Economist Newspaper Limited, London (April 2, 2016)