How Cross-Border Acquisitions Spark Economic Nationalism

By Huang Hong, PhD Candidate, School of Accountancy, CUHK Business School

Big cross-border mergers and acquisitions (M&A) by Chinese state-run companies in recent years have been controversial because of worries about the government’s involvement and that they attracted the attention of regulatory authorities. So how can a government react in the face of such bids?

The US$43 billion takeover of the Swiss pesticides and seed maker Syngenta by ChemChina, the Chinese state-owned chemicals conglomerate, is one such deal.

It received the approval of European Union (EU) and United States authorities in April and once the purchase is completed it will become the largest-ever overseas acquisition by a Chinese company.

The Syngenta deal led to American concerns about the possible threat to its national security because the Swiss company’s biotechnology division is based in the US.

The Republican politician Chuck Grassley, who chairs the US Senate Judiciary Committee, had raised concerns in March 2016 about the possible threat posed by China’s ownership of a vital part of the US’s agricultural infrastructure.

Chinese M&A surge focuses on West

Last year saw a surge in cross-border M&A involving Chinese capital, while the deals have increasingly focused on more developed nations in the West.

Direct investment by Chinese businesses into the US and Europe more than doubled to a record US$94.2 billion during 2016 as more and more major American and European companies were strategically acquired.

China’s outbound M&A, nearly a third of which was in the US, totaled US$221 billion last year – more than double the record of US$109 billion set in 2015 – as companies from the Asian nation pressed ahead with acquisitions.

In addition to the Syngenta deal, the M&A included Tencent buying Supercell, a Finnish mobile game developer, for US$8.6 billion, Zhongwang International acquiring US aluminium producer Aleris for US$2.3 billion and Haier Group paying US$5.4 billion for General Electric’s home appliance division. Dalian Wanda, the property and media group controlled by Wang Jianlin, China’s richest man, paid US$3.5 billion for a controlling stake in US film company Legendary Entertainment, which has produced films such as Godzilla and Pacific Rim.

Europe was the prime focus of Chinese M&A investment last year, with US$76.5 billion spent on the acquisition of European firms up to the end of August, according to a report in Forbes business magazine last September. Within Europe, Germany attracted the most interest from Chinese enterprises, with 24 of its businesses acquired in the first six months of 2016 alone.

Do Chinese acquisitions threaten national interest?

Many of the big, cross-border acquisitions were initiated by Chinese state-owned companies or funded by state-owned banks. The deals sparked heated debate in the target countries about the Chinese government’s increased influence over the existing “free-market doctrine” and concerns about whether they would pose a threat to the target nations’ national interest in areas such as security, food, energy and other resources, technological innovation and consumer welfare.

China’s own foreign exchange regulator has also proved an additional barrier to Chinese companies keen to acquire foreign assets since the end last year. Fears that cross-border M&A had been used by Chinese firms as a way to move capital abroad led to action by the State Administration for Foreign Exchange, the agency that drafts foreign exchange rules and regulations, and manages the state foreign exchange reserves.

China’s regulators said they would block acquisitions deemed speculative or “irrational”, scrutinize any deals of more than US$1 billion outside an investor’s core business, and monitor cross-border deals involving land, hotels, film production and entertainment assets.

Beijing’s regulators target overseas bids by Chinese firms

The regulatory clampdown and foreign exchange restrictions led to 30 Chinese overseas deals with European and US groups worth almost US$75 billion falling through last year.

Several of the attempted cross-border deals lacked an obvious link to the buyers’ original businesses in China. The biggest acquisition to be blocked by Chinese regulatory officials was Anbang Insurance’s planned US$14 billion takeover of Starwood Hotels & Resorts in the US. In February 2016 two attempted deals involving Fosun International, one of China’s most acquisitive private conglomerates, and the state-backed China Resources collapsed in two days.

Ten US deals worth US$58.5 billion were scrapped, including some as a result of US regulatory concerns, while another 20 planned acquisitions in Europe, worth US$16.3 billion, were cancelled, including the proposed sale of German chip equipment maker Aixtron to Chinese investors for €670 million (about US$750 million).

Does economic nationalism exist with the EU?

Such developments bring to mind an interesting question: whether there is clear systematic evidence of a government – especially those of nations where a business is the target of a big cross-border deal – resisting acquisitions of domestic companies by foreign businesses. And if so, what possible factors are driving these governments’ attitudes.

A 2013 study, Economic Nationalism in Mergers and Acquisitions, published in the Journal of Finance, looked at government reaction to large corporate merger attempts in the EU during 1997 to 2006 and revealed widespread “economic nationalism” – a preference for natives over foreigners in economic activities.

The study showed governments prefer that target companies remain domestically owned rather than foreign owned.

Two US-based academics, Serdar Dinc, of the Rutgers Business School, and Isil Erel, of the Ohio State University, examined a sample of 415 merger bids in 15 EU countries between 1997 to 2006. The sample comprised 197 domestic bids by companies in the same country and 218 foreign bids by businesses around the world.

Target-nation governments prefer domestic firms

The study found that, instead of staying neutral, the governments of countries where the target firms are located tend to oppose foreign merger attempts while supporting domestic ones.

It also showed that nationalist reactions are stronger in times and countries with stronger far-right parties and weaker governments, in countries holding the rotational presidency of the EU, and against firms in countries for which the people in the target country have little trust or affïnity.

Sociological and political factors seem to play a bigger role than economic factors in explaining the nationalism in mergers, the study concluded, although target governments might also worry about increasing vulnerability to foreign economic shocks through foreign ownership.

Interestingly, domestic governments were shown to be more likely to give backing to domestic acquirers and oppose foreign ones even though the EU treaty does not give them the jurisdiction to rule in merger attempts on the basis of nationality.

For large cross-border M&A in the EU, it is the European Commission – the institution that proposes legislation and implements decisions on behalf of the EU – rather than the national governments, which has the authority to block a deal on antitrust grounds. So domestic governments use other methods to resist foreign bids.

How to resist foreign bidders

One common method, described in the study as “moral persuasion”, sees governments try to stop a merger at the rumour stage by stating that they are against it. Although they may have no de jure power to stop a merger, the implicit threat is that the company trying to complete the M&A will be dealing with a hostile domestic government on many regulatory issues if it goes through. This threat is more powerful if the government is also a major customer of the target company.

In many privatized companies, domestic governments still hold ”golden shares”, or the right to veto major corporate changes such as the decision to be acquired. This can be a major deterrent to foreign acquirers even though such rights are frequently rejected in the European Court when challenged.

Another way to resist a foreign bid involves governments supporting the merger of two domestic companies in the hope of creating a “national champion” – a new company that is too big to be taken over by foreign firms: target size is often a good deterrent to M&A.

Instead of vetoing an acquisition by foreign businesses outright, governments may also demand that the companies first secure the approval of various commissions to gain time while they search for an acceptable “white knight” bidder.

Huge impact of economic nationalism on M&A

Widespread economic nationalism, which sees governments prefer that target companies remain domestically owned rather than foreign owned, has both a direct and indirect economic impact on mergers.

The opposition of a government to an acquisition decreases the completion chances of M&A attempts while government support increasese them.

However, more interestingly, these reactions have an indirect, longer-term consequence. Concerns about a government’s willingness to intervene may deter foreign companies from bidding for other companies in that country in future.

The study found that the rate of attempted foreign acquisition drops during the first six months after a nationalist reaction – reaching its lowest point about 13 to 18 months later before slowly recovering.