China Business Podcast

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M&A in China – Why Deals Fail: Part I


Qi Tang

M&A in China – Why Deals Fail: Part I



Interviewer: Steve Ganster


My name is Steve Ganster; Managing Director of Technomic Asia, a market strategy and growth consultancy based in Shanghai. I am pleased to kick off our series on M&A in China with our first segment on why deals fail.


It is well acknowledged that it is tough to culminate an equity partnership in China, even after a good candidate has been identified and taken through LOI. In Part I, in a conversation with Qi Tang, Technomic’s M&A practice leader, we’ll begin to unpack this very interesting and complex topic. I think you’ll find some very practical insights that you can apply to your China acquisition initiatives.


Steve:​I’m here with Qi Tang, senior member of our team who has done many projects in the world of acquisitions in China and I think brings a very unique perspective on this topic.


​Qi, welcome.


Qi:​Thank you.


Steve:​M&A in China is a big topic.  What I wanted to talk about today is one troubling area regarding why deals fail or don’t get done. As we’ve talked in other podcasts–It’s very difficult to find a qualified target who’s interested, but even when that happens and we have some good dialogue going, even an LOI in place, they tend more often than not to fall apart and never get culminated.


​Just as a starting point, Qi, what would you say some of the main reasons are? What’s different about China that makes this failure rate so high?


Qi:​China is a very different place versus the United States. Its political system, economic system and legal system, so you’ve got to pay attention to all of these differences when you are trying to find an acquisition target [or] when you’re trying to do your investigation into an attractive target. It’s just a challenging market in which we need first of all to think through whether we even want to do an acquisition in this environment or not.


Steve:​Do you think it’s appropriate to change the process in how we do deals?


Qi:​Definitely. While I think the western way or western process to makingacquisitions in China makes sense on a general basis, you’ve got to adjust this process considering the Chinese environment. You’ve got to be both objective and somewhat subjective when you are looking at a target.


Steve:​Where do you see many of the negotiations falling apart? Often it can seem we’re on track and then either the western company or the Chinese company starts to go in another direction, sometimes without any logic or apparent logic.  They change their mind [and] the deals end up falling apart. What’s going on?


Qi:​A major problem often is that objectives eventually turn out to be divergent, which in many cases were not realized to some degree because of language barrier, culturedifference or other factor.


Steve:​So often we’ve seen, I know in our cases, that we’re negotiating, we have a value on the table, and then a week later that value changes. I think the sense that western companies get is that they’re being manipulated or played with. And maybe sometimes they are, but what else might be going on?


Qi:​This change should never be treated as odd, particularly in China. I think Westerners change their mind too, so–.


Steve:​That’s true. While we’re on the topic of valuations, how do the Chinese sellers often approach valuation? We know in the West, it’s often EBITDA based and the multiple thereof, but in China, what are some of the typical perspectives on how youvalue your own company?


Qi:​I would say that the Westerners first need to be prepared that Chinese typicallywould view the value to be tied to their asset value as a benchmark. And on top of that, it would be subject to the expectation of the seller, subject to the stock market, PE ratio at that particular time, and also it would be subject to the industry sector that company is in.


Steve:​Yeah, and I think all those things come into play in the West as well. Different industries have different multiples and expectations, but it seems in China, some of the valuations just come out of left field…with no apparent logic.


Qi:​No, no. As I just mentioned, the Chinese seller typically would associate valuation with the existing asset value.  However, if the Chinese seller runs a profitable, good business in a promising industry, he would associate the valuation with the PE ratio in the stock market.


Back in 2007, 2006 when the average PE ratio in the stock market was 60, it was really a hard time to close a deal with the Chinese because the expectation then was very high. Typically, they would want a PE multiple of 20, something like that.


Steve:​Often it was their intent or hope to list, right?


Qi:​Of course, yeah. They continuously would get harassed, I would say, by investment bankers to go public, because in China, going public is viewed as an alternative avenue to make money. It’s not just about growing the business. Shareholders of many Chinese companies who eventually go public only expect to make quick money. Their intention is not to the use money raised from the stock market to further grow the company. That seems not the generic case in China.


Steve:​Qi, a very common aspect that we come across and I think many Western companies are familiar with is this phenomenon of two sets of books, and obviously, that can be problematic in M&A situations. Comment a little about what’s the genesis of this issue in China and give our listeners a little better understanding of what it looks like sitting in the chair of a Chinese business owner.


Qi:​Typically, a private Chinese company will have at least two books – one for internal accounting purposes, and the other for dealing with the government - the tax authorities in particular. From a practical standpoint, the first generation Chinese entrepreneurs saw the need to do something to protect their hard earned profit, both for business survival and for growth in a relatively high-tax, high-surcharge environment.


​I recall not long ago, a Central Party school professor argued that if all Chinese companies are made compliant to relevant tax regulations, they would’ve all been dead by now. While this argument may sound a bit strong, it revealed an often ignored aspect of Chinese business life.


Steve:​Yeah. I think western companies don’t probably appreciate the duress that many of these business owners are under. Not really excusing the issue, but it certainly puts a different explanation or color to it.


Qi:​I think what is actually important for the Western acquirers is first, they need to be prepared that there is a second book. And second, they need to figure out a way to have the Chinese seller table that second book as early as possible. And third, they need to figure a way to interpret and harmonize the numbers and facts from the real book.


Steve:​Yeah. How can they do that?


Qi:​The best way to do that is you need to go through what we call at TechonomicAsia a “Cultivation phase”, which is largely about confidence building. You need to build trust which is necessary before the seller will eventually open his mouth to tell you the truth. So is the real number real? This still poses a question I think for an acquirer.


Steve:​You mean even in the second set of books…Is that real?


Qi:​The second book. Because that book, to some degree, is not prepared on basis of western accounting standards, can be questionable also. Not to mention, there areoften some unutterable practices which can be necessary to survive and grow in the Chinese context.


Steve:​That’s an interesting phrase – unutterable practice. Unpack that a little bit. What do you mean by that?


Qi:​Unutterable, in my opinion, means something that can never be expressed in writing, something that is only existent in the head of the owner or the General Manager.


​Let me give you a case. For one acquisition project, we took all the way to get the owner to eventually tell us that he was actually doing something without the knowledge of other shareholders. Not to mention that the local tax authorities would have any idea about his practices.


Steve:​So this is something he only shared with you after multiple meetings and a buildup of a certain level of trust?


Qi:​You’re right. Only after he thinks that the foreign acquirer is serious. Only after he thinks that the person he is dealing with is trustworthy, and you will need to have to make a promise that the information will just be between you and him.


Steve:​Yeah. Well, it goes back, as you earlier commented on the importance of building trust and that’s everything with these deals. Just as a backdrop for our listeners, we’re really talking about private deals here, not about SOEs or certainly not about more closely held government entities. These are more private companies where you have this kind of phenomenon. SOEs have their own host of issues and that’s a subject in another podcast, but here it’s mostly in the private world.


Qi:​Yes, yes. Some SOEs will have a second book too, but for different reasons. This may deserve a different podcast as you say.


So an optimized approach to get the real accounting picture of a target is to combine book findings with validation exercises by going out into the market to check with the target’s customers, suppliers, etc.


Steve:​Yeah. Just doing good, street-smart work. Due diligence.  As we’ve told our clients many times, the process is the same anywhere, but in China you have to turn over more rocks, maybe to get the same answer to be sure you have at least 80-85% of the uncertainty revealed. There’s always going to be some level that you don’t know everything, but I think it’s a question of minimizing that.


Qi:​Yeah. I think western acquirers need to be aware that China, relatively speaking, is a low trusting society. Speaking of this “cultivation phase” which, in my opinion, is really important is it’s all about confidence building. This step, cultivation phase, is really critical to make a deal eventually happen.


Steve:​ I think maybe another way to say to that is there’s probably a lot more work to be done, pre-discovery or cultivation, prior to the LOI or the term sheet. Where in the West, we may get to that stage and then focus on the due diligence. In China, maybeone of the reasons so many deals fail after LOI is because of a lack of commitment tothis time-consuming and sometimes expensive deal cultivation phase.


I hope this brief perspective is helpful as your pursue your acquisition strategies in China. Stay tuned for Part II on this topic which will cover other issues, such as regional, geographic influences on M&A, private-owned enterprise versus state-owned enterprise deals, the impact of a softer economic environment, and other topics.


Thank you for your valuable time. You can visit our website at to find further information on our podcasts, as well as our strategic growth solutions.


Have a great day.



Steve Ganster discusses the main challenges of achieving successful acquisitions in China with colleague Qi Tang in Part I of this two part podcast on why deals don’t get done in China.


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