Opinion: are Chinese companies prepared for outbound M&A Wave Two?

Source: Cfbond| 2018-05-07 16:49:00

By Jay Milliken and Josh Feldmeth

In early March at the Two Sessions, Mr. Zhong Shan, Minister of Commerce said China will continue to curb 'irrational' outbound investment. In a bid to 'promote healthy growth of overseas investment and prevent risks', China has been trying to clamp down on 'irrational' outbound investment in industries ranging from real estate to hotels and entertainment.

According to the report from Thomson Reuters - Deals Insight - China Deals Landscape in 2017, China outbound M&A declined in 2017, but acquisitions along Belt & Road countries reach record high in 2017.

In addition to a changing regulatory environment, M&A strategy by Chinese firms has also shifted in terms of industry and sector. Historically, Chinese outbound M&A pivoted between raw materials and energy (Wave One). Now, we are seeing M&A strategies focus on acquiring new technologies and achieving scale through access to Western markets and brands from the US and Europe. This in turn drives growth for an increasingly consumer-oriented Chinese market (Wave Two), a sector that doubled to $1.5 trillion between 2013 and 2015.

China outbound M&A made a pivotal transition in 2017 and is entering a new phase of activity. The Question is: are Chinese companies prepared to integrate, operate and grow brands and consumer businesses?

Prophet, a leading consultancy believes there are three strategic essentials for Chinese firms preparing to purchase branded Wave Two assets abroad:

1. Know the true value of what to buy, not just what it's worth. Brands can represent upwards of 50% of the value of the acquired asset. While both sides have lawyers, bankers and consultants that understand this dynamic from a synergistic perspective, the Chinese acquiring firm needs to fully appreciate the market drivers of value, including access to new markets, relationships with high-value segments, and pricing power.

Each of these dynamics could result in a different playbook for integration and post-acquisition growth. For instance, the acquiring company could use the acquisition to transform their own business and brand, as Lenovo did in transferring the equity of Thinkpad from IBM and into Lenovo. Unfortunately, these opportunities are often misunderstood or missed altogether. With less direct experience with consumer insights, strategic marketing, brand building and customer experience, Chinese executives often feel forced to take a hands-off approach rather than risk engaging in an area where they lack expertise.

To overcome this skills deficit, it is critical that Chinese acquirers quickly build a working knowledge of the drivers behind the brand's asset value. Why is it relevant with consumers in the market? What drives customer choice? What are its strategic brand equities and where will the growth come from? Leaders from Chinese firms should engage with their new colleagues, dig into the customer and brand data, and visit customers or observe shoppers together.

2. Be a net giver in integration, not a net taker. M&A in general, but particularly large-scale cross-board deals, has a mixed track record. The most successful deals follow a tight value-creation logic with disciplined integration where the acquiring firm is specific about the value it brings to the acquired asset and team. It's a dynamic particularly in the tech sector (see Cisco and Oracle), and what HBR calls being a "smarter provider of capital growth". Beyond simply understanding the true value of the asset they are acquiring, outbound Chinese firms need to find a balance in value exchange after the deal.

Finding a balance between give and take can be difficult, particularly if the plan is to fully integrate the acquired business. Yet, regardless of the post-deal integration plan, maximizing value creation will require that Chinese firms open-up operations, share knowledge and give capability to their new partners.

To become a net giver and not a net taker, Chinese firms can:

a. Identify and promote skilled leaders, regardless from where they come.

b. Open-up often opaque (and suspicious) R&D and go-to-market processes to collaborate with new teammates, and even new customers.

c. Share their greatest asset, knowledge of the Chinese market and customers. For most international companies, China remains a top priority, if not their largest growth market outside of their home countries. Access to Chinese decision makers, professional networks, detailed competitive data and nuanced customer understanding are high-value assets that Chinese acquirers must transfer in the M&A in order to be a more than simply a capital provider.

Through its acquisition of GE Appliances, Haier is a benchmark example of a post-acquisition net-giver. Having paid a premium for the GE Appliance technology and brand, Haier could have attempted to absorb that value through operational integration. Rather, they radically decentralized into a "networked" organizational structure focused on the customer and defined by speed, agility and autonomy. Haier becomes a net-giver by allowing GE Appliances to participate in this novel structure, enabling start-up level entrepreneurialism with the benefit of scale and distribution strength.

3. A global business requires a global operator. For primarily domestic players like Great Wall, the acquisition of a foreign business and brand assets permanently changes the frame of reference from "China first" to "Global", requiring a new strategic and operational framework.

The most relevant and valuable global businesses, whether B2C or B2B, have long learned that in order to complete in dozens if not hundreds of markets around the world, they could not simply export a local operating model. Firms like P&G, BMW and Electrolux tap global insights capabilities, recruit diverse marketing talent, create flexible management frameworks and operate a governance model that addresses the fixed vs flex and central vs. local challenges.

Samsung's global expansion is a good example here. Samsung's global market share and brand relevance only took off after they built design and marketing centers around the world. Lenovo is another. After acquiring IBM's signature personal computer business, ThinkPad, it has invested years and millions of dollars to build a sophisticated marketing, design and global brand management capability. They have a valuable global franchise today because they are operating as a global player.

There are massive opportunities and challenges for Chinese companies navigating the water of Wave Two M&A. As long as large domestic Chinese firms have the capital and the West has big businesses and brands to offer, large outbound M&A activity will continue to happen.

(Jay Milliken and Josh Feldmeth are Senior Partners at Prophet, a leading brand and marketing consultancy)