M&A, Talking Point

Strings will be attached

International M&A deals now face a formidable hurdle: China

Strings will be attached

Long stretches of China’s commercial history have been about defending domestic monopolies rather than worrying about anti-competitive behaviour. The manufacture of silk was protected on pain of death, for instance, with the threat of a grisly end for anyone caught smuggling silkworms out of the country. That stopped the trade from arriving on the fringes of Europe until the middle of the sixth century, when two Nestorian monks brought silkworm eggs to the court of the Emperor Justinian in Byzantium.

It was the same for paper, invented by the Chinese but kept hidden from foreign eyes until 751 AD, when the Ottoman Turks defeated a Tang Dynasty army. Among the spoils of war was a small group of Chinese papermakers, who were marched to Samarkand and forced to reveal their craft.

Much later there was the demise of China’s tea monopoly, when the British employed an adventurous botanist to smuggle seedlings into India to break the Chinese grip on the hugely popular drink (see WiC57).

In each case, China’s imperial court was anxious to protect its interests. But its efforts were largely focused within its own borders. In the modern era, that emphasis is changing, with China’s antitrust regulators growing increasingly prominent overseas too. As multinationals seek their approval for mergers and takeovers, China’s decisionmakers are becoming more ambitious in their reach than ever before.

What’s the background to the latest antitrust cases?

Beijing has granted approvals for two high-profile deals this month. First to get the green light was Glencore’s $30 billion takeover of Xstrata. The deal had proved challenging from the start, living up to its Everest codename (John Bond, departing chairman of Xstrata, and Simon Murray, who chairs Glencore, are both said to be mountaineering enthusiasts). There was even last-minute drama, when former British leader Tony Blair was called in to bridge differences between Glencore and the Qatari Investment Authority, a leading shareholder in Xstrata, over price. According to the British media, the two sides were brought together at a midnight meeting at Claridge’s, the London hotel, with Blair pocketing a fee of $1 million for his role in breaking the impasse.

Glencore made its original offer to take over Xstrata last February, although the bid didn’t get approval from shareholders until November. But the longest wait of all – 15 months – was for China’s antitrust team to announce its own response. That finally came last week, as an approval but with conditions. Glencore must sell its $5 billion Las Bambas copper project in Peru and the new entity must supply a minimum of 900,000 tonnes of copper to its Chinese clients for each of the next eight years. At least 200,000 tonnes of this total will be priced at an annual benchmark level.

Then this week there was news that China’s Ministry of Commerce (Mofcom) was also approving Japanese trading house Marubeni Corp’s $5.6 billion purchase of US grain merchant Gavilon. Again, fairly stiff conditions are being imposed with Mofcom insisting that Gavilon and Marubeni must maintain separate, independent trading units when selling soybeans to China, with strict firewalls to prevent any exchange of market information.

So Chinese regulators are flexing their muscles?

Although other government agencies are involved in policing anti-monopoly rules inside China, Mofcom has taken the lead in reviewing international mergers that may impact on the Chinese market, under an Anti-Monopoly Law that came into effect in 2008.

Of course, few multinational businesses will want to rile the authorities in Beijing if they are planning to boost sales to Chinese consumers. But China’s regulators have also set the benchmarks for triggering antitrust reviews rather low, requiring that any “business concentration” with $63 million in annual China sales, as well as $1.5 billion in global revenues, must be submitted for regulatory approval.

Inevitably, this means that many multinational acquisitions will need to be reviewed and last year alone there were 201 notifications from companies wanting clearance, (about the same total as the year before).

It also means that Mofcom is assuming a much more prominent role in international M&A than before, applying the rule to takeovers even if they have a relatively minor effect on the Chinese market or involve companies lacking significant assets in the country.

Aside from the number of deals undergoing review, there is also a sense that the Chinese can be more demanding than other antitrust regimes in applying conditions to transactions.

Glencore’s experience is one example, with both types of conditionality applied: structural (in the divestment of the Las Bambas mine) and behavioural (in the stipulations that copper be sold at pre-determined quantities and within a pre-agreed pricing structure).

In particular, the pricing rules look similar to Chinese approval of a takeover by Russian potash firm Uralkali for its compatriot Silvinit two years ago. At the time Mofcom claimed the merger threatened to push up prices for potassium chloride, so it stipulated that the new entity must continue selling to Chinese buyers in the same way as before, with prices established by the “customary negotiation process”.

Two acquisitions in the hard disk drive sector – Seagate’s purchase of Samsung’s HDD business, and Western Digital’s buy-out of Hitachi’s disk drive unit – were also approved with more onerous conditions than many had anticipated, with both purchasers required to “hold separate” their acquisitions, maintaining them as independent competitors with standalone sales and pricing.

This was another case of the Chinese authorities going further than their counterparts in Europe and North America. The Seagate-Samsung transaction saw no remedies required by the US or EU competition authorities, while the EU required only minor remedies in the Western Digital case.

Then in May last year Mofcom was once again the only antitrust authority to impose conditions in clearing a deal, this time for Google’s $12.5 billion bid for phone maker Motorola Mobility. After expressing concerns about the new combination of Google’s hugely popular Android operating system and Motorola’s extensive portfolio of tech patents, Mofcom added provisos including that Google provide Android on a “free and open basis” and treat all original equipment manufacturers in a non-discriminatory manner.

It’s not just market economics at work?

No, there’s a sense that politics trumps economics in some of Mofcom’s decisions, and that there are other factors being considered, industrial policy among them.

These realities reappeared in the media discussion of the bids from Glencore and Marubeni this month. Noting that the takeover of Xstrata didn’t seem to raise the same level of concern about potential market abuse with other regulators, the Financial Times highlighted that the combined share of copper sales by Glencore and Xstrata to Chinese buyers looks relatively small (a little less than 18% of imports in 2011 – or well below the 30-35% level that typically triggers antitrust action in Europe or the United States).

“This is extremely low for a market threshold,” a source told the FT. “This case is about China securing access to resources at a fair price; it has nothing to do with antitrust.”

So China’s rulings have different motives to reviews in the US or Europe?

Much of China’s antitrust approach draws on similar legislation in the West in assessing market concentration, as well as its impact on market access, technological progress and pricing for consumers.

But the Chinese have also added further criteria that allow for more of an industrial policy edge to their decisionmaking, especially a clause requiring an assessment of how a merger or takeover might impact on “national economic development”, as well as a loosely-defined stipulation that allows for consideration of “other factors as defined by the State Council Anti-Monopoly Enforcement Authority”.

In moving beyond the more classical criteria shaped by market economics, Mofcom is carving out a wider remit. According to a review published by Daniel Sokol, an associate professor of law at the University of Florida, this philosophy is particularly distinct from the United States, where consumer welfare is the standard for deciding whether action should be taken. Unlike the Chinese, in the American review process there is no formal recognition of factors like the impact on other companies in the sector or the effect on the industry in general.

The Chinese make no apologies for applying their own rules and they look most likely to do so in industries classed as ‘strategic’ by policymakers (areas such as next-generation information technology, bio-technology, advanced equipment manufacturing and new-energy vehicles) or in sectors in which the largest state-owned enterprises will be able to argue their case against mergers among their foreign suppliers and competitors.

Additionally, the Glencore and the Marubeni deals are in the commodities sector, a fertile area for antitrust action as far as the Chinese are concerned.

Marubeni’s bid, already cleared by the competition authorities in Europe and the United States, seems to have caused more anxiety in China, the world’s top soybean importer, because the merged entity currently accounts for about a fifth of its grain imports. As soybeans become an increasingly important feedstock (reflecting China’s growing appetite for meat and dairy), policymakers will not have wanted to see further concentration in supply.

There may well have been similar concerns about the Glencore deal. WiC has reported how industrial customers for raw materials like iron ore in China have grown frustrated at their inability to wrest lower prices from international suppliers, despite making up a huge chunk of marginal demand. Although its combined presence in copper supply to China is relatively benign, Glencore’s bid for Xstrata may have suffered by association, with the Chinese determined to limit further situations in which they have little influence over the prices being demanded by global vendors.

Almost all of China’s state-owned energy or commodity heavyweights are trading partners of Glencore or Xstrata, 21CN Business Herald warned last month, so the tie-up will have been judged as likely to have a significant impact. And some of the other warnings in the Chinese press have sounded familiar, reviving memories of the proposed tie-up between the Australian iron ore operations of BHP Billiton and Rio Tinto three years ago. The move was bitterly opposed by the Chinese steelmakers before being dropped in 2010. Nonetheless, the broader experience of negotiating with the iron ore miners has been a jarring one, with CISA, China’s steel trade association, failing to get a better deal for its members. That has left the Chinese more watchful in the sector, especially with companies like Glencore, which seems determined to become the “Goldman Sachs of mega commodity trades”, International Finance News warned last week.

Still, context is important…

At the end of last year, Mofcom had handled 533 antitrust reviews and 517 had been approved without conditions. And although a small group of takeovers have seen remedies required, there has only been one outright refusal so far, Coca-Cola’s bid for Huiyuan Juice four years ago (see WiC7).

Since then there is also a sense that Mofcom has been adapting to its new role, albeit with a few growing pains. One of the grumbles internationally is that a review from Mofcom takes much longer than in other countries, often delaying deals by many months. That’s probably because the antitrust agency is understaffed, although its relative inexperience may also mean that it opts to go slow to see how other jurisdictions handle matters first.

Others claim that the slow pace is due to the political stipulations in the process, which mean that Mofcom has to gather a wide range of views from other stakeholders. Rather than reviewing a filing according to a clearly defined set of parameters, officials can struggle to coordinate their response, especially when a number of parties are pressing for their own interests. Hence outsiders have called for more clarity on how the review process is supposed to work, as well as more timely updates on how cases are progressing. Without transparency, there is always going to be suspicion about what is going on behind the scenes.

Another gripe, says Sokol at the University of Florida, is the relative lack of detail in Mofcom’s final rulings, giving the impression that the regulators want to “operate within a black box”. But that’s not wholly unexpected, he suggests, as other antitrust regimes also try to limit some of the transparency in their decisionmaking, because they want to leave more room for maneouvre in future. Further, the expectation is that Mofcom will start to offer more detail on its findings as it gets more experienced in delivering them. Indeed, the 15-page ruling on the Glencore-Xstrata deal was its most substantial yet.

Keeping track: the Glencore-Xstrata merger completed this week. In spite of earlier media reports that Xstrata’s chairman, Sir John Bond would be “departing” after the merger, he was instead named chairman of the new entity. (May 3, 2013)

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