USA Inbound Acquisitions & Investments Blog : Inbound Investment Lawyer & Attorney : Sullivan & Worcester Law Firm : Mergers & Acquisitions, Cross Border Investments

Does 2010 mean a renewal of inbound M&A activity? We have put the question to well-qualified investment bankers to get professional views. Brian McDonald, a Managing Director in the M&A Group of Houlihan Lokey, an international investment bank, has some very positive views. Brian has been a banker for over 20 years, advising both publicly traded and privately held companies in various industries. He has advised on numerous cross-border transactions.

USAInbounddeals: Commentators have pointed out that the level of M&A activity in the United States for mid-market businesses was lower in 2009 that it had been for several years. Are you forecasting an increase in M&A activity involving mid-size U.S. businesses for the remainder of 2010 or 2011 over 2009’s activity level? Can you suggest what the reasons for any increase might be? 

Brian McDonald: At Houlihan Lokey, we expect to see an increase in activity in 2010 and beyond, and we have already seen an increase in deal backlog. There is both pent up supply and pent up demand for transactions due to the lull in activity during the recent period of market disruption. Now that equity valuations have stabilized and the financing markets have begun to recover, we expect an uptick in M&A activity as buyers and sellers return to the market.

After the recent volatility in the equity markets, shareholders of family owned businesses are much more cognizant of the risks inherent in holding a significant portion of their net worth in illiquid stock of a single, small private company. Many such shareholders are now considering a sale, even though valuations are down from their pre-crisis highs. Also, long-term capital gains tax rates are expected to increase from 15% currently to at least 20% or 25% in 2011, providing an additional incentive for sellers to sell now rather than later. 

Private equity sponsors with older vintage portfolio companies need to sell those companies to return cash to their limited partners, so the current stabilization in valuations provides an opportunity to market those transactions. Corporates are also rationalizing their portfolios and exploring divestitures to either deleverage or to redeploy capital in their core businesses. 

Buyers also have a strong rationale to transact. Many large corporates have built up significant cash reserves by cutting expenses, reducing capital expenditures and reducing dividends. In 2009, many corporates were able to increase earnings even as revenues declined, because they reduced expenses significantly. This cannot be easily repeated in 2010. And since the economy is not expected to grow rapidly, these corporates will try to grow by using their cash reserves to make acquisitions. 

USAInbounddeals: If you believe that an increase will occur, are you predicting an increase in the activity level of foreign-based buyers (including their existing U.S. businesses) in the U.S. market? Are you willing to estimate how significant this increase might be? 

Brian McDonald: In recent years, foreign buyers have increasingly been active in the U.S. middle market. We believe that their demand for U.S. businesses will further increase in 2010 for a couple of reasons. First, the U.S. economy is expected to recover from its recession sooner and more rapidly than Europe. Therefore, European buyers will likely continue to look to the U.S. for growth acquisitions. Also, the recent sustained appreciation of the Euro relative to the dollar appears to be headed towards a reversal, particularly with the fiscal crisis in Greece. If European buyers conclude that their window for buying U.S. assets at “sale” prices will soon be closing, they may decide to jump in before the window closes. 

Asian buyers, particularly Japanese and Chinese buyers, have also been active, but less consistently. We expect buyers from these countries to continue to appear in select middle market transactions.

USAInbounddeals: Do you believe that specific U.S. industries are more likely to see increased interest from foreign investors or buyers? What might those industries be? 

Brian McDonald: We have seen the most foreign buyer interest in the industrial sector, real estate, and infrastructure services and materials.

USAInbounddeals: Are sell-side clients actively asking you to seek out foreign buyer interest? 

Brian McDonald: Yes. Sell-side clients often seek foreign buyers for several reasons. Most importantly, sellers want to maximize value and they recognize that foreign buyers can often pay more due to a strong currency or unique strategic considerations. If a foreign buyer views a U.S. business as a way to establish a platform in the U.S. or gain access to U.S. distribution channels, they may place a significantly higher value on the acquisition than a U.S. acquirer would.

Another reason sellers like foreign buyers is that they often represent the least disruptive buyer for the employees. If the buyer does not already have a U.S. business with which to integrate the acquisition, the buyer will typically retain most employees.

USAInbounddeals: Are you aware of any concerns in the M&A marketplace that the U.S. government’s screening of inbound deals makes them more difficult to complete?

Brian McDonald: Yes. Companies that service the defense sector or that sell directly to the government are often reluctant to include buyers from sensitive countries on their buyers list. Even if the seller is willing to invite a foreign buyer into the sale process, some buyers are reluctant to participate if they are concerned that the U.S. government may reject the transaction due to national security concerns. We have even seen this behavior by private equity funds that have significant limited partner equity from countries in the Middle East, for example.

This article is intended for informational purposes only and reflects the opinion of Brian McDonald, a Managing Director in the M&A Group of Houlihan Lokey. The material presented reflects information known to the author at the time this article was written, and this information is subject to change. 

About Houlihan Lokey

Houlihan Lokey provides a wide range of advisory services in the areas of mergers and acquisitions, financing, financial restructuring, and valuation. The firm was ranked the No. 1 M&A advisor for U.S. transactions under $3 billion in 2009 and the No. 1 U.S. fairness opinion advisor over the past 10 years by Thomson Reuters. In addition, the firm advised on more than 500 restructuring transactions valued in excess of $1.25 trillion over the past 10 years. Notable engagements cover numerous sectors and virtually all of the largest U.S. corporate bankruptcies, including Lehman Brothers, General Motors, WorldCom and Enron. The firm has more than 800 employees in 14 offices in the United States, Europe and Asia. Each year Houlihan Lokey serves more than 1,000 clients ranging from closely held companies to Global 500 corporations.

For more information on Houlihan Lokey, visit www.HL.com.

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Kraft Foods’ acquisition of Cadbury PLC has led at least one prominent British policymaker and one prominent business leader to consider whether Britain should take steps they believe will discourage short-term investment in its companies and encourage long-term investment, as if the two can be distinguished.  They are suggesting that legal and regulatory changes may be necessary to offset the market’s focus on short-term trading in favor of what they perceive as Britain’s need to retain the benefits of long-term investment. They appear to be advocating these changes without regard to the detrimental effects that their protectionist actions will have on worldwide foreign direct investment (FDI), including that originating in Britain. 

In an opinion piece published in the Financial Times in mid-January, Peter Mandelson, Britain’s Secretary of State for Business, Innovation and Skills, asked what steps might be taken to better align the interests of short-term and long-term investors and the interests of the owners and managers of publicly listed companies. He argued that financial markets often separate financial assets from real assets, with the consequence that the trading of financial assets leads to insufficient recognition of the importance of real assets. Lord Mandelson convened a roundtable discussion with investors, fund managers and company executives to establish a dialogue between investors and management of the companies in which they invest. The implication is that the lack of alignment between these groups too often results in a takeover of a real asset which in turn leads to the loss of the business itself to Britain. Additionally, the inability to assemble a pool of “patient capital” may be at odds with Britain’s needs for new technologies and infrastructure investment.

Lord Mandelson made clear that he was displeased with the failure of mergers and acquisitions strategies to create additional long-term value during the past 20 years. Although acknowledging that M&A can create economies of scale and technology synergies, he advocated openness by acquirors with respect to their intentions and robust criticism by shareholders. It is difficult to disagree with his analysis of the problem.  The recommendations for cure are quite another matter. 

More recently, Roger Carr, the chairman of Cadbury who resigned on February 3, called for an overhaul of M&A regulation in the UK. Mr Carr is arguing that his country’s regulatory scheme for takeovers works against the long-term interests of British businesses. According to news reports, he cited takeover practices as predatory and stated that the current rules reward short-term traders at the expense of owners with longer-term views. He suggested that the rules had resulted in too many UK business being sold off to foreigners, and that the sale of a domestic business to a foreign business was a loss to the UK. His sentiments were plainly protectionist and sounded like those of a sore loser. He seems to have said little about those UK companies who have walked the globe, acquiring businesses for strategic and other reasons or those UK businesses, such as Cadbury itself, who build plants outside of the UK to enhance profits.  

The thrust of the comments of both Lord Mandelson and Mr. Carr is that differentiation should be made between those who will hold their shares for the long term and those who will not. However, a requirement that shareholders be locked in or locked up means that investors give up their ability to sell their shares when the situation warrants. This stratagem shifts risk to shareholders, who will expect and in fact be entitled to a greater reward. These types of restrictions have existed in the past and have often allowed management to be less accountable to owners, since the owners cannot exercise their right to show their ultimate displeasure—by exiting their investment. 

Ultimately, however, changes in risk allocation and the balance of management/owner power in one geographic market can disadvantage companies in that market in terms of global capital allocation. If investment in British companies is stickier than in U.S. or Australian companies, then British companies may well lose value in comparison with their non-British peers. Given choices, FDI will always seek investment opportunities that are less encumbered. 

Then again, Lord Mandelson and Mr. Carr may believe that it is Britain’s best interest to erect a wall around its industry, buying some time to create Britain’s future. Deflecting foreign ownership will, however, likely lead to retaliation. It would not be surprising if other countries were to preclude British business from investing in or acquiring their businesses. Worse yet, it could lead to rounds of similar restrictions on investment in other developed countries and then to trade restrictions. This could have a disastrous effect on FDI and the strong world economy that has been developing since 1945, despite the shocks of 2008. Lord Mandelson and Mr. Carr could better serve their countrymen by leading UK businesses to build stockholder loyalty through the creation of true stockholder value and to be strong competitors in the world economy. 

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The withdrawal of the Chinese acquirer in Firstgold transaction has ignited a debate over whether U.S. investment policy has become more restrictive with respect to China. In fact, Firstgold is unlikely to be a reliable indicator of the policy or regulatory direction of the U.S. government. Firstgold presented an unusual set of facts, did not truly involve U.S. critical infrastructure and has little economic significance. The regulatory outcome was determined well before the blowup between Google and the Chinese government occurred earlier this month. Commentators should be wary before generalizing from the Firstgold outcome, as incorrect observations may reduce offshore investment interest in the U.S.  

The Financial Times reported earlier this month in an article bylined by its Beijing-based reporter Kathrin Hille that Chinese companies are expecting tougher scrutiny in the United States. This change is linked to Google’s announcement that Chinese hackers had accessed its systems and those of 20 other companies. Google’s stand might affect both inbound investors and companies already present in the U.S. The article reported that the failure of the Firstgold investment is an indicator of the Obama administration’s enhanced scrutiny of Chinese investment infrastructure. 

The Firstgold investment was not a conventional inbound investment. The company’s SEC reports contain unusual facts. Firstgold has been an exploration stage company with only minor operations since 1995. Its assets are principally property and equipment for gold prospecting at four sites in Nevada. It is financially distressed. Its audit included a going concern qualification. It must raise capital to survive. Its two hedge fund investors sued it for securities fraud 10 months after making their loans. The Chinese investor, Northwest Non-Ferrous International Investment Company Limited, intended to not merely invest in Firstgold, but to acquire the outstanding senior secured debt from the hedge funds, loan additional funds to Firstgold and invest enough to own 51% of the Company’s equity. The total investment package was valued at $26,500,000 but less than $10,000,000 was an equity investment in the company itself. Firstgold did not file its application with the Committee on Foreign Investment in the United States (CFIUS) until three months after the deal was first announced. Firstgold did have a property located in Fallon, Nevada, 50 miles from a U.S. Naval air facility that tests advanced weapons. It was this proximity that led the staff of CFIUS to conclude that there were national security concerns.

Firstgold’s assets are not critical infrastructure. The regulations promulgated under the Foreign Investment and National Security Act of 2007 define critical infrastructure to be an asset so vital to the United States that the incapacity or destruction of the particular asset would have a debilitating impact on national security. Firstgold’s assets do not satisfy that standard. Critical infrastructure is not an issue in the case.

Firstgold has no economic significance. In its 15-year history, it has produced no material revenues. Because it is not an active mining operation, it is not a factor in the local Nevada economy. Its debt is in default, and it is subject to foreclosure proceedings. The real importance of the transaction was the bailout of its lenders who thought they could offload their position at a favorable price. The value of Firstgold’s stock is questionable, since there are outstanding cheap warrants equal to 26% of the outstanding shares, a significant overhang. In fact, there was a period during 2009 where Firstgold’s stock could not be traded since it had failed to file its reports with the SEC.

On the other hand, it truly is difficult to understand what CFIUS gained from blocking this deal, in which case it may be that its action can only be a signal for a new hawkish outlook. In November 2008 CFIUS published a list of 11 illustrative factors that it will consider in determining whether a covered transaction poses national security risk. The Firstgold deal seems to present none of them. The CFIUS Guidance also discussed transactions that have presented national security considerations because of the nature of the U.S. business over which control is being acquired. Geographic location is not mentioned as a determinative factor. Because Firstgold has no products, it is not able to have products that may have implications for U.S. national security. It is possible that CFIUS determined that the buyer was acting on behalf of the Chinese government. If so, CFIUS never mentioned it. Therefore, if CFIUS intended to send a message, the message may be that a Chinese investor has the burden of proving it is not acting for the PRC government. Given the size of the transaction and the relative obscurity of the parties, however, it is difficult that CFIUS meant for its action to be considered a bellweather for other China-originated transactions. 

It’s appropriate for the media to be alert to policy changes that result from Google’s startling announcement. Reading tea leaves is a tricky business, however, and in the world of commerce, the media should refrain from issuing baseless alarms when the U.S. economy is earnestly seeking foreign direct investment. The rational view is that, all in all, there was little compelling reason once the national security monitors raised doubt as to the real reason for the transaction, for CFIUS to permit the Firstgold deal to go ahead. Had there been some compelling showing that the deal had a rational basis as a business investment, CFIUS would have approved it.

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FDI promises to grow in importance to both developed and the developing economies in the new year. The world economy as a whole has not fully recovered from the slowdown of the past three years. What recovery has occurred has been selective, leading to stronger economies in some cases and leaving weaker economies in others. The imbalance suggests that opportunities for cross-border investments and M&A activities will abound and that those businesses, funds and individuals that have available capital will likely pursue them.

Heightened FDI activity will raise issues in the media, in academia and elsewhere. The issues that will garner the greatest attention are likely to be:

• Protectionism. If there is a sudden, large upturn in FDI into developed economies, will more inbound transactions be challenged by regulatory authorities? At the end of 2009, the Obama administration prevented the acquisition of FirstGold by a Chinese acquirer on national security grounds. Will this be interpreted as protectionism disguised? CFIUS has rarely outright blocked deals in the past, so a moderate increase in number of challenged deals may well be interpreted as a change in political attitude. Complicating the assessment is that foreign buyers will likely be shopping for natural resources business and high technology firms – both of which may have assets that are inordinately valuable and difficult to find elsewhere. These values may raise the stakes to investee nations when control of these assets is shifted offshore.
• Credit Squeeze. Buyers and investors with strong credit lines will likely be very attractive to targets who are starved for debt and equity capital. Distressed assets are in strong supply and can often be revitalized with infusions from capital from new owners with adequate capital supplies. Will buyers and investors remain disciplined and limit their capital at risk, or will there be “shopping sprees” as holdout sellers give up, price spreads narrow and well-endowed players run the table?
• FDI Extends the Service Sector. Economies that have built their capacities and economic fortunes on exports of manufactured goods with price advantages will seek to compete more aggressively by incorporating more of the value chain into their enterprises. They may wish to acquire design capability and marketing interface directly with their ultimate customers. Confronted with the question of “buy or build,” some businesses will look to acquire or invest in businesses that provide those services. This means businesses whose assets go home at night. From an operational perspective, this will raise issues of conflicting corporate cultures. Return on investments into service companies can also be more difficult to measure than investments in hard assets. The range of results on these deals will likely be broader than in other investments.
• Developed Assets More Desirable. For investors in the U.S. and Europe, assets – both hard and soft – that are developed and therefore require minimal additional expenditure, are likely to be more desirable than those requiring considerable additional investment. Consequently, in both developed and developing economies, greenfield investments may have a difficult time competing for investment capital. For outbound investors in China – where capital appears to be less constrained and risk tolerance may be greater – greenfield investments in the energy and agricultural sectors will remain top priorities. There may be a strong divergence that is building, with those economies and businesses in need of significant capital infusions turning away from investors in the developed nations and looking almost exclusively to investors in emerging economies.
• What Direction for Global M&A? The year 2009 brought a large number of strategic cross-border mergers and acquisitions, many with high profiles. The trend toward consolidation within industries will accelerate – the Kraft/Cadbury transaction being the poster child for these deals. Absent from the space at this time are the financial players, such as the private equity funds who have relied on leverage to complete their acquisitions and generate their returns. Will private equity and other private investors step back into the ring before credit has become more available, or will financial deals continue to lag strategic deals? The lack of clarity ahead for many businesses also adds uncertainty regarding valuation and pricing. With these factors taken all together, the return of robust cross-border M&A transactions does not seem imminent.

If we gain information on these FDI issues in the next six months, then the last half of 2010 may appear to be more predictable, especially if it is more in line with past trends. Given the change in direction that 2008 and 2009 brought compared to the immediately preceding years, any predictions – at any point – may deny the reality that volatility persists, even in FDI.

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Earlier this month the United Nations Conference on Trade and Development released two significant new publications. On December 1, UNCTAD released its inital Global Investment Trends Monitor. The publication reported data on global foreign direct investment (FDI) for the second and third quarters of 2009. On December 4, the UNCTAD Secretariat published its first Investment Policy Monitor. The aim of the Monitor is to provide the international investment community with current developments in foreign investment policies at both the national and international levels.

UNCTAD intends to publish its Investment Trends Monitor quarterly to provide the international investment community with regular assessments of global FDI. UNCTAD has developed its own index to measure FDI, based on FDI data for 67 economies that comprise 90% of FDI flows. The Investment Trends Monitor recorded an increase in global FDI from Q1 to Q2 of 2009. Specifically, the index rose 65% to 115 on a quarter-over-quarter basis. The increase was the first posted in five consecutive quarters. The G20 countries alone produced a 38% increase, according to the Index, but the increase affected only certain countries in the G20. Increases in the emerging economies were more limited. The Monitor warns that a full global recovery might not yet be underway, citing two reasons. First, cross-border global M&A was flat during the first three quarters of 2009. Second, the number of international, greenfield investment projects declined for the fifth consecutive quarter. The publication predicts that FDI flows for the third quarter will not show material improvement and will remain significantly below the year-earlier levels, but offers the optimistic prediction that “the overall environment for international investment is slowly improving.”

The Investment Policy Monitor assesses the national policy frameworks reflecting attitudes toward FDI. The report notes that during 2009 the majority of the 51 changes analyzed were for the “liberalization, facilitation and promotion” of inbound FDI. The report interprets this majority to mean that countries continue to believe that FDI is a means to finance their economic recoveries and promote their economic growth. The remainder of the changes included prohibition of foreign participation in certain industries, modifications to screening requirements and tightenings of regimes on investments that may relate to national security. The analysis differentiates between changes in the G20 countries and in non-G20 countries. The Investment Policy Monitor also follows changes in the general legal framework relevant to foreign investors in taxation regimes, state aid and stimulus packages. The report notes that between July and November 2009, 34 countries undertook measures related to foreign investment and 31 enacted state aid or stimulus packages or otherwise enhanced earlier such initiatives. Also included are new international investment agreements (including bilateral investment treaties) and double taxation treaties. All together, 82 economies were direct parties to new agreements in 2009.

Both publications include useful hard data and metrics and, for that reason alone, should prove exceedingly useful in the months ahead as FDI participates in and generates the expected global recovery.

UNCTAD was established in 1964 with the goal of promoting sustainable development while integrating developing countries into the world economy.

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A relatively small proposed investment in Firstgold Corp. of Lovelock, Nevada, a development stage mining company, has lead to a flurry of press coverage of the refusal by the U.S. Treasury’s Committee on Foreign Investment in the United States (CFIUS) to permit the deal. 

The proposed investor is Northwest Non-Ferrous International Investment Company Limited of Xi’an, China. Firstgold is a small-cap, financially-challenged gold mining business with four tracts in Nevada, but little operating history—in its own words, “a junior mining and exploration company.” The deal size has not been disclosed and may be less than $10 million. The deal structure involves three parts—the acquisition of senior secured debt from a disgruntled private investor, an additional loan to Firstgold and a purchase of a control equity stake, making Northwest both Firstgold’s parent and secured lender. The deal was first announced in July 2009. The parties did not make their CFIUS filing until late September.

After both a review and an investigation, CFIUS is recommending that the President disapprove the transaction. According to CNNMoney’s report, CFIUS apparently based its rejection on the proximity of one of Firstgold’s properties to Fallon Naval Air Station and offered several mitigation possibilities, none of which Firstgold accepted. The company states that the air base is 50 miles away. 

There is other speculation that the investor would use Firstgold’s gold assets—even if undeveloped at this point—to add to China’s hoard of gold, now totaling a staggering estimated $1.95 trillion. China’s gold reserves exceed Switzerland’s. 

Other news reports and blogs covering the development include:

• Reuters
• Northern Miner
  
• Exec Digital
• As well as Firstgold’s own release

This blog, in its October 1 post, alerted readers to the possibility of an unfavorable CFIUS outcome. We noted that management did not seem to approach the CFIUS filing with seriousness and as recently as October had predicted that its CFIUS filing would not be problematic.

The furor surrounding this development has an interesting footnote. The California Gold Rush of 1848-52 began with the discovery on gold on Mexican soil, specifically on land owned by a Swiss farmer, John Sutter—and ultimately led to the annexation of California by the United States. So there may well be historical precedent for the concerns of CFIUS. 

Updated  On December 22, Northwest withdrew from the transaction, Reuters announced.  Therefore, President Obama will not have to take direct action to disapprove the deal. 

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Foreign direct investment has often created dismay and resistance in the investee nation. Self-appointed pundits may try to gain populist following by decrying the sale of local assets to foreign buyers with no regard to the historic contribution foreign ownership has made to the growth of their own economies.

Governmental regulation of foreign direct investment is implemented in part to allay these emotions by screening out those investments judged harmful according to legislated standards. It therefore is counterintuitive when the exercise of regulatory power to screen foreign direct investment also inspires equally ill-tempered reactions. Often, the sound and fury of those reactions do not withstand factual analysis, especially when journalists seek to stir the pot of public emotions. 

Take, for example, “US inquiry into sale of Virgin Galactic stake to Arab investor” which appeared in the online version of The Times of London earlier this week, written by Abu Dhabi based-reporter David Robertson. The Rocketeers and ParabolicArc blogs posted the same story. The story questions why the U.S. has elected to subject the proposed sale of a 32% stake in Sir Richard Branson’s privately-held space travel venture to Abu Dhabi-based Aabar Investments for $280 million to “a national security investigation” and whether the investigation genuinely serves the legitimate interests of the United States. 

Virgin Galactic and Aabar Investments had originally announced their deal in July 2009. The deal includes not only the equity investment but also Aabar’s commitment to fund a small satellite launch capability. 

Timesonline does not point out that the Committee on Foreign Investment in the United States (CFIUS), has reviewed over 300 transactions during the three years ended December 31, 2008 or that filings with CFIUS that seek its review are optional. However, CFIUS may initiate its own review of inbound transactions and, if it finds that a transaction may adversely affect U.S. national security, it can take remedial steps, including rescission. As a result, a prudent inbound investor and its investee will seek CFIUS review to insure that the transaction is permanently settled. Review is the first level of the regulatory process. Investigation is the second level. If review of a filing finds that the transaction could result in control of a U.S. business by an entity that is controlled by a foreign government, then FINSA and its regulations require an investigation unless CFIUS otherwise determines. Given this legal framework, CFIUS could have had sound reasons for subjecting Virgin’s deal to the second level of investigation. The fact that there is an investigation does not, however, suggest that the outcome will be adverse to Aabar.

The Timesonline report suggests that investors in the Arab Middle East will become concerned that their investments in the U.S. are subject to CFIUS review. According to the public version of the CFIUS annual report released last month, during 2006, 2007 and 2008, 11 transactions involving UAE investors or acquirers were filed for CFIUS review. During the same period, 14 transactions from Bahrain, Kuwait, Lebanon, Qatar and Saudi Arabia were filed. Deals originating in Saudi Arabia alone comprised 7% of the total value of completed transactions. Without regard to this body of facts, the writer drags up the divestiture outcome that followed Dubai World’s acquisition of P&O, a deal that CFIUS found did not impair national security and that did close. 

It certainly is legitimate to argue that the statute that CFIUS enforces has an incorrect premise with regard to government-controlled entities. It also is legitimate to argue that the term “national security” is not sufficient well-defined and gives CFIUS too much discretion and the overwhelmingly powerful argument is that Sir Richard Branson is not very likely to have transferred control of Virgin Galactic, despite the size of Aabar’s investment. But, in a government where the legislative branch makes the laws and the executive branch is charged with carrying out those laws, CFIUS is performing as it must. Moreover, CFIUS has taken steps to make the public aware of its views by publishing guidance regarding the types of transactions that it has reviewed and that have presented national security implications.

There is an additional fact that would have put much of this faux fury into perspective. Aabar now owns 4% of U.S.-based Tesla Motors, the electric car company that is a contender to lead the United States into the age of the electric car. In July 2009, Aabar acquired its investment stake in Tesla from Daimler. Because of the confidentiality of the proceedings of CFIUS, there is no way to know whether CFIUS reviewed the transactions that led to Aabar’s stockholding in Tesla. At a minimum, Aabar and its controlling family are not strangers to CFIUS. They have been welcomed into the U.S. in the past and no doubt they will be welcomed here again.

The New York Times coverage of the Virgin Galactic deal, published today, is infinitely more balanced and informative. Reporter Eric Lipton went into the subtleties and difficulties that underlie regulatory judgments regarding FDI. Factual reportage supports constructive public debate that can lead to public policies that enable FDI to produce its best results. 

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Foreign direct investment has often created dismay and resistance in the investee nation. Self-appointed pundits may try to gain populist following by decrying the sale of local assets to foreign buyers with no regard to the historic contribution foreign ownership has made to the growth of their own economies.

Governmental regulation of foreign direct investment is implemented in part to allay these emotions by screening out those investments judged harmful according to legislated standards. It therefore is counterintuitive when the exercise of regulatory power to screen foreign direct investment also inspires equally ill-tempered reactions. Often, the sound and fury of those reactions do not withstand factual analysis, especially when journalists seek to stir the pot of public emotions. 

Take, for example, “US inquiry into sale of Virgin Galactic stake to Arab investor” which appeared in the online version of The Times of London earlier this week, written by Abu Dhabi based-reporter David Robertson. The Rocketeers and ParabolicArc blogs posted the same story. The story questions why the U.S. has elected to subject the proposed sale of a 32% stake in Sir Richard Branson’s privately-held space travel venture to Abu Dhabi-based Aabar Investments for $280 million to “a national security investigation” and whether the investigation genuinely serves the legitimate interests of the United States. 

Virgin Galactic and Aabar Investments had originally announced their deal in July 2009. The deal includes not only the equity investment but also Aabar’s commitment to fund a small satellite launch capability. 

Timesonline does not point out that the Committee on Foreign Investment in the United States (CFIUS), has reviewed over 300 transactions during the three years ended December 31, 2008 or that filings with CFIUS that seek its review are optional. However, CFIUS may initiate its own review of inbound transactions and, if it finds that a transaction may adversely affect U.S. national security, it can take remedial steps, including rescission. As a result, a prudent inbound investor and its investee will seek CFIUS review to insure that the transaction is permanently settled. Review is the first level of the regulatory process. Investigation is the second level. If review of a filing finds that the transaction could result in control of a U.S. business by an entity that is controlled by a foreign government, then FINSA and its regulations require an investigation unless CFIUS otherwise determines. Given this legal framework, CFIUS could have had sound reasons for subjecting Virgin’s deal to the second level of investigation. The fact that there is an investigation does not, however, suggest that the outcome will be adverse to Aabar.

The Timesonline report suggests that investors in the Arab Middle East will become concerned that their investments in the U.S. are subject to CFIUS review. According to the public version of the CFIUS annual report released last month, during 2006, 2007 and 2008, 11 transactions involving UAE investors or acquirers were filed for CFIUS review. During the same period, 14 transactions from Bahrain, Kuwait, Lebanon, Qatar and Saudi Arabia were filed. Deals originating in Saudi Arabia alone comprised 7% of the total value of completed transactions. Without regard to this body of facts, the writer drags up the divestiture outcome that followed Dubai World’s acquisition of P&O, a deal that CFIUS found did not impair national security and that did close. 

It certainly is legitimate to argue that the statute that CFIUS enforces has an incorrect premise with regard to government-controlled entities. It also is legitimate to argue that the term “national security” is not sufficient well-defined and gives CFIUS too much discretion and the overwhelmingly powerful argument is that Sir Richard Branson is not very likely to have transferred control of Virgin Galactic, despite the size of Aabar’s investment. But, in a government where the legislative branch makes the laws and the executive branch is charged with carrying out those laws, CFIUS is performing as it must. Moreover, CFIUS has taken steps to make the public aware of its views by publishing guidance regarding the types of transactions that it has reviewed and that have presented national security implications.

There is an additional fact that would have put much of this faux fury into perspective. Aabar now owns 4% of U.S.-based Tesla Motors, the electric car company that is a contender to lead the United States into the age of the electric car. In July 2009, Aabar acquired its investment stake in Tesla from Daimler. Because of the confidentiality of the proceedings of CFIUS, there is no way to know whether CFIUS reviewed the transactions that led to Aabar’s stockholding in Tesla. At a minimum, Aabar and its controlling family are not strangers to CFIUS. They have been welcomed into the U.S. in the past and no doubt they will be welcomed here again.

The New York Times coverage of the Virgin Galactic deal, published today, is infinitely more balanced and informative. Reporter Eric Lipton went into the subtleties and difficulties that underlie regulatory judgments regarding FDI. Factual reportage supports constructive public debate that can lead to public policies that enable FDI to produce its best results. 

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Will President Obama’s recent trip to China product any inbound FDI results for the U.S.? According to the U.S.-China joint statement, the November 16-18 trip produced significant agreements in five key areas of bilateral interest. There were tangential, but not explicit, mentions of FDI into the U.S. either by way of mergers and acquisitions or Greenfield investments.

Judging from the tenor and substance of the joint statement, the meetings further developed the mutual confidence and trust that are the predicates for a favorable investment climate. The five key areas of agreement were:

• The importance and productivity of regular high-level exchanges to the growth of the overall U.S.-China relationship
• The building of a bilateral strategic relationship that is positive, cooperative and comprehensive
• Strengthened dialogue and cooperation on macro-economic policies leading to global recovery
• Shared responsibility to cooperatively address regional and global security challenges
• Vigorous responses to issues of climate change, energy and environment

The joint statement implicitly references the importance of FDI at several points. There was express recognition of the importance of the U.S.-China Strategic and Economic Dialogue. “Both sides believed that the first round of the Dialogue held in Washington, D.C., in July this year was a fruitful one and agreed to honor in good faith the commitments made and hold the second round in Beijing in the summer of 2010.” The bottom line is that the U.S.-China FDI relationship appears well and growing and on track to produce results. Those results may not be evident until later next year. 

Further, while addressing the need to support the global recovery, the statement made clear that both sides are committed to open trade and to jointly fight protectionism and to resolve bilateral trade and investment disputes. The joint statement articulated the explicit promise of the U.S. and China “to expedite negotiation on a bilateral investment treaty.”

Prior to the release of the joint statement, reports had appeared in the Chinese press, notably the South China Morning Post, that a specific agreement would be reached to promote acquisitions of small and mid-size U.S. financial institutions by Chinese lenders. No such agreement or memorandum of understanding appears to have emerged from Obama’s visit.

A recent transaction involving a proposed takeover by China’s Minsheng Bank of failed California-based bank, UCBH Holdings, illustrates the formidable difficulties to be overcome if U.S. regulators intend to encourage Chinese lenders to invest in U.S. banks. Minsheng Bank had acquired a 9.9% interest in UCBH in 2007 and recently raised US$3.86 billion in its initial public offering in China. According to a report in The Wall Street Journal, Minsheng Bank also sought to acquire United Commercial Bank before U.S. authorities closed the San Francisco-based lender earlier this month. 

UCBH operated the United Commercial Bank, with several branches in California and also in other key Chinese American areas, such as New York, Boston, Seattle, Atlanta and Houston. United Commercial suffered commercial lending losses from loans to developers and home builders during the housing boom. A financial scandal led to a management shake-up. 

The Federal Reserve rejected China Minsheng's proposal to buy United Commercial Bank because of regulatory restrictions on foreign investment in U.S. banks and instead closed the bank. Soon after the closure, East West Bank, based in Pasadena, California, took over United Commercial Bank's roughly $7.5 billion in deposits, as well as $10.2 billion in assets. The Los Angeles Times reports that its takeover of UCBH will greatly expand its reach of East West, which has concentrated on Southern California and the San Francisco Bay Area. Interestingly, East West has a full-service branches in Hong Kong. 

The plain result of the regulatory actions is that a domestic bank with no interest in UCBH was permitted to acquire the business, while a foreign bank that always was a part owner of UCBH was not. The broader implication seems to be that any federal policy determined to promote inbound FDI will have to be based on a full and complete alignment of regulatory agencies at all levels. Otherwise, well-intentioned policies will be incapable of being executed. 

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