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

Foreign direct investment (FDI) in a formidable natural gas deposit located under the northeastern United States is occurring at a breath-taking – perhaps even breakneck – pace this year. There is no indication that the U.S. government has reviewed any of these transactions for national security considerations. If it has not, then that is a plus, as review would hinder the accumulation of needed capital. This is a case where the government aids U.S. national security by abstaining from exercise of authority. 

To date in 2010, foreign investments in the Marcellus Shale formation have included transactions between U.S. companies and Japan’s Mitsui & Co., Norway’s Statoil, Britain’s BG Group, and Chinese and Korean sovereign wealth funds, to name a few. If the shale gas that lies below New York, Pennsylvania and West Virginia can be safely extracted at a competitive price, in terms of both economic and environmental costs, the United States may be able to radically decrease its reliance on imported oil. Funding the development costs and building the extraction technology are the primary challenges. Meeting these challenges requires significant investment capital. 

That’s where foreign partners come in. Just as U.S. entrepreneurs were willing to seek significant amounts of foreign investment capital for the building of U.S. railroads in the nineteenth century, their exploration and production descendents have wisely decided to partner with worldwide sources of investment capital. And the current low price environment for natural gas makes these deals attractively priced for foreign investors. Throw in the ability to learn (or even copy) the hydraulic fracturing technology used to access the shale gas, and the investment almost sells itself. 

Although the U.S. government has the authority to regulate, it has wisely chosen not to do so. Marcellus transactions are closing at a record pace, allowing U.S. owners to accumulate the dry powder they need to convert the prospect of energy independence into the real thing. 

Take for example one of the 2010 Marcellus transactions. Mumbai-based Reliance Industries acquired a 40% interest in Pennsylvania-based Atlas Energy Resources. Did the parties file with the Committee on Foreign Investment in the United States (CFIUS)? Their press releases don’t mention a filing. The purchase agreement did not reference any requirement that either party make the voluntary filing with CFIUS. CFIUS clearance was not a condition to closing. The deal was signed on April 9 and was closed on April 21, 2010.   CFIUS review generally takes at least 30 days. The time frame suggests no review and no filing. 

In another deal—the investment by the UK’s BG Group plc in EXCO Resources—the investment agreement references antitrust review but not foreign investment clearance. Purchase agreements for the other 2010 Marcellus Shale deals are not publicly available. It is difficult to assess whether the parties subjected their deals to voluntary CFIUS scrutiny to avoid a regulatory challenge to the transactions after their completion. 

Why is there any doubt about CFIUS review? CFIUS screens FDI transactions to identify U.S. national security risks. The official guidance it published in December 2008 states that U.S. requirements for energy sources is a factor it considers. Effects on critical technologies is another. Effects on physical critical infrastructure “such as major energy assets” is a third. CFIUS has given fair warning that those investors who come to the U.S. to invest in U.S. major energy assets fall within its purview. 

It is therefore not surprising that foreign buyers of U.S. oil and gas interests have invoked CFIUS review. The 2009 Annual Report of CFIUS (unclassified edition) specifies that four of the 404 notices filed with CFIUS in 2006-2008 were for oil and gas extractive industry transactions. The annual report does not identify the transactions. Whether any of them involved Marcellus Shale is simply not known.

CFIUS does not announce its decisions on specific deals. There nonetheless is precedent. At the end of 2009 CFIUS blocked a proposed Chinese investment in a failing U.S. gold miner, FirstGold. Whatever the basis for the regulatory position, FirstGold made clear that CFIUS can wield its authority in extractive industry deals.

CFIUS may have it just right this time. U.S. national security requires that not only the U.S., but also the world at large, develops as many safe alternatives to oil in as many locations as possible. According to a recent special report in The Wall Street Journal, shale gas discoveries in the U.S. and elsewhere will prevent energy cartels from forming and deprive the petro-states of their influence in world affairs. Financial Times columnist Gideon Rachman argues that national security of the U.S. and other countries as well requires development of shale gas wells and that accordingly any investment – domestic or otherwise – that develops these resources should be encouraged. 

It’s a safe bet that the regulators are aware of these views as well. Seeming inaction may be saying more than any articulated policy could. There is more than one way to announce, “Open for business.” 

Or, contrary to our view, does the U.S. need to be more protective here? Is there a case to be made for screening to insure that we are not allowing other nations to strip our prized assets? If you believe there is, your comment is welcome. 

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Chesapeake Energy Corporation, headquartered in Oklahoma City, is one of the largest producers of natural gas and the most active driller of new wells in the United States. Earlier this month, Chesapeake Energy announced that it expected to raise $5 billion of equity over the next 2 years to repay senior debt and increase investments. As part of that plan, it will sell up to a 20% stake in its Marcellus Shale properties before May 2011. Reuters reported that the sale of the Marcellus shale gas business will net Chesapeake at least $2 billion from the sale as part of its latest plan to raise cash. 

Now, Korea Investment Corp (KIC) and China Investment Corp (CIC) are turning their attention to natural resources, which they see as more tangible than financial services, and may have bought stakes in Chesapeake Energy. According to the Financial Times, KIC and CIC were set to lead a $900 million investment in Chesapeake Energy, becoming the latest Asia-based groups to focus on the sector. While Chesapeake is set to issue the convertible preferred stock, KIC and CIC are expected to acquire $300 million each. 

At the same time that it announced its intended restructuring, Chesapeake also announced a sale of $600 million of nonvoting 5.75% cumulative non-voting convertible preferred stock to an affiliate of Singapore state investor Temasek Holdings and an affiliate of Beijing-based Hopu Investment Management Company. The offshore investors also received an option to acquire $500 million of additional preferred stock for 30 days. 

The Asian funds generally believe the price of natural gas, trading at less than a third of the price of oil on an equivalent basis, is at a cyclical low point and that demand will climb for environmental reasons. 

Today Chesapeake announced that it has sold $1.7 billion of its 5.75% cumulative non-voting convertible preferred stock to Asian investors. Although the release does not specify, based on the prior press speculation, those investors could include KIC and CIC and indeed that KIC and CIC led the deal as forecasted. It could also mean that Temasek and Hopu exercised their option. Chesapeake may provide information to clarify.

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International investment is snowballing to the multi-billions in the Marcellus Shale, a large deposit of natural gas embedded in shale deep below the northeastern United States. This month British BG Group closed its deal for Marcellus assets with EXCO Resources for slightly less than $1 billion. Last month, India’s Reliance Industries bought a 40% interest in the Marcellus acreage of Atlas Energy, Inc., a U.S. exploration and production company. In February, the Japanese energy conglomerate Mitsui & Co. purchased a 32.5% stake in the Marcellus Shale assets of energy giant Anadarko Petroleum Corp. The value of each of these deals exceeded $1.3 billion. 

According to a recent report by industry expert John-Laurent Tronche appearing in the Fort Worth Business Press, during the first three months of 2010, there were more than $2 billion of Marcellus Shale deals, including foreign investments--a record for unconventional oil and gas plays. 

The Marcellus Shale is a formation of marine sedimentary rock located in much of the Appalachian Basin of eastern North America. The rock formation is named for a distinctive outcrop near Marcellus, New York. The Marcellus Shale runs across the New York’s Southern Tier and Finger Lakes regions, northern and western Pennsylvania, eastern Ohio, western Maryland, most of West Virginia and extreme western Virginia. In eastern Pennsylvania, the Marcellus bedrock lies across the Delaware River into New Jersey. Consequently, the shale is relatively close to some of the largest consumer and industrial markets for energy in the United States. 

On April 21, Mumbai-based Reliance Industries Ltd. bought a 40% interest in shale gas acreage owned by Atlas Energy, Inc., based near Pittsburgh, Pennsylvania, as part of its $1.7 billion joint venture with Atlas. Reliance is the largest private sector company in India. The reported terms of the deal were $340 million in cash on closing and an additional $1.36 billion to fund part of Atlas’s drilling costs over 5 ½ years. Atlas’ announcement emphasized that Reliance’s inbound investment would result in a significant number of well-paying jobs for Pennsylvanians. Atlas reported that Reliance also obtained the right to acquire a 40% interest in new parcels plus a right of first refusal should Atlas elect to sell additional acreage in the future. Reliance is paying approximately $14,000 an acre, which is the highest price to date for Marcellus acreage.

Two months earlier, on February 16, Anadarko reported that it had signed its joint-venture agreement with Mitsui E&P USA LLC, a subsidiary of Japan’s Mitsui & Co., Ltd. According to Oil and Gas Eurasia, Mitsui paid $1.4 billion for its share in the venture. Anadarko stated that Mitsui will earn a 32.5% interest in Anadarko's Marcellus Shale assets by funding nearly all of its development costs through 2013. On a per acre basis. Mitsui paid slightly less than Reliance did for its deal. According to The Wall Street Journal, an RBC Capital Markets study calculated the 2010 average price for an acre in Marcellus Shale at $5,650. 

The trend is continuing. In the first week of May, Dallas, Texas-based independent energy business EXCO Resources signed a Marcellus Shale joint venture for $950 million with BG Group, Plc, a natural gas company based in Reading, England. BG Group is an integrated natural gas company with operations across five continents. Under the terms of the transaction as disclosed by EXCO, BG Group acquired a 50% interest in EXCO’s Marcellus Shale assets, principally in Pennsylvania and West Virginia. The operations of the joint company will be based in Pittsburgh. Under the terms of the deal, EXCO and BG will each participate in further acreage that the other acquires in the same region. These global partners have a history. In June of 2009 BG Group has acquired an interest in EXCO’s shale gas resources in Texas and Louisiana for $1.3 billion. 

The 2010 cross-border transactions added momentum to the investment that has been building since November 2008. In that month Oklahoma-based Chesapeake Energy Corp. formed a joint venture with Norway’s StatoilHydro for the exploration and development of natural gas in the Marcellus region. In that deal, Chesapeake sold a 32.5% interest in its Marcellus Shale assets for $3.375 billion and retained 67.5% working interest. Statoil paid $1.25 billion at closing and agreed to fund 75% of Chesapeake’s share of drilling and completion expenditures until its $2.125 billion obligation has been funded.

Not all industry analysts are encouraging investment in U.S. shale gas. Oil and Gas Eurasia quotes Texas geologist and consultant Arthur Berman who suggests that this is yet another market bubble. Berman thinks shale gas reserves are greatly overstated, while the cost efficiency of shale gas production is questionable at best.

Furthermore, the prospect of producing natural gas from the Marcellus Shale using new hydraulic fracturing, or “hydrofracking,” has raised serious environmental opposition. The principal question is whether the drilling fluids used to break through the rock in which the shale gas is housed can contaminate the drinking water aquifer. For example, today’s Capital Business Blog reported that the Tompkins County legislature (representing Ithaca, New York and surrounding communities) just passed a resolution urging the State Legislature to ban hydrofracking pending further independent study. The debate promises to become far more robust than it had been, given the environmental disaster resulting from the massive BP spill in the Gulf this month. 

None of the debate has focused on U.S. regulation of inbound investment in this potentially significant source of clean energy for much of the U.S. A subsequent post will analyze the role of the Committee on Foreign Investment in the United States for the Marcellus Shale transactions. 

 

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Top Chinese telecom equipment manufacturer Huawei Technologies is at it again. Back in 2008 Huawei made an attempt to participate with Bain Capital’s proposed acquisition of 3Com Corporation. The deal didn’t go through. There was much speculation that the Committee on Foreign Investment in the United States (CFIUS) determination that Huawei had ties to China’s People's Liberation Army and posed a threat on national security grounds. The failed transaction is discussed in more detail in a past December 2009 blog posting.

Huawei’s latest endeavor, despite continuing U.S. security concerns, is its reported bid for a unit of Motorola, the U.S. mobile phone manufacturer. Earlier this year, Motorola announced a plan to split into two separately traded companies, one for mobile and home business and the other focusing on enterprise mobility and networks business. In March, Motorola Co-CEO Greg Brown paved the way for a sale or merger of its mobile network business unit. 

Huawei is considered the most probable potential buyer and intends to expand its sales in the North American market.

Since Huawei has lost major deals in the past because of political and security fears, the company is considering negotiating a "mitigation agreement" with CFIUS to show its willingness to cooperate with the United States government.

When asked about its motivation to enter such an agreement, Charlie Chen, senior vice-president of marketing at Huawei, responded to questions by the Financial Times, "We are aware that some in the U.S. government have expressed concerns about Huawei and we will work diligently to address those concerns."

If Huawei does manage to receive approval from the U.S. government, the Huawei-Motorola deal could create a new powerhouse and increase competition among the other major mobile network equipment manufacturers: Nokia-Siemens, Cisco, Alcatel-Lucent and Ericsson. It is uncertain whether or not Huawei’s bid will be successful, but it all may not be lost for Huawei in the United States.  

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February 24 brought the end of GM’s proposed sale of its Hummer business to Sichuan Tengzhong Heavy Industrial Machines Company of Sichuan, China, with GM’s direct announcement that the buyer “was unable to complete the acquisition of Hummer.” The deal was initially announced in June 2009 and was to have been completed by the end of January 2010. The sale would have resulted in the first Chinese-owned automobile business in North America. Hummer’s operations were to have remained in the United States. 

GM stated that it would work closely with Hummer employees, dealer and suppliers to wind down the business. It also stated that it would honor warranties and provide service and parts to owners.

What killed the deal? There were no definitive announcements and as a result various theories have been advanced. The general media speculation was that Sichuan Tengzhong was apparently not able to receive necessary approvals from Chinese regulatory authorities. Time Magazine reported that, according to Yale Zhang, a China market analyst for auto-industry consultants CSM Worldwide, "The purchase of this brand is not a match for China. The government's general policies about efficiency and environmental protection, and No. 2, about consolidation — it is all about these two very broad, general policies. This purchase does not match those." The environmental blog Ecosalon emphasized the ecological basis for the Chinese’s government’s refusal to approve the deal. 

More plausible is that insufficient financing was available. The New York Times reported that because the Chinese government had not approved the transaction, Chinese banks were unwilling to lend. As to western banks, the current nonfunctioning state of acquisition finance markets for mid-size deals meant that other bank financing was not available to Sichuan Tengzhong. 

On the day the deal collapsed, there also was a press report that a private equity fund was about to enter the transaction. The fund, newly formed and based in the Cayman Islands, had proposed to acquire a 20% stake in the Hummer business. 

Despite all of the other reports, the Motor Authority blog, ever hopeful, says that the real deadline is May 31 and that the deal is not yet over. That report is not likely to be reliable. To paraphrase General Douglas MacArthur, “old transactions don’t die; they just fade away.”

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A pair of transactions between U.S. and India was announced during the first week of March. Essar Group, an Indian conglomerate, with $15 billion of revenue and one of India’s biggest steel producers, announced its acquisition of Trinity Coal Corporation from its parent, Denham Capital Management LP. Founded in 2005, Trinity Coal is based in Scott Depot, West Virginia and is one of the U.S.’s ten largest coal producers. Trinity operates mines in Kentucky and West Virginia. Trinity’s annual coal output is about 7 million tons, and it has reserves of 200 million tons. The reported price for Trinity is between $550 million and $600 million. The basis for the deal was Trinity’s substantial metallurgical coal reserves and its skilled personnel. 

Essar has interests in telecommunications companies, steel, power, oil refining and outsourcing. Essar is controlled by Shashi and Ravi Ruia, who are brothers. One of India’s biggest steel producers, it has manufacturing capacity of 14 million tons. According to VCCircle, the purpose of the deal is to secure raw materials for Essar’s North American steel plants and iron ore operations. 

Last November Essar acquired a controlling interest in Warid Telecom Uganda and Warid Telecom Uganda. Essar had earlier launched a telecom service in Uganda. Essar looks to be opportunistic around the world. The Trinity transaction fits this opportunistic bent. 

In a transaction going the other way, U.S.-based private equity fund New Silk Route Partners, agreed to invest $50 million for approximately 30% of Nectar Life Sciences Ltd. of Chandigarh, India. Nectar Life Sciences is an integrated generic pharmaceutical manufacturer with technology that is used to inject its products into patients. Its shares are traded on the Bombay Stock Exchange and the National Stock Exchange of India. Nectar will use the investment to fund its growth. New Silk Route is based in New York and is a growth capital firm dedicated to private equity investments in India, South Asia, Middle East and other rapidly growing economies of Asia. As recently as last November, the fund said it was looking for investments in the $100 million range. Nectar must have been quite attractive to win over New Silk Route. According to RTT News, New Silk Route is now the largest overseas investor in Nectar. 

This pair of transactions is emblematic for the contrast apparent in the current world of cross-border transactions. In one direction, a large multinational is vertically integrating by acquiring available resources in a developed market, such as the U.S., aggregating its components close to their ultimate markets, rather than shipping the components in from low-cost sites overseas. At the same time, in stark contrast, U.S. investors are funding potential high growth investment opportunities in emerging markets. 

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The regulatory clearance process for inbound acquisitions is playing a central role in the ongoing takeover contest for Terra Industries, Inc. A second buyer has made a higher bid and has cited Terra’s need for regulatory approvals and regulatory delays in the agreed-upon deal in arguing its case to Terra’s shareholders. That and other factors now seems to have won the day for the second buyer. 

Terra is based in Sioux City, Iowa and produces and markets nitrogen and methanol products, predominantly agricultural fertilizers. In February, Norway’s Yara Iternational ASA, the world’s largest fertilizer company, agreed to pay $4.1 billion to acquire Terra in a merger transaction. The merger requires the approval of the stockholder of both companies. According to the Alfidi Capital blog, Yara’s bid for Terra was valued at $41.10 per share. The parties have agreed that the transaction is expressly subject to review by the Committee on Foreign Investment in the United States (CFIUS).

Terra’s merger agreement, as filed with the SEC, illustrates the operation of the U.S. statutes and regulations that apply to an inbound investment. First, the U.S. business that is the target warrants to the buyer – Yara in this case – that the approval of CFIUS is among those governmental consents that are required for the transaction to be completed legally. Second, the U.S. target and the foreign buyer then agree to cooperate to make the necessary filings with CFIUS and to update those filings as necessary. Third, as a condition to completion of the transaction, full regulatory compliance must have been achieved. For a more complete analysis of these and other contractual provisions that are used in acquisitions, please visit the Sullivan & Worcester Web site and review our white paper that discusses contractual provisions.

On March 2, CF Holdings Industries, Inc. of Deerfield, Illinois announced that it was offering $47.40 per share for Terra, or $620 million higher than Yara’s bid. Earlier this year, CF had ended its year-long attempt to acquire Terra. CF’s new bid is $840 million higher than its last bid. Because CF Industries, Inc. is not a foreign buyer, review by CFIUS is not a factor. In its press release, CF says that its offer not only has higher value than Yara’s but is not burdened with the various conditions that apply to Yara’s offer. CF’s letter to Terra’s directors cites “numerous conditions beyond Terra’s control [that] will not be satisfied, including regulatory, legislation and stockholder approvals.” Obviously, CFIUS approval falls under the first of these categories. The Daily Finance blog also handicaps the Yara offer because of CFIUS screening. CF gives Terra the opportunity to make a quick deal.

Going back to the Yara deal, it may be interesting to speculate what factors in its business drove the decision to file with CFIUS. Submitting a notice to CFIUS is optional. If there is no filing and CFIUS later determines that the acquisition adversely affected U.S. national security, CFIUS can attempt to unwind the transaction. The mere prospect that an unwinding might subsequently occur is sufficient to lead parties, their advisors and their financing sources to play the game conservatively and engage in the CFIUS screening process.

Viewed from a less conservative perspective, however, perhaps Terra’s transaction does not affect U.S. national security. Terra’s last annual report did not disclose that it had contracts with the U.S. government or that it was satisfying U.S. defense requirements. Additionally, Norway is a NATO ally and is not a proliferation risk. It is more likely that Terra’s fertilizer products are considered critical resources and material in U.S. agricultural markets. Interestingly, among the risk factors in its annual report is Terra’s disclosure that its fertilizers can be used as explosives and that “governments could impose limitations in the sale, use or distribution of [its products],” so there may well be a general security consideration in the background. On balance, the more conservative position with respect to CFIUS seems warranted.

CF appears to have gained the initiative with its heftier price and its arguments that rely on conditions that apply only to Yara’s deal. Today, Terra announced that its board had notified Yara that CF’s offer constituted a superior offer and that, barring an overbid from Yara within 5 days, Terra would terminate its merger agreement with Yara. Although not the only factor by any means, CFIUS review is tilting the contest toward the domestic buyer. 

We are forced to ask whether that was among the intended results of the legislation that regulates foreign direct investment. 

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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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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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The proposed business combination between India’s Bharti Airtel and South Africa’s MTN Group collapsed at the beginning of last month. Local and international politics appear to have played a substantial role in its demise. Therefore, some important questions should be posed. To what extent was the collapse a result of nationalism or protectionism masquerading as a different public policy? Is the withdrawal of that deal evidence of a wider global trend that may make foreign direct investment (FDI) more difficult to execute? As government stimulus programs end, will governments—U.S. and otherwise—use their power to shield companies that have been nursed through the downturn from foreign takeovers? 

Bharti is Asia’s leading integrated telecom services provider, with operations in India and Sri Lanka. MTN is South Africa’s leading mobile and fixed-line telecom company, with over 100 million subscribers and operations in over 20 countries in Africa and the Middle East. Their proposed combination was negotiated from the end of May to the end of September and had a value of approximately $24 billion. Bharti would have received a 49% stake in MTN, while MTN and its shareholders would have received a 36% stake in Bharti. The combined enterprise would have been the world’s third largest telecom company. 

The ominous notes for FDI come from reports in Dealbook and elsewhere that the South African government failed to approve the transaction because of protectionism and nation-building policies. This outcome was not necessarily predictable because both the Indian and South African governments have supported increased trade among developing countries in sub-Saharan Africa and South Asia. That “South–South” trade is intended to offset growing Chinese economic influence in the region.

Dealbook also reported that interventions by both Indian and South African governments imposed conditions that led to the end of the deal. The South African government required that MTN keep South African management in place and maintain a listing on the Johannesburg stock exchange in addition to its listing on the Mumbai exchange. Indian financial regulators were unwilling to waive their rules against dual listings. 

The South African blog SAgoodnews pointed out that there is a long history of dual listed companies and saw no reason why that requirement should have been terminal for the transaction. The blog also dismisses arguments that national political and labor pressures were at fault.

The Indian blog Trak.in News asserts that the Indian government had backed the deal at the highest level, with Prime Minister Manmohan Singh expressly giving the combination his support. The blog also suggests that the real issue was whether the national character of the combined business would be Indian of South African. South Africa’s insistence on the dual listing was a cover for this point. On the other side, the Indian authorities believed, but seem not to have stated, that the dual listing would effectively set a conversion rate for the rupee that could differ from the official rate of exchange. 

Both companies’ share prices rose after termination was announced. Stock analysts who had trepidations were pleased to see the transaction crater. It therefore is possible that, in addition to political agendas, there were financial issues underlying the headline events. Investors may not have been as supportive of the transaction as were the managements of Bharti and MTN. 

After September 30, both governments issued the usual palliatives, saying that they remain open for business and underscoring the importance of FDI. Rather than helping business decide whether to pursue cross-border deals in emerging economies, however, these positions and unarticulated rationales only obscure the facts. The recovery from the worldwide turndown is in its early stages. Obfuscations and half-truths do not bring recovery any nearer, as they only add uncertainty where business strategists would prefer to deal with articulated policies and certainties. 

What is true for developing economies such as South Africa and India is also true for the United States. Efforts to generate inbound investment must be very transparent and free from hidden conditions. Actual decisions and measures must align with policy pronouncements. In an environment in which the U.S. is hotly competing with other countries for inbound FDI, the U.S. government cannot afford to be less than utterly committed to inbound investors. Anything less will lead those investors to look for greener pastures—a lesson that South Africa may yet learn. 

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In a headline-grabbing inbound acquisition deal, General Motors Corp. and Sichuan Tengzhong Heavy Industrial Machinery have reportedly reached definite agreement on the terms of the sale of GM’s Hummer Brand by early 2010 for approximately $150 million. According to a Reuters report appearing in The New York Times, Tengzhong has begun to seek Chinese regulatory approval for its purchase of the Hummer brand, Hummer trademark and manufacturing expertise. The report surmises that three Chinese regulatory bodies – the Ministry of Commerce, the National Development and Reform Commission and the Ministry of Industry and Information Technology. In our post of last June 15, we noted that Chinese regulators could have a significant role in the purchase.

There also are questions as to what U.S. regulatory approvals may be required. Reuters reports that approvals from U.S. regulators are required, but doesn’t specify which regulators. Although far reduced in size from the original $500 million estimate, the $150 million price exceeds the minimum size for filing with the antitrust regulators in the Department of Justice and the Federal Trade Commission. There seem to be few tangible assets changing hands – no plants, no real estate, no equipment. The reports suggest that only intangibles are being bought and sold. Therefore, the key question becomes whether the parties have obligated themselves to make a voluntary filing with CFIUS. In posts earlier this year, we raised the question of whether sales of U.S.-based automotive businesses to offshore buyers would trigger review under the Foreign Investment and National Security Act of 2007 (FINSA). Review under that statute could interpose a 30-day review period plus an additional 45-day period if an investigation is warranted. The descriptions of the deal, structured as the purchase and sale of intellectual property whose value lies in the marketing of the product and certain manufacturing rights, suggests that the parties have taken reasonable steps to minimize those factors that could lead to an adverse regulatory outcome.

It even is possible that GM, Tengzhong and their advisors are so confident of their structure that they will elect not to make the filing with CFIUS which, after all, is voluntary. The deal apparently has provisions that will save 3,000 U.S. jobs through 2011. It may be unlikely that a U.S. regulatory body will risk adding those workers to the already sizeable portion of the workforce that is unemployed. Although there could be regulatory risk, it may not be high for GM. CFIUS could, however, have an interest in fully analyzing the ownership and business relationships of Tengzhong and its 20% partner, Suolang Duoji, to determine whether there could be control by the PRC government.

GM has not yet filed the definitive agreement with the Securities and Exchange Commission. Under SEC rules it has until later the week to file the agreement if it is “material” agreement. Once filed, a review of the agreement should disclose whether the parties will make their voluntary CFIUS filing. 

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September produced two transactions worthy of comments because of CFIUS’ role.

Last July gold mining company Firstgold Corp. of Lovelock, Nevada, announced that it had entered into a binding agreement with a new investor, Northwest Non-Ferrous International Investment Company Limited of Xi’an, China, located in Shanxi province (northern central China). Firstgold is a development stage company with total assets of $19.8 million and a net worth of $5.0 million according to its last annual report filed with the SEC for its year ended January 31, 2009. Its financials are subject to a going concern qualification. Firstgold has been caught up in litigation with two holders of senior secured promissory notes. Northwest agreed to acquire those notes, lend an additional $5.5 million to Firstgold and buy shares representing 51% of the company’s equity, making Northwest both the parent and senior lender to Firstgold. The July announcement stated that the proposed transaction was subject to obtaining all required governmental and regulatory approvals. The deal documentation did not specify Committee on Foreign Investment in the United States (CFIUS) approval, only “regulatory approvals” generally.

Flash forward to September 21, when Firstgold announces that it and Northwest have agreed to extend the time to close their transactions until December 1, 2009. Firstgold’s September 21 press release suggests that Northwest had determined in the interim that it was advisable or necessary for it to file a voluntary notice with CFIUS. In the release, Firstgold takes the position that the CFIUS notice “will not prove to be an obstacle to our closing the transactions we have previously announced.” No doubt it would have been even less of an obstacle if filed in July or August. 

The filing could prove to be more complex than Firstgold believes. CFIUS review of Chinese purchasers tends to be quite exhaustive, particularly on the point of any connections between the purchaser, its board of directors and its principal shareholders and the PRC government. Chinese language submissions are not allowed.

There is a larger question that the Firstgold/Northwest deal raises. Does the U.S. really need CFIUS review for a company that is relatively small and financially weak? Why did Congress not provide a small reporting company-type exemption from FINSA’s notice scheme? Given the scarcity of risk capital in current markets for development stage companies, wouldn’t the U.S. be better served if there were thresholds for U.S. targets before FINSA review is required? 

Updated October 12, 2009--  On October 7 Firstgold updated investors on the status of its proposed refinancing transaction.  Firstgold has made filings with the Ontario Securities Commission so that trading of its stock could resume.  With respect to CFIUS review, the company said that it expects by late October or early November to receive notice from CFIUS that the ongoing review under FINSA is complete and that no further action will be taken.

The New York Times Dealbook blog commented on the September 16 announcement by Chemring Group PLC that it had agreed to acquire aerospace company Hi-Shear Technology for $132,000,000. Hi-Shear is a defense business based in Torrance, California, while Chemring is an English company. The Dealbook blog voices a concern that the parties to the deal have not committed outright to pursue CFIUS and other regulatory approvals. The post points to language in the merger agreement for the proposed deal that requires the parties only to use “reasonable best efforts” to close. But in the following sentence, the agreement requires the parties “to make appropriate filings” under what it refers to as Exxon-Florio. The Foreign Investment and National Security Act of 2007 (FINSA) replaced Exxon-Florio in late 2007. There is a specific provision in the merger agreement that elaborates on the allocation of responsibilities for the parties to file their notice with CFIUS and also sets a timetable. The agreement also specifies a process for the required submission to be made under the International Traffic in Arms Regulations. Receipt of a notice from CFIUS stating that there are no national security concerns or that the CFIUS service has been completed without further investigation is an express condition to completion of the deal. The commentary in Dealbook seems misplaced. Compared with similar language in other merger agreements, the language in the Chemring deal is quite clear and well-drafted.

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Forget about Dubai Ports, forget about Huawei Technologies. There is a new crisis boiling over in foreign direct investment. A Russian billionaire may become the owner of a dearly beloved, U.S. professional basketball team and acquire a controlling interest in the team’s proposed arena in New York City.

On Wednesday of this week, the New Jersey Nets announced that, pending approval from the owners of other National Basketball Association teams and subject to a favorable outcome of litigation surrounding the construction of its new arena, Mikhail Prokhorov’s Onexim Group has agreed in principle to invest $200 million to acquire an 80% interest in the team, a 45% interest in the team’s unbuilt sports arena and the right to acquire a 20% stake in Atlantic Yards, the adjacent real estate project being developed by the team’s current owner, Forest City Ratner Companies. According to the release, the deal will ensure the completion of the proposed Brooklyn, NY-based arena, the relocation of the Nets to Brooklyn and the completion of Atlantic Yards. The tentative date for closing the deal is the first quarter of 2010. 

Mikhail Prokhorev is a high-profile, self-made Russian investor. Many blogs, including Keith Gessen of The New Yorker and Ethan Trex of Mental Floss, catalogue his controversial history. His six-foot-seven height and the fact that he has played basketball make Mr. Prokhorev one of those figures that invite focused interest, even if past media coverage wasn’t enough. And there is the matter of his reported $9.5 billion net worth, making him Russia’s richest man. In his statement, Mr. Prokhorev said, “I have a long-standing passion for basketball and pursuing interests that forward the development of the sport in Russia.”

Forest City’s Bruce Ratner added his own rationale for the deal, stating that he was thrilled that ”[S]mart global investors appreciate the exciting economic potential of Brooklyn. We are one step closer to achieving our goals of creating much needed jobs and economic development for Brooklyn and the city.”

Notwithstanding the promised benefits of the agreement, critics were quick to attack. NoLandGrab, a local opposition group, argues that there must be shady side deals that were undisclosed. Develop Don’t Destroy Brooklyn is adamantly opposed as well, asking

Putting aside legal questions, what are the ethics and policy principles of subsidizing the 40th richest man in the world with city, local and federal financial gifts, as well as a highly controversial use of eminent domain?

The New York Observer reports that Congressman Bill Pascrell Jr., who represents a district that is adjacent to the Arena where the Nets now play, has asked the NBA Commissioner to investigate the deal. Mr. Pascrell has raised questions about a foreign corporation’s benefiting from tax incentives being employed to support the arena. 

So all the elements now are in place for another epic battle over FDI. What will play out here—in the cosmopolitan metropolis of New York, in the legendary Borough of Brooklyn—is the same drama that unfolds in many American towns and villages when the concept of FDI materializes into the real-life acquisition of a local treasure. The forced migration of a sports team is almost always a deep and searing wound. Thousands of fans still mourn the losses of the New York Giants and the Brooklyn Dodgers to California, even though they happened 50 years ago.

The questions proliferate. Will the players or coaches be Russian? If they buy this franchise, will they buy others? Will Americans lose their jobs, even though they are high-paying jobs that most Americans can only dream of? Will foreign ownership change basketball, even though the team in question has never achieved a spectacular record? Will America lose control over one of its institutions, now treasured more in the anticipation of loss than ever before? Arguing that foreigners will benefit somehow from U.S. tax benefits is usually a start to a “we/they” analysis of the situation. Ultimately, someone will ask whether there can be some adverse affect on our national security? 

It’s a good bet that somewhere someone is toiling away, trying to figure out how review by the Committee on Foreign Investment in the United States (CFIUS) can be invoked. Forest City’s hometown paper, The Cleveland Leader, is already advocating that CFIUS must review the deal. 

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 While there has been and currently is considerable focus on inbound mergers and acquisitions originating from China and other Asia-Pacific countries, Brazil’s multinational businesses are also showing strong interest in U.S. targets.

  Earlier this month there were several reports that JBS SA of Sao Paulo was on the verge of purchasing financially troubled Pilgrim’s Pride of Pittsburg, Texas for approximately $2.5 billion. If completed, the deal would create the second largest chicken producer in the U.S. According to another report, in July, a U.S. unit of JBS filed to list its shares on the New York Stock Exchange. CNNMoney.com makes the case that JBS has a strong track record for U.S. purchases. In 2008, JBS acquired the beef operations of Smithfield Foods for $565 million. In 2007, JBS bought Swift & Co. of Greeley, Colorado for approximately $225 million. 

The Deal’s blog also pointed out that a highly-effective Brazilian-dominated management team led InBev’s $52 billion merger with Anheuser-Busch Cos. 

JBS’ planned and completed acquisitions and the accomplishments of InBev’s executives can be viewed in the context of the recent significant growth in Brazil’s direct investment abroad. According to an August 2009 publication of the Vale Columbia Center on Sustainable International Investment, authored by Luís Afonso Lima and Octavio de Barros, Brazil’s outbound foreign direct investment (OFDI) has surged. Although 2009 is likely to show substantially less OFDI than 2008, growth is likely to resume in 2010. If Brazil is able to overcome certain obstacles to OFDI, its investment should permit it to grow at even faster rates.

Vale’s publication reports that from 2000 to 2003, Brazilian OFDI averaged $0.7 billion each year. That annual average increased to $14 billion for 2004 through 2008. In 2008, Brazil’s outbound investments reached nearly $21 billion. In the first five months of 2009, however, Brazil’s OFDI was reduced by almost 90% from the comparable period in 2008. Vale’s publication predicts that Brazilian OFDI would hit the $4 billion level for all of 2009. If completed, JBS’ acquisition of Pilgrim’s Pride would account for over 60% of that amount.

According to the publication, Brazilian enterprises, whether private or governmentally sponsored, are seeking to make outbound investments, motivated by their desire to:

• follow clients into international markets
• defend competitive positions
• monitor competition in international markets
• meet international demand
• reduce dependence on Brazil’s domestic market
• find lower costs, better infrastructure and more attractive fiscal incentives

In the case of JBS, the likely reason behind its US initiative is to continue to build its meat products platform in the world’s largest developed consumer market, as well.

There are factors that may impede growth in outbound investment from Brazil. The Vale publication cites three principal impediments that must be overcome if Brazilian OFDI is to fulfill its promise:

• the Brazilian Development Bank and domestic Brazilian banks must provide investment and acquisition financing to support OFDI initiatives 
• more personnel with skills and knowledge about offshore markets must become available
• the Brazilian government must enter into additional double taxation treaties to relieve the inordinately high tax burden on Brazilian multinationals

The Vale publication is by Luís Afonso Lima and Octavio de Barros, and is entitled “The growth of Brazil’s direct investment abroad and the challenges it faces,” Columbia FDI Perspectives, No. 13, August 17, 2009. The information relating to the report has been reprinted with permission from the Vale Columbia Center on Sustainable International Investment (www.vcc.columbia.edu).

Updated: On September 15 Pilgrim’s Pride confirmed that JBS SA will buy a majority stake in the company in a deal that values the company at $2.8 billion. Pilgrim’s Pride has agreed to sell 64 percent of stock in the reorganized company to JBS for $800 million in cash. Existing shareholders will receive shares totaling 36 percent of the company. It is not yet clear whether the parties will file a notice with CFIUS for regulatory clearance.  At the same time JBS will acquire control of  Bertin SA, one of Latin America’s largest producers and exporters of milk products, beef and leather.

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Continuing with the overworked agricultural metaphor for inbound mergers and acquisitions activity, rainy July did not produce many more green shoots. What grew was largely confined to the fields of pharma, medical devices and battery technology.

On July 14, Japanese pharma business Hisamitsu Pharmaceutical announced its offer to purchase publicly-traded Miami-based Noven Pharmaceuticals for approximately $428 million. According to Corporate Financing Weekly, Hisamitsu is pursuing its strategy of expanding within the U.S. CFW also notes that the 22% premium being paid is slightly below the average premium for pharma transactions announced to date in 2009. Since 2005 there has been a shift to more inbound deals than outbound deals in this sector. The Hisamitsu/Noven transaction is one of $47.4 billion of inbound pharma deals to date this year. 

Dublin, Ireland-based medical device maker Covidien PLC announced on July 30 that it will buy OTCBB-traded Power Medical Interventions Inc. for about $39 million plus assumption of $25 million of debt. Power Medical is based in Langhorne, Pennsylvania and the world's only provider of computer-assisted, power-actuated surgical cutting and stapling products. According to DeviceSpace, once the transaction has been completed, the acquired company will report as part of Covidien’s Endomechanical product line in its Medical Devices segment.

July brought another inbound deal in the battery technologies segment. On July 14, SB LiMotive announced that it had agreed to purchase Cobasys LLC of Orion Michigan (formerly GM Ovonics) from owners Chevron Corporation and Energy Conversion Devices, Inc. According to The Daily Deal, the nickel metal hydride batteries that Cobasys manufactures now are considered second tier to lithium-ion batteries. Other companies are choosing lithium-ion batteries since they weigh less and provide more power in less space. SB LiMotive is a $520 million joint venture between Samsung SDI Co. Ltd. of South Korea and Robert Bosch GmbH of Germany. The SB Limotive joint venture was formed last year to market lithium-ion batteries.  This transaction follows the activity in battery technology earlier in the summer involving Tesla motors.  See our earlier post on the Tesla deal with Daimler. 

August can be a surprise month in the capital markets. The great bull market of the 1980’s started during August 1982. We’re rooting for the comeback, vacations or not. 

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The Foreign Investment and National Security Act of 2007 (FINSA) and its regulations are intended to strike a balance between the opportunities and threats associated with inbound investment into the United States. The regulatory structure for addressing the conflicts often created by inbound investments is review by the Committee on Foreign Investment in the United States (CFIUS), and its approval or disapproval of acquisitions and investments that might harm genuine U.S. interests.

For example, if a foreign nation with intent inimical to the United States were to acquire a high-tech business whose products were, or had the potential to be, essential for the critical functioning of large portions of the U.S. economy, the regulators would scrutinize the risks arising from the transaction. If necessary, the regulators would impose conditions to mitigate those risks or perhaps even block the transaction. Because it is based on national security grounds rather than economic security grounds, the system is designed to be less susceptible to undue political influence. 

A reasonably designed system would also designate a class of transactions between a foreign buyer and a U.S. target that need not be scrutinized. One reason for doing so would be that certain transactions as a class present low risks to U.S. national security. Therefore the costs of review far outweigh possible benefits. Similarly, the efficient and timely functioning of the regulator may require that fewer than all transactions be reviewed. In defining the class of transactions that is except from the system, legislators often use quantitative, rather than principle-based, measures. So, for example, review by CFIUS does not reach investments of less than 10% of outstanding voting stock of a U.S. business if the investment is passively held. The exemptive rule applies both to an initial investment in a U.S. business and to subsequent transfers that the investor may make to foreign persons. The rule applies to transfers made by the transferee and by any subsequent transferee as well.

The exemption, however reasonable, can lead to questionable results. For example, after a recent transaction Aabar Investment PJSC of Abu Dhabi has now come to own approximately 4% of Tesla Motors Inc. of San Carlos, California. Tesla is perhaps the most advanced developer of commercial all-electric cars in the United States. Aabar is an investment company whose largest stakeholder is the International Petroleum Investment Company, which in turn is wholly-owned by the Government of the Emirate of Abu Dhabi. Aabar’s shares also trade on the Abu Dhabu Securities Exchange. Aabar acquired its interest in Tesla from Daimler, AG, based in Stuttgart, Germany. Daimler had acquired an interest of slightly less than 10% in March of this year in exchange for an infusion of $50 million into Tesla. Aabar holds 9.1% of Daimler, making it Daimler’s largest shareholder. According to the blog earth2tech, Daimler never intended to keep the full investment for long. Daimler and Tesla apparently tried to make the original investment jointly, but terms could not be fully worked out between them in March.

There is no indication that either Daimler’s original investment or its resale to Aabar underwent CFIUS scrutiny, even though Aabar is a government-controlled entity. Both seem to have relied on the exemption for acquisitions of less than 10% of shares. 

Now to engage in a law school-styled hypothetical. What if the participants were other than Daimler or Aabar? Suppose the shares wound up in the hands of a nefarious investor who intended to use its position to retard Tesla’s technology or to put it in the hands of an ill-willed competitor. As noted above, reasonable standards for exemption may be necessary to prevent bureaucratic overreach. Reasonable standards can, however, morph into a pathway for circumvention. 

Tesla has presumably protected its own interests. It may have retained the ability to approve or limit transfers and subsequent transfers of its shares. It may have restricted by contract its obligation to share its technology with stockholders. It may have imposed legal limitations on the ability for any investor who has access to its technology to use or transfer it. These protections are normal and sound, as long that the company has the bargaining power to obtain them while negotiating the deal with its prospective investors.

As a final note, there must be something about the name Tesla that attracts the possibility of bad acts. Nikola Tesla was a Serb-American physicist and electrical engineer, inventor of the radio and the electric motor and generator. He is regarded as one of the major forces in the development of commercial electricity. Although famous in his day, Tesla became embroiled in disputes with Marconi others about his intellectual property. No doubt the responsible executives at Tesla Motors are aware of the burden of history.   

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Last month Thomson Reuters and J.P. Morgan jointly published  "The Era of Globalized M&A: Winds of Change."  The research document points out that currently mergers & acquisition activity that is targeted at U.S.-based companies accounts for only 10% of global cross-border activity.  As can be seen from Exhibit 3.3 included in the document, this compares to levels of 20% to 30% or more during 2005 through 2007.  

 

The inbound activity level has not been this low since 1992, suggesting that when it returns it may show a sharp rate of increase.   

At the same time, China appears to be positioned to increase its outbound foreign direct investment. The  Reverse Mergers blog authored by noted New York attorney David Feldman recently reported that

The government has worked to encourage “ODI” (overseas direct investment) by Chinese folks. Often the level of ODI is compared to “FDI” (foreign direct investment), which is also encouraged. They expect ODI to reach $180 billion this year while FDI will probably hit around $100 billion. Watch for more Chinese takeovers of companies throughout the world as the recession continues to lower values while China has huge foreign exchange reserves.

So if there is a rebound in U.S. inbound M&A activity, it is possible to estimate how much of the anticipated increase will come from China?

Bloomberg News reported last week however that China’s direct investment abroad fell substantially in the first half of this year.  According to Chen Jian, Vice Chairman of China's Ministry of Commerce, non-financial overseas direct investment was $3.7 billion in the first quarter of 2009, a small fraction of the $170 billion invested outbound up to 2009.  From that perspective, the U.S. appears to be unlikely to receive much direct investment from China.  But the answer is simply not that straightforward.

A policy brief published last month by Daniel H. Rosen and Thilo Haneman of the Peterson Institute for International Economics, entitled "China's Changing Foreign Direct Investment Profile," provides a remarkably comprehensive and insightful view of China's programs and policies underlying outbound foreign direct investment (OFDI) . The Peterson Institute's brief describes the changing trajectory and nature of China’s OFDI toward those investments that will rebalance its economy and capture a larger share of the value chain in the manufacture and sale of its goods. It then offers six principal conclusions:

• readjustment of China’s growth model, more than political considerations, is driving the changes in the motives and targets of China’s OFDI
• currently, investment review by developed nations focuses on national security issues, and away from economic security issues; the exceptional degree of Chinese governmental involvement in China’s corporate and economic sectors will test the direction of investment reviews
• because China’s business are globalizing after OECD-country businesses have become globalized, it is in China’s interest to sustain open cross-border investment
• China’s need to accelerate its global investment presence is important for reasons beyond those narrowly related to foreign direct investment, including restoring global growth, alleviating poverty, rebalancing global growth patterns and mitigating climate change
• better statistical clarity is a prime requisite for China to maximize the benefits of OFDI
• in growing its OFDI, China will require assistance and cooperation from businesses, individuals and other governments

The brief does not single out the U.S. as being a more or less likely destination for China’s OFDI. Given the ability of U.S.-based business to enable China to achieve its OFDI goals, the inflow to our shares seems almost inevitable. There are no guarantees, however. The report itself points out:

The global financial crisis rekindled expectations that China would be buying, but lost value in the US securities and other poorly performing investment in a US financial firm .  .  . again turned the tide, prompting statements from Beijing that investment in distressed sectors abroad would be off limit. At present it again seems that political wind is blowing outward, carrying delegations to “bottom fish” the United States and Europe. Yet the callousness with which Beijing has blocked a number of inward investments in the past raises questions about its seriousness toward cross-border investments both ways.

 In a subsequent post, we will summarize those findings of the Peterson Institute brief that relate to national security reviews of inbound investment, inlcuding CFIUS. 

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 June produced a few more noteworthy green shoots for inbound deals.

In a strategic transaction announced at the beginning of the month, Taiwan-based Prime View International is acquiring Cambridge, Massachusetts-based E Ink Corporation for approximately $215 million. Prime View develops, manufactures and sells thin-film transistor liquid crystal display (TFT-LCD) products. Shares of Prime View are traded on the Taiwan stock exchange. E Ink is the leading supplier of electronic paper display (EPD) technologies and is privately-held. The transaction is subject to shareholder and regulatory approval and is expected to close in the fourth quarter of 2009. CFIUS approval is not  specified.  The Pulse 2 blog reports that Prime View and E Ink have been partners since 2006, and that together they have supported about 20 e-book manufacturing companies worldwide. 

On June 16, Calgary-based TransCanada Corporation announced that it had reached an agreement to buy the remaining interest of Houston-based ConocoPhillips in the Keystone Pipeline System. Now under construction, Keystone will be one of the largest oil delivery systems in North America, extending through the upper Midwest to Illinois and Oklahoma. TransCanada will pay approximately $550 million, and assume both $220 million of short-term debt and ConocoPhillips’ obligation to fund its share of the capital investment to complete the project, valued at approximately $1.7 billion. The transaction is expected to close in the third quarter of 2009, subject to regulatory approvals. CFIUS approval is not specified. 

On June 23, Atlanta-based Office Depot sold a significant equity position to funds advised by BC Partners, the London-based international private equity firm, raising $350 million. The equity stake represents a 20% interest in the U.S. company, assuming full conversion of shares. Three executives named by the investors will join the board of Office Depot.

On June 25, Arcadis NV announced that it planned to acquire privately-held Malcolm Pirnie Inc., a water-services company based in White Plains New York, for $222 million in cash and stock. Malcolm Pirnie provides engineering and consulting services to states and cities in the United States. Arcadis, with over 13,500 employees worldwide, is based in Arnheim, Netherlands, and provides consultancy, engineering and management services worldwide. According to Mergers Unleashed, the shares being issued in the transaction were valued based on the closing stock price for shares of Arcadis of $14.981 on June 24. The Dealbook blog reports, “The deal, expected to be completed next month, will improve Arcadis’s position in the United States, and in the water services business worldwide.” Dealbook also reports that the deal will afford Arcadis access to investments in U.S. infrastructure by municipal governments. It is possible that access to infrastructure might lead the parties to seek CFIUS review, but there is no confirmation on that point.

We look forward to reporting what transactions July brings. With better weather, and a little less rain here on the east coast of the U.S., the shoots may become more of a lawn. 

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Inbound investments into the United States by sovereign wealth funds (SWF’s) were the subject of a second report issued last month by the Government Accountability Office (GAO). Last September GAO released a report describing data that was available on the size and investments of SWF’s in the United States. Both reports responded to questions that members of the Senate Committee on Banking, Housing and Urban Affairs had raised about the increasing investment activities of SWF's. The May report examines U.S. laws that specifically affect foreign investment and the processes that U.S. agencies use to enforce these laws. The report found that no laws targeted only SWF’s. It’s a important resource for any advisor or principal looking for a survey of the regulation of foreign investment. 

The Harvard Law School Forum on Corporate Governance and Financial Regulation contains a good summary of the report, authored by Jeff Trinklein, in particular that part of the report that catalogues the applicable laws:

Before proposing a transaction involving a U.S. asset, the GAO suggests that foreign investors should be aware of four different areas of focus.

1. CFIUS Review. The Foreign Investment and National Security Act of 2007, an amendment of the Defense Production Act of 1950, provides that any foreign acquisition, merger, or takeover of a U.S. business is subject to a review by the Committee on Foreign Investment in the United States (CFIUS), if the proposed transaction could potentially impair U.S. national security interests. The review is intended to determine if the proposed investment presents serious national security concerns, and if so, CFIUS can enter into an agreement that will impose conditions in order to mitigate those concerns. Following the review, the President is authorized to suspend or prohibit the transaction if there is credible evidence of a national security threat. Furthermore, due to recent changes in CFIUS rules, the normal 30 day review period is extended by an additional 45 days if state-owned entities are deemed to have a controlling interest in a transaction.

2. Emergency Powers. The International Emergency Economic Powers Act gives the President the authority to prohibit certain transactions if the transaction is seen as a threat to national security, foreign policy, or the economy of the United States.

3. Political Risk. General political risk may threaten a proposed investment. For example, the Dubai Ports World investment in U.S. port facilities was first approved by CFIUS but ultimately was abandoned due to the intense political controversy it provoked on Capitol Hill.

4. Public Disclosure. Any company that does business in the United States is subject to general reporting requirements including, but not limited to, confidential disclosure requirements for foreign-owned companies.

The report concludes that staff at certain agencies do not routinely review information from other governmental agencies or private sources to supplement the information that they use to enforce their own rules. GAO reached this conclusion after detailing the various and differing approaches to enforcement that six agencies follow. 

Reading between the lines, there may be a suggestion for a more uniform approach across federal agencies to foreign investment by SWF’s or perhaps even regulation centralized within a single agency.   There's no indication of whether there will be a third report and, if so, whether with wil address itself to the question of whether inter-agency uniformity or centralization would assist foreign investors who may be deterred by the current mutli-facted process.

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It’s well to remember that CFIUS is not the only regulator of cross-border deals that affect U.S. businesses. 

The Wall Street Journal’s Deal Journal on June 11 quoted Liu Shanwen, the CTO of Dongfeng Motor Group, who discussed Sichuan Tengzhong Heavy Industrial Machinery’s pending purchase of Hummer.  Mr. Liu estimated the transaction has less than a 30% chance of being approved by China’s Ministry of Commerce.  Hummer’s buyer does not have a high profile in China, and the Hummer product seems to be the opposite of the fuel-efficient automotive technology that the Chinese government is actively promoting.  According to Automotive News, Sichuan Tengzhong is privately owned and manufactures heavy special-use vehicles, structural components for highways and bridges and construction machinery. Hummer’s management is optimistic about an enhanced product line after the deal closes later this year, including changes to current products.

Even if it were predictable that Chinese regulators would be less than enthusiastic with Hummer’s becoming a Chinese product, there may have been another Chinese contender for the purchase of Hummer—Beijing Automotive Industry, Daimler’s China partner. According to several reliable media sources, Beijing Automotive has also expressed interest in acquiring Volvo from Ford, having been unable to capture GM’s Opel unit. Beijing Automotive and Geely Automotive Holdings are reportedly in competition for Volvo. Geely, China’s biggest private automobile maker, had been mentioned as an interested purchaser of some of GM’s models. There is no indication yet whether China’s regulators will weigh in on the Volvo transaction.

 

Not to be outdone, even if in Chapter 11, GM too is looking to shed its Scandinavian unit, Saab Automotive AB. According to MarketWatch, a Swedish TV station has reported that Saab has agreed to be bought by Koenigsegg Automobile AB, a niche sports-car maker that employs only 45 full-time workers and produces only a few cars a year. The deal apparently has the backing of the Swedish government, which may be prepared to issue a loan guarantee to support Saab going forward. Unlike Beijing, there do not appear to be regulatory hurdles in Stockholm.

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As of yesterday evening, the U.S. Supreme Court allowed the purchase of Chrysler’s business to proceed as part of Chrysler’s Chapter 11 proceedings. The sale now has closed. A consortium that includes Italy’s Fiat SpA will acquire key assets of Chrysler’s international operations, including the core U.S. business, within a matter of days. The deal has been prominent in the news, particularly when the appeal by pension funds and consumer groups generated some uncertainty. The deal also is historic because of the extent of the U.S. government’s direct involvement as a party and as a dealmaker.

The sale of Chrysler provides a case study for applying the Foreign Investment and National Security Act of 2007 (FINSA) and its implementing regulations, administered by the Committee on Foreign Investment in the United States (CFIUS). 

Fiat and its wholly-owned subsidiary--the buyer that will carry on Chrysler’s business--have entered into a “Master Transaction Agreement” with Chrysler and most of its subsidiaries. The U.S. Treasury, the Canada Development Investment Corporation and an independent health care trust have entered into agreements to subscribe for equity membership interests and become Class A members of the buyer. The buyer will apply the proceeds of those subscriptions to pay its $2 billion cash acquisition price to Chrysler. Fiat has agreed to contribute to the buyer certain rights to Fiat technology--including product platforms, powertrains and other key technology, management services, access to international markets and other distribution enhancements--and retains a 20% membership interest. The buyer can increase its 20% interest to 35% in three tranches of 5% each by satisfying certain performance metrics. Fiat also has the option to own a 51% membership interest in the buyer. Fiat and the buyer will be cooperating in the development of joint purchasing programs, the sale of Fiat products in North America and the sale of the buyers products elsewhere through Fiat’s network, R&D activities and branding opportunities. 

According to the White House’s initial announcement of the deal on April 30

• The U.S. Treasury will receive 8% of the equity of the new Chrysler and also has the right to select the initial group of four independent directors of the buyer; and
• The Canadian participant will receive 2% of the buyer’s equity of the buyer and will have the right to select one independent director on the same basis as the four independent directors initially chosen by the U.S.

Analyzing these parties and their relationship to each other under the U.S regime for regulating foreign investment leads to a conclusion that their deal is a “covered transaction.” Covered transactions are subject to the voluntary notice procedures that CFIUS administers and to unilateral CFIUS review if no filing has been made. If a deal is a “transaction” with “foreign person,” and if as a result the foreign person acquires “control” or could acquire “control” of a U.S. business, then the transaction is a covered transaction. The FINSA regulations give the words in quotation marks special meanings. Applying those special meanings to the facts of the deal determines whether the voluntary filing requirement apples. 

• First, since the transaction among Chrysler and the other parties is an acquisition, it is a “transaction.”
• Second because Chrysler is a business entity engaged in U.S. interstate commerce, it is a “U.S. business.”
• Third, is the buyer a “foreign person”? Under the rules, a “foreign person” is any entity over which a foreign person exercises control. Fiat is a foreign person. Before the deal it owns 100% of the buyer. After the deal it owns 20% of the buyer with the right to own 51%. The rules define control to mean the power to “determine, direct or decide important matters affecting an entity.” The basis for the right need not be a majority position; a “dominant minority” is sufficient. Fiat’s business arrangements with the buyer, the board members it presumably will be able to appoint and its ability to achieve 51% ownership satisfy the requirements for control to exist.  The public's perception, expressed by Carcorner, is that Fiat is in control.
• Fourth, the buyer--a foreign person--is conclusively acquiring control of Chrysler.

If the parties have entered into a covered transaction, have they filed with CFIUS? Although their agreement details what antitrust filings the parties will make, it uses general, non-specific language for all other governmental filings. The receipt of governmental approvals was a condition to closing for all parties. Was the condition met or was it waived to close ASAP? The details of what filings were being made are in annexes to the agreement that do not appear to be publicly available. 

It may be interesting to speculate here. In all likelihood, the parties have made their CFIUS filing. If Chrysler and Fiat have not filed, however, it may be because they perceive no national security aspect to their deal and therefore no risk that, because of the absence of a filing, CFIUS will challenge their deal--a risk that few others might take. In its December 2008 Annual Report, CFIUS provided data on filed transactions in the transportation segment of the manufacturing sector. This means that other parties in the industry concluded that there was sufficient connection between the segment and U.S. national security to justify the time, expense and delay of filing a notice with CFIUS. The Report also points out that CFIUS monitors surface transportation and industrial automation as “critical technologies.” 

Since all CFIUS filings are shielded from public access, until CFIUS issues its next annual report the public may not know whether Fiat and Chrysler filed. If they haven’t, could CFIUS challenge the deal when a different administration is elected? 

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This morning's print and online media, including Dealbook, is covering GM's planned sale of its Hummer brand to China-based Sichuan Tengzhong Heavy Industrial Machinery Co., Ltd. for a price that is reported to be less than $500 million.  The business being sold does not include the military vehicle after which the Hummer is designed. Chinese news media also carried stories reporting the memorandum of understanding.

Sources reporting the planned sale included automotive blogs, including Kicking Tires and Autoblog.

This development for GM is an interesting follow up to our blog posted May 25 speculating whether sales of U.S. automotive businesses to non-U.S.buyers will trigger CFIUS review.  The article in today's Wall Street Journal reporting the transaction includes a chart that reviews the regulatory review record for major recent inbound deals originating in China. 

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Ben Bernanke’s now-famous green shoots may be sprouting in the inbound M&A and investments garden. During May, some inbound deals appeared in the financial press: 

• On May 11 Covidien Ltd. of Dublin, Ireland announced its offer to acquire San Jose, California-based VNUS Medical Technologies Inc. for $440 million in cash. According to Medical Devices Today, the deal is the largest acquisition that Covidien has made since its 2007 split off from Tyco.  
• Agrium Inc. continued its bidding for U.S. fertilizer maker CF Industries Holdings Inc., offering $40 per share. Agrium is based in Calgary, Alberta. CF Industries is headquartered in Deerfield, Illinois.
• In a small but prominent transaction involving both a Swedish buyer and seller, Seabay Media is acquiring U.S. newspapers group from Metro International SA. 
• The Wall Street Journal of May 13 reported that Peter Gray, a managing director with KPMG Corporate Finance LLC, expects international companies with cash reserves, especially from India, China and Korea, to more aggressively hunt for coal operators in North America.
• May also brought developments in the ongoing attempted takeover by CSL Ltd. of Talecris Biotherapeutics Inc. According to Dealscape, the FTC announced that

"it would go to court to stop a merger between the Victoria, Australia-based suitor and its Research Triangle Park, N.C., target because the agency believes the deal would further consolidate an already small pool of competitors."

This development shows that CFIUS is not the only regulatory obstacle to non-U.S. buyers as they focus on U.S. targets.  Updated June 10.  Talecris has withdrawn its offer for CSL because of regulatory hurdles. 

• Showing that all aspects of the U.S. economy--even leisure industries--are fair game for inbound buyers, a Chinese investment group acquired a 15% minority position in the Cleveland Cavaliers, according to the China Economic Review. Could last night’s defeat at the hands of the Magic be a material adverse change in the transaction? Hopefully, the lawyers for the Cavaliers drafted carefully around that point. 

 

• Updated:  One more May deal.  DRS Technolgies, headquartered in Parsipppany, New Jerse, and a subisidry of Italy's Finmeccanica SpA, agreed to acquire privately-held Soneticom, Inc. of West Melbourne, Florida.  Price and other deal terms were not available.  Soneticom is a leading provider of precision geolocation systems and communications products.  The transaction is expressly subject to CFIUS approval. 

USAInboundDeals looks forward to providing our readers monthly reports that show continuing vitality in inbound deals. If any readers are tracking inbound deals that we’ve overlooked, please send a comment. 

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