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

Although multinational enterprises (MNEs) from developed economies are likely to provide substantial outbound foreign direct investment to the United States by way of M&A transactions, buyers from other nations are gaining presence. The role of Russian MNEs and investors as buyers may be increasing. 

A publication earlier this month by the Vale Columbia Center quantifies the importance of Russia as a source of outbound foreign direct investment (OFDI) for the United States and other developed nations. Professor Andrei Panibratov, Associate Professor of the Graduate School of Management of Saint Petersburg State University, and Kalman Kalotay, Economic Affairs Officer at UNCTAD in Geneva, Switzerland, authored the profile to highlight the increasing importance of Russia’s FDI program. The profile demonstrates that Russian direct investors are continuing to penetrate foreign markets and undergo a process of internationalization. The authors suggest that a carefully considered policy from Russia’s government would significantly enhance the benefits to Russia from its OFDI.  

According to the publication, various motives drive Russian OFDI: 

• The desire of managers and owners to control or offset Russia’s political and economic risks 
• Expected profitability of the investments themselves
• Expectations for better global recognition

Although Russia’s OFDI fell by 15% in the first quarter of 2009, compared with the first quarter of 2009, at the end of 2008 Russia held the second largest stock of foreign direct investments among the emerging economies, aggregating US $203 billion. This stock exceeds the investments held by Brazilian, Chinese and Indian multinationals. Between 1995 and 2007, Russia’s offshore investments grew more rapidly than did the investments of Brazil, China and India. Mergers and acquisitions by Russia’s multinationals from January 2005 through June 2008 were over ten times the volume during the 2001 through 2004 period. There are 50 to 60 Russian multinationals that account for a significant part of offshore acquisitions. The total number of Russian MNEs investing offshore exceeds 1,000, the authors believe. 

Among the 2009 inbound U.S. transactions was the purchase by Trubnaya Metallurgicheskaya Kompaniya OAO (TNK) of a 49% interest in Kentucky-based NS Group Inc. for an undisclosed amount. NS Group is a manufacturer of tubular goods.

It’s worth noting that the 2007 acquisition of publicly-owned Oregon Steel Mills by Evraz Group SA, a Luxembourg company with Russian affiliation, cleared the Committee on Foreign Investment in the United States (CFIUS) without much apparent problem, unlike transactions originating in other emerging market economies. Most of these business operate in the oil and gas, metallurgy, finance and communications industries. 

All of which suggests that Russia may provide fertile soil for inbound deals. 

The report is the first in a series of Columbia FDI Profiles that the Vale Columbia Center on Sustainable International Investment has recently launched. Material in this post is reprinted with permission from the Center (www.vcc.columbia.edu). 

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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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The global economy is struggling with some success to recover from the turmoil of the last two years. Attorneys, investment bankers and other professionals now are trying to predict where global mergers and acquisition activity will begin to increase. What markets are likely to first benefit from the return of global FDI?

Earlier this year, the United Nations Conference on Trade and Development (UNCTAD) released its World Investment Prospects Survey for 2009-2011 (WIPS). WIPS provides an outlook on future trends in FDI by the largest multinational business enterprises. WIPS compiled the results obtained from a sample of 241 company executives of the large non-financial multinationals and from 20 direct interviews. 

WIPS predicted the top 15 countries that will receive FDI for 2009 - 2011:

1. China
2. United States
3. India
4. Brazil
5. Russian Federation
6. United Kingdom
7. Germany
8. Australia
9. Indonesia
10. Canada
11. Vietnam
12. Mexico
13. Poland
14. France

The United States improved its position by one step over last year’s survey, replacing India in the number 2 slot. Brazil moved past Russia, achieving the 3^rd place position.

The reasons underlying the selection of these countries were predictable and included:

• market size
• market growth
• availability of less expensive labor
• access to natural resources
• quality of the business environment

Of even greater interest, however, is the distribution of the responses from the survey participants. First, the top 15 countries accounted for 74% of the total responses. This is close to the 80/20 phenomenon seen in other measure of voluntary market participant choices—such as favorite websites or favorite books—in which 80% of the respondents pick the same 20% or less of available choices. Second, as shown in the accompanying chart from WIPS, China, the United States and India appear to have more favorable responses than do the other twelve nations. This type of sharp drop off from highest to lowest in frequency of choice is referred as a power law curve. The power law curve is an algebraic graph plotting data in which the N position has 1/N^th of the first position’s rank. This distribution occurs where the responses represent free choices and is at odds with a normal bell curve distribution.* 

Then, what are those attributes that make a country attractive to FDI. WIPS recites:

• “For market growth, developing and transition economies are generally favored, such as China, India, Brazil, the Russian Federation, Indonesia, Vietnam, Poland and Thailand.
• For market size, the largest economies are favored, either developed ones such as the United States, Germany and Canada, or emerging ones such as China, the Russian Federation and Brazil.
• For access to regional markets, countries that are integrated into large markets, or which are close to large and growing economies, are favored, such as Mexico, Germany, Vietnam and Poland.
• For presence of suppliers, mostly developed countries are favored, such as the United Kingdom, Germany and France, and, to a slightly lesser extent, some developing countries such as India.
• For their business environment (including government effectiveness, stability and quality of infrastructures), developed countries such as the United States, Germany and Australia are favored. France is frequently mentioned for the quality of its infrastructure.
• For skills and talent, developed countries such as the United States, Germany, the United Kingdom and France are favored, but also some developing countries, such as India and Thailand.
• Cheap labor is cited for favoring developing countries, mostly in Asia, such as China, India, Vietnam, Indonesia and Thailand.
• For access to natural resources, countries well endowed with them, such as Canada, Australia and Indonesia, are favored.
• Access to capital markets is frequently mentioned as an asset for the United States, the United Kingdom and Canada. 
• Incentives is frequently mentioned for Australia, Vietnam and Brazil.” 

WIPS concludes on an optimistic note, expressing the view of its respondents that a progressive recovery will start slowly in 2010 and gain momentum in 2011. The basis for the optimism is that the growing internationalization of business enterprises will lead to a new wave of international investment projects as the recovery takes hold. When and if that occurs, these key factors are likely to play a major role in deciding where FDI is targeted. 

Implicit in these findings, and in the power curve as well, is a warning for the United States. The United States could fall behind its competitors for any one or more reasons – a slower recovery, unfavorable tax policies, protectionist trade practices or restrictive regulation of which investments, to name just four. The power curve is a slippery slope. If the U.S. falls to 4th or 5th place, it will fail to receive substantial amounts of FDI and may be unable to require the 1st or 2nd position for years to come.

*For a compelling discussion of the power law curve and its application in the context of social media, see Clay Shirkey's Here Comes Everybody: The Power of Organizing Without Organizations.

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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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How likely is it that the remainder of 2009 will see an upsurge of mergers and acquisitions or other investment activity from China?

Financial Web site 24/7 Wall St. provided its answer in a September 1 post, arguing that, in spite of China’s insatiable appetite for energy deals, that nation is more than reluctant to invest in the U.S. 24/7 Wall St. catalogued announced deals over the past year with public companies across the globe and tallied $50 billion of oil and gas purchases, as well as uncounted unannounced deals, without the merger or acquisition of a single U.S. public oil company:

As asset prices sink, it is easier for China and its central government to buy more and more of whatever it wants on the cheap. . .  . [T]he pace at which China is locking in energy supply deals seems to only be increasing. And it is effectively doing it without a single handshake taking place on U.S. soil and without U.S. oil.

The post suggests that the 2005 CFIUS action that blocked Chinese National Overseas Oil Corporation from acquiring Unocal—later acquired by Chevron—still looms as a basis for Chinese buyers to avoid U.S. deals. This view discounts the Obama Administration’s desire to turn the page on the actions of the prior Administration, as recently shown by the July Chinese/U.S. cabinet-level meetings held in Washington, discussed in this blog’s August 6 post.

As Exhibit I to 24/7 Wall St.'s position, there was the August 31 announcement from Athabasca Oil Sands Corp. of its joint venture with PetroChina International Investment Company Limited, a wholly-owned subsidiary of Asia’s largest oil and gas company. Through the venture, PetroChina has agreed to acquire a 60% working interest in AOSC's MacKay River and Dover oil sands projects for $1.7 billion. The agreements also provide for certain financing arrangements for AOSC. The projects are located in the centre of the Athabasca area in northeastern Alberta and have been independently assessed to contain approximately 5 billion barrels of bitumen resource.

Looking more broadly, however, there is a significant amount of FDI that is directed at the United States, particularly in areas other than the energy sector, and the future seems quire promising. The International Trade Administration (ITA) of the U.S. Department of Commerce recently reported that from 2004 to 2008 the FDI position of the Asia-Pacific nations in the U.S. grew at an average annual rate of 10%, exceeding the global average growth rate by 25%. The annual growth rate of FDI from China into the U.S. during that period was 23%. Although this growth rate was not as high as that of Singapore (49%) or India (48%), it approximates that of South Korea. It can hardly be considered to be negligible.

The ITA cites three motivating factors that drive FDI: access to innovation, markets and resources. The ITA makes that case that the U.S. excels in each category, noting that, "In many cases, Asian-Pacific companies do not invest in the United States solely to minimize the cost of inputs, such as . . . natural resources . . . ." Therefore, although the U.S. can offer a workforce with high productivity to offset its higher cost, a highly efficient transportation system and openness and transparency, in the natural resources sector, our assets may come with costs that compare unfavorably to Canada, Australia and other markets.

The ITA report states that "the United States should expect large increases of FDI flows, especially from China and India . . . ," the third and twelfth largest world economies. Based on trend evidence accumulated over the past 50 years for other economies such as Japan, the relative and absolute amounts of their OFDI into the U.S., ITA predicts that OFDI from those nations will increase to be in line with their rankings. The report also points to academic studies demonstrating that developing nations generally promote OFDI and eventually become net outward bound investors. Those trends cannot occur without significant investment into the US from Asia-Pacific nations in general and China in particular.

The ITA report asserts that inbound FDI will occur. Nonetheless, the predicted influx seems to not yet be occurring, as 24/7 Wall St. points out. Q4 of 2009 may reveal more as to which camp has the better argument.

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Investment bankers, lawyers and other professionals often overlook the importance of other third parties in facilitating inbound FDI transactions. A prime example is the increasingly critical role that the economic development community may be able to play in bringing inbound mergers and acquisitions to the United States to stimulate recovery. 

Worldwide, there are over 7,000 economic development organizations (EDOs) and investment promotion agencies (IPAs) operating on behalf of cities, towns, regions and countries. There are over 4,500 members of the International Economic Development Council (IEDC) in the U.S. Since the economic turndown has resulted in significant businesses closures and job losses, U.S.-based agencies now may be looking to continued foreign investment to restart their economies.  Their search for inbound investment leads to rivalry and competition because demand for investment greatly exceeds supply. 

Economic development efforts are at an inflection point. Until 2008 or this year, EDOs have been seeking “greenfield investment”— the startup of a new business or the relocation of a existing business to their area. The worldwide economic crisis has, however, led to business consolidation. 

In a business consolidation phase, expansion is unlikely to take place. Instead, business combinations — mergers, consolidations or takeovers — occur. The aim is to spread greater business activity over lower expenses.

Lower expenses, however, often mean job losses, reduced requirements from vendors and fewer outflows in general. These effects are not the effects that EDOs desire to create. EDOs advocate for more jobs, more business for local vendors and increased outflows from new business into their community. So it becomes challenging for EDOs to advocate mergers, takeovers or other business combinations when the result may be to exacerbate conditions that already are bad. 

But, in a downturn, if businesses already are devastated, business combinations that take advantage of companies already shuttered or whose fate is clear unless repositioned can have salutary effects. It’s a question of public perception. That’s where marketing and education come in.

So the EDO agenda now has two goals. First, win public support for all forms of inbound investments, including business combinations with inbound buyers. Second, continue convincing inbound buyers of the significant benefits to be gained from owning and operating businesses in the U.S. 

The Strengthening Brand America Project aims to have U.S. EDOs place a higher priority on FDI attraction as a strategy for accelerated economic recovery. Founded by Edward Burghard, the Project is a community of practice targeted to EDO professionals. The Project’s goal is to facilitate the transfer of private sector product and corporate branding principles to the public sector.

The Project has succeeded in making publicly available data for inbound capital investment on a state-by-state basis for 2003 through 2008. fDi Intelligence, a specialist division of Financial Times, harvested and analyzed the data. The data gives an excellent perspective on the comparative successes of state-level EDO campaigns. For the five-year period:

• the top 10 states picked up more than 45% of the inbound investment
• the results vary considerably from $57,320 million for top-rated Texas to $287 million for bottom-rated Vermont
• among the bottom 80% of states, no state received more than 2.9% of the incoming funds

Results for 2009 are likely to differ significantly because the total incoming amount will be significantly less.

The overall challenge looms large—to replace these meaningful amounts of inbound capital investment with inbound M&A. With the support of the Strengthening Brand America Project and the data it provides, states and localities have superior tools to take on the task ahead. 

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Intuitively, FDI into the U.S. should be increasing. An increasing chorus of economists is declaring that the recession at or near to an end. Asset prices remain low. IPO’s in the stock markets have begun to stir, raising hopes for exits from investments and for capital to recast balance sheets. The anecdotal evidence is that FDI continues to stream toward other developed economies such as Australia, and transitional economies, such as China and Brazil. Is the U.S. likely or not likely to be an early beneficiary of FDI flows as the world economy recovers?

OCO Global develops strategies for economic development organizations and investment promotion agencies worldwide. Led by its CEO, Mark O’Connell, earlier this year OCO’s editorial team published “A New Investment Paradigm,” a forecast of near-term market directions for FDI.

The findings of OCO’s report include:

• a prediction for a bounce in M&A from companies that normally would have expanded through greenfield investments
• firms from emerging markets have entered the world FDI market in force and are formidable competitors; these firms will use M&A as the pathway for investing in host economies; for example, Indian FDI into the U.S. could triple over the five years ending 2014
• OFDI from China nearly doubled and the trend is likely to continue, following the government’s promotion of a “go global” policy, particularly in service industries
• the vast majority of recorded OFDI from China has been from large state-owned enterprises (SOE’s); future OFDC is more likely to originate within its private sectors
• less than 5% of China’s OFDI has been directed at North America; there are at least two rationales for this relatively small percentage:
  • a lack of readiness by Chinese businesses to compete with large U.S. companies on their home turf; and
  • a fear of U.S. protectionism hiding behind a regulatory screen
• in China, the availability of foreign exchange reserves combined with credit availability makes OFDI affordable and inviting, particularly if targets with existing market share and recognized brands are cheap

One could connect the dots among these factors and conclude:

• the greater availability of credit to offshore businesses -- plus a strategic need to bolt on the right target -- gives inbound acquirers significant advantage
• the “buy versus build” scale may have tipped to the “buy” side for multi-national enterprises and investors
• low visibility of revenue growth for U.S. based companies may hold down valuation multiples, making acquisitions more affordable
• the need for capital, especially capital that increases employment and capital expenditures, may make inbound acquisitions more palatable -- even desirable -- in parts of the U.S.
• as more foreign buyer become truly privately-owned, and fewer are SOE’s, U.S. businesses and their constituencies (i.e., labor, localities, vendors) may become less averse to inbound deals

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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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Is it reasonable for U.S. businesses to expect mergers and acquisitions activity and investments from Chinese businesses?  In pursuit of a reliable answer, last week we posted Part I of our interview with Dr. Daniel H. Rosen.  Dr. Rosen is an economic advisor specializing in China’s commercial development and writes and speaks extensively on US-China economic relations. He is the Principal of Rhodium Group, a specialized practice helping decision-makers analyze and understand commercial, economic and policy trends in Greater China. He is a graduate of the Graduate School of Foreign Service at Georgetown University and the Department of Asian Studies at the University of Texas, Austin. He is a Member of the Council on Foreign Relations and the National Committee on U.S.-China Relations. He is the author of Behind the Open Door: Foreign Enterprises in the Chinese Marketplace. 

Our interview continues:

China’s State Administration of Foreign Exchange has recently announced policy changes intended to encourage OFDI, including broader access to foreign exchange to finance acquisitions.  Will these changes result in increased acquisition activity, as intended?

Rosen: Yes, but not by themselves.  Global asset price volatility is particularly distasteful to Chinese firms, which face political pressure from units of government other than SAFE if their undertakings abroad underperform.  There remains a discouraging schizophrenia in China’s policy toward investing abroad.

The July 5 detention of Stern Hu, Rio Tinto’s lead negotiator with China’s iron ore importers, was initially perceived as a step backward for both inbound and outbound investment in China.  More recently, statements by Chinese officials suggest that the government was acting to protect its legitimate interests.  Are you willing to predict the outcome of the affair?

Rosen: It is impossible to say how his will be resolved.  However the lesson learned is that China has a business planning and market transparency problem, which will poison commercial practices and create inefficiencies as long as it remains unaddressed.

How do Chinese businesses and governmental officials perceive the U.S. regulatory structure for reviewing inbound investments? 

Rosen: They are unhappy with them, and believe that the US is disingenuous when it says that we have no “no go” sectors or strategic industries apart from national security concerns.  They want clarity on US sensitivities. 

Do the CFIUS regulations provide sufficient clarity for those required to provide information to that agency?

Rosen: Not necessarily, but usually.  The system is inherently subjective, in part because the motivation of the buy side is inscrutable and yet relevant to the outcome.

Is CFIUS considered to be a fair or non-politicized regulator?  Is there a perception of bias against Chinese acquirers? 

Rosen: Generally CFIUS works ok, but CFIUS is not the only factor impacting China’s OFDI to the US.  It is the process of record, but super-regulatory forces can impede a given deal, as they did in the Unocal case.

If Chinese investors were to suggest changes to the U.S. regulatory structure, what might those changes be? 

Rosen: They have asked for a “negative list” of areas that are off-limits.  What is equally important is what they do not want to see, which is an expansion of the CFIUS mandate to include any sort of national “economic security” considerations. 

Thank you, Dr. Rosen. 

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Is it reasonable for U.S. businesses to expect mergers and acquisitions activity and investments from Chinese businesses? Our posts of July 10 and 13 highlighted a policy brief on China’s Changing Outbound Foreign Direct Investment Profile published by the Peterson Institute for International Economic and written by Daniel H. Rosen and Thilo Hanemann. Dr. Rosen agreed to respond to questions that we posed regarding China’s approach to mergers and acquisitions and other direct investments in the U.S.  Part I of our interview follows.

Dr. Rosen is an economic adviser specializing in China’s commercial development and writes and speaks extensively on US-China economic relations. He is the Principal of Rhodium Group, a specialized practice helping decision-makers analyze and understand commercial, economic and policy trends in Greater China. He is a graduate of the Graduate School of Foreign Service at Georgetown University and the Department of Asian Studies at the University of Texas, Austin. He is a Member of the Council on Foreign Relations and the National Committee on U.S.-China Relations. He is the author of Behind the Open Door: Foreign Enterprises in the Chinese Marketplace. 

Your recent policy brief addressing China’s changing outbound foreign direct investment (OFDI) makes a strong case for an expectation of increased OFDI.  In fact, you write that China’s OFDI is at an inflection point and that the geographical distribution of OFDI will shift toward the OECD countries. Do you expect OFDI into the United States to accelerate? 

Rosen: Yes.  Wherever Chinese producers are already OEMs or producers in value chains that lead to the US, they should be expected to move up and down those value chains toward US assets.

What are the characteristics of those American businesses that would be most attractive as investments for Chinese strategic investors?  

Rosen: Complementarily to Chinese capabilities, low price, non-union.

How important is the price level for those businesses?  Are distressed U.S. assets attractive to Chinese investors as an investment class?

Rosen: Price is important to Chinese firms, but not if it reflects extremely complicated situations.  China has little ability to work-out regulatory, labor or legal complexities, and so will tend to avoid them, or else have to rely on co-investors to deal with them. 

At various times in the past, both strategic and financial buyers have acquired or invested in U.S. companies.  How close are we to a time when Chinese financial buyers, as opposed to strategic buyers, will acquire U.S. businesses? 

Rosen: I think Chinese investment will be weighted toward strategic buyers who can generate value through expanded scope for a long while.  Financial investors from China have little ability to add value in the US.

You have written about the imperative for China’s firms to capture a greater share of the production chain.  The 2005 Lenovo transaction with IBM was a precursor of this type of transaction.  Do Chinese businesses and the Chinese government perceive the Lenovo transaction as a model to be followed?

Rosen: Lenovo is still considered an exceptional case, involving exceptional entrepreneurship.  Even still, it is not considered a home run in terms of performance.  It is a healthy example of the real, normal business challenges that will arise in even better Chinese forays abroad.

Part II of the interview with Dr. Rosen will be posted on August 3, 2009.

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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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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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