It was a landmark corporate event that turned out to be more like a soap opera. Little had Xugong Group, the largest machinery manufacturer in China, imagined the controversy it would stir when it agreed to its takeover by Carlyle Group, an American private equity firm.

In 2005, Carlyle won a bid against five international competitors to buy a controlling stake in Xugong’s subsidiary for $375m. Pending its approval, the agreement would have been one of the largest acquisitions of a Chinese state-owned company by a foreign investor.


But, just as champagne glasses chinked, Sany Corporation, a Chinese machinery firm, barged into the scene, demanding to outbid Carlyle’s offer. Sany’s CEO, Xiang Wenbo, whipped up a feisty PR campaign, claiming that Xugong had been sold for a song. On September 22, he blustered on his blog (read by 1.5 million bloggers): “Xugong is cheaper than a pot!”

As dramatic as they sound, Mr Xiang’s vitriolic remarks reflect deeper concerns for pensive regulators in Beijing.

Concerns over M&A

According to the Shanghai University of Finance and Economics, the annual value of mergers and acquisitions in China between 1988 and 1996 averaged $261m. By 2003, it had reached $1.65bn, a six-fold increase. In the first six months of 2006 alone, 21 M&A deals were struck, a record-breaking number, of which 18 involved foreign acquisitions of Chinese firms.

In the steel industry, India’s Mittal Steel has acquired Hunan’s Valin Group. In heavy machinery, US-based Caterpillar has bought a majority stake in Shandong’s SEM Machinery. In automotive diesel, Germany’s Bosch Group has taken over the Wuxi Weifu Group. Even in the lighter field of kitchen appliances, French manufacturer SEB has sought a buyout of Zhejiang’s Supor Cookware.

In recent years, foreign investors have targeted leading Chinese companies in key industries. As a result, local companies, such as Sany Corporation, face intense competitive pressures from foreign takeovers that combine capital muscle with established local names.

As one blogger retorted on Mr Xiang’s blog on September 23: “Why do you [Sany Corp] want to buy Xugong? Can you really afford it? I think you are just afraid of losing market share.” It was no surprise, then, that when France’s SEB tried to acquire Supor Cookware, Chinese manufacturers petitioned the government to veto the process.

Local businessmen like Mr Xiang are not alone in their apprehension. Experts have questioned the impact of China’s FDI policy on its long-term economic growth.

As professor Huang Yasheng of the MIT Sloan School of Management argued in his book, Selling China, the private sector has been squeezed out of the market. Chinese private companies are at the bottom of the pecking order. They have neither the capital stockpile of foreign corporations nor the privileges of state-owned firms.

Yet another concern, beyond parochial interests, is that good old-fashioned FDI seemed to be losing ground to M&A. While the M&A market expanded rapidly, the number of foreign-funded companies fell by 6.89% in the first half of 2006.

New rules for M&A

Against a backdrop of corporate melodrama and shifting trends in FDI, the Chinese government has quietly revised the M&A regulatory framework.

On August 8, 2006, much to investors’ eager anticipation, the ministry of commerce issued a revised set of rules on the purchase of Chinese companies by foreign investors. It came into effect on September 8.

Building on the 2003 provisions, the revision seeks to standardise M&A procedures and tighten control over large-scale takeovers of local enterprises. Henceforth, foreign investors are required to seek approval from the ministry of commerce if either party of a proposed merger boasts annual sales of more than Rmb1.5bn ($190m). Bids for enterprises in strategic industries, prominent brands, and companies employing more than 2000 workers have to undergo a similar process of checks.

Transactions in strategic industries, such as heavy machinery, could be voided if not sanctioned. That was unfortunate news for acquisition firms such as Carlyle, which found themselves waylaid in the thicket of changing rules.

New monopoly rules

Anti-monopolistic measures have also been put in place. Approval is required if a merger results in a foreign investor holding a market share of more than 25%.

Concurrently, a competition commission is expected to be created in the near future. In June 2006, the National People’s Congress debated, for the first time, the enactment of a national anti-monopoly law.

However, Chinese authorities have been careful to stress that the revised rules on M&A are not a sign of local protectionism. Quite the reverse, they propose that the revision offers greater transparency and new avenues for M&A.

A striking feature of the revision is permission for cross-border share-swapping between foreign and Chinese firms. While in the past, acquisitions had to be paid for with cash, it is now possible for payments to be made through stock exchanges. With share-swapping, it is hoped that more foreign firms will participate in the restructuring of local industries.

Redirecting FDI

From a macro perspective, China is clearly beginning to rethink its FDI strategy. In the early years, the republic rolled out the red carpet for foreign investors, with tax breaks and low costs. Today, it commands the top FDI spot. And it wants quality, not just quantity, foreign investment.

Vice-premier Wu Yi kicked off the opening of the 10th China International Fair for Investment and Trade in Xiamen, Fujian Province, in September. With typical pageantry, she stressed in her opening speech that “holding steadfast to an open economy is China’s foundational policy”.

Specifically, China would like more investment in the high-tech and environmentally friendly sectors, such as electronics and pharmaceuticals. Investments in agricultural development, a key priority for president Hu Jintao’s administration, are eagerly sought after. The services sector, comprising only 30% of China’s gross domestic product (compared with 56% in India in 2003), is another prime target.

In 2004, China increased export tax rebates for selected high-tech products in a bid to attract quality FDI. The government wants foreign investors to stay for the long haul and help to develop China’s domestic technological capabilities, rather than to buy up local assets and then leave.

New directions for FDI spell tighter controls for some and untapped opportunities for others. M&A is likely to remain a vibrant market for China despite added restrictions. Meanwhile, foreign investors should be prepared to scale the value-added ladder in China.