A Buying Binge In China

An M&A wave breaks over the country

For early risers in China's capital it is a familiar sight: Beijing Sanyuan Food's trucks and three-wheeled bicycle carts tooling around the city, delivering milk, yogurt, and other dairy products door-to-door. In recent years, Sanyuan has come to dominate Beijing's $120 million dairy market. Now the company has national ambitions. But to get there, it needs to boost capacity. So in September Sanyuan offered $9.3 million for the Beijing dairy operations of New York-based Kraft Food International.

The acquisition, which should be approved soon, will buy Sanyuan a seven-year-old, state-of-the-art plant in Beijing. That will enable the company to boost annual production by 40%, to 350,000 tons. Sanyuan also has a renewable license to sell Kraft dairy products, which will allow it to target richer customers. To Lei Kunshi, Sanyuan's vice-general manager, buying Kraft's money-losing operation is a matter of survival. "We have to prepare for WTO," says Lei. "If you want to dance with wolves, you must act like one."

For China, membership in the World Trade Organization is perhaps six months away--which means that a raft of trade barriers will fall, forcing prices down and luring new foreign competition into Asia's fastest-growing market. How do you survive WTO? Bulking up is an obvious strategy.

"MARKET PRESSURE." That's why an unprecedented wave of mergers and acquisitions is sweeping the nation. The number of M&As is expected to grow by as much as 40% in 2001, to $40 billion worth of deals. In some cases, state-owned companies are taking over other state-owned companies. In others, they are buying the local operations of a foreign multinational. For the most part, companies are financing the acquisitions themselves. Says Fred Hu, executive director of Asian Economic Research at Goldman, Sachs & Co. in Hong Kong: "There is tremendous market pressure for companies to merge."

This M&A boom is something of a departure from previous waves of consolidation. In the past, Beijing has engineered combinations in such strategic industries as steel, aluminum, and finance by government fiat. Often Beijing's shotgun marriages were more political--to save jobs, say--than commercial. Beijing is still encouraging consolidation in industries ranging from food to pharmaceuticals to transport. But now many Chinese companies are merging and acquiring for competitive reasons and trying to do it right.

It's about time. Most businesses are woefully inefficient, and many have not achieved sufficient economies of scale to compete against foreign rivals. As it is, too many players are chasing too few customers. The result is vicious competition and price cutting. Consider the airlines. Over the past few years, the nation's 10 largest carriers have been engaged in debilitating price wars that have forced fares down by as much as 60% and pushed many of them into the red. To keep the industry from self-destructing, Beijing has ordered the companies to put in place old-fashioned price floors.

In some cases, Chinese companies are seeking national heft. One is beer brewer Tsingtao. It lacked a large customer base near its main production facility in Shandong province. To get the beer closer to its customers, Tsingtao, over the past year, has acquired eight breweries around the country. Among the buys: a 75% stake in Copenhagen-based Carlsberg's Shanghai brewery and a 63% stake in Beijing's Five Star Brewery. Now Tsingtao is China's largest brewer, with 8% of a highly fragmented market.

In other cases, companies are buying entree into foreign markets. In August, for example, Shenzhen-based Sanjiu Enterprise Group paid $36 million for a 68% stake in Sichuan-based Long March Pharmaceutical Co. At a stroke, Sanjiu grabbed Long March's $22 million in annual hard-currency exports to the U.S., Europe, and Australia.

While Chinese companies have made woeful acquisitions in the past, they are increasingly savvy about what businesses to buy. Before Sanjiu acquires another company, for example, it hires independent Chinese auditors to evaluate the target's assets. "If it isn't transparent," says a Sanjiu official, "we won't buy it." The company has learned from past mistakes. During the 1990s, Sanjiu bought several factories in western China--in part to heed Beijing's exhortations to develop the impoverished region. The company found the factories were losing money and, besides, were hundreds of miles from their markets.

The upshot is that more Chinese companies are going into mergers and acquisitions with their eyes open, not because Beijing tells them to. For its part, Sanyuan hired Ernst & Young to audit Kraft's Beijing dairy operation, as well as a Beijing-based asset evaluation company. It did so despite the fact that Kraft's China operations adhere to superior accounting practices. Sanyuan also hired Beijing's Gonghe Law Office, to help negotiate with Kraft.

SAVING JOBS. The government is not taking an entirely hands-off approach, especially in such strategic industries as air transport. In July, it called for the consolidation of the top 10 state-owned carriers into three groups. And even though Beijing understands the need to allow market forces to shake out the industry, it can't stop meddling. While Shanghai's China Eastern Airlines has already agreed to merge with Ningbo-based Great Wall Airlines and is negotiating with other carriers, Beijing is determined to have final say over which mergers are allowed. Again, its main aim is to save jobs.

In fact, official interference still hurts many Chinese M&As. Sanjiu, the pharmaceutical company, wanted to lay off two-thirds of Sichuan-based Long March's workers when it bought the company. It ended up keeping all 1,500. "Local governments face great pressure from unemployed workers," says the Sanjiu official. "They always want us to keep as large a staff as possible." Onerous government regulations can hang up the process and limit the kind of restructuring allowed. Local governments often want to interfere in management decisions. Sometimes they expect quick profits. And while the central government is increasingly inviting outside companies to buy Chinese ones, bureaucrats continue to resist foreign takeovers.

Government's meddling hands will continue to distort the process. Still, the growing M&A boom eventually will force mainland companies to become more efficient. "It will give the next boost to productivity," says Jonathan Woetzel, principal and general manager for Chinese corporate finance at McKinsey & Co. in Shanghai. With WTO membership around the corner, consolidation is not a choice. It's a necessity.

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