Macroeconomic News

Sino-Western relations and the impact on global M&A activity

With the recent exclusion of Huawei from the 5G network by the UK government and the strong rhetoric from the US, tensions between China and the West are at an all-time high. This week’s closing of the PRC Consulate in Houston follows new national security laws imposed in Hong Kong, military dispute over the South China Sea, and the continued unease over the human rights abuses in the Xinjiang region against Uighur Muslims. Privacy and intellectual property concerns and the risk to national security from cyber-attacks are significant factors in the TMT sector but this issue is prevalent across all markets. The UK energy sector is currently at the centre of attention, with Conservative Party backbenchers pushing for nuclear power projects by state-owned China General Nuclear to be blocked. 

The relationship between geopolitical risk and M&A activity

According to an article in the Strategic Management Journal by Olivier Bertrand and Marie-Ann Betschinger, there is an inverse relationship between acquisition prices and the quality of international relations between the respective countries of an acquirer and the target company. The study found that if bilateral relations were strained, this may increase the purchase premium offered to the target company’s shareholders by 25% – results obtained from a study which looked at 700 large-scale international mergers and acquisitions between 1990 and 2008. This suggests potential acquirers may be priced out of any auctions by risk premiums, depressing M&A activity where geopolitical risk is higher.

Inward and outward M&A activity in China

An increase in tariffs, along with increased scrutiny of cross-border deals by public authorities, is impacting M&A timelines and investment flows, with Chinese acquisitions of US companies declining significantly in the past few years. In 2018, this number fell by almost 95% from a peak two years ago and led to inbound M&A activity in China surpassing outbound M&A activity at the half-year mark for two successive years (2019 and 2020), for the first time since 2005. 19th June 2020 recorded inbound M&A activity of $13.4bn compared with $12.5bn of outbound activity at the half-year mark, according to data provider Refinitiv. This is a result of greater Western scrutiny of inward FDI from China, along with further liberalisation of mainland China in opening up its financial and automobile sectors – with Wall Street banks and Volkswagen acquiring controlling stakes in China. 

Private equity and South-East Asia

However, the greater geopolitical risk of acquiring Chinese companies is also making Western investors look elsewhere for alternatives. 2020 has seen the continuation of the trend of US private equity houses diverting their investment away from China and into other South-East Asian countries. Morgan Stanley Private Equity Asia raised more than $440m for a Thailand-focused fund and the private equity house KKR has placed a greater significance on investments in Asia, which accounted for more than 30% of their investment portfolio in Q1 2020. KKR recently acquired 427 million shares (11.9% stake) in a Philippine power company, First Gen, for $192m – their third investment in the Philippines since December. They have also acquired solar power assets in India in April and led a consortium that acquired a 6% stake in Vinhomes Joint Stock Company, a Vietnamese real estate developer, for $650m in June.

Future trend

Chinese outbound investment flows into the US are likely to remain low should relations continue to deteriorate, with Chinese investors favouring projects with more certainty during the COVID-19 economic slowdown and liquidity squeeze. The increased levels of protectionism between the two superpowers are likely to have consequential effects on the foreign policies of “secondary powers” in the West, with the UK strengthening its position against China. Despite further Chinese liberalisation, increased Sino-Western tensions are likely to benefit emerging markets in India and South-East Asia – countries with a low-cost manufacturing base and a burgeoning middle class. Private equity houses repositioning themselves and restructuring their portfolios to target these markets look set to continue. 


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