Chinese overseas merger and acquisition (M&A) activity is diversifying in line with the country's structural reforms towards a consumption-driven model from investment-led growth, says Moody’s Investors Service.
"Outbound M&A activity by Chinese companies continues to grow at a rapid pace, but the country's structural reform drive is shifting the focus of activity away from resource-related sectors and towards higher-value industries, in the pursuit of technology, brands and new markets," says Rahul Ghosh, a Moody's Vice President and Senior Credit Officer.
"Because of rising labor costs in China, companies in the country are eager to migrate to high-value-added production and expand their presence, especially to emerging markets," says Nino Siu, a Moody's Assistant Vice President and Analyst. "Chinese companies are therefore looking for opportunities overseas, in the form of M&As."
Moody's conclusions are contained in its just-released report titled "China Credit —Overseas M&A Shift Towards Higher-Value Sectors Set to Continue," and is co-authored by Ghosh and Siu.
For the nine months between January and September 2016, the volume of completed and pending outbound M&A deals exceeded the record annual level reported in 2015, driven by the slowing domestic economy and supportive government policies.
Moody's report points out that privately owned companies have been particularly active in the technology industry, and also in consumer and entertainment-related sectors, such as healthcare products, media and hotels.
Less prominent role
Moody's says that state-owned enterprises (SOEs) will play a less prominent role in driving overseas M&A. In fact, the dominance of Chinese SOEs in overseas acquisitions is moderating, and Moody's expects that this trend will persist. Elevated leverage in the SOE sector could pose an increasing constraint on companies' overseas ambitions, because these companies mainly rely on debt financing.
Furthermore, in line with the broader SOE reform agenda, government support for the SOEs' outbound M&A activity will diverge between those motivated by national strategic importance (where support will remain high) and those more inclined to pursue commercial interests in competitive sectors (where support could be less forthcoming).
Chinese entities have relatively short experience in managing cross-border investments, and there are significant execution and financial risks that could prohibit an M&A deal from generating synergies. Such risks could also negatively affect the acquirers' credit quality.
In many recent cases of Chinese outbound M&As, the acquired companies have continued to be operated by their existing management, due to differences in corporate cultures, market focus, and/or production platforms.
However, it remains to be seen as to whether or not they can keep existing management structures in place over the long term, or transition to their own management after the retention period.