When China's Companies Take Over U.S. Firms

Chinese merger and acquisition activity offshore is likely to continue to intensify for the remainder of 2010 as the authorities direct the country’s massive foreign exchange reserves away from low-yielding US dollar-denominated government securities towards aggressively secure long-term energy security requirements. Global acquisitions are the quickest way for Chinese companies to achieve scale, integrate their supply chains, expand into large foreign markets like the U.S., boost their technological skills and globalise their brand.

 
Typically Chinese acquirers are heavily focused on assets in the Americas, although Australia, Africa and Latin America are attractive as a source of oil, gas and natural resources. Recent changes to China’s regulatory regime are encouraging Chinese businesses to believe that their business policies are now comparable to those in the EU or North America.
 
The truth is that while ambitious Chinese companies pursuing offshore targets believe these regulatory changes make them more competitive, they still face an uphill struggle. As many Chinese acquirers have discovered, they face tremendous regulatory and political obstacles offshore as well as other barriers as they start operating in an unfamiliar legal and social environment.
 
China has environmental protection-related laws and regulations. However many Chinese companies lack full comprehension of compliance and enforcement requirements in managing environmental and pollution risks abroad. While several marquee Chinese companies have successfully acquired assets, implemented an effective post-merger integration and extracted value from offshore investments, they sometimes fall short of the mark in terms of risk management, says Paul Wilkins, Greater China CEO for Marsh.
 
China Inc.
The speed and vigour with which Chinese outbound investment is occurring underscores the sheer number of risk management challenges companies face when bidding for offshore assets says Gary Ding, Senior Vice President and Head of China Global Client Services, Marsh China. “Suddenly Chinese companies are exposed to the same liabilities that faced Japanese and Korean companies that strategically invested in the U.S. 30 years ago.”
 
One of the biggest misconceptions was the underestimation of numerous forms of liability exposures that existed outside of Asia, such as Workers Compensation, Products Liability and multimillion dollar Punitive Liability Awards. “Chinese companies may face large exposures because of their approach to risk management,” says Wilkins. “They cannot simply bring Chinese practices to their overseas investment, they need to learn how to manage risk in the local context and local culture rather than just leverage their experience in China.”
 
In particular, foreign acquirers of U.S.-based firms face a number of risks unique to the United States, ranging from statutory requirements for workers’ compensation and auto liability to environmental liability and self-insurance obligations with surety and collateral requirements. Chinese firms may be unfamiliar with liability risks such as product liability and recall, class actions and punitive damages. These risk issues pose major challenges to their brands and business model. Many risks arise out of government-imposed regulations, that if not properly addressed can have serious financial consequences.
 
  • Workers Compensation: This is often the second highest expense next to employee health retirement benefits. The US in particular has exceedingly aggressive and liberal workers’ compensation regulations which are set by law in each state or province.

 

  • Obscure worker entitlements: For example, in the US, there are regulations governing the payment of overtime to certain classes of workers if they work more than a certain number of hours per day or per week. Other classes of workers are exempt from these regulations. Companies are responsible for classifying workers into one category (i.e., subject to overtime regulations) or the other (i.e., exempt from the overtime regulations).

 

  • Class action lawsuits: These have been initiated by groups of workers who believe that they have been improperly classified as exempt from the regulations; the lawsuits typically seek compensation for the overtime worked by these employees historically and seek to have the employees re-classified as subject to overtime regulations so that they will be paid overtime in the future

 

  • Auto Liability: Claims activity on a frequent basis with some reaching catastrophic levels

 

  • Environment: Legacy environmental issues are a significant issue for industrial firms in the US. Ongoing claims relating to previous work practices, pollution from as long as decades ago, and a complex web of federal and state-based regulations make this a potential minefield for firms unfamiliar with the territory.

 

  • Disaster Recovery and Business Continuity Planning: Very few firms have a current plan known to all levels of management. This leaves acquiring firms open to significant losses should a disaster occur after takeover

 

Understanding risk
Cross-border deals present two major challenges from a risk management standpoint. Managing future risks, i.e., determining the optimum structure and integration of risk management programs after the deal has been done; and properly addressing the target’s pre-close legacy liabilities.
 
Addressing these challenges all starts with understanding the target’s risk profile, total cost of risk, legacy liabilities and historical insurance assets, says Ann Keller, Managing Director at Marsh in San Francisco. “Asian companies may not be familiar with the kind of risks they face in the US,” she says. “They often do not buy adequate liability limits, focusing on rates rather than risk exposure.”
 
Typically, Chinese companies have a fraction of the excess limit of US companies given the lack of awareness around punitive damages that can arise in the U.S. More importantly, many firms fail to do proper due diligence. This can be fatal: according to some reports in the U.S., 32% of all deals fail because of lack of due diligence.
 
How to Integrate Acquisitions
Performing a thorough due diligence review forms the basis for planning any integration, developing pro forma cost projections, and identifying and implementing synergies. Often, the best answer is to maintain separate and distinct insurance programs to reflect the specific needs of each geography and business operation, but in other cases a global integrated program makes the most sense. There are a number of risk management solutions specifically geared for companies acquiring or investing overseas, including:
 
Transactional Solutions
  • Identify/resolve issues in the sale and purchase agreement.
  • Help control litigation costs from known claims.
  • Transfer credit, asset, and other operational and market risks to insurers.
  • Explore environmental liability solutions.
  • Cap the cleanup costs of known liabilities.
  • Transfer the risk of third-party bodily injury/property damage and cleanup cost arising from unknown environmental conditions.
 
Post-Acquisition Services
  • Assess and benchmark retained losses and identify opportunities to reduce those losses and minimize collateral obligations.
  • Develop in-depth loss analysis to facilitate intelligent deployment of loss reduction solutions.
  • Design a comprehensive, accelerated loss reduction strategy that fully integrates carrier, broker and client resources.
  • Drive and monitor execution of the loss reduction strategy.
  • Identify opportunities to mitigate and close legacy claims.
  • Evaluate the feasibility of alternative risk management strategies and solutions.
 
Risk Management Infrastructure and Staffing
  • Examine and benchmark all risk management processes against leading practices.
  • Facilitate outsourced alternatives where appropriate.
  • Identify required risk management skill sets, including consideration of geographic needs.
  • Develop an optimum risk management staffing model based on findings.
  • Evaluate technical qualifications of candidates for staff positions.
  • Supply interim staffing support as needed.
 
Human Resource Solutions
When a non-U.S. buyer comes into the United States, there are a number of critical issues related to employer provided health care, pension, and other benefits that are unique to the United States. If not addressed, such issues could result in material negative surprises. These issues include:
  • U.S. regulation of benefit plans, including requirements for adequate funding;
  • Large/excessive severance payments or change-in-control plans/Golden Parachute payments, stock options;
  • Organizational culture and performance management (cultural fit); and
  • More flexibility in changing terms and conditions of employment than in many other countries (employment at will).
 
Cultural Conflict
According to James Cowan, Managing Director of Asia Global Client Services, Americas, based in New York, Asian multinationals often rely heavily on a preferred insurer and thus may not get a broad range of opinions on handling risks. They focus on rate, not cost of risk. They do not undertake benchmarking of limits, retentions, etc. with a peer group. Finally they do not have risk management information systems or loss prevention protocols that many Western firms utilize to contain and mitigate their exposure to risk.
 
It can be frustrating for U.S. managers in firms taken over by Chinese companies as they will often have had a full risk management program in place and have a much more granular understanding of the risk landscape facing the company’s business than the new owners. Effectively communicating a risk management protocol with new concepts and approach to handling risks is a daunting challenge complicated by multiple languages as well as corporate and social cultures.
 
A key issue for all Asian companies investing outside their home country is the level of awareness of international trends and regulations from a risk and insurance point of view. Chinese firms in particular must ensure that insurance protection is compliant. That is often not fully understood. Many try and arrange programs directly from China and don’t take on board local regulatory requirements – for instance, it is illegal to insure on a non-admitted basis in many territories. Also if they were to have an insurance loss, they need to have a detailed understanding of where the claims are paid – at a subsidiary or group level – and what tax issues can arise from the receipt of funds.
 
The common risk management mistakes Asian firms make when investing offshore include:
  • An overemphasis on asset protection – they make sure that plant and equipment are insured on an actual cash value basis, but fail to account for replacement cost – the global standard.
  • They make very limited use of business and contingent business interruption coverage.
  • They often purchase inadequate policy limits to protect them against catastrophic losses.
  • They often fail to take advantage of opportunities to use captive insurance vehicles – these are commonly used in the west but less so by Asian firms.
 
This article first appeared in The Marsh Directors’ Series, Q3/Q4 2010 and has been re-edited for conciseness. Marsh is a global provider of risk and insurance services and solutions.
 
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