www.lehmanlaw.com

Edward LehmanEdward Lehman

Practising Law Institute Practising Law Institute 810 Seventh Avenue, 20th Floor 810 Seventh Avenue, 20th Floor

New York, NY 10019 New York, NY 10019

LEHMAN, LEE & XULEHMAN, LEE & XUwww.lehmanlaw.comwww.lehmanlaw.com

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M&A Strategies M&A Strategies in Chinain China

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Of InterestOf Interest

BizChina BizChina

Dialogue Dialogue

Discussion of new anti-monopoly law Discussion of new anti-monopoly law and impacts on M&A in Chinaand impacts on M&A in China– located at located at www.lehmanlaw.comwww.lehmanlaw.com under TV & under TV &

MediaMedia

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General thoughtsGeneral thoughts

Why is common sense left at the Why is common sense left at the border?border?

Three basic rules of M&A in Three basic rules of M&A in China:China:

1.1. Due diligenceDue diligence

2.2. Due diligenceDue diligence

3.3. Due diligenceDue diligence

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ContentsContents

Growth of M&AsGrowth of M&As

M&A OpportunitiesM&A Opportunities

Nature of M&As Nature of M&As

Importance of Privately Importance of Privately Owned Enterprises Owned Enterprises

Case Study – Mengniu Case Study – Mengniu Diary GroupDiary Group

Role of GovernmentRole of Government

Restrictions Restrictions

M&A Methods within M&A Methods within ChinaChina

Offshore TransactionsOffshore Transactions

Current Law on M&ACurrent Law on M&A

Practical ConsiderationsPractical Considerations

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Growth of M&AsGrowth of M&As Every year since 2002 has been a record Every year since 2002 has been a record yeyear of M&A growthar of M&A growth M&A transactions rose 50% in 2004 over M&A transactions rose 50% in 2004 over preprevious year vious year HSBC USD $1.74bn acquisition of 19.9% HSBC USD $1.74bn acquisition of 19.9% stastake in Bank of Communicationske in Bank of Communications Anheuser-Busch USD $600 million acquisition Anheuser-Busch USD $600 million acquisition

of Harbin Brewery Group of Harbin Brewery Group

More M&As over traditional More M&As over traditional “Green-field” “Green-field” investmentsinvestments

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From the headlinesFrom the headlines ““China is formally launching its wealth fund, China is formally launching its wealth fund,

amid market talk…what the nearly $200 billion amid market talk…what the nearly $200 billion will be used for”will be used for”

““Nasdaq won China’s approval to open a Nasdaq won China’s approval to open a Beijing representative office”Beijing representative office”

““Citic Resources was expected to buy a Citic Resources was expected to buy a majority stake in Tincy, making it China’s majority stake in Tincy, making it China’s fourth-largest oil producer”fourth-largest oil producer”

““Chinese telecom shares leapt after Chinese telecom shares leapt after government plan to audit five-major operators government plan to audit five-major operators spurred talk of sector restructuring.”spurred talk of sector restructuring.”

From the Wall Street Journal Asia (September From the Wall Street Journal Asia (September 28-30, 2007 Edition)28-30, 2007 Edition)

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Opportunities Opportunities for M&Asfor M&As

Government expansion of industries Government expansion of industries for for M&A investment M&A investment

Privatization of State-owned Privatization of State-owned Enterprises Enterprises (SOEs) - approx 4,000 to (SOEs) - approx 4,000 to 5,000 each year 5,000 each year

Acquisition is the cheapest and Acquisition is the cheapest and fastest way fastest way to enter the Chinese market to enter the Chinese market

Fragmented sectors of the economy Fragmented sectors of the economy present present opportunities to consolidate and opportunities to consolidate and create create economies of scale economies of scale

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Nature of M&AsNature of M&As Vast majority M&A involved Vast majority M&A involved

recently – privatization of recently – privatization of SOEsSOEs

Trend is changing to involvTrend is changing to involve e Private-owned Enterprises Private-owned Enterprises

(POEs) (POEs) POEs, especially those that POEs, especially those that

develop from SOEs, are develop from SOEs, are nnow major targets of M&As ow major targets of M&As

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ImportanImportance of ce of POEsPOEs

Fast growth = attractive Fast growth = attractive investment targets investment targets

Usually capital starved, Usually capital starved, welcome cash in welcome cash in

exchange exchange for minority stake for minority stake

Low-costs, non-Low-costs, non-bureaucratic, bureaucratic, local local knowledge, effective knowledge, effective

good partners for good partners for restructuring SOEs (most restructuring SOEs (most POE POE managers come from managers come from SOEs) SOEs)

““Guanxi” (Relationship) Guanxi” (Relationship) with with SOEs SOEs

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Case Study: Mengniu Case Study: Mengniu Dairy GroupDairy Group

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Case Study in POEs: Case Study in POEs: Mengniu Dairy GroupMengniu Dairy Group

Second largest producer of milk, yogurt, ice Second largest producer of milk, yogurt, ice cream cream

Niu Genshen, former vice-president at state-Niu Genshen, former vice-president at state-owned Yili Dairy, founded Mengniu after owned Yili Dairy, founded Mengniu after leavileavi

ng the companyng the company Borrowed $1million to establish Mengniu Diary Borrowed $1million to establish Mengniu Diary

Group Group After 7 years, Mengniu rapidly closing-in on After 7 years, Mengniu rapidly closing-in on

Yili Dairy Yili Dairy Mengniu’s annual revenue was $1.3bn, while Mengniu’s annual revenue was $1.3bn, while

Yili’s Yili’s annual revenue was $1.5bn (2005)annual revenue was $1.5bn (2005)

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Role of Role of Government in Government in

M&AsM&As Government approval required for Government approval required for

M&A M&A transactions transactions

Includes: Includes:

I.I. Ministry of Commerce Ministry of Commerce (MOFCOM)(MOFCOM) - - principle principle foreign investment examination foreign investment examination and approval and approval authority, entitled to authority, entitled to supervise and approve supervise and approve M&A M&A transactions transactions

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Role of Role of Government in Government in

M&AsM&AsII.II. State Development and Reform Commission State Development and Reform Commission

(SDRC)(SDRC) is responsible for both approving foreign is responsible for both approving foreign investment project application and supervising investment project application and supervising restructuring of state-owned enterprisesrestructuring of state-owned enterprises

III.III. State-Owned Assets Supervision and State-Owned Assets Supervision and Administration Commission Administration Commission (SASAC)(SASAC) comes into comes into picture if the target enterprise is state-ownedpicture if the target enterprise is state-owned

IV.IV. China Securities Regulatory Commission China Securities Regulatory Commission (CSRC)(CSRC) – if is listed on China’s stock market– if is listed on China’s stock market

V.V. Other industry-specific regulators, e.g. Other industry-specific regulators, e.g. if the if the target is a Chinese bank, the approval of China target is a Chinese bank, the approval of China Banking Regulatory Commission Banking Regulatory Commission (CBRC)(CBRC) will be will be required required

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RestrictionsRestrictions Catalogue for the Guidance of Catalogue for the Guidance of

Foreign Investment Foreign Investment (CATALOGUE)(CATALOGUE)

Classifies investment projects Classifies investment projects by by sector as “sector as “encouragedencouraged,” ,” ““permittedpermitted,” “,” “restrictedrestricted,” or ,” or ““prohibitedprohibited” ”

Majority Chinese Majority Chinese shareholding shareholding mandated in mandated in several restricted several restricted sectors sectors

Other sectors prohibit 100% Other sectors prohibit 100% foreign shareholding foreign shareholding

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M&A Methods M&A Methods within Chinawithin China

Equity Equity TransactionTransaction

Asset PurchaseAsset Purchase

Statutory Statutory Merger Merger

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I.I. Equity TransactionEquity Transaction Foreign investor acquires equity in an Foreign investor acquires equity in an

existing FIE or a domestic enterprise existing FIE or a domestic enterprise from from foreign or Chinese shareholders foreign or Chinese shareholders

Requires Chinese examination and Requires Chinese examination and approval approval

If target is purely domestic, it will If target is purely domestic, it will become become an FIE after equity purchase an FIE after equity purchase

FIE must assume target’s FIE must assume target’s responsibilities responsibilities and and liabilities liabilities

All agreements subject to Chinese All agreements subject to Chinese Government’s approvalGovernment’s approval

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II.II. Asset PurchaseAsset Purchase

AAcquire select assets cquire select assets

““Peel-off” unwanted assets and Peel-off” unwanted assets and liabilities liabilities

No change in equity ownershipNo change in equity ownership

Target retains all original rights and Target retains all original rights and liabilities liabilities

Foreign companies not allowed to Foreign companies not allowed to directly directly operate assets without PRC operate assets without PRC presence presence

Needs to establish FIE to purchase Needs to establish FIE to purchase assets assets

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III.III. MergerMerger

Foreign investor must establish FIE Foreign investor must establish FIE in China in China for merger for merger

Subject to multi-step approval Subject to multi-step approval process process

Two Types: Two Types:

I.I. Merger by Absorption - absorbing Merger by Absorption - absorbing company company will remain, while absorbed will remain, while absorbed company will dissolve company will dissolve

II.II. Merger by New Establishment - combined Merger by New Establishment - combined

companies will dissolve, while new companies will dissolve, while new company is established company is established

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Off-shore Off-shore TransactionTransaction

U.S. C CorporationU.S. C Corporation

↓ ↓ Acquires a Acquires a 70% stake 70% stake HK B Offshore Corporation HK B Offshore Corporation Indirectly Acquires Indirectly Acquires

AA

↓ ↓ ShareholderShareholderChina A Domestic CorporationChina A Domestic Corporation

Offshore transaction most effective

Doesn’t require approval within China unless any item (i.e. shareholders’ names) needs to be changed

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Current Law on M&ACurrent Law on M&A Acquisition of Domestic Acquisition of Domestic

Enterprises by Foreign Enterprises by Foreign Investors ProvisionsInvestors Provisions

(Effective Sep 8, 2006) (Effective Sep 8, 2006) Supersedes 2003 Supersedes 2003

Tentative Provisions on Tentative Provisions on Using Foreign Using Foreign Investment to Investment to Reorganize State-Reorganize State-Owned EnterprisesOwned Enterprises

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Current Law on M&ACurrent Law on M&AI.I. Share SwapsShare Swaps The shareholder of an overseas company to The shareholder of an overseas company to

use the shares it holds in the overseas use the shares it holds in the overseas company or to use the newly issued shares of company or to use the newly issued shares of the overseas company to purchase the the overseas company to purchase the shares held by the shareholder of a domestic shares held by the shareholder of a domestic enterprise or the newly issued shares of the enterprise or the newly issued shares of the domestic enterprise.domestic enterprise.

The domestic company or its shareholder The domestic company or its shareholder shall engage a PRC registered agency (e.g. a shall engage a PRC registered agency (e.g. a law firm, a CPA firm) to act as their M&A law firm, a CPA firm) to act as their M&A counsel to conduct Due Diligence. counsel to conduct Due Diligence.

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Current Law on M&ACurrent Law on M&A

II.II. Offshore Special Purpose Offshore Special Purpose Vehicles (SPVs)Vehicles (SPVs)

An Overseas company directly or indirectly An Overseas company directly or indirectly controlled by a PRC company or PRC controlled by a PRC company or PRC individuals for the purpose of individuals for the purpose of consummating the overseas listing of the consummating the overseas listing of the interests it actually owns in a domestic interests it actually owns in a domestic company.company.

Domestic company needs MOFCOM and Domestic company needs MOFCOM and CSRC approvalCSRC approval

After overseas listing, domestic company After overseas listing, domestic company must report to MOFCOM proceeds must report to MOFCOM proceeds repatriation plan – required to repatriate all repatriation plan – required to repatriate all foreign currency incomeforeign currency income

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Current Law on M&ACurrent Law on M&A

III.III. National Economic SecurityNational Economic SecurityRequires both foreign investors and Requires both foreign investors and domestic enterprises to report domestic enterprises to report

details details of acquisition to MOFCOM if itof acquisition to MOFCOM if it

Involves China’s “key industries”Involves China’s “key industries” May affect China’s economic May affect China’s economic

securitysecurity May lead to transfer of ownership May lead to transfer of ownership

of famous Chinese trademarksof famous Chinese trademarks

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Practical Practical ConsideratioConsideratio

nsns Importance of Due Importance of Due Diligence Diligence

FIE Tax Preference FIE Tax Preference I.I. 15% to 24% tax rate for FIEs; 15% to 24% tax rate for FIEs;

II.II. ““Two-plus-three” year tax holiday fTwo-plus-three” year tax holiday for FIE manufacturersor FIE manufacturers

New Unified Tax New Unified Tax SysteSystem m ( Jan 1, 2008) ( Jan 1, 2008) 25%25%

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THANK YOUTHANK YOU

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Telephone: 86-10-8532-1919Fax: 86-10-8532-1999

Email: elehman@lehmanlaw.com

Website: www.lehmanlaw.com