China outbound guidance to boost M&A funds

New regulations expected to slow China outbound deals are in fact paving the way for more cross-border buyout funds targeting government-favored industries, such as agriculture and natural resources.

Guidance from China’s State Council which classifies outbound transactions into encouraged, restricted and prohibited categories is expected to increase the number of China M&A funds targeting agriculture and energy.

According to the new rules, ‘encouraged transactions’ – which include infrastructure projects in the Belt and Road Initiative, high-tech businesses as well as energy resources – stand to benefit from preferential taxation, foreign exchange, insurance, customs and information sharing.

As a consequence of these recent capital control changes, Chris Lerner, head of Asia for Eaton Partners, told sister publication Private Equity International that the industry is seeing the “development of more so called M&A funds – which are essentially offshore acquisition funds – focused on directed industries that relate to manufacturing and industry upgrading.”

“The proliferation of these vehicles has no doubt slowed but they still exist, often in size and with government support, where the mandate includes direct investments in sectors or areas that are deemed important to the development of the overall economy and various well publicized initiatives such as Made in China 2025 or One Belt One Road,” he said.

This growth in M&A funds is reflected in China outbound deal flow. While the number of newly announced outbound M&A transactions by Chinese companies fell by 20 percent in the first six months of 2017 compared with the same period in 2016, basic materials, energy & utilities have demonstrated resilience. Five out of the top 12 deals announced since January saw state-owned companies buy overseas basic materials, energy & utilities assets, according to research firm Rhodium Group.

Chinese government-backed funds, increasingly used to restructure state-owned enterprises under pressure in oversupplied domestic markets, have been developing rapidly since mid-2000s. Recently, the Chinese government has adopted several policies inducing private capital and encouraging SOEs, particularly the listed ones, to invest in cross-border transactions.