Chinese M&A to Continue Despite Regulatory, Policy Hurdles: A.M. Best

December 30, 2016

While Chinese companies have been increasing their overseas merger and acquisition (M&A) activity in recent years, there are signs that growth could slow in the coming year, as a result of uncertain economic outlook and evolving government policies in China and in overseas markets, according to a report published by A.M. Best.

“Some deals that have already been announced are facing regulatory challenges and other unexpected issues,” said A.M. Best in its report titled “Chinese M&A Activity Continues Amid Evolving Regulatory and Policy Environment.”

“Even after closing a transaction, Chinese buyers still have to prove their ability to sustain the acquisition financially and to successfully manage the acquired companies, which may need capital injections, restructuring, or credit rating improvements,” the report added.

Despite the many challenges, the report said, Chinese M&A activity will continue as a long-term trend and a vital part of the country’s economic development.

“The number of both outbound and domestic deals is expected to continue to grow, although depreciation pressure on the yuan and eroding foreign currency reserves may cause some downside impact on outbound deals,” A.M. Best said.

Over the past few years, the report said, a wide range of strategic factors have been driving the M&A trend such as the hunt by Chinese buyers for asset diversification, international business expansion and financial investment and long term development.

Outbound M&A

Chinese buyers of foreign insurers come from diversified backgrounds, including private companies, insurance groups and state-owned enterprises, said the report.

“As relatively new players in the global M&A marketplace, Chinese buyers take a different strategy than that of Japanese acquirers, which tend to be established insurance groups with a focus on acceleration and geographic diversification of their portfolios,” A.M. Best said.

Most Chinese buyers have just started their insurance M&A activities, said the report, citing the example of Fosun Group, which has looked overseas in its insurance expansion to build a global financial group by making acquisitions to enhance the group’s financial capabilities and investment funds.

“More than 200 Chinese companies are waiting for local regulatory approval to start new insurance businesses,” said the report, noting that acquisitions could be a way to speed up their presence in the insurance sector.

“In fact, a few Chinese financial and investment groups are seeking insurance acquisitions both in local and international markets, using the leverage of their investment strength to help insurance companies’ investment returns.”

While private Chinese companies have mainly driven outbound M&A in mature markets such as the United States, Europe, and South Korea, the report explained that state-owned groups also recently have become active in the space.

Another factor driving Chinese buyers’ M&A activity “is the desire to run an international business, as well as the technical skills and experience that the buyer can gain from the acquired insurers in mature markets.”

For example, China Pacific Property Insurance Co. Ltd. invested US$50 million in usage-based insurance (UBI) firm Metromile in the U.S. as a strategic partner and investor. “China Pacific believes this investment will let it learn international technologies and skills that will enable it to promote UBI development in China,” said A.M. Best.

Strategic Partnerships

“In light of the increasingly competitive domestic market, Chinese companies have to strengthen their niche advantage or create new areas of expertise through strategic partnerships formed by outbound M&A,” the report continued.

“With the expectation of yuan depreciation, arising targets in overseas markets, and the Chinese government’s ‘go global’ initiative, many Chinese buyers are motivated to invest or pursue M&A in international markets,” it explained.

In addition to the high-profile U.S. and European purchases, there may be an increased number of smaller deals supported by the “One Belt, One Road” initiative, the report said. [Editor’s note: the One Belt, One Road project aims to increase central Asia’s connections to the rest of the world via investment and development in regional trade routes.]

Nevertheless, A.M. Best said, this outbound M&A trend has experienced substantial challenges:

  • Financial consideration of an M&A deal looks at not just the transaction value but also the potential capital investment required in the acquired company in the future.
  • In recent years, an increasing number of potential Chinese buyers from both insurance and non-insurance groups have been looking at M&A targets, which creates strong competition that may lead to overpriced transactions.
  • When a buyer takes over a financially weak company with a low credit rating, the acquired company may not only need further capital injection, but may also require a restructuring for long-term sustainability.

“All this means is that Chinese buyers have to consider their commitment to substantial capital and management requirements,” the report said. “Chinese companies are still in the relatively early stage of foreign investment, while the CIRC [the China Insurance Regulatory Commission] builds up its supervision experience.”

As a result, execution risks are potential issues for buyers and sellers, both before and after the transaction, A.M. Best affirmed.

Regulatory Challenges

Some of the M&A activity has also faced regulatory challenges, the report said. “For acquisitions in mature markets like the U.S., transactions are subject to multiple regulatory approvals, so buyers have to be mindful of complying with extensive regulations.”

The A.M. Best report pointed to Anbang’s withdrawal of its application for approval for its Fidelity & Guaranty Life deal after New York regulators required additional information on its funding and shareholder structure. Other withdrawn deals include Anbang’s US$14 billion bid for Starwood Hotels & Resort Worldwide Inc. and Fosun’s purchase agreement for Israeli insurer Phoenix Holdings Ltd.

“An acquisition’s sustainability is also an emerging issue. Fosun recently agreed to sell Ironshore to Liberty Mutual Insurance for US$3 billion after holding the company for just over a year,” the report continued.

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