M&A Advisory

China M&A: 2008 Is A Record Year, And The Strong Growth Will Continue

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Even as IPO activity all but came to a standstill in 2008, China’s M&A market reached an all-time high in 2008, with almost USD$160 billion in deals completed, according to Thomson Reuters. This makes China the biggest M&A market in Asia, for the first time ever. 

This is an important development, and I expect China’s role as Asia’s largest M&A market will continue into the future, despite the current economic slowdown. The reasons: M&A deals in China will continue to make business and financial sense. China’s M&A activity in 2008 was almost equally split between purely domestic deals – where one Chinese company buys or merges with another – and the cross-border acquisitions where Chinese and foreign firms join together – either with the Chinese firm buying into the overseas business, or the foreign firm taking a stake in a Chinese one.  

I see huge scope for growth in both areas. China’s economy, though growing more slowly now than in recent years, is still expanding. Despite its vase size (China is now the world’s third-largest economy, trailing only Japan and the US) Chinese companies are still, most often, small-in-scale relative to the size of the industries they serve, particularly in areas where private companies, rather than those with partial or complete state-ownership, predominate. China’s private sector is filled with minnows, not whales. 

The result: there is ample room for consolidation in virtually every industry. Smaller firms will continue to merge, to gain both market share and scale economies. Strong regional companies will acquire competitors elsewhere in China to become national powerhouses. 

The M&A market, more than IPO activity, tends to holds up well even during sour economic times, or when stock markets fall. As share prices drop, the lower valuations make it cheaper for acquirers to act. We had evidence of this recently in the US, where one of the biggest M&A deals of all-time was recently announced: Pfizer’s planned acquisition of Wyeth Labs

In China, valuations for both quoted and private companies are lower than they were a year ago. That lowers the cost of acquiring a competitor. The cheapest way to build market share, at this point in China, will often be to buy it. 

All M&A transactions have risk. Very often, the planned-for gains in efficiency never materialize from combining two similar businesses. In China, the complexities go above and beyond this. There is due diligence risk – the difficulty of getting accurate financial information about an acquisition target – and management risk as well.  Good Chinese companies are  usually owned and run by a single strong Chairman, with scarce management talent around him. In a merger, the boss of the acquired company will often step aside, leaving a big hole in that company’s management, and so making it harder for the acquiring company to integrate its new acquisition. 

How to do M&A right in China? Good deal-structure and good advice are crucial. Structure can anticipate and resolve some of the larger post-acquisition headaches. Advice is important to make sure that the price and strategic fit are right. Just as China’s SMB’s need specialized merchant banks to serve their needs in raising capital, these SMBs, as they grow, will also need competent M&A advisors to identify target companies, manage the DD, do the valuation work, help negotiate the price, and assist with post-acquisition integration. 

Last year was a strong one for M&A in China. But, the future should be even brighter, once current economic uncertainty begins to abate.  Looking ahead, I see a real possibility that China’s M&A market will overtake America’s as the world’s largest. I’m planning for my company to play a part in this. 

Houlihan Lokey Founding Partner James Zukin Sets His Sights on China

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I had the good fortune, while in LA, to have lunch recently with James Zukin. Jim is one of the name partners of the premier middle-market investment bank in the US, Houlihan Lokey Howard & Zukin. Jim and his partners were so far ahead of the curve, in spotting market opportunities, that they had to wait years for the curve even to appear behind them.

Over lunch, Jim explained how the firm stayed clear of Wall Street, both literally and figuratively, locating its headquarters in Los Angeles, and making the astute strategic decision to build a highly-focused and well-differentiated fee-based investment banking franchise, rather than an “all-purpose financial supermarket” that mixes advisory work with proprietary trading, market-making and IPO underwriting. We all know now how that supermarket model holds up over a full cycle: it doesn’t. The biggest of that breed, Merrill Lynch, sold out to Bank of America, and two other titans, Bear Sterns and Lehman Brothers, are both kaput.

Meantime, Houlihan Lokey (“HL”) has built and sustained a very successful business based first on providing fairness opinions and other valuation work, and then built up its lucrative practice advising on restructuring and M&A, and doing private placements. Even in dire financial times like now, HL continues to perform, doing solid, high-quality work a range of middle-market and SMB clients. HL again ranked as the number one firm in M&A advisory work in 2008 in deals of $2 billion or less, beating out Credit Suisse, Goldman Sachs, and others.

The race is won by the smart and focused, not the “supermarketized”.

Jim Zukin, no surprise, is the embodiment of the strategic qualities that have made his firm a consistent, anomalous success. A self-described “outsider”, he is by turns smart, charming, witty and modest. (Like me, he also likes a good burger.)

We met to talk about China, where Jim has personally spearheaded HL’s activities over the last few years, traveling back and forth frequently from LA, and opening offices in Beijing and Hong Kong. He speaks with palpable joy when discussing his visits to China. His workload at home in the US means fewer trips to China now, but he still refers to China, with heartfelt passion, as his “mistress.” It’s a description I’ve now shamelessly lifted from him, to describe my own long-term, requited love affair with China.

Jim Zukin is the one remaining “name partner” of Houlihan Lokey Howard & Zukin. He remains the chairman of Houlihan Lokey Asia. That’s a concrete sign of the company’s commitment to build a dynamic and durable business there.

HL has built a solid platform for growth in China. Its areas of expertise – and entrepreneurial outlook – position it well there. I know from my own experience that there is a sizable opportunity, to cite one example, to provide financial opinion, M&A and restructuring advisory work to the leading international PE firms active in China.

I have every reason to expect HL to succeed in China, with the same sort of approach that has worked so well for the firm in the US. How do they do it? Simple: Don’t run with the herd. Run with a better map.