For decades China has been an export-dependent economy, but it is now embarking on an acquisition drive. Xiaoming Li and Alex Zhang ask what this new interest in overseas investment means for lawyers doing business in the country

Western companies have long looked to China as an entry route into the expanding Asian market. Now, however, the roles are shifting. China is increasingly looking outwards as it seeks to move from an export-dependent economy to a consumer-driven one. 

While China gets to grips with its new-found status as an acquirer, western companies are seizing the opportunity to divest non-core assets and to take up investment finance to secure growth.

Seemingly, China has the one thing that much of the rest of the world lacks right now: access to capital. This is funding its acquisition drive, leaving western businesses more cognisant of the commercial benefits of East-West alliances.

Rising tide of capital outflows

China first opened its doors to foreign investment in 1978. Now, helped by changing government policies and liquidity, outbound investment is rapidly increasing.

Outbound investment figures speak for the scale of the upsurge in activity. In 2007, the historical aggregate amount of China's outbound direct investment in the non-financial sector stood at $117.9bn (£74.1bn).

In scarcely four years, the figure has almost quadrupled to $424.8bn (£267.1bn). China's outbound direct investment to Europe tripled from 2004 to 2008, and tripled again in 2011 to $10bn (£6.3bn). 

In Europe, companies in France, the UK and Germany are the principal targets, notably those in the manufacturing and services sectors. Many acquisitive Chinese companies are also setting their sights on technology and research and development (R&D) investments as a means of future-proofing their domestic operations. 

At an institutional level, the increase in outbound investment has seen massive growth in loan portfolios too. China's largest outbound investment bank is the China Development Bank (CDB). Though only established in 1994, as of the end of 2011 it has an outstanding foreign currency loan portfolio of $210bn (£132bn) and is central to most outbound investment deals. 

So, what makes Chinese buyers so keen to acquire western assets? There is an ongoing drive to secure staples – energy and natural resources – for domestic use. But also the country has a pressing need to upgrade its commercial capabilities by acquiring foreign technologies, talents and other assets in many manufacturing and services industries to enable it to emerge as a truly international player. Acquisitive Chinese businesses are seeking opportunities in:

• new markets: domestic competition in China is increasingly cut-throat. The country is struggling with overcapacity in many of its core sectors. When the big players cannot grow from within, they are seeking new opportunities outside its borders. Many industries – including construction, equipment manufacturing, financial services and energy – are looking beyond China not simply for economic returns and international recognition, but for their continuing business survival;
• technology: China's technology sector is concentrated in the low-margin manufacturing end. If it is to compete on a world stage, the sector needs to upgrade its capabilities and climb the production chain to where the value is. Many Chinese technology companies are therefore seeking high-tech assets overseas to strengthen its core base; and
• higher returns: many Chinese companies are simply seeking higher returns in overseas investment when the prices are depressed by the recent crisis. 

Domestic policy

The enabling and even encouraging policies from the Chinese government are fuelling the growth of Chinese outbound investment. 

Chinese state-owned enterprises (SOE), compared to private companies, have the access to cheap financing and are fast-tracked for governmental approvals. Though SOEs accounted for just one-third of Chinese outbound deals in Europe, they were responsible for 72% of total transaction value between 2000 and 2011, mostly attributed to a handful of large-scale acquisitions in capital intensive sectors such as mining and nature resources.

Worrying about business risks associated with the fast growth of the SOEs in foreign countries, the Chinese government recently adopted a new directive aiming to prevent SOEs from entering into deals outside their core sectors.

This regulation forces the Chinese SOEs to focus on business synergies and fundamental strategic value before entering into an outbound deal. It will be a welcoming trend for the western targets because the Chinese SOEs will be more likely to invest in and nurture the asset in which it acquires a stake.

Cash-rich smaller private Chinese companies also have the green light from government to invest overseas, especially when they are acquiring relatively inexpensive assets to complement their core competence in China.

The private companies are more likely to be interested in acquiring raw material supply, R&D, distribution network and brands. Certain sectors have received encouragement from the Chinese government to go abroad, including high-tech and advanced manufacturing, infrastructure, agriculture, finance and the service industry.

Streamlining procedures

China's government recognises that the current approval procedures for Chinese companies to invest abroad, which could be opaque and subject to unexpected delays, may be further streamlined.

The National Development and Reform Commission (NDRC) is charged with drawing up policies that will maintain the balance of economic development in China while restructuring economic systems. It has pledged to further simplify existing approval procedures for overseas acquisitions.

Although China's approval process for outbound investments probably will remain onerous compared with western standards, a more amenable approval procedure will make Chinese outbound investment easier to execute and better tolerated overseas.

On the other hand, would-be Chinese buyers are equally frustrated by western regulatory conditions, national security clearance, anti-trust procedures and pension and labour laws that can create problems pre and post-deal, especially when Chinese buyers are often greeted with suspicion in western countries.

Such hurdles create unwanted delays and uncertainties in deal-making for the Chinese parties. They are more likely to be flexible on pricing if it means that a foreign investment can be concluded swiftly with certainty.

Of course, as more high-profile deals are sanctioned by the west, the more likely it is that anti-Chinese perceptions will be dismantled, leading to more open-minded and collaborative deal-making.

There can be a gap in understanding between China and the rest of the world because of clashing commercial cultures and language difficulties. Dialogue needs to be open to improve transparency, negotiation and progression towards end goals.

It is worth remembering that Chinese companies are relative novices at the acquisition game – more accustomed to being acquired by western counterparts than acquiring. It is here where bilingual financial and legal advisers can take the lead, helping buyers and sellers to negotiate the approvals process and achieve successful resolution.

That is not as simple as it sounds. Bilingual and qualified financial and legal resources are hard to come by. As more companies expand outside China, headhunters are increasingly occupied with finding the right blend of skills and linguistic capabilities to translate and execute contracts in Chinese and English.

Not all plain sailing

On the downside, the failure rate for cross-border acquisitions is high. A sense of growing urgency among Chinese companies to acquire assets while prices are favourable and to move into higher levels of production to drive future growth exists. This scramble for acquisitions can result in hasty due diligence and ill thought-through investment decisions.

Cutting corners on due diligence can be costly down the line for M&A activities. The tendency to inspect an acquisition in a rush and to only pull out where there is an obvious problem is short-sighted.

Further changes are needed to the way that Chinese companies value assets if they are to remain credible suitors for international businesses. 

The speed of outbound lending from China, and the often less-than-rigorous approach to due diligence in the lending arena, will inevitably surface as bad debts along the way. Chinese banks that have made long-term commitment to the less liquid market segments could be vulnerable in the future.

For now, however, the conditions are right for boosting China's stature within world markets. Western companies, short on capital, are finding that their expertise in sectors such as technology, finance and manufacturing carries a relatively attractive price. Deals are being made that could change the commercial status quo as traditional barriers are being reduced. 

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East-west relations: tips for making outbound deals work

1. Start with a sense of trust. A transaction is a business deal; start out with a sense of trust and a collaborative spirit. Everyone wants the deal to work and to achieve both the target and the acquirer's commercial motivations.

2. Understand the Chinese mindset. Commercially, China has lagged behind much of the rest of the world in terms of business practices. It has some catching up to do. Some Chinese business practices may seem outdated; this may be inexperience or ignorance, but definitely not insincerity. 

3. Make allowances for political change. China's political system and decision-making procedures are unlike the western world's. Though steps are being taken to simplify existing systems, China's legacy may confound and prolong deal execution in the immediate term. 

4. Ignore stereotypes. The Chinese treasure their culture and they respect people who respect the Chinese culture. Learning one or two phrases in Chinese will show your respect for them. 

5. Engage advisers who understand East and West. By appointing advisers accustomed to working in both cultures, the learning curve and deal execution can be considerably shortened.

Xiaoming Li is head of White & Case's Chinese practice and Alex Zhang is head of the firm's Shanghai office.