Freshfields' Miriam Perez-Schafer and Alfonso de Marcos explain why China's growing interest in Spanish companies could see the two form a successful trade partnership in 2013

As one of the eurozone's main economies, Spain's severe economic downturn has been particularly trying for the EU and the countries forming part of the single currency.

In the second half of 2011 – and particularly during 2012 – the ghost of a complete bailout of the Spanish economy and the break-up of the eurozone loomed as certain indicators, such as the yields of Spanish bonds, soared to critical levels. 

During this time Spain's corporates, including blue chips, have suffered, with local demand for their products and services contracting and access to capital/debt markets and credit proving near to impossible.

However, they coped by reducing their exposure to the Spanish economy. In 2010, for the first time, foreign revenues of the companies listed in the IBEX 35 market exceeded 53% of the total.

They also sold non-core assets to reduce debt (several corporates have announced and have been carrying out plans in this regard).

In addition, they sought to reinforce their capital structure by incorporating foreign investors. At the end of 2009, foreign investors held more than 40% of the capital of Spanish listed companies.

The Spanish bank rescue, together with the reforms implemented by the Spanish Government, are restoring confidence.

While Spain will still suffer the effects of its recession in 2013, the worst of the sovereign debt crisis may be over and the bailout of the Spanish economy – which seemed all too probable last year – has been discarded, at least for the moment.

Things are starting to look up and Spain is, once again, an attractive destination for foreign investment.

Opening new doors

Spanish companies have traditionally knocked on the door of Middle Eastern state-owned enterprises (SOEs). For decades, their presence was more symbolic than real.

But in the past few years, Middle Eastern SOEs and sovereign wealth funds (SWFs) have made substantial investments in Spanish blue chips.

In a context characterised by a lack of credit, SOEs offer a significant advantage over other investors: they have sufficient funds and liquidity to undertake investments on their own, without the need for external financing.

Examples include the investments in Spanish utility company Iberdrola (2011), oil company Cepsa (2011) and utility firm Gas Natural Fenosa (2011).

However, the Middle East is no longer the only door to knock on. Chinese outbound investment is rising exponentially, fuelled by the financial strength of Chinese companies and their desire to compete on a global basis, along with the Chinese Government's aim to balance inbound and outbound investment.

Historically, Chinese investment in Spain has been irregular and, with certain exceptions, low in value.

But this is changing. During a visit to Spain in May 2012, Wu Bangguo, chairman of the Standing Committee of China's National People's Congress (NPC), said relations between China and Spain are at the best time in history.

The country is now Spain's largest trade party outside the EU.

Given Spanish public companies' current share prices, which have decreased significantly during the downturn, this provides a positive framework for Chinese SWFs and other companies to seek opportunities to invest in Spanish blue chips.

So far, there have been several examples of Chinese SWFs and Chinese companies (some of which are also SOEs) attempting to invest in and co-operate with Spanish companies.

Some have been successful, such as the China Unicom investment in Telefonica in 2009-11, and the collaboration established between the Spanish hotel chain Melia, the Chinese hotel group Jin Jiang in 2011 and the Chinese real estate group Greenland in 2012.

However, other ventures have not made it past the finish line, such as the failed investment by the Chinese group HNA for the Spanish hotel group NH Hoteles in 2011.

But the trend is there. Timidly, more Chinese investors are seeking – and are being sought by – Spanish corporates.

Down to business

Chinese investors fall into two camps: financial and industrial. Financial investors are seeking a steady flow of dividends from companies they invest in.

Industrial investors not only want financial return, but also the collaboration and the exchange of technology and know-how.

No matter the nature, Chinese investments normally range between 5% and 15% of the target company's share capital, with the 30% Spanish mandatory bid threshold acting as a glass ceiling.

In addition to purely economic and financial considerations, such as price or projected revenues, Chinese investors may target specific stakes to benefit from additional rights under Spanish corporate law (eg shareholders holding at least 5% of the company's capital can call for extraordinary shareholders' meetings or contest board resolutions).

Chinese investors tend to approach and negotiate their investments with the target company rather than with significant shareholders.

This means investments usually take the form of treasury stock transactions, equity issues or both. 

Generally, treasury stock transactions, such as the one between China Unicom and Telefonica, are the fastest and easiest way to implement the investment (with a legal limit of 10%).

In fact, treasury shares might be transferred through a plain stock market trade without entering into heavy documentation. These transactions also benefit from some pricing flexibility.

But they require that the shareholders' meeting has previously authorised the company's board to deal in treasury shares.

As for equity issuances, the decision to increase the company's share capital is generally reserved in Spain to the shareholders' meeting.

However, there are instances where the board may have been delegated the authority to increase the company's share capital by up to 50% and against cash contributions.

Interestingly, this delegation may also invest the board with the faculty to derogate, on the grounds of the company's corporate interest, preferential subscription rights that would otherwise correspond to the company's existing shareholders. This was the case in the failed HNA/NH Hoteles deal.

Whenever this derogation is agreed, specific limits apply to share discounts (shares must be issued at a fair value; ie market value) and additional corporate documentation is required (including an independent auditor's report addressing the proposed issue price).

Chinese investors may also consider a combination of treasury stock and equity issues as a way to achieve a shareholding in excess of the 10% treasury stock threshold and make the deal more palatable by limiting the dilution of existing shareholders.

Other investment structures, such as equity-linked instruments (eg warrants or convertible/exchangeable bonds), are also available, but Chinese investors tend to prefer simple structures that can be quickly and easily implemented.

As a distinctive feature, Chinese industrial investors are usually eager to access the target company's board and, in most cases, enter into alliance and/or knowledge-sharing agreements.

This was the case in the China Unicom-Telefonica deal, the aborted HNA-NH Hoteles deal and in the strategic alliance between Greenland and Melia.

Normally, these agreements provide for the promotion of joint investment opportunities, notably in China, where applicable regulations often require foreign investors to team up with local entities and sometimes also for the Chinese investor's right to access certain know-how of the Spanish corporation.

Pitfalls

Although Spain has become a more investor-friendly environment than it was traditionally, Chinese investors are nevertheless wary of certain difficulties that may arise; for example, foreign investment restrictions in strategic sectors such as defence or energy.

And investors may be faced not only with Spanish regulatory hurdles but also – particularly when the investment is in companies operating at a multi-national level – with regulatory restrictions in other jurisdictions.

In addition to these technical complexities, cultural differences can arise. A more complex decision-making process and the need for the Chinese government to authorise outbound investments must be appreciated and factored into any timetable.

Similarly, outbound deals are almost always negotiated and executed in English, but sometimes key decision makers will only read the Chinese versions of internal memos and papers, so it is important to make sure high-quality translations are available.

These factors should not dissuade either party, but should be factored into the overall timetable of the transaction.

It may seem challenging today but, as Chinese investment in Spanish listed companies becomes more common, we are confident that the barriers will soften – even disappear in some cases – and what now seems unusual, exotic and overly complicated will prove to be, as Rick says to Louie at the end of Casablanca: "The beginning of a beautiful friendship."

Miriam Perez-Schafer and Alfonso de Marcos (both pictured) are senior associates at Freshfields Bruckhaus Deringer in Madrid.