China’s M&A drive is a bubble
By Jon Connars
When China’s stock market started tumbling, dragging the yuan down with it, few would have anticipated the furious shopping spree Chinese companies would embark on. So far in 2016, some 102 M&As have been announced, amounting to $81.6 billion in value – some eight times more than in the same period last year. A weak yuan is incentivizing SOEs to consolidate, before further depreciations in the currency makes overseas assets too expensive. However, in an interesting turn of fate, the same uncertainties that are putting downward pressure on the yuan may also scupper some of the very deals the slowdown is spurring. Like so much of China’s state-controlled economy, this unprecedented M&A drive is just another bubble fed by a self-defeating, circular logic.
Two solid reasons underpin this assessment. To begin with, market uneasiness about the extent to which the Chinese government will allow enterprises to operate independently of its control plays into the continued depreciation of the yuan, therefore shortening the window of opportunity that makes M&As attractive ventures. Those same fears also serve to heighten the systemic distrust regulators and shareholders in the West have towards Chinese companies, a barrier that will be impossible to overcome in the current economic climate.
Fearing fear itself
The yuan first began its tumble against the dollar last year when the Chinese government intervened in the stock market to prevent a selloff in equities caused by the bursting of a housing bubble. This was done by forcing state controlled enterprises to buy up shares before they flooded the market and caused a generalized market selloff. It worked, but it did nothing to persuade western observers that the communist nation was serious about market liberalization, and neither did subsequent events, which only served to illustrate the difficult situations that governments find themselves in when they try to manipulate a market rather than allow it operate freely. Worried that the state controlled enterprises would all try to offload the shares they had bought at the same time, thus being responsible for the very selloff they were meant to prevent, the government put a circuit breaker in place that would halt all trading once market prices fell below 5% in one day. The blowback was punishing: within days, panic selling ensued as traders tried to offload as many of these shares as possible before the circuit breaker kicked in. Recognizing the counterproductive effect that this had had, the circuit breaker was removed the following day but the government continued to support the currency against downward pressure.
Before the dust from this episode had time to settle, further questions were raised about China’s commitment to laissez-faire markets. In August, the yuan was unexpectedly devalued causing traders to sell the currency, which in turn resulted in further interventions that saw the government burn through $500 billion to prop up it up. A similar event occurred in December when, under the pretense of allowing greater exchange rate flexibility, the yuan was unpegged from the dollar in favor of a basket of weighted currencies, and the government had to step in again to prevent a precipitous decline in its value. The government’s fitful stop-and-start approach, claiming to embrace market forces to dictate the currency’s value before stepping in to prevent that very event from happening, is precisely what has investors shorting the yuan. Indeed, several Wall Street hedge funds have piled up billions betting against the currency.
The continued downward slide of the yuan has spurred a rash of M&As as cash rich, mostly state-owned enterprises seek to rid themselves of the currency by investing in foreign companies. In the first two months of 2016 cash outflows reached $110 billion in January alone. But just as the level of state interference in the equity and currency markets has spooked traders, unease has also been caused by the role of the Chinese government in the SOEs that are now eyeing up Western companies.
A case in point is the potential record-setting purchase of Syngenta, a Swiss biotechnology company, by state-owned ChemChina, which has already raised concerns in the US over possible national security issues. These relate to fears over the Chinese company taking ownership of Syngenta’s research facilities, a number of which are close to US army bases, as well as questions about Chinese access to seed and pesticide technology that is considered critical infrastructure due to its importance in food production.
Similar proposed tie-ups have been rejected on the same grounds by the Committee on Foreign Investment in the US (CFIUS), which has the power to recommend the president to block deals that are threatening national security. Last month, Fairchild Semiconductor International pulled out of talks with a group of state-backed Chinese interests for fear that CFIUS would block the takeover due to concerns about Chinese access to the sensitive microchips that go into making drones and smart bombs.
Whether it is traders betting against the currency precisely because the government has done so much to bolster it, or the US government scrutinizing deals, again because of the perceived influence of the Chinese government in the companies involved, it seems that most of China’s economic woes stem from the same source: its overbearing central government. While a lot of ink has been spilled by China’s growing appetite for Western companies, don’t expect the drive to last. Bubbles never do.
Jon Connars is an investment risk analyst and researcher with an expertise in the ASEAN region who currently shuttles between Singapore and Bangkok.
Copyright 2016 Jon Connars