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M&A concerns are magnified when it comes to doing
deals in China, where there is less familiarity with due
diligence. "You have to be more careful when internal
controls are not as good, corporate governance is not
as well developed and there is a longer time to discover
data," warns Stephen Law, an Institute Council member
who worked on many M&A transactions when he was a
managing director of private equity group TPG.
There were about 3,000 reported M&A transactions
in China during 2011, of which 80 percent were domestic
transactions. The remainder were inbound deals from
overseas, which have slowed in the wake of downturns
in the European Union and United States.
However, outbound deals by Chinese companies
are proceeding apace. In October, China saw its biggest
foreign acquisition when the state-controlled oil
company CNOOC struck a US$15.1 billion blockbuster
deal to acquire the Canadian energy
producer Nexus. "It is a particularly
strong market at the moment,"
says David Brown, who leads
M&A transaction services
business in the Mainland and
After a spate of high-
profile scandals, M&A
due diligence in China
in recent years is much
more focused on looking
out for fraud, Brown says.
"There are more forensic
due-diligence procedures in
place," he says.
There are also lessons
for Hong Kong businesses
involved in M&A deals
with Chinese companies.
It was the HK$418 million
acquisition of Hong Kong-
listed Omnicorp in 2010 that
put Sino-Forest Corporation
in the spotlight when it
was found that some of
Omnicorp's logging licences
had expired. Sino-Forest
filed for bankruptcy in 2012.
There can be many
when conducting M&A due diligence in China, or on
Mainland-invested entities, experts warn. These include:
Complex corporate structures Acquiring a minority
interest in a business or entering into a joint venture
are common ways to invest in Chinese companies, as
is the use of cross holdings, offshore entities and shell
and holding companies, but some set-ups may not be
entirely legal under Chinese law. "Make sure you are in
fact buying one company and not 30 companies," adds
Velisarios Kattoulas, chief executive of Poseidon Research,
a consultancy that advises on M&A.
Multiple sets of books It is common for Chinese private
companies to have multiple sets of books and it is essential
to understand why this is and the differences between
books. "Frequently the 'tax books' will understate income
in order to reduce the tax liability," says Barry Tong,
transaction advisory services partner at Grant Thornton in
Hong Kong and an Institute member. "[This] may result in
a potentially large contingent liability for a buyer."
Revenue recognition and cash reconciliations
Experts recommend reconciling cash deposits from bank
statements to revenue. "There is often an early recognition
of revenues and inclusion of one-off gains as recurring
revenue," observes Jack Clipsham, a partner and head of
Asia Pacific corporate finance at Mazars and an Institute
Owners' compensation and personal expenses
These are among the most common causes of
adjustments to earnings. "Look for signs of inappropriate
expenses," advises Law at TPG.
Related-party transactions Relatives of the owners or
managers may be on the company's payroll, customers
may include related or affiliated companies and key
suppliers may be related or affiliated by common
ownership. "The due diligence process needs to
determine if there is contractual employment, sales or
purchase agreements that will survive [the] closing [of the
deal]," Tong says.
Last but not least, make sure all parties understand
the documentation, especially if it requires a translation.
"Language itself can also be a challenge -- both oral
and written," Clipsham warns. "The Chinese language
does come from one of the world's oldest cultures and
possesses an eloquent tradition rich in ambiguities."
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