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Last April, Management Buy-Outs ("MBOs") of large-scale State-owned Enterprises (SOEs) were suspended in response to an outcry over perceived abuses by existing management in some of these transactions. What caused most concern was management's participation in the valuation process of the companies they were acquiring, which could cause state-owned assets to be disposed below the value they could fetch on an open market.
The model for many deals with large-scale ex-State-owned groups in the last couple of years has been for management teams to complete the MBO prior to inviting foreign strategic and private equity investors to acquire an equity stake. Several large-scale deals involving foreign investors were slowed down or put on hold pending clarification of the suspension.
This suspension has effectively now come to an end with the issue on January 23 of "Opinion on the Implementation of Further Regulations on the Restructuring of State-Owned Enterprises" ("the Opinion") by the State-Owned Assets Supervision and Administration Commission of the State Council ("SASAC").
The Opinion states that management should not participate in the reform process (including valuation), sets qualifications for which managers are entitled to obtain equity through the process, stipulates that management should not obtain controlling equity stakes through the process, and requires that management prove it has independent sources of capital obtained independently from the Company. The Opinion also specifically identifies categories of managers who do not qualify to participate, which is effectively a list of the abuses that the Opinion seeks to control.
The validity of MBO transactions had become a major headache for dealmakers in due diligence. Unusual changes in reported performance around the time of the MBO and the gap between the valuation done at the time of the MBO and the amount that the new owner was asking the foreign investor to pay all raised concerns that the MBO transaction could be challenged in the future.
SASAC's Opinion is part of an ongoing process of regulatory evolution, as China's M&A environment continues to evolve and deals become more complex. Deal activity is likely to be encouraged by the Opinion and by a similar clarification of rules issued by the State Administration of Foreign Exchange (SAFE) last October, which put in place a framework for the use of offshore investment vehicles. As many deals in recent years have involved an MBO prior to the ownership of the Company being transferred to an offshore vehicle prior to an IPO or investment from a foreign investor, then seen together these two sets of clarifications should give investors confidence to move ahead.
If you would like more information on these rules, including an English translation, please Contact Us or Graham Matthews, email me.
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