China’s rejection of Coke/Huiyuan believed to have short term effect on inbound deal flow

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Regulatory experts predict that the pace of inbound China deals will slow until the Ministry of Commerce [MOC] clarifies its methodology for rejecting Coca-Cola’s bid to takeover China Huiyuan Juice, dealReporter reports.

This comes after the MOC surprised market observers on 18 March by rejecting Coca-Cola’s USD 2.4bn bid to acquire China’s largest juice maker due to antitrust concerns.

Huiyuan shares fell from HKD 8.30 to HKD 4.80 the following day.

The high profile review was widely seen as a test on China’s new antitrust legislation which came into effect last August, cementing the MOC’s position as the ultimate deal gatekeeper in China. However, as many aspects of the new legislation are still being hammered out, some in the legal community expect overseas corporates to remain in the background before pursuing similar high profile deals.

Inbound China transactions

”The decision will send a negative message to potential foreign investors in China, particularly at a time when foreign investment in China is actually declining,” said Kirstie Nicholson, Shanghai-based legal counsel for Lovells’ Competition, EU and Trade practice. ”Namely, it may be difficult to make acquisitions in China where there is sufficiently powerful domestic lobby against the proposed transaction.”

According to Allen Wong, a partner at Simmons & Simmons’ China Corporate Group, the MOC’s decision will likely lead to less inbound China deals being announced until the regulator is able to provide detailed reasons for blocking Coca-Cola’s bid. ”The key here is how they define the relevant market,” he said, adding that with Coca-Cola’s bid it is still unclear which market definition the MOC had used.

According to a detailed explanation made by MOC spokesperson Jian Yao yesterday, the regulator had defined the relevant market for its recent review as the entire juice market, which includes 100% juice, 99%-26% concentrated juice and 25% or lower concentrated markets. Yao said in the explanation that the MOC, after a carefully conducting economic analysis, believed that carbonated beverages are unlikely to act as substitutes for juice products.

But the MOC’s explanation still remained quite vague, a Beijing-based independent antitrust expert said. ”So far the real material and details on the mathematical analyses are still missing,” the expert added.

”It is not important whether the [MOC’s] conclusions is right or wrong now, as foreign practitioners care more about how the Chinese authority drew to their conclusion to block the deal,” the expert explained. ”The Huiyuan deal can be understood as a single case and has no implications on other deals, but if other deals are to be all viewed in this way, foreign investors will really worry then.”

The MOC is still believed to be working on the final draft of the antimonopoly law, which is expected to lay out a more detailed list of guidelines that apply to M&A deals, said Richard Lee, a consultant at Simmons & Simmons’ China Corporate Group.The review process is still relatively new to Chinese authorities, so it will take more time for them to make the process more efficient, according to a source close to Coca-Cola. ”It seems that China is still using its foreign investment policy to review the antimonopoly law.”

Nicholson and Wong go on to interpret the MOC’s rejection as a sign that parties looking to take part in similar transactions should enter into a dialogue with the MOC as soon as practically possible in order to ensure as smooth a merger notification process as possible. There is also a political aspect involved with any potential acquisition, both counsel note.

Outbound China transactions

Although market chatter has been brewing that the recent decision laid down by the MOC could have an impact on outbound China transactions, namely Rio Tinto Group’s planned AUD 19.5bn sale of mines to Chinalco’s Aluminum Corp, there are some market observers who believe otherwise.

A Chinese government advisor claimed that it would be unfair to criticize China for rejecting Coca-Cola’s bid for Huiyuan, as the government has approved more inbound deals than it has blocked. The advisor said that the recent rejection is unlikely to influence overseas regulatory bodies, as most Chinese buys overseas involve minority stakes or partial assets.

”Protectionism is no good and we should be against it,” the government advisor said.

However, Wong argued that the MOC’s decision will have touched the nerves of Australian regulators and politicians, which could cause them to reciprocate by blocking Chinalco’s proposed transaction. ”But consumers and natural resources are very different sectors. If there is an impact on the Chinalco deal, it will all be on the political front.”

Chinalco’s bid is still awaiting clearance from Australia’s Foreign Investment Review Board, which recently extended the review period.

Since the MOC’s decision to block Coca-Cola’s bid only represents one review, Nicholson added that it does not necessarily represent a general trend against international companies by Chinese authorities and should not cause authorities in other jurisdictions to immediately retaliate.

The MOC’s decision in hindsight

After discussing the matter with people with close ties to Beijing, a source close to Huiyuan said that it seemed slightly naive of the government to block the deal since they had not realized how big of a backlash there would be. ”They now recognize they screwed up and it may bite them back.”

The bottom line is that China, which is still predominantly a net buyer, will be the one that suffers by shutting out inbound investment, the source said.

“I’m starting to think that maybe selling a Chinese brand to a foreigner went a bit too far - they’re not ready for it,” a second source close to Coca-Cola said. “People need to recognize there is always a political element to these things. So if the government doesn’t want Chinese companies to sell, then they’re not going to sell.”

Many questions also remained, as the MOC has preliminarily indicated that Coca-Cola’s could leverage its dominant position in China’s carbonated beverages to restrict competition in the juice market, the first source close to Coca-Cola said. ”I don’t know what evidence made the MOC come to this conclusion,” the source added. ”The question is, if other famous beverage makers such as Wahaha or Uni-President [Enterprises] propose to buy Huiyuan, will the MOC still have such worries?”

For the time being, Huiyuan is expected to focus on running its business, the source close to the juice maker said, though it was possible for Huiyuan to divest a small piece down the line.

An insider at Goldman Sachs, which represented Huiyuan as its financial advisor, confessed that it was likely that there was a political aspect involved in the MOC’s decision to block Coca-Cola’s bid. There have been rumors early on in the process that China was using this deal as a card in the ongoing trade war with the US, the insider said, though this remains to be seen.

The insider summed up the situation by saying: “The deal’s been rife with rumors from the start.”

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