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With China’s economy transforming from a high-growth economy into a high-quality development-oriented economy, multinational corporations (MNCs) in the PRC are facing a unique challenge in terms of dynamic industrial structures and markedly shortened cycles for new business models and technological updates, coupled with the overall complexity of China’s evolving macro landscape. On the one hand, local Chinese companies – after years of development, substantial technological innovation and sharpened agility to respond to local emerging demands – now present a threat to the leading position of some MNCs. On the other, the gradual disappearance of a demographic dividend in China has led to rising labor costs, weighing in particular on foreign enterprise operations.

Consequently, MNCs have started to re-examine their Chinese businesses and investment portfolios. By restructuring or disposing of non-core businesses, they can focus resources on core business areas that carry higher entry barriers and sustainable growth potential. However, the actual execution of a contemplated sale entails a multi-step and challenging process that, if not managed properly, could prolong the transaction extensively or even present deal breakers. This article shares some recent cases from KPMG's financial advisory team to help provide insights and suggestions on key challenges that can arise in a divesture transaction.

1) How to ensure the certainty and confidentiality of transactions?

Case 1:

KPMG assisted a European industrial group sell its commercial products-related business in China. The target was a part of the group’s China business and operated as an independent entity. Given a mismatch between the target’s market positioning and the client’s global strategy, a quick divesture decision was made to avoid the financial consolidation of the target business into the Group report before the new fiscal year.

The challenges:

  1. How to improve the timeliness of a decision-making mechanism for the transaction?
  2. How to control the transmission of sensitive information?
  3. How to accurately screen and assess potential buyers?
  4. How to ensure the certainty of the transaction?

Our response:

The KPMG team and the client’s core management team (at both Europe and China headquarters) formed a working group. KPMG helped the client select a number of non-direct competitive buyers with potential business synergies, and directly approached the decision-makers of the potential buyers through our channels to gauge their respective interests and capabilities. All project-related materials were prepared uniformly by KPMG and sent to potential investors step-by-step after the client team’s approval. KPMG served as a single information transmission and Q&A channel. After the buyer and seller confirmed the main investment terms, the communication of highly sensitive information was completed face-to-face by the final decision-makers of both parties. The transaction documents were signed quickly afterwards. 

Takeaways:

  1. Leading the transaction process directly from the MNCs’ headquarters can ensure that project progress and key issues reach core decision-making levels quickly, facilitating timely decision-making while limiting operational interference to the target. Meanwhile, utilizing a China-based core management team devoid of conflict of interest in the transaction process is preferable in assisting with information preparation and communication. 
  2. It is essential to strictly manage communication channels, approaches and content as well as classify all requisite information in terms of sensitivity level and clearly define the appropriate audience scope and delivery schedule. Control over information leakage can be maximized by communicating via a single channel (e.g. an exclusive financial advisor).
  3. Two models are usually adopted in a divesture transaction: 1) exclusive negotiation; or 2) a bidding process among a select limited-number buyer pool. Exclusive negotiation entails one-on-one liaison with the top-ranked potential buyer, facilitating high confidentiality and fast transaction speed, but presents risk as to delays or missing the best sales window if the transaction folds. Meanwhile, bidding via limited buyers evokes a competitive momentum, improving certainty of a transaction and enabling confidentiality to a certain extent by keeping information within a limited scope. However, this requires a higher level of capability in terms of selecting and assessing the most appropriate short-listed buyers.
  4. For divesture transactions in China, MNCs generally select potential buyers who have established business in the same industry as – or along the value chain of – the target’s operation to generate synergies post deal. It is particularly important to evaluate the strategic planning and assess overall industry positioning of the potential buyers.
  5. Given high requirements as to timeliness and certainty of the transaction, the potential buyer’s funding capacity and transaction execution ability must be determined, especially in terms of attitude and experience of the decision-makers. The potential buyers can then be ranked based on the feasibility of transaction consummation. Buyers with higher feasibility would be prioritized for approach, but flexibility should be considered based on further communication with the buyers.

Demonstrated financial advisory traits for case success:

  1. In-depth insight into the industry and businesses to be sold and ability to identify and propose the appropriate transaction process management is pivotal. A degree of flexibility is also needed in understanding, communicating and delivering information and providing timely advice on necessary adjustments along the way based on the progress of the project.
  2. Thorough understanding of the interests and strengths of the potential buyers – and ability to act as a facilitator in the transaction via direct communication with the buyers’ decision-makers – is also essential. 

2) A smooth transaction completion can often rest on the handling of HR issues. How can communication with the target’s employees be effectively handled?

Case 2:

A few years ago, we had a case where the client announced the divesture plan to mid and senior management of the target company before the financial advisor was involved. Owing to uncertainties as to the transaction prospects, employees stopped working and began persistent discussion regarding their compensation schemes. The client had to halt the transaction process and spend excessive time dealing with employee problems and adverse market rumors regarding its restructuring plan in the China market.

Last year, another multinational retail company approached us on its plan to sell all its businesses in China. Local employees already had a clear preference as to the type of new shareholders, meaning the cooperation of these employees could hinder on a successful deal closing.

The challenges:

  1. How to eliminate a potential panic mentality among China-based employees and obtain their support?
  2. When to initiate the transaction communication with employees?

The challenges:

To reduce interference with the transaction, the KPMG team only communicated with the client headquarters directly throughout the entire process. No transaction information was disclosed to any Chinese employees before the final buyer was selected. Concurrently, with the assistance of KPMG and legal counsel, the client formulated a detailed employee compensation and incentive plan, which was discussed with the buyer beforehand, and drafted a complete communication plan that covered multiple scenarios. As the transaction approached the later stages and deal certainty was near confirmation, the compensation plan and incentives were discussed with the employees as soon as possible to reach an agreement, resulting in a smooth closing.

Takeaways:

  • The employee compensation or resettlement plan (under multiple scenarios) is a key preparation task in the early phase of a transaction. An appropriate retention/transfer plan and incentive mechanism for key employees is crucial to ensuring a successful transaction. As the employee compensation or resettlement plan is an important commercial term in the transaction documentation, it should be negotiated and confirmed with the potential buyer as early as possible.
  • Communicating the deal plan to employees should be based on the certainty of the transaction. After confirming serious interest from buyers, communication should begin with the core senior management level first to understand their feedback and requirements, before ensuring that they can actively assist in the communication with all employees. 
  • After the transaction is confirmed, it is pivotal to initiate discussions with existing shareholders, new shareholders and all employees as soon as possible to avoid adverse impact. If necessary, liaising with the local government should be conducted as well to align and reach a consensus of the interest for the enterprise, employees and society.

Demonstrated financial advisory traits for case success:

The ability to discern the impact of the core requests of different stakeholders and employees on the transaction, control the pace and progress of communication, and leverage on platform resources (HR, operations and other professional teams etc.) to work closely with the client and develop a reasonable employee compensation scheme and practical communication strategy are crucial. This can help maximize the interests of shareholders, employees and the target business as a whole.

3) Many Chinese investors lack cross-border M&A experience and are accustomed to following local investment and transaction patterns. How can the requirements of these investors best be met while still following a global transaction protocol?

Case 3:

KPMG was engaged by a UK-listed entity to assist it in selling its car dealership business in China to a Chinese-listed company. As most of the potential buyers were Chinese enterprises, they generally did not involve external advisors and were unfamiliar with the use of a virtual data room to conduct due diligence, exerting pressure on the timetable to complete the transaction. Further, the Chinese enterprises were unfamiliar with the cross-border M&A valuation concept of "cash free and debt free” enterprise value. The target had a large amount of cash on the balance sheet. If the cash was not considered, the actual valuation would be greatly reduced.

The challenges:

  1. How to manage the process to meet the necessary due diligence and internal approval requirements of Chinese investors without affecting the normal operations of the target?
  2. How to persuade Chinese investors to understand the value of the target business?

Our response:

To avoid disrupting the ongoing daily operation of the target, KPMG helped the client establish a complete virtual data room in advance in line with the general requirements of Chinese investors. As the due diligence process began, KPMG managed multiple investors to conduct due diligence simultaneously, guiding the investors to effectively use the virtual data room, and coordinated the communication between the buyers and the seller. Given time zone differences, KPMG communicated with buyers during day times, analyzing and classifying the due diligence issues essential to the buyers’ decision-making, and at night discussed and advised on issues identified with the client. Within 1.5 months, we assisted our client to successfully meet the rigorous local due diligence requirements from several investors in parallel and ultimately concluded a smooth transaction.

During the valuation negotiation, with the consent of the client, KPMG set the principle of additional compensation for cash. KPMG helped the buyer and seller analyze and discuss the value of the target based on each party’s own valuation method, ultimately reaching a final agreement.

Takeaways:

  1. Due diligence in China is more comparable to audit work, thus the completeness of database information, understanding of the internal approval requirements of Chinese enterprises, and proficient communication and responses from financial advisors are necessary to help Chinese investors complete their due diligence work. The interpretation of Chinese investors’ questions and response advice is important to help MNCs understand Chinese investment logic. 
  2. Different from the standard global M&A protocols, Chinese enterprises focus more on P/E and P/B ratios, while being relatively unfamiliar with the concept of "enterprise value on a cash free and debt free" basis. The role of a financial advisor is to help investors understand the value drivers of the target, find a balance point of mutual conversion and confirmation under different valuation methods, and obtain the approval of both parties.

Demonstrated financial advisory traits for case success:

Familiarity with the internal decision-making process, pricing model and investment logic of different types of investors (including but not limited to SOEs, POEs, foreign enterprises, listed/private companies, foreign/local private equity funds) was paramount. Flexibility to respond to the decision-making needs of all parties and accurately articulate to each party problems that could otherwise be easily misconstrued by a counterparty in a cultural context. Effective bridging of the gap between the two parties during the transaction process to maintain a high success rate of the transaction is key.

4) How to formulate a carve-out plan to meet the sale timetable?

Case 4:

KPMG assisted a global food group looking to sell part of its production business in China but retain its sales business. The divesture of partial business necessitated consideration as to various carve-out topics (staff retention, use of brand/trademarks, transition arrangement of the group’s internal services post-transaction, etc.), that would affect the negotiations and timetable of the transaction.

The challenges:

  1. How to ensure the completeness of the carve-out plan and ensure it would not affect the completion of the transaction during implementation?
  2. No individual financial statements for the business to be sold were in place. How to deal with investors’ due diligence and valuation?

Our response:

We formulated a carve-out plan together with our client at the beginning of the transaction – factoring in all assets, personnel and operations involved in the carve-out – and prepared the pro forma financial statements on a post carve-out basis. Consequently, we quickly arrived at an agreed valuation and carve-out timetable with the investor. Given the sufficient amount of preparation in the early stages, both parties cooperated to carry out the relevant transition period arrangements after signing the transaction documents, and also periodically discussed the carve-out progress together to resolve any potential emerging problems in a timely manner, enabling the transaction to be concluded on time.

Takeaways:

  1. For transactions involving restructuring, a carve-out plan and pro forma financial statements should be prepared in advance to ensure a smooth response to the investor’s project evaluation and analysis. 
  2. The carve-out plan is a primary part of the transaction documentation given the potential commercial and legal impacts (payment of trademark licensing fee in the transitional period, payment of the headquarters service fee, etc.) post deal. Full consensus of the carve-out plan should be reached in the negotiation stage, while some time-consuming but non-core carve-out work can be completed after closing to ensure the closing can be made on time.

Demonstrated financial advisory traits for case success:

Coordinating between the client and other advisory teams was critical in formulating the carve-out plan in advance, preparing reasonable pro forma financial reports in alignment with the client’s interest, planning the carve-out timetable in an orderly manner, and providing solid oversight to ensure a smooth implementation.

Conclusion

Investment, expansion and exit are critical phases in the growth cycle of enterprises. Successful completion of a divesture transaction can be a key step to realizing the investment value. Leveraging on KPMG’s deep experience and understanding of the Chinese market can help MNCs achieve investment value optimization in China.

Andy Qiu

Partner, Deal Advisory
Tel: +(86) 21 2212 3572
Email: andy.qiu@kpmg.com

Vera Zhang

Manager, Deal Advisory
Tel: +(86) 21 2212 4624
Email: vt.zhang@kpmg.com

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