The Kominsky Method

In the highly entertaining Netflix series ‘The Kominsky Method’, Michael Douglas plays the role of an acting coach. One of his techniques relies upon a simple principle: ‘I see you – You see me’. It is about two actors making a conscious effort to acknowledge each other’s presence with a view to establishing a way to work and perform together. Presidents Trump and Xi seem to be implementing this approach, and they will most certainly be successful. The relationship between the U.S. and China is set to find a new normal which will allow economic actors to enjoy the fat tail of a rather twisted macroeconomic cycle.

It is currently expected that a broad trade agreement would have China enlarge the access to its domestic economy to foreign investors whilst taking concrete measures to enhance IP protection (including a ban on forced technology transfer) in addition to increasing U.S. imports.

The deal implications for China’s GDP growth this year would be positive but modest since the monetary and fiscal stimuli designed to support the economy in the absence of an agreement could and would be tuned down. The yuan would stabilize thanks to an anticipated increase in foreign direct investment, including through inbound acquisitions at a time when a number of maturing industrial sectors would welcome some consolidation.1

China’s efforts to liberalize domestic investments are not new, though. In 2017, a flurry of measures were taken to open the market to foreign investment, including in manufacturing (check here). Despite these initiatives, inbound M&A in China has stagnated, with barely more than $50bn of acquisitions in 2018 or zilch when put in a global perspective.

Why? Beyond the uncertain macro-economic trends, a history of poor acquisitions have weighed on potential buyers’ appetite to do deals in the country. More critically, the total lack of sophistication of most selling shareholders when it comes to handling M&A processes has been a major obstacle to deals. The fact is, there is literally no M&A market in China, even more so when it comes to sell-side processes. The lack of historical transaction value data points is on its own a big hurdle as there is no factual counterweight to irrational price expectations from potential sellers.

A broad pick-up in inbound activity will have to follow a tedious learning process for all local parties involved. Creating a liquid market from the current status will be hard work when considering technical and cultural aspects alongside the entire M&A value chain: vendor due diligence, due diligence, synergies, estimated costs of achieving synergies, fair valuation, negotiation, regulatory approvals and, last but not least, post-merger integration.

Private equity firms will play a valuable role as intermediary owners as they prepare targets for a Western audience, thereby contributing to establishing a liquid M&A market. In the immediate future, foreign companies have an opportunity to consolidate their ownership in their Chinese joint ventures.

The Chinese M&A opportunity represents an exceptional value creation path for Diversified Industrials firms and their shareholders. However, the play will require some art and patience. Potential acquirors would be well advised to follow the Kominsky method. In that respect, a locally visible corporate M&A presence in China may represent a source of competitive advantage. I see you – you see me...