Just after the Ministry of Commerce announced that it had rejected Coca-Cola's (NYSE:KO) bid for Chinese juice-maker Huiyuan (OTC:CYUNF), I got a message from a very astute friend of mine who noted "that deal was dead the minute it made the headlines in the South China Morning Post."
We are going to hear a lot of hindsight-laden "I knew it was going to be rejected" statements in the coming days. So let me start by stating for the record that this will at first sound like one of those posts, but what I really want to do is explore (with the full benefit of hindsight) why this deal may have been killed, in the fervent hope we can learn something at Coke's expense.
It Sounded Like a Hard Sell at the Time
A momentary slide into the "I told you so" zone.
Not long after this deal was announced, I noted that this was going to be a rough sell for Coke in Beijing. Apart from the threat of the deal falling afoul of China's shiny, new, and not-yet-tested anti-monopoly law, I said that Beijing has over the years actually made its current policy on FDI rather clear. Looking at that policy, it was fairly clear that the deal would have a difficult time passing muster with the government. and that Beijing might relish an opportunity to say "no."
Rather than suggesting the deal was DOA, however, I noted that Coke had best kick a communications program into gear to start building support for the deal, because doing so would be their only hope in getting past the barriers they faced.
Whether this deal succeeds, then, has less to do with its considerable business merits or with the law itself. It has much more to do with how well Coke handles the government debates and public discussion on the deal's merit.
Hopefully, Coke has learned from Carlyle's experience, and has prepared a case that will convince the nation's leaders to make an exception to policy and will gain the support of consumers and influential public voices in China.
Coke, in short, needed to manage the public debate, because regardless of the reason given by the Ministry of Commerce for rejecting the deal, there was actually a lot more stacked against Coke in its bid for Huiyuan. I count at least seven.
Reason One: One Man's Market Leadership...
The first reason is the one the government gave, that the deal would violate the spirit of section 23 of the Anti-Monopoly Law, which appears to be designed to ensure that a single player does not become so dominant as to be able to dictate market terms. As the Ministry of Commerce noted, their concern was that the deal would hurt small local players, drive up the consumer price of juice, and limited consumer choices.
Market share figures are painful to discern in most markets, and in China, where data flows like concrete doesn't, the numbers are much harder to pin down. As best as we can tell, Huiyuan as market leader holds a bit over a third and possibly as much as 42% of China's estimated $10 billion market in juices and nectars. That's a pretty dominant position in a fragmented market.
Coke, for its part, is number two with about 10% of the market. If we use those figures, Coke would have owned somewhere around half of an otherwise fragmented $10 billion market. Does this count as a "monopoly" in the classic economic sense? Probably not.
But without other strong players to act as a counter (if Coke was #2 with 9.7%, the next biggest player would have held much less than 10%), you can see that the government was concerned about allowing the creation of a company that would have the brand, manufacturing, and distribution muscle to dictate market terms.
Would that concern have been enough by itself to derail the deal? Maybe. But there were other factors involved as well.
Reason Two: Not Our Kind of FDI
China's foreign direct investment policy since the country began its "reform and opening" process three decades ago has been to create laws and administrative regulations to channel the investment into the sectors and vehicles where China needed it most. The policy has not changed, but the means of the channeling - and the government's general attitude toward FDI - have.
Foreigners are free to invest in China through WFOEs [wholly-foreign-owned enterprises] or JVs [joint ventures] in the areas of investment classified as permitted or encouraged in the current Catalog for Guiding Foreign Investment.
Foreigners are permitted to purchase small established Chinese companies where the government is too busy to be concerned with management of the small company
Foreigners are permitted to purchase large established Chinese companies suffering from financial problems, provided the foreign purchaser will restructure the company and assume the company's obligations to workers and creditors.
Foreigners are permitted to acquire a minority interest in large and successful Chinese companies, provided such investment will provide collateral benefits in the form of technology transfer or access to new markets.
Foreigners are not permitted under any circumstances to purchase a majority interest in a large and successful established Chinese company.
I can't speak to the first issue, but it seems fairly clear that the Coke-Huiyuan deal failed to qualify under the other four.
This might have actually been the deal-killer, but since none of this is written down anyplace, it was easier to cite the Anti-Monopoly law.
But wait. There's more.
Reason Three: Hands Off the Brands, Boys
An unwritten goal of China's industrial policy is the creation of leading brands that will not only lead to a healthy, stable market at home, but also form the basis of a bevy of global Chinese brands. Even though candidates arise from time to time, China's enterprises are still in the early stages of creating international markets.
Huiyuan, however, was a better-than-average candidate, with a leading position at home, smart marketing, and a brand that consumers associated with quality and purity. To have a potential champion gobbled up by a foreign company before it even had a chance to go abroad was probably too much for China's leaders to stomach.
Which is probably the reasoning underlying China's restriction on purchasing a majority interest in a "large and successful established" Chinese company.
Reason Four: What We Have Here is a Failure to Communicate
As my former colleague and frequent lunch companion Imagethief noted, public sentiment was probably not too terribly in favor of the deal to begin with, and things went from bad to worse as allegations came out that Coke's people were trying to quash criticism of the deal.
A core rule of public relations is that you don't try to stop journalists or others from trying to criticize your company because that effort then becomes a story, and you lose all credibility. Now, this rule is often ignored in China, in particular by Chinese companies, who use all kinds of creative and interesting tactics ranging from calling the government, to placing (or withholding) advertising dollars, to outright paying the reporter in order to try to keep negative stories about their company out of the press. Some foreign firms, sadly, have decided that the best thing to do in Rome is wear a toga, and so have picked up the practice.
Whether or not Coke actually did any of these things is not the point - the perception is that they did. That perception was built atop public sentiment that appeared to be skewing neutral to negative on an issue where what Coke needed was widespread support.
Coke failed to realize that it is now a truism that foreign companies cannot hope to successfully test the limits of government policy unless that effort appears to have widespread support - not just among China's elites, but increasingly among the broader public as well.
Few companies will remember that, I'm sure, but the wiser heads among M&A advisors - investment banks, attorneys, and accountants - will realize they need to make room at the table for someone who understands how to win in the court of public opinion.
Reason Five: Morning After Syndrome
Speculation has been rampant of late that Coke may well have been looking for a way out of the Huiyuan deal long before it was dealt its regulatory death blow. Coke, for its part, denied the rumors, and we may never know the truth.
But less than two weeks after the announcement, the U.S. government decided not to rescue the beleaguered Lehman brothers, setting off a chain of events that immediately altered the priorities of companies around the world. Certainly if I were sitting at Coke headquarters in Atlanta, I'd be worried about whether I could afford to part with $2.4 billion in cash right as world credit markets were drying up and consumers were rethinking their spending habits.
Even if Coke lost a little of its ardor for the deal, that might have been enough for the company to give less than its full effort in trying to gain approval.
Or, indeed, it might have been enough for the company to become completely ambivalent about it. Given the challenges they faced, that might have been enough to weaken Coke's chances.
Reason Six: Kindergarten Dynamics
There is a school of thought that Coke's bid was sabotaged before it happened, not by either company or the Chinese government, but by the U.S. government when it blocked the acquisition of Unocal by CNOOC (NYSE:CEO), or when it blocked the purchase of 3Com (COMS) by a group led by Huawei. The belief is that this rejection was a tit-for-tat, China treating a U.S. company in a manner to which Chinese companies have become accustomed in America.
This is not unlikely. China is a big fan of reciprocal behavior in its international relations, even raising visa charges for citizens of countries that have raised the cost of a visa for Chinese travelers.
Certainly there must have been a bit of that sentiment in the smoky room in Beijing where this matter was decided. How much of a role it played we will never know.
Reason Seven: The Global FDI Problem
Last June the Council on Foreign Relations published a special report, Global FDI Policy: Correcting a Protectionist Drift, in which the authors quantify a decided chill in the past several years by a number of countries toward foreign direct investment. While the authors (a Carlyle executive and a distinguished academic) might well have turned the report into a China-spank, the report is remarkably data-focused and even handed.
What they quantified - before the world lurched into its current state - was a decided tendency by nearly all of the world's major polities to restrict foreign direct investment. The biggest culprit in the report was the United States, but the authors note that there is evidence of this trend worldwide.
The problem is that unlike trade, there is no global policy protocol around cross-border direct investment and acquisitions, kind of like the situation we had with international trade prior to World War II. And frankly, this is no time for countries to be turning off the tap, especially (as the authors note) local affiliates of foreign firms on average deliver greater economic benefit to host countries than local firms.
The Coke-Huiyuan deal was taking place in an global FDI policy environment that is starting to sour, and may come to be emblematic of the need to raise the matter of FDI to a global intergovernmental level - once the banks are sorted out, of course.
The lesson here is that the problem of FDI policy to an extent transcends Coke, Huiyuan, China, and the United States, and that those issues probably played some role here.
Making it Better
The above list is by no means balanced in terms of the relative importance of the factors, and it is by no means complete. Taken together, though, they underscore that Coke had to climb a cliff on this deal, and they will not be the last who face such a political escarpment.
But as China extends its policy fence around those companies and industries it wants to keep in Chinese hands, there are some lessons to be drawn from the above.
1. We need to begin with a clearer idea for how China defines a "monopoly," so that we either avoid deals that test that definition, or we recognize the risk and seek to mitigate it intelligently yet aggressively. That definition will change on a case-by-case basis, based on the industry, the intended target, the buyer, and who is asking the questions.
2. The FDI policies that matter may not be written down, but they exist, they evolve, and they are ignored at one's peril.
3. Healthy companies that may one day become global Chinese brands are not good targets. Sickly companies that could blossom under better management, with capital injections, and with a global owner are much safer. Of course, they bring their own problems, but China's government wants value-add from foreign investors, not just a fat check.
4. Any acquisition of a local firm by a foreign company demands a communications effort directed at both the general public and the policy making elite that makes a logical, intelligent, and sensitive case for the purchase. The bigger the buy, the better you need to be at the communications.
5. Don't ever let up or appear to hesitate.
6. International relations matter in business, and especially with M&A. Companies need to lobby their home governments to be as open with FDI as they are with trade, because the alternative is a deteriorating global FDI environment with companies caught in the middle.
A Final Note
As I said in my September post, I am no fan of mergers and acquisitions. I think they burn management attention and corporate capital, they are often used as a substitute for innovative strategy, and they rarely deliver the benefits promised. But I also recognize I am spitting in the wind - there is going to be a lot more of this activity in the coming years, particularly as Chinese companies step abroad.
The best we can do is work to reduce the friction of the process. As more about these events comes to light in the coming weeks, It is incumbent on those of us whose work touches M&A in China to learn whatever lessons we can. The next one will probably not be any easier.