As the rest of the world (and China's banks) obsess on the unfolding saga of Fannie Mae (FNM) and Freddie Mac (FRE), here in China Coca-Cola's (NYSE:KO) announced intention to purchase Chinese beverage maker Huiyuan Juice Company is about to force the government to make a very hard choice.
An excellent acquisition...
You don't need a Ph.D. to see the business value of the combination. Huiyuan, a company that produces a quality product with a better-than-average reputation, lacks the marketing and distribution to turn itself into the leading brand in China in its sector, or to expand beyond the mainland. Coca-Cola desperately wants an acquisition that will allow it to expand its hold in the non-fizzy soft drink category. Coke's distribution network and marketing prowess are a perfect fit for Huiyuan.
I am not a big fan of mergers or acquisitions, but at the ground level in China, this one makes huge sense for both brands.
The only possible fly in the ointment is a fairly large one: How will the Chinese government react to Coke's offer?
...at an "interesting" time.
Steve Dickinson at the law firm of Harris and Moure, pllc posted an extended analysis of China's new Anti-Monopoly Law a few weeks ago on China Law Blog. In that context, he took the time to lay out what he sees as the government's policy and regulatory approach to foreign direct investment:
• 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.
In addition, the government may look at the transaction in the light of the new anti-monopoly law. While I doubt Coke would pass a pedestrian definition as a monopolist in China's highly fragmented beverage market (even after the Huiyuan purchase), any acquisition by a foreign market leader would invite scrutiny.
So since this deal involves the purchase of a large, healthy Chinese company by a major foreign player, we are almost assured that the matter is being discussed at high levels of the Chinese government.
Communications will decide
On the surface, all of the above seems to spell trouble for the deal. At the very least there is likely to be a formal review, and there is the possibility that the government might attempt to block the transaction, or force a revision of the terms.
(Ostensibly, the government should have no direct say in this matter, as it appears that what is being purchased are shares listed in Hong Kong. Yet while Hong Kong is a special administrative region of China and thus possesses considerable autonomy, if the Chinese government is concerned about the precedent the transaction will set, they will almost certainly step in.)
All of this depends on how closely the government wants to adhere to its explicit and implicit policy regarding foreign direct investment. And to a great extent, that depends on how carefully Coke and Huiyuan have laid the groundwork with the government in advance of announcing the deal.
Because if there is anyone in the beverage industry in China who decides that such an acquisition would damage them, or if there is someone who just wants to play the spoiler as a means of keeping Huiyuan from turning into a killer competitor, a campaign to derail this deal may be in the offing. Such opposition stopped Carlyle's effort to purchase a major stake in construction equipment maker Xugong. Given the current policy climate, a similar campaign could have a devastating effect on the Coke/Huiyuan deal.
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.
FDI is not just for foreigners anymore
What makes this interesting, of course, has nothing to do with Coke or Huiyuan, but the future of foreign direct investment in China and the role Chinese business will play on the world stage.
Whatever action the Chinese government takes - or does not take - in this case will serve to further define what is seen as acceptable foreign investment, and what is unwelcome. To accept the deal would be an acknowledgement that China remains open to investment, but that it does not regard every single Chinese company of a certain size as a "national champion."
To block the deal - or to force its significant revision, will send a message that China will not have its brands acquired just as they are building equity. It will put the nation on record as saying that from now on, it will be China doing the buying, thank you, except when somebody else can help us clean up an inconvenient mess.
In other words, if China blocks Coke, it will be a statement that China wants to approach foreign direct investment in a manner not terribly different than the way governments in developed worlds do.
China's policy makers would not shrink from making such a statement - on the contrary, it would have incredible emotional appeal.
But for the sake of Coke and Huiyuan, let us hope that they can wait a while to do so.