Chinese Outbound Investment: Buying into Distribution Channels

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June 23 – One of the recent phenomena to raise its heads in terms of evolving business flows has been the recent emergence of Chinese companies wanting to list overseas, and especially in markets such as NASDAQ and the London Stock Exchange. American and European lawyers and auditors are experiencing a new trend of Chinese inquiries wanting to raise money. Often a response is a bemused “What to do?” with no real perception of what could be a good deal, and what is a bad deal, or any way of evaluating a Chinese business.

Certainly there’s the odd potato farmer from Hebei who thinks he can raise money in the United States and list his farm for millions of dollars. But not all inquiries are like that at all. Some are far smarter, and are worth listening too.

At Dezan Shira & Associates, we are working with a number of U.S. and European law and tax firms to assess the extent of the viability of Chinese outbound investment. Increasingly, we see the acquisition by Chinese businesses of distribution channels overseas as an increasing area of interest. It makes sense. Chinese manufacturers are simply not making the margins they need out of manufacturing product. In an increasingly competitive home environment, let alone the rise of manufacturing nations such as Vietnam, India, Brazil and Russia, manufacturing only is increasingly a game of decreasing returns. The sale value of the product is being assessed in local RMB terms, while the profit margin is being realized in dollars or euros at the point of sale. It’s the distribution channel that possesses the wealth creation.

Interestingly, Chinese companies are now therefore looking at target such supply chains in the United States and Europe. Companies in these markets that possess good distribution networks are prime targets for Chinese businesses. A word to the M&A lawyers, your local manufacturing or distribution business with a decent supply chain now has a far higher value than previously thought.

Consider the lot of the Chinese manufacturer. He may only realize 5 dollars on the sale of his product to an American middle man who gets it into the distribution chain. At point of sale, the item goes for US$25, five times what can be realized in China. U.S. and European lawyers seeing inquiries over raising funds locally for Chinese companies wanting to develop or buy into businesses with such supply chains may now want to reassess their potential credibility, and look deeper into the viability. It’s a smart move.

Back in China, the work to be done to ascertain the viability of the Chinese business needs to be twofold: legal due diligence needs to be done to ensure that what is being offered is owned by the right people; secondly, those pesky financial due diligence audits and to ascertain whether or not the Chinese business can be upgraded to support U.S. GAAP examinations.

At Dezan Shira & Associates, we can help kick those tires. And rather than spend time with hopelessly naive potato farmers, any Chinese company that comes looking for money to buy into supply chain businesses may well be worth talking to. It’s a trend that is going to keep growing.

Dezan Shira & Associates is a premier boutique professional services firm in China providing legal and tax advice to foreign investors in the country. Established in China 16 years ago, they maintain nine China offices. This website and the China Briefing Magazine are produced by the firm. For advice on foreign investment legal and tax issues in China, please email info@dezshira.com or visit www.dezshira.com.