In Global M&A Deals, Attention Must Be Paid to Minority Assets Based in China

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Majority equity ownership in China does not always equate to majority control

Op-Ed Commentary: Chris Devonshire-Ellis

Nov. 13 – As the proposed Apollo-Cooper Tires M&A deal continues to go south amid accusations and lawsuits, lessons can be learned from this New York-brokered deal about the perils of ignoring even minority-owned assets based in China.

Cooper, who own 65 percent of a joint venture with state-owned Chengshan Group in China, have been the subject of a US$2.5 billion takeover by Apollo Tires of India. Lessons about structuring this deal, and the importance of getting both political and operational due diligence into M&As, are highlighted by the manner in which this particular acquisition has run into problems. It is in fact the minority equity holder, Cooper Tires’ joint venture partner Chengshan Group, who have been dictating terms, despite the fact their equity is not being acquired. With the Cooper-Chengshan deal, the Chinese side viewed Cooper as an ideal partner to allow them access to the huge American automotive market. Cooper has seen its global business develop as a result, up until a suitor – Apollo – came knocking.

Apollo is an India-based tire manufacturing company, yet also concentrates on other markets – they own plants in India, Africa, and Europe, and made an offer for Cooper’s NYSE listed shares at a 43 percent premium back in June. That deal, structured in New York, did not include any provisions for the Chengshan Group – as it was not their shares that were being acquired. Cue pandemonium in China. As we reported on China Briefing earlier this year, Chengshan Group promptly called all of its roughly 5,000 workers out on strike. They have remained so (or only working on Chengshan’s domestic Chinese tire production) ever since. Of interest to note here is the relationship between Chengshan Group – as a state-owned enterprise (SOE) – and the local government. Dreams of having what is a provincial flagship Chinese company succeed in the American market via their Cooper Tires JV have been destroyed, a situation alluded to by the Chinese Labor Union responsible stating: “We oppose this purchase because Apollo is an Indian company. If it was Michelin, we might have agreed.”

That simple statement reveals serious strategic and political shortcomings on behalf of Cooper, Apollo, and the advisers responsible for negotiating this deal – as it seems that since Chengshan’s equity was not being acquired, they left them out of the due diligence equation. What should have happened is that Apollo and their advisers discussed the issue with Chengshan in detail first. India actually has a rapidly growing auto industry, as does Africa, and Apollo is in prime position to target both. Yet the Chinese side was simply not consulted or educated about the benefits that this deal would bring to them.

The other salient point here is that although in terms of equity, Cooper Tires owned 65 percent, in reality that does not always equate to control in China. Companies in China will not call workers out on strike without specific government approval, and Chengshan Group is an SOE. Cooper Tires lost control of their majority-owned operations. That was political naivety.

Chengshan Group has now filed to dissolve their Cooper JV in its entirety. This may or may not be granted, but it is in all likelihood a delaying tactic to force Cooper Tires and Apollo back to the negotiating table. The deal, meanwhile, remains in limbo.

The sad fact is that with a bit of practical common sense and acknowledgement of the strategic asset that Chengshan Group partially possessed, a US$2.5 billion deal is now in serious jeopardy. Remedies in dealing with the Chengshan Group correctly should have been put in from the front end and presented to them. These should have included a strategy as to what Apollo would have been willing to give to Chengshan to garner their support, which could have included, among other things:

  • Global board participation
  • Consultation on business decisions
  • Secondment/appointment of qualified Chinese managers to global positions
  • Exchanges between labor reps, R&D managers, marketing/sales personnel, etc.

Most of these things involve little to no costs and are critically needed integration and loyalty-building exercises. On the monetary incentive side, formulas can be developed and offered that provide for profit-sharing for Chengshan if performance metrics are met.

In the meantime, Apollo doesn’t have a lot of choices. Chengshan has already wrestled the JV operation away from Cooper. Chengshan contributed the land and facilities to the JV, and they control by possession. The same is true for the labor unions and governmental approval processes. Meanwhile, what’s likely to be the real purpose of the litigation between Chengshan and Cooper Tires is to increase Chengshan’s bargaining power and to hold up the transaction. They’ve done that so successfully that both Cooper Tires and Apollo have been involved in litigation of their own. It would make far more sense to get to the core of the issue, negotiate with Chengshan, and show them why being a JV partner with Apollo is a good idea.

This is a deal whose genesis should never have been concentrated purely in boardrooms in New York and India, and which should never have omitted the minority Chinese component – even though that was not being acquired. That they ignored the Chinese position was both naïve and demonstrative of a lack of awareness of the cultural, operational and political due diligence processes required when it comes to structuring multinational M&A deals with minority component assets physically based in China – and especially so if an SOE is involved. Such deals require China knowledge and strategic input, not just American or Indian.

Chris Devonshire-Ellis is the Founding Partner of Dezan Shira & Associates – a specialist foreign direct investment practice providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

For further details or to contact the firm, please email china@dezshira.com, visit www.dezshira.com, or download the company brochure.

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3 thoughts on “In Global M&A Deals, Attention Must Be Paid to Minority Assets Based in China

    Additionally a properly drafted “drag along rights” clause in the Joint Venture Agreement would have gone a long way to resolving this by compelling Chengshan as minority shareholder to sell its shares on equal terms.

    Richard Kimber
    RHK Legal

    Richard Allison says:

    Hi Chris, Big fan of yours and your newsletter, and have corresponded with you some over the years. While I agree with your statement of perils of ignoring even minority-owned assets in China, especially those of “state-owned” variety, my interpretation and take-aways are different.

    I can’t fault Cooper, or Apollo, for failing to open with Chengshan special considerations abnormal for a minority interest not already established under shareholder agreement, as much as I fault Cooper’s shortcomings for inadequately valuing China risk.

    Assuming Cooper has similar joint ventures in other countries, cost of re-opening considerations with each and every partner for a proposed transfer of interest higher up in the ownership chain would be prohibitive and more akin to opening Pandora’s box as to consequences. Suggesting that an acquiring interest should put remedies upfront in dealing with an unnamed minority interest (to the M&A) is akin to offering generous ransom even before the hostage is taken. Negotiation from such a weak position embodies fear of a potential. Instead of preventing it, the offer may further whet the appetite for additional demands and concessions, as well as promote copy-cat behavior of other minority interests. This case is not isolated to Shandong, or unique to the tire industry. Similar has occurred in China “partnerships” in steel, cranes, and wind turbine control systems, to name but a few.

    The state-owned entity directing all of its 5000 employees out to strike, where they have remained – or only to work on Chinese domestic tire production – is either a violation of law or it is not. A labor union mouthpiece citing their preferences of acquirer or what they might or might not do is irrelevant.

    Apollo doesn’t necessarily “lose” here, as the true riskiness – and thus value – of their proposed acquisition is revealed before the deal is consummated and they are out the money. The loser is Cooper. Failure to fully understand potentials in China, perhaps due to over reliance on ownership interest and legal provisions, leaves them with an impaired asset and/or perilous road for recourse. It’s probably unrealistic to expect Shandong state court to rule in Cooper’s favor or to make them whole. Appeal provisions to Beijing, or to international arbitration if these exist probably are prohibitive in time and money, and maybe with no better expectation of outcome.

    While nothing can prevent bad actors from acting badly, prudent strategic risk management may include the company pre-defining its global exposure limits on a country by country basis based upon analysis of defined “risk” components such as: enforceability of contracts, adherence to independent judiciary, et al.. Corporate leadership must be circumspect and willing to adhere to limitations on investment, even if it means turning down “expansion” offers beyond its agreed to limits. Bottom line, never cede control and remain able to walk away from the hostage taker.

    @Richard – fair point, and normally that should have been in the contract. That is wasn’t suggests legal negligence somewhere down the line.

    @Richard Allison: Your quote: “The state-owned entity directing all of its 5000 employees out to strike, where they have remained – or only to work on Chinese domestic tire production – is either a violation of law or it is not.” is an interesting point. It’s legal as long as the CCP (in this case represented by the local government) decides whether it is or not. Much of what happened to Coopers in this dispute has been due to them looking at this whole deal solely through American eyes and perspectives; and they’re paying the price for that.

    Thanks guys
    Chris

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