China and the Art of Due Diligence
by Mark Finnie, Director, Merrill DataSite, Asia Pacific
The costs of negative association
As several high-profile cases have shown, with Rino International Corporation perhaps at the epicentre, there are significant and costly gaps in due diligence processes in China, which are causing real issues at home and abroad when it comes to conducting M&A and cross-border deals. Deal makers, particularly in the U.S., have acute fears about conducting business with Chinese companies, which has reached a point where even the suggestion of a negative report can cause a company’s shares to plummet. According to MarketWatch.com “Shares of Chinese meat processor China Yurun Food Group Ltd. (1068.HK) fell nearly 20 percent one day in June (2011) amid speculation a damning report would be issued on the company by short seller Muddy Waters.”
Even if the negative reports are never forthcoming, there comes a point where it’s easier to avoid an investment, or get rid of stock, rather than to take the risk of it turning sour. With difficulty in the ability to routinely perform formal due diligence for deals in China, investor confidence is low and this is undoubtedly leading to missed opportunities, which has even meant some companies in Hong Kong carrying out scrutiny on their own companies to try and repair some of the damage done to reputations.
Understand the issue
A recent survey carried out by Merrill DataSite, which included 150 Global Corporate Executives and Financial Consultants, showed just over half (51 percent) had little to no interest in accepting an investment from, or being acquired by, a Chinese company. Additionally, over a third (34.2 percent) of respondents said they were unlikely to make an investment in, or acquire a Chinese company in the next 12 – 18 months. During a webcast, which Merrill DataSite hosted on the subject of conducting M&A in China, panellist Mitch Nussbaum, Partner and Chair of the Securities Practices Group at Loeb & Loeb LLP, said “Recent accounting scandals involving Chinese companies have become a growing concern on both sides of the Pacific. American businesses and investors are increasingly reticent about conducting business with, and investing in, both private and public Chinese companies. Similarly, Chinese companies are understandably concerned about reputational fallout and are carefully weighing the pros and cons of conducting business in the U.S. or listing on U.S. exchanges.”
Capitalise on opportunities
With reputations dented, Chinese sellers are now battling perceived, as well as real issues when it comes to attracting bidders to their deals, and even as things improve there is still clearly a need for Chinese sellers to operate with greater transparency across the global economy. On the flip-side, the opportunity to make money in China still looms large. Although growth in the region is predicted to slow down, it’s still likely to be as high as 8.5 percent in 2012 according to commentary from Thomson Reuters, published in November 2011. The potential to capitalise on this growth will be hard for investors to resist, but deal makers will demand transparency to protect their investment.
The key to open due diligence
Successfully completing an M&A transaction is a complex enough process, without adding questions of trust into the equation. Successful M&A transactions are the result of a measured approach to organising data in preparation for a bidding audience to perform due diligence. Failure to segment and present information as the M&A process moves forward increases the likelihood that sensitive business documents may be released too early, but equally not disclosing information can cause a deal to collapse, or worse, create a postclosure law suit.
A simple solution to aid transparency and increase confidence is to use a virtual data room (VDR) and the expert services of project managers and customer service teams that come with a premier solution. This will not only facilitate an M&A deal by allowing multiple bidding parties and sellers to concurrently participate in the due diligence process within a secure and controlled online environment, it will also use the experience of professionals who can organise and index information for a sell-side team. A VDR dramatically reduces the total time and expense associated with completing M&A transactions, (as compared with a paper data room and unsecured email), but perhaps more importantly it ensures complete protection against non-disclosure claims, for both the sell and buy-side.
The best practice approach
In Merrill DataSite’s experience, having worked on close to 20,000 due diligence and document management projects globally, we’ve found that those selling an asset can prepare, present and secure their essential business documentation with a VDR solution. For the buyer, it ensures accurate and timely disclosure of information, delivered for due diligence purposes. As a result, buyers and sellers are able to achieve their business goals, while increasing the chances of a positive outcome for their M&A transaction.
The process of participating in, and completing, an M&A deal is intricate enough for both buyers and sellers – whether in China or elsewhere – it doesn’t need to be further complicated or hindered by questions of trust and non-disclosure. With the importance and size of today’s global M&A market and cross border dealings, enterprises and investors can rely on solutions, such as VDRs, to eliminate both the security and legal risks associated with due diligence procedures, while still facilitating the distribution of critical information during a business process that is essential to completing a deal successfully.