China Unveils New Capital Controls

Back in March, when China's various forms of soft capital controls had failed to stem China's relentless capital outflows, we reported that "bizarro M&A" deals were rapidly becoming "China's Most Innovative Capital Outflow Yet." We pointed out several M&A deals that simply made no sense from the fiduciary perspective of a rational buyer, and had all the signs of a panicked attempt to park cash offshore in the form of mergers and acquisitions with zero regard for cost or return on investment. Among these were:

  • Zoomlion, a lossmaking Chinese machinery company that is partially state-owned: its total debt stands at 83 times its EBITDA.
  • Fosun, a serial Chinese acquirer that spent $6.5bn on stakes in 18 overseas companies during a six-month period last year, had a a 55.7x total debt/EBITDA in June 2015. "Fosun has bought brand names such as Club Med and Cirque du Soleil as well as a host of other assets including the German private bank Hauck & Aufhaeser."
  • China Cosco Holdings acquisition of the Greek Piraeus Port Authority for €368.5m. Cosco has promised to invest €500m in the Greek port despite having total debt at 41.5x its EBITDA!
  • Cofco Corporation, which recently reached an agreement with Noble Group under which its subsidiary, Cofco International, would acquire a stake in Noble Agri for $750m (in the process preventing the insolvency of the biggest Asian commodities trader), has total debt equivalent to 52 times its EBITDA!
  • Bright Food, which bought the breakfast group Weetabix for $1.2bn last year, and has total debt at 24 times EBITDA!

This "bizarro" scramble to park cash offshore culminated with "China's Most Innovative Capital Outflow Yet: Buying Legendary Italian Football Club AC Milan."

After nearly a year of capital trickling out of China through the M&A back door, Beijing has finally come around to closing this most notorious loophole, one which incidentally has had a major role in boosting stock valuations to beyond bubble levels due to the constant possibility of a totally unpredictable "Chinese M&A premium" in which a Chinese conglomerate (coughanbangcough) would swoop in and aquire some failing business at a 50-100% premium.

As the WSJ reported, China is set to clamp down with tighter controls on Chinese companies seeking to invest overseas, confirming what we had observed since the start of the year in "intensifying efforts to slow a surge in capital fleeing offshore amid tepid growth and an uncertain economic outlook."

Having launched various capital controls last September (noted here, when we correctly predicted that bitcoin would be the biggest beneficiary of Beijing efforts to stem the outflow of Chinese capital), the new measures are the first to go after big deals by China Inc. According to the paper, the State Council, China’s cabinet, will soon announce new measures that subject many overseas deals to reviews of “strict control,” according to people with direct knowledge of the matter and documents reviewed by The Wall Street Journal.

Beijing is said to focus on “extra-large” foreign acquisitions valued at $10 billion or more per deal, property investments by state-owned firms above $1 billion and investments of $1 billion or more by any Chinese company in an overseas entity unrelated to the investor’s core business. The new controls will apply to deals yet to receive approval from China’s top economic planning agency, the people familiar with the matter say.

The latest round of capital controls underscore Beijing concerns about capital flight and a weakening currency. As a reminder, according to Goldman's calculations, in September Chinese capital flight accelerated far more than the officially reported number of $19 billion and hit $78 billion, the highest monthly total since the start of the year. 

The crackdown also comes amid an overseas buying binge by Chinese companies unlike any other since a similar Japanese merger scramble briefly resulted in a Japanese owner for the Rockefeller Center in the '80s. This was profiled here previously in Eight Things The Chinese Are Scrambling To Buy In America, and courtesy of the following charts showing China's unprecedented contribution to global M&A activity, which we now know was nothing but another form of capital flight. Total overseas direct investment rose more than 50% to $145.9 billion in the first nine months of this year from the same time a year earlier, according to official data. We showed a representation of the torrid Chinese dealmaking pace earlier in the year:

Not all Chinese M&A, however, has been gratuitous: Chinese companies have been moving to scoop up needed technology and management expertise, much of it at Beijing’s blessing. Headline-grabbing deals include petrochemical giant China National Chemical Corp.’s pending $43 billion acquisition of Swiss pesticide maker Syngenta AG, and a bevy of real estate, finance and other investments by Anbang Insurance Group Co., a recently obscure company that has emerged as global deal maker.

In all, Chinese buyers have announced $212.7 billion of overseas acquisitions in 2016, a year in which announced global deal volume has reached $3.28 trillion.

The WSJ adds that the latest set of capital controls will likely remain for a long time, in effect killing all notable cross-border M&A: "the new controls, once in place, are to remain in effect until the end of September and thus are intended as a temporary tool to stabilize outflows ahead of a major reshuffle of the top echelon of the ruling Communist Party late next year, the people familiar with the matter said. That’s in keeping with other efforts by Beijing to try to keep the economy on an even keel before the leadership change."

Why implement this latest hurdle to stem capital flight now? Simple: as a result of the surging dollar, the Yuan has plunged, crashing to record lows since the Trump election, which in turn has prompted even more capital outflows as the local population scrambles to preserve its purchasing power and put its savings offshore. A steady depreciation of the Chinese yuan, after years of overall strength, has ensued, and as businesses and individuals try to take more money out, the pressure for further weakening is piling on. In the past week the yuan has fallen to its lowest level against the dollar in eight years.


Late last week, the offshore Yuan tumbled as low at 6.96 against the dollar, just shy of the 7.00 level at which point the PBOC is said will begin selling reserves in earnest to stabilize the currency.

Cracking down on M&A is not China's only recent overture: earlier this week, the central bank announced it will use a new risk-control system to monitor capital flows through Shanghai’s much promoted free trade zone, which previously was hailed as a bold experiment to liberalize China’s financial markets; instead it has emerged as yet another conduit to transfer funds out of China instead of welcoming foreign capital in.

A five-page action plan released by the Shanghai branch of the People’s Bank of China stresses efforts to ensure that currency inflows exceed outflows in the zone—a backhanded suggestion that more money may be moving out of the zone than coming in.

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So is major Chinese outbound M&A effectively over for the next year? It would appear so: the soon-to-be announced controls empower the Commerce Ministry and the top economic planning agency to take a closer look at larger deals, the people familiar with the matter said. Under the current rules, companies trying to undertake many of the targeted transactions in foreign markets only need to register with the authorities and don’t have to go through any lengthy approval process.

Aside from the major transactions, other deals covered by the pending rules are: overseas direct investments made by limited partnerships, investments in overseas-listed companies that are less than 10% of those firms’ total equity, and Chinese capital trying to participate in the delisting of overseas-listed Chinese companies.

The elimination of the Chinese M&A bid premium from stock valuations will likely serve as another cooling factor on already record high stock market valuations, which are best summarized in the following chart courtesy of David Rosenberg.