Deal Cultivation – Key to Success in Making Acquisitions in China Steven H. Ganster, Managing Director Technomic Asia A Subsidiary of Tompkins International [email_address] www.technomicasia.com www.tompkinsinc.com Presented at the… 2009 & 6 th Annual Mergers & Acquisitions in China Summit

Topics China’s M & A Landscape Evolution of M & A as a growth strategy in China Unique complexities in China’s M & A process Strategy vs. Structure Cultivating the deal Key principles of success

China’s M & A Landscape

Evolution of M & A as a growth strategy in China

Unique complexities in China’s M & A process

Strategy vs. Structure

Cultivating the deal

Key principles of success

The M&A Landscape China is in a “late adolescent” phase in terms of market maturity... Infant Toddler Young Teen Late Adolescent

The M&A Landscape Opaque financial systems Corruption Rule of man versus rule of law Unpredictable regulations Huge cultural differences Expensive and time consuming to get things done Lacking enough local talent Defining your addressable market Dealing with high level of uncertainty Access to local markets Being cost competitive Dealing with counterfeits and IP infringement Understanding Chinese business culture Successfully China-fying your business model A number of planning and operating challenges color the backdrop of making acquisitions in China…

Opaque financial systems

Corruption

Rule of man versus rule of law

Unpredictable regulations

Huge cultural differences

Expensive and time consuming to get things done

Lacking enough local talent

Defining your addressable market

Dealing with high level of uncertainty

Access to local markets

Being cost competitive

Dealing with counterfeits and IP infringement

Understanding Chinese business culture

Successfully China-fying your business model

The M&A Landscape Business is getting tougher No “low-hanging fruit”—obvious ones gone or unavailable Margins being squeezed--Increased competition Companies are suffering financially Motivations for buyers to buy are solidifying Control supply chain Accelerate penetration of local market Obtain cheaper assets Motivations for sellers to sell are poorly defined but clarifying SOEs privatizing Cash out Thirst for technology (hard and soft) Lock in big ticket customer Access to global distribution and customer list Possible alternative to listing (though still a motivation for many) Given this environment, several key issues are shaping M&A in China today…

Business is getting tougher

No “low-hanging fruit”—obvious ones gone or unavailable

Margins being squeezed--Increased competition

Companies are suffering financially

Motivations for buyers to buy are solidifying

Control supply chain

Accelerate penetration of local market

Obtain cheaper assets

Motivations for sellers to sell are poorly defined but clarifying

SOEs privatizing

Cash out

Thirst for technology (hard and soft)

Lock in big ticket customer

Access to global distribution and customer list

Possible alternative to listing (though still a motivation for many)

The problems in the “early days” of the JV are leading to altered strategies today… What went wrong…? JV-structure before strategy WOFE-reactionary response Acquisition-using a hybrid approach via M&A Evolution of M&A as a Strategy 80s – 90s 2000 2010 50/50 JV WOFE Acquisition

What went wrong…?

JV-structure before strategy

WOFE-reactionary response

Acquisition-using a hybrid approach via M&A

There are many complex issues surrounding acquisitions or joint ventures in Asia. Opaque management structures Complex state and township - owned conglomerates Added political risks Transaction sizes small Regional fragmentation Market environment more fluid Government/regulatory impasses Reliable information scarce Legal system ambiguity Lack of professional management Thin historical data Dynamic competitive landscape new entrants Unique Complexities in China M&A Unsophisticated sellers

Opaque management structures

Complex state and township - owned conglomerates

Added political risks

Transaction sizes small

Regional fragmentation

Market environment more fluid

Government/regulatory impasses

Reliable information scarce

Legal system ambiguity

Lack of professional management

Thin historical data

Dynamic competitive landscape new entrants

Unsophisticated sellers

Market/Competitor Assessment Develop Strategic Intent Partner Qualification Deal Cultivation LOI Due Diligence Deal Close Integration / Start up WOFE, Other Alliance Unique Complexities in China M&A Fluid market environment Reliable information scarce Dynamic competitive environment with new entrants Deal flow – identify appropriate targets Finding right deal size (often too small) Unsophisticated sellers Lack of professional management Understanding motivations of all players Satisfying multiple wants/needs Not enough focus Less meaning in China – no “teeth” 30% close rate Opaque management structures Multiple books Regulatory impasses Gov’t obstruction / intervention High cost/deal ratio Keeping deal together until final agreement signed

Fluid market environment

Reliable information scarce

Dynamic competitive environment with new entrants

Deal flow – identify appropriate targets

Finding right deal size (often too small)

Unsophisticated sellers

Lack of professional management

Understanding motivations of all players

Satisfying multiple wants/needs

Not enough focus

Less meaning in China – no “teeth”

30% close rate

Opaque management structures

Multiple books

Regulatory impasses

Gov’t obstruction / intervention

High cost/deal ratio

Keeping deal together until final agreement signed

Non linear Time consuming Expensive Frustrating A discovery process … a lot like a ride on Disney’s Space Mountain! Unique Complexities in China M&A

Non linear

Time consuming

Expensive

Frustrating

A discovery process

… a lot like a ride on Disney’s Space Mountain!

Strategy vs. Structure China’s tough market environment necessitates doing “strategy before structure” In the past… Structure (JV) China Strategy Force-fit the strategy to the structure Find the structure to fit the strategy Structure (any) China Strategy Today…

Foreign Investor Chinese Company LTD FIE (JV, WFOE) Non-China offshore company (NCOC) FIE (JV, WFOE) China border FIE (JV, WFOE) Buy shares or the whole NCOC to own the FIE in China* Convert the Chinese Company to an FIE in case of equity deals or concurrently set up an FIE to hold acquired assets The Foreign Investor owns or intends to set up an FIE first Direct acquisition Buy and run acquired assets The NCOC owns the FIE Strategy vs. Structure *It is also popular when establishing a JV, to set up the partnership outside of China which entity then wholly own the China WFOE FIE (JV, WFOE) Convert JV to WFOE in case of buying equity form Chinese owner(s) or concurrently set up an FIE to hold acquired assets

China sellers often have a different deal paradigm that is critical to appreciate … Everything flows from financials… Everything flows from relationships… vs. Cultivating the Deal – Buyer and Seller Motivations Types of Sellers Unsuspecting Inexperienced Resistant Desperate “ The West” Financial due diligence Commercial (calculated) Structure … .. Relationship China Commercial (intuitive) Relationship …… Structure Financial due diligence

Types of Sellers

Unsuspecting

Inexperienced

Resistant

Desperate

Financial due diligence

Commercial (calculated)

Structure

… ..

Relationship

Commercial (intuitive)

Relationship

……

Structure

Financial due diligence

The Acquisition Process… Transaction Structure & Execution Candidate Identification & Qualification Acquisition Strategy Legal, Financial & Commercial Due Diligence LOI Signed In China, acquisitions require more upfront target cultivation and pre-due diligence than is typically needed in the West. Cultivating the Deal – Doing the Work! Deal Cultivation & Pre Due Diligence Market Assessment & Business case These areas often short changed

At the Discovery Stage, “Level of insight per dollar” is very high! The Acquisition Process… Approach to target companies Negotiation of Framework Agreement Discovery Stage Formal DD Stage and Valuation Definitive Agreement Signing of LOI Transaction costs can be quite high in China, compared to the deal sizes available, so effective “discovery” is important before spending substantive dollars in due diligence. Cultivating the Deal –Discovery Stage Transaction costs

At the Discovery Stage, “Level of insight per dollar” is very high!

Some Key Principles for Deal Success Strategy before structure!! Start with a clean company whenever possible—asset purchase Know what assets you really need to own Be creative—don’t just transplant your western business model Controlling the operation is paramount (key management functions) … but you don’t have to own everything to control it Consider “strange bedfellows” as targets/alliances Work closely with local government from the beginning Invest in RELATIONSHIP building Observe the 6 Ds

Strategy before structure!!

Start with a clean company whenever possible—asset purchase

Know what assets you really need to own

Be creative—don’t just transplant your western business model

Controlling the operation is paramount (key management functions)

… but you don’t have to own everything to control it

Consider “strange bedfellows” as targets/alliances

Work closely with local government from the beginning

Invest in RELATIONSHIP building

Observe the 6 Ds

Thank You!

Thank You!

Introduction to Technomic Asia A Division of Tompkins Associates Summer 2009 For more information, contact: Steve Ganster Managing Director [email_address] Technomic Asia China Office Room 502, Jin Tai Building 58 Mao Ming Road (South), Shanghai 200020, China Tel: +86-21-6473-2588 Fax: +86-21-6390-6659 www.technomicasia.com www.tompkinsinc.com

Background Technomic Asia recently became the Asian arm of Tompkins Associates, a renowned global business and supply chain consultancy. As of January 2008, Technomic merged into Tompkins Associates. Technomic Asia has over 25 years of consulting experience in Asia having assisted over 200 multinational clients with their Asia business strategy, sourcing and supply chain strategies. Technomic Asia and Tompkins have deep experience in the acquisition process from candidate identification/qualification through due diligence.

Technomic Asia recently became the Asian arm of Tompkins Associates, a renowned global business and supply chain consultancy.

As of January 2008, Technomic merged into Tompkins Associates.

Technomic Asia has over 25 years of consulting experience in Asia having assisted over 200 multinational clients with their Asia business strategy, sourcing and supply chain strategies.

Technomic Asia and Tompkins have deep experience in the acquisition process from candidate identification/qualification through due diligence.

Technomic Asia provides the following solutions for multinational firms to support their Asian strategy needs for both new investments and existing operations: Asian entry and growth planning and support including market assessment, business case development and entry strategy. Acquisition support from candidate identification, qualification, deal structure and negotiation and commercial due diligence. Asian sourcing and supply chain assessments including supplier relationship and improvement programs. Assessment of Asia “ readiness” for portfolio companies based on our proprietary methodologies. Technomic Asia Core Services

Technomic Asia provides the following solutions for multinational firms to support their Asian strategy needs for both new investments and existing operations:

Asian entry and growth planning and support including market assessment, business case development and entry strategy.

Acquisition support from candidate identification, qualification, deal structure and negotiation and commercial due diligence.

Asian sourcing and supply chain assessments including supplier relationship and improvement programs.

Assessment of Asia “ readiness” for portfolio companies based on our proprietary methodologies.

We have been on-the-ground in China since 1985 (JV) and have assisted over 200 MNCs in their China strategy and operational initiatives. Legal status comprises WOFE and Representative offices We have broad experience in multiple industrial areas, including commercial, residential, industrial and infrastructure segments. China Capabilities Through its subsidiary in Shanghai, Technomic has extensive operational experience in China (as well as the Asian region in total). Our China consulting services are supported by a set of effective tools at the corporate level to assist companies in the benchmarking process. Our China operation is well integrated with Tompkins worldwide to enable the seamless implementation and rollout of global programs.

We have been on-the-ground in China since 1985 (JV) and have assisted over 200 MNCs in their China strategy and operational initiatives.

Legal status comprises WOFE and Representative offices

We have broad experience in multiple industrial areas, including commercial, residential, industrial and infrastructure segments.

Our China consulting services are supported by a set of effective tools at the corporate level to assist companies in the benchmarking process.

Our China operation is well integrated with Tompkins worldwide to enable the seamless implementation and rollout of global programs.

China Capabilities (cont’d) ~20 professional staff with varied backgrounds All but one are mainland Chinese citizens Most have masters degrees both from China and overseas business schools Multilingual Chinese, English and other All with industry experience Priority characteristics of our China operation include… Longer Time Based Experience in China, Ahead of Any Other Major Firms Innovative, Pragmatic, “Street Smart” Approach Client Centered Solution Possessing In-depth China know-how and Cultural Sensitivities Deep experience working with MNC management on their China initiatives Direct involvement of senior management in program engagement Broad industry experience, including capital equipment Trust and Integrity

~20 professional staff with varied backgrounds

All but one are mainland Chinese citizens

Most have masters degrees both from China and overseas business schools

Multilingual Chinese, English and other

All with industry experience

Priority characteristics of our China operation include…

Longer Time Based Experience in China, Ahead of Any Other Major Firms

Innovative, Pragmatic, “Street Smart” Approach

Client Centered Solution

Possessing In-depth China know-how and Cultural Sensitivities

Deep experience working with MNC management on their China initiatives

Direct involvement of senior management in program engagement

Broad industry experience, including capital equipment

Trust and Integrity

Technomic Asia was one of the first foreign consulting firms licensed to practice in China We have completed over 650 programs in China alone across a wide range of industries Technomic Asia provides a unique value proposition which differs from other consulting and firms in Asia. Our Value Proposition Basic data Limited analysis Minimal strategic direction Low cost On-the-ground, “street-smart” approach. Deeper, more mature market understanding Ability to filter, sort and process insight to determine implications Extensive experience to recommend how client can respond to “win” Can take client all the way to an actionable business plan Moderate cost High level market view “35,000 feet” Often “valuation” focused Limited tactics High cost

Technomic Asia was one of the first foreign consulting firms licensed to practice in China

We have completed over 650 programs in China alone across a wide range of industries

Basic data

Limited analysis

Minimal strategic direction

Low cost

On-the-ground, “street-smart” approach.

Deeper, more mature market understanding

Ability to filter, sort and process insight to determine implications

Extensive experience to recommend how client can respond to “win”

Can take client all the way to an actionable business plan

Moderate cost

High level market view “35,000 feet”

Often “valuation” focused

Limited tactics

High cost

We provide capabilities in candidate identification, qualification and due diligence, as well as underlying alliance/acquisition strategy and deal support. Candidate Qualification and Screening Market Based Due Diligence Negotiation and Close Core Services Include... Acquisition Strategy Development Screen on first level criteria Qualify and focus on primary candidates Profiling of short-listed candidates and attractiveness level Determine candidate interest Develop & Sign LOI Deeper assessment of target candidates from perspective of customers, suppliers and the supply chain Validate viability of business case. Deal Structure Negotiation Support Optimize Government subsidies Legal & Financial due diligence Integration Planning Closure Acquisition Services Core Objectives of Deal Target Products & Technologies Geographic Focus Critical success factors Candidate Criteria Develop long-list of candidates

Screen on first level criteria

Qualify and focus on primary candidates

Profiling of short-listed candidates and attractiveness level

Determine candidate interest

Develop & Sign LOI

Deeper assessment of target candidates from perspective of customers, suppliers and the supply chain

Validate viability of business case.

Deal Structure

Negotiation Support

Optimize Government subsidies

Legal & Financial due diligence

Integration Planning

Closure

Core Objectives of Deal

Target Products & Technologies

Geographic Focus

Critical success factors

Candidate Criteria

Develop long-list of candidates