Morgen, Evan & Company, Inc.Morgen,Evan & Company, Inc.

Morgen, Evan & Company, Inc.Morgen, Evan & Company, Inc.

China Market Report

Acquisition Opportunities

2006-2007

Legal Review and Update

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China Acquisition Opportunities: 2005-2006

CHINA ACQUISITION OPPORTUNITIES 2006-2007

Morgen, Evan & Company, Inc. New York • Tokyo • Shanghai

About the Author Morgen, Evan & Company, Inc. is a private investment banking firm founded in 1992, which focuses on cross-border business transactions between North America, Europe, and Asia. Our

firm's activities are primarily concentrated on structuring mergers and acquisitions, strategic partnerships, joint ventures, and private financing. Our principal objective is to assist North American, European, and Asian firms in creating mutually beneficial, synergistic relationships. We understand that forming a partnership is a major undertaking requiring substantial planning and the right resources. To that end, our experienced multinational staff is here to help guide firms through the opportunities of a changing global economy.

With principal offices in New York, Tokyo and Shanghai, Morgen, Evan maintains excellent references and exhaustive contacts in a wide range of industries. Utilizing this expertise, we provide our clients with valuable advice on establishing contacts, consummating business transactions, and further maintaining strong working business relationships.

Morgen, Evan & Company, Inc. is affiliated with BB&T, the 9th largest bank in the United States, and works exclusively on all BB&T transactions requiring international representation.

Morgen, Evan & Company, Inc. is a member of M&A International, Inc., the world's largest alliance of privately-owned investment banking firms focusing on merger and acquisition transactions.

About M&A International, Inc. M&A International, Inc. offers the unparalleled resources of 42 independently owned merger and acquisition specialists and investment banking firms in 36 countries. These firms are linked in a global network created to exchange information, ideas and contacts and most importantly close transactions. M&A International’s strength lies in the combined resources of more than 300

professionals with a strong working relationship and real experience of conducting joint business initiatives. M&A International’s expertise lies in all market sectors. In 2005, M&A International completed over 270 deals worth over $21 billion. This success demonstrates the added value that M&A International brings to any M&A assignment.

Mark Lerner, the Managing Partner of Morgen, Evan is the current Vice President for the Asia Pacific region, and was the past chairman of M&A International from 2003 to 2005. In addition, Morgen, Evan & Company is a co-founder of M&A International’s Technology and Healthcare sector specialty groups and an active member of the Logistics, Automotive, Business Services, Food & Beverage and Retail sectors as well.

Appendix contributed by Baker & McKenzie, the world's leading global law firm, has been providing sophisticated legal advice and services to many of the world's most dynamic and global organizations for more than 50 years. It has been recognized by various awards, including “2005 China Client Choice Award – International Law Office”, and “China Practice of the Year – ALB Hong Kong Law Awards 2005,2004”.



Contents

1. Introduction...................................................................................................1 2. China Facts …………………………………………………...………………..…. 2 3. The Top Ten Reasons for Entering China ……………….…….….……...…. 3 4. The Top Ten Problems You May Encounter When Entering China ….…. 7 5. Economy ......................................................................................................10

5.1 Overview ............................................................................................................................10 5.2 Economic Trends ...............................................................................................................12

6. Politics ………………………………………………………………...……………14 6.1 General Environment .........................................................................................................14 6.2 Structure of the State .........................................................................................................14 6.3 Accession to WTO .............................................................................................................16

7. Infrastructure ...............................................................................................18 7.1 Transportation ....................................................................................................................18 7.2 Telecommunication............................................................................................................19 7.3 Electricity............................................................................................................................20

8. Investment Climate .....................................................................................22 8.1 Overview ............................................................................................................................22 8.2 Regulatory Environment ....................................................................................................23 8.3 Foreign Exchange Control .................................................................................................23 8.4 Regional Guide ..................................................................................................................25

9. Foreign Direct Investment (“FDI”) & Current Mergers and Acquisitions (“M&A”) Activity ..........................................................................................29 9.1 Foreign Direct Investment (“FDI”) ......................................................................................29 9.2 Mergers & Acquisitions (“M&A”).........................................................................................30

Markets of Opportunity ....................................................................................33 10. Technology ..................................................................................................33

10.1 Telecommunication Sector ..............................................................................................33 10.2 Software Sector................................................................................................................36 10.3 Hardware Sector ..............................................................................................................39

11. Healthcare ....................................................................................................42 11.1 Pharmaceuticals Sector ...................................................................................................42 11.2 Biotechnology Sector .......................................................................................................45

12. Food & Beverage .........................................................................................48 12.1 Food Sector......................................................................................................................48 12.2 Beverage Sector ..............................................................................................................51

13. Auto Components .......................................................................................55 14. Consumer/Retail ..........................................................................................60 15. Textiles .........................................................................................................64



Other Markets of Opportunity..........................................................................67 16. Financial Services .......................................................................................67 17. Logistics.......................................................................................................68 18. Energy & Resources ...................................................................................69 19. Real Estate...................................................................................................70

Appendix ...........................................................................................................71 A. Summary of the PRC Foreign Investment Regime....................................71 B. Types of Investment Transactions .............................................................73 C. Exchange Control.........................................................................................75 D. Documentation and Due Diligence .............................................................79 Sources ……………………….……………….……………………………………... 82

Morgen, Evan & Company, Inc. 1



1. Introduction China is currently one of the world’s fastest-growing economies. The country’s gross domestic product (“GDP”) reached USD 2.26 trillion in 2005, growing at 9.9 and 10.1 percent in 2005 and 2004, respectively. The Chinese government has taken proactive approaches to implement World Trade Organization (“WTO”) rules and regulations. The banking system is currently undergoing reform to reduce its non-performing loans. The transparency of financial transactions is improving as well. The government is also actively investing in China’s infrastructure, which results in higher efficiency of the transportation system and leads to improvements in many other infrastructure necessities. With outstanding economic performance, the Chinese mergers and acquisitions (“M&A”) market has remained active in recent years. In 2003, the total number of inbound deals was 1,566, and the figure was 42 for outbound deals. By 2004, the numbers increased to 2,162 and 72, respectively. In the first half of 2005, the total number of inbound and outbound deals decreased slightly, to 804 and 32, respectively, compared to 920 inbound and 34 outbound deals in 2004 for the same period. However, Chinese M&A activity is expected to increase in the near future. Foreign direct investment (“FDI”) has also shown significant growth. At present, China is the world’s number one recipient of FDI. The utilized amount of FDI reached USD 60.63 billion in 2004, up 13.32 percent from 2003. During 2005, China drew USD 60.33 billion in FDI, maintaining approximately the same level as 2004. In the first month of 2006, FDI to China increased nearly 11 percent from a year earlier, attracting USD 4.55 billion. Morgen, Evan & Company, Inc. (“MECo”) firmly believes that the current economic development in China is sustainable, and the investment opportunities in this enormous market are highly attractive. The timing is right for entering China, with investment characteristics still at economically sound levels as compared to most developed, or other developing countries.

“Poverty is not socialism. To be rich is glorious.”

Deng Xiaoping, 1978




2. China Facts

• China has overtaken the United States as the world’s biggest supplier of information technology goods, according to a report from the Organisation for Economic Co-operation and Development (“OECD”). China’s exports of information and communication technology – including laptop computers, mobile phones, and digital cameras – reached USD 180 billion, compared to U.S. exports of USD 149 billion in 2004.

• China is on track to overtake Germany to become the world’s second

largest car manufacturer this year. Foreign automakers have committed more than USD 20 billion into new capacity in China.

• China’s middle class population is currently estimated to be between 150-

200 million (almost as large as the total population of the U.S.) and is expected to grow to 300-400 million in the next 10 years.

• In 2005, China’s trade surplus tripled to a record USD 102 billion. • China is now the world’s leader in consumption of four out of the five basic

food, energy and industrial commodities. • In 2005, there was more new office space built in Shanghai than all of the

existing office space in New York City.

• China’s steel usage is now more than twice that of the U.S. In 2003, China’s usage was 258 million tons and U.S. usage was 104 million tons.

• Shanghai operates the world’s third busiest port behind Hong Kong and

Singapore, handling over 18 million 20-foot equivalent units in 2005. The Yangshan deepwater port, a facility that sits on an island 32 kilometers out at sea, is predicted to become the world’s largest container shipping port by 2020.

• According to a BBC poll, China is forecast to become the world’s largest

economy by 2026.

• China has overtaken Japan as the world’s largest holder of foreign exchange reserves. Reserves reached USD 853.7 billion at the end of February in 2006, compared to Japan’s USD 850.1 billion.

• Japan’s investment into China rose 19.8% in 2005 to a record USD 6.5

billion, driven by investment from manufacturers and electronics firms.




3. The Top Ten Reasons for Entering China 1. CHINA IS THE 4TH LARGEST ECONOMY IN THE WORLD.

• The country has achieved phenomenal economic development since 1978. China has realized an average real GDP growth rate of over 9 percent annually.

• 2005 GDP was USD 2.26 trillion and real GDP growth was 9.9 percent.

0

2000

4000

6000

8000

10000

12000

14000

USD

Bill

ions

US Japan Germany China UK France Italy Brazil Russia India

Top Ten Countries GDP 2005

Source: Worldbank

2. CHINA HAS THE WORLD’S LARGEST POPULATION WITH A RAPIDLY GROWING MIDDLE CLASS.

• The total population of China is 1,350,000,000 according to the July 2006 estimate by the government.

• 50 million Chinese families (150-200 million people) are qualified as middle

class, with per household annual income of USD 9,248, and USD 38,224 of assets on average. The number of middle class families in China is expected to reach 100 million by 2010.




3. WITH A LITERACY RATE OF 90.9 PERCENT, CHINA IS AHEAD OF

OTHER MAJOR DEVELOPING COUNTRIES. ITS ABILITY TO PROVIDE QUALITY LABOR AT A LOW COST CANNOT BE MATCHED.

• The world’s average adult literacy rate for all developing countries is 76.4

percent. China exceeds this figure by 14.5 percent.

• India has long been considered China’s rival in terms of economic development. Yet, when examining adult literacy rates, China enjoy a superior position in comparison to India’s 61.07 percent literacy rate.

4. CHINA IS CURRENTLY THE THIRD LARGEST TRADER IN THE WORLD

AFTER THE U.S. AND GERMANY. IN 2005, CHINA BECAME JAPAN’S LARGEST TRADING PARTNER WHILE BEING THE SECOND LARGEST OF THE U.S. AND THE E.U.

• In 2004, the trade volume between China and the U.S. reached over USD

152 billion, and over USD 151 billion between China and Japan. • Japan is China’s largest import partner as 16.8% of China’s imports came

from Japan in 2004. • The trade volume has increased 34.66 percent on average with all top ten

trading partners in 2004.

Adult Literacy Rates 2000-2004 (%)

Region Total Male Female Developing Countries 76.4 83.2 69.5 China 90.9 95.1 86.5 India 61 73.4 47.8 Malaysia 88.7 92 85.4 Source: UNESCO Institute for Statistics (UIS)




China's Top Trade Partners (USD Billions)

Country/Region Jan.-Nov

2004Rank 2004

Rank 2003

% Change

United States 152,763.30 1 2 34.3 Japan 151,495.50 2 1 26.4 Honk Kong 99,873.20 3 3 28.8 South Korea 81,353.20 4 4 44.7 Taiwan 70,873.20 5 5 35.7 Germany 48,895.20 6 6 31.5 Singapore 23,906.20 7 8 39.1 Malaysia 23,806.40 8 7 32 Russia 19,334.40 9 9 35.2 The Netherlands 18,952.20 10 10 38.9 Source: PRC General Administration of Customs, China's Custom Statistics

5. CHINA HAS SIGNIFICANTLY IMPROVED ITS INFRASTRUCTURE OVER

THE PAST DECADE.

• The government assigned top priority to the development of the transportation system in its 7th Five-Year Plan (1985 - 1990).

• China’s telecommunications sector averaged an annual growth rate of 20

percent from 1997 to 2004.

• China’s electricity generating capacity has been growing at 6 percent annually.

6. FOLLOWING THE COUNTRY’S ACCESSION INTO THE WTO, CHINA IS

OPENING UP ITS MARKET TO FOREIGN INVESTORS.

• China’s commitment to WTO rules and agreements has brought about significant changes.

• Previously off limits industries such as banking, insurance, and

telecommunication are now gradually becoming more and more accessible.




7. CHINA OFFERS GENEROUS TAX INCENTIVES TO ATTRACT FOREIGN

INVESTMENT. • Investments often are granted tax breaks for up to two years, depending on

the industry and location of the business.

• Various taxation incentive packages are available in free trade zones throughout the country. Free trade zones are designated cities and regions designed to attract foreign investment. Companies registered in these zones are exempt from complex customs regulations.

8. CHINA HAS MADE REMARKABLE IMPROVEMENT IN LABOR

PRODUCTIVITY.

• According to official statistics, China’s labor productivity (the quantity of output produced by a given quantity of labor input) rose from 24.77 in 1995 to 60.54 in 2001.

• The current average labor productivity growth rate in China is 6.5 percent

per year, exemplifying the productiveness of China’s labor force. 9. CHINA HAS BEEN RESTRUCTURING ITS BANKING INDUSTRY.

• Until recently, China’s state-owned banks have been instructed by the government to lend to large failing state-owned enterprises (“SOEs”), while small or private businesses were unable to secure credit. This resulted in significant portfolios of non-performing loans. After the reform, local financial institutes will have more funds available for promising new businesses.

10. CHINA HAS SIGNIFICANTLY IMPROVED ITS LEGAL STRUCTURE, IN AN

EFFORT TO PROMOTE TRANSPARENCY.

• Regulations and periodic updates regarding investment in China are now available on the website of the Ministry of Commerce (“MOFCOM”). In addition, WTO agreements also required that all notices of regulatory changes be accompanied with appropriate translation.




4. The Top Ten Problems You May Encounter When Entering China

1. EXERCISING DUE DILIGENCE PROVES TO BE HARD IN CHINA, AS

MANY CHINESE FIRMS DO NOT KEEP PROPER DOCUMENTATION.

• In China, it is still rare to find accounts and audit numbers in line with international standards.

• Many firms maintain three different sets of books: one for the government,

one for investors, and one for themselves.

• Many firms have hidden assets and liabilities that are not shown in their financial records.

2. CHINA’S BANKING SYSTEM IS CURRENTLY BURDENED BY NON-PERFORMING LOANS TO SOEs

• Though the restructuring of Chinese banks will help them in the long run,

they are heavily burdened by non-performing loans in the short run. Statistics releases by the China Banking Regulatory Commission show that the cumulative non-performing loans issued by major banks totaled USD 307.1 billion in 2003. The bad debt ratio was 19.6 percent which may have an impact on their lending capability. Major banks include the four state-owned commercial banks, three government-run non-profit policy banks and eleven joint-stock commercial banks. Loans issued by these financial institutions account for 82 percent of the country’s total banking loans.

3. DUE TO FOREIGN EXCHANGE CONTROL, THE CONVERTIBILITY OF

THE RENMINBI (“RMB”) TO OTHER FOREIGN CURRENCIES IS LOW.

• The Chinese RMB is convertible relatively freely on current accounts, while stringent administrative measures apply to the country’s capital account.

• Foreign exchange is not allowed to circulate or to be used in the settlement

of accounts, except in free trade zones.




4. STRICT REGULATIONS ARE IMPOSED ON MOST INDUSTRIES.

VARYING DEGREES OF GOVERNMENT PROTECTION IS EXPECTED IN MOST REGIONS.

• China’s banking and insurance industries are heavily regulated, and

government intervention is common.

• Industrial monopoly and local protectionism prevails in certain areas. SOEs are especially likely to be sheltered from competition. Though the situation is improving due to China’s gradual implementation of WTO rules, the country still has much room for improvement.

5. CHINA HAS AN INSUFFICIENT SUPPLY OF DOMESTIC SENIOR

MANAGEMENT TALENT.

• The country has significantly improved the quality of its workforce over the past decade; as a result, the number of college graduates has increased dramatically. However, China still lacks a large pool of highly experienced senior managers. According to a 2004 survey conducted by the American Chamber of Commerce in Shanghai, 40 percent of foreign companies report having trouble filling top managerial positions for their operations in China.

6. CHINA LACKS PROPER PATENT/INTELLECTUAL PROPERTY

PROTECTION.

• A study by China’s State Council Research and Development Center reported that in 2001, the country’s economy was flooded with between USD 19 - 24 billion worth of counterfeit goods. Counterfeiting is estimated to account for about eight percent of China’s gross domestic product.

• In 2003, China accounted for over 62 percent of all counterfeit and

infringing goods captured by the US Customs Service at ports of entry into the United States.




7. EMPLOYMENT ISSUES MAY BE A POTENTIAL PROBLEM FOR

INVESTORS, WHEN ENGAGING IN A MERGER OR AN ACQUISITION.

• Rules regarding employee transfer vary depending on the nature of the relevant transaction and the nature of the target entity.

• Chinese law does not permit transfer or assignment of rights and

obligations under an employment contract directly from one employer to another.

8. DUE TO CHINA’S RESIDENCE REGISTRATION SYSTEM, LABOR

MOBILITY IS LOW.

• The current residence registration system discourages the migration of labor to a large extent. Non-residents are not entitled to most local benefit programs, such as free basic education and subsidized medical service.

9. ADDITIONAL COMPLICATIONS ARE EXPECTED WHEN THE ACQUISITION INVOLVES SOEs OR COMPANIES WITH STATE-OWNED INTERESTS.

• Though in recent years China’s policy has favored the privatization of SOEs, many SOEs were privatized through sweetheart deals, sham auctions of assets, and corrupt lending transactions.

10. AFTER ALL, CHINA IS STILL A COMMUNIST COUNTRY.

• The fundamental difference of national ideology could possibly be a problem in the long run, although the potential is low.

Despite these problems, this report will present the various investment opportunities that can be found in China, and explain why it is critical to build a strong presence in this market.




5. Economy

5.1 Overview

Since 1978, China has adopted a series of open policies under Deng Xiaoping’s direction. Slowly but steadily, the country shifted from a Soviet-style central planned economy to a market-oriented one. The government adopted a series of economic reforms leading to rapid economic growth and an unprecedented reduction in the level of poverty. In 2005, the Chinese economy grew 9.9 percent and is expected to grow 8.2 percent in 2006 according to a World Bank report. Total GDP reached USD 2.26 trillion in 2005. Real retail sales grew 10.2 percent and the foreign exchange reserve reached USD 610 billion by the end of 2004. China’s balance of payments has also improved significantly.




The chart below provides a breakdown of per capita GDP by province in 2004. In general, coastal provinces enjoy higher income, while inner provinces are lagging behind. The ten provinces with the highest per capita GDP are Shanghai, Beijing, Tianjin, Zhejiang, Guangdong, Jiangsu, Fujian, Liaoning, Shandong, and Heilongjiang. The national average per capita GDP reached USD 1,730.

Per Capita GDP (RMB)

Region 2001 2002 2003 2004 % Growth 2001-2004 Shanghai 36,727.00 39,683.05 45,361.39 52,373.92 42.6 Beijing 19,830.66 22,542.76 24,637.79 27,071.77 36.51 Tianjin 18,327.69 20,722.66 23,493.11 25,101.39 36.96 Zhejiang 14,179.89 16,062.83 19,067.36 20,508.21 44.63 Guangdong 14,094.99 15,040.27 16,909.61 18,161.31 28.85 Jiangsu 13,214.64 15,082.07 16,938.92 18,124.32 37.15 Fujian 12,502.64 13,658.05 15,071.02 16,508.97 32.04 Liaoning 12,311.89 13,209.58 14,373.80 15,352.81 24.7 Shandong 10,623.93 12,176.77 13,699.99 14,742.10 38.76 Heilongjiang 9,724.19 10,859.23 11,852.94 12,682.57 30.42 National Average 8,448.04 9,340.48 10,352.03 11,218.83 32.17 Hebei 8,348.75 8,998.82 9,748.50 10,606.03 27.04 Hubei 7,833.17 8,543.23 9,313.15 10,186.14 30.04 Jilin 7,658.25 8,366.28 9,005.17 9,616.96 25.58 Xinjiang 7,918.44 8,269.51 8,928.50 9,548.83 20.59 Hainan 6,885.25 7,888.89 8,620.99 9,126.62 32.55 Chongqing 5,597.57 6,391.77 7,044.77 8,513.70 52.1 Qinghai 5,766.28 6,590.91 7,307.12 7,996.10 38.67 Inner Mongolia 6,519.61 6,911.90 7,347.11 7,870.64 20.72 Hunan 6,136.19 6,445.95 6,992.15 7,605.91 23.95 Henan 5,913.29 6,367.01 6,867.57 7,443.39 25.88 Jiangxi 5,231.31 5,958.60 6,663.53 7,300.71 39.56 Shaanxi 5,134.47 5,958.13 6,541.04 7,032.58 36.97 Anhui 5,244.86 5,739.86 6,203.28 6,786.75 29.4 Shanxi 5,446.76 5,832.38 6,265.95 6,770.42 24.3 Tibet 5,253.79 5,584.91 6,184.21 6,709.41 27.71 Ningxia 5,300.18 5,708.26 6,151.30 6,667.13 25.79 Sichuan 4,917.48 5,364.33 5,941.09 6,371.20 29.56 Yunnan 4,838.39 5,135.70 5,470.99 5,866.62 21.25 Guangxi 4,704.20 5,174.63 5,643.61 5,837.67 24.1 Gansu 4,062.50 4,427.50 4,822.46 5,294.11 30.32 Guizhou 2,855.75 3,073.72 3,251.42 3,436.30 20.33 Source: Access Asia, Quarterly, NBS




5.2 Economic Trends

The table below provides a breakdown of the significant growth China has achieved from 1997 to 2005. During this period, China has experienced stable GDP growth. At an average annual growth rate of 8.23 percent, China’s GDP more than doubled from USD 918.16 billion in 1997 to USD 2,225 trillion in 2005.

China’s stringent monetary policy in the past has kept the inflation rate low while maintaining stable growth. In 1998 and 1999, the consumer price index (“CPI”) declined for two consecutive years. After a small increase in 2000 and 2001, China’s CPI fell negative again by -0.8 percent in 2002. However, recent figures indicate that China’s consumer price level is increasing. The rising urban per capita income has significantly outpaced the rural per capita income, with a discrepancy of USD 377 Million in 1997. By 2004, the income difference had already reached USD 800. The income inequality has become a growing problem for the government during recent years. Outbreaks of protests by underpaid farmers often develop into violence against local government officials and police. The unemployment problem is another top priority for China’s government. The unemployment rate peaked in 2003 at a recorded 4.3 percent, rising from 3.1

General Indicators of China (RMB Billions or % unless otherwise indicated)

Indicators 1997 1998 1999 2000 2001 2002 2003 2004 2005 GDP 7,897.3 8,440.2 8,967.7 9,921.5 10,965.5 12,033.3 13,582.3 15,987.8 18,282.0

Real GDP Growth 9.3 7.8 7.6 8.4 8.3 9.1 10 10.1 9.9

Consumer Price Index 2.8 -0.8 -1.4 0.4 0.7 -0.8 1.2 3.9 1.8

Urban per Capita Disposable Income (RMB) 5,160.3 5,425.1 5,854.0 6,280.0 6,859.6 7,702.8 8,472.2 9,421.6 10,493.0

Rural per capital net income (RMB) 2,090.1 2,162.0 2,210.3 2,253.4 2,366.4 2,475.6 2,622.2 2,936.4 3,255.0

Unemploy-ment Rate 3.1 3.1 3.1 3.1 3.6 4 4.3 4.2 4.2 Source: The US-China Business Council




percent in 2000. In 2004, the unemployment rate fell by 0.1 percent to 4.2 percent. The higher unemployment rate is predominantly due to the number of workers laid off by China’s long-troubled state-owned enterprises. In May 2005, China’s National Development and Reform Commission announced that the GDP and GDP per capita for the 10th Five-Year Plan (2001-05) had been realized one year ahead of schedule. The government originally set a goal of seven percent annual average GDP growth rate for the 10th Five-Year Plan. From 2001 to 2004; however, China’s average annual GDP growth was over eight percent as mentioned before. In addition, investment in fixed-assets totaled more than USD 3 trillion during these four years.




6. Politics

6.1 General Environment

Currently ruled by the Communist Party of China (“CPC”), China follows an open-door policy emphasizing political stability and economic growth. The goal is to keep the country’s economy moving forward while for the most part avoiding major shocks to the political system. In 1978, Deng Xiaoping initiated China’s current era of economic reform. Since then, China has enjoyed rapid and sustained economic growth. However, under the so-called “socialism with Chinese characteristics” ideology, China’s development policy favors the coastal area, while neglecting the western region. The income inequality between the East and the West, and that between rural residents and urban residents has grown larger than expected over the past two decades, hence the outbreaks of farmer protests in recent years. These protests have gradually developed into violent acts in certain areas, which have raised concern among central governmental officials. Another source of potential political instability comes from China’s rising unemployment rate. Due to China’s large number of failing SOEs more and more workers have been laid off or only paid partially. The country’s unemployment rate has risen from 3.1 percent in 2000 to 4.2 percent in 2004. The government’s inability to ensure full employment as promised by its communism ideology has further lowered its credibility to its populace. The launch of China’s Great West Development Program represents the government’s solution to regaining its trust among people who were left behind in the economic development. Though the program has so far been less than successful, it has provided the poverty-stricken western areas the hope that they will eventually catch some steam of China’s development engine.

6.2 Structure of the State

The Party in Power The CPC is the party in power and has organizations at central and local levels. At the top is the Central Committee and, when not in session, the Political Bureau and its Standing Committee exercise the power of the Central Committee. Both the Political Bureau and its Standing Committee are elected by the plenary session of the Central Committee.




The Military The Central Military Commission of the People's Republic of China (“PRC”) is the highest state military organ with the responsibility of commanding China’s entire armed forces. Led by a chairman and consisting of a vice chairmen and members, the Commission is elected for a term of five years and can stand for reelection. The Head of the State The president, as the head of the state, promulgates laws, appoints the premier, vice premiers, state councilors, ministers of various ministries and state commissions, the auditor-general, and the secretary-general of the State Council, according to decisions of the National People's Congress (“NPC”) and its standing committee. The president also confers awards and honorary titles of the state, issues order of special amnesty and martial law, declares state of war, and announces order of general mobilization. The Organizational Form of State Power The National People’s Congress is the organizational form of supreme power in the PRC. Its permanent organizational form in office is the Standing Committee. Both the NPC and its Standing Committee are elected for a term of five years. The NPC is established via democratic elections and the NPC in turn elects the member to the Standing Committee. The NPC exercises the power of legislation, decision, supervision, election, appointment and dismissal. The State Administrative Organizational Form The administrative branch of the state power is the Central People's Government and local people's governments. The State Council, another term for the Central People's Government, is the supreme administrative organ of state power. The State Trial Organizational Form The people's courts are the trial organizational forms of the state. The trial system consists of the Supreme People's Court, local people's courts and special people's courts such as the military court. The State Prosecution Organizational Form The people's procuratorates are the legal supervision organizational form of the state. The prosecution system consists of the Supreme People's Procuratorate,




local people's procuratorates and special people's procuratorates such as the military procuratorate. The Political Consultative Organizational Form The Chinese People's Political Consultative Conference is a united front organization under the leadership of the Communist Party of China and an organizational form for various other political parties, mass organizations, and personages of various social circles to take part in the running of the state. Social Organizations Mass organizations are an important component of political life in China. Despite the fact that they are non-governmental organizations, the All-China Federation of Trade Unions, the Communist Youth League of China, and the All-China Women's Federation exercise, to a fairly large extent, some of the functions of the government. As a result, the tasks, the organizational setup, and posts of leaders of some mass organizations are decided by organs of the central authorities. For the same reason, these organizations receive appropriations from the state treasury for funding.

6.3 Accession to The WTO

After over a decade of negotiations, China became a full member of the World Trade Organization on December 11, 2001. China's entry into the WTO accelerates its movement toward a market-oriented economy and opens up new markets for foreign goods and services, impacting both the Chinese and global economies




China’s acceptance of WTO legal agreements means assuming extensive legal and economical obligations. Under WTO rule, China is required to cut its import barriers imposed on foreign products and services. In addition, the government is also expected to address problems encountered by foreign firms while they are doing business in China. The country has already significantly reduced its tariffs on industrial products to 8.9 percent and tariffs on agricultural products to 15 percent. Some tariffs will be eliminated and others reduced no later than 2010.

Information transparency has long been a problem for most foreign investors in China. In an effort to promote transparency, China began regularly publishing law and regulation updates in official journals, including the responsible government agency and the effective date. Notice will be given of laws and regulations soliciting comments, with translations provided prior to implementation or enforcement. Laws and regulations concerning trade in goods and services will be implemented in a uniform manner throughout the country.

Upon WTO accession, China agreed to implement the WTO Agreement on Trade-Related Investment Measures (“TRIMs”). China has gradually opened opportunities for foreign investment in specific sectors that had previously been off limits, such as financial services, telecommunication, and insurance to foreign investors. It is also committed to eliminate and cease enforcing trade and foreign exchange balancing requirements and local content and performance requirements. China has also committed to enforce laws or provisions relating to the transfer of technology or other know-how, if they are in accordance with WTO rules on protection of intellectual property rights and TRIMS. In the past, the Ministry of Foreign Trade and Economic Cooperation (“MOFCOM”) had sturdily encouraged contractual clauses stipulating export requirements. Now, China has said that it will no longer enforce export performance requirements in private contracts.

While many challenges still exist, it is clear that China’s accession to the WTO will benefit both the domestic and global markets. The country’s WTO membership, with a huge market of 1.3 billion people, will give a tremendous boost to the development of the world economy.




7. Infrastructure

7.1 Transportation

Transportation is a major factor in China's national economy. Since 1949, however, development of the transportation system occupied a relatively low priority in China's national development. Inadequate transportation systems hindered the movement of coal from mine to user, the transportation of agricultural and light industrial products from rural to urban areas, and the delivery of imports and exports. As a result, the underdeveloped transportation system constrained the pace of economic development throughout the country. In the 1980s the updating of transportation systems was given priority, and improvements were made throughout the transportation sector.

Since 1985, the Chinese government has given high priority to the development of its transportation system, particularly quality inter-province/city highways. Improvement of public transportation was first designated as a top priority in the Seventh Five-year Plan (1986 - 1990). Prior to 1986, the Chinese transportation system mainly relied on railroads for long distances, and on buses and trucks for medium distance travel. By 2002, China already had a total of 1,765,222 kilometers of highways with more than 25,130 kilometers of expressways.

*Currently, Shanghai’s Maglev is the world’s fastest rail transportation system in commercial operation.

The World Bank recently approved funds for two major Chinese highway projects. The first one is the USD 200 million Guangxi Highway Project, which will support




the construction of a 238-kilometer inter-provincial highway. The highway will connect Nanning, the provincial capital of Guangxi, to Shuiren in the north, creating a key section of China's National Truck Highway System. The new highway will connect the relatively poor, land-locked inner provinces of Guizhou, Yunnan, Sichuan, and the city of Chongqing to the southern seaports of Beihai and Fangcheng in Guangxi and Zhanjiang in Guangdong province, bringing a shorter and faster route to the sea.

The second project is the USD 350 million Fourth National Highway Project. It was designed to support construction of the 300-kilometer Wuhan-Changsha expressway, the central section of the highway linking Beijing to Hong Kong. The project is the fourth in a series of World Bank-funded operations to help China improve its highway system between Beijing and Guangzhou, providing an important trade link between some of the country's major cities, and integrating remote parts of the country with major urban areas. The Wuhan-Changsha expressway is the central portion of a larger, 2,500 kilometer Beijing-Guangzhou expressway. When completed, it will connect the capital cities of Hubei and Hunan and will serve approximately 40 million people in its wider area of influence. The project will also help to alleviate growing income disparities between inner land and coastal provinces by improving access to coastal port cities and increasing integration of Hunan and Hubei into the world trading system. The new highway will give an economic boost to one of China's poorest areas by promoting commerce, trade, and tourism in the region, serving approximately 40 million people. While focusing greater effort on highway construction, the Chinese government has continued expanding the rail transportation system. By 2008, the Shanghai government will build a new Maglev between Shanghai and Hangzhou, and this new Maglev is expected to enhance the commercial valuation of the Changjiang Triangle Area (the Yangtze River Delta). 7.2 Telecommunication Between 1997 and 2004, the Chinese telecommunication sector’s annual growth rate was approximately 20 percent, twice as fast as China’s annual GDP growth. It is by far the world’s fastest and strongest growth in the telecommunication industry. The following chart illustrates the significant growth China achieved from 1998 to 2003.




0

50

100

150

200

250

300

Mill

ions

1998 1999 2000 2001 2002 2003

Fixed Line, Mobile, and Internet Users

Fixed Line Mobile Internet

Source: Mill Data, Park Associates

During the last few years, China’s telecommunication companies have invested over USD 25 billion to build network infrastructure. China currently has the world's largest landline and mobile telecommunications networks with 523 million total subscribers. The number is still increasing rapidly each month. In 2004, the Chinese telecommunication operators attracted an average of approximately 8.6 million new telephone users each month.

The number of Internet users in China has also grown significantly. In 1997, there were only 620,000 registered Internet users in China. Official statistics from the China Internet Network Information Center (“CNNIC”) show that by the end of 2004, China had 94 million Internet users, compared with 80 million registered users in 2003.

7.3 Electricity

So far, China’s electricity industry relies mainly on state-owned assets. China has recognized the electrical industry as an industry important to supporting national economic development, and has built a new electric industry system primarily meeting the needs of a socialist market economy. According to the 2000-2010 Strategy Plan of the State Council, development of the electric industry must grow at the same rate as the national economy in order to meet the requirements of national economic development. Since the implementation of the Reform & Open policy, and with the further evolvement of China’s economic system reform, the electricity industry has witnessed rapid growth and scored eye-catching success. Over the past 20 years, the average annual increase of installed capacity is 10 million kilowatts. During the period of 1993 to 1999, electric energy production increased by 6.3%




annually, meeting the needs for national economic development. Now the electric industry has entered into an important era of full-scale development that is characterized by large generating units, large power plants, a large power network, super high voltage, and automation. In 1999, the total installed capacity reached 298.76 million kilowatts, and electric energy production of China reached 1,233.1 billion Kilowatt Hours (“KWH”). However, China’s economy has still managed to outgrow its electricity generating capacity by a considerable amount. Despite the rapid growth of China’s electric generating capacity, periodic blackouts still happen regularly throughout the year, especially during the summer. The booming eastern areas suffer the most severe electricity shortage, with the gap estimated at around 11 million KWH, according to an analysis report of the China Electricity Council (“CEC”). The installed electricity generating capacity is supposed to rise 70 million KWH, or 15.88 percent, to 510.7 million KWH in 2005. Yet, according to a research paper published by the State Power Economic Research Center, China’s electricity shortage should be solved by the end of 2006.




8. Investment Climate

8.1 Overview

As a result of more than 25 years of reform and liberalization, China’s investment climate has changed dramatically. In the early 1980s, foreign investments were restricted to export-oriented operations. In addition, it was required that foreign investors form joint ventures (“JVs”) with Chinese companies to gain entry into the Chinese domestic market. These policies have been changing rapidly since the early 1990s. China has opened up more industries, allowing foreign investors to manufacture and sell a wider range of products in the market. The Chinese government took a large step in freeing China’s economy and domestic market by authorizing the establishment of wholly foreign-owned enterprises (“WFOEs”). Today, WFOE is the preferred form of FDI in China. The three main investment vehicles used by foreign investors in China are: wholly foreign owned enterprises, equity joint ventures (“EJV”), and cooperative joint ventures (“CJV”) (please refer to Appendix A for further details). Because of the operational freedom it enjoys, WFOEs are currently the most popular. For the first time in 2000, new registration of WFOEs exceeded that of joint ventures. In 2004, WFOEs accounted for 70.3 percent of approved projects, while representing 74.9 percent of the deals by value. The Chinese government divides investment into three categories: encouraged investment, restricted investment, and off-limits investment. The industry determines the nature of the investment, as the government attempts to guide new foreign investment towards certain encouraged industries and regions. Since 1997 China has implemented new policies creating incentives for investments in high-tech industries. Investments in the under-developed central and western regions of China are also favored. Over the last 25 years China has developed a complex system of investment incentives In addition to the Special Economic Zones of Shenzhen, Shantou, Zhuhai, Xiamen, and Hainan, hundreds of smaller regional development zones have been established. They offer a variety of unique packages of investment and tax incentives. The majority of FDI, however, is still directed to China’s coastal area, especially Guangdong, Jiangsu, Fujian, Shanghai, and Shandong. Despite the rapid move towards a free economy, China’s labor mobility remains low. The country maintains a residence registration system, which limits the migration of labor. Under the current system, urban residents are entitled to housing, medical, education and employment benefits. Farmers, on the other hand, are confined to rural areas and denied the benefits available to their urban counterparts. Chinese lawmakers acknowledge that the existing household




registration system will soon no longer be suitable to the changing situation characterized by the anticipated migration of workers and professionals.

8.2 Regulatory Environment

All acquisitions of companies with operations in China are subject to a certain level of official review by the local, provincial, or central government. However, the complexity and time required to complete the government review and approval process vary depending on the type of acquisition target, transaction size, and impact on the industry or sector involved. In general, a deal cannot be completed until all relevant government approvals and licenses have been issued. The table below provides some insight into the current regulatory situation of M&A activity. First, all deals are classified into three categories based on the industry. This determines the general set of regulations by which they will be governed. Furthermore, among the three general categories, deals are again separated according to their size, indicating which government authority will be responsible for approving the deal.

Source: Baker & McKenzie LLP

8.3 Foreign Exchange Control

In China, the State Administration of Foreign Exchange (“SAFE”) supervises all foreign exchange related issues. SAFE's main responsibility is to regulate and supervise foreign exchange transactions, including overseeing international commercial borrowings, issuing foreign-currency bonds, and managing the overall foreign-debt exposure of Chinese entities. SAFE implements case-by-case

Approval Thresholds

Category Total Investment (USD Millions) Approval Authority < $100 Local DRC, Local Counterpart of MOFCOM >= $100 NDRC, MOFCOM Encouraged >= $500 State Council, MOFCOM

< $50 Provincial DRC, Provincial Counterpart of MOFCOM

>= $50 NDRC, MOFCOM Restricted

>= $100 State Council, MOFCOM Prohibited N/A N/A Key DRC: Development Research Center; MOFCOM: Ministry of Commerce; NDRC: National Development Research Center




reviews of the conversion of RMB to freely trading currencies. SAFE is also empowered to take regulatory action against illegal acts involving foreign exchange (please refer to Appendix C for further details).

On December 1, 1996, China introduced a new system of foreign exchange control under which the Chinese RMB is convertible in current accounts. However, stringent administrative measures still apply to the country’s capital account. Foreign exchange is not allowed to circulate or to be used in the settlement of accounts except in free trade zones. Any organization or individual with international balance of payment (including overseas-invested businesses, foreign financial institutions and the resident Chinese offices of foreign legal persons except for those of international organizations and foreign embassies or consulates) should declare for statistical purposes their international balances and go through the foreign exchange settlement and sales procedure when collecting foreign exchange in export and paying foreign exchange in import.

China’s accession into the WTO did not change the current foreign exchange control situation. At the WTO Accession & International Cooperation Forum, Long Yongtu, China's Vice Foreign Trade and Economic Cooperation Minister, made it clear that it is a misunderstanding that by gradually opening their banking and insurance markets to foreign companies, China is opening its capital markets. People’s Bank of China had previously indicated that from July 21, 2005 onwards, China will reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to an undisclosed basket of currencies. The RMB will no longer be pegged to the US dollar and the RMB exchange rate regime will be improved with greater flexibility. Thus, the reform marked the end of China’s stringent currency peg of RMB 8.28 to the dollar since the Asian financial crisis in 1997. Though it is only a 2 percent initial shift so far (to RMB 8.11 per USD), this change opens the way for further gradual moves ahead.




At present, there are numerous uncertainties about when and what the Chinese government will do next with their currency. What is clear, however, is that Beijing’s move alleviates some of the political tension between the U.S. and China caused by the long-debated issue. The move gave pause to a potential trade war between two of the world’s greatest powers that would almost certainly have had a negative impact on the global economy.

8.4 Regional Guide

Yangtze River Delta The Yangtze River Delta consists of Shanghai, the southern Jiangsu Province, and the northern Zhejiang Province. Shanghai is currently mainland China’s largest city with a population of 13.42 million (2004 census, registered residents only) as well as the world’s third busiest port. The city’s remarkable development in the past two decades has established its status as China’s economic, commercial, financial, and communications center. The economic reform of Shanghai began in 1992. Though it started almost a decade later than the Pearl River Delta economic reform, the city has been moving forward faster than expected. In 2004, the city achieved a GDP per capita of USD 6,465, and a total GDP of USD 87 billion. It has also increased its role in the finance and banking industries, and as a major destination for corporate headquarters, fueling demand for a highly educated and modernized workforce.

Western Region

Northeast Rustbelt

Pearl River Delta

Yangzi River Delta




Shanghai’s economy is currently growing at a steady average rate of about 11 percent annually. Shanghai is also increasingly becoming a critical communication center in the world. The city has hosted numerous international conferences, both small and large, over the past 15 years. In addition, Shanghai will host the world expo in 2010. The city’s government actively promotes the city’s new image of being an international metropolis. Shanghai's international diversity is perhaps the world's foremost window into the rich, historic and complex society of today's China. The Province of Jiangsu is historically oriented towards light industries such as the textile and food industries. Benefiting greatly from Deng Xiaoping’s economic reform, the three major cities of Jiangsu (Nanjing, Suzhou, and Wuxi) have shown rapid growth. Singapore built the Suzhou Industrial Park in the eastern outskirt of Suzhou, representing the close relationship between China and Singapore. In 2004, the GDP per capita of Jiangsu reached USD 2,237.5, compared with USD 2,028.5 in 2003. Total GDP reached USD 169 billion in 2004. The Zhejiang Province’s manufacturing is centered in the electromechanical, textile, chemical, food, and construction materials industries. The provincial government’s economic policy emphasizes large public investments in infrastructure and the production of low cost goods for both domestic consumption and export. Zhejiang’s GDP per capita as of 2004 was USD 2,532, total GDP was USD 120 billion, and the literacy rate was 92.12 percent. In addition, Zhejiang also has four important commercial ports: Ninbo, Wenzhou, Taizhou, and Zhoushan. Pearl River Delta The Pearl River Delta includes Hong Kong, Macau, and eight prefectures of the Guangdong Province, namely Guangzhou, Shenzhen, Zhuhai, Dongguan, Zhongshan, Foshan, Huizhou, and Jiangmen. Before 1985, the Pearl River Delta was mainly dominated by farms and fishing villages. The 7th Five-Year Plan (1985-1990) set off a series of economic reforms in the region and helped turn the region into an economic strength for China. The growth was mainly fueled by foreign direct investment from Hong Kong manufacturers who expanded their operations into the area. Main products of the area include electronic products, toys, garments, textiles, and plastic products. Since the launch of China’s reform in 1978, the Pearl River Delta has been China’s most economically dynamic region. In 1980, the region’s GDP was just a little over USD 8 billion. By the end of 2000, its GDP had already grown to USD 89 billion. During the two decades, the average annual rate of GDP growth in the




Pearl River Delta Economic Zone was 16 percent, twice that of China’s national GDP growth. Approximately 40 percent of foreign investment was in the Pearl River Delta. By 2005, the region’s GDP had risen to over USD 100 billion, while continuing to experience rapid growth.

According to the national Census, the Pearl River Delta Economic Zone had a population of over 40 million people. Both per capita income and consumer expenditures grew substantially in recent years.

While this region encompasses only 0.4 percent of the land area and only 3.2 percent of the Census population of mainland China, it accounts for 8.7 percent of GDP, 32.8 percent of total trade, and 29.2 percent of utilized foreign capital. These figures show the remarkable level of economic development that the Pearl River Delta Economic Zone has achieved and the international orientation of the region’s economy. This orientation has attracted numerous investors from all over the world who use the Greater Pearl River Delta region as a platform for serving global and Chinese markets.

Western Region The vast western region of China consists of twelve provinces: Xinjiang, Tibet, Inner Mongolia, Gansu, Qinghai, Sichuan, Ningxia, Shanxi, Chongqing, Guizhou, Guangxi, and Yun’nan. While the economy of China’s coastal area has been booming since the economic reform, the western region has lagged behind due to the high level of transportation difficulty. This region contains 71.4 percent of mainland China’s area, but only 28.8 percent of its population and 16.8 percent of its total economic output. The economy in these twelve provinces relies heavily on agriculture and natural resources. More than half of China’s identified natural resources are in the western region. In China’s 10th Five-Year Plan, the central government announced the “Great Western Development” program. So far, the state has invested about USD 8.48 billion in the area, while actively seeking help from international sources such as the World Bank, the Asia Development Bank, and international corporations. The fixed asset investment growth rate from January to October 2004 hit 23 percent and the region’s GDP has grown at 8 percent annually. More than 1 million hectares of low-yielding farmland have been converted into grassland and 910,000 hectares of hill or waste land have been planted with trees. As stated by a Ford Motor Company representative, the western provinces have the right conditions for foreign investment: abundant natural resources and cheap labor. Northeast Rustbelt Northeastern China consists of three provinces: Heilongjiang, Jilin, and Liaoning.




Heilongjiang is an important source of lumber and oil for China. Its major industries include coal, petroleum, lumber, heavy machinery, and food. Because of its geographic location, Heilongjiang is an important gateway for China’s trade with Russia. The GDP of Heilongjiang reached USD 59.7 billion in 2004, and the GDP per capita was about USD 1,565. The Jilin Province’s industry is concentrated on cars, train carriages, and iron alloy. The province’s nominal GDP for 2004 was USD 31.9 billion, and the GDP per capita was USD 1,187. Liaoning is one of China’s most important industrial bases. The province covers a wide range of industries, such as machinery, electronics, metal refining, petroleum, chemical industries, construction materials, and coal. Its provincial capital, Dalian, has developed into a major port as well as the economic gateway to the Northeast region. In 2004, Liaoning’s GDP was approximately USD 81 billion, with a GDP per capita of USD 1,895. The Northeast region was the first to industrialize in China before World War II. After 1949, northeastern China continued to be a major industrial center of China. However, during recent years, the heavy-industry based economy of the Northeast has suffered from stagnation as China’s economy continues to privatize and liberalize. The region at present has the most serious unemployment problem nation-wide. In an attempt to solve the problem, the central government has initialized the “Revitalize the Northeast” program.




9. Foreign Direct Investment (“FDI”) & Current Mergers and Acquisitions (“M&A”) Activity

9.1 Foreign Direct Investment (“FDI”)

At present, China is the number one recipient of FDI in the world. About ten percent of global FDI flows into China. Yet, with an inbound FDI volume of such magnitude, the country only captures two to three percent of global cross-border M&A activity. As shown in the chart below, wholly foreign-owned enterprises still occupy the largest share of FDI in 2005. Among the USD 60.63 billion invested during this one-year period, USD 40.22 billion, or 66.34 percent of the total amount of investment was invested in Wholly Foreign-Owned Enterprises. Cooperative development and share-based enterprises with foreign investment only take up a small proportion of the total investment. However, these two categories have observed the fastest growth rates of 226.45 percent and 136.68 percent respectively. On the other hand, equity joint ventures and contractual joint ventures have both suffered a loss of popularity. EJVs had the slowest growth of 6.46 percent relative to the above mentioned investment vehicles, while contractual JVs declined by 18.88 percent.

Foreign Investment in China 2005 Investment

Vehicle Number of Contracts Amount Contracted Amount Utilized

Total %

Change % of Total $ Billion

% Change

% of Total $ Billion

% Change

% of Total

Foreign Direct

Investment 43,664 6.29 100 153.47 33.38 100 60.63 13.32 100 Equity Joint

Ventures 11,570 -7.6 26.5 27.64 8.37 18.01 16.39 6.46 27.03

Contractual Joint

Ventures 1,343 -13.19 3.08 7.79 4.13 5.08 3.11 -18.88 5.12

Wholly Foreign-Owned

Enterprises 30,708 13.97 70.33 117.28 43.7 76.42 40.22 20.49 66.34

Share-based Enterprises

with Foreign Investment 43 16.22 0.1 0.77 99.09 0.5 0.77 136.68 1.27 Cooperative Development 0 -100 0 0 -100 0 0.11 226.45 0.18 Source: Ministry of Commerce and the USCBC




9.2 Mergers & Acquisitions (“M&A”)

Mergers & Acquisitions are becoming increasingly prevalent in cross-border and domestic transactions worldwide. For most foreign investors, M&A is considered a viable method to enter the Chinese market. Acquiring a strong local brand, local manufacturing capabilities, and/or local distribution is more time-efficient than trying to build the same company from the ground up. Though the concept of M&A is still relatively new to China, the volume of M&A activity in the country has increased dramatically during the last few years. According to Thomson Financial, Chinese companies were Asia’s most preferred targets for the full year of 2005, both by value and by number of deals. In 2005, 1,707 transactions were announced, amounting to USD 31.5 billion in 2005. In comparison, 2,141 transactions worth USD 24.5 billion were announced in 2004, and 1,504 transactions worth USD 28.5 billion were announced in 2003. China has been the most active country for M&A transactions over the last 4 years. The following tables compare overall Chinese M&A activity by number of deals and by value.

0

500

1000

1500

2000

2500

2003 2004 2005

Total Number of Announced M&A Deals

05

101520253035

USD

Bill

ions

2003 2004 2005

Total Value of Announced M&A Deals




In the first half of 2005, 804 inbound M&A deals were announced, compared to the 570 and 930 deals in the first half of 2003 and 2004, respectively. This slowdown can be attributed to the uncertainty of the market following a number of regulatory changes in January 2005. The total value of inbound deals was USD 15 billion in the first half of 2005, while the value was USD 7 billion in 2003 and USD 9.2 billion in 2004 for the same period. The most active sectors for M&A were energy, utilities and mining, financial services, logistics and telecommunications. The general industrial manufacturing, consumer and industrial products, pharmaceuticals, brewing and automotive sectors were also relatively active. Many highly visible international companies such as Amazon.com, Yahoo! Inc., Eastman Kodak, and Anheuser-Busch Cos. Inc., have acquired Chinese companies as a key component of their strategic business initiatives in China. Though large acquisitions make up a relatively small proportion of the total inbound FDI, foreign investors who have traditionally invested in joint ventures or WFOE’s view such transactions as a new alternative of entering China’s domestic market. The deal size of such high-profile acquisitions averaged more than USD 100 million per transaction. In terms of mid-sized foreign acquisitions of local companies, there have been an increasing number of transactions in traditional manufacturing sectors such as auto components and industrial equipment. Small deals of less than USD 20 million predominantly occur in textiles, toys, services, apparel, and food sectors. Until recently, M&A activity involving Chinese companies had mainly been inbound deals. Global multinational corporations were leveraging China’s highly efficient low cost manufacturing base and rapidly growing consumer market, by accelerating their pace of M&A transactions in China. However, Chinese companies have started to show an interest in acquiring Western corporations, resulting in a significant surge in outbound M&A activity. This outbound M&A trend was initiated by China National Offshore Oil Company’s (“CNOOC’s”) USD 18.5 billion bid to acquire Unocal in July 2005, and Haier Group’s USD 2.25 billion bid to acquire Maytag in June 2005, both of which failed. Now Chinese companies perceive international M&A as a means to enter the global stage, and the Chinese government has given tacit encouragement, with the aim of developing a global profile for Chinese companies. In the first half of 2005, the total number of outbound transactions was 32, which is higher than the combined outbound transactions of 2002 and 2003 for the same period. During this period, the transaction value reached USD $3.9 billion, compared to USD 0.7 billion for the same period in 2004. The energy sector was the most active sector for China’s outbound M&A transactions, followed by the retail and financial services sectors. Given China’s rapid industrialization, the




need for new energy sources to fuel this growth has become a major driver of China’s international M&A activities. Chinese M&A activity is expected to continue expanding in the near future. China’s large potential consumer market and strategic moves by leading Chinese corporations’ to establish global brands and gain access to international markets will increase both inbound and outbound M&A activity in China.




Markets of Opportunity 10. Technology

10.1 Telecommunication Sector

Market Overview

China is currently the largest mobile communications market in the world. By June 2005, China had over 350 million mobile phone subscribers, or more than 30 cell phone users per every 100 people. In 2004, revenues generated by the telecommunications sector amounted to USD 62.71 billion, a 13.2 percent increase from 2003. The extraordinary growth in the mobile service sector is boosted by increased competition, lower terminal prices, and the rise of prepaid services. Four major Chinese telecom companies, China Telecom, China Netcom, China Mobile, and China Unicom, each maintain high market shares.

Despite the remarkable growth, the government remained cautious about the eventual issuance of Third Generation (“3G”) licenses. The Information Industry Minister Wang Xudong indicated that the Chinese government is not in a hurry to release 3G mobile licenses due to market uncertainty and doubts about the maturity of the technology. However, judging by the current trend of development, both the market and the technology will be mature enough before long. This will create a market that is worth billions of dollars for telecommunication companies worldwide.

Currently, the ceiling on foreign ownership in basic value-added telecommunications service providers is set at 50 percent, while foreign ownership of mobile communications operator is limited to 49 percent. Foreign ownership of wireline operators was barred until recently, but was opened to a limit of 25 percent in some cities in 2004. As part of its WTO obligations, China is required to further open up its telecommunications market to foreign investment.

By the end 2004, the number of Internet subscribers in China had grown to 94 million, or over 10 percent of the world Internet user base. This is remarkable growth from 0.62 million in 1997. After a slowdown in 2002, the sector has shown strong and steady growth. The Chinese Internet access market generated total revenue of USD 9.1 billion in 2004, representing a compound annual growth rate (“CAGR”) of 46 percent for the five-year period spanning 2000 – 2004, according to a report by Datamonitor. The report also states that China has considerably outperformed Japan, which grew with a CAGR of 25.9 percent over the same period.




The Chinese government remains well aware of the enormous social and economic value of the Internet and its importance in creating a prosperous nation. At the same time, however, it is concerned by the perceived risk to cultural heritage and political stability.

Number of Internet Users in China

9400

7950

5910

3370

2250

89021062

0

2000

4000

6000

8000

10000

1997 1998 1999 2000 2001 2002 2003 2004

Thou

sand

s

Source: China Internet Network Information Center

China is also emerging as a broadband superpower, showing further strong growth coming into 2004. Though penetration remains comparatively low, in early 2005, broadband was growing in China at a rate of around 8 percent per month (or close to 100 percent per annum), with China Telecom being the largest supplier.

Domestic Competition

Only a handful of licensed basic services operators currently exist as the telecommunications market remains almost completely under the control of the state. Large players in the fixed line sector include China Telecom and China Netcom. The two principal mobile communications operators are China Unicom and China Mobile. In the Internet access market, the key players include Equant, ChinaNet, and CERNET.

Market Trends Uncertainty over issues such as 3G licenses, restructuring of state-owned telecom operators, and censorship of content and applications offered over fixed-line and mobile telecom networks remains a concern within the telecommunication industry. The number of Internet subscribers should continue to rise. The government has pushed various educational institutions towards integrating Internet usage into




education. The increasing number of online Internet game players has also helped the growth. In 2004, the basic telecommunication enterprises had 23.851 million new broadband subscribers. According to MOFCOM, data communication was the fastest growing business in terms of income in 2004, with a growth rate 1.5 times faster than that of the predominant services. China Internet Network Information (“CINIC”) statistics show that among all users in 2004, leased line users added up to 26.6 million, which is 31.5 percent more than a year ago. Dial-up users reached 49.16 million, increasing 4.15 million or 9.2 percent, which is also 105.7 times of the (465,000) same figure in the 1997 survey. There are now 5.52 million ISDN users, 620,000 or 12.7 percent more than six months ago and 27.8 percent more than last year. Broadband households yield 17.4 million, growing 7.6 million or 77.6 percent over the past six months and 163.6 percent over the previous year.

707

1886

857

2196

1227

2698

315280

1606

3342

432660

2023

4080

490980

2342

4501

552

1740

2660

4916

0

1000

2000

3000

4000

5000

Tho

usan

ds

Jan '01 July '01 Jan '02 July '02 Jan '03 July '03 Jan '04

Users of Different Accessing Methods

ISDN Broadband Leased Line Dial Up

Source: China Internet Information Center

According to an official report from MOFCOM, the fast growth in wireless city-wide telephone subscribers has become the main driving force for the growth in fixed line telephone subscribers. In 2004, among the new fixed-line telephone subscribers 56.2 percent were wireless city-wide telephone subscribers.

In the long-distance telephone service sector, IP telephone service is taking the lead due to its lower charge. Long-distance calling time of IP telephones grew 40.7 percent in 2003, and 39 percent in 2004. The proportion of IP telephones




calling time grew to 46 percent in 2004, compared with 42.2 percent in 2003 and 37.2 percent in 2002. In comparison, calling time of traditional long-distance

Telephones grew only 5.9 percent in 2003 and 26.3 percent in 2004. As for mobile long-distance telephones, the growth rate was 24.4 percent in 2003 and 11.4 percent in 2004.

Market Forecasts

The Ministry of Information Industry (“MII”) expects the telecommunications service revenues to reach USD 75.9 billion by 2006. Specifically, the internet access market is forecasted to grow to USD 26.4 billion by 2009, representing an increase of 190.7 percent since 2004. The compound annual growth rate of the market in the period 2005-2009 is predicted to be 23.8%. China also expects to have 255.5 million Internet users by 2009.

Recent High-Profile Deals

In 2004, Google made a strategic investment in Baidu.com Inc., a leading Chinese-language Internet search engine. Amazon.com Inc. also recently purchased China's largest online book seller, Joyo.com Ltd., in August 2004. The deal closed at approximately USD 75 million in cash and stock. As part of the deal, Amazon also gained possession of several Chinese subsidiaries and affiliates controlled by Joyo.com. Amazon’s chief executive, Jeff Bezos, said in a statement, “We are happy to be part of the world’s most dynamic market.” The company is already planning to expand its operations in China, while remaining mindful of the unique challenges of entering this huge and complex market.

10.2 Software Sector

Market Overview The Chinese domestic market for software has been expanding rapidly. In 1999, China’s software output value totaled USD 2.2 billion, a 31 percent increase over 1998. In 2000, the number reached USD 2.47 billion. Though the market experienced a slowdown in 2001 and 2002, it started picking up in 2003 and is expected to keep its fast-paced growth. The market reached USD 3.1 billion in 2004. The total market value is predicted to grow to over USD 6 billion by the end of 2007.




0500

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Packaged Software Market Value

Source: IDC

Domestic Competition

Competition is tight in China’s software market. Currently, foreign software producers account for over 65 percent of the market. Microsoft, Oracle, and Sybase are the top three foreign software companies. China National Software Service Corporation, China Neusoft, and China Ufsoft are the top three Chinese software companies.

Market Trends

At present, foreign software companies, such as Microsoft and Oracle, dominate the market and should continue to experience strong sales, especially in the high-end software market. However, there is an increasing demand for domestically produced software tailored to fit Chinese customers. This demand is demonstrated by the growing reliance of the top multinational firms on their Chinese partners for localizing their products for China’s domestic market.

In addition, China’s accession to the WTO accelerates the nation’s demand for software services, as more Chinese companies are relying on information technology to keep themselves updated and competitive in the global market. The best prospects in the field are application software and customized software. For foreign firms who are trying to make their entrance into the China market, high-end products such as database management systems, systems management software, networking security software, and industry application software are the fastest growing categories.

Moreover, because of China’s accession to the WTO, software import tariffs were eliminated in 2003. The central government issued a series of policies such as export incentives, value-added tax rebates, and financial assistance in an effort to encourage the growth of China-based software companies. WTO rules also




addressed the intellectual property rights issue, which has lead to China’s nation-wide crack-down on pirated software.

Market Forecasts

The total market value is predicted to grow to almost USD 6 billion by the end of 2007, three times greater than what it was in 2002. According to IDC, a subsidiary of IDG International Data Group, the growth will be driven by steady economic growth, improvements in IT infrastructure, and increasing demand from enterprises.

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Packaged Sofware Market Forecasts

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In 2003, Yahoo Inc. reached an agreement with 3721 Network Software Co. Ltd. to purchase the company. In an effort to expand its presence in China’s rapidly developing market, Yahoo arranged to pay USD 120 million for full ownership of 3721. Under the agreement, Yahoo took control of 3721’s operations in Beijing which focus on selling software that people can install into a web browser to enable Chinese keyword service. In February 2005, PalmSource, Inc. completed its acquisition of China MobileSoft for USD 16 million. China MobileSoft is a leading Chinese mobile phone software company providing mobile device manufacturers and original design manufacturers complete, integrated software platforms and user-friendly applications for the Chinese market.




10.3 Hardware Sector Market Overview In 2004, China’s production scale of computers, electronic components, and electronic instruments and equipments further expanded their proportions against the whole industry. According to official statistics, they enjoyed increases of 1.3 percent, 1.1 percent, and 0.2 percent respectively. At the same time, many enterprises enhanced their technology innovation capabilities, which caused a noticeable shift toward high-end products in terms of production and sales in 2004. Notebook sales reached 12 million units with a 50 percent share of PC sales. The production and sales of the new type of electronic components also witnessed a remarkable increase. The production and sales of both micro-display products and integrated circuit products have enjoyed more than 50 percent increase year-on-year. The Chinese computer hardware market, which consists of personal computers, servers, mainframes, workstations, and peripherals, experienced a compounded annual growth rate of 16.4 percent between 2000 and 2004. In 2004, the value of the Chinese hardware market reached USD 28.2 billion, a 16.8 percent growth from 2003.

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Computer Hardware Market Value

Source: Datamonitor Domestic Competition Lenovo, majority-owned by the Chinese government is the largest maker of desktop PCs in China, with a market share of approximately 27 percent. Other important players include Founder, Tongfang, Dell, and TCL. China’s accession to WTO has led to increasing competition as the average selling price for desktop PCs in China has fallen by 17 percent. Similarly, Lenovo with a 15 percent share




dominates the portable PC market. Other key players in this competitive market include Toshiba, Dell, and HP. Cisco is the market leader in the networking hardware market with close to 40 percent market share. Other top competitors include 3Com, Huawei, Nortel and D link. Collectively, these top five companies form the first tier of this market and account for 66 percent of the market share. As for the computer peripherals market, Seiko Epson, HP, Canon, and Lenovo dominate the market, with a combined 82.7 percent share. Market Trends In 2003, China overtook Japan as Asia’s biggest market for PC sales. It is now the second largest in the world, after the U.S., in terms of market size. The increasing investment in IT infrastructure by various entities ranging from schools and traditional manufacturing organizations to financial institutions and telecommunication companies will provide market opportunities for both foreign and domestic hardware companies. Recent trends indicate a shift towards high-end hardware products. One of the most obvious indications of this shift is that the growth of desktop sales has slowed down, while the growth of laptop sales and other high-end products sales continue to increase. The Chinese portable PC market grew by 27 percent from the prior year in 2004, according to a report from Euromonitor. The report also states that portable PC sales comprised 18.8 percent of the total number of PCs sold in 2004. Laptop sales growth outpaced desktop sales growth by a wide margin. Although the scale of the laptop market is small compared to the desktop market, the growth in the 2003-2004 period marked a new trend as more local computer producers entered the market with low-priced laptops, fueling a jump in demand.

On the other hand, the growth of desktop PCs sales has slowed. Despite positive growth in terms of market size, desktop PCs sales occupied approximately 70 percent of the total PCs sales in 2004, which was lower than 2003’s 74 percent share. Intense price competition has led to a downward pricing trend for desktop PCs, which is slowly wiping out the high returns desktop PC producers had become accustomed to. According to Euromonitor’s report on the desktop PC sector, China’s domestic desktop manufacturers are facing the same problems that have haunted the PC industry everywhere else in the world. Some of the identified problems include slower growth, fierce price competition, and a constant struggle to keep profit margins from narrowing.




Market Forecasts The Chinese computer hardware market is expected to reach USD 50 billion by 2009. This growth is fueled by China’s Tenth Five-year Plan (2001-2005) on computerization as it will accelerate PC demand in the Banking, Securities, Telecom, Social Security, and Education sectors. SMEs and users in third or lesser tiered cities will also continue to create PC demand.

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Source: Datamonitor Recent High-Profile Deals IBM sold its PC division to Lenovo Group, a China-based computer hardware giant, in 2004 for USD 1.8 billion. After the acquisition, Lenovo became the world’s third largest PC maker in the world. The combined venture has approximately 10,000 IBM employees and 9,200 Lenovo employees; with headquarters in New York and operations in Beijing and in Raleigh, NC.




11. Healthcare

11.1 Pharmaceuticals Sector

Market Overview In 2004, the pharmaceuticals market for China grew by 17 percent over the previous year to USD 26.1 billion. The growth of the Chinese pharmaceuticals market is mainly fueled by the rising incomes, increased number of insurance policy holders, and demand growth for lifestyle-related disease drugs, according to a Euromonitor report. At present, China is one of the world’s major producers of pharmaceuticals. About 6,700 pharmaceutical manufacturers are currently operating in China, with the capacity to produce 1,350 chemical drugs and more than 8,000 traditional Chinese medicines (“TCM”). From 2000 to 2004, the size of China’s pharmaceuticals market doubled. The compounded annual growth rate remains over 10 percent.

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Pharmaceuticals Market Value

Source: Euromonitor The largest pharmaceuticals market sector in China in 2004, excluding TCM, was the anti-infective sector. Sales of anti-infective drugs totaled nearly USD 3 billion in 2004, a 14 percent share of the total pharmaceuticals market value. The fastest growing sector in 2004 was the central nervous system sector. Total sales of central nervous system drugs grew 78.3 percent in 2004. At present, China is the world’s number one producer of penicilliosis, Vitamin C, terramycin, vibramycin, and cephalosporin.




China Pharmaceuticals Market Segmentation 2005

Skin5%

Vitamin, Nutrient, Hermatinic

5%

Genito-urinary4%

Respiratory system2%

Central nervous system2%

Immunity system3%

Analgesic6%

Cardiovascular system6%

Gastrointestinal8%

Anti-Infective14%

Others14%

TCM31%

Source: Euromonitor Domestic Competition The Chinese pharmaceuticals sector is highly fragmented, with the top four players occupying only five percent of the total market share. Xi’an Janssen Pharmaceutical has a 1.4 percent market share, while Beijing Tong Ren Tang Group, Taiji Group, and Shanghai Roche Pharmaceutical each enjoy only a 1.2 percent share of the domestic market. Market Trends With a total population of over 1.3 billion and a rising GDP, China has the potential to grow into the world’s largest pharmaceuticals market. The chart below demonstrates the rapid growth of health expenditure in China. From 1995 to 2001, total expenditure on healthcare more than doubled with private expenditure experiencing the fastest growth rate. In 1995, only USD 14 billion belonged to private healthcare expenditure. By 2001, the figure had grown to USD 38.4 billion, or 60.4 percent of the total money spent on healthcare. With China’s steady economic growth, these figures are expected to continue to rise at a rapid pace over the next few years.




Total Health Expenditure (RMB Billions)

1995 1996 1997 1998 1999 2000 2001 % of Total

Government Expenditure 38.3 46.1 52.2 58.7 64.1 71 80.1 15.6 Public health services 27.1 32.5 36.2 41.1 45 50 n/a n/a Medicines 11.2 13.6 16 17.7 19.1 21.1 n/a n/a Social Expenditure 74 84.4 93.8 100.6 106.5 116.8 123.6 24 Private Expenditure 113.5 155.2 192.5 218.3 247.3 288.7 311.3 60.4 Total 225.8 285.7 338.5 377.6 417.9 476.5 515 100 Total (USD Billion) 27.2 34.4 40.8 45.5 50.3 57.4 62.2 100 Source: Official estimates, China Statistical Yearbook, 2003

In 2004, 69 percent of China’s pharmaceuticals market was held by medicine produced by domestic firms. Imported drugs represented 17 percent of the market, and drugs produced by joint venture firms claimed 14 percent. Compared with 2003, the market shares of imported drugs and those produced by joint venture firms dropped by one percent and two percent respectively, while domestic firm’s market share rose by three percent. The change can be explained by Chinese drug producers’ effort in improving the quality of their pharmaceutical products while offering a relatively lower price to the consumers. In the long run many domestic drug companies face the vital problem of lack of new medicine, due to inadequate drug research and development. Euromonitor reports that an estimated 97 percent of chemical drugs in China are copied from foreign technologies. Chinese drug companies contribute only 0.5 percent to 1 percent of their sales revenues to research and development, while the world’s leading pharmaceutical firms typically invest 15 to 20 percent. Market Forecasts The pharmaceuticals market for China is expected to grow 70.6 percent to USD 38 billion by 2008. With the reduction of tariffs since China’s entry into the WTO, the country is able to import newer and more advanced drugs. At the same time, many foreign companies with independent patents will enter the Chinese market, raising the level of market competition. Demand for imported high-end drugs will continue to grow in China’s wealthy coastal area.




Recent High-Profile Deals In July 2005, Bausch & Lomb, the listed U.S. ophthalmic products group, acquired a 55 percent stake in Shandong Chia Tai Freda Pharmaceutical Group (“CTF”), the Chinese ophthalmic pharmaceuticals company, for a cash consideration of USD 200 million. Warburg Pincus, a U.S. private equity firm; Citic Capital Markets, the Chinese investment bank; and Heilongjiang Chenergy HIT Hi-tech Venture Capital, the state-run Chinese venture capital firm, have agreed to acquire a 55 percent stake in Harbin Pharmaceutical Group, a Chinese state-owned pharmaceutical group, for USD 246 million.

11.2 Biotechnology Sector

Market Overview China has quickly emerged as an important player in the global biotechnology industry over the recent years. Though the country only started issuing patents for medicines in 1993, radical changes have been witnessed during the past decade of development in the biotechnology sector. China’s large, increasingly affluent, and health-conscious population presents a huge opportunity for biotechnology-oriented companies in developed countries. According to a Datamonitor report, the Chinese biotechnology market grew by 23.4 percent in 2004, reaching a total value of USD 6.3 billion. Between 1999 and 2004, the compounded annual growth rate of the market was approximately 25 percent. The strongest growth occurred in 2002, when the market increased 28.2 percent. The leading source of revenue for the Chinese biotechnology market was product sales, which had a total value share of 55.5 percent. Research funding also accounted for 30.6 percent of the market value. In 2004, China was the fifth largest genetically modified (“GM”) crop-growing country in the world, planting over 2.8 million hectares of GM cotton.

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Biotechnology Market Value

Source: Datamonitor




Unlike countries such as Malaysia and Singapore, China has a history of scientific research, developing its talent over a 20-year period with a pool of more than 50,000 research scientists. Currently about 6,000 Chinese Academy of Sciences (“CAS”) research professionals are linked to 24 research institutes, 13 research centers, 26 key state laboratories and key CAS laboratories, 12 botanical gardens, 18 specimen museums, and 9 repositories for type culture collection. Domestic Competition Most of the existing biotechnology companies are small and wholly dependent on government-sponsored R&D. Private capital investment in Chinese biotechnology is low due to a lack of clear regulations, inadequate legal infrastructure to enforce existing laws, and insufficient financial infrastructure to guarantee security and recovery of investment. Leading companies include Global Biochem Technology Group, which is listed on the Hong Kong Stock Exchange, and Sino Bio-pharmaceutical Ltd. Market Trends Many multinational biotechnology companies, pharmaceutical companies, and research centers have started working with Chinese bio-service providers as a result of their cost-reduction strategy. Biotech companies in China provide indispensable services such as nucleotide sequencing and synthesis, protein expression, and library construction, etc. These services are often labor intensive, but also have high skill requirements. Invitrogen’s recent acquisition of Shanghai-based BioAsia Co. is a landmark that showcases the advantages foreign firms are able to enjoy when partnered up with Chinese biotech firms. The acquisition expanded Invitrogen’s presence in China on a significant scale, in terms of enhancing distribution and augmenting service capability. China’s market for enzymes has also been growing rapidly as a result of increased industrial demand. While most foreign technology-based biotech enzyme companies go for high-end industrial enzymes, many local players stay in the market through price competition of product lines that are less technologically advanced. Organic fertilizer, aqua-farming waste products and services, and organic pesticides are quickly emerging as new areas of opportunity for many biotech companies in China. The government has been encouraging the development of businesses in these fields. Due to water resource degradation and health risks associated with air pollution, China has suffered from severe environmental problems during its past two decades of development. At present, there is an




emergent need to improve the environmental conditions in China, hence the demand for environment-friendly biotechnology products. Market Forecasts The Chinese biotechnology market is forecast to grow by about 13.5 percent annually as substantial amounts of growth will come from multi-national companies (“MNCs”), which are conducting more R&D and production activities in China to take advantage of the talented, yet cheap, labor pool. Intellectual property will see a rapid growth, as China strengthens the financial, legal, and regulatory infrastructure, which should lead to an inflow of foreign investment and managerial talent. Recent High-Profile Deals In 2004, California-based U.S. biotech giant Invitrogen Corp. acquired BioAsia Co., a Shanghai-based company in the biotechnology business. Through this deal, Invitrogen positioned itself among China’s largest medical research supply companies. This acquisition also made Invitrogen one of the first U.S. biotech companies to enter the Chinese medical supplies market. According to a report, Invitrogen’s strategy is to begin forging relationships with local Chinese research institutions and biotechnology firms and developing products specifically targeted at China’s domestic market.




12. Food & Beverage 12.1 Food Sector Market Overview With a total population of 1.3 billion people, China is one of the world’s largest consumers of food. Total market size reached USD 315.5 billion at the end of 2004. Rising incomes and continued urbanization in China have brought significant changes to the structure of the Chinese diet. From 1998 to 2004, the dairy products sector in the urban retail food market witnessed the fastest growth (109.47 percent) during that period. Consumption of fresh meat climbed from USD 23.1 billion in 1998 to USD 40 billion in 2004. The alcoholic drinks sector has also experienced rapid growth, as people enjoy longer public holidays and higher income. Consumption of canned foods has also increased substantially. China is a net exporter of food products. The country’s exports include processed food and beverage, vegetables, fish and seafood, tea, fruits, and animal products. China’s top export destination countries/regions are Japan, Taiwan, South Korea, the U.S. Germany, Australia, and China’s neighboring Asian countries.




Food imports have been growing slowly. In 2004, China imported about USD 17 billion worth of agricultural products and approximately USD 1.9 billion worth of fish and seafood products. Japan accounts for 18 percent of China’s food imports, followed by Taiwan at 12 percent, South Korea at 10 percent, and the U.S. at 8 percent. The biggest competitor of imported food is China’s domestic processed food industry. Relatively low prices and expertise in producing regional specialties keep China’s domestic processed food producers competitive. Despite the drastic liberalization of the economy, China’s food policy has seen little change over the past few decades. The top priority is ensuring adequate urban food supplies, accumulating grain reserves, stabilizing food prices, promoting self sufficiency, and improving rural income levels.

Current Value of Food Sales (RMB Billions)

Product Category 2000 2001 2002 2003 2004 Fresh and dry vegetables 276.81 296.58 332.45 364.03 406.07 Fresh meat 213.49 230.85 261.25 288.31 324.84 Tobacco 194.43 206.05 223.6 239.47 259.79 Cereal Products 211.98 225.61 256.75 280.55 317.1 Edible oils 87.89 92.42 101.14 108.81 118.69 Fresh fruit 96.67 102.26 115.2 125.13 140.16 Alcoholic drinks 242.08 264.18 307.54 344.06 399.24 Fresh seafood 50.27 54.79 62.58 69.52 78.96 Eggs 43.97 47.07 52.64 57.58 64.04 Sauces and condiments 39.66 42.7 48.79 53.75 60.97 Dairy 45.31 50.6 58.99 66.75 77.55 Bakery products 23.1 25.53 29.26 32.81 37.51 Bean curd 4.34 4.7 5.39 5.97 6.81 Baby foods 31.9 34.91 40.43 45.13 51.97 Canned foods 25.27 27 30.57 33.46 37.68 Spreads 4.08 4.43 5.17 5.76 6.67 Soft drinks 23.85 26.37 30.67 34.44 39.83 Hot drinks 14.76 15.83 18.07 19.84 22.48 Sugar 8.94 9.56 10.74 11.75 13.12 Confectionary 6.56 7.26 8.39 9.43 10.85 Salt 4.74 5.12 5.78 6.36 7.14 Savoury snacks 4.15 4.57 5.24 5.86 6.71 Frozen food 33.53 36.99 42.92 48.17 55.49 Dried food 2.48 2.59 2.84 3.04 3.32 Chilled food 7.29 8.02 9.23 10.32 11.8 TOTAL 1697.58 1825.99 2065.6 2270.28 2558.79 Source: Access Asia, NBS




Domestic Competition Food manufacturers in China have enjoyed strong growth as a result of the growing consumer market. One of these companies is China Resources Enterprise Ltd., as both its revenues and profits have increased by about 20 percent from the prior year. Leading players in the canned food market include Hock Seng, Nestle S.A., and Unilever. Hock Seng is headquartered in Singapore and markets its own brands, as well as the brands of Procter and Gamble and Colgate-Palmolive, in China. Wrigley is the leader in the Chinese confectionary market with an approximately 15 percent market share. Effem Foods (Mars) lags behind with a 9 percent share. Other key players include Dongguan Xuchi, Perfetti Van Melle, Nestle, Joyco, Shanghai Guanshengyuan, Guangzhou Want Want, Warner-Lambert, and Wuxi Jibao. Market Trends In recent years, there is a clear trend among Chinese consumers towards consumption of processed foods. Primarily in urban areas, people start incorporating more processed food into their daily diet, due to the rapid pace of city life. Official statistics show that China’s food processing industry grew by 16 percent between 2001 and 2002, and an even more impressive 23 percent between 2002 and 2003. Packaged foods such as baked goods, dairy products, oils and fats, baby food, and ice cream have witnessed exceptional growth in recent years in China’s processed food market. Urban consumers also demonstrate a higher demand for healthier food selections, larger variety and better quality. Hence, demand for imported food ingredients are expected to continue, as food companies continue to enhance their product line to meet market demand. Market Forecasts The food sector is expected to grow approximately 20 percent in the near term as the recovering world economy supports its expansion. Growth prospects remain promising throughout the industry, with higher disposable income and increased awareness of health and nutrition among consumers. Consumers have become more sophisticated and the demand is rising for new and improved products, which add value and offer high quality. Market liberalization is also giving foreign retailers an opportunity to meet these demands and expand their share of the country’s food retail segment.




Recent High-Profile Deals Japanese beverage giant, Asahi-Itochu Breweries Co. Ltd., purchased 50 percent of Kangshifu Food, a well-known Chinese instant food manufacturer, in 2004. The acquisition was among the largest transactions in China’s food sector. Asahi-Itochu invested USD 475 million in total, demonstrating its determination to participate in China’s growing food industry.

12.2 Beverage Sector

Market Overview China’s alcoholic beverage market reached USD 35.4 billion in 2004. Between 2000 and 2004, China’s total beer consumption grew 27.6 percent. The total market volume reached 29.11 billion liters, while total expenditure on beer rose 15.5 percent from 2003, reaching a market value of approximately USD 16.85 billion. As early as 1995, China overtook Germany as the second largest beer market in the world in terms of consumption volume. In 2003, China surpassed the U.S., and is now the world’s largest beer market. The significantly smaller wine market expanded at a slower rate than the beer market while the spirits market decreased in value reaching USD 3.15 and USD 15.37 billion respectively.

Total Market Value for Alcoholic Drinks Current Price (RMB Millions) 2000 2001 2002 2003 2004 Beer 99,107.37 101,750.78 106,989.03 118,092.36 136,485.40 Wine 15,778.40 16,758.81 18,932.31 23,184.30 25,582.46 Spirits 217,428.98 193,577.18 177,671.80 140,073.30 124,537.89 TOTAL 332,314.75 312,086.76 303,593.13 281,350.26 286,605.75 Litres (Millions) 2000 2001 2002 2003 2004 Beer 22,812.82 23,384.31 24,462.51 26,355.95 29,111.60 Wine 235.36 257.36 257.36 353.07 396.65 Spirits 7,756.08 7,294.12 6,990.71 6,346.71 6,062.44 TOTAL 30,804.27 30,935.79 31,748.62 33,055.31 35,570.69 Source: Access Asia/China Spirits Industry Association/China Wine Association/NBS/ company data/International trade statistics/China Customs Statistics

From next page’s chart, it is clear that the popularity of beer has been rising steadily from 2000 to 2004, while the popularity of spirits has been declining. The consumption of beer as a percentage of the total volume of alcoholic drinks rose from 74.06 percent in 2000 to 81.84 percent in 2004. Although the consumption proportion of wine has also increased slightly, there is a decreasing trend for spirits.




% Breakdown of The Total Market For Alcoholic Drinks % Value 2000 2001 2002 2003 2004 Beer 29.82 32.6 35.24 41.97 47.62 Wine 4.75 5.37 6.24 8.24 8.93 Spirits 65.43 62.03 58.52 49.79 43.45 TOTAL 100 100 100 100 100 % Volume Beer 74.06 75.59 77.05 79.73 81.84 Wine 0.76 0.83 0.93 1.07 1.12 Spirits 25.18 23.58 22.02 19.2 17.04 TOTAL 100 100 100 100 100 Source: Access Asia/China Spirits Industry Association/China Wine Association/NBS/ company data/International trade statistics/China Customs Statistics

The soft drinks market has also maintained a high average annual growth rate of 13.4 percent between 2000 and 2004. Retail market value totaled USD 4.9 billion in 2004, up USD 1.8 billion from 2000.

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Source: Access Asia Currently, carbonated soft drinks continue to claim the largest share in the soft drinks market. With an increase of over 100 percent since 2000, sales of carbonated soft drinks in 2004 reached USD 2.7 billion in value, or almost half the total market value for soft drinks. Domestic Market Leading players in the Chinese beer market include Tsingtao Brewery, Beijing Yanjing Beer Group, Budweiser (Wuhan) International Brewing, and Guangzhou Zhujiang Brewery. Tsingtao dominates this fragmented market with roughly 14




percent of the market share. Budweiser is the leading foreign beer with a 4.6 percent market share. Guangming dominates the dairy drinks market with a 35 percent market share. Other leading dairy drinks companies include Yili, Mengniu, Sanyuan, and Nestle. The Top five juice and nectar companies are Yeshu, Tongyi, Huiyuan, Lolo, and Kangshifu, each with approximately 10 percent of the market share. The Chinese carbonated soft drinks market is dominated by Coca-Cola and PepsiCo. Coca-Cola has 55 percent of the market share while PepsiCo has 21 percent. Other key players are Robust, Wahaha, and Jianlibao. Market Trends In the Chinese beer market, standard lagers are the dominant sector, accounting for over 90 percent of total consumption by volume. However, its market share has been declining over the past few years. Standard lagers’ percentage share peaked in 1998 at 93.10 percent, and has been declining since. More diversity has been observed during the same period as brown ales, stout, and specialty beers have enjoyed a continued positive growth. Meanwhile, Chinese consumers are paying more attention to the health factor of their soft drinks. In recent years, carbonated soft drink’s leading position in the market has been threatened by healthier products such as sports drinks, bottled drinking water, tea drinks, and fruit juices. The total market value of non-carbonated soft drinks grew by 95 percent between 1998 and 2004, totaling USD 2.2 billion in 2004, or 45 percent of the soft drinks market. Market Forecasts The total market for alcoholic drinks in China is forecast to reach approximately USD 38.2 billion by 2009. The beer market is expected to grow by 20 percent between 2005 and 2009 while the wine market is forecast to increase by 45 percent for the same period. In the next few years, the beer market in China will continue to become a buyers market. Fierce competition will force beer manufacturers to focus on economies of scale and product range. The continued rise in average consumer income will widen the consumer base for wine as it becomes more affordable. Greater marketing of wine and the continued aspiration of Chinese consumers to adopt western-style eating and drinking habits will further attribute to the growth of this market.




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Alcoholic Drinks Market Forecasts

Source: Access Asia The total soft drinks market is forecast to grow approximately 8 percent in the near future and is expected to reach USD 7.22 billion in 2009. Recent High-Profile Deals Anheuser-Busch Cos., Inc., a leading global brewer, agreed to acquire a 99.7 percent stake in Harbin Brewery Group in 2004. The deal totaled over USD 600 million. In addition, the U.S.-based brewery company also holds a 9.9 percent share in Tsingtao Brewery Co. Ltd., China’s largest brewery company. Another brewery giant, Heineken N.V., also acquired a minority stake in Guangdong Brewery Holdings Ltd. Heineken has entered into an agreement to purchase a 21 percent stake in the Chinese brewery through a combination of 133.8 million new shares and 165.5 million existing shares from GDH Limited. Chairman of Heineken NV, Thony Ruys, said that the Guangdong province is one of the most important beer markets in China. The strong position of Guangdong Breweries in this region offers an excellent platform for further growth of the Heineken brand.




13. Auto Components Market Overview In 2004, China’s total auto components production reached approximately USD 8 billion, a compound annual growth rate of 38 percent from 1994. Within China’s auto components industry, the production of mechanical parts accounted for approximately 56 percent of the industry’s entire output. Electrical and electronic parts split the remaining production.

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Automotive Components Market

Source: Access Asia The Chinese auto component industry’s exports have been growing rapidly during the past few years. Major export destinations include the U.S., Western Europe, and Southeast Asia. Many major multinational automotive component manufacturers have already set up operations in China. Both Japanese and South Korean car manufacturers are increasingly exporting auto parts from their plants in China.




Exports of Automotive Components, 1990-2003

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Source: Access Asia, Automotive parts & aftermarket in China. Aug. 2003: China Markets Yearbook 2004; KPMG in Hong Kong Analyst

Over the past few years, a large number of sophisticated multinational automotive component manufacturers have been establishing operations in China. Sumitomo Metal Industries invested USD 14 million to build a manufacturing operation in Guangdong to produce cranks and crankshafts for both the China and South-east Asian markets. Mitsubishi established a USD 250 million joint venture in Shenyang, Liaoning Province. The joint venture, Shenyang Aerospace Mitsubishi Motors Engine Manufacturing Co. Ltd, produces engines and other components for approximately 10 automotive manufacturers. Domestic Competition Original equipment manufacturers (“OEMs”) generally require component suppliers to be located close to their premises. This has created a fragmented component production environment, mirroring the OEM sector itself. According to Access Asia, approximately 1,700 automotive components manufacturers have registered with the government, of which around 450 are foreign invested companies. Additionally, there are around 3,000 additional smaller components parts manufacturers in the industry, most of which focus on products for the aftermarket. Many of the major global automotive component manufacturers have already established manufacturing operations in China through a combination of wholly-owned enterprises and financial or strategic joint ventures. In many cases, these operations have followed the automotive manufacturers into China. Over the past year, an increasing number of new, more specialized automotive component manufacturers have been establishing operations in China which has helped increase the availability of higher quality locally produced component parts.




Market Trends China is now the world’s second largest auto market. Car sales rose 15.17 percent in 2004 to 2.33 million units and reached 2.77 million units in 2005. As China’s car sales climb up, the demand for auto components is likely to follow. OEMs are now increasingly sourcing auto parts locally in an effort to reduce cost and remain competitive.

Name Country of Headquarters

Summary of China activities

Calsonic Kansel Japan • Established a USD 8.6 million wholly owned company in Shanghai in August 2003

• Calsonic plan to establish a production base in Xiangfan (Hubei) and Huadu (Guangdong)

Cummins Corp USA • Established 15 wholly owned and JV companies in China • Has developed a network of 8 regional service centers and over 70 authorized

dealers Delphi Automotive Systems

USA • Invested more than USD 500 million in 12 businesses, 10 of them are manufacturing JV’s

• Established 3 customer service centers, 1 technical service center and 1 training center

• Plan to invest USD 12 million in a new engine management system component. Multec 3 gasoline fuel injectors

Denso Corp Japan • Established 6 manufacturing joint ventures throughout China • Plan to continue developing partnerships with foreign carmakers in China and

expanding retail sales GM Daewoo Auto & Tech. Group

USA • Inherited 2 JVs after GM acquired Daewoo Corp in 1999: FirstAuto/Daewoo Auto Engines Co Ltd and Shandong-Daewoo Auto Parts & Components Co Ltd

Hyundai Mobis Korea • Established 3 manufacturing and distribution centers in Jiangsu, Beijing, and Shanghai

• Plan to double production of module parts to 1 million units by 2008 ITT Industries USA • ITT’s Connectors & Switches division established 2 JVs in China, one of which

has 4 manufacturing locations

Koito Manufacturing Co.

Japan • Established a Shanghai JV in producing over 100 automotive related products • Commenced construction of a technical center in June 20000

Robert Bosch • Established 10 representative offices, 4 trade firms, 7 wholly owned subsidiaries and 10 JVs, with a total investment of USD 600 million

SKF Sweden • Established 2 JVS: Anhui Zhongding CR Seals Ltd, with ASIMCO, manufacturing oil seals, the other is the Beijing Nankou SKF Railway Bearings Company Ltd

Tong Yang Taiwan • Established 6 automotive parts and accessories plants including 3 JVs in Changchun, Chongqing, Fuzhou, Guangzhou, Jiangsu and Tianjin

TYC Brother Industrial Co. Ltd.

Taiwan • Established 8 automotive headlight plants • Continue to expand production at Changzhou Tamao Lighting Co., its mainland

affiliate, in a bid to become the largest auto headlight maker within 5 years. Zahnradfabrik Friedrichshafen

Germany • Established 6 wholly owned subsidiaries specializing in driveline, steering systems and chassis technology




Currently, China’s auto components manufacturing is concentrated in the area close to automobile manufacturing locations due to inefficiency of transportation. Provinces with a concentration on the auto industry include Guangdong, Hubei, Jilin, Liaoning, and Shanxi. However, as the logistics industry improves, this situation is expected to change. Auto parts production will move to areas where the quality to cost ratio is the highest. Share of vehicle component production by province

Source: China Markets Yearbook, 2004 Foreign auto parts manufacturers are also increasingly enjoying their technology advantages. Auto makers in China are gradually producing more high-end cars, while the supply of matching auto components is scarce. Manufacturers such as BMW rely on imported auto parts for their plants in China because many of China’s domestic manufacturers lack the capability to keep up with the latest models demanded in the international market. Opportunities await those who stay up-to-date with recent technology advances and are quick to take advantage of China’s low labor cost. Market Forecasts Auto components production is predicted to reach USD 13 billion by the end of 2007. This will be fueled by China’s expanding automotive market and the increasing localization of parts. In line with the changing regulations and the need to reduce costs, OEMs are increasingly sourcing parts locally. Under China’s new policy, effective in 2005, domestically assembled sedans made with imported key assemblies (e.g. chassis, gear box, engines) may be treated as “imported” vehicles. This is expected to spur localization of these assemblies by OEMs to help ensure their products remain price competitive. Additional pressure will be




faced by international parts suppliers to relocate and produce parts in China to remain competitive.

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Source: Access Asia Recent High-Profile Deals In 2004, two global auto part giants teamed up with Shanghai Longhua Industrial Co., Ltd., and founded a joint venture. One of them is Germany-based Behr GmbH &Co. KG, one of the world’s leading specialists in automotive air conditioning and engine cooling systems. The other is the Japanese Sanden Corporation. The JV, Shanghai Sanden Behr Automobile Air Condition Co. Ltd., is based in Shanghai and focuses on the development, production and marketing of refrigerant compressors for car and truck HVAC systems. More recently, Key Principal Partners (KPP), a private investment firm, led the USD 96.5 million acquisition of Asimco Technologies, a leading auto components manufacturer in China.




14. Consumer/Retail Market Overview China’s retail industry consists of three main categories of businesses: department stores, grocery stores and supermarkets, and superstores and warehouse clubs. The department stores market size totaled USD 66.7 billion in 2004, up 12 percent from 2003. The sector has traditionally been focusing on sales of non-food products, such as clothing, electronics, cosmetics, and furniture. During the past decade, Chinese department stores’ food to non-food sales ratio remained stable. In 1999, the food to non-food sales ratio in department stores was 27 to 73. In 2004, the ratio was 28 to 72.

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Department Store Market Value

Source: Euromonitor Grocery stores and supermarkets dominate China’s food retailing market. In 2004, this segment increased 10.6 percent to USD 300 billion. It is also the largest sector within the retail industry in China. Top destinations for foreign retailers entering the Chinese market are Shanghai and Beijing. By the end of 2004, the percentage of foreign capital in Shanghai and Beijing was 8.9 percent and 8.6 percent, respectively.




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Grocery Stores and Supermarkets Market Value

Source: Euromonitor The superstores and warehouse clubs sector has experienced solid growth in the past years, typified by a 20 percent increase in 2004, amounting to USD 8.15 billion.

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Superstores and Warehouse Clubs Market Value

Source: Euromonitor Domestic Competition The department stores sector is highly fragmented. In 2005, the nation’s top ten department stores had a combined share of 11.8 percent of the total market size. The ten largest players in the market are: Shanghai No.1 Department Store, Dashang Group, Shanghai Yuyuan Tourist Commercial Center Group, Beijing Huanlian, Beijing Wangfujing Department Store, Shanghai Friendship, Pacific, Shanghai Hualian, Parkson, and Shanghai New World.




The Chinese grocery stores and supermarkets sector is highly fragmented as well. The largest player in the market, Shanghai Lianhua Supermarket, accounted for only 1.3 percent of the total market share in 2005. Other key players include Carrefour, Shanghai Hualian, Wal-Mart, Aoyama Trading, Jiangsu Suguo, Metro, Little Sheep, and Beijing Hualian. Independent grocers accounted for about a quarter of total food sales. Usually the independent grocer can be managed by one person with a capital outlay of as low as USD 1,200, whereas in some small cities the amount can be lower than USD 120. The superstores and warehouse clubs sector is highly consolidated with the top five market players accounting for 84 percent of sales in 2005. Sam’s Club dominates with a 23 percent market share, followed by Pricesmart with 19 percent.

Superstores and Warehouse Clubs Share of Market 2005

Sam's Club (Walmart)

21%

Itoyokado14%

Pricesmart21%

Aeon (Jusco)7%

Metro AG15%

Other22%

Source: Euromonitor Market Trends China’s booming economy has led to an overall increase of disposable income. Consumer spending is expected to continue the current steady growth rate, which brings market opportunities for foreign investors. The superstores and warehouse clubs market is currently the fastest growing sector within the retail industry. Due to their wide selection of products and heavily discounted prices, superstores and warehouse clubs are rapidly gaining popularity among Chinese consumers.




The retail industry in China remains highly fragmented, which leaves many opportunities for mergers and acquisitions. Small to medium–sized retailers enjoy a good reputation and create lasting relationships with local customers making them attractive investment targets. Market Forecasts The size of the department stores sector is forecast to reach USD 105 billion in 2008. China is expected to be the most attractive emerging market in the world for retailers. The non-food sector is predicted to capture larger market share with an expected value of USD 75 billion. The grocery stores and supermarket sector is expected to reach a value of USD 440 billion in 2008. An increasing number of mergers and acquisitions are expected to take place as foreign retailers attempt to make a quick entry into the country. From 2006 onwards, retail businesses are forecast to grow as a result of the industry’s open policies such as lower taxation and minimum registration capital. The market for superstores and warehouse clubs is forecast to reach USD 13 billion in 2008. Superstores are expected to be the fastest growing retail format as their sales soar. Nevertheless, the superstores phenomenon will remain restricted to urban and suburban areas of China for the near future. Recent High-Profile Deals Singapore-based property company CapitaLand has set up plans to double its investment in China’s retail industry during the next few years through acquisition of retail malls. The listed group acquired a 100 percent equity stake in two retail malls from the Beijing Hualian Group Investment Holding Co. Ltd. for USD 215 million in February 2005. Before this deal, CapitaLand had already invested USD 740 million in the country over a 10-year period, making China its second largest overseas market after Australia.




15. Textiles Market Overview China is the world’s biggest textile manufacturer and exporter, manufacturing 17 percent of the clothing worn in the world and employing 19 million workers. The textiles industry was valued at USD 193 billion in 2004 and plays an important role in the earning of foreign exchange as textiles and garments command 16 percent of China’s total exports. China’s textile exports were approximately USD 46 billion in 2004, a 9.5 percent increase from 2003.

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Source: China National Textile & Apparel Council China’s textile production is mostly concentrated along the coastal areas. Guangdong has long been a focus of textile factories, with large trade volumes passing in and out of Hong Kong. The Yangtze delta region is also a strong textile center as the city of Ningbo alone produces approximately 1.4 billion pieces of apparel annually, close to 12 percent of the country’s total textile production. Opportunities for foreign investors exist in every sector of China’s textile industry, from manufacturing and retail to machinery, design, and research. The large scale of the industry provides huge potential. High production capacity together with the ability to meet strict quality control standards make’s China’s unique, large and inexpensive labor force the world’s preference for textile manufacturing.




Domestic Competition China’s textile industry remains highly fragmented with an estimated 6,000 textile companies located mainly in the coastal region. One of the largest textile companies in China is Shandong Weiqiao Pioneering Group, which is primarily engaged in cotton spinning, weaving, dyeing, and finishing and thermoelectricity products. The company has a gross capital of approximately USD 1.5 billion and is one of Top 500 companies in China. Other players include Three Gun, Guangzhou Textiles Holdings, and Huawei Garment Manufacturing Company. Three Gun is one of the largest textiles and underwear manufacturers in China. Guangzhou Textiles is also one of China’s leading enterprises and manufactures yarn and fabrics, woven garments, and knitwear. Huawei is a leading apparel contract manufacturer with over 1,200 employees. Market Trends The U.S. and China recently agreed to limit exports of Chinese clothing through 2008: China has agreed to U.S. import curbs on 34 textile and clothing categories. During the life of the agreement, China will receive only a minimal increase in market access in the 14 largest and most sensitive textile apparel categories. These products include trousers, skirts, knits, underwear, and bras. For Category 1 (more sensitive), growth is restricted to 5.5 percent in 2006 and 10.3 percent in 2008. For Category 2 (less sensitive), growth is limited to 10 percent in 2006 and 16 percent in 2008.

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Category 1 (more sensitive) Category 2 (less sensitive)

Source: China Ministry It is expected that Chinese textile manufacturers will shift production to the less sensitive category of goods. Furthermore, there are many additional categories of textiles, covering almost half of the total trade volumes, which are not covered by the U.S. agreement. As such, many Chinese produces are expected to increase




output in those areas. Chinese textile companies are also realizing that the key to their survival is to focus on value-adding products and greater competitiveness through technology and fashion trend-following. Market Forecasts In 2005, the export of textiles and garments increased to USD 117.5 billion, a 20.7 percent year on year rise. Yet, due to the acceleration of trade friction, growth of China’s export of textile products is forecast to slow down to 15 percent in 2006 according to a report recently issued by the Economic Operation Bureau of the National Development and Reform Commission. An immediate consequence of the slowed growth in China’s exports of textile products will be the increased competition in the domestic market as products that would have been sold overseas will instead flood the home market. Recent High-Profile Deals China National Textile Apparel Council, the national federation of all textile, apparel and home textiles industries in China, and its affiliate, China Textile Network Company, announced in October 2004, the formation of a joint venture with CNTextile LLC, a U.S. company, in an exclusive agreement to conduct U.S. sourcing with China factories. The joint venture combines experienced executives in the U.S. fashion industry with the professional staff of China Textile Network Company to transform a complex sourcing market into a one-stop, full-service e-market using state-of-the-art sourcing processes.




Other Markets of Opportunity 16. Financial Services Market Overview At present, China’s banking system is dominated by state-owned banks. There are four categories of domestic key players in the financial services market: the “Big Four” state-owned commercial banks, three policy banks, second tier commercial banks, and trust and investment corporations. The “Big Four” refers to the Bank of China, the China Construction Bank, the Agricultural Bank of China, and the Industrial and Commercial Bank of China. The three policy banks are the Agricultural Development Bank of China, China Development Bank, and the Export-import Bank of China. Each of the seven banks mentioned above have their own specializations and functions. Since 1985, China has issued approximately 714 million banking cards; however, 96 percent of the cards issued were debit cards. With only 29.13 million credit cards, issuance has considerably lagged behind China’s booming economy. China’s entry into the WTO has created tremendous opportunities for foreign banks. The Chinese government has released the Rules for Implementing the Regulations Governing Foreign Financial Institutions in the People’s Republic of China in January 2002, which standardized business operations of foreign banks in China. Some of the world’s largest credit card issuers have already started investing in China. At present, Citigroup, American Express, and HSBC Holdings have already signed credit card partnerships with Chinese banks. Recent High-Profile Deals ING Group acquired a 19.9 percent interest in Beijing Commercial City Bank, thus joining the ranks of other foreign banks, such as HSBC and Standard Chartered Bank, acquiring minority interests in Chinese banks. The transaction once again illustrates the ongoing consolidation in one of the fastest growing industries in China.

In 2004, HSBC acquired a 19.9 percent share of China’s state-owned Bank of Communications. The deal value totaled USD 1.747 billion. It is, by far, the largest foreign inbound acquisition in the financial sector. In addition, HSBC also purchased a 10 percent stake in Ping An Insurance Group Co. of China Ltd. in 2002 for USD 600 million, and an 8 percent interest in Bank of Shanghai in 2001 for USD 62.6 million.




17. Logistics Market Overview China’s logistics industry has entered a stage of rapid growth in recent years. In 2004, China’s logistics market exceeded USD 9 billion, up 30 percent from 2003. At present, there are approximately 730,000 logistics enterprises in operation in China. From 2000 to 2004, approximately 70 percent of the logistics service providers experienced an annual growth rate as high as 30 percent. As the logistics industry was not introduced to China until the 1980s, China’s domestic logistics industry is still in its infancy. The government has yet to formulate a complete logistics law to standardize the booming industry in order to ensure its healthy and sustainable development. Today, the logistics businesses in China consist of five main parts: traditional transportation, warehouse enterprises, Sino-foreign, foreign-invested and private logistics enterprises, and those affiliated with large manufacturers. Though analysts have different views of the Chinese logistics market, the prevailing estimation is that the revenue of China’s logistics services will continue to increase by approximately 20 percent on a year-on-year basis in the upcoming 10 years. The massive market demands for logistics service are driving local governments into a wave of construction of logistics parks. Six large logistics parks are being designed or are under construction in Shenzhen, while mainland China’s biggest city, Shanghai, is developing Waigaoqiao, Pudong International Airport, and Northwest Shanghai logistics parks. Recent High-Profile Deals Meridian IQ, the global logistics management subsidiary of Yellow Roadway Corporation, announced its acquisition of the Shanghai-based GPS Logistics Group on March 10, 2005. The acquisition is expected to further advance Meridian IQ as a single source for comprehensive and seamless global logistics solutions, and provide management depth and expertise in the world’s fastest growing economy. The company has added 25 offices with 230 employees throughout Asia and a Class A license in China through this deal.




18. Energy & Resources Market Overview Currently China ranks second worldwide in terms of overall energy consumption. The country largely relies on coal and oil as primary energy sources. Natural gas provides only about three percent of China’s energy demand, much lower than the average in Asia of 8.8 percent and the world average of 24 percent. In early 1970s China started offshore exploration and drilling, which heavily relies on foreign technology. The government established the China National Offshore Oil Corporation to assist foreign oil companies in exploring, developing, extracting, and marketing China’s oil. At present, China’s power sector faces two critical challenges. First, China still needs to enhance its domestic regulatory framework for the energy industry. The country has a long way to go in order to fully meet WTO standards and prepare for further opening up of the domestic market. Second, the efficiency of China’s industrial sector is an issue. Energy consumption per unit of GDP in China is five times greater than in the U.S. and twelve times greater than in Japan, according to official statistics. Rapid economic growth has fueled a growing demand for energy in China. Under such market pressure, this traditionally off-limits sector is gradually opening up to increasingly larger scale foreign participation. Offshore industries with high technology components are especially in great demand. Tremendous opportunities lie in the natural gas infrastructure development sector and offshore exploration and production sector. In addition, great potential for future development exists in the domestic natural gas market. In 2004, the total demand for natural gas was over 50 billion cubic meters. It is estimated that by 2010, China’s domestic demand for gas will reach 120 billion cubic meters. Recent High-Profile Deals CNOOC Limited ("CNOOC") signed an agreement with MEG Energy Corp ("MEG"), a Canadian oil sands company, to acquire a 16.69 percent stake for USD 126 million. The announcement was no surprise given China's desire to secure further oil sources amidst rising oil prices and increasing demand. Andes Petroleum, a joint venture of Chinese petroleum companies including China National Petroleum Corp. (“CNPC”), is acquiring Encana Corp.’s oil and pipeline assets in Ecuador for USD 1.42 billion. In addition, CNPC agreed to acquire Petrokazakhstan Inc., a Canadian company with energy assets in Kazakhstan, for USD 4.18 billion, as China continues to seek energy reserves world-wide.




19. Real Estate

Market Overview

China’s real estate market experienced fast growth in 2004. Commodity housing area under construction reached over 1,404 million square meters. Investment in developing real estate was USD 162.15 billion, with USD 106.29 billion in commercial housing, and USD 4.69 billion in office buildings. In 2004, the total area of commodity housing sold reached 382 million square meters. The national average selling price of commodity housing was USD 334.65 per square meter. According to official statistics, the contractual projects of foreign direct investment in real estate totaled 1,767 in 2004, with USD 13.49 billion in contractual foreign investment and USD 5.95 billion in actually utilized foreign investment. Compared with USD 9.11 billion in 2003, contractual FDI rose 48.08 percent in 2004. Housing consumption is now becoming an important impetus to economic growth, as people’s living conditions continue to rise steadily. The current national average housing floor space for each resident is 20.4 square meters, indicating a promising potential for further growth in the coming years. The rules regulating real estate businesses owned by foreign investors consist of two levels: central government and local authorities. The central government sets ground rules for land administration, while local authorities set regional regulations and policies. The most notable law that governs the real estate industry in China is the Law of Land Administration of the People’s Republic of China (1998).

China quietly started housing reform in 1998. State-owned enterprises that used to provide cheap housing to its workers on behalf of the government are now selling off these apartments to their tenants at below market value prices. Housing mortgages from local banks are also becoming more available, which fueled the privatization of China’s real estate market. In recent years, it has evolved into a trend for individuals to own their apartments, hence a rising demand for low-cost housing.


In 2004, Australia’s Macquarie Bank formed a 50-50 joint venture with Schroder Asian Properties through its subsidiary Macquarie Real Estate Asia to invest in China. The JV, First China Property Group, acts as a residential developer and a fund manager for foreign investors. The company plans USD 400 million in investments in China over the next five years.




Appendix1 (contributed by Baker & McKenzie) A. Summary of the PRC Foreign Investment Regime Forms of Establishment Foreign investors usually establish a presence in the PRC via one or more of the following legal forms:

• Representative office (“Rep Office”); • Sino-foreign joint venture (“JV”); • Wholly foreign-owned enterprise (“WFOE”); and • Foreign-invested joint stock limited company (“FISC”).

Rep Offices are non-legal person extensions of their foreign investors in the PRC. Either a JV or a WFOE would take the form of a limited liability company (“LLC”) that does not issue shares but has “registered capital” and “total investment” (paid-up capital plus permitted borrowing) figures which are both approved by the PRC government. FISCs, which are currently rare in China by comparison, are share-issuing companies similar in legal form to western-style corporations. JVs, WFOEs and FISCs are collectively known as “foreign-invested enterprises or “FIEs,” and generally enjoy various policy incentives, including tax benefits, if the foreign shareholdings in these enterprises are 25% or greater. In the paragraphs below, we will briefly summarize each of the common foreign investment vehicles in China mentioned above. Representative Offices Rep Offices are a popular business vehicle in the PRC, both as a first step into the market and as a way of maintaining a presence in the country without committing any more resources than what is absolutely necessary. Given the current impossibility of setting up branches in China (as discussed below), establishing a Rep Office is currently the least capital-intensive means for foreign investment in China.

1 Important Disclaimer: The material in this article is of the nature of general comment only and is not intended to be a comprehensive exposition of the issues arising in the context of a business or assets, nor of the law(s) relating to such a transaction. It is not offered as advice on any particular matter and should not be taken as such. The firm disclaim any liability to any person in respect of anything and the consequences of anything done or permitted to be done or omitted to be done wholly or partly in reliance upon the whole or part of any of the contents of this article. No person, whether a client of Baker & Mc.Kenzie or otherwise, should act or refrain from acting on the basis of any matter contained in this article without taking specific professional advice on and in light of the particular facts and circumstances in issue, and no reliance should be placed on the statements made in this article.




Rep Offices allow foreign companies to conduct local promotional and marketing activities for their products and to conduct local research. However, one of the primary distinctions between Rep Offices and FIEs is that PRC law prohibits Rep Offices from engaging in “direct business operations” in the PRC. Accordingly, Rep Offices are not permitted to sell products in the PRC, and Rep Office personnel are not permitted either to sign contracts in the PRC on behalf of the Rep Office’s parent company or to issue sales invoices. Unlike FIEs, a Rep Office is not a separate legal person from its head office, and the head office will assume all liabilities resulting from the Rep Office’s operations in China. In this way, investors may conceptualize Rep Offices as branches with significantly restricted scopes of permissible activities. Sino-Foreign Joint Ventures A JV is typically a non-share-issuing limited liability company formed between one or more non-PRC entities (including Hong Kong, Macau and Taiwan entities) with one or more Chinese entities. A JV can be set up in the form of an equity joint venture (“EJV”) or a cooperative joint venture (“CJV”), which are structurally similar in most respects. JVs have definite, albeit extendable, terms of operations. JVs are popular investment vehicles either for foreign investors less familiar with investment in China that would prefer a local partner with connections to help handle local issues, or for those investing in certain industries that require the participation of a Chinese partner under the current PRC legal regime. Most investors seeking to establish JVs in China choose to set up their ventures as EJVs. Investors typically would adopt a CJV structure if they specifically desire to adopt a non-legal person structure, need more freedom in configuring their profit distribution ratios, or prefer the ability to recover their investments early under certain circumstances (these are the main benefits of a CJV structure not available for typical EJVs). Wholly Foreign-Owned Enterprises A WFOE is a limited liability company 100% owned by one or more foreign entities (in other words, a joint venture formed between two foreign investors would also be categorized as a WFOE in China), although currently most WFOEs only have one investor. As in the case of a JV, the ownership of a WFOE is also in the form of equity interests, and no shares are issued. Like JVs, WFOEs have definite, albeit extendable, terms of operations. During the past several years, WFOEs have become popular investment vehicles especially favored by foreign investors that are more familiar with investment in China because they are totally owned by foreign parties. This usually means that there will be greater flexibility in terms of management and control, and less




complexity arising from having to deal with Chinese partners. However, because it is wholly foreign-owned, a WFOE may be subject to more stringent investment restrictions with respect to the types of activities in which it may engage, especially in certain sensitive industries. Foreign-Invested Joint Stock Limited Companies Unlike JVs or WFOEs, the shareholding of the investors in a FISC is in the form of issued shares, similar to western-style corporations. As such, a FISC is the only form of FIE that can be directly listed on PRC stock exchanges-other forms of FIEs would have to be converted into an FISC before they could be listed. Unlike a JV or a WFOE, a FISC can be operated for an unlimited duration. B. Types of Investment Transactions Common Types of Acquisition Transactions in the PRC A foreign investor who wishes to acquire or increase an equity interest in a PRC target company would commonly do so in one of the following ways: Direct Acquisition

The foreign investor may purchase all or part of the non-listed equity interest of the PRC target company directly from one of the investors in the target company (“direct acquisition”), or by subscription to any increased capital of the target. The direct acquisition transaction is conducted in the PRC and will be subject to full PRC approval requirements, which can be time consuming and which involve government discretion (i.e. the PRC authorities may withhold approval if they perceive problems with the transaction).

Offshore/Indirect Acquisition

Alternatively, the foreign investor may acquire or increase control of the PRC target company via the offshore purchase of some or all of the shares of the PRC target company’s foreign parent(s) (“offshore acquisition” or “indirect acquisition”). This option is available only if the PRC target company has foreign investors and applies only to acquisitions of interests in such foreign investors.

An offshore transaction is conducted in the jurisdiction of incorporation of the offshore company and is generally not subject to PRC jurisdiction and review, except in certain circumstances pursuant to the newly established antitrust review regime in the PRC. In addition, if the offshore company’s ultimate shareholder or




shareholders are PRC nationals, certain PRC filings should have been made with the foreign exchange authorities in the PRC and should be reviewed during the due diligence process. (Please refer to the “Exchange Control” section below for details.)

Asset Acquisition

A foreign investor may, using a new FIE or an existing FIE as the acquiring vehicle, purchase directly some or all of the business and assets of the PRC target company. Such transactions are subject to PRC jurisdiction and full PRC approval requirement.

Special Types of Acquisition

State-Owned Interests and Special Types of Acquisition

As a remnant of its planned economy history, China has a large number of SOEs or private corporations with state-owned interests, many of them in poor financial shape and desperately in need of reform. In an attempt to accelerate their transformation to viable enterprises through the utilization of foreign participation, the Chinese government has issued special regulations governing the acquisition by foreign investors of interests in such SOEs or state-owned interests in companies. One of the special means of acquisition provided for in the regulations is that foreign investors may acquire domestic creditors’ rights in the target and thereby qualify for the opportunity to later convert such debts into equity in the companies (similar to a convertible bond concept). The normal means of direct equity/asset acquisition applicable for regular companies outlined above will also apply, subject to certain special rules and restrictions. Furthermore, there could be additional issues involved with such acquisitions, such as state-asset valuations and employee resettlement issues, which are discussed later in this brochure.

Mergers

Western-style mergers between two companies are possible but are rarely seen in the PRC. Current PRC statutory mechanisms recognize two means of mergers: a “merger by absorption” or a “merger by new establishment.” A “merger by absorption” involves the absorption by one company of another pursuant to which the absorbed company is dissolved and its registered capital and assets merged into the surviving entity. In a “merger by new establishment,” each of the pre-




merger companies is dissolved and a new company is established holding an aggregate of the pre-merger companies’ assets and registered capital. Generally, the post-merger entity would be a complete successor of the pre-merger entities in that it would assume all rights and liabilities of such entities; however, creditors of the companies to be dissolved are given the option of having their claims repaid in full prior to the completion of the merger. Whether the merger is a “horizontal merger” or “vertical merger” (defined by the merged entities’ market positions) does not have an impact on the PRC regulatory process.

It should be noted that cross-border mergers are currently unavailable under PRC law, i.e. it is not possible to directly merge a foreign entity with a domestic company (including FIEs).

As far as foreign investors are concerned, the only permissible forms of mergers in China are between FIEs and FIEs, or between FIEs and domestic companies. In order to effect these mergers, the FIE must be fully capitalized and have commenced operations. The merger should comply with the Foreign Investment Catalog and in principle the post-merger FIE should also comply with all other aspects of the PRC regime governing FIEs.

As mergers are rarely seen in the PRC in practice, this brochure will discuss only share and asset acquisitions in detail.

C. Exchange Control Background China imposes strict control over all types of foreign exchange transactions across its borders, and its official currency, the RMB, is not freely convertible in the international foreign exchange market. SAFE, the authority in charge of foreign exchange control in China, regulates the following four types of transactions involving the movement or conversion of foreign exchange:

• Inward remittance of foreign exchange, i.e. the remittance of foreign exchange into China from an overseas party;

• Settlement of foreign exchange, i.e. the conversion of foreign exchange into RMB;

• Sale of foreign exchange, i.e. the conversion of RMB into foreign exchange; and




• Outward remittance of foreign exchange to an overseas party.

Current Account and Capital Account Items In its administration of the foreign exchange control regime, China distinguishes between “current account items” (generally, funds for the daily operations of a company, such as revenue from export or provision of services, payment for imported goods, etc.) and “capital account items” (generally, items of a non-trade, nonrecurring nature, such as investment in China, real estate purchases, repayment of the principal of hard currency loans and contributions to registered capital). Current Account Items As a result of the reform of the PRC foreign exchange system in 1996, China has liberalized its foreign exchange control regime to permit the so-called “current account convertibility of the RMB.” In essence, PRC companies are allowed to effect current account foreign exchange transactions free of any prior approval of SAFE. Instead, PRC companies are only required to submit the documents of the underlying transaction to the PRC designated foreign exchange bank for verification. Capital Account Items Foreign exchange transactions involving capital account items, on the other hand, are currently more heavily regulated, though the PRC government has announced a policy of gradually moving towards full capital account-convertibility of the RMB. For large cross-border capital account foreign exchange transactions, prior approval from SAFE would be necessary. Supervision and Approval for Foreign Exchange Transactions There are detailed rules specifying the precise extent of approval authority that local banks and local branches of SAFE have over each type of foreign exchange transaction. Such rules are changed periodically, but generally the trend appears to be that SAFE is delegating more authority to approve foreign exchange transactions to the local banks. Remittance Issues While PRC statutes allow multiple forms of payment for a merger and acquisition transaction, some foreign purchasers may opt to pay the purchase price for the relevant interest or assets transferred, utilizing foreign currency funds currently held outside of China. This means that, in mergers and acquisitions involving




foreign investors acquiring targets in China, generally the “inward remittance” and “settlement” aspects of foreign exchange control are more relevant. Payment to a Seller outside of the PRC In the case where the seller in either an indirect acquisition or a direct acquisition has a bank account outside of China, the purchase price is typically paid completely offshore by the foreign purchaser to the foreign seller. To the extent that such payments do not cross the PRC border, SAFE would not have jurisdiction over the transaction. Many PRC parties try to avoid or reduce the foreign exchange controls, governmental approvals and tax consequences that apply to mergers and acquisitions in China by forming offshore investment vehicles, such as holding companies in tax havens. Investment of funds from China into such offshore investment vehicles must be approved by SAFE, but in the past this requirement was not enforced and hence not complied with. In 2005, SAFE issued notices reiterating the requirement for prior SAFE approval for overseas investments by PRC residents. Enforcement measures include requiring foreign-invested enterprises in China to declare ultimate shareholders of foreign investors. Furthermore, any foreign exchange proceeds obtained by PRC individuals through their offshore investment vehicles should be repatriated and settled in full within 30 days from receipt. Violations of this requirement will be treated as exchange control evasion. The strengthening of control of overseas investments by PRC residents complicates mergers and acquisitions involving PRC parties, as many PRC parties would prefer to effect transactions through their offshore investment vehicles. The legality of offshore investment vehicles will be an additional due diligence item for foreign investors presented with investment structures involving such offshore investment vehicles. Payment to a Seller in the PRC Equity Acquisitions If the transaction involves a seller who must be paid in China, the foreign purchaser will have to remit the purchase price into the PRC. In this situation, the purchase price will typically be remitted to a special account that the seller establishes for the specific purpose of receiving funds of such nature (called the “capital account”). For the large amounts of such inward remittances that are typical in merger and acquisition transactions, the PRC seller may be required to apply to SAFE for approval in order to settle the purchase price and convert the purchase price into RMB. After remittance of the purchase price into the special account and conversion into RMB, the foreign investor will have to carry out special foreign exchange registration for the foreign exchange paid to the seller (or the foreign investor may authorize the seller of the equity to carry out the




registration). A registration certificate will be issued. The certificate is proof that the foreign investor has made the payment(s) and is also important for the registration procedures to be carried out by the target enterprise. It is at this point that any overseas investments by PRC residents into special purpose vehicles must be disclosed, as discussed above. Asset Acquisitions In an asset purchase involving the formation of a new FIE as the acquisition vehicle, the new FIE will first need to be funded, and the inward remittance procedures for the funding of the FIE are quite similar to the procedures described above, where a capital account will be established to receive such capital contribution funds. The PRC foreign exchange regime mandates that all transactions in China are to be priced and settled in RMB. Consequently, the purchasing FIE will need to use RMB to purchase any assets from a domestic company. Such RMB may come from conversion of part of its initial capital contributions, or from its operational income. In any event, in such a transaction, the payment to the seller itself will typically not trigger specific foreign exchange issues. Special Issue for the Lenders In the event that an FIE takes out any foreign-exchange denominated loans or borrows from an offshore entity to finance the acquisition, lenders in such transactions should note that such loans require registration with SAFE. Unregistered loans would, among other things, result in outward remittance difficulties when the principal or interests of the loans need to be remitted to lenders located outside of China. Revaluation of the Renminbi Yuan Since July 21, 2005, the official currency of China, the Renminbi has no longer been pegged firmly to the United States Dollar, but instead has been allowed to float in a tight band against a basket of foreign currencies. The People’s Bank of China intervenes on a daily basis to keep the value of the Yuan within a desired range. In the longer term, it is thought that the Chinese government will rely on a mechanism linked to key economic indicators to manage the fluctuation of the Yuan against other currencies. Under the managed float system, movement of the Yuan against the US Dollar, the Euro and other major currencies is a reality that parties to merger and acquisition transactions should take into account when negotiating price and the payment currency.




D. Documentation and Due Diligence Preliminary/Framework Agreement There is no strict PRC legal requirement for a preliminary/framework agreement between the parties, such as a letter of intent (“LOI”) or memorandum of understanding (“MOU”), for merger and acquisition transactions. Nevertheless, an LOI or MOU is an important tool that can be used to reach agreement at an early stage on the principles, basic terms and contemplated procedures of proposed transaction, and is usually prepared in major transactions. It should be noted that although LOIs and MOUs are generally stated to be non-binding in nature, the Chinese parties usually expect that all the terms contained in the LOI/MOU will eventually be replicated in the formal agreements should the transaction proceed. Generally, aside from special issues that parties wish to include in the document, an LOI/MOU would stipulate the following key terms of the transaction:

• Identities of the parties;

• Total purchase price, timing and method of payment;

• Total investment, registered capital and business scope of the target company post acquisition;

• Equity percentages and form of capital contribution by the investors (if any);

• New management arrangements;

• Land use arrangements;

• Labor arrangements;

• Trademark and technology licensing and other ancillary agreements;

• Conditions precedent that must be satisfied in order for the transaction to proceed;

• Exclusivity and confidentiality obligations (this part should expressly be made legally binding on the parties);

• Purchaser’s right to due diligence and seller’s undertaking to cooperate and participate;




• Further steps to be undertaken by the parties in order to proceed with the proposed transaction; and

• Due Diligence.

Introduction Due diligence investigations are essential tools for reducing the risks inherent in a merger/acquisition transaction in China. In the absence of complete knowledge of the operations, the scope of the assets, and the extent of the liabilities of the target company, due diligence investigations afford the prospective purchaser an opportunity to assess the legal and financial state of affairs of the target company. They also facilitate consideration of structuring issues in the proposed transaction based on the results of the pre-acquisition review. Accordingly, due diligence is vital in almost all mergers and acquisitions in China. However, the concept of due diligence is relatively new to many target companies in the PRC. Many PRC companies do not keep proper corporate or accounting books and records, and the Chinese parties are used to concluding transactions in the absence of any pre-acquisition documentary review of target companies. As a consequence, foreign purchasers may still find some Chinese parties quite reluctant to fully disclose information concerning the target company. There have also been reports that lawyers, accountants and other business professionals have been accused of violating China’s vague state secrets regime because they were closely inspecting certain financial and management records of some Chinese SOEs. Document forgery can also be an issue when dealing with some Chinese parties. Generally, foreign investors and their advisors need a high level of patience, experience and diplomacy to carry out proper due diligence investigations that are up to international standards. Due Diligence Process Typically, the due diligence process will begin with the purchaser and its advisors determining the nature and scope of the due diligence investigations. A written questionnaire or checklist that identifies the essential matters to be investigated would then be prepared and sent to the target company. Upon receipt of the questionnaire, the seller/target company or its advisors will formally answer the questions raised therein, providing copies of the relevant requested documents as required. The purchaser and its advisors will generally also carry out site visits at the site of the target company and conduct interviews with its management and staff members in order to obtain complete information on the matters to be covered. While the purchaser and its advisors typically need to drive the due diligence process in the PRC, China is in the process of converging with international practices, as more sophisticated sellers do hire advisors and prepare organized data rooms.




OTHER RECENT RESARCH REPORTS AND NEWSLETTERS BY MORGEN, EVAN & COMPANY, INC. Country Reports Japan Acquisition Opportunities 2004-2005 Japan Acquisition Opportunities 2006-2007 Cracking Japan’s middle market Acquiring in China …a long and winding path? M&A in Japan- A Primer Industry Reports Biopharmaceutical CMO Market Report 2006-2007 Opportunities within Japan’s Consolidating Logistics Industry Outlook for Global M&A Markets in 2006 Retailing Sector M&A in 2006 Technology Sector M&A Outlook for 2006

For any of the above reports or newsletters please visit our website at www.MorgenEvan.com or email us at [email protected]




Sources Access Asia

Business Week

China Internet Information Center

CIA World Factbook

Cygnus

Data Monitor

Euromonitor

IDC International

M&A Asia

Ministry of Commerce of People’s Republic of China

National Bureau of Statistics of China

New York Times

Park Associates

People’s Daily, China

PRC General Administration of Customs

PricewaterhouseCoopers

The Deal

UN Population Division

U.S.-China Business Council

U.S. Commercial Service

Wall Street Journal

Wikipedia



For further information on Mergers and Acquisitions in China, please contact: Morgen, Evan & Company – New York Mark Lerner [email protected] Morgen, Evan & Company – New York (European Business Group) John Mondoloni [email protected] Morgen, Evan & Company – Tokyo Tom Eastling [email protected] Morgen, Evan & Company – Shanghai Amy Liu [email protected] Baker & McKenzie – Shanghai Danian Zhang [email protected] © Morgen, Evan & Company, Inc. 2006 DISCLAIMER It should be noted that the material in this book is designed to provide general information only. It is not offered as advice on any particular matter, whether it be legal, procedural or other, and should not be taken as such. The authors expressly disclaim all liability to any person in respect of the consequences of anything done or omitted to be done wholly or partly in reliance upon the whole or part of the contents of this book. No reader should act or refrain from acting on the basis of any matter contained in it without seeking professional advice on the particular facts and circumstances at issue.

Morgen, Evan & Company, Inc.Morgen,Evan & Company, Inc.

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