Step-transaction plans for M&A and listco restructurings (3)

By Yin Yi, Grandway Law Offices
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In the past two articles, the author summarized cases where listed companies obtained approval from the China Securities Regulatory Commission (CSRC) after adopting step-transaction plans, and examined the advantages and other issues with step-transaction plans. This article continues to examine other issues with step-transaction plans.

Restrictions on acquisition of minority interest and use of raised funds. At a training seminar held by the CSRC on sponsors regarding M&A, in July 2017, it was stated that relevant funds raised in the acquisition of a minority interest of a holding subsidiary should only be used for payment of the cash consideration, and taxes and fees for the said transaction, and should not be used for work in progress of the target asset (the holding subsidiary).

Yin Yi
Associate
Grandway Law Offices

The report submitted to the CSRC in the case of Maoye Communication and Network showed that the raised funds would be used for three works in progress of the target company. In the first feedback, the CSRC asked: “Is the purchase of the remaining 49% equity in SINOWEL by the listed company through issuing shares a purchase of minority interest of the target asset? If so, is the use of the raised funds in construction of relevant projects of the target company in compliance with CSRC regulations?”

Maoye Communication and Network replied that the purchase of the remaining 49% equity by issuing shares and the purchase of 51% equity of the target with cash comprised a package deal, and the former was a step in the package deal and should not be regarded as a separate purchase of minority interest.

However, the CSRC didn’t seem to recognize the reply, and in the amended report upon approval by the CSRC’s M&A and restructuring review committee, Maoye Communication and Network cancelled the part of raising funds in the transaction plan.

In this case, Maoye Communication and Network’s initial scheme wasn’t accepted by the CSRC, which means that, when acquiring the remaining equity after gaining control of the target with cash in the step transactions of a package deal, the funds raised should not be used for work in progress of the target.

We should note that the raised funds in the case of Yantai Dongcheng Biochemicals, approved on 30 March 2018, were also used for work in progress of the target. However, because Yantai Dongcheng Biochemicals didn’t take control of the target after buying 48.5497% equity of the target, the subsequent equity transaction did not constitute an acquisition of “minority shareholder’s interest of the held subsidiary”, and thus was not subject to the restrictions at the CSRC training seminar on sponsors, in July 2017.

Recognition of goodwill in full in the step-transaction plans composing a package deal. In the case of Maoye Communication and Network, the CSRC was also concerned about “whether the calculation process and base of goodwill effect in the transaction are in compliance with the Accounting Standards for Business Enterprises”.

In its reply, Maoye Communication and Network said that it would, upon CSRC approval of its plan on the subsequent share issuance for purchase of the remaining 49% equity of SINOWEL and the implementation of such plan, recognize the goodwill as RMB1,233,278,136.69, which is calculated by subtracting RMB246,721,863.31, the fair value of SINOWEL as of 31 May 2018, from RMB1.48 billion (US$220 million), the total merger cost (i.e., the total purchase price of the deal).

Maoye Communication and Network explained that, according to the Accounting Standards for Business Enterprises, identifiable assets and liabilities of the target acquired by the investor in a merger should be measured based on their respective fair values on the acquisition day.

Where the buyer and the target adopt different accounting standards before the merger, their standards should be unified based on the materiality principle, that is, the book values of assets and liabilities of the acquired target should be adjusted according to the accounting standards of the buyer.

The positive difference between the merger cost on the acquisition date and the fair values of the identifiable assets and liabilities of the target acquired in the merger should be recognized as goodwill.

Case study

In the case of Maoye Communication and Network, because the purchase with cash and the share issuance are closely intertwined, and the former is the precondition of the latter, the two steps of the transaction are considered as “a package deal”. Thus, the goodwill should be recognized in full as the total transaction price minus fair value of 100% equity of the target.

In practice, when companies under different controls carry out a merger through multiple transactions, and the multiple transactions don’t constitute “a package deal”, accounting treatment can be made as per article 47 of the Accounting Standards for Business Enterprises No. 33: Consolidated Financial Statements, namely, where a parent company purchases minority interest of its subsidiary, in the consolidated financial statements, capital surplus (capital premium or stock premium) should be adjusted at the long-term equity investment acquired from purchasing minority interests, minus attributable share of net assets of the subsidiary, calculated continuously from the purchase date or the merger date. Where the capital surplus is insufficient for the offset, retained earnings should be adjusted.

To put it more simply, in accordance with the Accounting Standards for Business Enterprises, when continuing to acquire minority interest of a holding subsidiary by a multiple-transaction plan until gaining 100% of the target’s equity, no additional goodwill is produced, and equity, i.e., capital surplus, is the only account title affected.

In conclusion, although step-transaction plans in M&A and restructurings of the listed company can boost M&A efficiency, include the target in its consolidated statements at the earliest time possible, and bring revenue to the listed company, such transaction plans also have their limitations. Therefore, different restructuring plans need to be designed, adopted and implemented based on different conditions of the listed company, the target assets, and the counter-party.

Yin Yi is an associate at Grandway Law Offices

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