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The Politics of Takeovers by Chinese Companies

November 03, 2012 | About:
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Gordon Pape

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The Canadian government is clearly having a tough time deciding whether to allow a state-owned Chinese company take over one of our major petroleum producers, Nexen Inc. But we're not the only country that is struggling with this complex issue. Our closest neighbour and ally, the United States, took a very long hard look at the Canadian take-over of one of its key technology companies before finally giving it the go-ahead last week.

Last June, MacDonald, Dettwiler of Vancouver (MDDWF) announced it was acquiring 100% of Space Systems/Loral Inc. (SS/L) for a price of US$875 million in a deal the company said would be immediately accretive to its bottom line. At the time, MDA president Daniel Friedmann described it as "a game-changing transaction" for the company and the share price leaped.

It looked like a perfect fit. MDA is a major supplier of satellite antennas and electronics and produces communications satellites for business and military customers around the world. The company is Canada's leading participant in the space industry, having provided several components for the Mars rovers, the International Space Station, and NASA's OSIRIS-REX asteroid mission. It's the firm that designed, developed, and built the now-iconic Canadarm under contract to the National Research Council of Canada.

SS/L, which is based in Palo Alto in the heart of California's Silicon Valley, bills itself as "The world leader in satellite communications manufacturing". Much of the hardware that orbits the planet was built in whole or in part by SS/L, including satellites used for TV signals, cell phones, broadband transmission, satellite radio, weather forecasting, defence, and, although the company doesn't say much about it, spying.

Combined with SS/L, MacDonald, Dettwiler would be an international powerhouse in the technology industry. That's why the U.S. government decided to take a much closer look. In September, the U.S. Department of Justice announced that it would probe more deeply into the proposed takeover from an anti-trust perspective while an investigation into whether America's national security might be jeopardized was already under way at another agency.

There may have been some tit-for-tat in the background. Back in 2008, Ottawa vetoed the proposed sale of MDA's Information Systems and Geospatial Services operations to a Minnesota company for reasons of national security. This wasn't a sale to China, it was to a U.S. firm, yet the Harper government deemed it a security issue. No wonder the Americans decided the SS/L takeover was worth intensive scrutiny.

The national security issue was resolved in MDA's favour in late September. But the anti-trust study was another matter. When the Department of Justice demanded more information, investors began to dump the stock amid growing concern that the deal would be scuttled. The shares fell from a high of $61.74 on Aug. 24 to as low as $47.37 in intra-day trading on Oct. 24 - a drop of 23%.

Two days later, MDA announced it had cleared the anti-trust hurdle and it now appears that all systems are go. The share price immediately jumped by more than 10% and MDA shares were trading on Friday at C$55.84, US$55.91.

The fact a Canadian company had to jump through so many hoops to complete the acquisition of a U.S. firm is a classic example of the complexity of international takeovers. And this is between two friendly countries. Imagine the angst in Ottawa right now as the government tries to decide whether to allow CNOOC, a state-controlled Chinese oil company, to take over Nexen. The review period has already been extended by 30 days, to Nov. 10, but now sources in Ottawa are saying that a decision is unlikely even by then.

Ottawa's dilemma

The dilemma is obvious. Prime Minister Harper has been working hard to build better trade relations with China over the past few years. The Chinese ambassador to Canada has even raised the possibility of a free trade deal. But it's one thing to improve trade relations. It's quite another to have a foreign government play an increasingly larger role in our most important resource sector.

China is already involved in our energy industry. In 2010, Penn West Petroleum entered into a $2.6-billion joint venture with China Investment Corp. (CIC) to develop oil sands properties in northern Alberta. That deal also involved CIC taking a 5% stake in Penn West.

Last January, it was announced that Cretaceous Oilsands Holdings Ltd., a subsidiary of PetroChina, had taken 100% control of the MacKay River oil sands project from Athabasca Oil for $680 million and is aiming to eventually ramp up production to 150,000 barrels a day.

Then came the announcement last week that another PetroChina subsidiary, Phoenix Energy Holdings Ltd., is teaming up with TransCanada Corp. to build a new $3 billion pipeline to that would carry up to 900,000 barrels a day from Fort McMurray to near Edmonton.

The pattern is obvious. China is taking an increasingly aggressive role in developing the oil sands and is investing billions of dollars in the process. The $15.1 billion takeover of Nexen would be the jewel in the crown - at least so far. But if that deal goes ahead, where does it end? No wonder the cabinet is in a quandary.

Meanwhile, the NDP is promising to make life even more difficult for the Conservative government if the deal is approved. The official opposition party wants the sale blocked both on national security and environmental grounds. Further complicating matters is the concern being expressed in the U.S. Congress over allowing a Chinese company to gain control of Nexen's leases in the Gulf of Mexico. The whole thing is a political nightmare.

And that's not all Ottawa has to contend with. The government is still coping with the fall-out from its completely unexpected Oct. 19 decision to reject the $5.2-billion offer from Petronas, the Malaysian state oil firm, for Progress Energy Resources. The Globe and Mail described the veto as "careless", noting that "Malaysia is no geopolitical threat".

That deal isn't dead yet, however. Petronas and Progress have until mid-November to show that the acquisition is of "net benefit" to Canada and the expectation is that the companies will find a way to achieve that.

Other energy patch deals are also running into trouble. Athabasca Oil has experienced a long delay getting government approval for a joint venture project with Kuwait and Spain that would be worth a reported $2 billion.

Hal Kvisle, CEO of Talisman Energy (TLM) says Ottawa should butt out of these deals and let the free market take its course. "If it is a state-owned company that primarily operates as a commercial venture with minimal political interference, then I think we should welcome those companies to Canada," he told The Globe and Mail in an interview. It should be noted that Talisman itself has been identified as a potential take-over target if the Nexen deal is approved.

Book publishers too

Then there's the matter of the huge publishing merger between Germany's Bertelsmann, the parent company of Random House, and British-based Pearson PLC, which owns Penguin. Neither is a Canadian company but between them Random House and Penguin dominate this country's book publishing industry. There is already intense speculation in the arts community that allowing the two to combine will lead to a reduction in the number of Canadian titles published each year. Whether Ottawa can do anything about that is questionable, but the issue is potentially another political hot potato.

The problem always comes back to the same critical point: we do not have a clearly defined set of guidelines for foreign takeovers or significant joint ventures. The federal government has been promising such a policy ever since it vetoed BHP Billiton's hostile take-over bid for Potash Corporation of Saskatchewan in 2010. We're still waiting, although Mr. Harper has said we can expect some news "fairly shortly".

Ideally, such a policy should be clear, concise, and easily understandable. In the real world of international politics, that may be too much to ask but even some general guidelines would be better than nothing. Certainly, we should avoid a U.S.-style solution where several regulatory bodies can stick their noses in, as happened with MacDonald, Dettwiler's deal.

As far as investors are concerned, no take-over bid should ever be considered a sure thing, even one that is purely domestic. The CRTC decision on BCE's bid for Astral proves that.

So if you are fortunate enough to hold shares in the stock of a company that becomes a take-over target, your best bet is usually to sell into the market on the news and exit. There are too many things that can go wrong.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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