1. www.lehmanlaw.com Edward Lehman Practising Law Institute 810 Seventh Avenue, 20th Floor New York, NY 10019 LEHMAN, LEE & XU www.lehmanlaw.com

2. M&A Strategies in China

3. www.lehmanlaw.com Of Interest BizChina BizChina Dialogue Dialogue Discussion of new anti-monopoly law and impacts on M&A in China Discussion of new anti-monopoly law and impacts on M&A in China –located at www.lehmanlaw.com under TV & Media www.lehmanlaw.com

4. General thoughts Why is common sense left at the border? Why is common sense left at the border? Three basic rules of M&A in China: Three basic rules of M&A in China: 1.Due diligence 2.Due diligence 3.Due diligence

5. www.lehmanlaw.comContents Growth of M&As Growth of M&As M&A Opportunities M&A Opportunities Nature of M&As Nature of M&As Importance of Privately Owned Enterprises Importance of Privately Owned Enterprises Case Study – Mengniu Diary Group Case Study – Mengniu Diary Group Role of Government Role of Government Restrictions Restrictions M&A Methods within China M&A Methods within China Offshore Transactions Offshore Transactions Current Law on M&A Current Law on M&A Practical Considerations Practical Considerations

6. www.lehmanlaw.com Growth of M&As Every year since 2002 has been a record year of M&A growth M&A transactions rose 50% in 2004 over previous year M&A transactions rose 50% in 2004 over previous year HSBC USD $1.74bn acquisition of 19.9% stake in Bank of Communications HSBC USD $1.74bn acquisition of 19.9% stake in Bank of Communications Anheuser-Busch USD $600 million acquisition of Harbin Brewery Group Anheuser-Busch USD $600 million acquisition of Harbin Brewery Group More M&As over traditional “Green-field” investments More M&As over traditional “Green-field” investments

7. www.lehmanlaw.com From the headlines “China is formally launching its wealth fund, amid market talk…what the nearly $200 billion will be used for” “China is formally launching its wealth fund, amid market talk…what the nearly $200 billion will be used for” “Nasdaq won China’s approval to open a Beijing representative office” “Nasdaq won China’s approval to open a Beijing representative office” “Citic Resources was expected to buy a majority stake in Tincy, making it China’s fourth-largest oil producer” “Citic Resources was expected to buy a majority stake in Tincy, making it China’s fourth-largest oil producer” “Chinese telecom shares leapt after government plan to audit five-major operators spurred talk of sector restructuring.” “Chinese telecom shares leapt after government plan to audit five-major operators spurred talk of sector restructuring.” From the Wall Street Journal Asia (September 28-30, 2007 Edition)

8. www.lehmanlaw.com Opportunities for M&As Government expansion of industries for M&A investment Privatization of State-owned Enterprises (SOEs) - approx 4,000 to 5,000 each year Privatization of State-owned Enterprises (SOEs) - approx 4,000 to 5,000 each year Acquisition is the cheapest and fastest way to enter the Chinese market Acquisition is the cheapest and fastest way to enter the Chinese market Fragmented sectors of the economy present opportunities to consolidate and create economies of scale Fragmented sectors of the economy present opportunities to consolidate and create economies of scale

9. www.lehmanlaw.com Nature of M&As Vast majority M&A involved recently – privatization of SOEs Trend is changing to involve Private-owned Enterprises (POEs) Trend is changing to involve Private-owned Enterprises (POEs) POEs, especially those that develop from SOEs, are now major targets of M&As POEs, especially those that develop from SOEs, are now major targets of M&As

10. www.lehmanlaw.com Importance of POEs Fast growth = attractive investment targets Usually capital starved, welcome cash in exchange for minority stake Usually capital starved, welcome cash in exchange for minority stake Low-costs, non-bureaucratic, local knowledge, effective Low-costs, non-bureaucratic, local knowledge, effective good partners for restructuring SOEs (most POE managers come from SOEs) good partners for restructuring SOEs (most POE managers come from SOEs) “Guanxi” (Relationship) with SOEs “Guanxi” (Relationship) with SOEs

11. www.lehmanlaw.com Case Study: Mengniu Dairy Group

12. www.lehmanlaw.com Case Study in POEs: Mengniu Dairy Group Second largest producer of milk, yogurt, ice cream Niu Genshen, former vice-president at state- owned Yili Dairy, founded Mengniu after leaving the company Niu Genshen, former vice-president at state- owned Yili Dairy, founded Mengniu after leaving the company Borrowed $1million to establish Mengniu Diary Group Borrowed $1million to establish Mengniu Diary Group After 7 years, Mengniu rapidly closing-in on Yili Dairy After 7 years, Mengniu rapidly closing-in on Yili Dairy Mengniu’s annual revenue was $1.3bn, while Yili’s annual revenue was $1.5bn (2005) Mengniu’s annual revenue was $1.3bn, while Yili’s annual revenue was $1.5bn (2005)

13. www.lehmanlaw.com Role of Government in M&As Government approval required for M&A transactions Includes: Includes: I. Ministry of Commerce (MOFCOM) - principle foreign investment examination and approval authority, entitled to supervise and approve M&A transactions

14. www.lehmanlaw.com Role of Government in M&As II. State Development and Reform Commission (SDRC) is responsible for both approving foreign investment project application and supervising restructuring of state-owned enterprises III. State-Owned Assets Supervision and Administration Commission (SASAC) comes into picture if the target enterprise is state-owned IV. China Securities Regulatory Commission (CSRC) – if is listed on China’s stock market V. Other industry-specific regulators, e.g. if the target is a Chinese bank, the approval of China Banking Regulatory Commission (CBRC) will be required

15. www.lehmanlaw.comRestrictions Catalogue for the Guidance of Foreign Investment (CATALOGUE) Classifies investment projects by sector as “encouraged,” “permitted,” “restricted,” or “prohibited” Classifies investment projects by sector as “encouraged,” “permitted,” “restricted,” or “prohibited” Majority Chinese shareholding mandated in several restricted sectors Majority Chinese shareholding mandated in several restricted sectors Other sectors prohibit 100% foreign shareholding Other sectors prohibit 100% foreign shareholding

16. www.lehmanlaw.com M&A Methods within China Equity Transaction Asset Purchase Asset Purchase Statutory Merger Statutory Merger

17. www.lehmanlaw.com I.Equity Transaction Foreign investor acquires equity in an existing FIE or a domestic enterprise from foreign or Chinese shareholders Requires Chinese examination and approval Requires Chinese examination and approval If target is purely domestic, it will become an FIE after equity purchase If target is purely domestic, it will become an FIE after equity purchase FIE must assume target’s responsibilities and liabilities FIE must assume target’s responsibilities and liabilities All agreements subject to Chinese Government’s approval All agreements subject to Chinese Government’s approval

18. www.lehmanlaw.com II.Asset Purchase A cquire select assets “Peel-off” unwanted assets and liabilities “Peel-off” unwanted assets and liabilities No change in equity ownership No change in equity ownership Target retains all original rights and liabilities Target retains all original rights and liabilities Foreign companies not allowed to directly operate assets without PRC presence Foreign companies not allowed to directly operate assets without PRC presence Needs to establish FIE to purchase assets Needs to establish FIE to purchase assets

19. www.lehmanlaw.com III.Merger Foreign investor must establish FIE in China for merger Subject to multi-step approval process Subject to multi-step approval process Two Types: Two Types: I.Merger by Absorption - absorbing company will remain, while absorbed company will dissolve II.Merger by New Establishment - combined companies will dissolve, while new company is established

20. www.lehmanlaw.com Off-shore Transaction U.S. C Corporation ↓ Acquires a ↓ Acquires a 70% stake 70% stake HK B Offshore Corporation Indirectly Acquires A ↓ Shareholder ↓ Shareholder China A Domestic Corporation Offshore transaction most effective Doesn’t require approval within China unless any item (i.e. shareholders’ names) needs to be changed

21. www.lehmanlaw.com Current Law on M&A Acquisition of Domestic Enterprises by Foreign Investors Provisions Acquisition of Domestic Enterprises by Foreign Investors Provisions (Effective Sep 8, 2006) Supersedes 2003 Tentative Provisions on Using Foreign Investment to Reorganize State- Owned Enterprises Supersedes 2003 Tentative Provisions on Using Foreign Investment to Reorganize State- Owned Enterprises

22. www.lehmanlaw.com Current Law on M&A I.Share Swaps The shareholder of an overseas company to use the shares it holds in the overseas company or to use the newly issued shares of the overseas company to purchase the shares held by the shareholder of a domestic enterprise or the newly issued shares of the domestic enterprise. The shareholder of an overseas company to use the shares it holds in the overseas company or to use the newly issued shares of the overseas company to purchase the shares held by the shareholder of a domestic enterprise or the newly issued shares of the domestic enterprise. The domestic company or its shareholder shall engage a PRC registered agency (e.g. a law firm, a CPA firm) to act as their M&A counsel to conduct Due Diligence. The domestic company or its shareholder shall engage a PRC registered agency (e.g. a law firm, a CPA firm) to act as their M&A counsel to conduct Due Diligence.

23. www.lehmanlaw.com Current Law on M&A II.Offshore Special Purpose Vehicles (SPVs) An Overseas company directly or indirectly controlled by a PRC company or PRC individuals for the purpose of consummating the overseas listing of the interests it actually owns in a domestic company. An Overseas company directly or indirectly controlled by a PRC company or PRC individuals for the purpose of consummating the overseas listing of the interests it actually owns in a domestic company. Domestic company needs MOFCOM and CSRC approval Domestic company needs MOFCOM and CSRC approval After overseas listing, domestic company must report to MOFCOM proceeds repatriation plan – required to repatriate all foreign currency income After overseas listing, domestic company must report to MOFCOM proceeds repatriation plan – required to repatriate all foreign currency income

24. www.lehmanlaw.com Current Law on M&A III.National Economic Security Requires both foreign investors and domestic enterprises to report details of acquisition to MOFCOM if it Involves China’s “key industries” Involves China’s “key industries” May affect China’s economic security May affect China’s economic security May lead to transfer of ownership of famous Chinese trademarks May lead to transfer of ownership of famous Chinese trademarks

25. www.lehmanlaw.com Practical Considerations Importance of Due Diligence FIE Tax Preference FIE Tax Preference I.15% to 24% tax rate for FIEs; II.“Two-plus-three” year tax holiday for FIE manufacturers New Unified Tax System ( Jan 1, 2008) 25% New Unified Tax System ( Jan 1, 2008) 25%

26. Copyright © Lehman, Lee & Xu All Rights Reserved THANK YOU Address: 10-2 Liangmaqiao Diplomatic Compound, Beijing Telephone: 86-10-8532-1919 Fax: 86-10-8532-1999 Email: elehman@lehmanlaw.com Website: www.lehmanlaw.comelehman@lehmanlaw.comwww.lehmanlaw.com