USA Inbound Acquisitions & Investments Blog

CFIUS Regulation is an Issue in the Acquisition Contest for Terra Industries

Bill Newman — Wed, 10 Mar 2010 17:46:34 -0500

The regulatory clearance process for inbound acquisitions is playing a central role in the ongoing takeover contest for Terra Industries, Inc. A second buyer has made a higher bid and has cited Terra’s need for regulatory approvals and regulatory delays in the agreed-upon deal in arguing its case to Terra’s shareholders. That and other factors now seems to have won the day for the second buyer.

Terra is based in Sioux City, Iowa and produces and markets nitrogen and methanol products, predominantly agricultural fertilizers. In February, Norway’s Yara Iternational ASA, the world’s largest fertilizer company, agreed to pay $4.1 billion to acquire Terra in a merger transaction. The merger requires the approval of the stockholder of both companies. According to the Alfidi Capital blog, Yara’s bid for Terra was valued at $41.10 per share. The parties have agreed that the transaction is expressly subject to review by the Committee on Foreign Investment in the United States (CFIUS).

Terra’s merger agreement, as filed with the SEC, illustrates the operation of the U.S. statutes and regulations that apply to an inbound investment. First, the U.S. business that is the target warrants to the buyer – Yara in this case – that the approval of CFIUS is among those governmental consents that are required for the transaction to be completed legally. Second, the U.S. target and the foreign buyer then agree to cooperate to make the necessary filings with CFIUS and to update those filings as necessary. Third, as a condition to completion of the transaction, full regulatory compliance must have been achieved. For a more complete analysis of these and other contractual provisions that are used in acquisitions, please visit the Sullivan & Worcester Web site and review our white paper that discusses contractual provisions.

On March 2, CF Holdings Industries, Inc. of Deerfield, Illinois announced that it was offering $47.40 per share for Terra, or $620 million higher than Yara’s bid. Earlier this year, CF had ended its year-long attempt to acquire Terra. CF’s new bid is $840 million higher than its last bid. Because CF Industries, Inc. is not a foreign buyer, review by CFIUS is not a factor. In its press release, CF says that its offer not only has higher value than Yara’s but is not burdened with the various conditions that apply to Yara’s offer. CF’s letter to Terra’s directors cites “numerous conditions beyond Terra’s control [that] will not be satisfied, including regulatory, legislation and stockholder approvals.” Obviously, CFIUS approval falls under the first of these categories. The Daily Finance blog also handicaps the Yara offer because of CFIUS screening. CF gives Terra the opportunity to make a quick deal.

Going back to the Yara deal, it may be interesting to speculate what factors in its business drove the decision to file with CFIUS. Submitting a notice to CFIUS is optional. If there is no filing and CFIUS later determines that the acquisition adversely affected U.S. national security, CFIUS can attempt to unwind the transaction. The mere prospect that an unwinding might subsequently occur is sufficient to lead parties, their advisors and their financing sources to play the game conservatively and engage in the CFIUS screening process.

Viewed from a less conservative perspective, however, perhaps Terra’s transaction does not affect U.S. national security. Terra’s last annual report did not disclose that it had contracts with the U.S. government or that it was satisfying U.S. defense requirements. Additionally, Norway is a NATO ally and is not a proliferation risk. It is more likely that Terra’s fertilizer products are considered critical resources and material in U.S. agricultural markets. Interestingly, among the risk factors in its annual report is Terra’s disclosure that its fertilizers can be used as explosives and that “governments could impose limitations in the sale, use or distribution of [its products],” so there may well be a general security consideration in the background. On balance, the more conservative position with respect to CFIUS seems warranted.

CF appears to have gained the initiative with its heftier price and its arguments that rely on conditions that apply only to Yara’s deal. Today, Terra announced that its board had notified Yara that CF’s offer constituted a superior offer and that, barring an overbid from Yara within 5 days, Terra would terminate its merger agreement with Yara. Although not the only factor by any means, CFIUS review is tilting the contest toward the domestic buyer.

We are forced to ask whether that was among the intended results of the legislation that regulates foreign direct investment.

The View from the International Investment Bank: Cross-Border M&A Activity in 2010

Bill Newman — Wed, 24 Feb 2010 16:32:47 -0500

Does 2010 mean a renewal of inbound M&A activity? We have put the question to well-qualified investment bankers to get professional views. Brian McDonald, a Managing Director in the M&A Group of Houlihan Lokey, an international investment bank, has some very positive views. Brian has been a banker for over 20 years, advising both publicly traded and privately held companies in various industries. He has advised on numerous cross-border transactions.

USAInbounddeals: Commentators have pointed out that the level of M&A activity in the United States for mid-market businesses was lower in 2009 that it had been for several years. Are you forecasting an increase in M&A activity involving mid-size U.S. businesses for the remainder of 2010 or 2011 over 2009’s activity level? Can you suggest what the reasons for any increase might be?

Brian McDonald: At Houlihan Lokey, we expect to see an increase in activity in 2010 and beyond, and we have already seen an increase in deal backlog. There is both pent up supply and pent up demand for transactions due to the lull in activity during the recent period of market disruption. Now that equity valuations have stabilized and the financing markets have begun to recover, we expect an uptick in M&A activity as buyers and sellers return to the market.

After the recent volatility in the equity markets, shareholders of family owned businesses are much more cognizant of the risks inherent in holding a significant portion of their net worth in illiquid stock of a single, small private company. Many such shareholders are now considering a sale, even though valuations are down from their pre-crisis highs. Also, long-term capital gains tax rates are expected to increase from 15% currently to at least 20% or 25% in 2011, providing an additional incentive for sellers to sell now rather than later.

Private equity sponsors with older vintage portfolio companies need to sell those companies to return cash to their limited partners, so the current stabilization in valuations provides an opportunity to market those transactions. Corporates are also rationalizing their portfolios and exploring divestitures to either deleverage or to redeploy capital in their core businesses.

Buyers also have a strong rationale to transact. Many large corporates have built up significant cash reserves by cutting expenses, reducing capital expenditures and reducing dividends. In 2009, many corporates were able to increase earnings even as revenues declined, because they reduced expenses significantly. This cannot be easily repeated in 2010. And since the economy is not expected to grow rapidly, these corporates will try to grow by using their cash reserves to make acquisitions.

USAInbounddeals: If you believe that an increase will occur, are you predicting an increase in the activity level of foreign-based buyers (including their existing U.S. businesses) in the U.S. market? Are you willing to estimate how significant this increase might be?

Brian McDonald: In recent years, foreign buyers have increasingly been active in the U.S. middle market. We believe that their demand for U.S. businesses will further increase in 2010 for a couple of reasons. First, the U.S. economy is expected to recover from its recession sooner and more rapidly than Europe. Therefore, European buyers will likely continue to look to the U.S. for growth acquisitions. Also, the recent sustained appreciation of the Euro relative to the dollar appears to be headed towards a reversal, particularly with the fiscal crisis in Greece. If European buyers conclude that their window for buying U.S. assets at “sale” prices will soon be closing, they may decide to jump in before the window closes.

Asian buyers, particularly Japanese and Chinese buyers, have also been active, but less consistently. We expect buyers from these countries to continue to appear in select middle market transactions.

USAInbounddeals: Do you believe that specific U.S. industries are more likely to see increased interest from foreign investors or buyers? What might those industries be?

Brian McDonald: We have seen the most foreign buyer interest in the industrial sector, real estate, and infrastructure services and materials.

USAInbounddeals: Are sell-side clients actively asking you to seek out foreign buyer interest?

Brian McDonald: Yes. Sell-side clients often seek foreign buyers for several reasons. Most importantly, sellers want to maximize value and they recognize that foreign buyers can often pay more due to a strong currency or unique strategic considerations. If a foreign buyer views a U.S. business as a way to establish a platform in the U.S. or gain access to U.S. distribution channels, they may place a significantly higher value on the acquisition than a U.S. acquirer would.

Another reason sellers like foreign buyers is that they often represent the least disruptive buyer for the employees. If the buyer does not already have a U.S. business with which to integrate the acquisition, the buyer will typically retain most employees.

USAInbounddeals: Are you aware of any concerns in the M&A marketplace that the U.S. government’s screening of inbound deals makes them more difficult to complete?

Brian McDonald: Yes. Companies that service the defense sector or that sell directly to the government are often reluctant to include buyers from sensitive countries on their buyers list. Even if the seller is willing to invite a foreign buyer into the sale process, some buyers are reluctant to participate if they are concerned that the U.S. government may reject the transaction due to national security concerns. We have even seen this behavior by private equity funds that have significant limited partner equity from countries in the Middle East, for example.

This article is intended for informational purposes only and reflects the opinion of Brian McDonald, a Managing Director in the M&A Group of Houlihan Lokey. The material presented reflects information known to the author at the time this article was written, and this information is subject to change.

About Houlihan Lokey

Houlihan Lokey provides a wide range of advisory services in the areas of mergers and acquisitions, financing, financial restructuring, and valuation. The firm was ranked the No. 1 M&A advisor for U.S. transactions under $3 billion in 2009 and the No. 1 U.S. fairness opinion advisor over the past 10 years by Thomson Reuters. In addition, the firm advised on more than 500 restructuring transactions valued in excess of $1.25 trillion over the past 10 years. Notable engagements cover numerous sectors and virtually all of the largest U.S. corporate bankruptcies, including Lehman Brothers, General Motors, WorldCom and Enron. The firm has more than 800 employees in 14 offices in the United States, Europe and Asia. Each year Houlihan Lokey serves more than 1,000 clients ranging from closely held companies to Global 500 corporations.

For more information on Houlihan Lokey, visit www.HL.com.

Are Britain's Business Leaders Seeking Shelter for Domestic Businesses from FDI?

Bill Newman — Fri, 12 Feb 2010 18:00:00 -0500

Kraft Foods’ acquisition of Cadbury PLC has led at least one prominent British policymaker and one prominent business leader to consider whether Britain should take steps they believe will discourage short-term investment in its companies and encourage long-term investment, as if the two can be distinguished. They are suggesting that legal and regulatory changes may be necessary to offset the market’s focus on short-term trading in favor of what they perceive as Britain’s need to retain the benefits of long-term investment. They appear to be advocating these changes without regard to the detrimental effects that their protectionist actions will have on worldwide foreign direct investment (FDI), including that originating in Britain.

In an opinion piece published in the Financial Times in mid-January, Peter Mandelson, Britain’s Secretary of State for Business, Innovation and Skills, asked what steps might be taken to better align the interests of short-term and long-term investors and the interests of the owners and managers of publicly listed companies. He argued that financial markets often separate financial assets from real assets, with the consequence that the trading of financial assets leads to insufficient recognition of the importance of real assets. Lord Mandelson convened a roundtable discussion with investors, fund managers and company executives to establish a dialogue between investors and management of the companies in which they invest. The implication is that the lack of alignment between these groups too often results in a takeover of a real asset which in turn leads to the loss of the business itself to Britain. Additionally, the inability to assemble a pool of “patient capital” may be at odds with Britain’s needs for new technologies and infrastructure investment.

Lord Mandelson made clear that he was displeased with the failure of mergers and acquisitions strategies to create additional long-term value during the past 20 years. Although acknowledging that M&A can create economies of scale and technology synergies, he advocated openness by acquirors with respect to their intentions and robust criticism by shareholders. It is difficult to disagree with his analysis of the problem. The recommendations for cure are quite another matter.

More recently, Roger Carr, the chairman of Cadbury who resigned on February 3, called for an overhaul of M&A regulation in the UK. Mr Carr is arguing that his country’s regulatory scheme for takeovers works against the long-term interests of British businesses. According to news reports, he cited takeover practices as predatory and stated that the current rules reward short-term traders at the expense of owners with longer-term views. He suggested that the rules had resulted in too many UK business being sold off to foreigners, and that the sale of a domestic business to a foreign business was a loss to the UK. His sentiments were plainly protectionist and sounded like those of a sore loser. He seems to have said little about those UK companies who have walked the globe, acquiring businesses for strategic and other reasons or those UK businesses, such as Cadbury itself, who build plants outside of the UK to enhance profits.

The thrust of the comments of both Lord Mandelson and Mr. Carr is that differentiation should be made between those who will hold their shares for the long term and those who will not. However, a requirement that shareholders be locked in or locked up means that investors give up their ability to sell their shares when the situation warrants. This stratagem shifts risk to shareholders, who will expect and in fact be entitled to a greater reward. These types of restrictions have existed in the past and have often allowed management to be less accountable to owners, since the owners cannot exercise their right to show their ultimate displeasure—by exiting their investment.

Ultimately, however, changes in risk allocation and the balance of management/owner power in one geographic market can disadvantage companies in that market in terms of global capital allocation. If investment in British companies is stickier than in U.S. or Australian companies, then British companies may well lose value in comparison with their non-British peers. Given choices, FDI will always seek investment opportunities that are less encumbered.

Then again, Lord Mandelson and Mr. Carr may believe that it is Britain’s best interest to erect a wall around its industry, buying some time to create Britain’s future. Deflecting foreign ownership will, however, likely lead to retaliation. It would not be surprising if other countries were to preclude British business from investing in or acquiring their businesses. Worse yet, it could lead to rounds of similar restrictions on investment in other developed countries and then to trade restrictions. This could have a disastrous effect on FDI and the strong world economy that has been developing since 1945, despite the shocks of 2008. Lord Mandelson and Mr. Carr could better serve their countrymen by leading UK businesses to build stockholder loyalty through the creation of true stockholder value and to be strong competitors in the world economy.

Does Firstgold Really Mean That CFIUS Has Gone Hostile?

Bill Newman — Tue, 26 Jan 2010 21:00:00 -0500

The withdrawal of the Chinese acquirer in Firstgold transaction has ignited a debate over whether U.S. investment policy has become more restrictive with respect to China. In fact, Firstgold is unlikely to be a reliable indicator of the policy or regulatory direction of the U.S. government. Firstgold presented an unusual set of facts, did not truly involve U.S. critical infrastructure and has little economic significance. The regulatory outcome was determined well before the blowup between Google and the Chinese government occurred earlier this month. Commentators should be wary before generalizing from the Firstgold outcome, as incorrect observations may reduce offshore investment interest in the U.S.

The Financial Times reported earlier this month in an article bylined by its Beijing-based reporter Kathrin Hille that Chinese companies are expecting tougher scrutiny in the United States. This change is linked to Google’s announcement that Chinese hackers had accessed its systems and those of 20 other companies. Google’s stand might affect both inbound investors and companies already present in the U.S. The article reported that the failure of the Firstgold investment is an indicator of the Obama administration’s enhanced scrutiny of Chinese investment infrastructure.

The Firstgold investment was not a conventional inbound investment. The company’s SEC reports contain unusual facts. Firstgold has been an exploration stage company with only minor operations since 1995. Its assets are principally property and equipment for gold prospecting at four sites in Nevada. It is financially distressed. Its audit included a going concern qualification. It must raise capital to survive. Its two hedge fund investors sued it for securities fraud 10 months after making their loans. The Chinese investor, Northwest Non-Ferrous International Investment Company Limited, intended to not merely invest in Firstgold, but to acquire the outstanding senior secured debt from the hedge funds, loan additional funds to Firstgold and invest enough to own 51% of the Company’s equity. The total investment package was valued at $26,500,000 but less than $10,000,000 was an equity investment in the company itself. Firstgold did not file its application with the Committee on Foreign Investment in the United States (CFIUS) until three months after the deal was first announced. Firstgold did have a property located in Fallon, Nevada, 50 miles from a U.S. Naval air facility that tests advanced weapons. It was this proximity that led the staff of CFIUS to conclude that there were national security concerns.

Firstgold’s assets are not critical infrastructure. The regulations promulgated under the Foreign Investment and National Security Act of 2007 define critical infrastructure to be an asset so vital to the United States that the incapacity or destruction of the particular asset would have a debilitating impact on national security. Firstgold’s assets do not satisfy that standard. Critical infrastructure is not an issue in the case.

Firstgold has no economic significance. In its 15-year history, it has produced no material revenues. Because it is not an active mining operation, it is not a factor in the local Nevada economy. Its debt is in default, and it is subject to foreclosure proceedings. The real importance of the transaction was the bailout of its lenders who thought they could offload their position at a favorable price. The value of Firstgold’s stock is questionable, since there are outstanding cheap warrants equal to 26% of the outstanding shares, a significant overhang. In fact, there was a period during 2009 where Firstgold’s stock could not be traded since it had failed to file its reports with the SEC.

On the other hand, it truly is difficult to understand what CFIUS gained from blocking this deal, in which case it may be that its action can only be a signal for a new hawkish outlook. In November 2008 CFIUS published a list of 11 illustrative factors that it will consider in determining whether a covered transaction poses national security risk. The Firstgold deal seems to present none of them. The CFIUS Guidance also discussed transactions that have presented national security considerations because of the nature of the U.S. business over which control is being acquired. Geographic location is not mentioned as a determinative factor. Because Firstgold has no products, it is not able to have products that may have implications for U.S. national security. It is possible that CFIUS determined that the buyer was acting on behalf of the Chinese government. If so, CFIUS never mentioned it. Therefore, if CFIUS intended to send a message, the message may be that a Chinese investor has the burden of proving it is not acting for the PRC government. Given the size of the transaction and the relative obscurity of the parties, however, it is difficult that CFIUS meant for its action to be considered a bellweather for other China-originated transactions.

It’s appropriate for the media to be alert to policy changes that result from Google’s startling announcement. Reading tea leaves is a tricky business, however, and in the world of commerce, the media should refrain from issuing baseless alarms when the U.S. economy is earnestly seeking foreign direct investment. The rational view is that, all in all, there was little compelling reason once the national security monitors raised doubt as to the real reason for the transaction, for CFIUS to permit the Firstgold deal to go ahead. Had there been some compelling showing that the deal had a rational basis as a business investment, CFIUS would have approved it.

FDI Issues to Track in 2010

Bill Newman — Tue, 12 Jan 2010 06:00:00 -0500

FDI promises to grow in importance to both developed and the developing economies in the new year. The world economy as a whole has not fully recovered from the slowdown of the past three years. What recovery has occurred has been selective, leading to stronger economies in some cases and leaving weaker economies in others. The imbalance suggests that opportunities for cross-border investments and M&A activities will abound and that those businesses, funds and individuals that have available capital will likely pursue them.

Heightened FDI activity will raise issues in the media, in academia and elsewhere. The issues that will garner the greatest attention are likely to be:

Protectionism. If there is a sudden, large upturn in FDI into developed economies, will more inbound transactions be challenged by regulatory authorities? At the end of 2009, the Obama administration prevented the acquisition of FirstGold by a Chinese acquirer on national security grounds. Will this be interpreted as protectionism disguised? CFIUS has rarely outright blocked deals in the past, so a moderate increase in number of challenged deals may well be interpreted as a change in political attitude. Complicating the assessment is that foreign buyers will likely be shopping for natural resources business and high technology firms – both of which may have assets that are inordinately valuable and difficult to find elsewhere. These values may raise the stakes to investee nations when control of these assets is shifted offshore.
Credit Squeeze. Buyers and investors with strong credit lines will likely be very attractive to targets who are starved for debt and equity capital. Distressed assets are in strong supply and can often be revitalized with infusions from capital from new owners with adequate capital supplies. Will buyers and investors remain disciplined and limit their capital at risk, or will there be “shopping sprees” as holdout sellers give up, price spreads narrow and well-endowed players run the table?
FDI Extends the Service Sector. Economies that have built their capacities and economic fortunes on exports of manufactured goods with price advantages will seek to compete more aggressively by incorporating more of the value chain into their enterprises. They may wish to acquire design capability and marketing interface directly with their ultimate customers. Confronted with the question of “buy or build,” some businesses will look to acquire or invest in businesses that provide those services. This means businesses whose assets go home at night. From an operational perspective, this will raise issues of conflicting corporate cultures. Return on investments into service companies can also be more difficult to measure than investments in hard assets. The range of results on these deals will likely be broader than in other investments.
Developed Assets More Desirable. For investors in the U.S. and Europe, assets – both hard and soft – that are developed and therefore require minimal additional expenditure, are likely to be more desirable than those requiring considerable additional investment. Consequently, in both developed and developing economies, greenfield investments may have a difficult time competing for investment capital. For outbound investors in China – where capital appears to be less constrained and risk tolerance may be greater – greenfield investments in the energy and agricultural sectors will remain top priorities. There may be a strong divergence that is building, with those economies and businesses in need of significant capital infusions turning away from investors in the developed nations and looking almost exclusively to investors in emerging economies.
What Direction for Global M&A? The year 2009 brought a large number of strategic cross-border mergers and acquisitions, many with high profiles. The trend toward consolidation within industries will accelerate – the Kraft/Cadbury transaction being the poster child for these deals. Absent from the space at this time are the financial players, such as the private equity funds who have relied on leverage to complete their acquisitions and generate their returns. Will private equity and other private investors step back into the ring before credit has become more available, or will financial deals continue to lag strategic deals? The lack of clarity ahead for many businesses also adds uncertainty regarding valuation and pricing. With these factors taken all together, the return of robust cross-border M&A transactions does not seem imminent.

If we gain information on these FDI issues in the next six months, then the last half of 2010 may appear to be more predictable, especially if it is more in line with past trends. Given the change in direction that 2008 and 2009 brought compared to the immediately preceding years, any predictions – at any point – may deny the reality that volatility persists, even in FDI.

FDI Trends and Policies Tracked in New UNCTAD Publications

Bill Newman — Thu, 31 Dec 2009 09:36:57 -0500

Earlier this month the United Nations Conference on Trade and Development released two significant new publications. On December 1, UNCTAD released its inital Global Investment Trends Monitor. The publication reported data on global foreign direct investment (FDI) for the second and third quarters of 2009. On December 4, the UNCTAD Secretariat published its first Investment Policy Monitor. The aim of the Monitor is to provide the international investment community with current developments in foreign investment policies at both the national and international levels.

UNCTAD intends to publish its Investment Trends Monitor quarterly to provide the international investment community with regular assessments of global FDI. UNCTAD has developed its own index to measure FDI, based on FDI data for 67 economies that comprise 90% of FDI flows. The Investment Trends Monitor recorded an increase in global FDI from Q1 to Q2 of 2009. Specifically, the index rose 65% to 115 on a quarter-over-quarter basis. The increase was the first posted in five consecutive quarters. The G20 countries alone produced a 38% increase, according to the Index, but the increase affected only certain countries in the G20. Increases in the emerging economies were more limited. The Monitor warns that a full global recovery might not yet be underway, citing two reasons. First, cross-border global M&A was flat during the first three quarters of 2009. Second, the number of international, greenfield investment projects declined for the fifth consecutive quarter. The publication predicts that FDI flows for the third quarter will not show material improvement and will remain significantly below the year-earlier levels, but offers the optimistic prediction that “the overall environment for international investment is slowly improving.”

The Investment Policy Monitor assesses the national policy frameworks reflecting attitudes toward FDI. The report notes that during 2009 the majority of the 51 changes analyzed were for the “liberalization, facilitation and promotion” of inbound FDI. The report interprets this majority to mean that countries continue to believe that FDI is a means to finance their economic recoveries and promote their economic growth. The remainder of the changes included prohibition of foreign participation in certain industries, modifications to screening requirements and tightenings of regimes on investments that may relate to national security. The analysis differentiates between changes in the G20 countries and in non-G20 countries. The Investment Policy Monitor also follows changes in the general legal framework relevant to foreign investors in taxation regimes, state aid and stimulus packages. The report notes that between July and November 2009, 34 countries undertook measures related to foreign investment and 31 enacted state aid or stimulus packages or otherwise enhanced earlier such initiatives. Also included are new international investment agreements (including bilateral investment treaties) and double taxation treaties. All together, 82 economies were direct parties to new agreements in 2009.

Both publications include useful hard data and metrics and, for that reason alone, should prove exceedingly useful in the months ahead as FDI participates in and generates the expected global recovery.

UNCTAD was established in 1964 with the goal of promoting sustainable development while integrating developing countries into the world economy.

CFIUS Finds the Headlines in a Golden Investment Deal

Bill Newman — Mon, 21 Dec 2009 16:53:52 -0500

A relatively small proposed investment in Firstgold Corp. of Lovelock, Nevada, a development stage mining company, has lead to a flurry of press coverage of the refusal by the U.S. Treasury’s Committee on Foreign Investment in the United States (CFIUS) to permit the deal.

The proposed investor is Northwest Non-Ferrous International Investment Company Limited of Xi’an, China. Firstgold is a small-cap, financially-challenged gold mining business with four tracts in Nevada, but little operating history—in its own words, “a junior mining and exploration company.” The deal size has not been disclosed and may be less than $10 million. The deal structure involves three parts—the acquisition of senior secured debt from a disgruntled private investor, an additional loan to Firstgold and a purchase of a control equity stake, making Northwest both Firstgold’s parent and secured lender. The deal was first announced in July 2009. The parties did not make their CFIUS filing until late September.

After both a review and an investigation, CFIUS is recommending that the President disapprove the transaction. According to CNNMoney’s report, CFIUS apparently based its rejection on the proximity of one of Firstgold’s properties to Fallon Naval Air Station and offered several mitigation possibilities, none of which Firstgold accepted. The company states that the air base is 50 miles away.

There is other speculation that the investor would use Firstgold’s gold assets—even if undeveloped at this point—to add to China’s hoard of gold, now totaling a staggering estimated $1.95 trillion. China’s gold reserves exceed Switzerland’s.

Other news reports and blogs covering the development include:

This blog, in its October 1 post, alerted readers to the possibility of an unfavorable CFIUS outcome. We noted that management did not seem to approach the CFIUS filing with seriousness and as recently as October had predicted that its CFIUS filing would not be problematic.

The furor surrounding this development has an interesting footnote. The California Gold Rush of 1848-52 began with the discovery on gold on Mexican soil, specifically on land owned by a Swiss farmer, John Sutter—and ultimately led to the annexation of California by the United States. So there may well be historical precedent for the concerns of CFIUS.

Updated On December 22, Northwest withdrew from the transaction, Reuters announced. Therefore, President Obama will not have to take direct action to disapprove the deal.

Fiction vs. Fact in Tales of Foreign Direct Investment

Bill Newman — Fri, 18 Dec 2009 18:18:50 -0500

Foreign direct investment has often created dismay and resistance in the investee nation. Self-appointed pundits may try to gain populist following by decrying the sale of local assets to foreign buyers with no regard to the historic contribution foreign ownership has made to the growth of their own economies.

Governmental regulation of foreign direct investment is implemented in part to allay these emotions by screening out those investments judged harmful according to legislated standards. It therefore is counterintuitive when the exercise of regulatory power to screen foreign direct investment also inspires equally ill-tempered reactions. Often, the sound and fury of those reactions do not withstand factual analysis, especially when journalists seek to stir the pot of public emotions.

Take, for example, “US inquiry into sale of Virgin Galactic stake to Arab investor” which appeared in the online version of The Times of London earlier this week, written by Abu Dhabi based-reporter David Robertson. The Rocketeers and ParabolicArc blogs posted the same story. The story questions why the U.S. has elected to subject the proposed sale of a 32% stake in Sir Richard Branson’s privately-held space travel venture to Abu Dhabi-based Aabar Investments for $280 million to “a national security investigation” and whether the investigation genuinely serves the legitimate interests of the United States.

Virgin Galactic and Aabar Investments had originally announced their deal in July 2009. The deal includes not only the equity investment but also Aabar’s commitment to fund a small satellite launch capability.

Timesonline does not point out that the Committee on Foreign Investment in the United States (CFIUS), has reviewed over 300 transactions during the three years ended December 31, 2008 or that filings with CFIUS that seek its review are optional. However, CFIUS may initiate its own review of inbound transactions and, if it finds that a transaction may adversely affect U.S. national security, it can take remedial steps, including rescission. As a result, a prudent inbound investor and its investee will seek CFIUS review to insure that the transaction is permanently settled. Review is the first level of the regulatory process. Investigation is the second level. If review of a filing finds that the transaction could result in control of a U.S. business by an entity that is controlled by a foreign government, then FINSA and its regulations require an investigation unless CFIUS otherwise determines. Given this legal framework, CFIUS could have had sound reasons for subjecting Virgin’s deal to the second level of investigation. The fact that there is an investigation does not, however, suggest that the outcome will be adverse to Aabar.

The Timesonline report suggests that investors in the Arab Middle East will become concerned that their investments in the U.S. are subject to CFIUS review. According to the public version of the CFIUS annual report released last month, during 2006, 2007 and 2008, 11 transactions involving UAE investors or acquirers were filed for CFIUS review. During the same period, 14 transactions from Bahrain, Kuwait, Lebanon, Qatar and Saudi Arabia were filed. Deals originating in Saudi Arabia alone comprised 7% of the total value of completed transactions. Without regard to this body of facts, the writer drags up the divestiture outcome that followed Dubai World’s acquisition of P&O, a deal that CFIUS found did not impair national security and that did close.

It certainly is legitimate to argue that the statute that CFIUS enforces has an incorrect premise with regard to government-controlled entities. It also is legitimate to argue that the term “national security” is not sufficient well-defined and gives CFIUS too much discretion and the overwhelmingly powerful argument is that Sir Richard Branson is not very likely to have transferred control of Virgin Galactic, despite the size of Aabar’s investment. But, in a government where the legislative branch makes the laws and the executive branch is charged with carrying out those laws, CFIUS is performing as it must. Moreover, CFIUS has taken steps to make the public aware of its views by publishing guidance regarding the types of transactions that it has reviewed and that have presented national security implications.

There is an additional fact that would have put much of this faux fury into perspective. Aabar now owns 4% of U.S.-based Tesla Motors, the electric car company that is a contender to lead the United States into the age of the electric car. In July 2009, Aabar acquired its investment stake in Tesla from Daimler. Because of the confidentiality of the proceedings of CFIUS, there is no way to know whether CFIUS reviewed the transactions that led to Aabar’s stockholding in Tesla. At a minimum, Aabar and its controlling family are not strangers to CFIUS. They have been welcomed into the U.S. in the past and no doubt they will be welcomed here again.

The New York Times coverage of the Virgin Galactic deal, published today, is infinitely more balanced and informative. Reporter Eric Lipton went into the subtleties and difficulties that underlie regulatory judgments regarding FDI. Factual reportage supports constructive public debate that can lead to public policies that enable FDI to produce its best results.

Fiction vs. Fact in Tales of Foreign Direct Investment

Bill Newman — Fri, 18 Dec 2009 18:18:50 -0500

To Bring FDI from China, U.S. Policymakers and Regulators Must Align

Bill Newman — Mon, 07 Dec 2009 09:51:57 -0500

Will President Obama’s recent trip to China product any inbound FDI results for the U.S.? According to the U.S.-China joint statement, the November 16-18 trip produced significant agreements in five key areas of bilateral interest. There were tangential, but not explicit, mentions of FDI into the U.S. either by way of mergers and acquisitions or Greenfield investments.

Judging from the tenor and substance of the joint statement, the meetings further developed the mutual confidence and trust that are the predicates for a favorable investment climate. The five key areas of agreement were:

The importance and productivity of regular high-level exchanges to the growth of the overall U.S.-China relationship
The building of a bilateral strategic relationship that is positive, cooperative and comprehensive
Strengthened dialogue and cooperation on macro-economic policies leading to global recovery
Shared responsibility to cooperatively address regional and global security challenges
Vigorous responses to issues of climate change, energy and environment

The joint statement implicitly references the importance of FDI at several points. There was express recognition of the importance of the U.S.-China Strategic and Economic Dialogue. “Both sides believed that the first round of the Dialogue held in Washington, D.C., in July this year was a fruitful one and agreed to honor in good faith the commitments made and hold the second round in Beijing in the summer of 2010.” The bottom line is that the U.S.-China FDI relationship appears well and growing and on track to produce results. Those results may not be evident until later next year.

Further, while addressing the need to support the global recovery, the statement made clear that both sides are committed to open trade and to jointly fight protectionism and to resolve bilateral trade and investment disputes. The joint statement articulated the explicit promise of the U.S. and China “to expedite negotiation on a bilateral investment treaty.”

Prior to the release of the joint statement, reports had appeared in the Chinese press, notably the South China Morning Post, that a specific agreement would be reached to promote acquisitions of small and mid-size U.S. financial institutions by Chinese lenders. No such agreement or memorandum of understanding appears to have emerged from Obama’s visit.

A recent transaction involving a proposed takeover by China’s Minsheng Bank of failed California-based bank, UCBH Holdings, illustrates the formidable difficulties to be overcome if U.S. regulators intend to encourage Chinese lenders to invest in U.S. banks. Minsheng Bank had acquired a 9.9% interest in UCBH in 2007 and recently raised US$3.86 billion in its initial public offering in China. According to a report in The Wall Street Journal, Minsheng Bank also sought to acquire United Commercial Bank before U.S. authorities closed the San Francisco-based lender earlier this month.

UCBH operated the United Commercial Bank, with several branches in California and also in other key Chinese American areas, such as New York, Boston, Seattle, Atlanta and Houston. United Commercial suffered commercial lending losses from loans to developers and home builders during the housing boom. A financial scandal led to a management shake-up.

The Federal Reserve rejected China Minsheng's proposal to buy United Commercial Bank because of regulatory restrictions on foreign investment in U.S. banks and instead closed the bank. Soon after the closure, East West Bank, based in Pasadena, California, took over United Commercial Bank's roughly $7.5 billion in deposits, as well as $10.2 billion in assets. The Los Angeles Times reports that its takeover of UCBH will greatly expand its reach of East West, which has concentrated on Southern California and the San Francisco Bay Area. Interestingly, East West has a full-service branches in Hong Kong.

The plain result of the regulatory actions is that a domestic bank with no interest in UCBH was permitted to acquire the business, while a foreign bank that always was a part owner of UCBH was not. The broader implication seems to be that any federal policy determined to promote inbound FDI will have to be based on a full and complete alignment of regulatory agencies at all levels. Otherwise, well-intentioned policies will be incapable of being executed.

Huawei Technologies Ascends Despite 2008 CFIUS Turndown

Bill Newman — Wed, 02 Dec 2009 10:00:00 -0500

In the U.S. press, almost all mention of Huawei Technologies recites like a mantra the 2008 refusal by the Committee on Foreign Investment in the United States (CFIUS) to permit it to participate with Bain Capital’s in Bain's proposed acquisition of 3Com Corporation. The consensus line is that CFIUS determined that Huawei’s connections with the government of the People’s Republic of China might have been too strong and therefore refused to approve the deal. The failed transaction is often cited as evidence that the U.S. government will not permit Chinese investment in or acquisition of U.S. high technology businesses. Experts contend that the outcome continues to dissuade Chinese investors from acquisitions of U.S. businesses.

According to an article by Kevin J. O’Brien in the New York Times on November 30, however, Huawei has in a remarkably short timeframe become a communications equipment powerhouse without the 3Com acquisition and now wields significant market power both with China's mobile networks and around the globe.

According to the article, Huawei now is established as a serious competitor, winning contracts from major phone networks in Europe and elsewhere on the globe, beating the likes of Ericsson and Nokia Siemens Networks. Huawei has a 20.1% market share of the global equipment market. It ranks as the number 2 supplier of mobile phone systems in the world. Its quarterly sales now are greater than Alcatel-Lucent and Nokia Siemens. It supplies 36 of the top 50 mobile operators, including Cox Communications, Leap and Clearwire in the U.S. The article reports that customers have investigated the ownership of Huwaei, said to be a private company, and concluded that its ownership would not be a factor.

It seems likely that U.S. companies will increasingly become customers of Huawei because of its versatile products and their low cost of operation. Huawei has obviously found a way to prosper here and elsewhere–even if the U.S. government did not think it a suitable owner for a U.S. business. It’s not clear whether the CFIUS decision produced any long-term benefit here at all. And it’s certainly not clear from what national security risk CFIUS protected the U.S.

The ascension of Huawei to prime global competitor status illustrates that a robust multinational high technology enterprise does not need a U.S. base, whether bought or built. Regrettably, it also demonstrates that as a result of the CFIUS decision, the U.S. has lost out on direct contributions to its economy through jobs, purchases from local U.S. vendors and the use of U.S-created R&D.

Nationalist Sentiment vs. FDI: Bharti Airtel Leads to Important Questions re: Candid Policy Toward FDI

Bill Newman — Mon, 02 Nov 2009 10:00:00 -0500

The proposed business combination between India’s Bharti Airtel and South Africa’s MTN Group collapsed at the beginning of last month. Local and international politics appear to have played a substantial role in its demise. Therefore, some important questions should be posed. To what extent was the collapse a result of nationalism or protectionism masquerading as a different public policy? Is the withdrawal of that deal evidence of a wider global trend that may make foreign direct investment (FDI) more difficult to execute? As government stimulus programs end, will governments—U.S. and otherwise—use their power to shield companies that have been nursed through the downturn from foreign takeovers?

Bharti is Asia’s leading integrated telecom services provider, with operations in India and Sri Lanka. MTN is South Africa’s leading mobile and fixed-line telecom company, with over 100 million subscribers and operations in over 20 countries in Africa and the Middle East. Their proposed combination was negotiated from the end of May to the end of September and had a value of approximately $24 billion. Bharti would have received a 49% stake in MTN, while MTN and its shareholders would have received a 36% stake in Bharti. The combined enterprise would have been the world’s third largest telecom company.

The ominous notes for FDI come from reports in Dealbook and elsewhere that the South African government failed to approve the transaction because of protectionism and nation-building policies. This outcome was not necessarily predictable because both the Indian and South African governments have supported increased trade among developing countries in sub-Saharan Africa and South Asia. That “South–South” trade is intended to offset growing Chinese economic influence in the region.

Dealbook also reported that interventions by both Indian and South African governments imposed conditions that led to the end of the deal. The South African government required that MTN keep South African management in place and maintain a listing on the Johannesburg stock exchange in addition to its listing on the Mumbai exchange. Indian financial regulators were unwilling to waive their rules against dual listings.

The South African blog SAgoodnews pointed out that there is a long history of dual listed companies and saw no reason why that requirement should have been terminal for the transaction. The blog also dismisses arguments that national political and labor pressures were at fault.

The Indian blog Trak.in News asserts that the Indian government had backed the deal at the highest level, with Prime Minister Manmohan Singh expressly giving the combination his support. The blog also suggests that the real issue was whether the national character of the combined business would be Indian of South African. South Africa’s insistence on the dual listing was a cover for this point. On the other side, the Indian authorities believed, but seem not to have stated, that the dual listing would effectively set a conversion rate for the rupee that could differ from the official rate of exchange.

Both companies’ share prices rose after termination was announced. Stock analysts who had trepidations were pleased to see the transaction crater. It therefore is possible that, in addition to political agendas, there were financial issues underlying the headline events. Investors may not have been as supportive of the transaction as were the managements of Bharti and MTN.

After September 30, both governments issued the usual palliatives, saying that they remain open for business and underscoring the importance of FDI. Rather than helping business decide whether to pursue cross-border deals in emerging economies, however, these positions and unarticulated rationales only obscure the facts. The recovery from the worldwide turndown is in its early stages. Obfuscations and half-truths do not bring recovery any nearer, as they only add uncertainty where business strategists would prefer to deal with articulated policies and certainties.

What is true for developing economies such as South Africa and India is also true for the United States. Efforts to generate inbound investment must be very transparent and free from hidden conditions. Actual decisions and measures must align with policy pronouncements. In an environment in which the U.S. is hotly competing with other countries for inbound FDI, the U.S. government cannot afford to be less than utterly committed to inbound investors. Anything less will lead those investors to look for greener pastures—a lesson that South Africa may yet learn.

Will Inbound M&A Transactions Emanate from Russia?

Bill Newman — Fri, 23 Oct 2009 10:49:17 -0500

Although multinational enterprises (MNEs) from developed economies are likely to provide substantial outbound foreign direct investment to the United States by way of M&A transactions, buyers from other nations are gaining presence. The role of Russian MNEs and investors as buyers may be increasing.

A publication earlier this month by the Vale Columbia Center quantifies the importance of Russia as a source of outbound foreign direct investment (OFDI) for the United States and other developed nations. Professor Andrei Panibratov, Associate Professor of the Graduate School of Management of Saint Petersburg State University, and Kalman Kalotay, Economic Affairs Officer at UNCTAD in Geneva, Switzerland, authored the profile to highlight the increasing importance of Russia’s FDI program. The profile demonstrates that Russian direct investors are continuing to penetrate foreign markets and undergo a process of internationalization. The authors suggest that a carefully considered policy from Russia’s government would significantly enhance the benefits to Russia from its OFDI.

According to the publication, various motives drive Russian OFDI:

The desire of managers and owners to control or offset Russia’s political and economic risks
Expected profitability of the investments themselves
Expectations for better global recognition

Although Russia’s OFDI fell by 15% in the first quarter of 2009, compared with the first quarter of 2009, at the end of 2008 Russia held the second largest stock of foreign direct investments among the emerging economies, aggregating US $203 billion. This stock exceeds the investments held by Brazilian, Chinese and Indian multinationals. Between 1995 and 2007, Russia’s offshore investments grew more rapidly than did the investments of Brazil, China and India. Mergers and acquisitions by Russia’s multinationals from January 2005 through June 2008 were over ten times the volume during the 2001 through 2004 period. There are 50 to 60 Russian multinationals that account for a significant part of offshore acquisitions. The total number of Russian MNEs investing offshore exceeds 1,000, the authors believe.

Among the 2009 inbound U.S. transactions was the purchase by Trubnaya Metallurgicheskaya Kompaniya OAO (TNK) of a 49% interest in Kentucky-based NS Group Inc. for an undisclosed amount. NS Group is a manufacturer of tubular goods.

It’s worth noting that the 2007 acquisition of publicly-owned Oregon Steel Mills by Evraz Group SA, a Luxembourg company with Russian affiliation, cleared the Committee on Foreign Investment in the United States (CFIUS) without much apparent problem, unlike transactions originating in other emerging market economies. Most of these business operate in the oil and gas, metallurgy, finance and communications industries.

All of which suggests that Russia may provide fertile soil for inbound deals.

The report is the first in a series of Columbia FDI Profiles that the Vale Columbia Center on Sustainable International Investment has recently launched. Material in this post is reprinted with permission from the Center (www.vcc.columbia.edu).

Possible Cnooc Oil Lease Acquisition Leads to Speculation over CFIUS Involvement

Bill Newman — Tue, 20 Oct 2009 11:22:49 -0500

Late last week reports surfaced that the China National Offshore Oil Corporation (Cnooc), China’s state-owned energy company, was in unconfirmed discussions with Norway’s StatoilHydro ASA to acquire oil lease interests in the Gulf of Mexico. A completed transaction would open up oil reserves in the U.S. Gulf to China for the first time. The fact that a Chinese company is involved has led to speculation whether the U.S. will resist this particular foreign direct investment, recalling the political furor that resulted in Cnooc’s unsuccessful 2005 bid to acquire Unocal Corp.

Environmental Capital blog linked to a Wall Street Journal’s report that StatoilHydro had put five prospects up for sale, a small portion of its Gulf of Mexico assets. The Financial Times wrote that the transaction would have a value of approximately $100 million and that the proceeds would be used to cover the costs of drilling wells rather than to obtain acreage. According to Energy-pedia, StatoilHydro will remain majority owner of any projects for which it brings in partners, noting that oil companies typically offer partnerships in large exploration projects to help pay for drilling and spread risk.

Generating alarmism, Business Insider first claims that China’s overseas acquisition program is approaching the U.S. and then becomes somewhat more balanced:

[T]he political tides have changed. In 2005, it was easy to block investments on political grounds, because there was no shortage of cash. Plus, this is just a few leases -- putting their toe in the water, it looks like -- not an $18.5 billion bid for a U.S. company.

Still expect all kinds of howls before this goes through.

Assume that the media has accurately outlined the transaction. Will the transaction between StatoilHydro and Cnooc be a “covered transaction” under the Foreign Investment and National Security Act of 2007 (FINSA)? If so, will the parties then make a voluntary filing with the Committee on Foreign Investment in the United States (CFIUS)?

Not every transaction involving a non-U.S. investor and a U.S. business is subject to FINSA. Only a transaction that “could result in control of a U.S. business by a foreign person” is. A transaction that satisfies this transfer of control test is a “covered transaction.” But not every “covered transaction” is subject to FINSA. The general structure of FINSA is that parties to a covered transaction may file a notice with CFIUS for its review and, possibly, further investigation or Presidential action. If the parties do not file a notice, then CFIUS can block the transaction or later unwind it. The purpose of the CFIUS review and investigation is to determine whether the proposed transaction might impair U.S. national security.

CFIUS has published regulations that detail the coverage of FINSA, the review process and the contents of the voluntary filing. Applying the facts of the Cnooc discussions to the regulations produces some interesting results:

Does the fact that a Norwegian entity owns the oil leases save the deal from regulatory review? No. A U.S. business is subject to the regulations and to FINSA regardless of the nationality of the person that controls it.^[1]

Are the oil leases a U.S. business? To be a U.S. business, the leases must be an entity engaged in interstate commerce in the United States.^[2] Are they? The regulations define “entity” to include “assets (whether or not organized as a separate legal entity) operated by any [other entity] as a business undertaking in a particular location or for particular products or services.”^[3] Therefore, the leases could be an “entity.”

If the leases are an entity, is the entity engaged in interstate commerce in the United States? The wells are offshore, and not located within the boundaries of any state of the United States, as can be seen from the map published by Energy-pedia. The media coverage says that the leases are located in the “U.S. Gulf.” Is that a state or is it not?

Also, since the wells appear to not yet be operating, are the assets engaged in any commerce at all?

Under the regulations, certain transactions are not covered transactions, including the “acquisition of any part of an entity or of assets, if such part of an entity or assets do not constitute a U.S. business.”^[4] There is an example in the regulation of a foreign person acquiring individual discrete assets -- including land -- from a U.S. business. The example concludes that the acquisition is not a covered transaction.

If its purpose is to finance drilling, rather than to obtain acreage, then the proposed transaction is an investment, not an acquisition. FINSA, however, applies to investments if control is tranferred. The structure of the deal may be that Cnooc will obtain lease interests. If these interests do not have rights to vote for directors or vote on other matters affecting the entity, then the interests are not voting interests and there may be no “control” aspect to the transaction at all.^[5]

Lastly, if Cnooc is acquiring interests from StatoilHydro without any intent to exercise control, then Cnooc may be acquiring the interests or the leases “solely for the purpose of passive investment,” and the investment may be exempt from FINSA on that basis.^[6] The observation that StatoilHydro intends to remain in operating control supports this view.

Overall, there could be several bases for the legal conclusion that the proposed deal would not be a covered transaction under FINSA. Cnooc and StatoilHydro will no doubt take their own business assessment of their situation. It will be interesting to see if the views coalesce or diverge.

All references are to Sections of the CFIUS regulations:

^[1] Section 226

^[2] Section 226

^[3] Section 211

^[4] Section 302(c)

^[5] Section 228

^[6] Section 302(b)

Canadian Regulation of Inbound M&A and Other FDI Strongly Resembles CFIUS

Bill Newman — Fri, 16 Oct 2009 09:54:56 -0500

If imitation is the sincerest form of flattery, then the architects of the Foreign Investment and National Security Act of 2007 (FINSA) and its regulatory agency CFIUS can be proud. The Canadian government is revising its Investment Canada regulatory scheme. The result resembles the regulatory system here south of the Canadian border.

Recent Canadian statutory enactments and proposed regulations introduced a new national security review mechanism into the screening process. In 2007, FINSA amended the then-existing U.S. statute, known as Exon-Florio, to specify that national security was to be the sole focus of U.S. regulation. The new Canadian structure authorizes the government to review, block or limit inbound investments by non-Canadians based on national security concerns. One commentator has noted that although the legislation does not define “national security,” it remains to be seen whether the regulators will also consider issues of economic security under the national security umbrella.

Under the new regime, Canada’s national security process starts with a preliminary review of the transaction. If the initial review indicates that there are national security concerns arising from the proposed deal, then the Cabinet reviews and determines whether a full review is required. The review applies the standard, “injurious to national security.” If the transaction fails that standard, then the government may order the transaction blocked, restricted or, if closed, unwound. The maximum length of the review is approximately 3 ½ months. Once the time for review has expired, the Canadian regulators cannot challenge a reviewable foreign investment on national security grounds.

Under the legislation the government retains the authority to initiate a review of non-reviewable transactions, including minority investments, at any time within 45 days after completion.

Recent statutory changes will significantly modify the monetary thresholds for review of inbound transactions. If and when the proposed regulatory changes are made, the threshold will be applied to the enterprise value of the target, not the book value of its assets as is currently the case. The threshold itself is set at enterprise value of Cdn $600 million and will increase to Cdn $1 billion over the next four years.

FINSA and CFIUS are, of course, not the only national security-based regulatory schemes in place today. China, France, Germany, Japan, Poland, Russia and the United Kingdom, among others, based their regulatory reviews of inbound deals on national security grounds.

Canada is frequently mentioned together with Australia as the leading developed, resource-rich nations that are targeted for foreign investment by China and others aggressively looking to source commodities. Australia, by contrast, recently revamped its FDI regulatory scheme to limit the range of deals subject to review. Like Canada, it raised the threshold for review. That change and others are reviewed by our recent August 13 posting in this blog.

Unlike Canada, Australia did not adopt a regulatory scheme that specifically vets national security issues.

For a discussion of the role of national security in the CFIUS review process, please access the white paper located on our firm’s Web site.

Howard Burshtein of Torkin Manes LLP, Toronto, Ontario, contributed to this post.

Will CFIUS Review Inbound M&A Transaction to Acquire Hummer?

Bill Newman — Tue, 13 Oct 2009 06:00:00 -0500

In a headline-grabbing inbound acquisition deal, General Motors Corp. and Sichuan Tengzhong Heavy Industrial Machinery have reportedly reached definite agreement on the terms of the sale of GM’s Hummer Brand by early 2010 for approximately $150 million. According to a Reuters report appearing in The New York Times, Tengzhong has begun to seek Chinese regulatory approval for its purchase of the Hummer brand, Hummer trademark and manufacturing expertise. The report surmises that three Chinese regulatory bodies – the Ministry of Commerce, the National Development and Reform Commission and the Ministry of Industry and Information Technology. In our post of last June 15, we noted that Chinese regulators could have a significant role in the purchase.

There also are questions as to what U.S. regulatory approvals may be required. Reuters reports that approvals from U.S. regulators are required, but doesn’t specify which regulators. Although far reduced in size from the original $500 million estimate, the $150 million price exceeds the minimum size for filing with the antitrust regulators in the Department of Justice and the Federal Trade Commission. There seem to be few tangible assets changing hands – no plants, no real estate, no equipment. The reports suggest that only intangibles are being bought and sold. Therefore, the key question becomes whether the parties have obligated themselves to make a voluntary filing with CFIUS. In posts earlier this year, we raised the question of whether sales of U.S.-based automotive businesses to offshore buyers would trigger review under the Foreign Investment and National Security Act of 2007 (FINSA). Review under that statute could interpose a 30-day review period plus an additional 45-day period if an investigation is warranted. The descriptions of the deal, structured as the purchase and sale of intellectual property whose value lies in the marketing of the product and certain manufacturing rights, suggests that the parties have taken reasonable steps to minimize those factors that could lead to an adverse regulatory outcome.

It even is possible that GM, Tengzhong and their advisors are so confident of their structure that they will elect not to make the filing with CFIUS which, after all, is voluntary. The deal apparently has provisions that will save 3,000 U.S. jobs through 2011. It may be unlikely that a U.S. regulatory body will risk adding those workers to the already sizeable portion of the workforce that is unemployed. Although there could be regulatory risk, it may not be high for GM. CFIUS could, however, have an interest in fully analyzing the ownership and business relationships of Tengzhong and its 20% partner, Suolang Duoji, to determine whether there could be control by the PRC government.

GM has not yet filed the definitive agreement with the Securities and Exchange Commission. Under SEC rules it has until later the week to file the agreement if it is “material” agreement. Once filed, a review of the agreement should disclose whether the parties will make their voluntary CFIUS filing.

Government Contracting with Inverted Domestic Corporations: Forget About It!

John Howell — Tue, 06 Oct 2009 13:54:53 -0500

We wanted to alert you to a recent development that may be of interest to the FDI community. On July 1, 2009, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council issued an interim rule prohibiting the award of U.S. government contracts using appropriated funds to any foreign incorporated entity that is treated as an inverted domestic corporation or to any subsidiary of one. The rule implements Section 743 of Division D of the Omnibus Appropriations Act, 2009 (Public Law No. 111-8). The Department of Homeland Security (“DHS”) has had a similar rule since December 2003, but the new interim rule applies to all federal agencies.

Briefly put, an inverted domestic corporation is one that (1) used to be incorporated in the United States or used to be a partnership in the United States but now (2) is incorporated in a foreign country or is a subsidiary whose parent corporation is incorporated in a foreign country. Congress enacted Section 743 – as well as an earlier tax statute – to discourage would-be corporate expatriates from trying to avoid United States taxes on business income generated in foreign countries by incorporating in “tax havens” such as Bermuda, Barbados and the Cayman Islands.

Section 743 borrows the definition of “inverted domestic corporation” from the DHS statute, which in turn is related to the tax statute. The long three-part definition defines an “inverted domestic corporation” as a foreign incorporated entity that, pursuant to a plan (or a series of related transactions):

Directly or indirectly acquires substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership
Acquires at least 80 percent of the stock (by vote or value) of the entity held (a) in the case of an acquisition with respect to a domestic corporation, by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation, or (b) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership, and
After the acquisition, the expanded affiliated group that includes the entity does not have substantial business activities in the foreign country in which or under the law of which the entity is created or organized when compared to the total business activities of such expanded affiliated group.

Under the regulatory scheme, an offeror for a U.S. government contract must represent that it is not an inverted domestic corporation or a subsidiary of an inverted domestic corporation. If the offeror cannot affirmatively make such a representation, then the offeror cannot submit an offer absent a secretarial-level waiver that contracting with the inverted domestic corporation or its subsidiary is in the interest of national security.

Because of the complexity of the definition of “inverted domestic corporation,” companies that could be considered inverted domestic corporations should consult legal counsel.

Inbound M&A Transactions and Investments in the News in September

Bill Newman — Thu, 01 Oct 2009 19:49:04 -0500

September produced two transactions worthy of comments because of CFIUS’ role.

Last July gold mining company Firstgold Corp. of Lovelock, Nevada, announced that it had entered into a binding agreement with a new investor, Northwest Non-Ferrous International Investment Company Limited of Xi’an, China, located in Shanxi province (northern central China). Firstgold is a development stage company with total assets of $19.8 million and a net worth of $5.0 million according to its last annual report filed with the SEC for its year ended January 31, 2009. Its financials are subject to a going concern qualification. Firstgold has been caught up in litigation with two holders of senior secured promissory notes. Northwest agreed to acquire those notes, lend an additional $5.5 million to Firstgold and buy shares representing 51% of the company’s equity, making Northwest both the parent and senior lender to Firstgold. The July announcement stated that the proposed transaction was subject to obtaining all required governmental and regulatory approvals. The deal documentation did not specify Committee on Foreign Investment in the United States (CFIUS) approval, only “regulatory approvals” generally.

Flash forward to September 21, when Firstgold announces that it and Northwest have agreed to extend the time to close their transactions until December 1, 2009. Firstgold’s September 21 press release suggests that Northwest had determined in the interim that it was advisable or necessary for it to file a voluntary notice with CFIUS. In the release, Firstgold takes the position that the CFIUS notice “will not prove to be an obstacle to our closing the transactions we have previously announced.” No doubt it would have been even less of an obstacle if filed in July or August.

The filing could prove to be more complex than Firstgold believes. CFIUS review of Chinese purchasers tends to be quite exhaustive, particularly on the point of any connections between the purchaser, its board of directors and its principal shareholders and the PRC government. Chinese language submissions are not allowed.

There is a larger question that the Firstgold/Northwest deal raises. Does the U.S. really need CFIUS review for a company that is relatively small and financially weak? Why did Congress not provide a small reporting company-type exemption from FINSA’s notice scheme? Given the scarcity of risk capital in current markets for development stage companies, wouldn’t the U.S. be better served if there were thresholds for U.S. targets before FINSA review is required?

Updated October 12, 2009-- On October 7 Firstgold updated investors on the status of its proposed refinancing transaction. Firstgold has made filings with the Ontario Securities Commission so that trading of its stock could resume. With respect to CFIUS review, the company said that it expects by late October or early November to receive notice from CFIUS that the ongoing review under FINSA is complete and that no further action will be taken.

The New York Times Dealbook blog commented on the September 16 announcement by Chemring Group PLC that it had agreed to acquire aerospace company Hi-Shear Technology for $132,000,000. Hi-Shear is a defense business based in Torrance, California, while Chemring is an English company. The Dealbook blog voices a concern that the parties to the deal have not committed outright to pursue CFIUS and other regulatory approvals. The post points to language in the merger agreement for the proposed deal that requires the parties only to use “reasonable best efforts” to close. But in the following sentence, the agreement requires the parties “to make appropriate filings” under what it refers to as Exxon-Florio. The Foreign Investment and National Security Act of 2007 (FINSA) replaced Exxon-Florio in late 2007. There is a specific provision in the merger agreement that elaborates on the allocation of responsibilities for the parties to file their notice with CFIUS and also sets a timetable. The agreement also specifies a process for the required submission to be made under the International Traffic in Arms Regulations. Receipt of a notice from CFIUS stating that there are no national security concerns or that the CFIUS service has been completed without further investigation is an express condition to completion of the deal. The commentary in Dealbook seems misplaced. Compared with similar language in other merger agreements, the language in the Chemring deal is quite clear and well-drafted.

FDI Grows in Brooklyn, or "The Russians Are Coming, The Russians Are Coming"

Bill Newman — Fri, 25 Sep 2009 16:23:11 -0500

Forget about Dubai Ports, forget about Huawei Technologies. There is a new crisis boiling over in foreign direct investment. A Russian billionaire may become the owner of a dearly beloved, U.S. professional basketball team and acquire a controlling interest in the team’s proposed arena in New York City.

On Wednesday of this week, the New Jersey Nets announced that, pending approval from the owners of other National Basketball Association teams and subject to a favorable outcome of litigation surrounding the construction of its new arena, Mikhail Prokhorov’s Onexim Group has agreed in principle to invest $200 million to acquire an 80% interest in the team, a 45% interest in the team’s unbuilt sports arena and the right to acquire a 20% stake in Atlantic Yards, the adjacent real estate project being developed by the team’s current owner, Forest City Ratner Companies. According to the release, the deal will ensure the completion of the proposed Brooklyn, NY-based arena, the relocation of the Nets to Brooklyn and the completion of Atlantic Yards. The tentative date for closing the deal is the first quarter of 2010.

Mikhail Prokhorev is a high-profile, self-made Russian investor. Many blogs, including Keith Gessen of The New Yorker and Ethan Trex of Mental Floss, catalogue his controversial history. His six-foot-seven height and the fact that he has played basketball make Mr. Prokhorev one of those figures that invite focused interest, even if past media coverage wasn’t enough. And there is the matter of his reported $9.5 billion net worth, making him Russia’s richest man. In his statement, Mr. Prokhorev said, “I have a long-standing passion for basketball and pursuing interests that forward the development of the sport in Russia.”

Forest City’s Bruce Ratner added his own rationale for the deal, stating that he was thrilled that ”[S]mart global investors appreciate the exciting economic potential of Brooklyn. We are one step closer to achieving our goals of creating much needed jobs and economic development for Brooklyn and the city.”

Notwithstanding the promised benefits of the agreement, critics were quick to attack. NoLandGrab, a local opposition group, argues that there must be shady side deals that were undisclosed. Develop Don’t Destroy Brooklyn is adamantly opposed as well, asking

Putting aside legal questions, what are the ethics and policy principles of subsidizing the 40th richest man in the world with city, local and federal financial gifts, as well as a highly controversial use of eminent domain?

The New York Observer reports that Congressman Bill Pascrell Jr., who represents a district that is adjacent to the Arena where the Nets now play, has asked the NBA Commissioner to investigate the deal. Mr. Pascrell has raised questions about a foreign corporation’s benefiting from tax incentives being employed to support the arena.

So all the elements now are in place for another epic battle over FDI. What will play out here—in the cosmopolitan metropolis of New York, in the legendary Borough of Brooklyn—is the same drama that unfolds in many American towns and villages when the concept of FDI materializes into the real-life acquisition of a local treasure. The forced migration of a sports team is almost always a deep and searing wound. Thousands of fans still mourn the losses of the New York Giants and the Brooklyn Dodgers to California, even though they happened 50 years ago.

The questions proliferate. Will the players or coaches be Russian? If they buy this franchise, will they buy others? Will Americans lose their jobs, even though they are high-paying jobs that most Americans can only dream of? Will foreign ownership change basketball, even though the team in question has never achieved a spectacular record? Will America lose control over one of its institutions, now treasured more in the anticipation of loss than ever before? Arguing that foreigners will benefit somehow from U.S. tax benefits is usually a start to a “we/they” analysis of the situation. Ultimately, someone will ask whether there can be some adverse affect on our national security?

It’s a good bet that somewhere someone is toiling away, trying to figure out how review by the Committee on Foreign Investment in the United States (CFIUS) can be invoked. Forest City’s hometown paper, The Cleveland Leader, is already advocating that CFIUS must review the deal.

Will FINSA Affect Equity Swap Restructurings?

Bill Newman — Wed, 23 Sep 2009 16:11:41 -0500

Developments in corporate restructurings suggest that the Foreign Investment and National Security Act of 2007 (FINSA) may soon become a factor in debt/equity swaps. As U.S. companies in the telecommunications, defense and other national security-related businesses encounter difficulty in refinancing their debt and seek out-of-court workouts with foreign bank lenders or offshore hedge funds, FINSA’s regulations may apply and could impede those settlements.

The Wall Street Journal reported on September 19 that as a result of the credit crisis, lenders are taking sizable equity stakes of companies that borrowed from them and now must restructure their debt. These lenders are confronting the issues raised by Federal limits on ownership of media businesses in conjunction with equity-for-debt swaps transacted with radio, TV and newspaper companies in distress. The FCC rules have made restructurings more complex. The FCC must approve changes in ownership for a broad range of media businesses. FCC rules limit ownership of multiple media outlets in different markets and apply to all persons, regardless of nationality. But for foreign hedge funds and other foreign lenders, there is an additional set of issues. Federal law also fixes caps on equity ownership of broadcasters by foreign entities. The application of these rules has made restructuring far more difficult to achieve because it limits the amount of equity that can be swapped for debt.

There is a parallel to FINSA and its rules. FINSA applies to transactions between U.S. businesses and foreign entities that acquire control of the U.S. entity. In that case, the parties may file a voluntary notice with the Committee on Foreign Investment in the United States (CFIUS). To determine whether U.S. national security might be impaired as a result of the change in control of the U.S. business, the filing leads to a review process and, in some cases, an investigation and, even more remotely, Presidential review. If CFIUS does not object to the transaction or require that the parties enter into a mitigation agreement with it, then the transaction can proceed and further review is precluded. If the parties do not file a notice and comply with requests for information from CFIUS, then CFIUS can later unilaterally review and investigate the transaction and, in an admittedly extreme case, order divestment.

Where might these issues arise? The fact pattern would involve:

A U.S.-based company operating in an industry which is relevant to U.S. national security -- examples include, mineral extraction, energy, defense, telecommunications and certain manufacturers of highly engineered products
A foreign lender -- traditional or otherwise, including hedge funds -- that now finds that it has little choice other than to take an equity stake
The equity stake issued in exchange for the debt exceeds 10% of the voting equity of the business on an after-issued basis or has other rights, such as board membership, that give the lender a role in the management or operation of the business

The presence of other factors would exacerbate CFIUS concerns:

One or more of the lenders is controlled by a foreign government -- as a result of the financial turmoil of the last several years, these categories include all of those bank lenders which, although formerly private, have since been nationalized
The foreign lenders or offshore funds taking the equity enter into agreements with each other for the operation or management of the U.S. business

Under the FINSA statute, CFIUS has an unlimited period of time to look back and order reviews of previously completed transactions. Therefore, if an offshore lender’s strategy is to restructure today with a debt-for-equity swap and then sell the equity to a buyer -- U.S.-based or foreign -- in a year or two, a background legal issue may appear: Do the sellers have full, indefeasible legal title to the shares they are seeking to sell? Will their buyer in turn become sensitive to the possibility -- however remote -- that a CFIUS investigation may materialize in the future if a competitor brings the absence of a filed notice to the attention of CFIUS? Or if a voter brings the issue to the attention of a Congressperson who in turn will pressure CFIUS?

This chain of events may be far-fetched. But the provisions of FINSA and its regulations make this outcome possible, whether or not likely. Foreign lenders and their advisors may well have no choice but to consider the applicability of these requirements.

L. Elise Dieterich, a partner in the Washington, D.C. office of Sullivan & Worcester LLP, contributed to this post.