By Leonard P. Goldberger for China Brain.
“It doesn’t matter whether the cat is black or white, as long as it catches mice.”
Sales of technology–related assets out of financially-distressed companies ‑- especially those in bankruptcy -‑ are nothing new. The recent U.S. bankruptcy case of In re A123 Systems, Inc. is, however, noteworthy for at least three reasons: First, it involved the sale of highly advanced lithium‑ion phosphate battery technology to a Chinese buyer. Second, the controversial sale of this advanced technology, that was developed with U.S. government stimulus funding, was cleared by the Committee on Foreign Investment in the United States (“CFIUS”). And third, the U.S. creditors of A123 Systems mustered enough political support to counter stiff Congressional opposition to approval of the sale. In this respect, the U.S. creditors seemed to be channeling Deng Xiaoping’s pragmatic approach to advancement of economic self-interest in the face of entrenched countervailing political ideology.
When considered separately, the first two reasons are not particularly remarkable. By agreeing to pay $256 million for A123 System’s automotive battery technology assets, Wanxiang America Corp., the U.S. subsidiary of Wanxiang Group Corp., a leading Chinese automotive parts manufacturer, simply outbid Johnson Controls, Inc., its Milwaukee-based rival, at the U.S. bankruptcy court-supervised auction. (Wanxiang’s final bid was over $125 million more than Johnson Controls’.) Money talks in bankruptcy — that is what’s supposed to happen.
This is certainly no surprise considering that advanced battery technology for automotive purposes falls neatly in the intersection of the huge Chinese automotive market — the fastest growing in the world — and the Chinese government’s highly incentivized focus on development of alternative fueled cars as provided in its Twelfth Five-Year Plan. Indeed, A123 Systems’ battery technology is already being used in cars produced for the Chinese domestic market (e.g., various models produced by Shanghai Automotive Industry Group (Roewe 550 PHEV; Roewe E50 EV; Roewe 750 HEV) and by Geely (PHEV sedan)), so it is only natural that a major Chinese automotive parts supplier like Wanxiang would take advantage of this opportunity to acquire such a strategically‑important technology asset.
The second reason also follows. The U.S. bankruptcy court‑approved sale was conditioned upon Wanxiang receiving favorable CFIUS review of the transaction. CFIUS is a high-level, federal inter-agency committee chaired by the Secretary of the Treasury that is charged by law with reviewing transactions that propose to transfer ownership of U.S. businesses to foreign control for potential threats to U.S. national security. Putting A123 Systems’ advanced battery technology (developed in part with U.S. government stimulus funds — a sore spot for many of the deal’s critics) into the hands of a Chinese buyer, so soon after CFIUS’ recent denial of a transaction involving a Chinese-owned windmill farm in Oregon, made the timing of this review somewhat sensitive. However, the part of A123 Systems’ business that involved military-related application of its technology was deftly carved out and sold to a U.S. buyer in a rather savvy bit of politically-sensitive maneuvering. This, of course, limited the CFIUS review to only the transfer of the consumer automotive battery technology aspect of the business. With that, there appeared to be few actual national security (as opposed to political) concerns, and CFIUS’ approval was obtained in the ordinary course.
The third factor was a bit more complicated and, indeed, the most interesting aspect of the entire transaction. In this respect it may portend well for future sales of technology‑related assets to Chinese buyers. Coming off of the robust China‑bashing from the 2012 presidential election, certain U.S. Senators and others in Washington were highly critical of this proposed sale. Adverse publicity from other recent China related developments in Washington added to the politically charged fallout: The House Intelligence Committee report recommending that U.S. companies not do business with Huawei and ZTE because of their connection to the Chinese government; the Ralls Corp. suit against President Obama over his order rescinding its acquisition of its Oregon windmill farm; and the steadily growing alarm over Chinese cyber attacks on U.S. businesses. And it certainly didn’t help that A123 Systems was the recipient of over $249 million in U.S. taxpayer funded stimulus money (only half of which, it turned out, was actually spent), and about $125 million in tax credit incentives from the State of Michigan. Among other things, Congressional critics argued that sales of advanced U.S. technologies — especially those to the Chinese — undermined national security by rendering Americans overly dependent on foreign sources for critical technologies (Recall that a similar political backlash occurred against the trend of Japanese purchases of U.S. assets in the 1990s).
Indeed, Johnson Controls hired its own lobbyist to oppose U.S. government approval of the sale to Wanxiang. In the face of these political headwinds, the official committee of A123 Systems’ unsecured creditors (which represents the collective interests of all unsecured creditors in the bankruptcy case) sought and obtained bankruptcy court approval to hire its own lobbyist to counter the political opposition to the sale within the U.S. government. This is highly unusual in any bankruptcy case; and significant because the bankruptcy court allowed the use of bankruptcy estate funds to engage in a controversial, extra-judicial political fight. Of course, the committee’s logic is clear: If the politically based opposition to the proposed sale could be overcome, and Wanxiang, the highest bidder by $125 million, allowed to become the successful purchaser, then the U.S. creditors stand to reap a much higher recovery on their unsecured claims. Apparently, the U.S. creditors’ political juice was sufficiently effective to neutralize the Congressional critics.
Is all of this just an isolated instance, or the beginning of a broader trend? My view is the latter. Chinese direct investment in U.S. businesses and assets has been steadily increasing over the last few years. According to The Wall Street Journal, in 2012 alone, Chinese direct investment in the U.S. exceeded $10 billion (which was higher than the total amount of Chinese investment in the U.S. in 2009 through 2011 combined). The demand for technology related assets, in particular, will inevitably increase as the Chinese government funds massive development of new technology related industries in order to implement its national economic goals according to its Twelfth Five Year Plan. The fact that technology assets are not geographically rooted, like real estate or other fixed assets which would necessarily have to remain in the U.S. to be economically exploited, will also likely accelerate the trend. Moreover, in an economy like China’s, where indigenous innovation is sometimes difficult to accomplish, the acquisition of existing, proven technologies is the fastest way for Chinese companies to move up the global value chain.
Here, Wanxiang’s acquisition of an advanced technology out of A123 Systems’ bankruptcy case provides a roadmap for other Chinese companies seeking to do likewise. With the smart engagement of skilled U.S. insolvency professionals, Wanxiang was able to successfully navigate the somewhat arcane bankruptcy sale process, as well as a perilous political minefield. Other Chinese companies, similarly flush with cash and in search of strategically important technologies, are likely to follow this strategy of acquiring valuable technology assets stranded in financially-distressed corporate shells. As Wanxiang America’s president, Pin Ni, commented, “You just need to understand the rules, follow the rules, be very transparent, and let them make the decision.”
Moreover, future deals involving Chinese investors are likely to be more plentiful and involve smaller acquirers and targeted companies alike. As more middle-market Chinese companies (Wanxiang being a huge company with about $4.2 billion in annual revenue) get comfortable with the U.S. bankruptcy sale process, they will inevitably come to better understand the limits of U.S. political sensitivities, and become more effective “players” in situations involving financially distressed U.S. businesses and assets. Wanxiang has shown them the way.
Finally, all of this is not likely to be lost on other U.S. creditors and their financial advisors. Often overlooked in marketing valuable assets trapped in financially distressed companies is the huge potential market of foreign (especially Chinese) buyers who are likely to pay cash at prices far in excess of typical “fire sale” values. This will create even greater liquidity in the U.S. bankruptcy marketplace, allowing it to function even more effectively than it already does. If the landscape of U.S. bankruptcy sales begins to shift in this direction, it is likely that creditors of other financially distressed sellers will demand that assets be marketed to foreign buyers in spite of any domestic political blow-back. U.S. bankruptcy courts, recognizing the inherent economic benefit of reaching a broader and deeper pool of potential buyers, will also likely relax, or even eliminate, certain existing impediments in the bankruptcy sale process that make it more difficult for foreign buyers to effectively compete. All of this will certainly accommodate the attraction of investment capital from a more global marketplace. As the U.S. creditors of A123 Systems seem to have figured out Deng Xiaoping, they too have come to realize that money trumps political ideology.