Anatomy of a Merger
When it comes to U.S.-China business deals, most of the attention has been on Chinese moves in a Western direction. Witness the furor that erupted last year after the Beijing-based conglomerate Lenovo Group purchased IBM's personal computer business, or this past summer when China-based multinationals made aggressive bids for Maytag and Unocal. Those moves, coupled with a mounting trade deficit, were enough to spark new calls for protectionism among many in the U.S. Congress.
Tim Jenks encountered no such uproar when his company, NeoPhotonics, decided to make a play for its Chinese manufacturing partner, Photon Technologies. It took nearly a year for the deal to make its way through China's unwieldy maze of bureaucracy. But in July, NeoPhotonics, a venture-backed firm that had yet to turn a profit, found itself in the unlikely position of being one of the few non-Chinese firms to own a majority stake in a Chinese one.
Indeed, until recently, the Chinese government frowned on such deals. Instead, foreign companies were pushed to form joint ventures, usually as minority partners. But that's beginning to change. Many Chinese firms and their investors are eager to be acquired by U.S. companies, China experts say, to help them both expand internationally and gain access to U.S. capital markets. "The Chinese economy is more and more in private hands, and there's now a legal structure in place for mergers," says Nicholas Lardy, a senior fellow at the Institute for International Economics in Washington, D.C.
"If you're not prepared to compete in China, you'll find you're not ready to compete in the rest of the world,"
Jenks always had sensed that China--the world's hottest market for telecom networks and a perfect base from which to target other growing Asian markets--was the key to his company's future. "If you're not prepared to compete in China, you'll find you're not ready to compete in the rest of the world," he says. He knew that NeoPhotonics had the technology. What he didn't know was how his company would be able to go head-to-head with Chinese rivals, which offered similar products at a fraction of the price.
The company began trying to solve the problem in 2003, when it outsourced some of its manufacturing to a Chinese contractor. That helped cut production costs by more than half. But Jenks fretted that he didn't have as much control and flexibility as he desired. He began searching for a new partner, which led him to Shenzhen-based Photon, China's largest maker of photo diodes, a component used in optical networks.
After several meetings with Photon's president, Zhangyong Huang, Jenks decided he didn't want to partner with Photon--he wanted to acquire it. The notion initially seemed far-fetched. After all, NeoPhotonics had just 100 employees and an estimated $10 million in revenue, compared with 1,000 employees and $40 million in revenue for Photon. But Photon's products complemented NeoPhotonics' perfectly. Plus, NeoPhotonics had the relationships in the West that Photon wanted, while Photon had close ties to customers throughout Asia. Huang, it turned out, was thinking along the same lines.
Jenks took the idea to his venture backers at Draper Fisher Jurvetson, Oak Partners, and ATA Ventures. At first they were skeptical. But they soon saw a that merger would instantly add heft to the start-up, making it more competitive with larger rivals. It also would put NeoPhotonics in a better position to go public eventually.
In the late summer of 2004, Jenks and Huang got started. Huang began lobbying Photon's 14 shareholders, including a government agency in Shenzhen that owned about one-third of the company. In October, the agency put its stake up for auction, and NeoPhotonics beat out six other bidders. It took nearly five frustrating months before the appropriate government approvals were in hand but finally in March, NeoPhotonics owned a stake in Photon.
But there were still other investors to woo. Indeed, Chinese law requires that any merger or sale be approved unanimously by shareholders. Huang and Jenks began an intensive series of meetings to explain to investors why merging with NeoPhotonics would give them the best return. Jenks at one point was flying to China twice a month. Finally, in July, almost a year after discussions had begun, the deal was completed. The value of the merger, which was for cash and stock, was not disclosed. Huang became president of the company's China operations, while Jenks became chairman, CEO, and president. Both men say the arrangement already is bearing fruit, with the larger NeoPhotonics bidding on deals it couldn't have in the past.
Clearly, acquiring a Chinese partner is not for every company. But Ken Tsang, executive director of Hina Group, a merchant bank based in Palo Alto, Calif., says he has more than a dozen similar deals in the works. "There's a big opportunity to make strategic acquisitions," he says. Jenks, for his part, already is scouting other potential deals. "There's this old wives' tale that you can't do business in China and you can't own property," Jenks says. "Neither is true."
Resources For information about Chinese-foreign joint venture laws and other business regulations, see chinatoday.com/law/a0.htm. For the complete results of Grant Thornton's 2005 International Business Owners Survey, go to grantthorntonibos.com.