Grant Thornton Hong Kong also sees a 9% drop in corporate transactions in the first quarter of 2022, but expects a rebound in the number of deals in the second half of the year on the back of anticipated post-pandemic recovery of market activities in China, and urges companies to conduct independent due diligence for transactions to protect rights and reduce risks
 
Grant Thornton’s latest Sale and Purchase Agreement (“SPA”) Research Report 2022 (the “Report”) reveals a decrease in the number of SPAs by approximately 26% to 248 (2020: 333) in 2021 amid the prolonged pandemic which impeded economic activities. Among different asset types, the number of business acquisitions and disposals, the major transaction type, decreased 28% year on year in 2021, while there was a slight increase of 8% in the properties SPAs in 2021 from 2020.
Grant Thornton has focused on SPAs initiated by Hong Kong-listed companies and/or their subsidiaries from 1 January to 31 December 2021, where the underlying transactions were classified as Major Transaction, Very Substantial Acquisition (“VSA”) and Very Substantial Disposal (“VSD”) under the relevant definitions of the Listing Rules in Hong Kong. The Report shows that major and non-connected transactions executed by companies listed on the Main Board continued to dominate the deals in 2021.
Grant Thornton analysed data from the HKEx website on 248 SPAs entered into by Hong Kong-listed companies and/or their subsidiaries in 2021, of which 113 were acquisitions and 135 were disposals. The Report shows that in 2021, in terms of the types of assets involved in the SPAs, acquisitions and disposals of businesses remained the major transaction type. Business acquisitions accounted for approximately 74% of all acquisitions (2020: 74%), while business disposals accounted for approximately 79% of all disposals (2020: 84%). Other transactions involved land use rights, properties, and other assets. Out of the overall decline in SPAs across asset types in 2021, including businesses, land use rights and other assets, a slight increase of 8% was noted for the properties SPAs from 2020 to 2021.
 
Cautiously optimistic towards rebound of corporate transactions in 2H 2022
The decline in the number of SPAs extended to the first quarter of 2022. Data shows that the number of SPAs initiated by Hong Kong-listed companies in the first quarter of 2022 has decreased by 9% year-on-year, as a result of a 17% drop in acquisition SPAs and a 3% decrease in disposal SPAs.  In the short term, disposals are expected to continue to be the more common type of transactions, especially for listed companies trying to streamline their corporate structures due to the volatile market conditions and financial difficulties.
The drop in SPAs in 2021 and the first quarter of 2022 was attributable to  a number of factors, including the pandemic induced reduction in business activities, the economic frictions between China and the US, as well as credit control in China’s property sector, which blocked the deal negotiation processes and the announcement of the SPAs. As the majority of the target companies of business acquisitions and disposals were located in China (including Hong Kong and Macau), with those located in Mainland China alone accounting for 67% of all business acquisitions and disposals in 2021, and those in Hong Kong and Macau accounting for a quarter, developments and policies in Mainland China and Hong Kong were having noteworthy impacts on the transactions. For instance, the spread of the Omicron variant in Hong Kong and Mainland China in early 2022 had significantly hindered the deal negotiation and transaction processes. Although the transactions were already impacted by the pandemic in first quarter of 2021, the situation worsened in the first quarter of 2022.
Barry Tong, National Leader of Forensic and Investigation Services at Grant Thornton China, said, “Notwithstanding the decline last year and in the first quarter of this year, we are cautiously optimistic about the transaction market in the second half of 2022 and expect a recovery in the overall number of corporate transactions in the second half from the low base number in the first quarter this year, as we anticipate more post-pandemic recovery in business activities and further monetary easing in China to support the economy and the property sector later this year. The introduction of SPAC listing in Hong Kong may boost local SPA transactions as well, though the impact is expected to be seen in the medium to long term as the SPACs have 24 months to announce a proposed De-SPAC transaction after they are listed. ’’
More than 90% of M&A targets located in China
During the year of 2021, approximately 92% of the businesses acquired and 93% of the businesses disposed were located in China. Approximately 38% of the businesses acquired and disposed were located in the Guangdong Province, Hong Kong and Macau region, compared with approximately 40% in 2020.
Mr. Tong said, “The figures reflect that the economy of Hong Kong and that of Mainland China are becoming highly and closely integrated. The China-US economic frictions may likely exacerbate the trend, which may in a way benefit Hong Kong. Hong Kong as a market may become a better option for companies based in China to conduct transactions compared with other regions abroad, no matter due to regulatory or other concerns.”
 
Increased disposals in Properties & Construction and Financials industries
In 2021, there were a total of 106 business disposals and most of them were in the Properties & Construction and Consumer Discretionary industries, accounting for approximately 45% of all business disposals, compared with 35% in 2020. In particular, there was an increase in the number of sellers from the Properties & Construction, Financials and Healthcare industries.
A great number of disposed targets were in the Properties & Construction industry, accounting for 34% of all business disposals in 2021. Data suggests that sellers from the Properties & Construction industry were likely to sell target businesses within their own industries.
Mr. Tong said, “Despite the decrease in the overall number of SPAs in 2021 amid the COVID-19 pandemic, the properties SPAs rose 8%, driven by an increase in the disposals of properties. It could be attributed to the challenges faced by the property sector in Mainland China, which has led to more restructuring and deleveraging in the sector. The trend in property disposals would probably continue in 2022.”
Cash-only settlement remaining dominant while asset approach becoming popular
In 2021, cash-only settlement continued to be the most widely adopted settlement method for both business acquisitions and disposals, accounting for 64% and 94% respectively. Meanwhile, the data also reveals that the proportion of shares-only settlements increased to 16% in 2021 (2020: 7%). The dominance of cash-only method was likely due to advantages of cash in terms of liquidity, time and costs over issuing financial instruments such as bonds and promissory notes.
In terms of valuation approaches adopted by Hong Kong-listed companies for transactions, the asset approach surpassed the market approach and became the most popular valuation method in business acquisitions in 2021, accounting for 43%. The asset approach continued to be the most used valuation method for business disposals, with its percentage jumping from 48% in 2020 to 64% in 2021. The proportion of the market approach for business disposals, on the contrary, dropped from 37% in 2020 to 24% in 2021.
Mr. Tong said, “The corporate transaction market in 2021 suffered from vulnerabilities in the economy and uncertainties in the financial markets. Entering 2022, the global markets have further encountered headwinds such as inflation and interest rate hikes, aggravated by the adversities brought by the prolonged COVID-19 pandemic. Amid market turmoil and fluctuations, valuation through the market approach has become more difficult. The dominance of the asset approach in business disposals indicates that sellers prefer maximising considerations based on the objective and constant NAV stated in the balance sheet, which may represent a more stable set of value.”
 
Due diligence becoming more critical in times of uncertainty
Grant Thornton strongly recommends the listed companies to include independent due diligence processes and independent valuation of the proposed investments as precedent conditions in SPAs, as they can help buyers identify potential deal breakers and mitigate the identified risks through legal protection clauses, such as warranties and indemnities. Although there has been an increasing trend of carrying out due diligence, only about 32% of the SPAs of business transactions have listed due diligence investigation as one of the major conditions. The number was still far from satisfactory.
Financial information provided by the counterparty should always be carefully reviewed and scrutinised, especially unaudited financials. Conducting a due diligence process can better safeguard the success of a transaction.
Mr. Tong concluded, “Implementing independent due diligence and other proper precedent conditions are crucial for protecting the rights and interests of the parties involved in the transactions, especially in uncertain business environments.”
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Top 10 Acquisition Locations in Mainland China 2021
 
 
Top 10 Disposal Locations in Mainland China 2021