By Staff Reporters Lu Yanzheng and Cheng Zhe

Five months after the US-based firm, the Carlyle Group (Carlyle) agreed to purchase an 85% stake in state-owned Xuzhou Construction Machinery Co. Ltd. (XCM), the Ministry of Commerce (MOFCOM) has raised concerns over details of the purchase and its eventual fate remains uncertain. Carlyle’s purchase of XCM was China’s first case of a local firm being purchased by a foreign buyout firm. After being approved by the local and national development and reform commissions, the deal is now awaiting MOFCOM’s final approval.

On October 25, 2005, China’s biggest machinery engineering manufacturer XCM and Carlyle signed the stock purchase and join-venture agreements. These two agreements finalized the sale of XCM’s foreign capital introduction and reform. Carlyle will pay US＄375 million to purchase an 85% stake in XCM, a subsidiary company of Xuzhou Construction Group (XCMG).

XCMG is a state-owned firm under the supervision of the Xuzhou State-owned Assets Supervision and Administration Commission, and was once designated by Jiangsu Province as the main state-owned company in need of reform. XCMG spent over two years looking for a partner through many rounds of biddings, and finally chose the private equity fund Carlyle. The local government controlled the entire negotiation process, from the reform plan to the eventual sale; as a result, the local government quickly approved the agreement.

The deal is considered a milestone in the domestic property capital field. However, it has been slowed down after reaching higher level review and approval procedures.

According to the “Provisional Measures of Administration for Examining and Approving Foreign Funded Projects”, a national legislation, XCMG falls in a category of state-owned enterprises which the government would encourage to bring in foreign investment. However, the project needed approval from the National Development and Reform Commission (NDRC) because the total investment amount in the company was over US＄100 million. The purchase also needs MOFCOM’s consent because it is a foreign investment project.

Sources say that NRDC had examined Carlyle’s purchase, and approved it a month ago. Even before NRDC’s approval, both sides of the deal were required to explain details of the project to national regulators. Furthermore, NDRC has written a report after conducting a market investigation into Xuzhou city, where XCMG is located.

The project was submitted to MOFCOM in early 2006, and MOFCOM has raised questions demanding explanations from both XCMG and Carlyle. MOFCOM asked for an “Antitrust Report” in order to prove that Carlyle’s purchase of China’s biggest machinery manufacturer would not create a market monopoly that harms domestic firms. It is still awaiting Carlyle’s final reply.

At the same time, many details are scrutinized, including Carlyle’s future exit plan, whether it is appropriate for a foreign firm to control as much as 85% of XMG, etc., although most of the questions have been clearly answered in the agreement.

Both sides have met twice with MOFCOM to discuss the above questions. The ministry has made it clear that it is not satisfied with the mere conclusions in the agreements – it also demands to know how both sides have reached these conclusions, Carlyle’s motives for the purchase, as well as more precise wording in the agreements.

According to the “Provisional Regulations on the Merger and Acquisition of Domestic Enterprises” passed in 2003 by MOFCOM’s predecessor, the Ministry of Foreign Trade and Economic Cooperation, the examining and approving authority shall, within 30 days upon receiving the complete set of documents requested, decide whether or not to approve the it. If the authorities think that “the acquisition might lead to over-concentration, the hindering of fair competition and harm consumer benefits”, they shall within 90 days call a hearing with the related government agencies, businesses and other interested parties, and decide whether or not to approve the application. Up until now, MOFCOM has not raised doubts about whether this purchase conflicts with these related policies or laws.

Insiders tell Caijing that, “The examination and approval authority is very cautious because of public pressure and because this is the first time for this type of deal”.

During the National People’s Congress session in March, Li Deshui, a former director general of the National Bureau of Statistics, openly called for “caution in dealing with multinational mergers and acquisitions”. Apart from that statement, the All-China Federation of Industry and Commerce also submitted a legislative proposal demanding be a “bottom line in foreign mergers” in order to ensure China’s economic security. As a result, ongoing foreign acquisitions and mergers of Chinese businesses, with the  have come under much close scrutiny, with many voicing concerns for potential harms these deals might have on national economic security.

But to both sides of the deal, national economic security had apparently not been an issue. Sources tell Caijing that XCMG had originally wanted to sell 100% stake to Carlyle, but in the bidding process, the latter proposed to leave 15% for the government in order to secure governmental support.

Stakes are high for XCMG, who wishes to put its financial woes behind and secure a brighter future through the introduction of a foreign owner. The giant machinery group has put three years of negotiations into the acquisition, and faces the burden of a total of 9,000 retired and laid-off workers. Many local enterprises that the group had purchased in Jiangsu and Anhui in an expansion craze in past years are now in financial trouble, all depending large sums of fund injection from the parent group to survive.

Much of XCMG’s gains from the deal, once completed, would go to re-employment projects for laid-off workers, repaying bank loans and restructuring other struggling subsidiaries. However, the recent slowdown in government approval seems to dampen many of XCMG’s high hopes. Sources within the group tell Caijing that chairman Wang Min of XCMG has warned group executives to “make preparations for all possibilities”, indicating the deal might fail.

Analysts say it is still too early to tell whether Carlyle and XCMG will be able to pull the deal off, due to lack of transparency in MOFCOM’s decision-making process. But time is clearly running out for all parties.