Coca-Cola's Huiyuan Bid Illustrates BIT Challenges, AML

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 003775

SIPDIS

STATE FOR EAP/CM -- PARK AND FLATT
STATE FOR EEB/OIA -- SCHOLZ, TRACTON, AND HICKS
STATE FOR E -- YON
STATE PASS USTR FOR STRATFORD, WINTER, BAHAR, AND KATZ
STATE PASS FTC FOR GENERAL COUNCIL BLUMENTHAL AND KALLAY
STATE PASS TDA FOR JACKSON
DOJ FOR DAAG O'CONNELL AND CHEMTOB
NSC FOR DNSA PRICE, SMART, AND LOI

E.O. 12958: DECL: 09/28/2018
TAGS: EAID ECON EFIN CH
SUBJECT: Coca-Cola's Huiyuan Bid Illustrates BIT Challenges, AML
Implementation Problems

Classified By: Econ Minister-Counselor Robert Luke for Reasons 1.4
(b) and (d)


1. (C) Summary. Coca-Cola Pacific Deputy Group President Paul
Etchells briefed Acting Economic Minister-Counselor 9/17 on Coke's
proposed acquisition of a leading Chinese juice maker for US$2.4
billion. Coke, which agreed to the meeting at our request,
emphasized that it is not seeking U.S. Government assistance and does
not want it to become public that it had met Embassy staff.
Coca-Cola is cautiously optimistic China will approve the
transaction, speculating that Ministry of Commerce (MOFCOM) officials
will not want to be seen blocking the first big foreign transaction
filed under the Anti-Monopoly Law (AML),especially one that
minimally affects competition and is unrelated to China's security.
Comment: Coca-Cola may not fully appreciate the risks that the
transaction could become politicized. The case is an important test
of China's use of the AML. The proposed deal also concretely
illustrates China's convoluted foreign investment review process,
thus providing an on-the-ground perspective relevant to ongoing
U.S.-China Bilateral Investment Treaty (BIT) negotiations. End
Summary.

The Deal's Legal Structure
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2. (SBU) Etchells said Coca-Cola had received legally irrevocable
backing for the transaction from Huiyuan's four largest shareholders
- the company's Chinese founder, French beverage group Danone,
Warburg Pinkus, and Fidelity - who collectively control 70% of
Huiyuan's stock. The other 30% of Huiyuan's shares are listed on the
Hong Kong stock exchange. The proposed transaction price represents
a 200% premium to the firms' market value. The contract is dependent
upon China approving the transaction within 200 days, a deadline that
can be extended if all parties to the transaction agree. (Note: AML
implementing regulations allow China 30 days to review transactions,
plus 150 days to conduct more intensive reviews, if needed. End
Note.) Coke said it had never before acquired a firm of Huiyuan's
size in China.

Coke Cautiously Optimistic
--------------


3. (SBU) Coca-Cola was cautiously optimistic that the deal would be
approved. MOFCOM would not want to block the first transaction filed
under the AML when competitive and security concerns were both
minimal, Etchells opined. Coca-Cola said that the best, independent
data, provided by a firm called "Canadian," showed that Coca-Cola and
Huiyuan would have a combined share slightly exceeding 20% of the
non-alcoholic beverage market and slightly less than 20% of the juice
market. Coca-Cola currently has a miniscule share of the juice
market in China, so its acquisition of Huiyuan would not meaningfully
impact concentration in that sector. Besides market share, Coca-Cola
noted that large grocery chains have countervailing bargaining power
and that the beverage sector has low barriers to entry, an analysis
it had shared with MOFCOM. Coca-Cola had heard informally that
MOFCOM planned to take a "market-based view" of the transaction.
Earlier conversations with a MOFCOM-affiliated think tank support
Coke's assumption that MOFCOM would take such a view. Also, working
in Coca-Cola's favor, China's Guidance Catalogue for Foreign
Investment lists "fruit drinks" as a sector where foreign investment
is "encouraged."

Roles of MOFCOM, NDRC, and Other Agencies
--------------


4. (SBU) Regarding China's approval of the transaction, Etchells said
MOFCOM appears to be playing the leading role. Coca-Cola had met
with MOFCOM anti-trust staff after announcing the deal and planned to
formally file paperwork with MOFCOM's anti-trust office on September

18. Coca-Cola's lawyers have advised that Coke does not need to file
with any other agencies. Etchells assessed that the National
Development and Reform Commission (NDRC) likely would not pay
attention to the deal because it was so obviously not a national
security issue. Etchells sai Coca-Cola had not lobbied high-level
Chinese fficials before announcing the deal, and since hen, had met

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only MOFCOM working-level staff.


5. (SBU) Comment: Other agencies certainly will also play roles.
MOFCOM has told us separately that, in addition to internally
reviewing foreign mergers and acquisitions (M&A),it also
disseminates filings to other "relevant" agencies for "pre-approval."
In addition, NDRC Vice Minister Zhang Xiaoqiang stated at the first
U.S.-China Investment Forum in June 2008 that NDRC heads up China's
inward investment approval process. According to NDRC, any
cross-border M&A transactions that would lead to additional
investment in the operations of the acquired firm require separate
approval under China's "investment approval process," which is
distinct from the "M&A approval." In typical cases, the approval of
a sector regulator, such as the Ministry of Industry and Information,
is also required. For transactions that China believes impact its
"national security," an ad hoc interagency committee also reviews
deals. (Note: China is in the process of formalizing this national
security review. End Note.) M&A transactions also require an
updated business license for the new, combined firm, issued by the
State Administration of Industry and Commerce, the same agency that
separately investigates abuse of market dominance under the AML.
Finally, all foreign transactions that result in the transfer of
state-owned assets -- which is not the case here -- require approval
by the State Council. End Comment.

Coke Uncertain Which Reviews MOFCOM is Conducting
-------------- --------------


6. (SBU) Regarding MOFCOM's review, Coca-Cola troublingly was unaware
whether MOFCOM would evaluate the transaction solely under China's
new AML, for its competitive effects. Etchells said Coca-Cola did not
know whether "interim" regulations issued by MOFCOM and six other
agencies in August 2006 which, under Article 13, require a acquirers
to notify MOFCOM of transactions that would transfer control of a
famous Chinese trademark, time-honored Chinese brand, and
transactions that impact China's "national economic security" would
be the basis for a separate review.


7. (SBU) Note: When China released the 2006 rules, MOFCOM officials
told us that their antitrust provisions were a "placeholder"
describing MOFCOM's review of foreign M&A until China passed an AML.
It is not clear if the AML's subsequent release invalidates the
requirement that foreign parties notify MOFCOM of transactions
affecting trademarks, brands, and thus whether there remains a
separate review. In any case, apart from the antitrust review,
MOFCOM never publicly released standards guiding its evaluation of
transactions filed because they transferred control of famous
trademarks or brands, or impacted national economic security. As a
result, foreign firms may not know if they are being reviewed, as is
the case here. End Note.

China's Review of Trademark and Brand Acquisitions
-------------- --------------


8. (SBU) Etchells said Coca-Cola believes China likely will not
examine the effect of the transaction on the Huiyuan brand or its
trademarks. Coke assessed that the reference to famous trademarks
and time-honored brands in the 2006 regulations refers to products
pre-dating China's economic reform; that is, products in which the
State had invested development capital or products reflecting China's
traditional culture. For example, Etchells said that the popular
Chinese tea-based beverage drink "Wanglaoji" was an old brand with
state-owned industry ties. He added that Coca-Cola had at one point
"looked at . . . Tong Ren Tang" a well-known, old beverage brand that
uses traditional ingredients, and was advised that the state would
not allow the brand to fall into foreign hands. Etchells noted that
the Coca-Cola brand pre-dates Huiyuan in China. He dismissed Chinese
press reports cautioning that Coca-Cola would plan to "kill off" the
Huiyuan brand, as any such move would force Coca-Cola to recognize an
accounting loss on the goodwill it acquires in the transaction.

Role of Industry Association, Competitors
--------------


9. (SBU) Etchells added that Coca-Cola expects MOFCOM will consult

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with the Chinese Beverage Industry Association (CBIA) on the
competitive effects of the transaction. Coca-Cola has lobbied CBIA
to remain impartial. One potential problem was that MOFCOM could
base its evaluation of the transaction's competitive effects on less
reliable CBIA data. If that were the case, CBIA and MOFCOM may not
share the data with Coca-Cola, making it difficult to rebut.
Coca-Cola assessed that while competing firms had expressed their
opposition to the deal and reportedly lobbied MOFCOM, that this
behavior was not unique to China.

Coke Discounts Public Opposition to the Deal
--------------


10. (SBU) Coca-Cola was skeptical of reported public outcry against
the deal, illustrated by a widely cited Sina.com online poll which
showed that up to 80% of respondent's opposed the transaction.
Participants in the Sina.com poll were a self-selecting group, Coke
said. Net traffic on the topic had also fallen off, especially as
the number of stories on tainted milk had ballooned. Chinese print
media had been reasonably balanced. Coca-Cola was working on
background to correct inaccurate initial reporting on the combined
firms' market shares.

Market Culture Has Not Fully Entered the "Public Psyche"
-------------- --------------


11. (SBU) Most troubling to Coca-Cola was the vitriolic reaction on
the internet to news that Huiyuan's founder stood to clear $1 billion
by selling the firm. The founder must have found the reaction
distressing and has come under some pressure not to sell. Etchells
observed that Chinese people seemed to be "incompletely tuned into
capitalism." While they widely acknowledged that a person had the
freedom to start up a company and conduct business, when it came time
to sell, there was still a public perception that the asset was
somehow collectively owned. The idea of freely disposing of assets,
which would allow entrepreneurs to use their gains to start new
firms, had not yet entered the public psyche, he said.

Comment -- Transaction Could Become Politicized
-------------- --


12. (C) Coca-Cola may not fully appreciate the range of problems the
proposed transaction could encounter. The acquisition touches a
number of hot button issues, including China's intention to secure a
more self-sufficient domestic food supply, its desire to develop and
protect domestic brands, and the lack of transparency in China's
multiple and overlapping inward foreign investment reviews. In these
circumstances, the proposed transaction will be a clear and important
test of MOFCOM's repeated assurances that it will evaluate AML
filings from a "market-based perspective," as well as the utility and
accurateness of the foreign investment catalogue, which "encourages"
foreign investment in "juice drink manufacturing." Coke's
uncertainty about which filing requirements apply to the case and
which ones it has met, which agencies are reviewing the deal, and the
standards those agencies are using are a concrete illustration of the
challenges U.S. businesses face when they seek to acquire big Chinese
companies.