Podcast: Key Chinese Regulatory Approval for Cisco’s Acquisition of Acacia

Cisco's drawn-out bid for Acacia Communications began in July 2019 amid the U.S.-China trade war. When regulatory approval proved to be slow, Acacia announced at the beginning of 2021 it would terminate the deal. A revised agreement led to the transaction eventually closing in January 2021 for USD 4.5 billion. Host Julie-Anna Needham is joined by Mergermarket Managing Editor Lisha Zhou and Ed Vinales, M&A Editor in Hong Kong, who explain the saga of the long-delayed tech merger and lessons to be learned. Dealcast is presented by Mergermarket and SS&C Intralinks.

In this podcast, you'll hear about:

  • The history of Cisco's long-delayed acquisition of Acacia.
  • How the deal was finally able to close amid rising tensions between China and the U.S.
  • Why both parties agreed to remedies.
  • Lessons to be learned from this transaction.


JULIE-ANNA NEEDHAM: Welcome to Dealcast, the weekly M&A podcast presented to you by Mergermarket and SS&C Intralinks. I'm Julie-Anna Needham. In this episode, we're looking at the Chinese regulatory approval for the takeover of optical components maker Acacia by fellow US group Cisco.

Joining me are Lisha Zhou China managing editor for PaRR, and Dealreporter editor Ed Vinales. So to begin with, can you just give us some background to this deal?

ED VINALES: Yeah, I'll give you a brief overview of the background. The deal was announced in 2019, in the second half of 2019. And it was a Cisco Systems, the big high-tech, $200 billion market cap tech giant from the US, agreeing to a, I think, 70 per share $2.8 billion deal for Acacia Communications, which Acacia's key technology is in silicon photonics, which is basically this sort of optical chip sector.

So this deal is taking place as part of the general chip semiconductor deal activity that we've been seeing over the last several many, many years -- well, several three or four years. And it's that area of consolidation, that sector, which has become very sensitive to China, because China, the semiconductors is the foundation of a modern economy. And so any activity going on between us giants has implications for Chinese companies that rely on goods and services from this companies. So it's an area that's seen a lot of Chinese regulatory scrutiny of these US deals.

And the US companies obviously have to pay attention because they derive a lot of their revenue from China. So I mean, that's the basic deal. It's a deal taking place in that sector. And, as [INAUDIBLE] will explain, the regulatory approval processes for these deals can take a long while and be quite slow for the reasons I've mentioned. And this one, I think, particularly slow. But [INAUDIBLE] might be able to explain a bit more there.

So that's the background. And the reason that is very interesting is because of what happened this month, basically, which we can come to.

JULIE-ANNA NEEDHAM: And so what did happen is that this deal was announced some 18 months ago, I think. And then things really came to a head a few weeks ago.

LISHA ZHOU: Yeah, the deal was announced in July 2019. And during the past year, the relationship between China and the US were escalating. And US has kept putting Chinese companies on a sanction list. So China side is worrying about whether the US suppliers would block the material supply to Chinese companies. With this background, this has slowed down SAMR's review of semiconductor deals involving US companies.

And in January-- when-- the deal termination date is January 8, 2020. And Cisco has to obtain SAMR approval to complete the deal before the end of January 7. Otherwise, Acacia has the right to terminate the date. As Acacia's share price has increased a lot, and even higher than the offer price, Acacia will terminate the deal immediately if Cisco fails to obtain the approval.

And we heard that SAMR is ready to give approval. But to whether SAMR will give approval before January 8 is a big question for Cisco. So Cisco claimed that it has obtained SAMR notification saying that it is satisfied with Cisco's offered remedies proposed on September 15, 2020. But whether this notification means SAMR grant approval is still a question. So Acacia thought that it was not an official approval, so it terminated the deal immediately on January 8 morning. But Cisco immediately brought this deal to the Court, and asked the court to issue an injunction to stop Acacia to walk away from the deal.

JULIE-ANNA NEEDHAM: And they've managed to now reach a new agreement, haven't they? Can just give us a brief outline of that?

ED VINALES: Well, just one thing to mention in the build-up to all of this was the fact that Acacia's-- the peers and competitors of Acacia had been-- their valuations had been rising. And so that was why we go into this legal battle, because Acacia was desperate to get out of this contract, to renegotiate a contract. And so that's the tension that's come between Acacia and Cisco.

JULIE-ANNA NEEDHAM: So Acacia used the fact that Cisco hadn't obtained Chinese regulatory approval to get out of the existing agreements, but they've now renegotiated another agreement on more favorable terms.

ED VINALES: So we saw-- about a week before this all happened, we
saw another deal where something similar happened, which

[INAUDIBLE] can explain. But basically, what happened was that yes, it looked like it was going into a big legal battle. And in the end, Acacia and Cisco have agreed a $115-per-share deal instead of a $70-per-share deal. So it's up some 60%.

So Cisco is paying an extra $1 and 1/2 billion, and now is buying Acacia for $4.5 billion as opposed to $2.8. So that's all the legal battles gone away, and that's probably what it was all about. And they had to go through this legal process just because it is following fiduciary duties, and that was the way it went.

But the whole situation does arise some very interesting implications going forward, which we can perhaps get into. But that's what's happened. And [INAUDIBLE] could probably explain, about a week before this happened, there was some sort of similar dynamic going on in another deal which KEC Kokusai deal. [INAUDIBLE] I don't know if that would be something to explain briefly.

LISHA ZHOU: Yeah. KEC Kokusai to be bought by Applied Materials deal. This deal is involving the chip equipment, chip-making equipment, which is very essential to China. This deal is quite difficult because before that, Applied materials has proposed to acquire Tokyo Electron, which is number two. KEC currently is number three in the world of providing the chip-making equipments.

That deal was impacted by -- the US side has kept putting bans on Huawei and require all the companies making US technology to make chips to stop supplying Huawei. So that deal is quite impacted by the escalation of the China-US tensions, especially in the [INAUDIBLE] sector. But before that deal, initially, we heard that the approval of that deal could come before Acacia and Cisco deal, as both parties have agreed to the remedies.

But looks like in the later time when the US kept putting more Chinese companies on the sanction list, and that impacted the SAMR to grant the approval of the deal. And Applied Materials suddenly bumped up its price by 59%, and to extend the termination date of the deal till March.

ED VINALES: Because that reached -- it went beyond its termination date, didn't it? Or it was about to go beyond its termination date. And so the target could ask for a higher price. Is that right?

JULIE-ANNA NEEDHAM: So there are two factors at play here. We've got the Chinese regulatory approval. And into that is the US-China tensions. And then also the fact that tech stocks have been so successful over the past year with the pandemic going on.

But just bringing it back to the Cisco-Acacia deal, what were the conditions of the Chinese approval?

LISHA ZHOU: The conditions is quite simple, because the China side is worried about after the deal, the combined entity could block the material supply to Chinese companies. And also, they're worried about the combined entity to raise the price, and to engaged in tying sales, or refusal to deal, or to impose any unreasonable conditions on the transactions.

So the remedies are mainly to ensure supply to existing Chinese customers, and do not terminate the existing contracts with Chinese companies. Unless the Chinese customers voluntarily terminated those contracts. The second is to supply the relevant products on the friend basis, friend terms. And the second is no tying sales promise, and not attach unreasonable conditions to the Chinese customers. And the fourth is to ensure and make efforts training the staff and employees to implement the offered remedies.

So all these remedies are behavioral. And you can clearly see that it's remedied what Chinese side are worried about, which is mainly to ensure the supply and ensure the supply on the friend basis.

ED VINALES: What we don't know is-- what's curious is that, although the approval did not quite come in time for Cisco to -- had the approval come before the 8th of January, Cisco would not have had to revise its price of the deal because it could have could have completed the deal. However, it came just after the 8th of January.

Nonetheless, it came around the 8th of the January. And the suspicion is that Cisco has been having chats with SAMR and saying, look, what you need? Let's just get this done before the 8th of January so we don't have to pay more in a revised deal. However-- I mean, this is just a suspicion. However, it looks like they've given SAMR what they need on the remedies and who knows what else. Trying not to sound [INAUDIBLE].

But they've given SAMR what they need. And they've also had to give another billion and a half dollars Acacia because the deal approval didn't come in ahead of the 8th of January. So Cisco's not necessarily done brilliantly here. And that's, I think, the key issue from the point of view of Cisco's side. And the key issue from any investors or event funds that are looking at the situation is monitoring these kind of SAMR approvals towards the last stages, especially this year going forward, where we've got some other similar deals that could similar be impacted.

And if the approvals don't come in ahead of the deadline, those deals also could see revised bumps. So it might even be a little bit of a trading strategy or opportunity this year, with these long SAMR approval processes.

JULIE-ANNA NEEDHAM: And do we know why the regulatory approval took so long? How does it-- you mentioned the other deal earlier on, but how does it compare to other deals in the space? Is this just a normal time frame?

LISHA ZHOU: Yes. From the SAMR decision, we can see this deal has been refiled for second times, for twice. The deal was notified to SAMR on 22 October, 2019. And it was accepted for review on 20 December, 2019. And in 2020, June 11, the company withdrawed, and it referred 16 June, 2020. And in December, the company withdrew again, and immediately refiled on 11 December, 2020.

So for many deals, it's rare to see a company has to refile twice during a review. Only before that, SAMR-- NXP and Qualcomm deal has been refiled for twice. And Applied Materials and the KEC deal has been refiled twice. And this deal was the third one. So it's very rare.

Before that, we have seen SAMR tends to completing transactions in the second term. Which means the company only needs to refile for once. But this deal, they refile for twice.

ED VINALES: In days. Sorry, [INAUDIBLE] I was going to say, in days. I mean, the ZF-- the two big deals last year that were similar to this, I think, they took ZF-WABCO and Nvidia-Mellanox were two big deals. And, respectively, they were, I think, 172 days and 245 days from acceptance to clearance. And so this one was clearly a lot longer. 380 days or something like that.

LISHA ZHOU: The main reason why SAMR took so long is because the US kept to putting more and more Chinese companies on the sanction list. And Chinese side is worrying about what happened to Huawei will happen to the other companies. So whenever the agency is ready to close the deal, the US side has escalated its tensions with China.

For example, in the end of May, we reported that this case has been impacted by the US side. At that time, the US has escalated it's ban on Huawei from 25% to 10%, and to even 0, and all the company have to stop supply to Huawei. So for the China side, intends to wait and see what will happen, because things change so fast. And the Chinese side wants to see how worse it will be, and whether Cisco and Acacia, the related company is-- Acacia's main supplier is the [INAUDIBLE] in China. So whether any kind of ban on the related companies will happen to this deal.

So this is why China sides review is very careful and cautiously. And you can see the remedies is all about ensure the supply. And this is the main concern by the Chinese side. And also, during this review, SAMR has changed its minister from the former minister, Xiao Yaqing, is quite familiar with merger review. By the new minister is quite new and had no experiences. And this change has slowed down the process as the new minister has to get familiar with all the signing process.

JULIE-ANNA NEEDHAM: Great, thank you. And you mentioned about Huawei and the trade war between China and the US. There's obviously a new president in the US now. Can I just ask you to briefly give me your thoughts on what impact Joe Biden is expected to have on Chinese-US relations and how that might impact any future deals in the tech space and approval for them?

LISHA ZHOU: Currently, we don't know what Biden will-- it seems that China has been prepared for that Biden administration may not completely change its attitude to China. I mean, the tensions between China and the US involving the tech sector may still continue. But we don't know how it will evolve.

If things is getting better, China-side, the approval process may speed up. But if still changes to the bad way, bad direction, the review of these tech deals involving US companies may still be slow and carefully.

JULIE-ANNA NEEDHAM: Great. Lisha, Ed, thanks very much.

WOMAN: Thank you.

ED VINALES: Thank you.

JULIE-ANNA NEEDHAM: That was Ed Vinales and Lisha Zhou speaking to me, Julie-Anna Needham. Thank you for listening to this week's episode of Dealcast, presented to you by Mergermarket and SS&C Intralinks. Please rate, review, and subscribe to the podcast. You can find us on Apple Podcasts, Spotify, or look out for your Mergermarket news alert.

3 March 2021