THE AGE OF INFLUENCE
Our M&A insights and deal intelligence 2018
“Welcome to our annual review of global M&A. As boardrooms and investors look forward to a strengthening economic outlook in 2018, we explore some of the forces and trends that will shape the M&A environment.
Long-established businesses are fired up by the need to transform as they seek to take on the challenge of tech titans, new entrants and start-ups. Data residing within their own systems, as yet not fully monetised, is their greatest asset as they fight to stay relevant in fast-changing markets.
We are in an age of influence, where shareholder activists are training their sights well beyond their traditional North American hunting ground. Listed companies need to become more active in managing shareholder expectations and responding to unexpected demands.
Recent political upheaval in the US and across Europe has led to shifting views on the benefits of globalisation and some governments are tightening channels for foreign direct investment in response, in part motivated by populist demands. Others, including China, are beginning to open up as they weigh the benefits of inbound investment.
The private equity industry’s funding and fee model is under pressure with ever-growing levels of undeployed capital and fierce competition for quality assets.
These are just a few of the evolutionary shifts and market changes which we expect to drive M&A activity in the coming year. I hope you enjoy the report and, as ever, welcome your feedback around these developments.”
A new asset class comes of age
Investors are prepared to pay more for a target with data assets which sharpen their competitive edge, helping them to create new products and unlock new revenue streams.
The vast majority of global data lies with ‘nontech’ companies and much of this has yet to be converted into tangible value. 2018 will see established companies making more of their data, spurring continued growth of midmarket tech M&A activity.
Incoming data privacy regulation is defining what businesses can and cannot do with their data - from the EU’s General Data Protection Regulation (GDPR) to the People’s Republic of China’s recent cyber-security law. This is becoming a key driver of strategy and deal structure.
Intel-Mobileye deal - One of the largest deals driven by Artificial Intelligence (AI)/Internet of Things (IoT) to date
The bytes of data produced per day
Predicted value of European data economy by 2020
THE DATA-DRIVEN TRENDS WE ARE SEEING
MAXIMISING STRATEGIC OPPORTUNITIES BY MANAGING CYBER AND REGULATORY RISK
The emergence of data as a coveted asset class is changing how buyers approach deals.
The value of data
High profile, data rich targets have been acquired at significant discounts, signalling a shift from traditional valuation methodologies. As acquirers become more familiar with the associated risks, they are adapting their approaches to valuation. Innovative solutions are being devised to bridge valuation gaps – from straightforward milestone-related payments to more sophisticated revenue sharing arrangements.
The dark side of data
We have recently seen some of the largest data breaches in history hitting valuations. Cyber risk sits among the top items on diligence agendas, particularly where data is core to the target’s business, yet it remains a difficult area to diligence as big-impact issues may remain latent, deep in the target’s systems.
Data-driven deals have not been confined to the traditional centres of the data industry. Investors are following tech talent and making acquisitions where they find it. For buyers, this means getting familiar with new and different regulatory environments and market practices. Increased regulatory scrutiny in Europe and the US has not resulted in a flight towards ‘regulatory-light’ jurisdictions as many established jurisdictions are also hubs of tech talent and will continue to attract investment.
Data cannot always be owned under traditional forms of intellectual property ownership. So in order to realise the value of target data, deal documents must secure rights equivalent to ownership. Understanding the target’s rights over data is critical - overlooking this creates future execution risk. As the law evolves, so will the strategies to achieve the right control and ownership over acquired data.
“Diverging standards can close off rather than create opportunities. Achievements of some of the Chinese tech giants at the cutting edge of AI and big data, for example, may not export well into markets where stricter personal data regulation could undermine their data collection and processing models.”
Shareholder activism in M&A 2018
Shareholders of listed companies are increasingly influencing boardroom decision-making globally. Activism is growing beyond traditional North American markets into Europe and Asia.
A common campaign focus is M&A, where activists seek better returns through pressuring boards to sell underperforming businesses or influencing pricing on takeovers.
The strategies that activists can employ are varied, as are the types of investors seeking to bring about change. Listed companies need to respond in a new era of shareholder engagement, and take into account the style, tactics and demands of the relevant activists.
Number of activist campaigns started in 2017 globally*
Increase in activist campaigns against European HQ companies over the last 3 years
Percentage of activist campaigns launched in 2017 that were partially or wholly successful*
Percentage of campaigns focused on M&A, corporate strategy or balance sheet activism*
Source: Activist Insight
THE ACTIVISM TRENDS WE ARE SEEING
A NEW ERA OF ACTIVISM
We are in a more dynamic era of shareholder activism with players and tactics more varied and activists working across a broader geographic area.
No longer simply the aggressor
The perception of activists as ‘corporate raiders’ - using aggressive media campaigns, litigation and proxy fights to effect change for short term investment and gain - has evolved. Today, shareholder activism is multi-faceted and demands a more tailored response from the target.
US activists broaden their horizons
Activist campaigns peaked in 2016 and 2017. In North America the rise was moderate, but activity has surged in Europe and Asia. US activists looking outside their saturated domestic market are finding friendly legal and regulatory climates to pursue targets abroad. Activists in Europe and Asia are meanwhile initiating more domestic campaigns.
Activism transcends industries and market caps
Mid caps in certain sectors have been traditional targets for activism, but no corporation is immune in today’s relatively low return economic climate. Investors actively seeking higher returns can turn their spotlight on the strategy, business and management of any enterprise perceived not to be optimising returns. Size is no barrier.
The many faces of activism
Activists are increasingly sophisticated, employing an array of tactics in an attempt to achieve their aims. The philosophy and approach can vary significantly. They can be hostile or collaborative, public or private, active or passive. At the same time, more traditionally passive shareholders – including institutions, index funds and private equity funds – are deploying activist tactics as the line between ‘corporate raider’ activist and institutional shareholder is blurred.
M&A is a focus
M&A is often a focus for activists as a means of enhancing returns. Activists may oppose existing M&A transactions (e.g. Clariant/Huntsman) or undertake bumpitrage campaigns (e.g. KKR/Hitachi Kokusai). In other cases they agitate companies to undertake M&A and shake up existing businesses (e.g. Whole Foods).
KNOW YOUR ACTIVIST
Most activist demands are premised on seeking increased shareholder return, but a broad range of tactics can be employed. Within any given campaign, several of these might be used in tandem:
- Payout Seeker
Seeking cash returns through special dividends, share buybacks, recapitalisations. Proposing a sale or other M&A-based strategy to reward shareholders.
- Portfolio Appraiser
Evaluating the business divisions and structure of a business. Recommending divestments and spin-offs. Opposing planned mergers.
- Boardroom Agitator
Injecting new blood to stimulate action in the boardroom. Calling for CEO replacement or executive compensation changes linked to performance.
- Strategist or Reformer
Looking for a long term strategic shift or shake-up in current goals. Might look for a board seat to influence strategic direction.
- Bid Opportunist
Buying in to get short term gain in a takeover situation. Undertaking ‘bumpitrage’ to increase the bid price.
- Ethical Activist
Pushing for change around a wide range of sustainability and ethical issues, such as climate change or gender and diversity gaps. The Ethical Activist is the new kid on the block.
“We are seeing increasing levels of activism in Japan as recent reforms in the corporate governance and stewardship codes encourage greater dialogue between companies and their shareholders. Activists are pursuing strategies linked not only to financial returns but improved corporate governance, in line with developments in the US and Europe”
Attitudes to foreign investment are in flux with some nations raising new barriers to address national security concerns and populist sentiment, having a particular impact on Chinese bidders. Meanwhile other countries are becoming more ‘open’ as they seek the benefits of an injection of overseas capital, technology and knowhow.
Regulatory restrictions are changing, but dealmakers must also be conscious of the influence of the public and political mood on the deal’s likelihood of success.
Opportunities exist for buyers who can navigate the new and shifting barriers to entry. Agile buyers can also take advantage of opportunities in countries that are becoming more open.
Fall in value of Chinese outbound M&A in 2017 compared to 2016
Chinese-backed Canyon Bridge’s US$1.3bn bid for Lattice Semiconductor Corp was blocked by President Trump on the recommendation of CFIUS in 2017
Bid for German blood plasma products maker Biotest by China’s Creat Group is facing CFIUS review, demonstrating the increased scrutiny of deals in industries not traditionally related to national security
Increase in foreign direct investment into China compared to 2016*
Source: Chinese Ministry of Commerce. Data relates to period from 1 January to 30 November 2017.
TRENDS WE ARE SEEING IN FDI
DIVERGING TRADE DYNAMICS: AMERICA TIGHTENS WHILE EUROPE FRAGMENTS AND CHINA OPENS
Cross-border investment is increasingly politicised, leading to diverging attitudes and rules.
Both President Trump and Congress are seeking greater scrutiny of foreign buyers. The Committee on Foreign Investment in the United States (CFIUS), is following through on this by increasing reviews of certain foreign acquisitions, particularly when the target is a tech business or in a strategic industry. There have been two Presidential orders blocking foreign bids following recommendations from CFIUS (Aixtron SE/Fujian Grand Chip and Lattice Semiconductor Corp/China Venture Capital Fund) since December 2016 compared with just two in the previous 25 years. Increasingly CFIUS appears to be interpreting US national security concerns to include issues of competitiveness and innovation.
The picture in Europe
Europe is characterised by a patchwork of national foreign investment laws and divergent attitudes to inbound investment. Despite calls by some countries for a pan-EU regime on foreign takeovers, the recently-proposed EU ‘framework’ would preserve this diverse set of rules and regulations.
Politics drive restrictions
Governments are dealing with varying political and economic issues. The UK government is seeking to balance the need to remain ‘open’ while bolstering its powers to intervene in foreign takeovers on national security grounds. The Dutch government is considering similar measures in key sectors. In response to an influx of Chinese investment, Germany is seeking greater oversight, particularly where targets are advanced technology assets. The Italian government is using its ‘golden powers’ to block foreign deals.
China opening up?
China is implementing new policies encouraging inward FDI. We consider these policies and their potential impact on M&A further on page 20 of the full report.
“As CFIUS reviews become longer and more unpredictable, it is critical that deal strategies mitigate national security risks and the potential impact on deal timing and execution early on.”
Europe remains a region that is very open to FDI. However dealmakers should inform themselves of the diverging approaches and political sentiments which characterise individual countries, and the latest ‘direction of travel’.
New moves in private equity
Traditional private equity operating models used by financial sponsors are under pressure.
Sponsors both old and new are in fierce competition for quality assets as vast sums of private capital have yet to be deployed and investors seek returns comparable to the past. In response, sponsors are innovating to generate returns and mitigate competition in auctions.
Sponsors are diversifying asset classes and geographies, strengthening their internal teams by hiring sector leaders to focus on operational value creation and adapting their funding structures, with an increasing use of credit instruments.
Those who succeed will emerge as the sector leaders and key participants in global M&A in 2018 and beyond.
US$ 1 trn
Undeployed capital or “dry powder” available to private equity fund managers hit the record US$ 1trn number at the end of 2017, up from US$838bn in 2016
US$ 24.6 bn
Apollo Global Management closed its 9th fund at a record setting amount. In aggregate, private equity vehicles closed in 2017 raised US$ 453bn, an all-time record
Average valuation for high-end transactions (above US$ 250m) as a multiple of EBITDA. Rising year on year from 10.3x in 2014
Proportion of transactions with monitoring fees in 2017, down from 32% in 2016
THE INDUSTRY TRENDS WE ARE SEEING
INNOVATION IN THE ALLOCATION OF CAPITAL
Early stage risk, minority investments, club deals, corporate carve-outs and sector focussed value creation are key features of an industry innovating to find returns in a low-growth environment. Differentiation and specialisation are critical to success for sponsors to mitigate the challenge of direct investment.
With established funds setting fundraising records, debt readily available and limited partners moving into direct investment, the heightened competitive climate is putting the traditional ‘2 and 20’ fee model under pressure. Given the deployment challenges, having access to capital is not enough.
Sponsors are shifting to organise themselves by sector and regional lines, hiring experts to advise and focus on operational value creation. Larger, global players (increasingly operating by sector – e.g. Apax recently closed on a US$1bn tech growth fund, or on regional platforms – e.g. KKR’s recent US$9bn Asian fundraising) can attain full coverage and competitive advantage over smaller outfits, helping to explain the record levels of investment in more established funds.
Through sector focus sponsors can target early stage minority investments, which allow for flexibility, potential ‘buy and build’ strategies and put the sponsor in prime position to acquire control should the business grow. ‘Platform’ strategies can also be adopted, allowing for the ring-fencing of assets.
Corporate carve outs are of interest to sponsors seeking to take advantage of the opportunities as activist investors apply pressure to businesses to divest divisions and boost shareholder returns.
“Sponsors are adapting to win. Investing strategies focus on hedging downside, the popularity in club deals can be explained by sponsors seeking to mitigate equity concentration across the fund, and fund investment theses are increasingly specific to differentiate and enhance marketability to limited partners.”
Outlook for 2018
Using insight and deal intelligence from across our global network and year-end data from Mergermarket, we analyse the key trends and drivers for global M&A in 2018.
Overall M&A deal values globally are relatively flat - down 3% on the previous year - but with pockets of activity growth in certain hotspot locations and industries.
With growing confidence in boardrooms and amongst dealmakers, a positive outlook for the world economy, a stable oil price, strong company balance sheets and ample dry powder, the initial indications are that 2018 will be a busy year for M&A. Uncertainties around the impact of midterm elections in the US, rising interest rates, trade disputes and geopolitical flareups may throw up some speed bumps but at this point we see a positive year ahead.
Increase in value of inbound M&A into Japan compared with 2016, illustrating growing confidence in Japan’s economy following re-election of Shinzo Abe and his ongoing economic reforms
Sempra Energy’s acquisition of Energy Future Holdings, the largest deal in the Energy sector in 2017
Increase in value of M&A within Latin America in 2017 compared to 2016
Vodacom of South Africa’s acquisition of a 35% stake in Kenya’s Safaricom, the largest deal in Africa in 2017 outside of the Energy sector
CROSS-BORDER M&A INVESTMENT FLOWS
- Global M&A activity is down 3% by value, totalling US$ 3.16trn for the year. Q4 was the strongest quarter of the year with US$ 896bn worth of deals.
- European M&A is strong with deal value up 14%, driven by intra- European M&A activity (+53%) and inbound deals from the US (+8%). This helps counter-balance a 52% fall in Chinese M&A into Europe. All other major regions are seeing subdued activity as compared to 2016. US M&A is down 14%.
- Cross-border M&A is seeing a significant shift, with inter-regional deals now comprising 26% of global deal value, down from 30%, partly due to the decline in Chinese outbound activity in 2017. Asia-Pacific is the only region to see increased inbound activity into the region.
- Consumer, Retail and Leisure is the hottest sector – up from 10% to 15% share of total global activity, as a result of megadeals such as BAT/ Reynolds American and Amazon/Whole Foods.
- The private equity market remains strong with sponsor-led M&A totalling US$ 874bn – accounting for 28% of global deal value. Ever-growing levels of capital need to be deployed and corporate carve-outs are being targeted. The €4.1bn Bain/Cinven buyout of STADA is Europe’s largest in 5 years, an example of returning public companies to private ownership.
“It is crunch time for traditional retailers, many of whom now face a pressing choice between rapid transformation for the digital age, a major strategic pivot or potential extinction. These high stakes will drive M&A in the retail and consumer sectors, including M&A between traditional CG&R companies and tech companies.”