A GLOBAL SHIFT:
September 2017 M&A Trends review
A Global Shift
LOOKING AHEAD TO THE END OF 2017
“There has been a slow start for M&A this year. We see three principal reasons for this. First, a 'wait and see' approach for many multinationals, as they continue to observe the regular flow of geopolitical chaos. Secondly, outbound foreign investment restrictions in China put a strong brake on Chinese investment overseas. Thirdly, in today's politically-charged environment, rising government, antitrust and regulatory hurdles are increasing implementation risk and complexity, with big deals either taking longer to land or often failing to leave the starting blocks at all.
We nevertheless expect that the global M&A market will strengthen in the final months of the year. The past few weeks have seen some bold cross-border deals announced, including Vantiv/Worldpay, Cheung Kong’s purchase of ista* and the US$12bn take private bid by a Chinese Consortium for Singapore’s Global Logistic Properties*. The picture around China’s curbs on capital outflow may also be brightening. Shareholder voices and activism are leading to corporate break-ups, sales of non-core assets and new acquisitions. In certain sectors, the low-growth environment is prompting consolidation as pressurised boards take action, which is promising for activity in Q4.
Record levels of dry powder are driving activity in private equity as financial investors look to capitalise on volatile currency markets and corporate break-ups. Also, firms across all sectors are focusing on lower-value but strategically-critical investments and partnerships in digital technology and innovation.”
2017 TO DATE, AND OUR EXPECTATIONS FOR THE REST OF THE YEAR:
- China outbound deals paused – As we predicted at the start of the year, the uncertainty around China’s restrictions on capital outflows has led to a sharp decline in Chinese outbound activity. We are now seeing the pipeline strengthening, as clarity emerges over regulatory attitude, and we expect more China outbound activity in the final months of the year.
- Increased Antitrust deal scrutiny – Acquisitions of data-rich companies now raise full-blown competition issues, at least in Europe, which makes multi-jurisdictional transactions far more likely to be scrutinised or challenged when there is a significant data element.
- Non-controlling stakes to secure strategic opportunities – Businesses are focusing on strategic opportunities, particularly around digital/innovation, through minority investments in innovative businesses. These strategic stakes are key to secure access to new technologies without over-burdening the balance sheet or creating a cluster risk.
- European M&A market is strengthening – Europe surfaces from a prolonged ‘soft’ M&A period, and we are seeing increasing deal activity across the continent as a result of regional M&A activity and inbound acquirers from North America. M&A in Germany and Spain is expected to be particularly strong for the remaining months of the year.
- Private equity revival - Strong buyout levels in Europe are due to relatively weak £, continuing availability of cheap debt and record levels of dry powder. Investors are however wary of paying ever higher prices in the highly competitive environment. In the US, exits continue to surpass buyouts. Funds are looking to hold assets for longer through long term holding vehicles or strategic funds. We expect to see ever more complex corporate carve outs and “bolt-on” strategies.
- A surge in Consumer sector M&A – Consumer M&A announced in the first half of 2017 beat the value for the sector’s M&A activity in the whole of 2016, as sluggish organic growth in mature markets drove consolidation. Consolidation will be a feature of the market for the remainder of the year.
“The surge in megadeals in the Consumer sector is a consequence of sluggish growth, which is driving companies, particularly in the US, to consolidate both nationally and internationally, so as to maintain or increase market share and drive cost savings in a tough low-margin environment. Consolidation will continue to be one of the primary features of the market for the remainder of the year.”
China on the rise
CHINA’S RESTRICTIONS ON
CAPITAL OUTFLOWS: WHAT’S NEW?
China is restricting outbound foreign investment through a tightening of its approval and filing regimes in a bid to curb depleting FX reserves. Largely as a result of this, Chinese outbound M&A announced in the first six months of 2017 is down 42% on the previous six month period. However a good number of outbound deals, including big-ticket M&As, are still being done.
Greater clarity around regulatory attitude
- •On 18 August 2017, the Chinese government published a set of outbound investment guidelines aimed at regulating “irrational” overseas acquisitions by restricting investments in certain sectors such as real estate, hotels, movie studios, entertainment and sports clubs. However, outbound transactions that are consistent with China’s ‘Going Out’ policy from a sector perspective or reflective of Chinese Government’s ‘One Belt One Road’ strategy will continue to receive strong support.
- •The recent guidance effectively formalises previously published piecemeal rules as well as unofficial measures, and helpfully classifies types of investment and sectors as ‘encouraged’, ‘restricted’ or ‘prohibited’:
Rumoured relaxation of FX policy
- •As the foreign exchange reserve of China has stabilised in recent months, it has been rumoured in the market that some of China’s local foreign exchange authorities (SAFEs) are starting to relax to a certain degree their tightening of cross-border remittance in some cases. It remains to be seen how far this goes in practice.
Impact on deal terms
- •China’s restrictions cause significant nervousness among foreign sellers around the ability and feasibility of Chinese bidders to close an outbound transaction, particularly from the funding perspective. Reverse break-up fees and signing deposits payable by Chinese bidders have become standard market practice, with a higher amount typically requested than in previous years.
Innovative deal structures
- •On large or complex outbound deals, we are seeing PRC strategic investors increasingly team up in a consortium structure with one or more PE investors who have funds available offshore. Alternative offshore financing arrangements, e.g. bridge financing or full leverage financing, are also increasingly considered by Chinese bidders in the current environment.
- •Support for ‘One Belt and One Road’
- •Export of China’s advanced production technology and capacity
- •High-tech investment/offshore R&D
- •Energy/mining exploration; agriculture; commerce, culture, logistics
- •Growth of Chinese financial institutions
- •Investment in sensitive regions
- •Real estate, hotels, movie studios, entertainment industry, sports clubs
- •Equity investment where no substantive project
- •Violation of the host’s environmental, energy or safety standards
- •Export of military technology/products
- •Banned exports
- •Sex industry and gambling
- •Violation of China’s international treaties
- •Harm to national interests/security
“Using innovative security and funds flow structures, we are helping bidders address the regulations in a meaningful way while ensuring the deals get done”
Minimise the Impact
With growing political and regulatory scrutiny, it is critical, at the outset of any M&A process, to identify the various ‘invisible stakeholders’ beyond the immediate deal parties, who could affect the transaction. These could include government agencies, tax authorities and regulators, but also activists, campaigners and the media.
These ‘invisible stakeholders’ can be underestimated, resulting in increased execution risk, financial liability or reputational harm.
A plan must be developed to manage these stakeholders proactively and sensitively to secure the right outcome.
INVISIBLE STAKEHOLDERS AND THEIR IMPACT
Lexmark – a Chinese and Hong Kong consortium obtained insurance (costing over US$ 10m) for a US$ 90m reverse break fee if CFIUS rejected the consortium’s US$ 3.6bn bid for US printer maker Lexmark. The deal completed in December 2016.
CFIUS - Approval can be unpredictable. The parties withdrew from the proposed sale of Philips’s lighting business to a Chinese-led consortium due to unforeseen (and unexplained) CFIUS national security concerns. However, CFIUS approved a US$ 43bn bid by China National Chemical Corporation to purchase seed giant Syngenta AG, despite public lobbying.
Governments are concerned with the volume of outbound M&A and the expatriation of funds. In particular, China’s SAFE and central bank are tightening capital outflow regulations to ease pressure on the Renminbi and support foreign exchange reserves.
US$ 38bn acquisition of Baker Hughes by Halliburton – abandoned after US DOJ litigation to prevent the merger and opposition from the European Commission, triggering a US$ 3.5bn reverse break fee.
Foreign exchange restrictions and practical difficulties in repatriating cash are a brake on M&A and can require bespoke FX arrangements. New central bank regulations to manage currencies can create artificial FX rates or spark significant and rapid devaluation.
Sale of BHS to Dominic Chappell for £1 – the 2016 collapse of UK retailer BHS led to 20,000 members of the pension scheme being at risk of cuts to retirement income. The large estimated pension deficit (£571m) resulted in public outcry and criticism of the regulator itself.
So called ‘bumpitrage’ sees hedge funds buy a stake large enough to cause issues or derail a takeover offer. Bidders have responded by enhancing the price. More common in the US where corporate governance rules favour activist shareholders. As European institutional shareholders are pressured to meet returns objectives, and activists reap more success, we expect more bumpitrage.
Employee bodies exercise consultation and approval rights with greater frequency. In France and other European jurisdictions, works councils must be informed and consulted prior to the execution of contracts. In the UK, government public statements indicate greater rights for employees will be provided for in the future, including the possibility of board representation or advisory panels.
Tanzania Revenue Authority – recently sought to tax a UK plc on ‘investment income’ following a transaction between two foreign entities outside Tanzania on the grounds that the UK plc acquired a greater interest in a local ‘asset’.
In no small part due to social media, public interest in all manner of business activities, including M&A, is increasing. Pharma price ‘gouging’, tax practices and executive pay attract scrutiny and opprobrium.
ANTITRUST DEAL SCRUTINY
WHAT’S CHANGING AND WHAT DO DEAL-MAKERS NEED TO KNOW?
Acquisitions of data-rich companies now raise full-blown competition issues, at least in Europe, which makes multi-jurisdictional transactions far more likely to be scrutinised or challenged when there is a significant data element.
- •Antitrust is of critical interest to any CEO or leadership team that has ambitions to advance through M&A transactions. With antitrust and regulatory rules and cultures radically diverging in the EU and the US, a significant increase in time, care, sophistication and attention is needed to get deals done.
- •The European Commission has toughened its stance, adopting robust positions on procedural infringements relating to data, market concentration and innovation. Antitrust authorities in Asia are showing signs of following suit, while the intervention by US agencies appears to be softening under the current administration.
- •In the high stakes contest of a full-blown antitrust review,
what is it that will assist your deal go through? Planning,
preparation and focus are of course essential, but
navigating the following is increasingly important:
- -Shift in emphasis to deals that increase concentration levels, rather than only those that achieve or enhance dominance, meaning the authorities look at the market not the deal. A combination of the smallest two players in a narrow market could trigger a concern, even if this does not create a market leader.
- -Focus on procedural infringements, which can involve significant fines. Facebook was fined €110 million by the European Commission (EC) for ‘misleading’ the EC during its WhatsApp acquisition and Altice was fined €80 million by the French Competition Authority for getting involved in the target’s business decisions prior to closing.
- -Innovation – authorities are focusing on R&D in the broader market and not only in specific markets where overlaps exist between the merging parties. This has led to more sweeping remedies in cases like Dow/DuPont than might otherwise have been imposed.
- •Deal teams also need to evaluate non-antitrust concerns (including consumer protection concerns) as these are weaving their way into the merger control analysis, especially in the US.
“Globally, we are seeing increasing proliferation of inconsistent merger control procedures and greater scrutiny of foreign takeovers on non-competition grounds. Navigating these complexities requires careful planning, understanding of local sensitivities and early identification of remedies.”
“US merger control enforcement is unlikely to change dramatically, although non-antitrust factors may influence key decision makers – many of whom have yet to be appointed.”
“Obtaining merger clearance in Europe requires parties to address the authorities’ toughened substantive criteria as well as significantly heightened procedural demands.”
“Increasing cooperation between APAC authorities and their EU and US counterparts has seen concerns over innovation surface in China and Japan in particular”
'Innovate or die'
All businesses are now technology businesses. The rule of ‘innovate or die’ is extending well beyond pure tech firms that have always competed to be at the cutting edge. This is driving a sustained expansion of technology deal-making. But it also provides a long list of legal headaches in a fast evolving regulatory environment.
Although M&A can provide a quick path to innovation, it is not always the best solution. Many businesses are looking beyond conventional acquisitions to a range of cooperation-based deals, from joint ventures to outsourcing or licensing arrangements (or a combination), each with its own set of risks and challenges.
STRATEGIC OPPORTUNITIES THROUGH MINORITY STAKES
Businesses are focussing on strategic opportunities, particularly around digital/innovation, through minority investments in start-ups. These strategic stakes are seen as key to secure access to new technologies without over-burdening the balance sheet or creating a cluster risk.
FINTECH M&A FOCUS
Strategic minority investments in fintech businesses are on the rise. We are increasingly seeing corporates, banks and other financial institutions investing in strategically critical and innovative technology to increase efficiency, reduce cost or improve access to and delivery of financial services.
Fintech investments require a particularly careful balance to be struck between agility of commercial decision making, entrepreneurial spirit and regulatory and internal compliance. We have identified 4 areas of focus for businesses undertaking these deals: Emerging Financial Regulation; Using Data; Cyber Security; and Artificial Intelligence.
- •Patchwork of regulations
- •Implications for own compliance
- •Impact of emerging regulation on future value
- •GDPR changes everything
- •New fines – up to 4% of global turnover
- •Do current data consents match planned uses?
- •Business-critical risks
- •Fintech triple fine exposure: FCA, GDPR, NIS Directive
- •Third party ecosystem risk
- •AI already embedded in many products/services
- •GDPR – automated decisions subject to human review
- •Algorithmic bias litigation risk
Impacts of new privacy laws on M&A
“The era of sucking up lakes of data for profit without thought or care for the individual is coming to an end. Those who are ready for the next data age will be richly rewarded.
The upcoming changes in law when the GDPR comes into force in May 2018 will put the individual back in control of their data universe.
These changes will also create opportunities for businesses able to remodel themselves around the new requirements (and around customers) in response to this shift. Financial institutions already control huge databases of customer data. The burden of ensuring compliance will grow, but those financial institutions that can navigate the privacy rules while fully putting their data to work will leave their less adaptable competitors behind. ”
Economic drivers of dealmaking
Tax policy and acquisition financing drive cross-border dealmaking
Liquid debt markets, evolving tax policies and currency volatility were critical influences on global M&A throughout 2016.
Continued high levels of liquidity and low interest rates created favourable conditions for borrowers seeking acquisition financing. Conversely, a US-led clampdown on tax inversions eliminated the tax strategy driving some mega-deals, particularly in pharma.
We expect that debt markets, currency volatility, differing monetary policies, together with tax policy changes, will remain at the forefront of M&A decision-making in 2017.
Unlike 2008, sustained liquidity is currently mitigating the impact of political and economic events on M&A. Financing markets are highly liquid, resulting in a number of financing alternatives at attractive pricing for borrowers, and some of the largest M&A financings ever seen.
Diverging financing markets and differing monetary policies are adding complexity to the financing of M&A. Open market windows and momentary improvements in individual financing markets need to be seized. With cross-border M&A again on the rise, bridging the disparate expectations of sellers, buyers and financiers from international markets will be critical to getting deals financed.
President Trump has promised US tax reform. While details are few, one stand-out proposal could result in the repatriation of worldwide profits of US head-quartered groups to the US, leading to an increase in M&A as that cash is put to work. President Trump, senior members of the Trump administration, and leaders of the US Congress have recently held meetings to discuss tax reform amid the autumn 2017 legislative agenda, and further details regarding a tax reform package are expected to be released soon.
The OECD’s ‘base-erosion and profit shifting’ reform, which will be implemented in certain countries in 2017, will impact the structuring and financing of cross-border M&A, particularly leveraged acquisitions.
The Trends We Are Seeing
GLOBAL AND NATIONAL TAX POLICIES EVOLVE – CREATING M&A CHALLENGES AND OPPORTUNITIES FOR CORPORATE GROUPS
Global and national tax policies will evolve in light of continuing populist sentiment against perceived tax avoidance and the Trump administration. The impact of BEPS and the evolution of US tax policy will be crucial for M&A
- •BEPS is likely to reduce the tax benefit of debt financing, create heightened tax risk for acquisitions of legacy structures, and mean that many standard financing and acquisitions structures will need to be reconsidered from a tax perspective.
- •US tax reform: Proposals put forward by President Trump and the Republican Party include the revamp of US federal corporate tax. If enacted, consequences would include a cut in corporate income tax and a one-off 'deemed repatriation' requiring US corporations' non-US profits to be brought back and taxed at 10% (as opposed to the current 35% rate). If implemented this could result in a huge inflow of cash into the US. There is a renewed push for a tax reform package to be considered in the fall of 2017.
2017 – LOOKING AHEAD
“These reforms could significantly change the US tax landscape, both for US and non-US multinationals, and may prompt US-headquartered multinationals to restructure their international operations.”
CROSS-BORDER DEAL-MAKING WHAT NEXT FOR ACQUISITION FINANCING?
Evolving financing markets, currency volatility and differing monetary policies will add to the complexity of financing cross-border M&A in 2017. Current market conditions, and expected divergence and volatility will result in a variety of finance choices. Opportunism will be a key market feature, and fortune will favour the prepared
- •Mismatched expectations: Mismatched expectations will result in further challenges in 2017. This is not new, but nevertheless challenging. Borrowers may need to adjust their expectations as to the timing, availability and syndication book building process for financings, depending on the target’s home market and the sources of financing being used.
- •Regulation bites: Regulatory constraints will continue to influence leveraged M&A as US and European regulators consider policies on leveraged credit risk, and could move in opposite directions. Financial sponsors may be unable to achieve debt levels needed to match premium values paid by trade buyers or may find it easier to raise finance from non-bank investors or use debt with ‘equity-like’ features to work around leverage requirements.
2017 – LOOKING AHEAD
“It is a great time for refinancing and for financing appropriately leveraged M&A transactions. For increased leverage borrowers really need to think outside the box, although the range of options is increasing.”