Our M&A insights and deal intelligence 2017
A Global Shift
A snapshot of THE RISKS AND OPPORTUNITIES FOR GLOBAL M&A IN 2017
“The geo-political landscape is in flux, and there is a sense that the uncertain outlook marks a significant global shift.
US tax and wider policy reforms, the forthcoming European elections and the possible re-set of key global trading relationships will make some businesses pause their M&A plans. Others will make their strategic moves while financing fundamentals remain strong and markets are in their favour.
Overall, we expect a reasonably healthy level of M&A in 2017, as creative deal-makers continue to pursue growth opportunities and technological advancement amid ongoing disruption.”
WE REVIEW MERGERMARKET’S DATA FOR M&A ACTIVITY (BY VALUE) FOR 2016
- Global M&A is down 19% compared to the previous year, with deal activity totalling US$ 3.2trn. Volume of deals fell 6%. However, these numbers should be viewed in the context of 2015 being the best year ever for M&A. 2016 activity picked up significantly in September and October, which both recorded deal values exceeding the same months in 2015.
- Deal value in North America is down 23% (US domestic M&A fell 32%) and in Asia Pacific is down 22%. European M&A is also down year on year by 11% – a figure that masks significant differences between markets. For example, UK M&A fell 55% whilst German M&A rose 27%. Elsewhere, hotspots of activity include India and Africa.
- Companies and investors continue to look further afield for deals. In 2016, over 29% of total M&A value was through cross-regional deals. Chinese buyers are leading the charge globally – with outbound investment totalling US$ 208.5bn (+114%). Chinese investment is targeting Europe (US$ 88.2bn), North America (US$ 65.8bn) and Latin America (US$ 16.2bn).
- Tech, Energy and Natural Resources and Industrials & Chemicals M&A are the most active sectors. Here, mega-deals are taking centre stage – Time Warner/AT&T, Sunoco/Energy Transfer and Monsanto/Bayer are among 2016’s largest announced deals. The Consumer, Retail and Leisure sector has seen the biggest fall in deal value, with its share of total deal activity (by value) falling from 16% to 9% year on year.
- Private equity activity continues on an upwards trend as a result of increasing pressure on sponsors to deploy capital raised from limited partners seeking yield and an ability to act rapidly and turn volatility into opportunity. Sponsors are taking advantage of FX turmoil and uncertainty (e.g. euro and dollar funds targeting the UK post-Brexit vote). Loan market liquidity, particularly in Europe, is benefiting market participants through attractive pricing and improved ‘cov-lite’ terms both in the term loan and high yield markets.
China on the rise
Global M&A player
Outbound acquisitions by Chinese bidders topped US$ 208.6bn in 2016 – a 114% increase on the previous year, driven by Industrials and Chemicals (US$ 72.2bn) and TMT (US$ 39bn) deals into Europe and North America.
The momentum for outbound M&A comes from a range of factors, including abundance of capital and cheap debt, pursuit of growth outside a slowing economy and efforts to meet the demands of a more affluent middle class. However, the increasing capital outflow has attracted political scrutiny in China due to the drain on foreign exchange reserves, and Chinese authorities are seeking to regulate outbound flows.
Elsewhere, protectionist resistance to foreign bidders is increasing, and Chinese buyers in particular are subject to more stringent reviews on national security and public interest grounds, particularly in the US and Germany.
What impact will these developments have on the current tide of Chinese outbound M&A in 2017?
Chinese outbound M&A is up 114% by value in 2016.
Chinese M&A into Europe is up 201% and into North America is up 412% by value.
ChemChina/Syngenta – 2016’s largest China outbound deal.
Industrials and Chemicals M&A – the largest sector for China outbound.
“In Germany and beyond, working with China depends on the political desire to engage and partner, China’s continued focus on intelligent manufacturing, and increased scrutiny by Chinese regulators of outbound investment.”
CURBING CAPITAL OUTFLOWS FROM CHINA – WHAT NEXT FOR M&A?
THE CLIFFORD CHANCE PERSPECTIVE
Whilst the implications of the newly-announced restrictions on capital outflows from China remain uncertain, we consider the possible impact on Chinese outbound M&A in 2017 and beyond.
- •The Chinese authorities are reportedly introducing restrictions on certain outbound investments to reduce capital outflows. The new regulations would likely curb all outbound mega-deals (US$ 10bn+). In addition all acquisitions with value over US$ 1bn which are outside the Chinese bidder’s core business areas would be subject to strict scrutiny by Chinese authorities under the new regime.
- •Should this happen, what will be the likely impact on overseas M&A? We have already seen a number of outbound deals run into difficulties after the news of the restrictions, as uncertainty over the extent and timing of the restrictions heightened sellers’ concerns with regards to Chinese buyers – and we expect this to continue in the early part of 2017, until there is more clarity. For the longer term there are unlikely to be meaningful curbs on M&A, as we expect continued support by the Chinese Government for its ‘Going Out’ policy and ‘One Belt One Road’ strategy, for which overseas acquisitions are important. Overzealous investments (e.g football clubs and non-strategic real estate) will likely be reigned in, but strategic M&A deals by Chinese state-owned and private enterprises are expected to bounce back in the second half of 2017.
2017 – LOOKING AHEAD
“Despite the introduction of restrictions on capital outflows in China, we are helping Chinese buyers explore more innovative funding structures and we remain cautiously optimistic about the longer term ability of China to sustain a strong level of outbound M&A activity.”
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.
Value of broken global M&A in 2016, nearly double that of 2015.
Tianjin Tianhai Investment Company would have had to pay up to US$400 million to Ingram Micro, Inc. (over 6.6% of the total deal value) for failure to obtain Chinese and US antitrust or regulatory approvals and CFIUS approval.
Indirect sales of local companies in many African jurisdictions, including Tanzania, Cameroon, Mozambique, Uganda and Liberia, are attracting tax authority scrutiny and new taxes are being imposed.
In 2016 the European Commission blocked or imposed remedies on the highest proportion of deals since 2008.
INVISIBLE STAKEHOLDERS AND THEIR IMPACT
Lexmark – a Chinese and Hong Kong consortium obtained insurance (costing over US$ 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.
POPULISM, PROTECTIONISM AND PROHIBITIONS: THE GLOBAL IMPACT
THE CLIFFORD CHANCE PERSPECTIVE
The recent trend of increased government intervention is likely to continue into 2017 as we see populist and protectionist policies gain traction. However, ultimate approval for deals will take other factors, including the benefits of foreign investment, into consideration.
- •Global M&A faces a wave of national political and regulatory scrutiny and increased protectionist attitudes, largely as a result of rising populism and nationalist sentiment. This manifests itself in foreign investment and national security reviews, where elected politicians are often key decision makers.
- •We see a trend towards greater powers to intervene in transactions on public interest grounds. In recent years, such powers have increased in Europe, Africa, North America and Australia. Our view is that this will impact the ultimate approval of only a small number of deals in the near term. The trend coincides with increased Chinese investment – in Europe, three times higher in 2016 than 2015 and in the US, over five times higher – and so may well recede as Chinese outbound investment slows due to state intervention. Moreover, populist hostility to foreign takeovers is nuanced. Populist political statements must be weighed against the real politik of the need to attract foreign investment.
2017 – LOOKING AHEAD
“While less susceptible to populist sentiment, antitrust agencies will continue to pose a bigger threat to M&A than others in government.
Intimate knowledge of antitrust agencies and their ways of working is more important than ever to get complex deals done.”
'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.
Technology transactions represented 22% (US$ 694bn) of all global M&A value in 2016, making it the most active sector.
43% of executives cite digitisation as a key disruptor.*
46% of executives say the industry blur resulting from digitisation is among their top two disruptors.*
* Source: Technology Capital Confidence Barometer (EY, October 2016).
A ‘wait and see’ innovation strategy is high-risk. Large players are pursuing bold, ‘next big thing’ acquisitions to leapfrog competitors.
THE TRENDS WE ARE SEEING
FINDING THE RIGHT FIT
Technology M&A poses unique challenges. Issues which were traditionally considered peripheral – data protection, intellectual property ownership, transitional service support – are taking centre stage. These are some of the key deal trends here to stay:
- •Battles over IP: Acquisition may be the best route if full control of technology is required. Collaboration rarely results in exclusive IP ownership. Jointly held IP can prove challenging when it comes to further development and improvement of background technology.
- •Competitive advantage vs competition concerns: Acquiring exclusive rights to a technology can prevent a competitor from accessing the technology or eliminate the target as a competitor. But this is a potentially high-risk strategy and requires careful consideration of antitrust matters.
- •Separation and integration headaches: Getting hold of the technology is not enough: it may need to be separated from the seller group, and integrated into a new and very different business. This challenge can be especially acute when a non-technology business acquires a highly innovative tech business. These issues can take many months, if not years, to resolve.
- •Growing pains: The most innovative businesses tend to be fast-moving and work outside rigid structures, not afraid to challenge orthodoxy. Post-acquisition, the structure and compliance culture of a large business can sometimes work against this. Striking a balance is key.
2017 – LOOKING AHEAD
“2017 will be a big year for Tech M&A. Perhaps the best yet. The tech revolution is pushing the boundaries of innovation, regulation and corporate strategy. The opportunities are endless if you identify the critical drivers of your use of technology and devise a structure to maximise the benefit”
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.
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 new 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.
- •According to economists, a significant appreciation of the dollar could be likely. Any such rise, allied with an ability to repatriate future foreign profits free of US tax, could potentially spark a wave of foreign and domestic acquisitions by US groups (although trade protectionist policies may counteract this). Given that any rise in the dollar would be on top of the recent decline in sterling, UK companies could become particularly attractive targets for US bidders.
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.”