The Global Picture
US Leads the Market
Financial Institutions Sector
M&A Trends and the Focus on FinTech
Navigating political risks in growth markets
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Cross-border M&A investment flows
A Focus on Infrastructure
Infrastructure M&A market is maturing
Financing the Mega-deals
The Global Picture
"In 2015, we saw the pipeline of potential major M&A deals coming to fruition, many of which had been contemplated for some time. As companies had built cash reserves and acquisition finance conditions were favourable, we saw them come to market.
However, while 2016 is expected to continue to see some high value M&A, concerns around the Chinese (and world) economy and collapsing oil and commodity prices may see caution return to temper activity once again. Increasing political tensions globally, the prospective US election and 'Brexit' uncertainties may also impact activity as the year develops." Guy Norman, Global Head of Corporate, Clifford Chance LLP
- 2015 was a bumper year for M&A - Global M&A value has reached record levels, with over US$ 4.78trn of deals announced at year end 2015, making 2015 the best year ever for M&A. However these record levels have been driven by several mega-deals (including AB InBev/SABMiller, Pfizer/Allergan, Kraft/Heinz), which mask an underlying decline in deal volumes for the second half of the year.
- US buyers leading the market - North American buyers make up just over half of total global M&A activity (by deal value). Since the financial crisis, US boards had been inhibited from launching major or transformational transactions but now perceive inaction as riskier than pursuing opportunities while they are available. This, combined with favourable financing conditions and excess cash that cannot be repatriated without adverse tax consequences, is driving large and mega M&A by US companies.
- Inversions remain on the M&A agenda - Mega-deal corporate inversions, particularly in healthcare (e.g. Shire/Baxalta) and consumer goods (e.g. Burger King/Tim Hortons, Coca-Cola (bottlers)) remain part of the M&A landscape. These deals see US companies slash US corporate tax exposure by shifting the merged entity’s domicile to the lower-tax jurisdiction. Legislative action limiting the tax benefits of these transactions appears unlikely given the election cycle.
- Significant regional M&A boom in Asia Pacific - Despite continued international concerns over the slowdown in China, Asia Pacific M&A increased 63% year-on-year. This ‘mini boom’ is being driven largely by intra-regional deals, with Chinese companies’ continued pursuit of regional expansion and Japanese investment in the wider region (e.g. Japan Post/Toll Holdings, Mitsubishi/Olam) making a significant contribution to activity. The new trans-pacific partnership (TPP) will serve to make the region even more attractive and stimulate further activity.
M&A activity in 2015 at a glance
Global M&A activity increased 43% compared to 2014, with deal value totalling US$ 4.8trn (up from US$ 3.3trn) on lower deal volumes as a consequence of the number of mega-deals this year.
M&A in North America increased 58%, reaching US$ 2.4trn. Asia Pacific also witnessed a significant increase (+63% year-on-year), with deal value totalling US$ 1.2trn. European M&A grew by a moderate 9% to US$ 921bn.
Cross-border M&A represents 28% of total M&A deal value1. M&A flows between the five main regions represented 19% of total global M&A deal value.
TMT (US$ 1trn) and Consumer/Retail (US$ 885bn) sectors saw the most M&A activity (by deal value). Healthcare M&A is also a fast-growing sector (its share of total M&A increased by 2%).
The private equity market was dominated by exits. The trend for sponsors to partner with fund investors continues, with many funds on the road during 2016 raising fresh capital and using co-investment as an incentive for investors to commit to new funds.
US activity continues to drive global M&A levels, with significant rises in both domestic and cross-border inbound investment (up 62%). In addition to other strategic drivers, tax efficiencies are playing a critical role in US transactions. High-profile inversion deals and tax-driven transactions represent a significant portion of US activity.
- Tax savings can be a fundamental driver in US M&A deals. Corporate inversions are the most visible examples of US companies’ focus on tax savings across a range of deals. We are also seeing other high-profile, highly tax-structured transactions, including for example spin-offs and asset sales by companies that are seeking to unlock value, often in response to pressure from activist investors. Some notable deals are below.
- The US tax landscape is continuously shifting – for inversions, and also for spin-offs, asset dispositions, and other tax-structured transactions. The shifts may reduce tax savings on some deals but also may create new opportunities going forward.
Case study: Yahoo/Alibaba
- A sale of Yahoo’s 15% stake in Alibaba would result in a huge US corporate tax bill.
- When Yahoo announced a spin-off of the stake in a tax-free transaction, its share price rose 8%.
- The IRS then declared a review of such transactions. Yahoo deemed the risk of pursuing the spin-off as too high and decided not to pursue it.
- Yahoo is now considering a spin-off of its main businesses (potentially a tax-free transaction), leaving behind the Alibaba stake in the Yahoo corporate shell.
Case study: corporate real estate
- Operating companies with large real estate holdings (e.g., hotels (Hilton), retailers (Sears), restaurant chains (Darden)) have been placing real estate assets in holding companies and spinning them off to shareholders in tax-free transactions.
- The spun-off company would often obtain favourable financing terms and until recently would qualify as a REIT for US tax purposes.
- Congress passed a law in late 2015 generally denying REIT status. The spin-off is still tax-free and the financing benefits remain. Other structures may also be explored in the future to achieve similar results.
Spotlight: inversions remain on the rise
- Burdened by an excessive corporate tax regime, some of the largest US companies continue to flee to other jurisdictions. Pfizer, for instance, agreed to acquire Allergan (itself the product of an earlier inversion) in the biggest pharmaceutical merger in history.
- Inversion transactions have become increasingly sophisticated and innovative. For example, the tax structuring in the Burger King/Tim Hortons and Broadcom/ Avago inversion transactions allowed different groups of shareholders to elect between different types of consideration with different tax consequences.
- The IRS has been unsuccessful in stopping these deals. Instead, the ongoing string of inversions probably will not end without legislative reform, which is unlikely to occur prior to the upcoming presidential election. Democrats generally favour stronger restrictions on inversion transactions. Republicans generally favour reforming the US tax system to reduce or eliminate tax on non-US earnings.
- Non-US sellers can participate in the US tax savings of a corporate inversion by demanding a higher sale premium.
“US corporates continue to wrestle with the US tax system, as both a major potential cost and (through reducing their tax bills) a source of big opportunities in M&A deals.”Philip Wagman, Tax Partner, New York
Mega-deals are being driven by synergies and abundant finance. 2015’s mega deals were supported by the highly liquid debt markets and costs of debt financing at historic lows. The anatomy of a jumbo financing can be complex, and financing sources and structures differ across the global M&A landscape
Mega-deals: preparation is key
- Jumbo financings have helped facilitate mega M&A deals (such as the US$ 75bn financing for AB InBev/SABMiller)
- Relationship banks with sufficient capacity for the deal are critical.
- Depth in the capital markets for the take out is essential
“The importance of planning and timing the implementation of a deal of such size cannot be stressed enough.”
Peter Dahlen, Finance Partner, London
Borrowers: demand for flexibility
- Strong borrowers are seeking more flexible terms
- US regulators express concern as leverage terms are relaxed in buoyant markets
- Liquid markets are seeing looser terms, including larger thresholds in corporate M&A and increasing flexibility for incremental, additional and replacement debt in leveraged deals
Finance: more options?
- Outbound M&A has stepped up in Asia (e.g. ChemChina/Pirelli, Mitsui Sumitomo/Amlin)
- Cash in the business and bank loans are staple financing sources for Asian M&A. However there is growing interest in other sources such as high yield
“We continue to see Chinese banks assuming more active and prominent roles in financing for mega deals, and a willingness to go beyond the traditional approach of relying on the corporate credit of the Chinese parent.”
Maggie Lo, Finance Partner, Hong Kong
Financial Services M&A is being stimulated by disruptive technologies which are changing the way consumers interact with financial services businesses. The sector also continues to be influenced by consolidation activity and regulatory changes.
Banking and Asset Management
- Global banks have been analysing the value of their presence in national markets around the world with a renewed focus on strong markets and a desire to divest non-core assets.
- Disposals in emerging and low-volume markets have been driven by localised economic, political and regulatory factors.
- Interest in retail bank acquisitions has arisen from opportunistic buyers seeking to take advantage of post-recession changes in bank ownership (such as re-privatisations) and improvements in credit quality.
- Wealth management continues to be an area of activity with a number of major institutions adjusting their focus towards it, whilst others are existing businesses which are sub-scale.
- Private equity houses and financial services aggregators from both developed and emerging markets are increasingly acquisitive across the sector.
- Changing regulations and business environment issues such as a possible Brexit mean that institutions continue to explore corporate re-organisations.
Spotlight: the focus on FinTech
- We are seeing numerous strategic direct investments in, and acquisitions of, technology start ups. Financial institutions focused on competing with FinTech businesses, and companies operating in other industries investing in technologies and platforms with a financial services aspect which are often complementary to their principal businesses (e.g. social media networks investing in P2P payment arrangements, online consumer retail businesses investing in supplier finance platforms, etc), are driving this activity.
- With regulators across the US, Asia Pacific and Europe introducing new policies and establishing new supervisory teams designed to facilitate the launch and expansion of start-ups undertaking regulated activities, investment and M&A opportunities in the FinTech sector are expected to continue to increase.
- For companies across non-FIG sectors, the move into FinTech is typically causing them to be subject to financial regulation for the first time – for them, understanding this regulation and leveraging opportunities to operate under regulatory-lite frameworks if available, is key.
- Many financial institutions, who have traditionally not been technology-focused, are learning to understand the value of technology assets, and how they are protected and leveraged, as they transition from being financial institutions into being (to a greater or lesser extent) technology companies also.
“As financial institutions and corporates seek to integrate specialist tech enterprises into their traditional business lines, the focus of diligence has shifted towards financial regulatory compliance, data protection, cybersecurity, licensing software, use of big data, and the protection and leveraging of IP rights.”Melissa Ng, M&A Partner, Singapore
The maturing Infrastructure M&A market is highlighted by new investors, an increase in the number of funds being raised and a corresponding increase in the capital available. This trend is punctuated by rapidly increasing deal values.
Our expectations for 2016
Huge amount of capital available for investment – We are seeing strong fundraising by traditional infrastructure funds and massive amounts of dry powder available to direct investors.
Increased volume of secondary transactions – a sign of a maturing market, these will comprise a significant proportion of total deals in 2016 as funds take advantage of seller-friendly conditions as they exit investments made in the mid to late 2000s.
Increased competition for non-core assets – Competition for ‘core’ infrastructure, such as water utilities and energy distribution assets (e.g. acquisition of Australia’s TransGrid), is driving down returns and encouraging infrastructure investors to look harder at ‘non-core’ infrastructure and at less mature markets. This is particularly true of traditional infrastructure funds, who typically require higher returns than direct investors. Funds are forced to take greater risk in order to achieve target returns and are now chasing core-plus assets.
More partnerships – Regulatory risk will remain high on the agenda for infrastructure investors and we see an increased number of partnerships between infrastructure funds – who provide capital – and industrial firms – who bring expertise.
Platform investments – these offer steady transactions for funds to deploy capital and risk sharing with other investors or industrial partners and will continue to be popular. For example, OTPP, PSP and Santander’s joint venture into Cubico Sustainable Investments, which targets renewable energy projects, particularly in Europe and Latin America.
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“We are seeing fierce competition for infrastructure assets resulting in higher prices with corresponding pressure on returns. This is a result of the dramatic increase in the number of investors targeting the sector – particularly ‘direct investors’, such as pension funds and insurers, who previously invested through funds – and the amount of capital allocated to infrastructure investment. Favourable credit markets and greater use of non-bank debt financing are having an impact.”Brendan Moylan, Infrastructure M&A Partner, London
In spite of the slowdown in many emerging markets, companies still view these markets as interesting opportunities. The shifting sanctions landscape that tends to impact emerging markets requires vigilance
2015 has seen the continued use of sanctions as a foreign policy tool often aimed at regimes in emerging market economies. A particular feature of 2015, however, was the international policy shift in relation to Iran following the Joint Comprehensive Plan of Action agreed between Iran, the P5+1 and the EU in July 2015. With effect from Implementation Day (16 January 2016), there was a significant easing of existing sanctions and, consequently, 2016 is expected to offer much greater opportunity for those wishing to invest in or trade with Iran, provided the residual sanctions risks are manageable.
Companies exploring possibilities resulting from these and other sanctions changes will need to tread carefully, however, as they navigate the compliance challenges thrown up by differences in international frameworks and enforcement trends. Sanctions due diligence and appropriate contractual protections will assist in mitigating risk.
This is vital in relation to Iran in particular where European sanctions relief will be much more significant than that in the US, with much Iranian business remaining off limits for US entities. This means that non-US firms may have a ‘head start’ on entering newly available Iranian markets, if they are comfortable with managing any residual US sanctions risk.
Companies seeking financing in markets subject to sanctions risk will continue to face the stringent demands of banks that require thorough sanctions due diligence and assurances. Sanctions will be an early consideration in many transaction processes.
Spotlight: practical considerations in relation to Iran
- Extensive due diligence on any counterparties in Iran or that have significant Iranian interests.
- ‘Snap back’ risk – sanctions could be re-imposed by the US and/or the EU if Iran fails to meet its nuclear obligations. Wherever possible, contractual and joint venture arrangements should provide for this risk – but it will be interesting to see how willing Iranian counterparties will be to including such provisions.
- Protections for foreign companies – those acquiring companies/assets in Iran should seek to mitigate the risk of sanctions being re-imposed between signing and completion of any deal.
- Vigilance – all companies considering Iranian business need to be vigilant to identify and address US sanctions risks that can arise from involving US person employees or other US elements in transactions.