Q&A: M&A in emerging markets – managing risk and creating value


Financier Worldwide Magazine

June 2015 Issue

June 2015 Issue

FW moderates a discussion on M&A in emerging markets between Wael Jabsheh at Akin Gump Strauss Hauer & Feld LLP, Philip Lindop at Barclays Africa Corporate & Investment Banking, Thiago Sandim at Demarest Advogados, and Marcela Waksman Ejnisman at TozziniFreire Advogados.

FW: Could you provide a brief overview of M&A activity in emerging markets over the last 12 months? Is the outlook healthy and which regions are particularly active?

Lindop: M&A activity has increased in the emerging markets over the last 12 months – very much in line with the global trend in M&A. This is a real confidence booster for emerging markets considering all the challenges faced in recent times, including headwinds experienced by oil exporting nations, China and Brazil’s economic slowdown, India’s changing political landscape, South Africa’s low growth, sanctions imposed on Russia and socioeconomic turbulence in some regions. Announced M&A activity with Asian involvement reached a record high. China remained the most targeted nation in the region with $390.4bn of value from 4520 deals. 2014 saw a substantial increase in deal values – partially boosted by cross-border deals which accounted for 37 percent of all transactions by value. According to a number of market tracking data, M&A activity is off to its fastest start since 2007.

Jabsheh: While global M&A values reached significant levels in 2014, much of that activity was dominated by mega-deals in the US and other developed markets. The picture in emerging markets was mixed. Although regions such as Latin America experienced very strong growth in M&A values, emerging markets elsewhere underperformed, driven partly by concerns regarding geopolitical and economic uncertainty. However, the outlook for global M&A in the foreseeable future appears healthy. Many companies are reporting a larger numbers of deals in their pipeline going forward. Furthermore, the continued strength of the US dollar could accelerate outbound M&A from the US, which still dominates global M&A flows. As with the last 12 months, activity in emerging markets will probably vary from region to region, owing to geopolitical and economic factors. Of course, any sudden corrections in the economic or financial markets could quickly change the outlook, for both developed and emerging markets.

Ejnisman: In 2014, the level of M&A activity in the emerging markets was reasonably good, and we expect the M&A industry to continue to grow. In Brazil, the number of M&A transactions last year was 818, according to data from KPMG. A recent report from Track Record and Merrill DataSite recorded 213 M&A transactions in the first quarter of 2015 for a total amount of $20.48bn, representing a year on year increase of 20.4 percent. Thus, the outlook in the region seems good, despite the economic difficulties emerging markets currently face.

Sandim: Despite all the uncertainty related to the presidential election of 2014, a lower investment rate – less than 18 percent of national GDP – and the turmoil caused by the ongoing anticorruption investigations, the last 12 months have shown an interesting level of M&A activity. The fact that Brazil offers a stable institutional environment with a sizeable and reasonably liquid capital market makes it less volatile than other so-called developing markets and less dependent on seasonal events. We have seen a clear trend of investments in the infrastructure sector and a number of important deals in the education and health sectors. Although the majority of deals had the participation of strategic investors, private equity (PE) is becoming an important market player. The existence of interesting cheap assets that may in the medium term become liquid through the stock exchange and the distinct lack of sources for debt funding favours PE investments in the next couple of years.

In 2014, the level of M&A activity in the emerging markets was reasonably good, and we expect the M&A industry to continue to grow.
— Marcela Waksman Ejnisman

FW: Have any recent M&A transactions in emerging markets caught your eye? What factors are motivating buyers, such as opportunism, geographic expansion and new business development?

Jabsheh: An increasing sense of confidence by buyers in the overall stability of the global economy appears to be one of the main motivating factors. With global equities markets at or near all-time highs, there seems to be a general consensus that the global financial crisis of the past years has been overcome. This confidence is driving M&A levels upwards and causing buyers to more aggressively look for growth opportunities. Buyers are therefore making deals to access new markets, expand their geographical footprint and benefit from the increasing spending power of the emerging markets’ growing consumer base. Many deals are being made in consumer-focused sectors, such as healthcare, telecoms and consumer goods. Anheuser Busch’s multibillion dollar acquisition of Oriental Brewery in South Korea is just one example.

Sandim: Recent M&A transactions reveal an investment trend involving big PE houses, infrastructure funds and sovereign wealth funds in Brazil – for example, the investment made by a consortium of high-profile PE firms and family offices in BTG Pactual, the investment made by Carlyle in Rede D’Or, and the acquisition of ACECO by KKR. These types of investment mean that sophisticated investors are confident in medium term gains generated by the Brazilian economy and in the fundamentals of the local market. Similarly, the number of investments carried out by sovereign funds, with longer-term prospects, reveals that the international business community has confidence in the local institutions and economic growth of the country, despite the current downturn – with very slow growth and rising inflation.

Lindop: A number of recent transactions have caught the eye, particularly those involving investments by emerging markets into developed markets and the growing pool of non-traditional buyers participating actively in M&A. Some of these include sovereign wealth funds, hedge funds, pension funds, conglomerates, trading houses and family offices. Examples of such transactions include Brait’s acquisition of an 80 percent stake in Virgin Active Group and Steinhoff’s acquisition of Pepkor in deals valued at $1.6bn and $5.7bn respectively. Given the financial firepower that these non-traditional buyers have, their increased activity is expected to be the norm rather than the exception going forward. The common themes that are motivating buyers of late are the broadening of their geographic footprint, consolidations in the face of escalating regulatory requirements, pursuit of economies of scale and the need to put excess cash to use given today’s low interest rate environment.

Ejnisman: Many emerging markets have large territories and big consumer markets, which makes M&A deals attractive. With respect to Brazil, we have seen a good movement in M&A related to companies that are directly or indirectly involved in the corruption scandal ‘Lava-Jato’, which involves Brazilian oil & gas company Petrobras and many of its contractors. Many of the companies embroiled in the scandal are now selling their assets to minimise risks and to recover from the financial losses related to the scandal. This is certainly an area that is attracting investors, although potential risks cannot be clearly assessed. Also, Brazil has recently modified its legal framework allowing foreign investors to participate in the healthcare sector, including the acquisition of equity interests in clinics and hospitals, for example, so this is another area attracting investors in Brazil.

FW: With BRIC countries an important arena for M&A transactions, how sustainable is this in the long-term? Is M&A shifting to non-BRIC emerging markets?

Sandim: We believe Brazil continues to offer valuable opportunities for investors in a wide range of sectors. Healthcare, education and infrastructure should be, in principle, the hottest sectors for the next few years. In the long term, however, it is ultimately a matter of how the customary M&A growth drivers – the regulatory environment, consolidation in certain sectors, proper infrastructure solutions, a liquid capital market, public spending, and so on – evolve, and whether there will be the political will to implement the reforms and adjustments necessary to ensure that the Brazilian economy remains attractive to investors. In a nutshell, the long term still looks pretty sustainable, with Brazil offering a stable institutional environment and with the key business fundamentals in place. The challenges appear to be all short-term and recently the government has been taking the right actions. Let’s see if that persists.

Ejnisman: BRIC countries are a large consumer market with almost half of the world’s population. Thus, they can provide a sustainable business for companies in the long run, which maintains M&A in those countries. It is true that investors are willing to invest in non-BRIC countries as well. This is a natural movement for the industry – companies are always seeking new markets to gain a competitive advantage. Especially in Latin America, we have seen an increase in M&A in countries belonging to the Pacific Alliance, but that does not mean that M&A transactions in BRIC countries are declining. We believe M&A in BRIC and non-BRIC countries can, and will, coexist.

Lindop: It is important to consider that investors are taking a long-term view and thus M&A activity in the BRIC nations must be assumed to be sustainable. BRICs are an increasingly important area for M&A, for the simple reason that they are increasingly important to the global economy. A growing amount of inbound activity is aimed at establishing a foothold in the fast-growing consumer markets and financial systems of the BRICs. Other emerging markets are benefiting from the global economic recovery and thus in regions such as West and East Africa the conditions of doing business become more sophisticated and the ease of doing business improves. It is not a case of M&A shifting away from the BRIC nations but rather one of other emerging markets becoming more appealing as the economical climate of doing business improves.

Jabsheh: The BRIC countries, especially China, will probably continue to drive emerging markets M&A for many years to come. Their large and fast-growing populations, coupled with their increasing levels of per capita income, will continue to attract inbound investment, particularly in consumer-focused sectors. The BRIC countries are representative of a wider trend in the global economy, which is that emerging markets are expected over the long term to grow at a rate that is substantially higher than developed markets. This growth will accelerate M&A activity and deal values over the long term, in emerging markets generally and in the BRIC countries in particular. While certain emerging markets, such as Russia, face immediate headwinds, we don’t anticipate that this will change the long-term upward trend.

We believe Brazil continues to offer valuable opportunities for investors in a wide range of sectors.
— Thiago Sandim

FW: What strategies can companies involved in emerging market transactions employ to add value and create long-term positional advantage?

Ejnisman: The economies in emerging market countries are currently facing some difficulties. This can be an interesting aspect for companies involved in emerging market transactions because acquirers can bring great synergies which will help companies face a slower economy. Equally, the synergies resulting from M&A deals are key to adding value for companies. Buyers must always look to long-term relationships in the emerging markets – while more developed markets may secure a steady cash flow for their companies, business growth can come from the emerging markets. Thus, positioning companies ahead of their competitors by means of acquisitions and enjoying the benefits of the synergies provide companies with a good positional advantage once these economies start to grow more robustly.

Jabsheh: Buyers often understate the cost of assimilating a new business into their existing operations, and therefore fail to adequately account for those costs as part of their valuations. Unless buyers can adequately quantify those costs and feed them into the M&A valuation process, their investment may yield less than anticipated financial returns. Buyers who adopt a tactical approach to these issues are often those who create the best long-term value and positional advantage. While these principles apply to all M&A deals, post-acquisition integration in emerging markets can be particularly costly, time-consuming and generally fraught with business and legal risks.

Sandim: This really depends on the profile of the target companies. The ability to anticipate trends, understand the local market and a good level of resilience during downturn periods will allow investors to create long-term positional advantages. We have seen, over the course of the last decade, a number of foreign investors searching for successful, but undervalued family-owned businesses. In such cases, adding value to these companies was a relatively simple task. Implementing modern corporate governance models and bringing qualified and experienced people for the management of such companies would likely do the trick. However, with the growth of emerging economies, such opportunities are becoming scarcer. We are now seeing a considerable increase in high-value targets, which are already managed professionally and strictly follow demanding corporate governance models.

Lindop: The strategies that create the most value and ensure longevity in such markets have a lot more to do with the philosophy than to a step-by-step guide for the acquirer. Acquirers have to take a committed approach to really understanding the market they are exploring – it is crucial to have local partnerships to ensure full integration, a long-term ‘all-in’ approach. They should be prepared to consider innovative ways of financing and not rely purely on traditional avenues – vendor loan notes are a prime example of this. There is a need for experienced financial and legal advisers who have built up the necessary experience in that particular region. Companies involved in emerging markets will need to be willing to get fully integrated into the region where they are transacting. The deployment of the right personnel in advance of a process would better ensure effective cross-border integration.

FW: What steps can parties take to address the key risks associated with dealmaking in emerging markets, such as the accuracy of financial information, potential fraud and corruption issues, ownership and governance practices, and regulatory and legal issues?

Lindop: A number of steps can be taken by parties to address the variety of risks associated with doing business in emerging markets. It is worth noting that a large number of these precautions should be taken with regard to doing business in any jurisdiction as the level of due diligence by potential buyers has substantially intensified globally in the years following the financial crisis. The cornerstone of any effective organisation is a visible demonstration by top-level management of its commitment to promote integrity and prevent fraudulent and corrupt behaviour by persons associated with the organisation. In addition to making use of vendor due diligence to vet the accuracy of financial information, the buyer should investigate the target’s internal controls and procedures already in place to govern the accuracy of the financial information. Reviewing the historic and pending legal issues of the target company can help to reveal significant risks.

Jabsheh: A comprehensive due diligence exercise is an essential part of any M&A deal and this is particularly true in emerging markets. Sellers often enjoy a significant strategic advantage in emerging markets because of their historical familiarity with the legal landscape and other contextual issues related to the deal. Prudent buyers mitigate this advantage through effective due diligence, covering not only the target and its business practices but also a detailed survey of the local political, legal and regulatory landscape. Engaging local lawyers who are well versed in the target’s industry and who are plugged into the market’s latest political, legal and regulatory developments is critically important. It is also advisable for buyers to initiate a dialogue with local authorities early and often throughout the transaction in order to align expectations and minimise the risk of unpredictable regulatory or legal action at a later stage.

Ejnisman: Compliance due diligence is essential in most M&A transactions, but especially so as it pertains to companies that have a commercial relationship with the government. Compliance due diligence should not only involve the review of legal, tax and accounting documents but it should also involve high-level discussions with management in order to check for potential red flags. It is also relevant to check if target companies have policies, compliance programs and audit financials which may be an indicator of good practice. It is also important to insert protective provisions in transactional documents, such as guarantees and escrows in order to ensure investors’ ability to recover from liabilities related to these issues.

Sandim: Strong local advisers who have a proven track-record in the relevant sector or industry are of the utmost importance. Although fairly stable for the past 20 years, the regulatory and legal environment in Brazil is quite complex and challenging for any newcomer. Regarding key risks associated with doing business in Brazil, a comprehensive legal, tax and accounting due diligence exercise will help mitigate risks and quantify the potential exposures associated with legacy liabilities. Target companies may lack the appropriate accounting processes and supporting documentation for management’s use of estimates and assumptions to support the amounts reported in the financial statements – for example, a lack of supporting documentation for its bad debt policy and as a result insufficient reserves for bad debts, they could lack proper documentation of supplier agreements, often resulting in understatement of liabilities. Also, contingent or actual liabilities related to statutory employee welfare contributions and severance payments are often not recorded accurately. In addition, recent pieces of anticorruption legislation, and a substantial number of ongoing corruption investigations have contributed to greater awareness and a conservative approach toward fraud and corruption in the context of M&A deals. On top of all this, investors should ensure the relevant transactional documents provide for a proper set of representations and warranties, as well as a comprehensive indemnification package regarding potential past liabilities originated prior to closing.

As emerging markets continue to have an elevated perceived risk of corruption, it has required a higher degree of vigilance when it comes to addressing the investigation of existing relationships with third parties.
— Philip Lindop

FW: How important is it to investigate the existing relationships an emerging market target has with third parties? What can potential acquirers do to identify potential legacy liabilities in this regard?

Sandim: Due to the recent anticorruption legislation passed in Brazil and corruption scandals involving big players in the Brazilian market, it is highly advisable that investors conduct anticorruption due diligence on target companies and their business partners. These procedures are important not only for the purposes of contractually allocating the risk regarding potential legacy liabilities, but also due to requirements imposed by the anticorruption laws of the investors’ home countries and local anticorruption policies. It is worth noting that as this practice is relatively new, there are not that many qualified professionals and specialised companies providing those services.

Ejnisman: It is important to investigate the targets’ relationships with third parties to verify the connection and past associations of the company with customers, clients, suppliers and other parties for the purpose of identifying red flags related to  compliance, regulatory, tax and labour matters. The assessment of legacy liabilities most likely will not come solely from the target’s financials or official documents, but rather by checking internal procedures adopted by the target when dealing with third parties or in direct interviews with the senior management of the target. Thus, a detailed due diligence process, including interviewing senior management of the target, are steps that can be taken by potential buyers. In addition, because of the difficulties in assessing hidden liabilities, establishing responsibilities in the transactional documents and larger thresholds of indemnification for hidden liabilities are also good steps to protect a buyer from liabilities.

Jabsheh: The extraterritorial application of US, EU and other sanctions and trade control laws is important for buyers to keep in mind as they pursue M&A deals in emerging markets. While matters of corruption are difficult to unearth under the best of circumstances, concerns over such issues are elevated in emerging markets, where governance and accounting regimes may not be as stringent. These challenges make it unlikely that the buyer will have complete knowledge of all legacy liabilities prior to closing. For this reason, buyers should seek to reduce the risk of their acquisitions by structuring earnouts and other contingency payments and through insurance – which is no longer just a sell-side consideration.

Lindop: In order to inform any acquirer’s risk assessment of a potential target, thorough diligence is required on third-party relationships, the company’s policies governing the interaction with those parties and past issues that may have arisen as a result of that. Robust procedures in place allow the acquirer to take comfort in the reduction of potential legacy liability. As emerging markets continue to have an elevated perceived risk of corruption, it has required a higher degree of vigilance when it comes to addressing the investigation of existing relationships with third parties. In order to identify any potential areas of concern, and ascertain the validity and any possible mitigants for them, a combination of pre-transaction and pre-closing diligence should be utilised. Increasingly, we are seeing the use of agencies specialising in market intelligence, intensive background and reference checks employed.

FW: Although M&A activity in certain emerging markets has slowed recently, how confident are you that this is a short-term scenario? What factors do you see facilitating M&A activity in the year ahead?

Ejnisman: In Brazil, M&A activity has not been affected by the slowing of the economy and the sector has been growing in the past years. The government is trying to implement an austerity plan, which is already reflected in the economy, and it seems that for the first six months of the year the country will be in recession. If the government is successful in implementing its plan, there is a strong chance for a good second half of the year and a return to economic growth, which may boost M&A activity. As a whole, the key factor facilitating M&A activity in the emerging markets is the foreign exchange ratio between the national and US dollar that makes assets cheaper for foreign investors. In addition, with a slower economy, the financial figures of assets are currently weaker, which also makes them cheaper and more attractive to investors. Thus, this can be a good time for investors who see the emerging markets as a long-term investment and want to take advantage of lower target prices.

Lindop: The process of ‘emergence’ is irreversible for most of these countries, so even in cases such as Russia, there remains an acknowledgement for the need to financially integrate with the world. Although growth has been slowing in some emerging markets, it is expected that there will be bumps along the road, but these geographies continue to provide attractive investment opportunities. Potential factors facilitating activity in the year ahead include the resolution of a number of geopolitical issues, including increased clarity around Greece. There is no doubt that increased confidence in the West will inspire more activity. China’s return to stronger economic growth will act as a catalyst for more activity. Corporations and financial institutions are sitting on a lot of ‘dry powder’ they will need to use. Low interest rates and favourable credit markets have made financing deals currently much easier than in recent times.

Jabsheh: While conditions appear favourable for M&A deal levels to continue their resurgence generally, geopolitical and economic risks remain a significant and immediate concern in a number of emerging markets. In addition, if low oil prices persist for an extended period of time, this could suggest a general weakness in the global economy, which may reduce the appetite for deals in emerging markets in favour of the perceived stability of developed countries. However, several factors bode well for M&A deal levels in certain leading emerging markets, such as India, where a proposed liberalisation of the insurance sector is expected to spur significant inbound investment, and China, where the government has passed a new foreign investment law intended to facilitate greater access to the Chinese market.

Sandim: We strongly believe the fundamentals and the maturity of the Brazilian economy continues to favour M&A activity. Infrastructure, which remains an important bottleneck for business in Brazil, will continue promoting M&A and joint venture strategic work, such as the $6.5bn joint venture between Odebrecht TransPort and Mitsui which will operate primarily in the Brazilian urban mobility market, as government finance is not sufficient enough to promote the wide range of investments that the development of the country requires. Also, with new regulation liberalising foreign investments on healthcare services, we are definitely set to see this sector being one of the main targets for foreign investors. On the oil & gas front, the corruption turmoil involving Petrobras, and all of the associated legal and financial implications, have already triggered a massive divestment plan for the next two years, involving an estimated $13.7bn worth of assets.

Buyers must be able to adopt and accommodate different ways of approaching transactions, structures and negotiations, as these will differ from market to market.
— Wael Jabsheh

FW: What final advice can you offer to acquirers pursuing M&A transactions in emerging markets?

Jabsheh: There is no single approach that buyers should adopt when doing deals in emerging markets. Buyers must be able to adopt and accommodate different ways of approaching transactions, structures and negotiations, as these will differ from market to market. While doing deals in emerging markets carries a certain elevated level of risk, buyers must be savvy enough to identify when those risks are being overstated, or indeed when they are being understated. Resourceful buyers are able to clearly identify areas of true risk, quantify those risks and consider creative mitigation strategies, thereby opening up potential opportunities across many different markets.

Sandim: Do not underestimate the importance of retaining strong tax and legal advisers with a proven track record, who can navigate through a complex and challenging regulatory environment at the very early stage of any given transaction. A good understanding of the Brazilian Central Bank system of foreign investment registration and how it interacts with local tax legislation may play a big difference in the overall economics of a transaction. Above all, firms should ensure that they pick the right partner. Brazil is a US-sized country with EU-type borders and a China/India-like level of development. We are one of the most remote business environments in the world and one of the very few large economies south of the equator. One really needs people who live locally and understand the business environment to thrive. Once you have picked the right partner, the rest tends to conspire in favour of success in the long term.

Ejnisman: We believe that the advice would be the same as in any other market, developed or not – deals in emerging markets are not much different from other markets. Engaging legal and financial advisers specialised in the market in which the investor wishes to invest is key to minimising the risk of potential liabilities. Knowing the legal framework where the investor will be inserted and performing a comprehensive due diligence process, both legal and financial, of the target company will help investors to understand beforehand the scenarios they may face once the acquisition is concluded. Legal and financial compliance due diligence procedures are key. Understanding the local culture and the culture of the target company in depth helps the integration of the parties which will lead to a better absorption of the synergies. Use of protective clauses in the transaction agreements to guarantee the rights and the use of an arbitration clause to solve disputes regarding the transaction are important elements to safeguard the rights of buyers.

Lindop: If you are even vaguely considering entering these markets, it needs to be with an all-in and long-term view. There is no substitute for thorough due diligence before, during and after the transaction – even then there is no complete certainty. Understand that there will be setbacks but if you have taken all the necessary steps you will ride the wave of growth and opportunity. Listen veraciously to everything you hear; in an environment of uncharted terrain and incomplete information, the ability to balance what you hear and the traditional information you are provided with may very well lead to significantly superior decision making for the company’s future. In conclusion, there is no substitute for being on the ground and having an extensive network of quality reference points and contacts.


Wael Jabsheh focuses on domestic and cross-border M&A and joint ventures related to various industries, including entertainment and media, technology, communications, national security and defence. He has been based in the UAE since 2005 and has extensive experience advising on corporate transactions in the Middle East. He can be contacted on +971 2 406 8525 or by email: wjabsheh@akingump.com.

Philip Lindop is Head of Banking at Barclays Africa CIB. He is a member of the CIB Exco. Mr Lindop joined the firm in April 2012 from Goldman Sachs in London, where he led EMEA coverage for the metals and mining sector. He has over 19 years of investment banking experience. He holds a BComm (Hons) in Economics from the University of the Witwatersrand, Johannesburg and a MSc in Economics for Development from Oxford University. He can be contacted on +27 (0) 11 895 7580 or by email: philip.lindop@barclays.com.

Thiago Sandim is a specialist in mergers and acquisitions and private equity, cross-border and domestic transactions. Regular clients include the sovereign wealth funds of Singapore, Abu Dhabi and China, Canadian funds such as OTPP and Borealis and Brazilian conglomerates such as Odebrecht and BTG Pactual. He graduated from Pontifícia Universidade Católica de São Paulo School of Law in 1997 and was admitted to the Brazilian Bar Association, São Paulo Chapter, the following year. He can be contacted on +55 11 3356 2085 or by email: tsandim@demarest.com.br.

Marcela Waksman Ejnisman is a partner in TozziniFreire’s Corporate/M&A practice group. Ms Ejnisman has broad experience in corporate law, concentrating her work in the telecommunications and technology, intellectual property and privacy, life sciences and entertainment industries. She has advised clients on numerous transactions, including mergers and acquisitions, joint ventures and corporate restructurings. She uses her thorough knowledge of the technology and telecommunications sectors to assist clients with both regulatory and business issues. She can be contacted on +55 (11) 5086 5471 or by email: mejnisman@tozzinifreire.com.br.

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