M&A in a world of protectionism
July 2017 | FEATURE | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
July 2017 Issue
If the seismic geopolitical events of the past 18 months are anything to go by, protectionism now pervades the new world order. In this ‘new normal’ the spectre of sluggish growth, international discord, increased uncertainty and reduced returns on capital hovers over governments, industries and markets.
Almost certainly a price will need to be paid for the populist fervour that has emerged in recent times, with the M&A dealmaking space one sphere of corporate activity likely to be affected. Testifying to this is EY’s 2017 ‘Global Capital Confidence Barometer’, which states that 69 percent of global companies consider today’s broad range of geopolitical or emerging policy concerns to be the greatest risk to business.
Fleshing out how increased protectionism may impact global M&A activity is Intralinks’ ‘Deal Flow Predictor: forecast of global M&A activity through Q2 2017’, which highlights some recent examples of protectionism in action. These include president Trump’s executive order to withdraw from the Trans-Pacific Partnership (TPP), as well as his intention to renegotiate or scrap the North American Free Trade Agreement (NAFTA). President Trump’s ‘America first’ stance has also seen him threaten car manufacturers with a proposed 35 percent tariff on vehicles imported into the US and accused Germany of exploiting the US and other countries with an undervalued currency.
The Intralinks report also references the protectionist measures being considered by the UK government, including a strict ‘public-interest test’ for foreign takeovers of UK companies. Moreover, the report notes that protectionism is having an impact in China, with restrictions by the Chinese government on outbound M&A activity halting the pace of dealmaking in 2017 (following the record $238.4bn deal value seen in 2016).
Undoubtedly, protectionism is a paradigm shift which brings fundamental questions to the fore, including the factors that companies need to consider when structuring M&A deals in order to avoid running aground and the extent of the protection governments should give to key industries.
Whatever the specific aims or intended outcomes, the overall issue is whether protectionism and healthy M&A dealmaking are mutually exclusive.
The deal with protectionism
“Protectionism is here to stay for the foreseeable future, so we can expect to see this trend impact a number of megadeals in 2017,” suggests Philip Whitchelo, vice president of strategy and product marketing at Intralinks. “Global M&A activity is predicted to increase 7 percent in the first 9 months of 2017, and logically a higher volume of deals means that a greater number will be blocked as a result of protectionism. That said, with a likely increase in protectionist attitudes around the corner, there is also a strong chance that the proportion of deals held up for protectionist reasons will rise faster than the overall growth in announced deals.”
According to Neil McFerran, a vice president at AlixPartners, increased protectionism will not immediately have a material impact on deal flow. “Protectionism will increase the scrutiny given to potential deals and result in the deal horizon lengthening due to up front stakeholder engagement to evaluate potential value creation risks in areas like, for example, site consolidation and in-country headcount synergies arising from headquarters relocation,” he says.
Jonathan Klonowski, Europe, the Middle East and Africa (EMEA) research editor at Mergermarket, believes that the level of M&A activity seen in recent years suggests that protectionism has yet to have a widespread effect on dealmaking, with 2017’s £811.7bn year-to-date value up 27 percent year-on-year. That said, there have been certain areas where protectionism has had a clear impact, such as Chinese outbound activity. “In recent years, Chinese firms have used cheap financing to pursue foreign assets, which led to the Chinese government introducing capital controls on large-scale cross-border acquisitions and the results have been dramatic,” he explains. “We have also seen increased comment from the EU about how the bloc can handle large-scale foreign takeovers.”
Tax inversion deals are another clear example of protectionism hindering activity, with US authorities, following a number of high-profile takeovers, particularly in the pharmaceutical sector, looking to clamp down on any deals that would reallocate profits. “In the coming 12 to 18 months, much will depend on whether anything as concrete as new regulations occur,” continues Mr Klonowski. “It remains unclear how involved president Trump will be in any large-scale deals, or whether his disapproving comments in the wake of the Time Warner and AT&T announcement were just election rhetoric to gain votes.”
Technology and digital disruption
Alongside geopolitical concerns and rising protectionism, additional issues challenging companies as they search for new routes to growth include technology and digital disruption – both major drivers of the M&A market. “There are many potential high growth areas that companies are exploring, such as the Internet of Things (IoT), machine learning, virtual reality (VR) and augmented reality (AR),” suggests Nicodemo Esposito, managing director and head of M&A and strategic advisory for Equiteq in North America. “Understanding how these emerging technologies fit within a business and where to focus resources can be a challenge for companies looking to grow.”
In many instances, boards are adopting two distinct approaches to addressing emerging technology and digital disruption through M&A. First, some acquirers tend to take a wait and see approach, where they hold off on acquiring until a ‘winner’ emerges. “This often results in a premium valuation,” says Mr Esposito. “So, while the technology risk is reduced, the deal risk for the buyer is increased.” Second, and conversely, other acquirers tend to buy ahead of the curve across multiple nascent technologies and look to subsequently build on the targets’ capabilities internally. “These companies are taking on risk that certain technologies will not realise their full potential. However, these deals will often be done at cheaper valuations, reducing the buyer’s risk associated with each individual transaction,” he concludes.
“Tech has been one of the main drivers of M&A in recent years,” concurs Mr Klonowski. “There has been a distinct push by corporates to pursue the latest technology that will set it apart from competitors. Intel’s £12.3bn acquisition of Mobileye in March 2017 is a clear example of how large tech companies want to acquire the ‘next big thing’ – driverless cars in this case – and are willing to pay a large premium to do so. Moreover, many investors are not put off by geopolitical factors when pursuing desirable assets. Softbank’s £22.8bn acquisition of ARM was announced less than a month after the UK’s referendum on its EU membership.”
Pursuing deals amid protectionism
“Given the changeable nature of what constitutes a deal of strategic importance, it is sometimes difficult for companies to avoid pursuing deals that may be blocked under protectionist grounds,” believes Mr Whitchelo. “Take the potential takeover of French multinational food products company Danone, for example. Few predicted that yoghurt could be deemed to have ‘national importance’, but with the help of the French government, that is exactly how the company managed to twice fend off foreign interest.”
Another example of protectionism in action is the Trump administration’s signing of the “Buy American, Hire American” executive order and its anticipated impact on the H-1B visa programme for foreign workers in the US. “The objective is to preclude large, multinational outsourcers from profiting by utilising low-cost foreign labour to deliver services onshore within the US,” explains Mr Esposito. “As such, those looking to acquire in the US will do well to focus on targets whose value proposition is based on delivering high value-add services at a premium price with local staff rather than being the low-cost provider.”
Of course, in a protectionist environment, companies must ensure they target the right deals and integrate them appropriately. This will mean prioritising the due diligence phase to determine whether the deal involves strategic assets likely to be subject to protectionist controls. “Early engagement of key stakeholders such as works councils, even government departments, is increasingly important to generate goodwill behind a potential transaction,” says Mr McFerran. “Recently proposed large scale mergers in the chemical industry have shown the impact government hostility can have towards a potential process. Not addressing these issues early in the deal cycle has the potential to negatively impact deal value and execution risk.”
Protectionism and pipelines
The protectionist sentiment expressed in both the US and Europe over the past year has the potential to affect the pipeline of deals for years to come. Certainly, companies need to minimise the possibility of an adverse response to a cross-border deal and review the strategies which are most likely to work in calming protectionist opposition to a particular transaction. The fundamental question going forward is how far this apparent appetite for protectionism may inhibit companies as they look to greenlight M&A deals.
“Geopolitical and protectionism concerns played a role in the Brexit vote and in the 2016 US presidential election, and we saw a drop in deal volumes leading up to these events,” says Mr Esposito. “However, the fourth quarter of 2016 saw stock market indices rallying in the UK and US and strong global M&A activity with a large number of landmark deals. The 12-month M&A outlook is positive as buyer’s quests for new avenues of growth in rapidly transforming sectors, rising listed company valuations and cash-rich corporate and private equity buyers, drive up competition for assets. Well-positioned businesses will find interested buyers, regardless of any public geopolitical and protectionism sway.”
That said, Europe, the Middle East and Africa are predicted to lag behind Asia Pacific and the Americas as far as dealmaking activity is concerned. Furthermore, despite evidence of an economic recovery in the eurozone, political uncertainty around the outcome of the Brexit process is making dealmakers more cautious when assessing potential targets.
“While it is too soon to tell how protectionism is affecting every market, it is clear that it is particularly affecting Chinese buyers,” notes Mr Whitchelo. “Reportedly, China will deter significant foreign investments by Chinese companies that are above a certain value or in non-related industries unless these are deemed ‘strategic’ or in the national interest. Against a backdrop of protectionist obstacles for Chinese acquirers and restrictions on outbound M&A activity, it is likely that China will slow its overseas dealmaking pace in 2017.”
Going forward, while it is true that a number of M&A practitioners view protectionism as more cosmetic than functional, the reality is that protectionist rhetoric continues to surge and remains a potential threat to deals in the pipeline.
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