Steady going: North American cross-border M&A

May 2023  |  FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

April 2023 Issue

Cross-border M&A has been steadily increasing over the past 20 years as investors and corporations seek growth opportunities across the globe. For many companies, acquisitions are an attractive way of gaining access to new markets and customers, generating fresh revenue streams and increasing shareholder value. At $1.1 trillion, cross-border deals accounted for 32 percent of global M&A in 2022, according to Wachtell, Lipton, Rosen & Katz, a figure consistent with the average proportion over the prior 10 years (35 percent).

Cross-border acquisitions offer buyers the chance to pursue deals in line with their strategies, be it diversification, escaping regulatory uncertainty in domestic markets, unlocking cost synergies, accessing technology or boosting productivity, for example. While buying overseas companies has always involved a higher degree of risk due to unexpected changes, companies with a cross-border appetite that successfully navigate these risks can potentially reap large gains. Times of economic uncertainty often create tremendous opportunities.

Market trends

Despite the economic challenges posed by the coronavirus (COVID-19) pandemic (or perhaps because of them), the last few years have been notable for global cross-border M&A activity. According to Dentons, cross-border dealmaking reached its highest recorded level in both value and volume in 2021, with more than US$2.1 trillion invested across 9558 deals.

In 2021, the US recorded the largest increase of inbound foreign direct investment (FDI) of all economies. The latest release of the IMF’s Coordinated Direct Investment Survey shows the US position increasing by $506bn, or 11.3 percent, in 2022.

However, after a robust start to 2022, the market cooled around the middle of the year, though it remained above pre-pandemic levels. According to Pitchbook, cross-border transactions worth more than $1.57 trillion were announced last year, with the number of deals declining by 11.4 percent to 9156.

Acquisitions of US companies by non-US acquirers reached a combined $217bn in transaction value – 6 percent of global M&A volume and 19 percent of cross-border M&A volume for 2022, according to Wachtell, Lipton. Canadian, British, Australian, Singaporean and Japanese acquirers accounted for 50 percent of deals involving US targets, while acquirers from China, India and other emerging economies accounted for about 8 percent. The continent has been home to the vast majority of mega-deals, those transactions valued at $10bn and above, over the last few years.

Deals such as Microsoft’s $75.1bn merger bid for videogame developer Activision Blizzard, Broadcom’s $71.6bn offer for VMWare, Adobe’s $20bn purchase of Figma, Inc. and Elon Musk’s $44bn acquisition of Twitter were particularly notable in the US.

Yet the number of inbound cross-border deals struck in North America in 2022 declined 21.3 percent from a year earlier – the highest drop among all global regions, followed by Oceania down 14.4 percent, Asia down 12.1 and Europe down 8.6 percent.

The slowdown resulted from a number of factors, including steadily increasing interest rates, geopolitical tensions and supply chain disruptions. Soaring inflation and Russia’s invasion of Ukraine, arguably the two biggest factors in the global economy at present, also served to undermine confidence and drive down activity. Tightening finance markets may further threaten the recent pace of activity, along with more intense regulatory, media and political scrutiny of particular types of deals.

Outbound perspective

The cross-border M&A market has held relatively steady since the worst of the pandemic, with activity by North American acquirers now fully recovered from the lows recorded in 2020. Dealmaking sentiment remains high among North American companies.

However, despite the strong US dollar, there has not been a deluge of US outbound deal activity. The tech sector has continued to dominate US outbound M&A, but Silicon Valley firms currently prefer smaller cross-border deals – perhaps unsurprisingly as a number of major US tech firms have made major layoffs and undertaken restructuring efforts post-COVID-19. Furthermore, the pressures currently affecting the global economy have been more severe in Europe, giving would-be acquirers in North America reasons to delay potential deals. Europe is suffering from higher inflationary pressures and was plunged into recession quicker than the US. The war in Ukraine and rising interest rates are also significant roadblocks.

What deal activity there was in 2022 was, nevertheless, focused on Europe, which accounted for half of all US outbound deals. According to Ion Analytics, the UK remains the primary market for US acquirers, attracting 18 percent of all outbound deal value in 2022, down from 22 percent in 2021. Israel, Germany and China all saw an increased share of US outbound spend last year.

Despite challenges across the European continent, an uptick in outbound North American deal activity is expected, particularly given the huge amounts of dry powder held by private equity and the capital reserves on corporate balance sheets.

Mixed outlook

A recent survey by Dentons Canada and Mergermarket draws a mixed outlook for cross-border dealmaking in 2023. Over a third of North American survey respondents, and 40 percent outside North America, predict rising M&A activity for 2023 compared to the past 12 months. However, 39 percent of North American respondents, and 36 percent of non-North American executives, expect it to decrease. The majority expect to be involved in between one and four deals this year.

The survey also provides an insight into the most attractive sectors for transactions in 2023. The report notes that 72 percent of US and Canadian respondents, and 93 percent of their peers outside North America, predict they will be involved in transactions in the technology, media and telecommunications (TMT) sector. Financial services, cited by just over half the respondents, is the next most popular industry, followed by pharmaceuticals, medical and biotechnology (PMB).

Technology has been a major driver of dealmaking activity in recent years. During the pandemic, companies found themselves having to embrace technology out of necessity, and now continue to retool themselves with digital capabilities. Many cross-border acquisitions aim to acquire new technologies, innovations and intellectual property (IP) assets. In this way, acquirers can offer new service lines under existing brands or incorporate enhanced technology into their current offerings.

The private equity (PE) industry has also been notably active. According to PwC, PE has put record amounts of capital to work over the past few years, accounting for more than 40 percent of deal values globally in 2022. PE buyers have been targeting the tech space, funnelling dry powder into enterprise software businesses, attracted by their subscription-based revenue models and the promise of outsized returns.

Significant North American-focused funds have also been raised in recent years. In late February 2023, leading global alternative investment firm Investcorp announced the closing of its North American Private Equity Fund, which secured committed capital of over $1.3bn.

The North American market, particularly the US, will continue to offer compelling opportunities for acquirers in 2023. Overseas buyers seek exposure to a market with strong long-term growth fundamentals.

The middle market is attractive to PE investors due to its fragmented nature, offering opportunities for bolt-on acquisitions. Mid-market firms tend to be more flexible and better positioned to adapt quickly, embrace innovation and take advantage of opportunities to grow and capture market share. For PE investors, key value creation drivers are revenue and margin growth.

Regulatory obstacles and deal preparation

Foreign acquirers need to prepare when entering a new market. They should understand the cultural, political, regulatory and technical complexity of a cross-border deal. Optimal deal structures and strategic implementation are critically important. Dealmaking, particularly cross-border dealmaking, is inherently risky. One key aspect is the regulatory scrutiny around FDI.

In light of increasing FDI flows into the US, in September 2022 President Biden issued the Executive Order on Ensuring Robust Consideration of Evolving National Security Risks by the Committee on Foreign Investment in the United States (CFIUS). It was the first time in CFIUS’s history that a president expressly directed CFIUS to prioritise certain national security risks when reviewing covered transactions.

Although the Executive Order does not change the CFIUS review process or its legal jurisdiction, it elaborates on existing factors and adds new national security considerations for CFIUS to examine when evaluating covered transactions. Most notably, the Executive Order directs CFIUS to focus on supply chain resilience, US technological leadership in critical sectors, aggregate industry investment trends, cyber security risks and risks to US persons’ sensitive data.

These areas are hugely important, and a broader array of transactions will likely be captured in future CFIUS reviews. US target companies will need to ensure they have enhanced due diligence processes in place and a clear understanding of the foreign buyer or buyers involved, including any third-party relationships, to assess whether CFIUS could view the deal as a threat to national security.

Canada has also proposed amendments to its foreign investment rules to give the government greater power to scrutinise and potentially block overseas deals that raise national security risks. It would be the biggest overhaul to the Investment Canada Act (ICA) since 2009.

The ICA amendments include a requirement for foreign investors targeting certain Canadian industries to notify the government before finalising deals. Furthermore, they would allow the government to impose interim conditions to prevent acquirers from accessing trade secrets, intellectual properties and sensitive personal information, and to impose undertakings to mitigate national security risk. They would also allow greater exchange of information with allies to better address common national security challenges.

Foreign investors hoping to buy controlling or partial stakes in Canadian companies operating in sensitive sectors would need to give the government early notification of their intent to buy the asset. Under existing ICA rules, by contrast, a company can wait until 30 days after an investment has closed to inform the government. Failure to meet early notification requirements would incur a penalty of C$500,000.

The proposed changes would also allow the Canadian government to extend the time period for a national security review of a foreign investment. They would also increase penalties for foreign investors that run afoul of the foreign investment rules to a maximum of $25,000 per day per breach, up from $10,000.

A further modification would allow the innovation minister to put conditions on any foreign investment before a national security review was finished, which may help stop the transfer of intellectual property before a deal is approved or rejected.

Though the merger review amendments in the US and Canada are not intended to hinder dealmaking overall, they are likely to impinge on transactions in certain sectors, primarily sensitive technologies, critical minerals and those dealing with personal information. Certain foreign acquirers that may present national security risks will need to put regulatory strategy at the top of their agenda.

Appetite

Cross-border M&A is a significant driver of global deal volume, and these transactions have an important role to play in the global economy. Regardless of a tightening regulatory outlook, foreign acquirers sizing up North American assets are expected to maintain a strong appetite through 2023 and beyond.

© Financier Worldwide

BY

Richard Summerfield