Unlocking cross-border M&A and JV deal opportunities
February 2017 | COVER STORY | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
Unlocking cross-border deal opportunities via mergers & acquisitions (M&A) and joint venture (JV) activities can be both lucrative and risky for companies – an undertaking that walks the fine line between success and failure.
Looking back over 2016, there were numerous cross-border M&A deals residing on the prosperous side of this evaluation line; the top five according to Mergermarket being: (i) the $63bn acquisition of Monsanto by Bayer AG; (ii) the sale of NXP Semiconductors XP to Qualcomm Incorporated for $46bn; (iii) China National Chemical Corporation’s takeover of Syngenta AG (also for $46bn); (iv) the $41bn combination of Spectra Energy Corp and Enbridge Inc; and (v) the $35bn transaction which saw Shire plc acquire Baxalta Inc.
Further testifying to the strength of cross-border M&A activity is Dykema’s ‘12th Annual M&A Outlook Survey’ (October 2016), which notes that companies seeking growth via entry into foreign markets was the leading driver of cross-border deals in 2016. “Although there was a slowdown in overall deal activity in 2016, cross-border deals continue to represent a significant portion of M&A deal flow,” says Wilhelm E. Liebmann, leader of the Corporate Finance Practice Group at Dykema. “According to Thomson Reuters, in the first half of 2016, cross-border M&A accounted for 36 percent of overall M&A deal volume.”
Looking to build on this success, while at the same time recognising the economic volatility and geopolitical concerns that permeate in the early weeks of the new year, companies with intent to pursue cross-border M&A and JVs are now recalibrating how they identify, plan, structure and implement such activities.
“Cross-border M&A and JV activity was strong in 2016 as globalisation and diversification trends are top priority in the boardroom,” says Andrew J. Sherman, a partner at Seyfarth Shaw. “However, recent events such as Brexit and the election of Donald Trump may lead to a more nationalistic outlook where cross-border transactions are more tepid as company leaders wait to see what new laws and restrictions may be put into place such as immigration reform and trade sanctions enforcement.”
According to Jonathan L. Corsico, a corporate partner at Gibson, Dunn & Crutcher LLP, the populist trends recently seen in Europe and the US have resulted in businesses second guessing whether or not it makes sense to invest internationally, particularly if that investment involves the offshoring of jobs. “From a macro level, the biggest issue currently facing cross-border M&A and JV transactions is political uncertainty,” believes Mr Corsico. “Similarly, president-elect Trump’s tax plan – which significantly reduces both US corporate income taxes and the taxes placed on repatriated foreign source income – may make many cross-border deals less attractive to US acquirers, as much of the perceived tax savings may have evaporated.”
For many practitioners, the unlocking of deal opportunities requires careful planning as to deal structures, transfer pricing, regulatory approval requirements, supply chain integration, repatriation of profits, foreign tax implications, exit and buyout provisions, IP arrangements and technology development, incentives maximisation, management and governance and cultural considerations. With 2017 forecast to be a year of considerable risk and uncertainty, it is clear that robust cross-border M&A and JV strategies are a core topic on the corporate agenda, with executives keen to identify a target, execute a transaction, circumvent the risks and reap the rewards of a successful (and profitable) merger.
Planning a cross-border joint venture
When planning a transaction, the parties concerned must evaluate whether it is best to form an alliance, as this option may allow companies to grow faster at a lower cost and diversify some risk. “Acquisitions typically cost more money and require the seller to exit the business or give up control,” explains Mr Liebmann. “At the same time, a successful JV depends on the ability of the parties to agree on how to share operational control as well as profits and losses.”
With a target identified and the green light given, parties are faced with a raft of issues to address, including an array of complicated anti-corruption, antitrust, securities, data security, and environmental and employment laws and regulations – both at home and abroad.
“The major issues that parties need to consider are differences in law, regulation, culture and policy between their home country and the M&A target or JV partner,” says Mr Sherman. “In my experience, many companies enter into cross-border transactions with the false hope and expectations that things abroad will be similar to things at home. When major issues get missed there is a significant post-closing impact on the underlying business premise of the transaction which leads not only to unpleasant economic surprises, but also increases the chances of post-closing disputes which are particularly expensive between companies in different countries.”
However, despite the extent of the potentially problematic issues involved, in the view of David Ernst, co-founder and managing director of Water Street Partners, cross-border M&A and JVs can both succeed, although each has different success factors and risks. “Cross-border M&A is most successful in geographies where the acquirer has an existing footprint and some capabilities, and is riskiest in totally new geographies where it is challenging to capture synergies or effect performance improvements,” he submits. “Cross-border joint ventures are most successful when the relationship evolves gradually and the counterparties are both strong players, but bring different strengths, such as technology and product by one partner, and local production, distribution and sales capability by the other.”
Many of the risks involved in cross-border JVs relate to governance, partnering with companies that are current or future competitors and maintaining strategic alignment with said partners. For example, emerging market players may wish to expand while their global counterparts may look upon a JV as a contained business. “Most successful global companies have used both JVs and M&A successfully to expand into new markets – and the typical success rate can be much improved on by adherence to hard-won lessons and best practices from the many deals that have been done,” suggests Mr Ernst.
Tax is critical
Successfully structuring cross-border M&A or JV transactions requires reconciling the differences between business cultures and legal and tax systems, with specific areas of concern being limitations on foreign investment, antitrust restrictions, controls on foreign exchange and taxes. Indeed, this latter element is particularly important, as tax issues wield enough influence to dictate where and how a joint venture is formed and operated, as well as how it can be terminated.
“While there are certainly many issues that parties need to analyse, one of the most critical is tax,” says Mr Corsico. “A well thought-out tax structure can result in significant savings – savings that are so significant that a mediocre investment could turn out to be a spectacular investment on an after-tax basis. In that sense, tax planning should not be an afterthought. Instead, it should be a critical workstream that begins at the time that deal discussions commence, if not earlier.”
The top cross-border M&A deals of 2016, as well as being memorable due to their size and scope, also provide the dealmaking community with insight into how such transactions are being planned, conducted and completed. Of particular interest is the Bayer AG acquisition of Monsanto – a mega-deal which, although it is yet to close, is certainly worth examining.
The Bayer AG/Monsanto transaction got underway in May 2016 when German pharmaceutical and chemical giant Bayer made an unsolicited all-cash offer of $62bn, which US biotech company Monsanto quickly rejected over concerns that the offer did not address potential obstacles to closing the deal, including regulatory hurdles. In response, Bayer raised its offer and added a $1.5bn reverse break-up fee. “This transaction reflects an emerging trend in cross-border transactions where large reverse break-up fees payable by the buyer are negotiated to address doubts over closing certainty,” explains Mr Liebmann. “Such risks are real, as illustrated by a surge in abandoned deals. According to Thomson Reuters, withdrawn and terminated deals in the first half of 2016 totalled over $500bn in lost deal value. Successful deals require the parties to identify and carefully plan on how to avoid and allocate transaction risk and structure around regulatory challenges.”
Regulation and culture
Given their nature, companies undertaking cross-border M&A or JV transactions are susceptible to the impact of differing laws, regulations and culture – differences which can often be massive and lead to significant long-term value detractors. “An uncertain or unstable regulatory environment for the subject company of the transaction can mean that, over the long-term, the company would be unable to create as much value as the investor previously assumed it would,” says Iain Donald, a senior partner at Control Risks. “If taxation or royalty regimes change, for example, that can obviously be enormously disadvantageous and impact profits. The overall regulatory context can include, in a slightly more insidious manner, corrupt practices, and can lead to other exposures that can drastically impact profitability and efficiency in other ways, potentially resulting in fines and prison sentences. As such, it is clear that local understanding is critical.”
For Mr Liebmann, differences can often be of a sufficient level as to become ‘deal-breakers” in a potential cross-border M&A or JV transaction, with the decision to proceed being heavily influenced by a variety of laws and regulations, such as limitations on foreign investment, the existence of foreign exchange controls and various tax policies. To help counter this, one strategy is for companies to obtain expert advice early on in the deal process. “Legal, tax and accounting specialists with direct experience working in the countries involved can assist in identifying and structuring around the various legal, regulatory, tax, accounting, operational and commercial issues that exist in any particular transaction,” says Mr Liebmann.
Indeed, companies with recourse to a trustworthy local in-country business adviser can utilise such a contact as a ‘translator’ for cultural issues. “It is important for your other advisers, including banking, tax, legal and accounting, to be at least familiar with the jurisdiction in question, so that they know to ask the right questions,” he explains. “They do not have to be local country experts, but they have to be good enough to know their own limits.”
Of course, risk dimensions vary from location to location and transaction to transaction, which is why it is no longer deemed suitable for investors to carry out due diligence which simply tests integrity issues. “While an acquisition candidate may have high levels of integrity, the entity may be operating in a shifting, disadvantageous business climate, and within a political and country risk context that can imperil operating success,” explains Mr Donald. “Investors must also consider the risk governance practices of a potential partner organisation to determine if the procedures and management culture are in place that will allow it to be resilient in the face of changes to regulatory and political environments.”
Strong, flat or volatile
The wave of political populism and anti-globalisation movements across many western economies – Brexit and the election of Donald Trump among them – has obvious scope to adversely impact cross-border M&A and JV activity in the near term, with opinion decidedly mixed as to the extent to which the unprecedented geopolitical shifts will affect the dealmaking landscape in future.
In the view of Mr Ernst, cross-border M&A and JV activity will continue to be vibrant in 2017 and be driven by persisting forces such as: (i) a drive for scale and cost economies in industrial and other asset-intensive sectors; (ii) relatively rapid growth in emerging vs. mature economies leading global companies to pursue growth outside core developed markets; (iii) a focus by Middle East economies to diversify into new sectors; and (iv) various plays to commercialise emerging technologies and products on a global basis. “Domestic activity is likely to be strong in sectors affected by discontinuities in regulation, prices or technology. If uncertainty in the market continues to rise, we make actually see a preference for JVs, as they are often used as a hedge against volatility,” he adds.
Less confident about the prospects for cross-border M&A and JV deals in the wake of recent geopolitical events is Mr Liebmann, who expects activity levels to be relatively flat in 2017. “The leading drivers of cross-border M&A and JV dealmaking remain strong – including the need for growth, the demand for local presence in foreign markets and the search for lower labour costs, among others. However, these drivers are offset by high valuations for target companies, economic decline in some foreign markets, political instability, currency fluctuations and, for many, a general lack of experience managing international operations.” Furthermore, says Mr Liebmann, the emergence of populist reform agendas and a mood for anti-globalisation that challenges the formal mainstream, may further reduce cross-border deal activity in the near term.
As cross-border M&A and JV transactions become ever more challenging amid a volatile, uncertain, complex and ambiguous global landscape, the demands on dealmakers to adopt a more dynamic approach to transactional analysis, risk management, and holistic due diligence is increasingly acute. “The global economy is likely to remain volatile for our lifetimes and global business leaders must adjust their strategy and growth planning accordingly,” declares Mr Sherman. “They will also need to factor in a different set of metrics for risk management and risk tolerance.” In other words, the dealmakers’ desire for global expansion in times to come will not be for the weak or the fearful.
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