Cross-border M&A: opportunities and challenges

September 2018  |  FEATURE  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

September 2018 Issue

As a mechanism for fostering growth and increasing shareholder value, M&A is an important tool in a company’s armoury. Cross-border M&A in particular can be a useful springboard for those eyeing expansion and future prosperity.

Currently on a high, cross-border M&A, according to Mergermarket’s ‘Global & Regional M&A Report H1 2018’, totalled $740.3bn during H1 2018 – an 11.6 percent increase compared to H1 2017 ($663.4bn). Furthermore, European outbound totalled $108.6bn in H1 2018 – 21.1 percent lower than H1 2017 ($137.7bn).

Simply put, expansion into a foreign market requires a suitable target to be identified, effective execution of a transaction and successful integration of converging companies. That said, the processes involved are not simple, as they present numerous challenges and pitfalls. “The current cross-border M&A landscape is robust, but with a few hints of caution,” says Andrew Sherman, a partner at Seyfarth Shaw LLP. “Most growing companies understand that being acquisitive in a wide variety of markets has become the new normal in strategic growth planning.”

This new normal will often see firms exposed to a range of complex and often perplexing issues requiring careful navigation. Drilling down, these may include: (i) political considerations and their implications; (ii) legal and regulatory compliance challenges; (iii) cultural and communication obstacles; (iv) labour and employment problems; (v) tax and accounting difficulties; (vi) post-closing integration hurdles; and (vii) antitrust and anti-competition concerns.

Additional challenges impacting the cross-border M&A space include the emerging trade war between the US and China and its indirect impact on Europe, Canada, Mexico and Latin America, among others, as well as the nationalistic trends permeating politics, such as recently proposed changes to Committee on Foreign Investment in the United States (CFIUS) legislation. “The impact of Brexit and related developments could also lead to greater governmental scrutiny and transactional cost in the areas of national security reviews, antitrust reviews and regulatory approvals,” suggests Mr Sherman.

For Jonathan Klonowski, EMEA research editor at Mergermarket, increasing protectionism and political intervention is certainly having an impact. “With governments looking to block deals on the notion of ‘national security’, protectionism will be at the forefront of dealmakers’ minds when considering high-profile cross-border deals, meaning firms must weigh up the viability of a transaction,” he says.

Despite concerns, there is plenty of room for optimism. “In general, the M&A market has been quite busy, both for domestic and cross-border deals,” says Jonathan L. Corsico, a partner at Simpson Thacher & Bartlett LLP. “President Trump lowered taxes and reduced regulation, and these changes seem to have made a dramatic impact – both in terms of general confidence in the economy and in terms of actual underlying economic performance.”

Given the complexity of the dealmaking landscape, it is unsurprisingly that the majority of successful cross-border M&A transactions tend to be based on careful advance preparation, well thought-out strategies and anticipatory deal structures. How firms plan and execute is therefore key, as is a confident approach and a desire to create real value for shareholders.

Planning and preparation

With the planning requirements of cross-border M&A substantial, acquirers often recruit advisers experienced in managing the specific aspects involved in getting international deals done, such as transfer pricing concerns, adherence to local rules and supply chain integration.

“Identifying post-closing cultural challenges, technological challenges and logistical hurdles well in advance of closing will not only ensure that post-closing integration is successful, but can also influence specific provisions in definitive documents, such as representations and warranties, covenants and even earn-out provisions,” says Mr Sherman. “For example, if an acquirer can identify possible post-closing supply chain integration or channel partner disputes, it can build specific metrics or covenants that can influence hold-back provisions, deferred payment obligations and contingent consideration.”

Also having a major impact on the planning of cross-border M&A is the tax reform introduced in the US in December 2017. Since then, the reform – the most sweeping overhaul of the US tax system in more than three decades – has done much to shake up the cross-border landscape.

“Without a doubt, US tax reform has had a dramatic impact on cross-border M&A,” says Mr Corsico. “Some cross-border deals that used to make sense no longer do so, while other transactions that previously did not, now do. A critical element for dealmakers is to get tax advisers involved early, and to keep them involved throughout the process as the deal develops. Creative thinking on the tax front can discover opportunities that were not previously available, and discover pitfalls that would not previously have been an issue.”

For Jan Willem van Drimmelen, global head of corporate clients at Intertrust, increasing scrutiny of the tax treatment of multinational entities has sharpened attention on the technical aspects of cross-border M&A transactions. “Companies should put in place a robust transfer pricing framework as an essential risk mitigation tool in any complex cross-border transaction,” he advises.

Notable cross-border M&A

The cross-border M&A arena has been particularly active in 2018, with deal volume and deal value strong – 38.2 percent of global M&A value was generated by cross-border activity according to Mergermarket’s ‘Global & Regional M&A Report H1 2018’ – but down on recent years (the majority of the increase in global M&A seen so far in 2018 has been driven by domestic M&A).

Among the notable cross-border M&A activity seen this year were the Japanese pharmaceutical firm Takeda’s proposed $79.7bn takeover of Dublin-based and London-listed drugmaker Shire, China’s state-owned utility China Three Gorges’ $27.4bn bid to acquire Portugal’s biggest company Energias de Portugal, and the $40.7bn acquisition of pan-European British media and telecommunications company Sky Plc by US cable provider Comcast Corporation.

Regulatory burdens

The burden of ever-increasing regulation, both at a national and international level, and changing tax laws, among other developments, has done much to add complexity to the process of structuring cross-border M&A deals.

“Regulatory bodies are scrutinising deals to a greater extent and this has been particularly apparent with Chinese investments into Europe and the US,” says Mr Klonowski. “After a number of high-profile cases, regulations both in China and in targeted areas have looked to stymie such activity. In terms of mitigating risks, companies have long lobbied politicians to help smooth the waters and curry favour ahead of key investment decisions.”

In the view of Mr van Drimmelen, in order to navigate the myriad regulatory and cultural nuances of particular jurisdictions, it is essential that companies team up with the right partners at both a global and local level. “Cultural differences between jurisdictions should never be underestimated. If neglected, they can make it very hard to successfully execute a deal,” he suggests. “Advisers with strong local expertise can help to bridge the cultural divide and implement measures such as employee incentive plans that guarantee a smooth deal and retention of key staff.”

Another factor likely to impact how firms view cross-border M&A is changes in the approach being taken by key regulatory authorities. For example, the process by which CFIUS reviews foreign investment in the US has been a topic of debate in recent months, with the US Congress now primed to modernise and streamline it via the Foreign Investment Risk Review Modernization Act (FIRRMA). The proposed legislation provides for short-form ‘light’ filings, tightens the timeframe for CFIUS reviews, exempts acquirers from US allies, and expands the definition of ‘passive’ investments excluded from CFIUS review. The changes to the CFIUS review process are likely to be included in the National Defense Authorization Act of Fiscal Year 2019.

Expectations

In an increasingly unpredictable, tense and insular world – encumbered by trade wars, protectionism, nationalism and other parochial behaviour – cross-border M&A would appear to be facing formidable barriers. However, they are not insurmountable, as the dealmaking prognosis in the cross-border arena is good.

Of the myriad insularity on display across the globe, it is president Trump’s posture toward China that is arguably the most visible demonstration of how protectionist policies can muddy, if not empty, foreign investment waters. One high-profile victim of the US’s tough stance was the proposed $1.2bn acquisition of US money transfer company MoneyGram International Inc by Chinese firm Ant Financial early in 2018, a transaction ultimately rejected by the Trump administration on national security grounds.

“We have already seen a number of Chinese deals blocked that, in prior administrations, would probably have been approved,” says Mr Corsico. “I expect that president Trump will continue to take a hard line towards China and acquisitions by Chinese-backed companies, particularly in sensitive or high-tech industries.”

Potential pullback

Although cross-border M&A expectations for the remainder of 2018 and beyond are high (albeit with significant caveats), some commentators are forecasting a certain amount of pullback in 2019 and 2020.

“2019 is likely to be a digestion and integration period for many overseas acquirers for transactions completed in 2018, before there is a ‘hunger’ for consuming additional transactions,” says Mr Sherman. “The capital markets have been stable and quite resilient in 2017 and 2018 but some indicators point to a pullback in 2019. This will make acquisition capital more expensive and harder to find for many companies.

“While cross-border M&A has been robust in a variety of industries, 2019 and beyond may see deal activity in a more narrow band of verticals, such as artificial intelligence (AI), robotics, drone technology, Big Data, virtual reality and healthcare,” continues Mr Sherman. “Cross-border acquirers may put their plans on hold by mid-2020 and take a ‘wait and see’ approach. They will then adjust their plans and strategies for 2021 and beyond.”

Others, such as Mr van Drimmelen, see the underlying drivers of M&A remaining strong. “While the potential for a global trade war and a flattening yield curve has created a subdued environment for dealmaking, we believe there are many companies that will be ready to move when the timing is right,” he says.

Viewed objectively, cross-border M&A can be considered paradoxical in many ways, with commensurate drivers and barriers battling for supremacy. The challenge is for deal teams and their advisers to have recourse to a well-equipped toolkit – an armoury that needs to be able to manage the inherent risks that cross-border M&A presents, as well maximise the chances of a transaction being a success.

© Financier Worldwide

BY

Fraser Tennant