June 2016 Issue
Despite 2015 representing a record year for global M&A in terms of value, early signs in 2016 indicate an uncertain and potentially risky European M&A environment. The recently published results by Mergermarket reveal an alarming 17 percent drop in the number of announced European M&A deals in Q1 2016 when compared with Q1 2015. Anxiety on the market has emerged in the face of numerous geopolitical and economic factors, including the slowdown of China’s economic growth, a more aggressive corporate tax climate, the increase of US interest rates, the low price of oil and commodities, the European migration crisis and the looming British vote on EU membership. These issues are fostering a high degree of uncertainty and a lack of confidence in the market which is affecting business and M&A transactions across the globe.
Our recently-released eighth annual M&A study analysed over 2000 non-listed European and private company deals between 2010 and 2015. The key findings were that in 2015 it was a seller-friendly environment and that buyers had to pay more to complete deals as well as spend more time negotiating the price. This is in stark contrast to where we see the market today.
The market sentiment can be gauged by a close inspection of the characteristics in M&A transactions. The changes we observed in 2015 including those to locked box, purchase price adjustments, earn-out terms and de minimis/basket provisions were generally reflective of a seller-friendly environment throughout the various regions in European M&A. One particularly noteworthy change was the extent to which transactions included limitation periods for warranty claims. The study provides evidence that in recent years there has been an increasing shift in favour of shorter limitation periods. Limitation periods of more than 24 months decreased from the previous five year average of 24 percent to only 15 percent in 2015.
Similarly, material adverse change (MAC) clauses in transactions can be another strong indicator of the relative strength of the seller’s position. MAC clauses serve to allocate the risk in the case of a fundamental change occurring between the signing and closing of the transaction, and operate for the benefit of the buyer. Across Europe in 2015 they were used in 16 percent of the deals, which is a slight rise on the five year average of 15 percent. However, the inclusion of these MAC clauses varied significantly among different regions. The usage of MAC clauses continues to grow in Benelux, France and Germany, in contrast to CEE and Southern Europe, where, for instance, they dropped from being used in 38 percent of transactions (in both regions) to just 18 percent in CEE and 17 percent in SE.
Given these large fluctuations we have seen in recent times, a continuing assessment of the length of limitation periods and prominence of MAC clauses will provide a useful means for monitoring the M&A market environment in 2016. We expect that the strong bargaining position which sellers have acquired in recent years will be shifted back in favour of the buyer. Our experience in Q1 2016 is consistent with this – we are finding that sellers are showing signs they are more willing to increase their risk appetite in order to stay competitive.
From the perspective of the CEE region in 2015, M&A activity was relatively flat with a 3 percent decline in announced deals (2138 transactions) and 15 percent decline in total value (from €63bn to €53bn). Although there was a decline in overall activity, there was a jump of 61 percent in value and 9 percent in volume from US based investors – with 127 deals valued at almost €4bn in the CEE region. Furthermore, there was a significant spike in investment from China and evidence of a developing interest from South Korea. With the strong US dollar and the relative weakness of European currencies, all signs indicate that this strong investment from outside Europe will continue in the region. The interest of Chinese cross-border investment in particular continues to be encouraged in 2016 by consecutive cuts in Chinese interest rates.
Notwithstanding the surge of foreign cross-border investment, deal volume and value were significantly down within the CEE in Q1 2016. In addition to being susceptible to the aforementioned worldwide geopolitical and economic challenges, the CEE region is more volatile in its exposure to Russia. The dispute with Ukraine has been tempered for the time being, but the instability of the rouble and the consequences of economic sanctions continue to have an impact upon M&A in the region. M&A activity with Russia from the CEE region was very poor in 2015, especially in the first half of the year where there were only 14 inbound deals into Russia worth €2.6bn. There is a prevailing concern on the market that trade relations with Russia could be entirely cut off in the future. This enhances anxiety from investors about heightened regulatory clearances, which remains one of the foremost obstacles to market confidence.
The recent change of government in Poland also presents new challenges to the region. The new government, the Eurosceptic ‘Law and Justice Party’, is the first to have an outright majority in the country since the fall of communism and is making swift and unpredictable political and regulatory changes – resembling that of Hungary three years ago. To coincide with this development, there has been a flurry of M&A activity in the Polish market, including two government acquisitions of private businesses each in excess of €350m. In Q1 2016, Poland has continued to be a busy M&A market in the region, together with the Czech Republic. Nevertheless, year on year, activity levels in both markets are down on last.
In CEE and throughout Europe, investors remain deterred from M&A activity. More stability in foreign currencies, a ‘no’ vote in the Brexit referendum, an end to the bitter American presidential election campaign and an apparent easing of the migration crisis with the recent EU deal struck with Turkey could help stem the tide and restore market confidence. However, in the current context of the strong geopolitical and economic uncertainty surrounding Europe, we expect that for the remainder of 2016 and the foreseeable future, sellers will have to lower their expectations and accept more risk in order to complete M&A transactions.
Helen Rodwell is a managing partner at CMS. She can be contacted on +420 296 798 818 or by email: helen.rodwell@cms-cmck.com.
© Financier Worldwide
BY
Helen Rodwell
CMS
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