By Caroline Drummond, Associate Director | Osborne Clarke
Arriving in Osborne Clarke’s West Coast team, Caroline Drummond highlights some trends from recent deals that Osborne Clarke has acted on.
Global M&A markets may appear to be in a state of flux. The headlines remain dominated by stories that cause disruption and the type of uncertainty that typically hit M&A and capital markets hard.
Nevertheless, despite many M&A market commentators having predicted that the current M&A cycle had topped out in 2018 (a record year for deal values after several years of sustained value growth), or is coming to an end, activity remains high in H1 2019. Indeed, M&A volumes have picked up in 2019 to date after slowing in H2 2018
Challenges the global M&A market currently faces – political uncertainty (including over Brexit), trade wars and tariffs and slowing of economic growth in many jurisdictions etc. – present opportunities for those in the right businesses, jurisdictions and industries to capitalise on.
Key drivers for M&A activity
Private equity dry powder
PE investors have record amounts of committed capital (currently estimated to be in excess of US$1tn globally) and they are under pressure to create and return profits to their investors driving investment and competition for the best deals. Reflecting that, multiples being offered are increasingly matching or bettering what trade buyers can offer.
Focus on strategy and divestment of non-core assets
Corporates are focusing on their best-performing and most strategically important business divisions, and are undertaking reorganisations and divestments to streamline and focus on core activities. Disruptive acquirers can pick up the sold-off pieces of these divestment strategies to complement and synergize their businesses.
With more cash in the coffers, corporates are able to drive scale and growth in their core business through strategic acquisitions or joint ventures and/or partnerships (for example the Pfizer/GlaxoSmithKline joint venture), as an alternative to traditional M&A.
Investment into Europe from the US
A favourable tax regime in the US, including recently reduced corporate tax rates and cuts on taxation of funds being repatriated into the US from foreign subsidiaries, mean that there is more cash for US companies to pursue those targets that help them scale their businesses.
UK, Germany and France appear in the top five most targeted countries within Europe. Within these countries, technology, consumer products, automotive, industrials and financial services are some of the most sought-after sectors.
Fluctuations in GBP/USD exchange rates mean that UK-based businesses can be particularly attractive targets for US buyers.
Opportunities for investment from Asia
Trade tensions with the US, concerns about national security and a global trend towards increased foreign direct investment controls are all impacting the volume of international deals coming out of China (particularly to the US).
This creates increased international investment and expansion opportunities from countries such as Japan into the US and Europe (including noteworthy megadeals such as the US$ 79.7bn acquisition of Shire in 2018)
Venture capital investment from Asia into European target companies (including those in the UK) has been increasing rapidly. VC investment from Asia increased 22 fold between 2013 and 2018. In 2019 to date, 17% of VC investment in Europe has come from Asia (2018 – 8%, 2013 – 2%).
Despite the impact of the challenges listed above, China has opened its doors to international investment in some sectors.
Availability of cash and high corporate cash reserves
Low interest rates in the US and the knock-on effects for many other jurisdictions (coupled with concerns around how long the current low interest rates can last) means that many businesses have more available cash and an appetite to spend it now.
Corporates are using cheap finance and available cash on their balance sheets to make strategic acquisitions of high revenue generating businesses, talent/expertise-rich businesses and those with valuable technology and intellectual property (particularly in disruptive technologies), rather than relying on organic growth and in-house development.
One of the key features of the current market, particularly in Europe, is a shift in power in favour of sellers. There are still bargains to be had, but to ensure that their offers are in the running, buyers need to plan around sellers’ expectations and market trends, particularly in the context of sale auction processes.
Capitalising on competition for the best targets, particularly in disruptive technologies, sellers are opting for sale auction processes, pushing potential buyers (trade and private equity) to accept sellers’ deal terms and bid high to avoid losing out.
Earn-outs continue to grow in popularity as a way to incentivise founders of target businesses, buy talent and manage post-acquisition integration disruption. There was a 2% year-on-year increase in the use of earn-outs in European deals in 2018. A quarter of small and mid-cap European deals now involve earn-outs.
Increased regulation in Europe and new requirements for even modest sized mid-market transactions to be approved by regulators (particularly by competition authorities) are increasingly leading to transactions structured with split exchange and completion. Higher price multiples and sellers’ increasing ability to resist traditional buyer protections during the period between exchange and completion (such as repetition of warranties, wide reaching material adverse effect clauses and other rights of termination) point to buyers’ increasing willingness to accept some risk to secure the right targets.
Locked box mechanisms, typically the favoured consideration adjustment mechanism of sellers, are becoming more common than was historically the case – even with US based purchasers, who have traditionally preferred completion accounts-based price adjustments.
We have also seen a watering down of warranty protection and an increased reliance by buyers on warranty and indemnity insurance to reduce sellers’ exposure to contractual claims. 30% of deals worth over £100m in Europe involved this type of insurance. More reasonable pricing of policies with fewer standard exclusions in areas of cover mean that insurance is being used to create value for shareholders without increasing their risk profile.
How can we help?
Please reach out if you’d like to have a chat about the M&A marketplace or how US buyers can beat the competition for the international expansion opportunities in Europe and/or Asia.
Compliments of Osborne Clarke, a member of the EACCNY