IFLR European M&A forum: key takeaways

Author: IFLR Correspondent | Published: 30 Sep 2016
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Breaking down the process of private M&A transactions

• Locked box price mechanism is becoming the norm especially in M&A transactions where the seller has a stable cash generation position. The method provides certainty in the long period between when the deal is signed and when it closes

• Warranty and indemnity (W&I) insurance premiums are not as high now as they were 10 years ago, possibly because of the impact of the global financial crisis. Premiums are now between one and five percent of deal value

• One panellist warned: "Saying that as a buyer you are looking into W&I may discourage seller to carry out proper due diligence – you’re a better off only mentioning into internally first"

• There are some opportunities for sell-side managed processes, but this will depend if there is standardisation of sale and purchase agreements

• Some law firms are outsourcing due diligence work to third party firms instead. The exercise is crucial to the M&A process but "clients aren’t recognising the value of that effort," said one speaker

The unpredictability of acquisition finance

• The current climate has not really impacted the borrowing market – this may be linked to monetary easing/bond-buying. However, leveraged finance and M&A finance are both cyclical activities so may be impacted at some level in the next 12 to 18 months

• There is currently a depth and variety of liquidity available. Larger borrowers tend to access HY bonds, distributed syndicated loans, while smaller ones are tapping subordinated second lien loans, direct lending funds, retail bonds or crowdfunding – but the lines are blurring

• There is huge competition to underwrite large cap deals and this is creating more flexibility and liquidity in terms of funding options for borrowers – in the mid-market, this has not filtered through yet

• The amount of lenders in the UK at present is creating competition in the market. However, international lenders’ ability to do business in the UK may be impacted by Brexit

• There have so far been no significant changes to documentation as a result of Brexit – main change has been SPA with a Brexit clause included

Alternative strategies and structures for private equity exits

• Common routes for PE sponsors to exit their investment: sale to corporate (70 to 75% of cases), secondary buyout (10 to 15% of cases) and IPO (10 to 15% of cases). Informal dual-track option (IPO and M&A) can offer a chance to test the market during an IPO

• However, financial sponsors are always interested in alternatives exit strategies and structures. These can include an accelerated IPO or a sale to an existing listed company (reverse takeover)

• Auction sales have been on the rise, and PE buyers are up against trade buyers

• One speaker said that IPOs may be more attractive to a company’s management than an M&A deal, so there is a need to structure deals properly to ensure management remain focused on the deal outcome

• IPO is a multi-stage process and is less clean than a trade buyout. "You want financial sponsors to stay to bear part of the deal risk, so that public investors are not the only ones impacted," said one panellist

Effective management of shareholder activism

• Shareholder activism can take many forms, depending on the jurisdiction and type of investor – in the US, activists tend to be vocal about leveraging governance as a way to influence financial results but in the UK public campaigns are not so welcome

• A public battle with an activist shareholder is one of the most disruptive activities in the life of a company expect for maybe a hostile takeover – there needs to be ongoing dialogue between a company’s governance and investors

• There is a triangle dynamic between shareholders, boards and management – shareholders tend to want to engage with boards because they see CEOs as an embodiment of the company’s strategy

• Some defensive measures can be taken to dissuade activist shareholders. These include management-friendly majority investors and more management-board cooperation

Focus: European merger control 2016/17

• The Commission received attention in 2015 after launching in-depth investigations on a number of mergers, in particular proceedings on 11 mergers – the highest since 2007

• However, the 11 cases that the Commission took a closer look at only represented 3% of the mergers that it received notifications over

• The Commission blocked one deal this year: the Hutchison/Telefoncica deal in May. It hadn’t blocked one since 2013 until then

• The Commission is more open to considering remedies early on in the process. It is more likely to grant Phase 1 clearance decisions where parties are willing to solve competition issues upfront

• Complex mergers require complex remedies. The scope of remedies is broad. Preference for structural remedies (in particular divestitures over behavioural commitments (e.g Hutchison/VimplelCom JV in September 2016

Bridging the valuation gap using legal techniques

• The relevancy of earn-outs is gaining importance. Some former, technology-centred start-ups are more suited to earn-outs

• Negotiating earn outs with individuals has its challenges though.  Vendors sometimes view the earn-out as an entitlement that results in a tension often not solved on completion

• Advisors should be aware of it when entering into negotiations and document it

• So-called leaver provisions are also vital, particularly in technology companies often dominated by one or two inspirational figures. Part of the horizon scanning process is to ensuring you either have succession plans or employment arrangements with those individuals

• Legal advisors should become involved at an early stage when earn outs are being discussed. Panellists argued that at start of process the term is thrown about with little thought as to how it will be structured

FOCUS: Natural Resources

• Seller expectations for valuations are high and buyer expectations are low. There is often a mismatch, and so deals that do come to market and get past market sounding often fail to close. Prices often can’t be agreed

• This bid/ask spread is expected to decline as the oil price starts to stabilise from $25 and go up to around $50 to 60 per barrel. The oil price has recovered but not as buoyant as was hoped

• The last year has seen much more private equity and investor interest in deploying renewable energy infrastructure since 2008. That is possibly because of the search for yield. Infrastructure is a good play, as an equity-type investment but very structured and low risk when on energy sources such as solar

• Still plenty of PE dry powder and unclear whether that will play out and impact traditional M&A market, which is currently still quiet

The rise of Chinese outbound M&A

• Last year there was $62 billion of Chinese outbound M&A into Europe. In the first six months of 2016, Chinese outbound M&A into Europe amounts to 10% of global M&A

• The most popular destinations are: the UK; France; Germany; and Spain (in that order). There is a reported $2 trillion of Chinese M&A in the next two years

• The massive uptick in such M&A has been happening since before Brexit, but the exchange rate since June has made it an even stronger proposition

• However, for companies with factories remaining in China, the impact has been the opposite – costs have gone up

• There are three key drivers. First, it has been Chinese state policy to implement a global strategy for a number of years. Second, there is an industrial urge to purchase technology, processes and strategies. Finally, wealthy individuals are looking for strong returns

• In looking to the future, the panel pondered the growth and influence of Chinese banks in London (especially with regard to lending power). It also predicted a Chinese purchase of a FTSE500 company before considering Chinese exits. Will they only sell to Chinese companies? Or launch IPOs in the Chinese market?