FWE-BOOK
international mergers & acquisitions
creating value in an increasingly complex corporate environment
2008
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2008 International Mergers & Acquisitions: Creating Value in an Increasingly Complex Corporate Environment FWE-BOOK 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Contents NOTE: These Contents pages are interactive. Clicking on an article will take you to the relevant page.
About the Publisher 7 Acknowledgement ...... 8
CHAPTER ONE: Introduction 9
2007: a story of two halves 10 Sovereign wealth funds 16
CHAPTER TWO: Statistical data 19
M&A trends 1997-2007 20 Financial sponsor trends 2000-2007 ...... 29 M&A and private equity in 2007 ...... 34
CHAPTER THREE: Global outlook 39
Will the next wave of M&A create more value? 40 International M&A takes centre stage 43 Recent developments and their implications for M&A in 2008 ...... 46 Emerging markets and M&A activity ...... 49 Developments in merger control in the EU and worldwide ...... 53
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CHAPTER FOUR: Private equity markets 57
The case for value creation focused LBOs ...... 58 Is there a credit crunch in the mid-market? 61 The changing face of the MBO 64
CHAPTER FIVE: Structuring and negotiating the deal 67
Preparing a company for sale to maximise value 68 Steps to a successful private company sale ...... 71 Non-binding preliminary agreements: use ‘good faith’ with caution 74 Auctions in the M&A process ...... 78 Domestic versus foreign acquirers: managing an international sale process 81 Going global: successfully negotiating multi-jurisdiction transactions 85 Key issues in structuring and negotiating leasing company acquisitions 88 Drafting material adverse change clauses 93 Deal certainty and recent dislocations in the credit and M&A markets 97 Drafting and negotiating purchase agreements to anticipate challenges 101 Effective earn-out provisions in sale & purchase agreements 104 Risk allocation – driving force behind the M&A process ...... 106 Directors’ duties in M&A transactions 109 M&A – an insurable risk? 112 Exploring the potential of joint ventures to create value as opposed to outright M&A ...... 115
2 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER SIX: Accounting and financial challenges 118
Valuing assets in M&A under IFRS 3 ...... 119 Growing influence of IFRS in M&A: why dealmakers should care 122 Valuation and solvency analysis in failing firm claims 125
CHAPTER SEVEN: Due diligence and integration 128
The evolution of diligence: how a multi-discipline approach gives buyers a competitive edge 129 Commercial due diligence and the nine levers of corporate growth 133 Sell-side online datarooms 137 Utilising the extended customer chain to enhance due diligence 139 Due diligence trends in Europe – commercial, operational and cultural twists 144 Due diligence and integration planning in cross-border transactions 146 Breakthrough value creation in M&A 150 Cross-border M&A: downstream implications ...... 153 Integration – the key to a successful merger 157 Protecting your cultural assets through an integration 161 Human resources – a fundamental part of the planning phase 164 Maximising deal value through the human side of M&A integration 167 Post-deal soft skills in emerging markets 170 IT integration challenges in M&A ...... 174
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CHAPTER EIGHT: Environmental issues 177
Climate change and the cost of carbon: incorporation into M&A deals 178 Identifying opportunity in the carbon era 180 The affect of market turmoil on the treatment of environmental liabilities in transactions ...... 183
CHAPTER NINE: Sector analysis 185
Trends in independent oil company M&A 186 European airline industry: value creation through M&A ...... 190 M&A boom in the CEE telecommunications market ...... 195
CHAPTER TEN: Regional view – The Americas 198
The M&A world comes to the United States 199 Taking advantage of the weak US dollar ...... 203 Deal or no deal ...... 206 A brief glossary of US M&A terms 209 Recent developments in Canadian M&A 212 New rules of the game in Canadian antitrust 216 Canada’s foreign investment review process 219 New developments spur M&A growth in Latin America ...... 222 New incentives for investing in private equity in Chile 226
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CHAPTER ELEVEN: Regional view – Europe 228
Managing pan-European transactions for US buyers 229 Glimmers of optimism: better times ahead for the UK M&A market 232 The German M&A and private equity market ...... 235 The Spanish M&A market: entering a tunnel? 238 Trends and prospects for the Spanish M&A legal market 240 Developments in the Netherlands’ corporate and takeover law 243 Forced unbundling of Dutch energy companies 246 Private equity and public takeovers in Switzerland: finally a happy marriage? . 249 Current state of the Nordic M&A market ...... 253 Financing options and capital structures 256 Directors and officers duties according to Swedish law ...... 259 Takeovers of Norwegian listed companies ...... 262 M&A in Finland ...... 266 In search of deal security – the Finnish version 270 Practices, trends and acquisition structures in the Finnish property market . 273 Regional regulatory features of M&A deals in Russia ...... 276 Antimonopoly policy in Russian M&A deals 280 Recent trends in the Russian M&A mid-market 284 Nature and scope of M&A in Ukraine 287 Sector-specific M&A in Ukraine 290 Due diligence in Ukraine 293 Antimonopoly laws in Ukraine 296 Legal issues in Romanian M&A 300 The Baltic M&A markets 304 Completing a successful deal in the Baltic States 307
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CHAPTER TWELVE: Regional view – Asia Pacific 311
Recent trends in Japan’s M&A market 312 Buyouts, takeovers and surrounding legal issues in Japan 315 Australia’s foreign investment framework: a more challenging landscape emerging for M&A ...... 318 Control of foreign investment in Australia ...... 322 M&A in emerging Asia ...... 327 How to speed up M&A deals in China 331 Will cross-border buyouts in China ever be feasible? ...... 336 Rules and issues surrounding M&A with Chinese companies 340 Necessities in a cross-border Indian deal 344 Mergers under India’s new antitrust laws – challenges ahead for enterprises . 347 US-bound acquisitions by Indian companies 350 Legal issues and regulatory issues in Indonesia’s M&A market 354
CHAPTER THIRTEEN: Regional view – Middle East 358
The Middle East as an emerging market ...... 359 The growth of IT investments in UAE and the wider region – an improving legal infrastructure 362
CHAPTER fourteen: Contributor glossary 366
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About the Publisher
Financier Worldwide is a leading publisher of news and analysis on the global corporate finance market place. Financier Worldwide delivers in-depth commentary, research, and practical analysis that bridges the gap between theory and practice in the complex world of corporate finance.
Through a series of online, print and digital publications, the organisation has become recognised as a leading source of intelligence to the corporate dealmaking community. Financier Worldwide products reach a sophisticated and influential group of professionals responsible for doing the deals that move markets and shape the corporate economy.
Financier Worldwide tracks the latest trends in Mergers & Acquisitions, Private Equity & Venture Capital, Bankruptcy & Corporate Restructuring.
This e-book, entitled “International Mergers & Acquisitions: Creating Value in an Increasingly Complex Corporate Environment”, is published in an exciting new interactive digital format. It is the first in a series of e-books to be developed by Financier Worldwide’s digital publishing division in 2008.
To learn more about this and other e-books scheduled for distribution, please contact James Lowe on +44 (0) 121 710 5560 or email [email protected].
www.financierworldwide.com | FW 7 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Acknowledgement
Data featuring in this e-book was compiled with the help of Dealogic’s M&A Analytics team.
Dealogic’s M&A Analytics provides a comprehensive view of M&A activity worldwide covering a wide array of transactions such as public offers, open market purchases, stock swaps, buyouts, privatisations, recapitalisations, share buy-backs, acquisitions and includes industry leading financial sponsor coverage. Each transaction provides information on target and acquirer, deal value, advisers, financials, multiples along with a detailed deal commentary. M&A Analytics provides a host of analytical tools to help analyse transactions, regions and industries efficiently.
8 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER ONE: Introduction
www.financierworldwide.com | FW 9 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g 2007: a story of two halves
by Salim Mohammed
In 2007 global mergers & acquisitions year, all but two of the top 10 deals were reached historic levels with $4.83 trillion announced in the first half of the year. in announced deal volume. This surpassed The two deals announced in the second the 2006 record of $3.91 trillion by 23 half of the year were BHP Billiton’s hostile percent. Due to the credit crunch, which attempt on Rio Tinto and Rio Tinto’s own hit in the summer, the year became a story acquisition of Alcan in July. of two halves with volume surpassing $2.7 trillion in the first half but then dropping 21 The second half slowdown was notable percent in the second half. for the smaller number of billion dollar deals that crowded the first half of 2007. In fact, September 2007 volume of There were 376 deals over $1bn announced $216bn was the lowest month for global in the second half, down from 466 deals announced M&A volume since November announced in the first half. Deals over 2005. BHP Billiton’s bid for Rio Tinto in $10bn dropped to 17 in the second half November 2007, valued at $152bn, helped from 29 in the first half. In addition, the push second half volumes above $2 trillion. average deal size totalled $187m in the When looking at the top deals of the second half of 2007, down 30 percent from
iH versus 2H, 2002-2007
3000 25,000
2500 20,000
2000
) 15,000 bn me ($ Value ($bn) lu e 1500 Volume lu Vo
Va 10,000 1000
5,000 500
0 0 1H 2H 1H 2H 1H 2H 1H 2H 1H 2H 1H 2H
2002 2003 2004 2005 2006 2007
Source: Dealogic
10 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS an average of $260m in the first half of record, shy of the record BCE spin-off of 2007. part of Nortel in 2000.
As the frenzied pace of first half deal Hostile or unsolicited bids heated up in activity gave way to caution, transactions 2007. There were 949 hostile/unsolicited took longer to complete. The average time bids in 2007, up from 374 in 2006. Although to complete a deal rose to 91 days in the volume for these bids was up 36 percent in second half of the year, up from 85 days in 2007 from 2006 ($929bn in 2007, up from the first half. $683bn reported in 2006), volume was still short of the record $1 trillion posted in Significant events of the past year 1999.
In 2007, finance was the top targeted Cross-border M&A represented 41 percent sector with $720bn, accounting for of total announced volume with $1.99 15 percent of global M&A. The RBS trillion in 2007, up 78 percent from $1.12 consortium (RBS, Santander and Fortis) trillion in 2006. The US was the most beat out Barclays and completed the targeted nation by foreign acquirers with acquisition of ABN Amro for $96bn in the $363bn in announced deals in 2007, up 67 fourth quarter of 2007 making it the largest percent from $218bn in 2006 while the completed deal of the year and the fifth Netherlands saw the biggest year-on-year largest on record. increase, rising 642 percent to $188bn, due in large part to the $96bn acquisition Altria’s spin-off of Kraft Foods, valued at of ABN Amro. The UK was the leading $56bn, at the end of the first quarter was acquirer nation with deals worth $307bn in the second largest transaction of the year 2007, up from $83bn in 2006 driven by five and also the second largest spin-off on deals over $10bn.
sector activity 2007
Finance ABN Amro / RBS, Fortis, BSCH $95.6bn
Real Estate/Property Archstone-Smith Turst/Tishman Speyer, Lemhan Brothers $20.6bn
Utility & Energy Endesa/ENEL, Acciona $52.6bn
Telecom BCE/Providence Equity Partners $48.5bn
Oil & Gas GlobalSantaFe/TransOcean $17.6bn
Technology IBM repurchase $12.5bn
Mining Rio Tinto/BHP Billiton $152.0bn
Healthcare Medlmmune/AstraZeneca $14.9bn
Construction/Building Eiffage/Sacyr Vallehermoso $23.8bn
Chemicals Lyondell Chemical/Access Industries $19.2bn 2007 Volume $bn
0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 Value $bn *the largest deal in the sector is noted Source: Dealogic www.financierworldwide.com | FW 11 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Emerging market targeted M&A volume generated from Asia Pacific (excluding reached $909bn in 2007, up 43 percent Japan) companies reached $1.9bn in 2007. from $634bn in 2006 and became the Japanese companies generated revenue of highest annual total on record. Emerging $490m. market cross-border inflow increased 43 percent to $371bn in 2007 from $260bn in For the volume league tables, Goldman 2006. Sachs led the global and US advisory rankings in 2007 while Morgan Stanley led The year ended with sovereign wealth the European rankings and UBS led the funds (SWFs) making four significant Asia Pacific (excluding Japan) rankings. investments into well known financial Goldman Sachs, Morgan Stanley, JP institutions. Faced with billions of dollars Morgan and Citi all advised on deals worth of write downs, Citigroup, UBS, Morgan over $1 trillion in 2007. Previously, only Stanley and Merrill Lynch all received Goldman Sachs tipped the trillion mark in investments by Asian and Middle Eastern 2006. sovereign wealth funds within the course of a month. These four investments totalled Financial sponsors break records, then over $30bn and were about two-thirds of hits the brakes the total SWF investment of $48.5bn in 2007. The full 2007 figure was a 165 percent The booming buyout market experienced a increase on $19.2bn invested in 2006 and a slowdown in the latter half of the year due five-fold increase from the $8.2bn invested to the credit crunch. Even with only about in 2005. In fact, SWF investment made up six months of deal making time before the 1 percent of M&A, up from 0.5 percent in credit market dried up funding, financial 2006. sponsor buyout volume hit a new record high of $796bn in 2007, an increase of 9 For the year, investment banks racked up percent on the previous record $730bn revenues of $26bn though global M&A reached in 2006. Putting the two halves in advisory. This figure was up 21 percent comparison, second half volume reached from $22bn reached in 2006. Of the $221bn, down 62 percent compared to first total, US companies generated a total of half volume of $575bn. $10.8bn, just besting European companies who generated $10.5bn. Advisory revenue With the announcement of the $44bn TXU
top 5 announced Global Financial Sponsor M&A Buyouts 2007
Announced Target Target Nat. Acquirer/Financial Sponsor Target Sector Deal Value ($bn) 29-Jun-07 BCE (93.7%) (Bid No 1) Canada Providence Equity Partners; Teachers Private Capital; Telecommunications 48.5 Madison Dearborn 26-Feb-07 TXU United States Kohlberg Kravis Roberts; TPG Capital; Goldman Sachs Utility & Energy 43.8 Capital Partners 21-May-07 ALLTEL United States TPG Capital; Goldman Sachs Capital Partners Telecommunications 27.9 2-Apr-07 First Data United States Kohlberg Kravis Roberts Finance 27.7 3-Jul-07 Hilton Hotels United States Blackstone Dining & Lodging 25.8
Source: Dealogic
12 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS buyout in February by KKR, TPG Capital percentage of total M&A in June when it and Goldman Sachs Capital Partners, accounted for 38 percent. However this the previous record held by KKR for the dropped to only 11 percent in November, RJR buyout was broken after 19 years. the lowest level since February 2005. However, just four months later, Teachers Private Capital, Providence Equity Partners Emerging market financial sponsor and Madison Dearborn set another record buyout volume reached $47bn in 2007, with the BCE buyout at $48.5bn. up 17 percent from $40bn in 2006 and represented 6 percent of global buyout In all, there was a record nine $10bn- volume. India was the most targeted nation plus buyouts announced in 2007 and with a total volume of $8bn accounting for 158 above $1bn. However, of these, no 17 percent of all emerging market financial $10bn-plus buyouts and only 37 $1bn-plus sponsor buyout volume. China was the buyouts were announced from August to second most targeted nation with $6bn of December. volume, down 28 percent on 2006.
The average deal size for buyouts from Although emerging market financial August to December was $221m, down sponsor buyout volume has fallen steadily 77 percent from its peak of $958m in both since peaking at $7bn in August to $3.5bn in May and June. In fact, monthly volume for December, the falloff has been less intense financial sponsor M&A buyouts peaked in as the non-emerging markets. Finance May at $159bn and declined to $27bn in was the top industry targeted by financial December. sponsors in the emerging markets with $6bn. The largest deal was the $767m bid All financial sponsor M&A activity (entry by Carlyle Group and Citi for a 6.6 percent buyouts, portfolio company transactions stake in Housing Development Finance and exit deals) reached its highest Corp of India.
GLOBAL M&A BUYOUTS (excluding add-ons) 2007
$m - Volume represents full week volume E - Largest majority acquisitions of the week are noted BC
70,000 h it
60,000 Sm e e ng U es ta ts er l at on mi TX or ts st el
es ning Da oo ta ca nc ls
50,000 st lt St ic or Ga ti ar e e I on B ns Ma te e s Da l ch Al d s) ns rv lt es Le io e e eu ic t t nc ce on In ct p te na io Ar Hi as l Se ic n R h ti s rv ut c rs
40,000 ac al an du io at llia lt gl ou y y rv al Fi li ol na pl ca ea s er no de is A lida rm at e e ro l k li ea Gr nium e e io ds ap Al S Se si ob nt du ij en l iv oo t t so E omso ha ca unic H id bH at nP 30,000 er n la mi nn S oo en E Ca F G D P di oo a nn N bo rn pe on Th ar f io F de lu n Gl Th te yw At am ev ar Gm a al Ma IA an nc mm US rp te C ay le ll St tr Pe ar Me omot ur A e e ee n ou Ab re S r r d ea s I Ro in V 20,000 a ma te rs AS qu SA ldings Co e e ER In o ac io ti G ut Av st m Gr nt un da nc Do As ur ff o- de rd oo T au F F In e e od al ga at IB ky ld R Net nc (a re m Se Ho nt Bi nn R ge an La Co Co ma Ca re id llia di llw I fe GE G ly OG 10,000 ob Ed Pi Go Ca To ge Go 3 A or CL Al llia Re exan Pr UN Bu Sa N Gl Ra N Ke A US PP Po Sa Al 0
5 2 9 3 1 8 2 9 6 7 4 1 7 4 1 8 6 3 4 11 17 24 15 28 22 29 14 t t il il 28 1 1 4 2 1 1 8 2 5 1 1 2 2 1 8 2 5 1 3 y 2 0 y 2 5 2 7 e 1 8 1 0 1 7 2 4 1 p 2 p 9 21 1 6 2 3 3 0 c
t t t t ar il il il ec eb an an ay e e e y y ov y e e t t c c pr pr ug 5 ar ar ar ec ec ec eb eb eb ay ay ay ov ov ov ug 1 ug 1 ug 2 ep ep c ep J J O F M pr pr pr J ul J ul D N S S M J an J an A A J un A O O F F F M M M D D D J ul N J ul N J ul N A A A S S S J an M M M O ek ek A A A J un J un J un ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek ek We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We We
Source: Dealogic www.financierworldwide.com | FW 13 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Regional highlights AstraZeneca for $14.9bn in April.
The Americas Canada targeted M&A volume reached $259bn, up 67 percent from $155bn, fuelled US targeted M&A volume reached $1.6 by two significant deals: the BCE buyout trillion in 2007 – a slight increase on the for $48.5bn and the Alcan acquisition by 2006 $1.5 trillion volume. Despite a record Rio Tinto for $43bn. Latin America targeted second quarter ($581bn), second half M&A volume totalled $110bn in 2007, volume dropped 42 percent as multi-billion up 15 percent from $96bn in 2006 with dollar deals disappeared. Financial sponsor 41 percent of volume from deals with an buyouts, which accounted for 33 percent of acquirer outside the region compared to 48 US targeted M&A in the first half ($331bn) percent in 2006. fell to just 18 percent of volume in the second half ($107bn). Europe, Middle East and Africa
Volume from deals over $1bn dropped Europe targeted announced M&A reached significantly in the second half. However, its highest annual volume on record with $2 mid-market volume (deals valued between trillion, driven by robust volume in the first $100m and $1bn) remained fairly stable half. Western European volume reached – average monthly volume for deals over $1.6 trillion in 2007, the highest yearly $1bn dropped 39 percent from the first volume on record. Although second half half to the second half, while mid-market volume slowed 24 percent compared to average monthly volume decreased only 2 first half, it was still the third highest half- percent over the same time period. year volume on record after the first half of 2007 and the second half of 1999. US targeted cross-border M&A volume reached $363bn in 2007, up 67 percent Eastern European volume reached $277bn, from $218bn in 2006, fuelled by 16 deals an increase of 59 percent compared to over $5bn compared to eight deals in 2006. Eastern Europe bucked the global 2006. The UK was the leading acquirer trend with the second half recording an of US companies with $51bn in 2007, up increase of 102 percent compared to the 49 percent from $34bn in 2006, boosted first half with volume reaching $186bn, the by the acquisition of Medlmmune by highest half year on record. Russia was the
top 5 announced GLOBAL TRAnsactions 2007
Announced Target Target Nat. Acquirer Acquirer Nat. Deal Value ($bn) 08-Nov-07 Rio Tinto United Kingdom BHP Billiton Australia 152.0 25-Apr-07 ABN Amro Holding (Bid No 2) Netherlands Royal Bank of Scotland Group; Banco Santander Central United Kingdom 95.6 Hispano; Fortis Group 31-Jan-07 Kraft Foods (88.1%) United States Existing Shareholders United States 56.1 02-Apr-07 Endesa (55.03%) (Bid No 3) Spain ENEL; Acciona Italy 52.6 29-Jun-07 BCE (93.7%) (Bid No 1) Canada Providence Equity Partners; Teachers Private Capital; Madison Canada 48.5 Dearborn
Source: Dealogic
14 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS most targeted nation in Eastern Europe $551bn in 2007. First and second half with $176bn in volume, up 75 percent volume were virtually the same. China from 2006. The acquisition of 25 percent led the region with $144bn in announced of Norilsk Nickel by Russian Aluminum transactions, an increase of 38 percent (Rusal) for $13.3bn was the largest Russian on $104bn in 2006 and accounted for 26 targeted deal announced in 2007. Russia’s percent of the region’s volume. deal volume mainly consisted of domestic deals, with 22 percent of its volume coming China continued to be the top nation from cross-border acquirers. attracting foreign investment with $40bn, up 39 percent on 2006. Cross-border deals Middle East targeted volume totalled accounted for 28 percent of total China $39bn in 2007, up 36 percent from 2006. volume this year. India also attracted Telecommunications was the most substantial foreign investment, tripling targeted industry in 2007 with $19bn volume to $32bn from $10bn in 2006. doubling from 2006, followed by finance with $9bn, up more than three-fold from Outbound cross-region M&A reached $2bn in 2006. $219bn in the fourth quarter, driven by the $152bn bid for UK based Rio Tinto by The Middle East became the fourth most Australia-based BHP Billiton. The figure active acquiring region for cross-border was way above the previous quarterly investment with a volume of $106bn record of $51bn in the fourth quarter of in 2007, three times the $34bn in 2006, 2006. Inbound cross region M&A broke fuelled by 25 deals over $1bn. The US the $100bn barrier for the first time with was the most targeted nation by Middle $179bn. East investors with $34bn accounting for 32 percent of total Middle East cross- Australia was the most targeted nation border investment, fuelled by the $11.6bn with $42bn, representing 23 percent of acquisition of GE Plastics by SABIC and total inbound activity in the region. Kuwait Petroleum’s acquisition of Dow Chemical for $9.5bn. Japan targeted M&A reached $186bn in 2007, on par with 2006 volume of $183bn. Overall, EMEA targeted announced M&A Finance was the most active sector in 2007 reached the highest volume on record with with $56bn, down 4 percent on 2006. The $2.1 trillion, up 38 percent from $1.5 trillion healthcare sector saw a marked increase, in 2006. The first half of 2007 totalled $1.1 up four times on last year to $10bn. trillion, the highest half-year volume on Outbound cross-border volume was down record but this dropped 11 percent to reach 56 percent on last year while inbound $996bn in the second half. cross-border volume was up almost four times in 2007 compared to 2006. Asia Pacific
M&A volume in Asia Pacific (excluding Salim Mohammed is the director of M&A at Japan) was up 37 percent on 2006 reaching Dealogic.
www.financierworldwide.com | FW 15 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Sovereign wealth funds
by SONIA KALSI
On the back of the credit crisis, sovereign border SWF deals totalling $106bn. Activity wealth funds (SWFs) are emerging as a since 2005 has accounted for $99.3bn of serious investment source for companies in that total. Deals per annum have more financial distress. Leading western banks than trebled since 2004, with 30 in 2005 forced to make huge write downs have and almost 40 in 2007, compared to the turned to SWFs, whose buying power is 10 per annum prior to 2004. The first two rapidly increasing. According to a recent months of 2008 have already witnessed 14 report, the total write down figure at the SWF deals. end of January this year by the major banks was over $150bn. SWFs, with an Total deal value in 2007 reached $48.5bn, estimated fund pool of $3 trillion globally, a 165 percent increase from the $19.2bn have helped ease this burden by injecting in 2006 and a 492 percent increase from large sums of capital, totalling $52.7bn, in the $8.2bn in 2005. In the first two months exchange for minority stakes. of 2008, total deal value has already hit a remarkable $24.4bn – exceeding all total The ‘Sovereign Wealth Fund Review’, annual figures since 1998, except 2007. The released by Dealogic in March 2008, shows proportion of SWF investment of all M&A that since 1998 there have been 166 cross- activity was just over 5 percent in the first
sovereign wealth fund investments 1998–february 2008
60.0 40
35 50.0
30
40.0 25 ) ls bn
($ Value ($bn) D ea
e 30.0 20 of Volume lu . Va 15 No 20.0
10
10.0 5
0.0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Jan 1 2008 - Feb 29 2008 Source: Dealogic
16 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS two months of 2008, up from 1 percent in Dhabi Investment Authority. Merrill 2007 and 0.5 percent in 2006. The average Lynch’s write down of $22.4bn was eased deal size has also grown. In the first two by a $12.8bn investment by SWFs led by months of 2008, the average deal size was Kuwait Investment Authority and Temasek $1.7bn, 40 percent higher than the $1.2bn Holdings. The impact of Morgan Stanley’s average in 2007 and 271 percent higher write down of $9.4bn was reduced by than the $469m average in 2006. a $5bn SWF investment led by China Investment Corp. A whopping $53.5bn (88 The buying power of SWFs is proving a percent) of investment has poured into godsend for western financial institutions the finance sector since September 2007, hit hard by the economic downturn. The following last summer’s subprime crash. report shows that the finance sector attracted the most investment from SWFs Trailing the US as target countries for from 2007 to February 2008, totalling investment were Switzerland, which $60.7bn. This, coupled with the falling accumulated $12.1bn during the period dollar, has put the US in the lead among (largely made up of the $11.5bn invested countries targeted for investment. From in UBS by the Government of Singapore 2007 to February 2008, $43.1bn of SWF Investment Corp.) and the UK with $8.8bn. investment found its way to the US. Much In terms of investment by sector, real of this was attributed to investments estate followed finance at $4.7bn and retail in large US banks to offset huge write was third at $2.3bn. downs. Citigroup recorded a write down of $19.9bn but received $20bn in an According to the report, the $3 trillion SWF investment led by the Government held by SWFs is largely accounted for by of Singapore Investment Corp and Abu the UAE Abu Dhabi Investment Authority,
top 10 nationalities for swf investment inflows 2007–february 2008
50,000
45,000
40,000
35,000
30,000 m) $ ( 25,000 ue al
V 20,000
15,000
10,000
5,000
0 United States Switzerland United India Japan Australia Singapore Turkey Sweden Pakistan Kingdom Source: Dealogic www.financierworldwide.com | FW 17 INTERNATIONAL MERGERS & ACQUISITIONS 2008 which holds $875bn, Singapore’s two funds surpass $10 trillion in value. Their rapid with a combined $489.2bn, and the China growth rate has led to political debate in Investment Corp. with $200bn. Between the US and EU, over concerns about their 2007 and February 2008, Singapore was the operating models, motivations and long top regional acquirer, followed by the UAE term intentions. As a result, governments and China. Dealogic’s report deliberately have been pushing for increased excludes pension plans, such as Norway’s transparency and accountability. The G7 Government Pension Fund, due to and the International Monetary Fund operational differences when compared have pledged to establish a best practice with SWFs. code of conduct for SWFs but have gained varying degrees of support from individual Two SWFs analysed in the report also funds. own and operate private equity firms. Since 2003, the leading investment by The wealth of investment SWFs can offer the private equity arm of Dubai Holdings, distressed companies is proving attractive, Dubai International Capital, was $1.5bn in as they continue to bail out leading the UK’s Tussauds Group. For the private financial institutions and others hit by the equity investment arm of Government of credit crisis. The first two months of 2008 Singapore Investment Corp., GIC Special already showing rapid growth in deal value Investments, the largest investment was and volume, so even if markets do ease, $562m in Australian Mayne Group Ltd. SWFs are well on their way to becoming a firm and competitive fixture in cross-border According to data from Merrill Lynch investment. and Morgan Stanley, by 2015 SWFs could
LARGEST SOVEREIGN WEALTH FUNDS BY ASSETS UNDER MANAGEMENT
1000.0
900.0
800.0
700.0
600.0 m) $ (
ue 500.0 al V 400.0
300.0
200.0
100.0
0.0 US: Alaska Algeria: Libya: Libya Qatar:Qatar Singapore: China: Kuwait: Saudi Singapore: UAE: Abu Permanent Revenue Invesment Investment Temasek China Kuwait Arabia: GIC Dhabi Fund Regulation Authority Authority Holdings Investment Investment Various Investment Fund Corp Authority Authority Source: Dealogic
18 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER TWO: Statistical data
www.financierworldwide.com | FW 19 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g M&A trends 1997-2007
Global M&A 1997-2007
6,000 40,000
35,000 5,000
30,000
4,000 25,000 ) bn
($ Value ($bn) me
e 3,000 20,000 lu Volume lu Vo Va 15,000 2,000
10,000
1,000 5,000
0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year
Source: Dealogic
Year Deal Value Volume The graph provides a clear indication of the ($bn) global deal boom that began in 2004 and 1997 1,548.3 17,910 reached new highs in both value and volume 1998 2,317.5 23,224 in 2007. 1999 3,222.0 27,756 2000 3,335.5 31,196 Of course, based on credit volatility in the 2001 1,755.0 27,065 second half of 2007, the line is set to turn 2002 1,322.4 25,359 south in 2008. But how steep will its 2003 1,452.8 23,164 decline be? 2004 2,061.2 26,244 2005 2,937.4 31,122 2006 3,916.8 33,429 2007 4,873.0 37,267 (Announced transactions)
20 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
Global financial sponsor m&A 1997-2007
900 3500
800 3000
700 2500 600 ) 2000 bn 500
($ Volume me e
lu Value ($bn) lu 400
1500 Vo Va
300 1000 200
500 100
0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year
Source: Dealogic
2006 and 2007 were the golden years of Year Deal Value Volume ($bn) private equity. It was the most active period 1997 64.8 678 for buyout pros in the industry’s history. 1998 76.1 958 1999 130.9 1416 The jump between 1997 and 2007 is 2000 120.9 1745 astonishing. Volume increased by 363.7 2001 76.1 983 percent while value increased by an 2002 117.9 1045 astronomical 1,121.2 percent. 2003 157.8 1206 2004 275.7 1691 Whether this asset class can replicate 2005 344.1 2651 a similar high point in future years is 2006 733.5 3137 anyone’s guess. Some say the industry took 2007 791.4 3144 advantage of several factors which created (Announced transactions. Figures include an almost perfect dealmaking environment, acquisitions or divestments by portfolio companies) and that we are unlikely to see such a culmination again. Others argue that private equity has been through down cycles before – and emerged stronger.
www.financierworldwide.com | FW 21 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Global leveraged loans 1997-2007
2,000 3,500
1,800 3,000 1,600
1,400 2,500
bn) 1,200
$ 2,000 (
me Value ($bn) ue 1,000 lu al Volume V 1,500 Vo
eal 800 D
600 1,000
400 500 200
0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year
Source: Dealogic
Year Deal Value Volume Today’s leveraged finance market is almost ($bn) unrecognisable compared to a decade ago. 1997 405.3 2,218 New structures, new products and a host 1998 515.1 2,444 of new players drove a huge rise in activity 1999 559.7 2,402 from the low point in 2001 to the onset of 2000 540.8 2,347 the credit squeeze in mid-2007 . 2001 378.3 1,859 2002 432.1 1,879 Although the volume of leveraged loans 2003 578.5 2,073 increased by only 36.8 percent between 1997 2004 726.8 2,586 and 2007, their total value ballooned by 2005 1,003.3 2,860 2006 1,284.0 3,070 340.6 percent over the same period. 2007 1,786.1 3,035
(Announced transactions)
22 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
regional M&A 1997-2007
2,500 16,000
14,000 2,000 12,000
Americas Deal Value 10,000 ) 1,500 Asia Pacific Deal Value bn me ($ EMEA Deal Value
e 8,000 lu Americas Volume lu Vo
Va 1,000 Asia Pacific Volume 6,000 EMEA Volume
4,000 500
2,000
0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Year Source: Dealogic
While deal volume remained fairly stable in the Americas, both the EMEA and Asia Pacific regions experienced dynamic growth between 1997 and 2007. In fact, Asia Pacific generated the highest number of transactions in 2007, although the total value of deals was much lower. In the same year, EMEA overtook the US for the first time to become the leading region by deal value.
Year Americas Asia Pacific Deal EMEA Americas Volume Asia Pacific Volume EMEA Deal Value ($bn) Value ($bn) Deal Value ($bn) Volume 1997 1,035.3 106.0 407.0 10,959 1,376 5,575 1998 1,637.3 109.6 570.7 12,832 2,315 8,076 1999 1,741.7 252.0 1,228.3 12,935 3,742 11,079 2000 1,842.4 334.6 1,158.5 12,507 5,149 13,540 2001 927.9 226.9 600.2 10,093 4,824 12,147 2002 571.0 190.4 560.9 9,048 5,593 10,718 2003 642.1 229.9 580.8 8,758 5,081 9,325 2004 964.9 336.2 760.0 9,670 6,793 9,781 2005 1,326.2 498.9 1,112.3 9,945 9,218 11,959 2006 1,794.8 584.2 1,537.8 9,591 11,194 12,644 2007 1,984.7 743.8 2,144.6 10,583 13,571 13,108 (Announced transactions) www.financierworldwide.com | FW 23 INTERNATIONAL MERGERS & ACQUISITIONS 2008
UK versus US M&A 1997-2007
1414,0,00000.0 120,000
1212,0,00000.0 100,000
1010,0,00000.0 80,000
8,8,000.0000 ) bn me ($ lume e lu 60,000 lu Vo lue ($bn) Vo 6,6,000.0000 Va Va
40,000 4,4,000.0000
20,000 2,2,000.0000
0.00 0 UK US
Source: Dealogic
UK US Of the two world heavyweights in country- Deal Value ($bn) 2,982.3 12,511.8 specific M&A, the United States is clearly the Deal Volume 29,229 96,124 dominant force, hosting more than $12.5 (Announced transactions) trillion worth of deals in almost 100,000 transactions between 1997 and 2007. The UK, despite being second on the global league table by a clear margin, has provided less than a quarter of US transaction value over the same period.
24 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
country specific M&A VALUE 1997-2007
1,600
1,400
1,200
1,000 ) bn ($
e 800 lu Va 600
400
200
0
India Brazil China Japan Canada France Australia Germany Russian Fed.
Source: Dealogic
Excluding the US and UK, Germany generated the most M&A value between 1997 and 2007, closely followed by France. Although there is a sizeable drop to the BRIC countries (Brazil, Russia, India and China), these emerging markets have made up ground in the last few years, and the gap between them and established Western markets should close further over the next decade.
Australia Brazil Canada China France Germany India Japan Russian Fed. Deal Value 590.8 299.0 1,086.8 531.0 1,222.6 1,347.2 163.5 1,204.0 415.3 ($bn)
(Announced transactions) www.financierworldwide.com | FW 25 INTERNATIONAL MERGERS & ACQUISITIONS 2008
country specific M&A VOLUME 1997-2007
20,000
18,000
16,000
14,000
ls 12,000
D ea 10,000 of .
No 8,000
6,000
4,000
2,000
0
India Brazil China Japan Canada France Australia Germany Russian Fed.
Source: Dealogic
Looking at country-specific volumes reveals that pockets of activity around the world do not necessarily correlate to total deal values.
Here, Japan took the lead by a clear margin, with over 17,000 deals. Australia and Canada saw far more activity than the total deal values suggest. China actually overtook France and came very close to Germany by number of deals.
Australia Brazil Canada China France Germany India Japan Russian Fed. Deal Volume 11,373 2,412 12,870 11,403 10,116 11,784 5,290 17,414 4,817
(Announced transactions)
26 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
TOP 10 ACTIVE SECTORS BY VALUE 1997-2007
Insurance Food & Beverage 3% 3% Construction/Building Finance 3% 22% Healthcare 9%
Oil & Gas 9%
Real Estate/Property Telecommunications 9% 21%
Utility & Energy 10% Technology 11%
Source: Dealogic
Over the last decade, Finance has provided the highest total amount of deal value, closely followed by Telecommunications, which reached its peak in the 1999-2000 boom.
www.financierworldwide.com | FW 27 INTERNATIONAL MERGERS & ACQUISITIONS 2008
top 20 announced M&A transactions, by value 1997-2007
Announced Target Target Nat. Acquirer Acquirer Nat. Deal Value ($bn) 14-Nov-99 Mannesmann AG (99.6%) Germany Vodafone AirTouch plc United Kingdom 172.2 08-Nov-07 Rio Tinto plc (Bid No 1) United Kingdom BHP Billiton Ltd & plc Australia 154.4 10-Jan-00 Time Warner Inc. United States America Online Inc United States 112.1 04-Nov-99 Warner-Lambert Co United States Pfizer Inc United States 111.8 06-Mar-06 BellSouth Corp United States AT&T Inc United States 101.9 25-Apr-07 ABN Amro Holding NV (Bid No 2) Netherlands Royal Bank of Scotland Group plc; United Kingdom 95.6 Fortis Group; Banco Santander Central Hispano SA - BSCH 01-Dec-98 MOBIL CORP. United States EXXON CORP. United States 85.6 17-Jan-00 SmithKline Beecham plc United Kingdom Glaxo Wellcome plc United Kingdom 79.6 11-May-98 AMERITECH CORP United States SBC COMMUNICATIONS INC United States 76.2 28-Jul-98 GTE Corp United States Bell Atlantic Corp United States 74.6 26-Jan-04 Aventis SA France Sanofi-Synthelabo SA France 71.3 11-Aug-98 Amoco Corp United States British Petroleum Co plc United Kingdom 64.3 05-Jul-99 Elf Aquitaine SA (95.56%) (Bid No 1) France TotalFina SA France 63.1 28-Jan-00 Nortel Networks Corp (35%) Canada Existing Shareholders Canada 61.7 05-Jan-99 Airtouch Communications Inc (Bid No 2) United States Vodafone Group plc United Kingdom 61.5 28-Jan-05 Gillette Co United States Procter & Gamble Co United States 60.8 06-Jul-01 AT&T Broadband United States Comcast Corp United States 60.7 15-Jul-02 Pharmacia Corp United States Pfizer Inc United States 59.8 18-Feb-05 UFJ Holdings Inc (Bid No 2) Japan Mitsubishi Tokyo Financial Group Inc Japan 59.1 14-Jan-04 Bank One Corp United States JP Morgan Chase & Co United States 56.9
Source: Dealogic
28 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Financial sponsor trends 2000-2007
GLOBAL FINANCIAL SPONSOR BUYOUTS 2000-2007
900,000 3,500
800,000 3,000
700,000 2,500 600,000
2,000 m) 500,000
($ Value ($m) e Volume lu 400,000 1,500
Va me
300,000 lu
1,000 Vo 200,000
500 100,000
0 0 2000 2001 2002 2003 2004 2005 2006 2007 Year
Source: Dealogic
In two years, 2006 and 2007, the total Year Value ($m) Volume value of announced buyouts worldwide was 2000 120,916 1,746 almost 40 percent higher than the previous 2001 76,150 985 six years combined. 2002 117,880 1,048 2003 157,947 1,210 In 2000 the average deal size was $69m. By 2004 275,724 1,695 2007 it had almost quadrupled to $252m. 2005 344,110 2,655 2006 734,866 3,140 2007 792,551 3,144 (Announced transactions)
www.financierworldwide.com | FW 29 INTERNATIONAL MERGERS & ACQUISITIONS 2008
us targeted FINANCIAL SPONSOR BUYOUTS 2000-2007
500,000 1,400
450,000 1,200 400,000
350,000 1,000
300,000 800 m) me ($ Value ($m) lu e 250,000 Volume lu 600 Vo Va 200,000
150,000 400
100,000 200 50,000
0 0 2000 2001 2002 2003 2004 2005 2006 2007 Year
Source: Dealogic
Year Deal Value ($m) Volume As the world’s leading economy and the 2000 54,067 627 most developed market for buyouts, the 2001 25,432 353 US remained the destination of choice for 2002 51,341 413 private equity houses. 2003 64,761 518 2004 121,126 725 In 2007, transaction value increased over 2005 155,359 1,049 2006 despite a drop in the number of 2006 423,276 1,207 transactions. 2007 441,161 1,077
(Announced transactions)
30 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
EUROPEAN targeted FINANCIAL SPONSOR BUYOUTS 2000-2007
300,000 1,400
1,200 250,000
1,000 200,000
800 m) me ($ Value ($m) e 150,000 lu Volume lu 600 Vo Va
100,000 400
50,000 200
0 0 2000 2001 2002 2003 2004 2005 2006 2007 Year Source: Dealogic
Europe, like the US, hosted a gradual Year Deal Value ($m) Volume increase in buyouts since the early part of 2000 55,389 936 the new millennium. In contrast to the US, 2001 43,400 509 however, there were more deals announced 2002 59,608 514 in 2007 than 2006 but their total value 2003 81,107 543 actually declined from the previous year. 2004 122,085 715 2005 165,966 1,224 2006 246,000 1,278 2007 212,777 1,326 (Announced transactions)
www.financierworldwide.com | FW 31 INTERNATIONAL MERGERS & ACQUISITIONS 2008
rest of world targeted FINANCIAL SPONSOR BUYOUTS 2000-2007
160,000 800
140,000 700
120,000 600
100,000 500 ) e m ($m Value ($bn) e 80,000 400 lu Volume lu Vo Va 60,000 300
40,000 200
20,000 100
0 0 2000 2001 2002 2003 2004 2005 2006 2007 Year Source: Dealogic
Year Deal Value ($m) Volume Buyout markets have sprung up outside the 2000 11,460 183 US and Europe, as leading buyout houses 2001 7,318 123 look beyond their traditional borders for new 2002 6,932 121 opportunities. The appetite for emerging 2003 12,080 149 market deals has accelerated, particularly 2004 32,514 255 as these countries actively develop the 2005 22,786 382 legal and financial infrastructure to support 2006 65,591 655 private equity transactions. 2007 138,612 741
(Announced transactions) In 2007, the total value of announced deals was only 12 percent lower than combined totals for 2000 to 2006.
32 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
top 20 announced financial sponsor buyouts, by value 1997-2007
Announced Target Target Nat. Acquirer Acquirer Nat. Deal Value ($bn) 29-Jun-07 BCE Inc (93.7%) (Bid No 1) Canada Providence Equity Partners Inc; Ontario Teachers’ Pension Canada 48.5 Plan Board; Madison Dearborn Partners LLC 26-Feb-07 TXU Corp United States Kohlberg Kravis Roberts & Co; Texas Pacific Group; Goldman United States 43.8 Sachs Capital Partners 20-Nov-06 Equity Office Properties Trust (Bid United States Blackstone Real Estate Partners LP United States 38.9 No 1) 24-Jul-06 HCA Inc United States Bain Capital Inc; Kohlberg Kravis Roberts & Co; Merrill Lynch United States 32.7 Global Private Equity 21-May-07 ALLTEL Corp United States TPG Capital LP; GS Capital Partners LP United States 27.9 02-Apr-07 First Data Corp United States Kohlberg Kravis Roberts & Co United States 27.7 02-Oct-06 Harrah’s Entertainment Inc United States Apollo Management LP; Texas Pacific Group United States 27.4 16-Nov-06 Clear Channel Communications Inc United States Bain Capital Inc; Thomas H Lee Partners United States 26.4 (Bid No 2) 03-Jul-07 Hilton Hotels Corp United States Blackstone Group LP United States 25.8 29-May-06 Kinder Morgan Inc United States GS Capital Partners LP; AIG Global Asset Management Hold- United States 21.6 ings Corp; Riverstone Holdings; Carlyle Group Inc 29-May-07 Archstone-Smith Trust United States Tishman Speyer Properties; United States 20.6 Lehman Brothers Private Equity 30-Mar-07 Alliance Boots plc (85.013%) (Bid United Kingdom Kohlberg Kravis Roberts & Co United Kingdom 20.5 No 1) 15-Sep-06 Freescale Semiconductor Inc (Bid United States Blackstone Group LP; Carlyle Group Inc; Texas Pacific Group; United States 17.6 No 2) Permira Ltd 23-Jan-06 Albertson’s Inc United States SuperValu Inc; Schottenstein Stores Corp; Kimco Realty Corp; United States 17.4 Cerberus Capital Management LP; Klaff Realty LP; Lubert- Adler Real Estate Funds; CVS Corp 19-Jun-07 Intelsat Ltd (76%) (Bid No 1) Bermuda BC Partners Ltd Bermuda 16.4 12-Sep-05 Hertz Corp United States Clayton Dubilier & Rice Inc; Carlyle Group Inc; Merrill Lynch United States 15.0 Global Private Equity 30-Nov-05 TDC A/S (87.9%) Denmark Nordic Telephone Co ApS Denmark 13.9 27-Jun-06 Univision Communications Inc (Bid United States Madison Dearborn Partners LLC; Thomas H Lee Partners; United States 13.6 No 2) Texas Pacific Group; Providence Equity Partners Inc; Saban Capital Group Inc 28-Mar-05 SunGard Data Systems Inc United States Investor Group United States 11.8 18-Dec-06 Biomet Inc United States Blackstone Group LP; Kohlberg Kravis Roberts & Co; United States 11.4 Texas Pacific Group; Goldman Sachs Capital Partners
Source: Dealogic
www.financierworldwide.com | FW 33 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g M&A and private equity in 2007
global M&A 2007
1,800 12,000
1,600 10,000 1,400
1,200 8,000 )
bn 1,000
($ Value ($bn)
e 6,000 Volume lu 800
Va me
600 4,000 lu Vo 400 2,000 200
0 0 Q1 Q2 Q3 Q4
Source: Dealogic
Despite volatility in global financial markets Announced Value ($bn) Volume in the second half of 2007, overall M&A 2007 Q1 1,094.8 8,046 was fairly stable throughout the year, 2007 Q2 1,610.0 9,725 particularly in terms of deal volume. 2007 Q3 1,006.7 9,595 2007 Q4 1,161.6 9,901 (Announced transactions)
34 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
FINANCIAL SPONSOR buyouts 2007
400 900
350 800
700 300
600 250 )
bn 500
($ Value ($bn)
e 200 Volume lu 400 Va 150 me
300 lu Vo 100 200
50 100
0 0 Q1 Q2 Q3 Q4
Source: Dealogic
Announced Value ($bn) Volume The credit crunch sent shockwaves through 2007 Q1 197.1 778 the global private equity industry in the 2007 Q2 376.6 854 middle of 2007. As the graph shows, the 2007 Q3 131.7 803 effect was immediate. 2007 Q4 86.0 709 (Announced transactions)
www.financierworldwide.com | FW 35 INTERNATIONAL MERGERS & ACQUISITIONS 2008
regional M&A 2007
2,500
2,000
) 1,500 bn ($ e lu
Va 1,000
500
0 Americas Asia Pacific EMEA
Source: Dealogic
In 2007, EMEA edged out the Americas by Announced Americas Asia Pacific EMEA deal value. Asia Pacific, although trailing by 2007 1,984.7 743.8 2,144.6 a fair distance, increased its share of global (Announced transactions) activity.
36 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
country-specific M&A 2007
1,800
1,600
1,400
1,200
bn) 1,000 ($ e
lu 800 Va
600
400
200
0 Australia Brazil Canada China France Germany India Japan Russian UK US Fed.
Source: Dealogic
Country Value ($bn) Unsurprisingly, the US M&A market towered Australia 131.7 over other countries in 2007. But other Brazil 46.0 standouts were Canada, which claimed third Canada 259.6 spot by almost $70bn over Japan, and the China 144.9 Russian Federation, which eclipsed France France 164.3 and almost matched Germany. China was Germany 188.4 not far behind with around $145bn. India 62.0 Japan 191.0 Russian Fed. 181.6 UK 588.7 US 1,593.2 (Announced transactions)
www.financierworldwide.com | FW 37 INTERNATIONAL MERGERS & ACQUISITIONS 2008
top 10 active sectors 2007
Chemicals 5% Construction/Building 6% Finance 21% Healthcare 7%
Mining 8%
Real Estate/Property 14% Technology 8%
Oil & Gas 9% Utility & Energy Telecommunications 12% 10%
Source: Dealogic
In 2007, the majority of deals were announced in the Finance sector. Real Estate/Property and Utility & Energy were also active.
38 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER THREE: Global outlook
www.financierworldwide.com | FW 39 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Will the next wave of M&A create more value?
by Stephane Cohen-Ganouna and Natalia Danon-Boileau
After the M&A activity slowdown of the the existence of some country specificities early 2000s, the market is experiencing a regarding the average transaction size. new surge of mergers and acquisitions. It is Although M&A operations are much more largely known that in the past, two-thirds numerous in the UK than in other European of M&A transactions have destroyed value, countries, France is the place where large often resulting in abject failure. In this scale operations occurred most frequently. context, the key question today is: Will the Between 2000 and 2005, the average new wave of M&A create more value than value of transactions was $1.2bn in France the previous one? compared to $1bn in Germany and $500m in the UK. Lessons from the past Second, an acquirers’ previous M&A We have tried to identify the reasons experience has an influence on value driving value creation and value destruction creation. Our study indicates that frequent in M&A deals by analysing 2500 M&A buyers (involved in one or two acquisitions transactions that took place over the past a year) are more likely to create value. On 10 years in Europe. Four lessons jump out of the other hand, a company which carried this study and from our experience. out less than one M&A transaction over the past 10 years will risk destroying value. First, there is no statistical correlation between the value creation and the size As a matter of fact, previous experience of the transaction. However, large scale will allow a company to better evaluate transactions (more than $1bn) tend potential synergies with its target. A more to destroy value whereas small scale realistic approach on future synergies will transactions (less than $50m) tend to be translated into appropriate pricing. create value. During 2004-2005 periods, Previous experience also implies greater for instance, small scale transactions in our capitalisation of knowledge about the sample have an average positive return integration process (tested integration after one year of 6 percent, compared to methods in the pre- and post-acquisition -5 percent for the large scale transactions. phases) and nurtures a more open, less self- Furthermore, the average return weighted absorbed company culture. by transaction amount is below the average non-weighted return, which means that Third, a merger or acquisition can act as a large scale transactions are obviously catalyst in uncovering significant savings tending to destroy more value than small which were previously concealed. These scale ones. unforeseen savings could theoretically have been identified regardless of the M&A In this respect, it is interesting to mention operation. We have found that only half of
40 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the synergies publicised in the past were Better evaluation of the management and indeed true synergies, implying that the the human capital during the due diligence integration of these companies had actually process. Another point of attention during produced a greater result than simply the due diligence process is an in-depth adding these entities together. The other evaluation of the management team and half consisted of savings that could have the human capital of the target. In fact, been made without the M&A operation. some groups start copying LBO practices and taking into account – from the due Finally, value creation depends on how diligence phase – HR assets and cultural the merger preparation and post-merger differences, as a valuable input to structure integration process is managed. In fact, the forthcoming merger preparation and although the market is positive about value integration. creation after five days in 54 percent of deals, the average rate of value creation Realistic evaluation of the synergies and decreases to reach only 40 percent one their efficient implementation by dedicated year after the announcement, reflecting, line people. In some companies, line people among other issues, integration failure or work together with the due diligence team insufficient realisation of planned synergies. to carry out evaluations of the expected operational synergies, thus producing a Best practices and advanced approaches better evaluation of the target.
The key to efficient management of During the integration phase, devoted the M&A process is the optimum use of teams of dedicated line people follow up on ‘traditional’ best practices: evaluation the realisation of synergies and ensure their of the target’s strategic interest and of fast and full-scope implementation. the potential synergies, retention of key people, preparation of an integration Efficient management of the antitrust plan, massive use of internal and external notification process. The ongoing communication and, obviously, speed of consolidation process in many industries integration. In fact, it is imperative to keep leads to an increasing number of large the ongoing business under control during scale cross-border mergers. For these the integration period, as there may be kinds of operations, winning the approval one, two or even three years between the of antitrust regulatory bodies has become date of closing and the completion of the a critical issue. The companies’ M&A merger. While some teams are working on capabilities will also depend on their ability the establishment of the new group, other to articulate structured and professional (different) teams must remain focused on approaches to address antitrust issues; sales and customers: this requires transitory e.g., analyse their need to notify, define management systems. their notification strategy, prepare their associated dossier and draw up contingency Some companies now go beyond those plans in case the operation fails (such as practices, improving their chances to create Schneider/Legrand, GE/Honeywell). Such value. What are these advanced approaches an approach will help anticipate as much as to merger? possible how negotiations with authorities will evolve to better control the approval www.financierworldwide.com | FW 41 INTERNATIONAL MERGERS & ACQUISITIONS 2008 process and its impact on the operation. previous acquisition experience, these companies have defined and adopted Preserving the value of human capital. a standardised M&A process helping to The staff’s motivation is indeed the most address all operation’ phases in a coherent critical component in a merger’s success. and coordinated way. Also, they define Maintaining staff’s dynamism will ensure tools, methods, checklists and a team to continuity in the company’s management mobilise in case of a forthcoming M&A at a transitional time when the new group transaction. can be unstable operationally. Boosting motivation will require appointing the top- The advanced practices mentioned above management very fast, within a few days, are only emerging. Even if the value before or after the closing. In this matter, creation remains highly unpredictable, again speed prevails over perfection. Our the generalisation of those new practices survey shows that in 60 percent of cases, should lead to better value creation and key managers are actually appointed within better value capturing in future mergers 30 days before or after the closing. and acquisitions.
Adoption of standardised acquisition and integration processes. Some frequent acquirers have developed an extremely Stephane Cohen-Ganouna is a principal and formalised process, a sort of ‘acquisition Natalia Danon-Boileau is a senior manager and integration machine’. Based on their at BearingPoint.
42 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g International M&A takes centre stage
by Eric Benedict, Shepard Spink and George Varughese
With the increasing globalisation of Asian markets, showing more stability, business coupled with the protracted according to Dealogic. Buyers and sellers weakness of the US dollar, M&A activity is are still demonstrating an appetite for now playing out on a much larger stage, deals, with foreign buyers, buoyed by creating new opportunities for international financial strengths, becoming more active investors and growth-oriented companies participants in what they perceive to be a in emerging market countries looking to fertile environment for acquiring US assets. penetrate Western markets. Unlike earlier periods, such as the 1980s, which saw a Currency valuation is one driving factor. For spike in international transactions, evidence the last several years, foreign currencies suggests that recent activity is indicative of have been stronger against the US dollar. a more permanent global trend, with M&A Leading the pack is the euro, which hit targets of the past becoming the acquirers a record high against the dollar in late of today and tomorrow. February, exceeding for the first time $1.50. Many economists predict further weakness However, while market forces such ahead for the dollar, as a number of US as increasing access to global capital economic factors, including declining home and favourable currency valuations are prices and waning consumer confidence, providing transactional tailwinds, inherent continue to pressure the greenback. With challenges remain. For new global business US assets now roughly 20-30 percent ventures to be successful over the long cheaper than they were a decade ago, term, acquiring companies will need to find foreign buyers see an opportunity to ways to not only leverage strengths, such bargain hunt. This is especially true of those as low cost manufacturing, but overcome in oil-rich nations which are flush with relative inexperience managing complex liquidity. global enterprises. For companies in countries not enjoying Driving forces ‘petro capital’, another important factor has been the increasing willingness of The buyers local banks to provide funding for deals. With the balance sheets of many US and While worldwide M&A volume has plunged international banks suffering as a result of from the historic highs reached in recent the subprime mortgage crisis, local banks years, deals continue to get done. Even as in emerging markets, which had far less the US continues to see major declines, exposure than their US counterparts, are overall activity is down just over 6 percent stepping up to provide debt financing for compared to 2005’s January-February total, deals. The trend is likely to continue. At the with international activity, particularly in same time, local governments, which in the www.financierworldwide.com | FW 43 INTERNATIONAL MERGERS & ACQUISITIONS 2008 past often tended to frown on international have become much more difficult to expansion, are showing greater support execute – as evidenced by recent data. for companies looking to acquire foreign Beyond financing, however, combining with assets. companies outside of the US has become a viable strategic option for many growth- The maturation of foreign companies, oriented businesses. US companies, which both in terms of size, sophistication and have developed a strong domestic market experience, has also been a catalyst in presence, are seeking to attract foreign driving recent M&A activity. Historically, buyers with an eye toward leveraging cost foreign companies with the necessary advantages in foreign markets, such as market presence and management depth raw material access or labour rates. And to be serious international acquirers again, because the pool of foreign buyers have been few and far between. This has has expanded beyond Europe and Japan changed dramatically in recent years, to now include emerging markets such particularly in the wake of significant as Brazil, Russia, China and India, among growth in the Asian market. A new universe others, M&A opportunities have increased of capable, cash-rich and strategic-minded exponentially. buyers, who have successfully developed a critical mass in their domestic markets, Looking ahead have emerged and begun to make their presence known. Even when the dollar rallies, the US capital markets relax and the economy Netherlands-based ArcelorMittal, the strengthens, we are likely to continue to world’s largest steelmaker by output, see significant interest in US assets among provides a case in point. In 2006, CEO foreign buyers. In the past, companies Lakshmi Mittal – an Indian steel mogul who with the strength and the staying power ranks among Forbes’ 10 richest CEOs in the to engage in significant acquisitions have world – further expanded the steel empire primarily been based in the US and Europe. he established over several years with the Now, companies in markets outside the acquisition of European steel giant Arcelor. US – and in nearly every industry – have Since then, ArcelorMittal has continued on reached a critical mass and the number an aggressive acquisition spree, announcing of active buyers is likely to continue to 35 acquisitions around the world in 2007 increase. In addition, as the geographic and indicating the pace would continue this boundaries of global capital fade as year. investors pursue areas of highest return and workforces become more international, The sellers national corporate identity will become less and less relevant. From a sellers’ perspective, international deals have emerged as an important option Within this environment, however, for US companies navigating a challenging significant challenges remain and how economic environment. With the US credit international buyers deal with these hurdles markets virtually shut off and the overall will be a key factor in determining the domestic economy continuing to show ultimate success of these transactions. At a signs of weakness, pure US transactions time when more foreign governments are
44 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS showing greater support for international forming alliances with US partners, and M&A, the US could begin to take a more retaining individuals with the expertise to isolationist stance – particularly if the navigate the range of management and economy weakens further or national regulatory issues – will all be important security concerns heighten. Already we factors in executing a long-term business have seen a number of potential deals strategy. scuttled or postponed. National security concerns among lawmakers, for example, Conclusion postponed 3Com Corp.’s transaction with Chinese technology company Huawei International M&A activity has been a Technologies Co. relative bright spot in an otherwise doom and gloom deal environment. Rather than a A greater test will be how this new group short term phenomenon, the activity – and of corporate acquirers overcomes relative the driving forces behind it – suggests a inexperience entering new markets more permanent trend of large and middle and running global enterprises. Simply market US and European companies being leveraging strengths such as low-cost acquired by sovereign funds or companies manufacturing bases will not be enough with global ambitions that are located in to achieve success and staying power. strong emerging markets. Management will need to be equipped to deal with a range of regulatory issues But as foreign buyers take advantage and prepared to quickly develop global of market conditions and leverage their capacity in critical operations, such as strengths and acquire US assets, they must information technology systems, supply be mindful of the challenges inherent to chain and distribution, as well as enhance entering any new market and take steps their capabilities in areas such as brand to position the business for the long management and sales and marketing. term. Many have already discovered that creating meaningful value through M&A Steering through the US obstacle course transactions, particularly when premiums – which in many cases requires extensive have been paid, comes down to properly experience, knowledge and relationships executing the strategy and actually in the marketplace, community and realising the anticipated synergies. government – will be a challenge for even the most skilled executives if they are mainly accustomed to operating overseas. Utilising valuable resources within the Eric Benedict, Shepard Spink and George acquired company or bringing in new Varughese are managing directors at Alvarez executives with deep knowledge of the US, & Marsal.
www.financierworldwide.com | FW 45 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Recent developments and their implications for M&A in 2008
by Tom Hopkins and Jason Northcutt
It was the best of times; it was the worst strategic buyers. The steep increase in of times. So might Charles Dickens have defaults in the US subprime market led described the acquisition financing markets several lending institutions to fail or file in 2007. Fuelled by private equity sponsored for bankruptcy and has had broad effects buyouts using readily available credit, the throughout global credit markets. In number and value of M&A deals in the response, lenders have become more US reached record levels in 2006 and the cautious by increasing credit spreads, first half of 2007. Private equity sponsors decreasing leverage ratios, and insisting doing mega deals, including The Carlyle upon more restrictive covenants from Group, Kohlberg, Kravis & Roberts and The their borrowers. Despite Federal Reserve Blackstone Group, received unprecedented attempts to increase liquidity by cutting the media attention. Several recent fed funds rate by 225 basis points between developments, however, make it likely that September 2007 and January 2008, we strategic buyers will return to prominence expect lenders’ risk tolerance to remain in 2008 and beyond. Also, partially as a relatively low. Private equity buyers will result of the impact of less activity by have to readjust their expectations with private equity sponsors, sellers are likely to regard to financing terms and lower their have less leverage at the bargaining table. valuations of targets. Strategic buyers, by contrast, often are cash rich or able During the recent M&A boom, extensive to rely on existing lines of credit to fund liquidity in the credit markets created acquisitions. intense competition among lenders. Borrowers found themselves able to obtain Second, differences in the ways in which acquisition financing cheaply – at more private equity buyers and strategic buyers aggressive leverage multiples, at lower tend to view and analyse companies may spreads, and with fewer and less restrictive also lead to greater competitiveness by covenants than ever before. As a result, strategics. Private equity sponsors have private equity sponsors often were able finite holding periods and only want to pay higher valuations and offer more companies that can deliver an internal rate cash than their strategic counterparts. The of return in excess of 25 percent over the ability of private equity sponsors to outbid investment horizon. Private equity sponsors strategic buyers is likely to lessen as a result are further limited by credit pricing of several recent events. and financial models that forecast their anticipated returns and determine their First, the much-publicised credit crunch willingness to proceed with a transaction. that began in mid-2007 will make it more Strategic buyers, by contrast, often have difficult for private equity sponsors to a longer horizon and intend to integrate obtain competitive financing to outbid them into their existing business lines.
46 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
Additionally, strategics often include venture or retire, these requirements can non-financial factors in their transaction be unattractive. Strategic buyers, however, analysis, such as synergies, defensive have operational executives and systems advantages and other competitive factors. in place to run the business and are less sensitive to keeping management in place. Non-financial aspects of an acquisition agreement such as time to close, allocation Third, amendments to Rule 144 and Rule of risks and lack of closing contingencies 145 by the US Securities and Exchange can also play a significant role in Commission (SEC) that became effective determining the winning bid for a company. on 15 February 2008 will also likely benefit Because strategic buyers often have a strategic buyers. Strategic buyers often strong grasp of the fundamentals of the issue their securities to sellers as part target’s industry (and possibly of the target of the merger consideration. Sellers, itself), they are often better positioned understandably, prefer liquidity and want to assess the scope and magnitude of the ability to resell these securities as soon potential risks posed by the target’s as possible. The changes to these rules business. Private equity firms, however, reduce or remove restrictions on secondary often have to educate themselves about sales, which should allow strategic buyers the target’s industry and specific business, to use their stock as transaction currency which is a time consuming process. Further, to increase the valuations of the targets. since a private equity firm is compensated Below are summaries of some of the only if its returns are in excess of a hurdle primary changes to Rule 144 and 145 which rate, sponsors often take a more hard- are most likely to benefit strategic buyers. line view of the target’s potential risks, which results in transaction agreements Rule 144 provides a safe harbour for that allocate greater economic risks to the resales of restricted and control securities. sellers. Restricted securities include securities issued in a transaction not involving a Most private equity firms do not have the public offering, such as where a strategic human capital required to operate their buyer issues unregistered shares to the portfolio companies day-to-day. Private stockholders of a target in a private equity buyers often require management placement. Control securities are securities stockholders to ‘roll over’ a significant of an issuer held by an affiliate of the portion of their equity rather than cashing issuer. To qualify for a Rule 144 resale of out 100 percent of their holdings. They will restricted securities, several conditions also likely insist that most or all of the key must be satisfied. These conditions management sign long-term employment limit the ability of holders of restricted contracts as a condition to closing. Even securities to resell the securities, and though the selling stockholders will therefore reduce their value to the continue to hold a stake in the target holders. The Rule 144 amendments most going forward, the private equity firm will significantly affect secondary sales of control the company and the sellers will restricted securities by non-affiliates and find themselves as minority stockholders. make it easier and faster for sellers to get For a selling stockholder that is looking liquidity for their company. As amended, to ‘cash out’ and move on to the next Rule 144 (i) shortens the holding period www.financierworldwide.com | FW 47 INTERNATIONAL MERGERS & ACQUISITIONS 2008 for restricted securities of reporting governing control securities will continue to companies to six months from one year; apply). (ii) allows non-affiliates of reporting companies to freely resell restricted In addition to strategic buyers regaining securities after the six month holding competitiveness over private equity period if the issuer satisfies the public sponsors, the ongoing credit crunch is likely information condition; and (iii) allows to reduce the overall number of bidders; non-affiliates of reporting or non-reporting therefore, we expect sellers to have less companies to freely resell restricted leverage generally against buyers in the securities without complying with any Rule negotiation process. We expect fewer 144 conditions after a one year holding auctions, resulting in lower valuations. period, rather than two years. Affiliates Where auctions are commenced, we expect of reporting companies will still need an increase in preemptive bids with ‘go- to comply with the Rule 144 limitations shops’ – a limited ability of the target to and requirements when selling equity search the market post-signing for other securities of the issuer under Rule 144. potential buyers. As a result, target boards The holding period for affiliates of non- of directors will have to be increasingly reporting companies remains one year, mindful of their fiduciary duties relating to and will still need to comply with the Rule business combinations. Agreement terms 144 limitations and requirements when will likely become more buyer-friendly, such selling equity securities of the issuer under as more conditions to closing for buyers Rule 144. and lower indemnity baskets and higher indemnity caps and escrows. Simultaneously with the amendment to Rule 144, the SEC also substantially In conclusion, we think the continuing eliminated the ‘presumptive underwriter credit crunch and the associated deal doctrine’ in Rule 145. Under prior law, an execution risks involved in selling to private affiliate of a target who received securities equity sponsors will result in increased in a registered transaction was deemed competitiveness by strategic buyers. Also, to be an underwriter. Even though the the recent relaxing of rules regarding securities were not restricted securities secondary sales should increase the value (because they were sold in a registered to sellers of receiving a buyer’s securities, transaction), to negate this underwriter especially if the buyer is a reporting status, the resale had to comply with company. Less activity from private equity Rule 145 (which mirrored the Rule 144 sponsors is likely to lower the valuations requirements, without the holding period and otherwise lead to more buyer-friendly and Form 144 requirements). Now, except terms in deal agreements. in limited circumstances, affiliates of a target who receive shares registered on Form 4 will be able to freely resell them Tom Hopkins is a partner and Jason immediately, unless the holder is also an Northcutt is an associate at Sheppard, affiliate of the issuer (in which case the rules Mullin, Richter & Hampton LLP.
48 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Emerging markets and M&A activity
by Ian Coleman
There are numerous trends currently there are associated threats. Companies affecting the cross-border M&A market. seeking to complete M&A deals in their Investors from emerging economies home markets face fresh competition are increasingly interested in developed from investors in the developing world. As economies. Activity by private equity funds competition grows, so do the prices that is growing in emerging economies. National must be paid. investment strategies are growing. New hot sectors are emerging, particularly financial Notable among the new investors from services and infrastructure. Valuations the developing markets are sovereign are rising as a result of emerging market wealth funds, which are likely to have a investments. considerable impact on future investment flows. In 2007, the value of such funds grew Acquirers looking to complete M&A by around $1.3 trillion, while new issues of transactions in emerging markets face government gilts worldwide totalled just many challenges. Fiscal and legal regimes $600bn. Seeking a home for their surplus are often unpredictable. There is a need cash, sovereign wealth funds have begun to identify key tax issues. Buyers must turning to new, higher risk investments choose the appropriate method of market – including listed companies and private entry. Cultural differences can be a major equity. This trend seems set to continue. hindrance. Finance facilities are limited. For example, as long as energy prices There are differing approaches to business remain high, sovereign wealth funds from valuations and accounting policies. Political oil-producing states will continue to grow in risks must be assessed. size. If sovereign wealth fund investments quadruple over the next 10 years, as has Key trends been suggested, their influence on cross- border M&A will increase further. International investment flows are changing. Whereas in the past the direction While investors from emerging markets of flow was almost universally from the are creating competition for deals in more developed to the developing markets, developed economies, western private this is no longer the case. Last year, for equity funds are similarly increasing example, saw the Anglo-Dutch steelmaker competition in developing markets. PE Corus acquired for £6.2bn by Tata Steel of funds already account for a large proportion India, which outbid a Brazilian rival. of corporate acquisitions in established markets, and this phenomenon looks likely While this changing environment creates to be repeated elsewhere as PE houses seek opportunities for businesses in developed new high growth opportunities. markets seeking new investment finance, www.financierworldwide.com | FW 49 INTERNATIONAL MERGERS & ACQUISITIONS 2008
The impact of PE funds in emerging investigating the service opportunities open markets is, of course, affected by the to them in developing economies. Desire to availability of debt finance. Hence the upgrade infrastructure in emerging markets recent credit crunch has had an inhibiting is also stimulating interest both in corporate effect, one which is encouraging some PE investments and in the ownership of assets funds to look to sovereign wealth funds as such as roads and bridges. 3i, for example, alternative sources of finance to bank debt. has launched an infrastructure fund on the However, if this crunch proves to be merely London stock market. a cyclical event, over time increasing PE involvement in cross-border M&A will fuel There is, however, a potential inhibitor of existing inflationary price pressures. M&A in developing markets going forward, and one which could affect all sectors – the National investment strategies are increased valuations attached to companies also likely to shape future M&A trends. and assets in those markets. In China, for For example, the Chinese government example, high personal savings ratios, announced at the seventeenth Communist the relatively limited equity market and Party Congress a new national strategy to strong interest from overseas investors make higher value investments. Initially, have pushed up equity prices. Western China’s outbound investment was largely companies could find it increasingly difficult focused on securing the country’s supply to find growth opportunities at valuations chain – delivering the raw materials, that are acceptable to their shareholders. natural resources and energy needed to fuel growth. Now the Chinese are keen to Key challenges explore opportunities in more knowledge- intensive industries. Such national Businesses seeking to complete M&A investment strategies add additional transactions in emerging markets face competitive heat to the M&A arena, with numerous challenges. To begin with, acquisition decisions no longer being driven emerging markets are inherently fast solely by traditional financial metrics. moving, and this can be true of their fiscal regimes. Until last year, for example, China As a corollary, some countries are showing encouraged foreign investors by offering signs of a growing mood for protectionism more favourable tax arrangements than – so-called ‘resource nationalism’ – to were available to domestic companies. This prevent domestic businesses and treasured is generally no longer the case. Investors national assets from entering foreign thus need to consider the potential for tax ownership. If such tendencies develop into regimes to be altered, and not necessarily confirmed national policies, cross-border in a favourable way. M&A activity could stagnate or fall. They also need to identify the tax policies For the moment, however, deal volumes that have the greatest impact on the remain high. Some sectors, such as financial relative success of an investment. Investors services and infrastructure, are enjoying often focus primarily on the tax incentives particularly strong interest among investors available when making an investment, from developed markets. Private bankers such as the availability of tax relief on debt and insurance companies are increasingly interest costs. However, the long term
50 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS investment success of a transaction may – towards sole control investments and be more greatly affected by the investor’s organic growth models, where local ability to realise value from the investment regulations allow. in a tax efficient manner in the future. Given that some tax regimes penalise or inhibit Whatever the market entry model, capital or profit withdrawal more than cultural differences between domestic others, this is an important issue for upfront and developing economies need to consideration. be understood. The moral and ethical frameworks that exist in a number of If assumptions cannot be made about the emerging market countries are not the continuity of the fiscal regime, the same same as those in developed economies. In goes for legal systems. The presumption certain territories a monetary reward for of contractual certainty is the bedrock ‘assistance’ might be expected, whereas of business in the developed world, elsewhere this might be deemed a bribe. but can break down in some emerging These are serious legal issues, with markets where political motivations potentially far-reaching implications. For sometimes appear to override the rule of example, directors can fall foul of the US commercial law. The longer term in nature Foreign Corrupt Practices Act as a result an investment is, the more reliant it is on of actions that take place miles away specific legal structures and institutional from the US. Our survey of global chief stability. The need to accommodate legal executives found that cultural issues are flexibility, as well as fiscal flexibility, in M&A considered the biggest impediment to deals is therefore an important issue for cross-border M&A, particularly during the investors. post-deal integration period. It is essential that cultural norms and expected business Another challenge is the most appropriate practices are made explicit prior to any method of market entry – whether through transaction being completed. This extends forming a joint venture with a local party or to an understanding of the governance, going for sole control. Established practice control and reporting structures that will be has generally been to form a joint venture established – the structural manifestations with a local partner. The inward investor of corporate culture. benefits from the local partner’s cultural understanding and contacts, but may The options for financing and for subsequently seek to buy out the partner if successfully hedging M&A investments the venture proves successful. That model in developing economies can also be now appears to be losing favour, perhaps constraining. Although bilateral or due to its associated problems. It can, syndicated bank finance may be available, for example, be hard to agree on shared corporate bond markets are generally objectives for the venture. If the venture less developed than in more advanced is successful, the inward investor can have economies which may inhibit emerging difficulty extracting full value – many market acquirers. This will change gradually agreements give the local partner pre- – in India efforts are being made to create emption rights in the event of a sale. As a a financial centre in Mumbai, but this will result, there are early signs of a trend – both take time. in developing and developed economies www.financierworldwide.com | FW 51 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Differing approaches to valuation unstable regimes is being lost from the methodologies can also arise. In some corporate consciousness. Companies may, markets the standard basis for agreeing therefore, be underestimating the political a price is depreciated cost, rather than risks associated with emerging market discounted cash flow. Even where the transactions. This is a particular problem for latter is accepted, estimating risk and cross-border investments involving major establishing the appropriate discount rate physical assets, which are relatively difficult may not be straightforward. Variations to withdraw from without significant losses in accounting policies can also create being incurred. difficulties in interpreting reported figures. These and other technical issues all need to Even so, across all sectors, M&A activity be overcome. with developing economies remains a high priority for companies from more One other possible challenge for investee established markets. Despite the many companies looking at opportunities in challenges involved, the need to find developing markets concerns their ability growth opportunities will continue to to assess political risk appropriately. High stimulate transactions. turnover rates among senior executives in developed economies are arguably resulting in rapid corporate memory loss. Awareness of problems that have Ian Coleman is head of emerging markets at previously arisen due to politically PricewaterhouseCoopers LLP.
52 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Developments in merger control in the EU and worldwide
by David Harrison and Rachel Cuff
Review of a potential transaction by one August 2007, introducing a merger control or more competition authorities can regime. The law has been a decade in the seriously affect the structure and timing making, and will come into force in August of a deal, whether it be an acquisition, 2008. Certain important elements, such merger or joint venture. Many jurisdictions as thresholds for merger control to apply, prohibit implementation of a deal before still remain to be finalised, but pre-merger merger clearance is obtained, and time- notification will be required. Of particular periods for review of the transaction can concern is the requirement that acquisitions be considerable. The impact of merger of Chinese companies by foreign companies control worldwide is increasing as more go through national security checks, jurisdictions introduce new, or revise although details of this obligation are not existing, regimes. Such legislation is yet clear. In addition, observers are keen frequently produced in order to facilitate to see how the new law will be applied to self-assessment of a transaction by the Chinese state-owned companies, and how parties, and thereby to avoid prohibition the overarching requirement for behaviour by competition authorities of notified to be appropriate for a socialist economy deals. However, the fact that outright will be interpreted. prohibition of transactions remains relatively rare in many jurisdictions should India’s new regime introduces mandatory not deflect attention from the emphasis merger notification where specified that competition authorities such as the assets or turnover thresholds are met. European Commission place on ensuring However, the law incorporates a ‘domestic that their merger rules are respected, and nexus’ element, with notification to the their willingness to use their enforcement Competition Commission of India (CCI) only powers against merging parties (and even required where both parties have assets other countries) that attempt to circumvent or turnover in India. Under the new Indian those rules. law, the ‘suspensory period’ following notification of the merger, during which Development of merger legislation the transaction cannot be implemented, is worldwide theoretically 210 days. The relevant period under the previous regime was 90 days, In recent months, two industrial and this change has caused significant superpowers, India and China, have concern. However, the implementing passed new merger legislation, bringing regulation for the new regime (currently their regimes further into harmony with only in draft form) introduces an interim more mature systems such as those of the period of 30 days for the Indian authorities European Union and the United States. to take an initial view, upon the expiration China adopted its first competition law in of which approval of the transaction can www.financierworldwide.com | FW 53 INTERNATIONAL MERGERS & ACQUISITIONS 2008 be presumed. As the CCI is not yet fully The Office of Fair Trading (OFT) in the UK constituted, the regime is not currently issued revised guidance in November 2007 being enforced. regarding situations in which it will view the markets affected by a merger as not of Jurisdictions with well-established systems ‘sufficient importance’ to justify a referral of pre-merger clearance have also been to the UK’s Competition Commission. developing and clarifying their rules. Such The de minimis market size threshold was reforms are often driven by an aim of raised from £400,000 to £10m. The OFT has facilitating self-assessment by companies applied the revised thresholds in a number and their legal advise`rs, in order to of cases since their introduction, but has minimise the amount of pressure put also clarified that, as a matter of policy, it on the limited resources of competition will not apply the de minimis thresholds authorities. in cases where any harm to competition could, in principle, clearly be remedied by The European Commission has been clear-cut undertakings in lieu of a referral to continuing to review and develop its the Competition Commission. merger legislation. In April 2007, the Commission published a draft Notice on Yet other countries are in the process of remedies acceptable under the EC Merger reviewing and amending their merger rules. Regulation, with the aim of updating its The Federal Supreme Court of Germany current 2001 guidelines. The guidance has confirmed the geographic extent of relates to modifications that may be Germany’s de minimis provision, confirming proposed by parties to a transaction in that the relevant geographic market for order to ‘remedy’ competition concerns this provision refers to the German market, identified by the Commission in its merger and not to a wider geographic market. control review. The draft Notice has been Clarification of the de minimis exception subject to a public consultation, and is in both the UK and Germany should expected to be adopted in the first half of better enable companies operating within 2008. relatively small markets to avoid becoming subject to the merger control regimes of In 2007, the Commission also adopted these countries. guidelines on non-horizontal mergers, to complement its guidelines on horizontal Norway has made proposals aimed at mergers, which were introduced in 2004. improving the efficiency of its merger The non-horizontal guidelines relate to review system, and is considering both vertical mergers (between parties prohibiting implementation before operating at different levels of the supply clearance of any transaction that has chain) and conglomerate mergers (between to be notified. Currently pre-clearance parties active in closely related markets). implementation is only prohibited when a The Commission also combined four complete notification has been requested important pre-existing notices (relating to by the Norwegian competition authority or the calculation of turnover, as well as to the made voluntarily. concepts of ‘concentration’, ‘full-function joint ventures’ and ‘undertaking concerned’) The Czech competition authority is in the into a Consolidated Jurisdiction Notice. process of creating best practice guidelines
54 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS on pre-notification contacts between for consumers and ‘most likely [lead] to merging parties and the competition higher prices for more than 14 million EU authority, and Australia is, at the time passengers’ using the 35 routes on which of writing, consulting on draft revised the merger would create a monopoly or merger guidelines. As merger notification dominant position. Ryanair, whose chief is currently voluntary under the Australian executive accused the Commission’s system, such guidelines are of particular decision of being “bizarre, illogical, importance in enabling companies and manifestly inaccurate and untenable”, has their legal advisers to ascertain whether appealed the decision to the European voluntary clearance should be requested. Court of First Instance (CFI).
Merger control activity by competition The level of caution with which the authorities Commission approaches a decision to prohibit a merger will only have been While competition authorities work to increased by the decision of the CFI in July improve their merger control legislation, 2007 to award partial damages to Schneider they continue to review notified mergers Electric for loss stemming from the and sanction companies that do not adhere Commission’s 2001 prohibition of its to the rules. merger with Legrand. The CFI annulled the Commission’s prohibition decision in 2002, The European Commission received a considering that the Commission’s analysis record number of merger notifications in was riddled with “errors and omissions”. 2007, with the figure exceeding 400 for The Commission has appealed the CFI’s the first time. With over 60 notifications judgement awarding damages. received in the first two months of 2008, the level of notifications appears to be The Commission has, however, made it remaining reasonably constant. clear that it expects its rules relating to merger control to be respected, and in The Commission’s approach in relation particular those relating to pre-clearance to merger control continues to be implementation of a deal, or ‘gun-jumping’. relatively non-interventionist. Of some In December 2007, the Commission 3700 notifications received since 1990, conducted surprise inspections at the the Commission has prohibited only 20 premises of merging parties, INEOS and proposed mergers, and only two since 2002, Norsk Hydro, looking for evidence that the although a significant number have been companies had exchanged commercially cleared conditionally, after a first phase or sensitive information to such an extent that a second phase investigation, on the basis they could be considered to have already of commitments by the notifying parties. implemented the deal. This is the first However, 2007 saw the Commission’s first time that the Commission has conducted prohibition decision since 2004 and the raids in response to concerns about gun- first of Competition Commissioner Kroes’s jumping and, although it has now closed tenure, in relation to the proposed Ryanair/ its investigation and approved the merger, Aer Lingus deal. The Commission concluded the inspection serves as a reminder that the that the merger of the two leading airlines Commission has significant investigative operating from Ireland would reduce choice powers in this area, as well as the ability to www.financierworldwide.com | FW 55 INTERNATIONAL MERGERS & ACQUISITIONS 2008 impose considerable financial penalties. and Poland regarding mergers with a Failure to comply with an authorised ‘Community dimension’ and falling within Commission inspection in the context of a the Commission’s sole competency under merger investigation could lead to fines of the EC Merger Regulation. For example, up to 1 percent of a company’s turnover, further to the Commission’s approval while fines of up to 10 percent of turnover of the acquisition of the Spanish energy could result from implementation of a company Endesa by German-based E.ON, merger before approval is granted by the the Spanish National Energy Commission Commission. imposed conditions on the acquisition. Further to a number of formal requests and Nor can the presumption be made that decisions, the Commission referred Spain to the merger regimes of smaller countries the European Court of Justice, which ruled will not raise concerns and can therefore in March 2008 that Spain had failed to fulfil be disregarded. Jersey’s Competition its obligations under the EC Treaty. Regulatory Authority, for example, has imposed its first fine on a company for The cost of flouting merger control failure to notify a merger until after the rules can be high, leading to significant acquisition had been completed. The fine fines or even a requirement to undo of £10,000 was imposed on the Italian a completed transaction. With more travel restaurant company Autogrill countries developing sophisticated merger regarding its acquisition of Alpha Airport regimes, companies need to ensure that, Groups, clearly demonstrating that some when assessing the benefits of a potential smaller competition authorities will not transaction, they are aware of the merger hesitate to apply their powers to large control obligations and risks in the international companies operating within jurisdictions relevant to the deal. their jurisdiction.
The Commission has also shown its teeth in its response to displays of economic David Harrison is a partner and Rachel Cuff is patriotism by countries such as Spain an associate at Berwin Leighton Paisner LLP.
56 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER FOUR: Private equity markets
www.financierworldwide.com | FW 57 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g The case for value creation focused LBOs
by Olivier Sibenaler and mathieu baudouin
As it sparked off spiralling debt cost, proved attractive for newcomers, as its the subprime crisis has undoubtedly mechanisms – once mastered by a happy shaken the private equity industry, more few financial engineers – became available particularly acting as a brake on buyout to the rank-and-file. All it took to get funds’ activity. Large operations involving involved in LBOs was money. With low players of the likes of KKR were indeed debt costs and abundant liquidities, the abruptly cancelled. Those collateral effects, 2000s brought providential circumstances: influential as they may be, should not hide global private equity fundraising grew that since the mid-90s the industry has threefold between 2002 and 2006, with gone through a more fundamental, less the top 10 funds raising between $8bn and visible reshaping process. Although many $16bn. The value of LBO transactions also reasons may be invoked to support the boomed from $80bn in 1999 to $440bn in assertion, four key factors actually prevail. 2006. Unsurprisingly, those alluring market They have brought about a restructuring conditions called for an increase in the environment in which funds are confronted number of players, with approximately 2700 with new challenges. The latter, combined private equity funds in 2006, 850 of them with a soaring secondary LBO market, being devoted to buyouts. As one of its induce stronger demands in terms of consequence the commoditisation of the value creation for private equity backed LBO market came along with the gradual companies. What is at stake today is the vanishing of ‘cheap good deals’. funds’ ability to develop competitive advantages that produce high IRRs based External factors have added to those upon genuine industrial and commercial internal tensions. Intensifying competition strategies. was also propelled by corporations that are back in an M&A market that The buyout industry is under growing reached an estimated $3.8 trillion in pressure, both from the inside and the 2006. LPs’ increasing degree of expertise outside. The prevailing endogenous factor and selectivity has fostered internal is today’s intensifying internal competition, competition. From the mid-90s investment fuelled by the commoditisation of LBO banks have also helped to reshape techniques. Exogenous factors include the industry, as middlemen between limited partners’ (LPs) increasing expertise, buyers and vendors, as well as advisers. the extension of market intermediation Generalised banking pitches caused every and newly healthy corporations with an player to be in possession of the same appetite for M&A. average amount of information, paving the way for greater market efficiency. The Approximately 25 years after its early banks’ role is also evidenced in the auction beginnings, the buyout industry has process, leading to mounting pressure on
58 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS bids. Those factors have brought more funds’ profitability is significant. Economic efficiency to the markets – far from the performance of bought-out companies early days of LBOs when deals depended appears dramatically unequal. A recent on personal contacts. report by Standard & Poor’s found that 53 percent of the companies in the sample But those changes have raised new used failed to meet their EBITDA forecasts. challenges for PE firms. As funds strive to Here too, EBITDA underperformance or entice better informed LPs they have no overperformance has a high standard choice but to promise high IRRs. But those deviation (22 percent according to S&P). As are already high, at least on average. As a result, those funds that are determined The Economist stressed, “from 1980 to 2000 to survive and secure access to cash on the average fund generated higher gross a long term basis cannot merely rely on returns than investing in the S&P 500”. The ‘traditional’ levers – including financial average IRR in Europe was estimated to be engineering and tax integration – that are 13.7 percent at 2006 closing. proving insufficient in a context of intense competition and commoditisation. They are Besides – and thanks largely to the now compelled to increase their companies’ mounting efficiency of investment banks EBITDAs; in other words, create value – competition on the markets for targets through either side of the P&L statement. has caused both multiples and debt ratios to go up. Purchase multiples in 2007 were But what about companies that have about 7.15x EBITDA (for a $1.85bn deal), already been bought out once? Market compared to 5.75x in 2004. Debt multiples intermediation and commoditisation followed a roughly similar pattern, from are indeed translating into multiplying 5.2x EBITDA in 2005 to 6.1x two years later. secondary LBOs. About 20 percent of LBO- As for debt ratios, they reached 77 percent controlled entities were sold to other PE in 2007, of which 80 percent was classed as firms in 2007, against less than 4 percent in fine. in 2001. More secondary LBOs means the development on the market of companies Those challenges confront buyout funds that have – theoretically – gone through a with a major issue, one that may shape process of basic cost reduction, including their future: what new sources can be purchases and WCR management. In their identified for funds to build competitive case value creation needs a wider array of advantages and come up with IRRs that deeper, more implicating, measures. meet LPs’ expectations, in an environment where operations are put at risk by greater Building a competitive advantage will multiples and fast-growing debt leverage? require scrutinising the market potential of purchased companies and thinking in Not unlike Orwell’s Animal Farm the terms of strategic positioning. This is a clear PE industry is unequally rewarding. necessity for secondary LBOs, since cost Profitability is closely related to size; levers were used in the course of the first average returns at large funds were LBO. Competitive advantages in the future twice as high as those at small funds, are likely to rest increasingly on the ability while medium entities fell in between. to carry out successful growth strategies. In addition, standard deviation among Two different investment rationales – www.financierworldwide.com | FW 59 INTERNATIONAL MERGERS & ACQUISITIONS 2008 build-up and rollout – can be chosen, such transactions requires specific skills and each of which follows specific aims and savoir-faire which are increasingly available introduces specific levers. First, funds need from external advisers. to define their aims, whether they intend to implement operational synergies or plan The challenges facing buyout funds to boost sales efficiency. It is those very demand renewed reflection on the essence strategies that can provide the funds with of corporate value creation. Those on the an ability to loosen the grip, make up for right track will hold an advantage over the pressure produced by higher purchasing the rest of the pack. In terms of economic multiples, and implement momentum of value creation through build up and rollout value creation. strategies, poorly performing small funds clearly start the race at a disadvantage. To phase in such strategies and make sure But the dice are not yet cast. In those they are profitable, it is necessary to target conditions, it is still unclear whether the companies that closely fit one’s needs. That market will go through concentration goal contradicts the particular conditions and further evolve toward a model split that characterise an intermediated market between niche-focused small funds (in and lead to one-size-fits-all rather than terms of areas and industry) and large custom-tailored operations. To match the generalists. expectations, the fund has to strike a deal with a target that until it was approached had never planned to be bought – not to mention the eventuality of a buyout. Olivier Sibenaler is a principal and Mathieu Convincing shareholders and completing Baudouin is a consultant at BearingPoint.
60 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Is there a credit crunch in the mid-market?
by Mounir Guen
As many major financial institutions suffer and forced to defend their actions and from bone-crunching losses, their position, their assertion that they actually improve bullishness, and business outlook have been the operations and profitability of their deeply affected. While many are pointing portfolio companies rather than add to fingers at banks which aggressively offered national unemployment. debt packages to purchase companies, fuelling ever larger deals, it takes two to Meanwhile, the private equity universe tango; more than a few general partners has continued to expand. Deals, exits and willingly took advantage of the buoyant portfolios grew larger. Average deal sizes credit markets to ‘benefit their investors’. increased 265 percent from 2000 to 2007, Consequently, the private equity market according to Dealogic. Funded by investors witnessed some amazing activity and a slew writing ever-larger commitment checks, of acquisitions on an unprecedented scale. mega funds emerged, still touting their In 2007, $800bn of deals were executed, middle market heritage. The definition of with almost $600bn of that completed mid-market became so wide in the last in the first half of the year, according to few years that the sheer breadth of mid- Dealogic. This included record-breaking market managers began to resemble the deals such as Blackstone’s $38.9bn Grand Canyon. Then, as the risk appetite acquisition of Equity Office Properties and changed overnight, all went silent. Activity the $45bn acquisition of TXU by a private generated by financial institutions dropped equity consortium led by KKR and TPG. dramatically, with fourth quarter 2007 activity falling 70 percent year on year from However, not all was rosy in private equity 2006. land. The most recent credit cycle has brought new tensions and new learning However, it is in this broad middle market experiences for general partners who that we witness a private equity nuance. now suddenly understand the concept Here, general partners did not get caught of responsible public ownership and up in the land of leverage, and were not the necessity of ensuring clarity of their as involved with the euphoria that swept intentions, especially in the public eye. through the larger end of the market. Within the last year, private equity firms These general partners tended to have have come under intense scrutiny with more of an operational focus, buying and respect to the transparency of their profits building sound companies, or establishing and operations. Their ‘benefit to society’ platforms, focusing on growth and has been questioned. A number of the preparing companies to be market leaders larger firms that had previously been that could weather market cycles. In humming along without a care in the world fact, truly mid-market general partners have been dragged into the spotlight continued to exit companies for a healthy www.financierworldwide.com | FW 61 INTERNATIONAL MERGERS & ACQUISITIONS 2008 profit in the last few years, riding the rising continue to be relatively strong. Funds tides while still making investments at raised in the emerging markets have grown attractive acquisition multiples and not exponentially in recent years. Between loading up their acquisitions with debt. 2003 and 2007, the amount of capital raised While they could easily have taken on more has risen on an annual basis by 69 percent debt in every acquisition, these general in the Middle East & Asia, 82 percent in partners conservatively chose not to, as Latin America, 90 percent in Emerging they wanted to position their companies for Asia and 132 percent in Central & Eastern the future. Europe and Russia, according to Emerging Markets Private Equity Association. This is a By leveraging prudently, they were buying trend that has been mirrored in investment insurance for their portfolio companies. activity, as a growing percentage of global And, like all good insurance programs, private equity activity is attributable business protection has been there in a to the emerging markets. In 2001, they time of need. Today, these general partners accounted for 4.5 percent of private have not missed a beat in the pace of their equity fundraising and 3.3 percent of deal investments. While others wonder how volume. By 2007, they accounted for 15.9 they will put together the next deal, these percent of fundraising and in the first mid-market private equity firms are as busy half of the year, accounted for 7 percent as ever in developing their portfolios. In of global LBO deal activity, according to contrast to the larger end of the market, Thomson. Additionally, there has been a mid-market deal activity gained 19 percent marked increase in distressed investment, in the third quarter of 2007 over 2006, and particularly in the last two years. increased 55 percent in the fourth quarter of 2007 over 2006, according to Dealogic. One point to note is that given the size of smaller transactions, new players in the form of local banks are stepping up to provide prudent financing. While others wonder how they will put together the
We see these trends in the US mid-market, next deal, these mid-market private equity firms are where a number of general partners who as busy as ever in developing their portfolios. are raising successful funds up to $2bn have achieved great exit multiples, and continue to make interesting investments. We also see these trends in Europe where there is still a great deal of value and inefficiency to exploit in the middle market, particularly Ultimately, the recent events have had for the local players who have unparalleled an impact even on the mid-market networks in their respective markets. players who maintained a conservative approach. First, while the banks are open Significantly, we also see this in the for business, the debt packages available emerging markets where there is often today are not as attractive as they were conservative use of leverage (if any) while 18 months ago. Second, valuations have growth rates are the main focus and come down on unrealised investments;
62 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS and since many investors in private equity wealth funds in order to finance them, the use mark to market valuation techniques, circumstances surrounding the mid-market the funds in their portfolios are currently are relatively insignificant. Furthermore, showing lower performance even though they will be short lived as the mid-market the underlying companies may be doing continues to exhibit resilience, opportunity fine. However, compared to the large end and performance. of the market where private equity firms are being forced to look at much smaller deals than would normally fit their strategy and also potentially share their larger Mounir Guen is founder and chief executive of deals with increasingly powerful sovereign MVision.
www.financierworldwide.com | FW 63 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g The changing face of the MBO
by Oliver Hoffman
Management buyouts (MBOs) have not have as deep pockets as some trade become an established feature of the buyers) the upsides can be beneficial. With corporate landscape over the last 25 years. a sale to management the owner can sell The concept itself is simple. Who better without having to disclose potentially to buy a business than the people who sensitive information to someone in the manage it? The reality is more complicated trade. Also confidentiality surrounding sale and a whole industry of corporate finance discussions can be better protected than advisers, corporate lawyers, bankers and when a business is being marketed to a venture capitalists has been spawned wider audience. to help management teams (and the shareholders from whom they buy their Second, a plentiful supply of capital has businesses) through the buyout process. helped. Pension fund managers and This article highlights the reasons MBOs wealthy individuals alike saw the returns have become so popular. Additionally made by those that invested in some of it looks at the trends seen in the MBO the early MBOs and have allocated large marketplace in the last few years as a amounts of cash to be invested in this pointer towards the future of the MBO. market. The banks too have seen that there is profit to be made in lending to companies Why have MBOs become so popular? going through a buyout and have set up specialist leveraged finance teams to In a nutshell, an MBO is the purchase of provide finance to this market. a business from its shareholders by the current management, usually with funds Third, management teams have been lured provided by a bank and/or third party equity by the prospect of making life changing providers. amounts of money as well as taking control of their own destiny. This money making The MBO has become such a phenomenon opportunity comes from financial leverage. for three main reasons. First, it gives a In most cases, a management team buys all business owner an alternative to selling or most of the shares in the company with a to a trade buyer. Smaller businesses in relatively small amount of their own money. particular are often difficult to sell as they The bulk of the money is provided by third can be below the radar and interest level parties (banks and/or equity investors). of larger acquirers. The option of a sale to Over the next four to five years they use the the management team therefore opens profits generated by the business itself to up another avenue of possibility to the pay off the banks and investors. What they owner. Although there is sometimes a are left with is a business with little or no financial downside for a vendor in a sale to debt that can be sold, potentially making management (as management teams do a very large profit for themselves. Tens of
64 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS thousands of pounds are often turned into to provide 60 to 70 percent of the finance multi-millions for successful management for an MBO with the balance coming from a teams. VC.
But MBOs are not without their downsides. In the early 2000s, many VCs saw greater If a business veers off-plan and fails to profits to be made by financing larger deliver the profits required to pay off transactions and moved away from smaller its borrowings, the outcome can be MBOs (i.e., those with a purchase price devastating. Surveys have estimated that of below £5m). Management teams were up to a third of businesses that go through unable to meet the price aspiration of a buyout fail in their first few years with vendors with bank borrowings alone and administration or receivership often a asked the vendors to fill the gap left by consequence. Most advisers operating in VCs by deferring payment of some of the the MBO arena will argue that the majority purchase price, typically by two to three of MBOs that go wrong do so because the years. This ‘debt plus deferred’ structure MBO team overpaid for the business and has now become commonplace and has burdened it with too much debt. Hindsight virtually replaced ‘debt plus venture capital’ is a wonderful thing. at the smaller end of the market.
Higher risk than an MBO is a management The secondary buyout. Having moved away buy-in (MBI). The principles of an MBI from the smaller deals market but with are the same as that of an MBO with the massive funds provided by investors, VC exception that the management buying providers are awash with cash seeking a the business do not currently work for home. As Corporate UK has become a well- the company they are buying. MBIs are fished pond for MBOs in recent years, VCs particularly common in circumstances have been prompted to invest in businesses where the incumbent management team already under VC ownership. These does not have the strength and depth to situations, commonly known as ‘secondary mount an MBO bid themselves. These are buyouts’, typically involve one VC buying a higher risk than MBOs as there is greater business from another, enabling the first to potential for problems in the business to be crystallise its profit and return funds to its hidden by vendors and only unearthed once investors. Often new management teams the company has been acquired. are introduced as the first team cashes in its stake along with the outgoing VC. Recent trends in the MBO marketplace A move away from MBIs. Having looked The importance of vendor finance. Changing retrospectively at where they have made attitudes of those that fund MBOs has money and where they have lost it, the led to changes in the way MBOs are put funding markets have moved away from together and structured. The most notable financing MBIs in the last few years. This development seen in the last five years is has lead to the ‘BIMBO’ – short for buy-in the increased role played by vendors in management buyout – a hybrid of an MBO helping MBO teams, particularly in smaller and an MBI where an MBI team or individual businesses, achieve an MBO. In the 1980s leads the purchase of the business and 1990s, it was commonplace for banks supported by the existing managers of www.financierworldwide.com | FW 65 INTERNATIONAL MERGERS & ACQUISITIONS 2008 that company. The perceived risk of this buyouts will soon become the norm for type of transaction for funders is lower as larger deals in the same way that debt plus the inclusion of the existing management deferred has become the norm at the lower reduces the likelihood of problems arising end. within the business after purchase that were not previously identified. The appetite for MBOs from management teams, vendors and the financial A view of the future community alike shows no signs of abating. While it will undoubtedly continue to re- The MBO market is likely to become invent itself, it is a fair bet that the MBO will increasingly polarised with a divide forming be with us for many years to come. between large and small deals. With VCs focusing on progressively larger deals and bigger and bigger funds being raised for Oliver Hoffman is a corporate finance partner investment by them each year, secondary at Mazars LLP.
66 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER five: Structuring and negotiating the deal
www.financierworldwide.com | FW 67 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Preparing a company for sale to maximise value
by Richard Lieberman
Business owners and management are impending retirement or the death of key often so consumed with operating and personnel. Some will sell due to financial growing their businesses they do not difficulties or a similar crisis. Others will adequately prepare their company for sale. sell as a strategic method of growing the When those owners finally decide (or need) business or to gain better access to capital, to sell their businesses, they may miss markets and products. Regardless of the opportunities to maximise the value of their reasons, a company that is prepared for company or minimise the tax impact of sale will generally fare better in the sale the proposed transaction. Poorly prepared negotiations than those that have not companies may even face a dearth of undertaken proper efforts. buyers for their business. When to prepare for a sale Deficiencies in key areas can discourage potential buyers from bidding for the To help maximise the value of a company company, delay the transaction (which (as well as the after tax net proceeds increases the chances it will not close) or from the transaction), business owners lead to a lower purchase price. Similarly, should devote attention to preparing their unaddressed problems can result in greater company for sale as early as possible. Those retained liability of the seller or reduced preparations can even commence when payouts on earn-outs. The expense of trying preparing the company’s organisational to resolve the issues while in negotiation documents. Shareholder and operating often far exceeds the cost a seller would agreements often identify the rights and have spent fixing them before the obligations among the equity owners transaction arises. with respect to the sale of their interests. Addressing those issues at the outset Conversely, sellers who adequately can help owners and management avoid prepare their company for sale can be disputes at the time of a prospective more opportunistic when engaging in transaction. transactions and often can negotiate better results for their equity owners, employees Starting early in the process can have and other constituents. Transactions with additional benefits. For example, business prepared companies can close faster with owners can integrate a potential sale with less expense. their estate planning process, to help minimise estate and gift tax obligations. Sale transactions can result from a variety Those owners could benefit from valuing of circumstances. Prospective purchasers their business and transferring assets to and their advisers often approach a seller. their estate well before the sale. Similarly, Sellers may seek to sell due to their converting the form of the business entity
68 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS from one type to another, such as from a engagement of the other professionals, taxable corporation to a limited liability to address regulatory and legal issues in company, will have tax ramifications that structuring the transaction, to evaluate should be carefully analysed with the duties of the management to the equity company’s advisers. Those actions could owners and to serve as a resource to their affect the net proceeds to the seller, but client. Some acquisition intermediaries may need time to have a significant benefit. may discourage hiring counsel until later, to permit them greater freedom in structuring Business owners can still do much to the business terms of the transaction, as prepare for a sale even after discussions well as the terms of their own engagement. with the buyer have begun. The negotiation Experienced counsel, however, should and due diligence process often provides facilitate, not hinder, those processes, while adequate time to address many issues. helping the seller to protect its interests. Some may even be resolved with the knowledge, consent and perhaps Preparing for a sale encouragement of the prospective buyer. Among the steps to prepare for a sale, Assembling an advisory team sellers should consider evaluating the following issues. Of course, the list is not Prospective sellers should consider exhaustive, and the advisory team can the identification and engagement identify other areas of review particular to of experienced professionals to assist the seller. throughout the sale process. The advisory team typically includes investment bankers Company records. Buyers will scrutinise (sometimes called business brokers or the company’s contracts, customer advisory intermediaries) and legal, tax, correspondence, organisational documents, accounting and financial advisers. In- minute books, accounting, tax and financial house professionals, who know the buyer, records, patents and similar rights and and experienced and objective outside other important documents. professionals can form a powerful advisory team. Compensation arrangements. Sellers should evaluate whether key personnel need Experts in other areas should be engaged incentives to remain with the company as appropriate for the transaction. during and after a sale. Employees react Knowledgeable advisers in various differently to change, and the loss of key disciplines, such as information technology, personnel during a potential sale can can be added as needed. Purchasers adversely impact the proposed transaction. entering into a new industry or market can Sellers should not assume that the benefit from hiring consultants to advise transaction process can be consummated on those issues. International transactions in secret, and employees often know often warrant engagement of qualified or suspect a transaction is in process professionals in each jurisdiction. long before management discloses the prospective transaction. Sellers should consider hiring legal counsel early in the process to assist with the Employee policies. Companies should assure www.financierworldwide.com | FW 69 INTERNATIONAL MERGERS & ACQUISITIONS 2008 that appropriate policies and agreements bidders and prepare the company’s sale are in place to protect its trade secrets, strategy. An integrated team approach patents and other intellectual property. It is permits a business owner to benefit from often difficult to implement those policies the expertise of its team members and while trying to consummate a transaction, may relieve some of the burden on the especially if the parties are trying to seller, who must still operate the company maintain confidentiality. Buyers will also throughout the process, as well. review other company policies, plans and procedures to evaluate their adequacy. Business owners would be well advised to adequately prepare their company for sale. Litigation and other known problems. Most The effort and expense should inure back companies have some problems, such as to the seller in higher net proceeds and a ongoing litigation, customer claims and faster and smoother process. Sellers can similar issues. Appropriate resolution of benefit from those preparations, regardless those items can help maximise a company’s of the circumstances leading to the sale value, but doing so often cannot be or when they commence the process, achieved prior to entering negotiations with although greater flexibility remains for the buyer. The advisory team can help guide those who begin the process well before a the seller to the best method of presenting prospective sale. the matter to the buyer, as well as to help negotiate the impact of those issues on the proposed transaction.
Together with its advisers, business Richard Lieberman is chairman of the owners can take steps to prepare their Corporate, Securities and Finance company for sale. The advisers can also Department of Jennings, Strouss & Salmon, identify and negotiate with prospective PLC.
70 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Steps to a successful private company sale
by Frank A. McGrew IV and Dunn Mileham
Selling a privately held business may be succession planning are among the most the most important financial event in a common reasons business owners cite business owner’s life – years of hard work for selling their businesses. While the sale offer the prospect of financial security for of the business in accordance with terms life. However, without proper guidance and desired by the owner may be the ultimate financial advice, this exciting moment can outcome, the means to the end should start quickly turn into a misadventure in which well in advance of the liquidity event. In the owner may not realise the full value of fact, it is never too early to plan for a sale. his or her company. From day one, business owners can have a positive impact on the outcome of the Before and throughout the process, a liquidity event by focusing on the following number of questions are inevitable. What key issues: is my business really worth? What is the right transaction structure? What can I do Finances. While many private businesses to make sure the transaction closes with start small and use ‘off the shelf’ accounting minimal difficulty and maximum after-tax software, it is important to keep detailed proceeds? financial records and increase bookkeeping / accounting functions as the business Selling a business is a complex and time- grows. ‘Owner expenses’ should be kept to consuming process, and the addition a minimum and should be clearly identified. of family members and close friends as Audited financial statements (or, at the employees and/or shareholders often minimum, reviewed statements) will be adds to an already complex situation. In viewed favourably by both strategic and order to make the process as smooth as financial buyers and will expedite the possible, goals and specific issues must be process. clearly defined with appropriate advisers at the onset of a prospective transaction. Management. Business owners should Clearly defined goals and objectives will build a competent, independent middle allow the team of trusted advisers to seek management team. During diligence, out the ‘best’ deal for the seller to achieve buyers will always question the capabilities maximum benefit. However, it is important of the management team. An average to to remember that the ‘best’ deal may not poor team can detract value, while a solid necessarily provide the highest price. group can increase value and interest in the business. Additionally, while the seller Private companies are sold for a number of the business may take his proceeds of reasons. Liquidity, personal balance and retire to the beach, the ongoing sheet diversification, restructuring, growth viability of the company may be left in capital needs, ownership transition and the hands of its management. In certain www.financierworldwide.com | FW 71 INTERNATIONAL MERGERS & ACQUISITIONS 2008 instances where the seller may have Advisers. Last but certainly not least, some continuing interest in the ongoing business owners should build a team financial performance of the business (via of trusted financial and legal advisers. an earn out, stock consideration, etc.), Throughout the growth of the company the capabilities of the management team – from inception to sale – an attorney may have a material impact on the seller’s (or firm) well versed in corporate law will ultimate financial consideration. be an invaluable resource. The second key member of the team should be an Employees. Employees are the backbone external accountant, preferably from a of a company. Unlike the owner, and in regional firm with dedicated tax and audit some cases the management, many of the capabilities. An investment banker skilled employees will stay with the business post- in M&A and also knowledgeable about the transaction. Business owners may consider particular industry is the third key team having key employees sign confidentiality member. Working in conjunction, these and/or non-compete agreements in order three advisers will be able to orchestrate a to keep proprietary business processes transaction that fulfils the seller’s desires and trade secrets in-house. When a sale while minimising disruption to the business. process commences, owners should consider notifying ‘key’ employees of A key role of the advisers, particularly the process and keep them informed of the investment bankers, is the marketing changes. Unannounced unfamiliar faces process. An investment banker who lurking around in suits during diligence may understands the industry in which the cause undue angst among trusted and loyal company competes is imperative. Bankers employees when their continued focus is lacking industry knowledge will be unable needed more than ever. to target the marketing to the most likely set of prospective buyers. Legal structures / tax implications. When forming a business, owners should consult Relationships with both strategic and with attorneys and tax professionals financial buyers is key to a competitive regarding the pros and cons of forming process, as there may be pros and cons of an S-corp versus a C-corp. A number of a transaction with each. Financial buyers variables will influence this decision, and tend to (i) seek above average returns a choice of one corporate structure over (although they are potentially more another may hinder a process or leave the reasonable now than in recent years); (ii) business owner with an undesirable tax look for experienced senior management burden. teams with sound growth strategies; (iii) typically invest in a preferred security and Customer base. A large and diverse require majority control; (iv) ‘partner’ with customer base with identified new business management; (v) prefer capital be used for targets can add value to a company and growth; (vi) look to exit the investment in ease buyer concerns about customer a set timeframe (three to seven years); and concentration. Owners should maintain (vii) require audited financials. detailed prospect reports and evidence of successfully growing the customer base. On the other hand, strategic buyers (i) can be readily identified and are increasingly
72 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS global in nature; (ii) may be able to pay a financial performance. Finally, they have premium price due to synergies or cost attractive growth characteristics with elimination; (ii) can use stock as currency limited quantifiable downside risk. if they are a public company; (iii) may have an upper level management which Success, however, does not happen is ‘expendable’; and (iv) may have lighter overnight, and a sale process should not diligence requirements due to knowledge be taken lightly. An emphasis on pre- of the industry. sale preparation, data validation during pre-marketing diligence and well crafted While no two sale transactions are the marketing materials presented to qualified same, companies that yield premium buyers will ensure a competitive process valuations in today’s market share that yields the most desirable outcome to certain similar characteristics. First, the seller. they hold a leading position in a viable industry. Second, they are led by a strong management team. Third, they enjoy Frank A. McGrew IV is a managing director sustainable competitive advantages. and Dunn Mileham is a vice president at Fourth, they have achieved outstanding Morgan Joseph & Co. Inc.
www.financierworldwide.com | FW 73 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Non-binding preliminary agreements: use ‘good faith’ with caution
by Robert Coyne and Kevin Evans
Business negotiations often reach a stage attributes, the ramifications of cavalierly at which one or more parties want what using common business terms such as they have agreed to in principle to be ‘good faith’ can be very different. recorded in writing. The parties may sign a term sheet, letter of intent or heads of United Kingdom agreement – all variations on a common theme. These preliminary agreements spell Generally the English courts are reluctant out, in summary fashion, the key terms to enforce obligations to negotiate in of the proposed deal. These preliminary good faith, whether implied or express, agreements are often stated to be non- because such a concept is perceived to be binding, such as by the use of the words, irreconcilable with the parties’ freedom ‘subject to contract’, or ‘subject to the of contract. In addition, ‘good faith’ is execution of a definitive agreement’. considered vague, a type of ‘agreement to agree’ and therefore too uncertain to One party may request the inclusion enforce. It is also difficult to say whether the of a mutual obligation to negotiate the termination of negotiations was brought definitive agreement ‘in good faith’. This about in good or bad faith. Moreover, since request may be a difficult one to reject – it is difficult to determine whether good why wouldn’t each party agree to negotiate faith negotiations would have produced in good faith to finalise the deal? It may be a final agreement or what the terms of tempting for a party to conclude that such a that agreement would have been, how statement is harmless, since the term sheet can the loss for breach of any good faith is non-binding. obligation be determined? In the leading House of Lords case of Walford v. Miles If, for whatever reason, one party changes (1992), the court said: “While negotiations its mind, can it simply walk away from the are in existence, either party is entitled to non-binding arrangement? Does it make withdraw from these negotiations at any a difference if the term sheet includes time and for any reason. There can be thus a statement to ‘negotiate a definitive no obligation to continue to negotiate agreement in good faith’? until there is a proper reason to withdraw. Accordingly a bare agreement to negotiate This article considers the differing impact has no legal content.” of a provision to negotiate in good faith in the common law systems in the United However, the inclusion of a provision to Kingdom (no impact), Australia (some negotiate in good faith was considered impact), and the United States (a significant more recently by the English Court of impact). Although the common law in Appeal in the case of Petromec v. Petroleo these three jurisdictions has many similar Brasileiro (2005). The court commented
74 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS that it did not consider that Walford v. contractual duty of good faith is recognised Miles was binding authority that an express in Australia, both under common law and obligation to negotiate in good faith would statute, it is not imposed on all contracts. be completely without effect. It suggested While the courts may seek to imply a that when the parties enter into a written duty of good faith in the negotiation of contract that includes a provision for good contractual obligations, they will not faith negotiations, and in particular when override a contract’s express language. The legal advisers have been involved, then it express non-binding nature of the term may be appropriate for such a provision to sheet makes it likely that the Australian be enforceable. courts would not imply an obligation to negotiate in good faith when there is a non- Thus, when it is clear that the term sheet is binding term sheet. not binding and is only a ‘bare agreement to negotiate’, then Petromec would have no But what of the express obligation? It is impact on the traditional position espoused generally accepted that parties may by in Walford. Under English law, there is no contract bind themselves to negotiate recognition of an implied obligation to in good faith. But there remain practical negotiate in good faith, and the inclusion difficulties with this concept. Significantly, of an express provision does not, in the the courts have held that any express absence of a binding agreement, limit obligation to negotiate in good faith needs a party’s ability to walk away from the to be sufficiently specific as to the elements negotiations. of the obligation. In our example, because no attempt has been made to define what Australia is intended by the obligation, or what should happen if good faith negotiations The existence and scope of an obligation break down, the courts are again unlikely to to negotiate in good faith is not yet settled enforce the obligation. in Australia. Traditionally, Australia has followed the English courts and been If parties to a term sheet wish to bind reluctant to recognise an obligation themselves to negotiate in good faith in to negotiate in good faith. However, reaching a definitive agreement, because Australian courts have recently appeared the concept of good faith is uncertain more willing to depart from this position. and evolving, they should define what In Coal Cliff Collieries v. Sijehama (1991), it is that they mean by good faith. Even the validity of an express agreement to in the scenario of a binding obligation negotiate in good faith was considered. to negotiate in good faith, a party’s The court rejected the proposition that no obligations under Australian law are not promise to negotiate in good faith would onerous. Generally, the obligation can be ever be enforceable by a court. Subsequent fulfilled by simply taking part in the process cases in Australia have followed this of negotiations. Beyond this, there is no approach. requirement that a party act for or on behalf of or in the interests of the other party, nor How does the current state of the law does it require a party to act otherwise than in Australia impact on our non-binding by pursuing its own interests. term sheet scenario? Although an implied www.financierworldwide.com | FW 75 INTERNATIONAL MERGERS & ACQUISITIONS 2008
United States stated their intention that the preliminary agreement is non-binding pending the Any general statement of the law in the US definitive agreement, a court will impose is fraught with problems. English courts an obligation to continue good faith have only to consider decisions of higher negotiations. English courts. Australia, which also has a federal system, has state courts that There is little doubt that US courts will tend to take notice of the developments recognise express obligations to negotiate in other states and a High Court that in good faith. In Itek Corp. v. Chicago ultimately resolves questions of contract Aerial Industries (1968), a letter of intent law for the whole of Australia. In contrast, containing both a no binding effect clause in the US there is no effective review of and a provision stating that the parties state law by the US Supreme Court. As a “make every reasonable effort to agree result the common law of what it means to upon and have prepared as quickly as agree to negotiate in good faith develops possible a contract”, was found by the independently in 50 jurisdictions. That Delaware Supreme Court to impose an being said, it is possible to extract some obligation to negotiate in good faith. general guidance. Similarly, in the Massachusetts case of Schwanbeck v. Federal Mogul Corp. (1992), The obligation to negotiate in good faith a statement that: “This Letter of Intent is arises from either an express or implied not intended to create, nor do you or we obligation in an agreement. When the presently have any binding legal obligation obligation does not exist, the traditional whatever…,” but then went on to say: theory of freedom of contract applies and “…however, it is our intention, and we a party is free to walk away from a deal and understand, your intention immediately break off negotiations for any reason. to proceed in good faith in the negotiation of such binding definitive agreement”, Does a term sheet that expressly states was held to be a contractual obligation its non-binding status, as in our example, independent of the prior disclaimer that the nevertheless imply a binding obligation letter was non-binding. to negotiate? The watershed case is Teachers Insurance & Annuity Association of Itek and Schwanbeck are examples of how America v. Tribune Co. (1987), in which the otherwise non-binding letters of intent may applicable term sheet stated that it was impose a duty to negotiate in good faith. non-binding but did not expressly contain But what does this duty entail? any obligation of good faith. In this case the court identified a type of preliminary Good faith is defined in the Uniform agreement between parties that, although Commercial Code as “honesty in fact in not requiring that the final contract be the conduct or transaction concerned”. concluded, created an obligation on the However, the UCC deals with the parties to negotiate in good faith, what performance of already concluded the court called a ‘binding preliminary contracts, and not with good faith agreement.’ Although a number of cases obligations in the pre-contractual stage. have followed in Tribune’s footsteps, it is What constitutes pre-contractual good rare that when the parties have expressly faith is an open issue. Clearly, certain
76 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS actions such as fraud or duress, or other compensated for any loss resulting from ‘bad faith’ conduct, will violate any its reliance on the other party’s agreement good faith standard. Additionally, some to negotiate in good faith. The purpose commentators suggest that under an of this measure is to put the party in the agreement to negotiate, the good faith same position in would have been in had standard ordinarily requires: (i) actual the agreement to negotiate in good faith negotiations with no imposition of not been made. It is likely to cover out-of- conditions that were not contemplated by pocket expenses, but not the lost profits the parties; (ii) disclosure of enough about that the initial term sheet contemplated parallel negotiations to give a reasonable or lost opportunity costs. That said, the opportunity to match competing proposals; more advanced the negotiations towards and (iii) continued negotiation until a definitive agreement, the more likely impasse has been reached unless there is that an aggrieved party will seek to argue another justification for breaking off the for lost opportunity costs or damages to negotiations. its business that may have resulted from the impact on employees, suppliers and Commentators have also suggested customers of the failed negotiations. conduct permitted by the good faith standard. For example, an obligation to Conclusion negotiate in good faith should not require a party to negotiate exclusively, or for Cross-border deals are now the norm. The any specific length of time, or to continue cavalier use of commonly used terms such negotiations if its counterpart is not acting as ‘good faith’ across different jurisdictions in good faith, or if market conditions can have unexpected consequences. In change, or indeed if the opportunity to the context of preliminary agreements, conclude the deal with a third party comes particular attention should be paid to any along. language that suggests that there is an obligation to continue negotiations, or Finally, in the event of a breach of an otherwise negotiate in good faith. Consider obligation to negotiate in good faith, including explicit disclaimers reserving each what are the likely consequences? The party’s right to terminate negotiations at US courts have a number of remedies any time and for any reason. Resist the available. However, since it is not inclusion of a ‘good faith’ obligation to possible to determine whether good faith negotiate. Alternatively, spell out precisely negotiations would have produced an what needs to be done to comply with this agreement at all, or what the terms of obligation, or set forth the consequences that agreement would have been, certain for breach of this obligation, such as a remedies such as specific performance, termination fee. or ‘expectation damages’, i.e., damages based upon the expected profits that the aggrieved party would have received from the transaction, are inappropriate. The Robert Coyne is a director and co-chair of the more likely result is for a court to award Cross Border Transactions Group, and Kevin ‘reliance damages’. The aggrieved party is Evans is Counsel, at Gibbons P.C.
www.financierworldwide.com | FW 77 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Auctions in the M&A process
by Justin Pettit
Despite the increased use of competitive auction necessarily equates to the best auctions, the balance of power between price possible, and thus best meets the financial sponsors and corporates in today’s needs of their primary constituents. environment is in flux. The balance of power However, this may not be the case. For now has more to with the credit markets example, a business auctioned through and the availability of capital – the credit a tender offer with no representations crunch has put strategic buyers back into or warranties will typically clear a lower the drivers’ seat for now. Neither strategic premium than in a negotiated transaction. buyers nor financial sponsors generally prefer auctions. However, whether they And there is evidence to suggest that were called and managed as a formal auctions deter strategic buyers and that auction or not, the sell-side process has sellers are unable to extract the maximum always at least feigned some element value from a financial buyer. Buyers are of a ‘book-building’ process designed to suspect both around the fundamentals generate interest and enthusiasm in the of auctioned assets, as well as the likely negotiation. What has changed are the clearing price that will need to be paid. social norms around its visibility. Auctions do seem to be a more familiar Auction pros and cons process to the financial sponsors. Strategic buyers prefer to look at opportunities Sellers like auctions because the process is before they are formally auctioned. Banker quick, efficient, and it gets things over with books are regarded with scepticism not in one fell swoop. only because we know the ideas have been shown to hundreds of others to bid up the There can also be situations where price, but also because there is often a taint companies are legally compelled to hold associated with businesses that are put up an auction. Obtaining a fair and reasonable for sale. Ultimately, auctions can deter any price is a fiduciary responsibility of the buyer that is especially price-sensitive. directors in any public company – this may, or may not, be best achieved through Private negotiation is far less disruptive to an auction process. Furthermore, there the business being sold – the customers, are many regulated companies, where employees, and vendors, need not be regulators may have preferences. Finally, unnecessarily involved and worried with the encumbered assets can require lender transaction. Thus, value can be preserved. approval, which may also affect the method In many industries, the key players all of disposition. know each other, and the natural owners of different assets can be identified and Regulators may believe that a formal approached through quieter channels.
78 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
Formal auctions are not necessary, but Strategies can be deployed by the seller to visibility and dialogue certainly are. A maximise the sale proceeds in an auction. proactive out-reach to the close circle There are many degrees of freedom in of natural buyers can be done quietly. the value proposition, and price is but one All auctions are not created equal – in of them. Timing, consideration and risk, fact, there is a spectrum of tactics. There stapled financing, tax, governance, control, are a number of auction methods that people and chemistry, are all equally can be used. Managed book building, important issues. The maximisation of any discriminatory auctions, and uniform price one of these elements, such as price, can auctions are alternative approaches to be achieved through the careful calibration dialogue with multiple potential bidders. of the other elements, based on your The transparency of formal auction knowledge of what else matters to each of methods can lead to more competitive the potential buyers. pricing, but actually can work poorly in cases vulnerable to inaccurate information. There are ways the buyer can increase odds of being the successful bidder in an auction. For example, where the number of There are many elements to the value investors and the accuracy of investors’ proposition beyond price per se, though information is endogenous, managed book that is an obvious starting point. The form building controls investor access, allowing of consideration – cash or stock – and its reduced time and risk for both buyers risk also matters. Even in comparing all and sellers. It also controls spending on stock deals, risk can vary. M&A collars can information acquisition, thereby limiting be used to tailor the risk profile of stock underpricing. Interestingly, the US book deals to bridge differences in outlook building method has become increasingly between buyers and sellers. Similarly, popular for IPOs worldwide over the last deal structure also matters. Deals may be decade, whereas sealed bid IPO auctions structured differently for advantageous have been abandoned. tax treatment, alternative governance structures, etc. Finally, deal terms around Key success factors timing, board seats, control, management, etc., are often more important issues than There are many common mistakes made in deal price. auctions. Many companies fail to prepare adequately, often seeing the auction as Auctions of the future the end rather than a simple means to an end. In this preparation the development Sellers are increasingly attempting to of a clear and compelling ‘equity story’ ‘clean-up’ the target’s operations in of about the business, strategy and ‘right advance of conducting an auction, even to win’, markets, competitive dynamics, to the point of investing capital, making advantages, risks and prospects is essential. changes to management, and revising Advance planning is essential – the seller strategies. They are also increasingly should conduct their own in house due making sure that any contingent risks in the diligence to surface the relevant issues and business are resolved or mitigated. avoid any surprises. In terms of the balance of power www.financierworldwide.com | FW 79 INTERNATIONAL MERGERS & ACQUISITIONS 2008 going forward – if auctions will take and complexity reduction at each of the precedence in future transactions, or if intersections of business segment and privately negotiated deals ultimately value chain activity. Correlation between are preferred, the answer is most likely portfolio coherence, and financial measures some hybrid that falls between these of performance, growth, and valuation is two extremes. A professionally managed typically strong. process that quietly targets the (limited) natural circle of interested parties, and For example, our initial estimate of Citi combines the rolling disclosure of private coherence is roughly 45 percent, far below negotiation with the competitive bidding of the level we expect was envisioned for an auction mechanism. this portfolio. While Citi could improve coherence through a streamlining of its Fix versus sell: the portfolio coherence portfolio (e.g., auction assets), it could perspective also achieve a much higher level of coherence through operational means When a stock languishes, delivering total while maintaining the existing portfolio shareholder returns below the cost of composition. An improved articulation of capital and trading at valuations below portfolio strategy, including a roadmap publicly-traded comparables, buy-side for portfolio coherence, plus improved and sell-side analysts call for bold change execution, manifesting in enhanced to serve as a catalyst for the stock and a growth and returns on equity, can be revision to investor expectations (in some even more effective routes to sustainable cases, operating performance and business value creation than a change in portfolio integration are more problematic than composition. portfolio composition per se). We often see opportunity for a much greater degree of Justin Pettit is a partner at Booz Allen ‘portfolio coherence’ – greater integration Hamilton.
80 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Domestic versus foreign acquirers: managing an international sale process
by Darren Redmayne and Saurin Mehta
There is a rising level of cross-border US-based assets and vice versa. acquisition activity occurring among European and US companies and private Merits of domestic and foreign acquirers equity firms. As these entities increase their appetite for international targets, it When deciding whether to choose a foreign is prompting business owners to scrutinise acquirer over a domestic acquirer, a seller the advantages and commensurate will commonly ask ‘Is it worth the hassle?’ challenges of selling to a domestic versus This question is rooted in several complex foreign acquirer. themes – familiarity, transaction risk and the long-term fit of the business within the This article discusses the common issues new organisation. All are critical to ensuring a seller must consider when marketing a successful sale. a business that is likely to attract international interest. A seller must be Human instinct gravitates towards thoroughly prepared to ensure a smooth familiarity and cautiously approaches the sale process. In particular, we will examine unknown. Domestic buyers are naturally the following: (i) the relative merits of more familiar with targets in their selling to a domestic versus foreign own country and the market dynamics acquirer; (ii) how to manage a foreign buyer impacting those assets. The buyer and seller during the sale process; (iii) recognising enjoy cultural similarities – the business localised issues; and (iv) understanding the customs are identical, people act in a due diligence process. similar manner and there are no language barriers. However, this same familiarity Although it is virtually impossible these may also lead to seller trepidation when days to discuss globalisation without some contacting domestic acquirers which are reference to China or India, transatlantic deemed competitors. The prospect of M&A activity between Europe and the disclosing critical information to the enemy US still remains robust. In 2007, there often causes sellers to hesitate. Conversely, were over 1500 transatlantic deals with sellers frequently see foreign competitors a total disclosed value of nearly $625bn, as less threatening, partly, and due to the according to Mergerstat. An October 2007 foreign acquirers’ lack of familiarity with, Mergerstat survey found respondents and presence within, the local market. optimistic that transatlantic M&A will continue, with 77 percent believing the The second aspect sellers must consider volume of deals will increase or remain the is transaction risk. Although risk is same over the coming year. Recognising inherent with any buyer, there typically is and appreciating these trends, this article heightened concern surrounding a foreign revolves around European firms acquiring acquirer’s ability to secure financing and www.financierworldwide.com | FW 81 INTERNATIONAL MERGERS & ACQUISITIONS 2008 complete due diligence, both of which ensure maximum participation by foreign directly impact certainty of closing. A acquirers (especially strategics). At the foreign acquirer and its lender may require onset, a strategic buyer carefully weighs the extra time to familiarise themselves with resources required to participate in any sale local accounting principles and business process. This bar is even higher for a target standards. In an effort to expedite the 3000 miles away, thus requiring additional process of securing financing, the seller’s time to garner the buyer’s blessing to adviser may recommend the buyer work pursue the opportunity. By contacting with the lender’s local offices or affiliates. foreign acquirers a few weeks earlier than If unavailable, the foreign acquirer may domestic buyers, a seller may level the be best served teaming with a financier playing field and prevent domestic parties in the target’s country instead. Of course, from moving too far ahead and scaring off financing is a non-issue if the buyer is a international interest. The adviser may also strategic that can write a cheque from consider using its local offices to introduce its cash-laden balance sheet or has pre- the target (in the local language) to established credit lines dedicated to maximise marketing effectiveness. Once a acquisitions. foreign party is engaged in the process, the seller may contemplate additional actions The third, and perhaps most important, to intensify interest, such as conducting a merit to evaluate is the long-term fit mini ‘road show’ on the potential buyer’s of the selling business within the new home soil, which also gives them a chance organisation. A domestic acquirer may fold to meet and evaluate several potential the acquired asset into an existing division, owners early in the marketing process. lessening management’s independence and control. Synergies tend to be focused on cost cutting initiatives. A foreign acquirer, on the other hand, is likely to view the target as an entry vehicle into a particular geographic market, and its valuation may A foreign acquirer is likely to view the target as an reflect a market entry ‘premium’. The entry vehicle into a particular geographic market, seller’s management team is critical, as they will be relied upon to run the business and its valuation may reflect a market entry post-acquisition while the parent company ‘premium’. sits thousands of miles away. Further empowering management is the potential opportunity to ‘play with a larger train set’, given the revenue synergies a foreign owner may provide via international growth The strategies to maximise foreign acquirer opportunities. participation continue into the latter stages of a transaction. For instance, a How to manage a foreign acquirer during dinner the evening before a site visit is the sale process often an effective icebreaker, leading to a more productive, informative meeting A seller’s adviser can take actions at the following day. The opportunity to every stage of the marketing process to meet in a less formal setting may help
82 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS overcome some of the uncertainties and as these advisers are typically not hired cultural differences that exist between by the buyer until after entering into an the buyer and seller. In due diligence, the exclusivity period with the seller. In Europe, use of electronic data rooms is a must for the seller will often engage an independent any target hoping to solicit international accounting firm to draft a due diligence interest. The ability of a buyer and its report before starting the sale process. vendors to access information online By having this report completed earlier, anywhere in the world, at anytime, the seller mitigates the risk of a buyer neutralises the inefficiencies and costs backing out of a transaction during the that may make foreign buyer participation exclusivity period and the buyer is able to otherwise prohibitive. more accurately assess the target prior to investing substantial human and financial Recognising localised issues resources. Once the exclusivity period begins, the independent accounting firm Just as every deal has its nuances, every ceases to work on behalf of the seller and region has its unique hot buttons. For instead, provides additional services, as example, in the UK, pension-related required, to the buyer. matters are a top priority. Meanwhile, environmental issues are a primary focus If a seller decides to move forward with a in the US. Even more divergent are UK and foreign acquirer, the buyer is well advised US perspectives on representations and to use locally-based legal counsel and due warranties. In the US, a buyer and seller diligence vendors. Though a small nuance, may engage in a bitter debate over the the use of professionals with domestic reps, warranties, caps and indemnifications knowledge and experiences is critical to provided in a purchase agreement. ensure a speedy diligence process with Conversely, the only rep a UK financial minimal hurdles. sponsor provides is that the group owns the shares it is contemplating selling. A Conclusion knowledgeable adviser, particularly one with a local presence in key geographies, So what does this tell us when choosing can quickly discern those issues on which a between domestic and foreign buyers? foreign buyer will focus, allowing the seller Unfortunately, the most common answer to proactively address such concerns before is ‘It depends.’ Every deal has unique they become an impediment to the sale. dynamics that impact which buyer is best suited for a given target. The seller must sift Understanding the due diligence process through these complexities to determine whether and how to include financial buyers A discussion of domestic and foreign in its sale process. acquirers is incomplete without highlighting that the due diligence process is notably One thing that is certain, however, is that different in the US and Europe. In the corporations and private equity groups US, independent vendors (primarily large in Europe and the US continue to remain accounting firms) play a prominent role hungry for acquisitions. Financial sponsors in finalising the due diligence process. have raised record equity capital over the However, diligence is backend loaded, last few years and despite the recent credit www.financierworldwide.com | FW 83 INTERNATIONAL MERGERS & ACQUISITIONS 2008 crunch, moderate liquidity still exists for buyer participation in a sale process. The debt cheques under $200m. Valuation vigilant execution of these techniques may multiples and debt pricing for targets with enable a seller to capture the coveted ‘entry sound fundamentals remain reasonable premium’ a foreign buyer may place on a and buoyed by competition among target designated as a market entry vehicle. strategic and financial buyers. Perhaps most importantly, many European firms are Here, we have covered issues related to capitalising on the opportunity to acquire US and European buyers and sellers. As US targets at ‘bargain’ prices given the India, China and other developing regions continued strengthening of the euro over continue to become more acquisitive and the dollar. alter the M&A landscape, the domestic versus foreign buyer debate is certain to While possibly daunting at first, a seller evolve over the next several years. is well advised to consider foreign buyers in an effort to generate the highest value and best terms for its asset. With the aid Darren N. Redmayne is a managing director of an experienced adviser, a number of and UK CEO, and Saurin Y. Mehta is a vice strategies are available to maximise foreign president, at Lincoln International, LLC.
84 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Going global: successfully negotiating multi- jurisdiction transactions
by Richard R. Willis, Chris G. Baugher and Anthony M. Balloon
With the continued development of similar to − but simultaneously different the ‘global’ economy, more and more from − any other domestic deal a company businesses find themselves looking for undertakes. Failure to appreciate this acquisitions, joint ventures and strategic critical tension can at best make a deal alliances outside of their home country. more difficult and expensive than preferred. As the world globalises, it is only natural At worst, it can either derail a deal prior to that transactions themselves all take closing or create unnecessary post-closing on an increasingly global character. For challenges. example, the recent decline of the US dollar relative to other major currencies has Note, however, that the below commentary served to hasten this phenomenon as many is quite selective and is meant to include outside enterprises look to invest in the among its audience not just dealmakers United States. It is almost inevitable that who are accustomed to transactions in transactions in a foreign jurisdiction, and many jurisdictions, but also those who are potentially across multiple jurisdictions, are venturing into a foreign jurisdiction for the increasingly on the horizon for companies first time. that once only dealt within national boundaries. Understand the legal system involved
While issues will vary not only from The jurisdiction in which the transaction transaction to transaction, but also from occurs, and the structure and type of jurisdiction to jurisdiction, there are certain the legal system, may have a significant principles that, if followed, will facilitate impact on the transaction and transaction the smooth operating of a transaction and documents. While this point may considerably enhance the likelihood of a seem obvious, it bears emphasising as successful deal for all involved. The general understanding the structure of the legal principles in this article may serve as areas system involved in the transaction is key of emphasis to inform the considerations to understanding both the structure of the and preparations for a transaction, whether team (particularly local advisers), as well as acquisition, divestiture, joint venture the universe of law potentially applicable to or strategic alliance, or any of the other the transaction. For example, contrast the myriad of deals that are being made, federal system in the US with the European everyday, across borders all over the world. Union. A transaction in the US may involve The goal is to provide a few select insights aspects of federal law (e.g., taxation, that may be used in most any transaction antitrust filings, environmental regulations context. or securities registration requirements), together with state law (e.g., the body of A deal in a foreign jurisdiction is both ‘corporate’ law applicable to the transaction www.financierworldwide.com | FW 85 INTERNATIONAL MERGERS & ACQUISITIONS 2008 and state employment law) and local law intended deal. Accordingly, in a civil law (e.g., zoning, commercial incentives). In jurisdiction, it is vital to talk specifically – contrast, a European transaction typically and frequently – with local counsel about focuses primarily on the law of the relevant the impact that civil code provisions may member state or states. have on a transaction.
Further contrast can be drawn between Put together the right team common law and civil law jurisdictions. A dealmaker from a civil law jurisdiction, such Putting together the right deal team is as a typical continental European country, fundamental. As a general principle, the should be generally familiar with the length, more jurisdictions involved in a transaction, detail and content of deal documents the larger and more complex the deal from other civil law jurisdictions (even if team will be. While a single jurisdiction some of the norms that operate within transaction may often involve substantive that document are decidedly different). experts focusing on various substantive But if that dealmaker moves to a common aspects of any given transaction (tax, law jurisdiction such as the US, Ireland, real estate, employment, environmental, the UK or Canada (excluding Quebec), the perhaps a litigation assessment, etc.), a familiarity may wane. The basics will largely multi-jurisdiction transaction typically be the same, but the detail and, frankly, will involve, at least incrementally, more length at which concepts are expressed such ‘experts’ and perhaps exponentially will be decidedly different. A US deal will more. Contrast, for example, an acquisition have a relatively long purchase agreement, confined in scope to the State of Georgia and the impact of what is unwritten in the in the US and an effort to purchase a pan- agreement, while not as overarching as European business that operates in each of typical civil law principles, can be significant the UK, Germany, and Poland. The Georgia (e.g., Delaware case law on fiduciary duties acquisition likely can be conducted by and deal protection, obligations under the company’s home country legal and the Foreign Corrupt Practices Act, state tax advisers plus local counsel in Georgia, employment law enforcement principles who should be familiar with both Georgia such as the ability for a court to ‘blue pencil’ corporate law as well as any federal an otherwise unenforceable agreement). requirements (e.g., antitrust notifications). The European transaction, however, likely Appreciating these differences is critical. In will require local legal and tax advisers in no civil law jurisdictions, the various civil codes less than three jurisdictions, and likely more will inform the meaning and interpretation depending on whether a tax advantageous of contractual relations, and contractual acquisition vehicle (e.g., a Benelux entity) is provisions, to a much greater extent than involved. in common law jurisdictions. Thus, the agreements can be shorter because there When assessing and executing a multi- are codes which help give meaning to what jurisdictional deal − particularly when the contracting parties have agreed. The entering a new or unfamiliar jurisdiction unwritten hazard, however, is that civil − it is important to rely on local counsel to codes can, in certain instances, imperil assess both cultural and market issues, as the ability of the unwary to affect their well as where local issues may be brought
86 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS to bear. Understanding key notifications, suggests that communication or lack of regulatory or government reviews, required effective communication is consistently a approvals and their impact on a transaction challenge in multi-jurisdiction transactions. is important. The reason is simple: the number of participants and advisers is greater than In the context of the deal team, strong those typically involved in a domestic leadership is invaluable – at the business transaction. Accordingly, it is essential level and at the transaction negotiation that the entire team is well-informed and and execution level. The legal and tax moving toward the shared goal. As new advisory team must be well-organised. issues emerge, identifying them and their In that regard, a party typically has three implications, and gathering necessary input options: manage the team in-house (e.g., from the team, is essential. This fluidity via the general counsel); look for a one- demands leadership and the accompanying stop shop to manage resources within its accountability. own geographic footprint (e.g., a Big Four accounting firm or a ‘global’ law firm) or While the above principles are not rely on an experienced outside M&A adviser exhaustive, the tenets will serve parties well (e.g., the outside law firm with whom the in any circumstance. The dealmaker who business has a longstanding relationship) to understands the legal system, has a team coordinate the team and assist in selecting of local experts, and leads the deal team local counsel. through communication and coordination should be equipped to meet the many Process and communication matter challenges which will arise in transacting business in new jurisdictions, multiple The more jurisdictionally complex the jurisdictions and throughout the world. transaction, the more the negotiation process and deal team communication become important. A deal team leader Richard R. Willis and Chris G. Baugher are cannot coordinate the transaction unless partners, and Anthony M. Balloon is an there is regular communication. Experience associate, at McKenna Long & Aldridge LLP.
www.financierworldwide.com | FW 87 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Key issues in structuring and negotiating leasing company acquisitions
by Drew S. Fine and Alexander M. Kaye
The past few years have seen heightened Among the advantages of structuring M&A activity in the leasing company sector. the transaction in this manner is the Successful bidders in leasing company mechanical simplicity of consummating auctions have included strategic buyers, the acquisition. There is no need to go private equity players and both US and non- through the sometimes cumbersome US investors. The acquisition of a leasing process of re-registering the tangible company involves many of the issues that assets in the purchaser’s name. In addition, confront buyers and sellers in typical M&A because the company itself is being sold transactions, as well as a number of leasing (as opposed to the underlying assets), it and finance related matters that are specific will often not be necessary to obtain third to acquisitions in this space. This article will party consents to the assignment of the discuss certain material issues that need to company’s contracts (although care should be considered, as well as the key pitfalls to be taken to make sure that ‘change of avoid, when structuring, negotiating and control’ provisions, if any, are addressed drafting an agreement for the acquisition of appropriately). This helps to shorten the a leasing company. time period between signing and closing and removes uncertainty from the deal, as Structuring the transaction the occurrence of the closing does not need to be made contingent on the receipt of Although a leasing company acquisition such consents. can take many forms, the most common structures often involve one of the However, one of the key disadvantages following three alternatives: (i) the of the Holdco-purchase structure is that, purchase of the entire company (i.e., the by purchasing the equity of the entire stock of the upper tier Holdco); (ii) the company, an acquirer will generally be direct purchase of the underlying assets unable to leave behind any assets or (e.g., a portfolio of aircraft); or (iii) the liabilities of the company being acquired, purchase of the special purchase vehicles whether known or unknown. The reality (SPVs) which hold the underlying assets. of taking on all of the acquired company’s known liabilities, and the possibility Purchase of Holdco. In the first method of taking on unknown liabilities (such of acquisition, the acquirer purchases as potential lawsuits, undiscovered the entire leasing company. This is environmental claims and employment- accomplished through the transfer to the related liabilities) necessitates a full, purchaser of all of the outstanding shares traditional legal and financial diligence of stock (or other equity interests in) the of the target company, along with its upper-tier Holdco – the entity which owns attendant costs. all of the asset-owning subsidiaries.
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Purchase of assets. The second method definitive time and place of closing. of acquisition, the direct purchase of the actual underlying assets (e.g. the ‘metal’ Purchase of SPVs. Many leasing companies of the aircraft, ship, rail car, container, put their leased-assets into SPVs for a etc.) addresses the major downside of the variety of reasons, including limiting the first method. It is possible to structure an spread of potential liability and for ease of asset purchase agreement so that only transfer. Another method of acquisition the desired assets are acquired, thereby can be effected through the purchase of significantly limiting the buyer’s exposure all of the outstanding equity interests to the liabilities that would otherwise be in each asset-owning SPV. This form of transferred with the purchase of an entire acquisition marries the simplicity of a stock company. Of course, an acquirer who also transfer with the benefits of a direct asset takes an assignment of the operating purchase. For example, SPVs often have no leases will by contract law be assuming employees, are party to very few contracts the obligations and liabilities arising under (other than the operating leases) and own those leases. no real estate. Therefore, although the liabilities of the SPV are not retained by the However, despite its seeming conceptual seller (but remain with the SPV), it is likely simplicity from a legal point of view, that the liabilities just relate to the assets the direct purchase of transportation- being purchased, as most of the these related assets is a complicated asset-owning entities were formed and transaction in a mechanical sense. The structured solely for the purpose of holding direct transfer often requires complying the relevant assets. with government approvals or formal registration with official registries, and However, care should be taken during due may have incremental tax consequences diligence to confirm that the SPV did not to both sellers and purchasers. As an take on additional liabilities since formation example, aircraft are often registered in (and appropriate representations to that the country where the lessee is located. If effect should be included in the definitive a purchaser purchases a portfolio of 100 acquisition agreement). For example, an aircraft on lease to 30 lessees located in 25 SPV may have guaranteed debt incurred countries, then the seller and purchaser by the seller unrelated to the assets being may need to make appropriate local filings acquired. Structured correctly, a transaction and registrations in all 25 countries to involving the acquisition of special-purpose consummate the purchase. Also, since entities will grant to the buyer ownership the underlying leases will also need to of the assets in a manner which ideally be transferred to the purchaser, there reduces the key concerns raised by the may be a need to involve all 30 lessees other two methods: the mechanical and in the transfer process. Planning for and timing considerations involved in a direct accommodating these issues requires asset transfer, and the difficulty of ‘leaving in-depth knowledge of the nuances of liabilities behind’ in a Holdco acquisition. the various laws which may come into play. In addition, it is wise to consult with Diligence local counsel in the various jurisdictions where assets reside prior to scheduling a The possibility of any of these transaction www.financierworldwide.com | FW 89 INTERNATIONAL MERGERS & ACQUISITIONS 2008 structures yielding the expected trouble- physical inspections of each aircraft free results depends in large part on the and the production of highly detailed adequacy of the diligence performed prior lease summaries. Whereas the purchase to and contemporaneous with the drafting of a large pool of standardised leased of any purchase agreement. Thorough legal office equipment may merit no physical and financial due diligence is the foundation inspection and shorter, less complicated of any successful corporate acquisition. lease summaries, highly sophisticated deals Among other things, a good due diligence may involve a mix of assets, including assets investigation will help a savvy buyer: (i) which have yet to be produced or which uncover contingent or hidden liabilities; may be acquired only upon occurrence of (ii) better understand the day-to-day certain conditions (such as the conversion operations of the business; (iii) determine of a passenger jet into a freighter jet). Such the key areas of weakness in the business, deals require customised diligence which as well as the areas having the most matches the sophistication of the deal. potential for growth opportunities; and (iv) determine whether its proposed purchase Lease and financing due diligence, price is justified by the financial condition, particularly of moveable assets, demands a results of operations and prospects of the specific analysis of the terms and covenants business. which govern the relationship between the lessor and lessee. It is important to In addition, a good diligence investigation understand at the outset of the diligence will often uncover areas of concern that process that provisions which are fairly a buyer may want to address through routine in other contracts can present a seller representations (and accompanying costly, even insurmountable obstacle to the indemnification obligations) in the purchase successful completion of a deal, if present agreement. More importantly, a thorough in a lease or other financing document. For diligence examination allows a buyer to example, the added expense of negotiating discuss its concerns with the seller prior around a change-in-control provision may to entering into the definitive acquisition make a deal prohibitively expensive for agreement. both the seller, who must get a waiver of the condition, and the buyer, who may not In the context of leasing company be able to afford the risk of enforcement if acquisitions, due diligence encompasses a waiver cannot be obtained. Even where both corporate diligence (of the target added expense is not an issue, a deal company or SPV) and the particularly may be delayed while experts assess the specialised expertise required for asset and risks involved with moving forward with a lease diligence. transaction.
Depending on the size and value of the Also, there are many complicated lease assets involved in a particular deal, asset structures and provisions which contain and lease diligence may be a long and traps for the unwary, such as: (i) the right of exhaustive process or a relatively short a lessee to purchase the asset at a bargain one. Deals involving large and expensive purchase price; (ii) the right of a lessee to assets, such as the acquisition of dozens return the asset in a poor condition; (iii) of aircraft then under lease, may require underinsured assets; (iv) the obligation of
90 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the lessor to make substantial contributions typically sold ‘as is’ ‘where is’ since the to the maintenance or other costs related assets are typically in the possession of to an asset; and (v) lease arrangements the lessee and the seller has no ability to where a third party (which may or may not put the assets in any particular condition. be creditworthy) holds title to the asset. Accordingly, it is expected that the buyer Also, where the assets to be purchased will perform due diligence on the assets. are located in many countries around Additionally, although the seller may the world, it may be desirable to retain indemnify the buyer for breaches of general local counsel in each jurisdiction who can representations, warranties and covenants, advise the purchaser of the burdens of it will typically not provide indemnity repossessing the assets in the particular protection for losses relating to the jurisdiction should the lessee default. condition of these assets.
Approvals There are not many covenants unique to the acquisition of leasing companies. In addition to the standard approvals, Generally, a purchase agreement will consents and government filings that must contain covenants: (i) restricting the be obtained or addressed in an ordinary amendment of current leases; (ii) acquisition (e.g., permit transfers, HSR prohibiting optional modifications to the antitrust clearance), a leasing company assets; and (iii) prohibiting liens on the acquisition may require additional assets (with exceptions for ‘permitted approvals and filings depending on the liens’). types of assets involved. Moveable assets are often located in multiple jurisdictions; Indemnity clauses generally provide for approvals (including anti-competition cross-indemnity, with the seller responsible clearance) may therefore be required based for risks attributable to the period prior to on the location of the asset, where the asset the sale and the buyer responsible for risks (such as an aircraft or ship) is registered or attributable to the period after the sale. flagged, and/or where the SPV which owns the asset is incorporated. Acquirers must Another key consideration for an acquirer also comply with any formal procedures is management. In a highly specialised required to transfer title to the assets. field such as leasing, an acquirer will need an experienced management team. If the Other terms acquirer does not have this expertise, it should condition its obligation to close A definitive agreement for the acquisition on the entering into of satisfactory of a leasing company will contain employment arrangements with key customary representations and warranties members of management. with respect to the company and its business and operations. However, one Closings – scheduling and structuring notable exception to the ‘rep package’ closings normally found in a purchase and sale agreement relates to the condition of the The closing of any deal implies timing assets being sold. In connection with a concerns involving both the scheduling sale of moveable assets, the assets are of individual availability and coordinating www.financierworldwide.com | FW 91 INTERNATIONAL MERGERS & ACQUISITIONS 2008 the distribution of documents and the (i) waiting to close until the assets are delivery of the assets (if needed). There are located in a ‘tax-friendly’ jurisdiction; or particular concerns with moveable assets, (ii) structuring a staggered closing so that especially transportation assets, which the transfer of any particular asset only may not be evident to parties who do not occurs when such asset is located in such a regularly conduct business in the field. jurisdiction. These added concerns can impose both a financial and time cost if not anticipated Conclusion and properly coordinated. When properly structured and conducted, Transfer tax leasing company acquisitions can be exciting and lucrative opportunities, but When selling moveable assets, the location like all complex deals, such acquisitions can of the asset at the time of the transfer also be an expensive trap for the unwary. may determine whether a transfer tax Only investors who recognise the need for needs to be paid. Transfer tax laws vary by industry expertise and have acquired or are jurisdiction. For example, transfer taxes are willing to acquire that expertise can hope to not consistently and uniformly imposed be rewarded. within the US, let alone internationally. In any event, tax counsel in the relevant jurisdictions should carefully examine this issue. Generally speaking, the parties can best ensure that the transaction Drew S. Fine and Alexander M. Kaye are will not trigger a transfer tax that could partners at Milbank, Tweed, Hadley & McCloy have otherwise been avoided by either: LLP.
92 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Drafting material adverse change clauses
by Jeffrey Rothschild, Nick Azis, Patrice Corbiau, Dennis White and Abigail Reed
Merger and acquisition contracts typically Delaware Court of Chancery did not regard feature a material adverse change or this downturn as affecting IBP on a long- material adverse effect (both abbreviated term basis. In the standard set by the court here to MAC) clause, under which a buyer in IBP, a party seeking to invoke a MAC may exit the deal or renegotiate terms if clause and terminating a deal faces the high an unforeseen material adverse business burden of proving that the events claimed or economic change affecting the target to be a MAC “substantially threaten the company occurs between executing the overall earnings potential of the target in acquisition agreement and closing the a durationally-significant manner. A short- transaction. A MAC clause also provides term hiccup in earnings should not suffice; the seller with a means of qualifying certain rather the [MAC] should be material when representations and warranties so that viewed from the longer-term perspective immaterial breaches are ignored (at least of a reasonable acquirer”. The court for purposes of closing). MAC provisions determined that IBP had not suffered a are heavily negotiated, with buyers seeking MAC, and, as a result, Tyson Foods was broad MAC clauses for maximum flexibility forced to complete the purchase. to exit the transaction. Not surprisingly, sellers prefer narrow MAC clauses to ensure Frontier Oil Corp. v. Holly Corp,. C.A. No. that the transaction closes at the agreed- 20502 (Del. Ch. Apr. 29, 2005), which upon price. Understanding how courts view embraced the standard set forth in IBP these MAC clauses, as well as recent trends as Delaware law, also demonstrated the in their drafting, is essential in negotiating importance of carefully crafting MAC M&A transactions. clauses. The court noted that the phrase ‘would have’ or ‘would reasonably be MAC clauses in the US expected to have’ a MAC, as used in the agreement at issue, created an objective Below are details of a few cases regarding test with a significantly higher threshold MAC clauses which have been litigated and than the wording ‘could’ or ‘might’. This decided. standard requires a buyer to examine not only current conditions but also the future, In In Re: IBP, Inc. Shareholders Litigation, and to produce evidence of a long term 789 A.2d. 14 (Del. Ch. 2001), the merger downturn. agreement contained a broad MAC clause with no carve-outs. Tyson Foods asserted The MAC clauses at issue in Frontier Oil that IBP, the target, had suffered a material and IBP were similar in that they both adverse effect because its first quarter 2001 contained a qualifier that a given effect earnings were 64 percent behind those ‘would reasonably be expected to’ have for the first quarter of 2000. However, the a MAC, requiring the seller to consider www.financierworldwide.com | FW 93 INTERNATIONAL MERGERS & ACQUISITIONS 2008
the impact of possible future events. The Calling a MAC as a basis to renegotiate ‘reasonably expected’ qualifier continues to make frequent appearances in MAC clauses In several recent cases, the declaration today. However, the MAC clause in Frontier of a MAC was the basis for ‘busting’ a Oil also excluded certain events, such as transaction without the dispute even general economic, regulatory or political coming to trial. SLM Corporation v. J.C. conditions or changes; financial market Flowers II L.P., et al, commonly referred fluctuations; and general changes in the to as the Sallie Mae case, was a closely petroleum industry. These carve-outs are watched and recently settled Delaware also frequently seen. Court of Chancery case, which involved a merger agreement for the $26bn sale of Sallie Mae to a consortium of investors led by J.C. Flowers II L.P. According to Flowers, new federal legislation that reduced federal subsidies to student lenders and impacted In several recent cases, the declaration of a MAC on Sallie Mae’s earnings amounted to was the basis for ‘busting’ a transaction without the a MAC, and buyers should have been allowed to terminate the deal without dispute even coming to trial. paying the agreed-upon $900m break-up fee. Sallie Mae disagreed and sued for a declaration that no MAC had occurred and that defendants had unlawfully repudiated the merger agreement. The dispute never went to trial. The parties’ settlement called Recent litigation in Tennessee, in which for the defendants to refinance $30bn of Genesco filed suit against the Finish Line Sallie Mae debt. Similarly, Kohlberg, Kravis, Inc. and Headwind Inc. (collectively, ‘Finish Roberts & Co. and Goldman Sachs pulled Line’) in the Tennessee Chancery Court, out of an $8bn buyout of stereo company also demonstrated the importance of Harman International Industries, claiming careful drafting. Genesco sought specific that Harman’s financial condition was performance of a merger agreement under unacceptable and a MAC had occurred. which Finish Line was to acquire Genesco. However, the litigation was avoided and In December 2007, the court granted the acquisition was terminated, when the specific performance, ordering Finish Line former buyers agreed to buy $400m of to complete the merger. Although the court Harman convertible debt securities. found that a MAC had occurred with regard to Genesco’s financial condition, the court MAC clauses under UK law held that its financial decline fit within a carve-out to the MAC clause contained in MAC clauses are frequently used in UK the merger agreement, since it was due to M&A transactions, but their structure and “general economic conditions” and was not content differ, depending on whether the “disproportionate to the financial decline of transaction is of private or public nature. others in its industry”. In private company M&A, a MAC clause may take the form of either a condition to
94 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS completion or, more likely, a warranty that test “requires an adverse change of very no MAC has occurred since a specified date. considerable significance striking at the The buyer will try to negotiate that the heart of the purpose of the transaction in warranty is repeated at completion so as to question, analogous to something that have a termination right exercisable if the would justify frustration of a legal contract”. warranty, when repeated at completion, is As a result, the Takeover Panel held WPP not true. A typical private company MAC to its offer. More recently, the Panel has clause will contain similar exceptions as in a stated that a bidder need not demonstrate US transaction. legal frustration, but it must demonstrate the events are of considerable significance, In public company M&A, it is standard striking at the heart of the purpose of the practice for a UK offer document to transaction. contain a MAC clause (expressed as a condition to the offer), the wording of MAC clauses under Belgian Law which is largely standardised, as follows: “[save as publicly disclosed] no adverse Although MAC clauses were only recently change or deterioration having occurred introduced in Belgium, their use has now in the business, assets, financial or become quite common. It is premature to trading position or profits or prospects or generalise any Belgian trends related to operational performance of any member MAC clauses. However, it is interesting to of the Group which in any case is material note that, in Belgium, as in the US, parties in the context of the wider Group taken as will often claim a MAC as the basis for a a whole”. However, unlike in the private renegotiation of the contract, rather than company context, there are no negotiated an immediate termination. If one of the exceptions since the UK regulation parties to the transaction wishes to protect prescribes the circumstances when a itself from a specific event, that should be condition may or may not be invoked. provided in a separate contractual clause, rather than relying on a general MAC The most significant case law regarding a clause. MAC clause in the public company context was the Takeover Panel’s ruling on WPP Drafting MAC clauses in light of case law plc’s offer for Tempus Group plc. WPP and recent disputes plc’s offer had been announced in August 2001, and WPP argued that following the Following the IBP and Frontier Oil decisions, events of September 11, 2001, a material in which buyers were unsuccessful in adverse change had occurred. The Takeover invoking a MAC to exit a deal, M&A Panel took the view that those events, practitioners began drafting agreements although exceptional, unforeseeable where a ‘material change’ was defined and a contributor to the decline that had more precisely (for example, a material already affected the advertising industry, change would occur if a target’s revenues did not undermine the rationale for the dropped 10 percent). The generally seller- terms and the price of WPP’s offer, which friendly environment of the last several were Tempus’ long-term prospects. The years has seen more frequent utilisation of Takeover Panel stated in this instance exceptions to MAC clauses. For example, that to meet the material significance it was common for a buyer not be able to www.financierworldwide.com | FW 95 INTERNATIONAL MERGERS & ACQUISITIONS 2008 claim a MAC for changes resulting from either in a tailored MAC clause or as a general economic, financial, regulatory or separately stated closing condition. market conditions, so long as the changes have not affected the target in a ‘materially Regardless of the relative bargaining power disproportionate’ manner as compared to of buyers and sellers in the marketplace other similarly situated companies. generally, or in the context of a particular deal, MAC clauses remain important However, given the expected downturn mechanisms for terminating a transaction in M&A activity and tightening of credit and special care should be taken drafting markets, the trend in deal terms generally them with precision. and MAC clauses specifically may be starting to shift in favour of buyers as they seek more flexibility in terminating Jeffrey Rothschild, Nick Azis, Patrice Corbiau transactions. If a buyer has identified and Dennis White are partners, and Abigail certain concerns regarding a target, those Reed is an associate, at McDermott Will & concerns should be addressed specifically, Emery LLP.
96 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Deal certainty and recent dislocations in the credit and M&A markets
by Derek Stoldt
Deal certainty has always been a key signing of the transaction. IBP v. Tyson, the component in mergers and acquisitions, but leading Delaware Chancery Court case on the recent difficulties in closing transactions the interpretation of MAC clauses, makes have underscored its importance. This it clear that MAC clauses are a high bar to article analyses trends in deal certainty and clear. In that case, the judge explained the the impact of the recent dislocations in the purpose of MAC clauses as a “backstop credit and M&A markets. protecting the acquirer from the occurrence of unknown events that substantially In the context of M&A auction dynamics, threaten the overall earnings potential the bidder with the highest price is of the target in a durationally significant usually the favoured buyer, but a bid manner”. The court elaborated that with significant execution risk is not an ‘durationally significant’ meant a period appealing option regardless of whether measured in years rather than months. that bid carries the highest price. Sellers In that opinion, the court admonished are understandably concerned that a failed parties to purchase agreements to sale process will leave the target being adopt closing standards specific to the viewed as damaged goods. As a result, deal rather than to rely on generic MAC sellers and their advisers carefully focus conditions. Notwithstanding the court’s on the closing conditions proposed by encouragement, our annual survey of key bidders. Here, we examine three typical and LBO terms shows that MAC clauses remain significant closing conditions: (i) material pervasive, with 94 percent of deals in the adverse change (MAC) condition (taking survey utilising a MAC condition. into account any carve-outs); (ii) bring- down of representations; and (iii) financing MAC carve-outs contingency. While a MAC condition sets a high MAC condition threshold, sellers have been able to raise the bar even higher by introducing ‘carve- The typical MAC condition permits a outs’ to the MAC standard. MAC carve-outs buyer to refuse to close the transaction if a are categories of changes that may not material adverse change on the business, be taken into account when measuring operations, assets or financial condition whether a MAC has occurred. Common has occurred from a specified date or MAC carve-outs include changes due to is reasonably likely to occur. Generally general economic downturns; changes speaking, the purpose of the MAC clause in the industry of the target; changes is to assure the buyer and its lenders that in law or GAAP; war or terrorism; and at closing the target will look substantially announcements or pendency of the as it had been represented to look at the proposed transaction. By adding carve- www.financierworldwide.com | FW 97 INTERNATIONAL MERGERS & ACQUISITIONS 2008 outs, sellers further shift the risk of adverse to compel closing. The purchase agreement changes to buyers. included a MAC closing condition with a series of carve-outs, including one that Our survey shows that the use of MAC excused “changes in the national or world carve-outs has increased significantly in economy or financial markets as a whole recent years. For example, carve-outs or changes in general economic conditions based on changes in a target’s industry that affect the industries in which the increased from 50 percent in deals signed Company and the Company Subsidiaries in 2002/2003 to 86 percent in 2006/2007. conduct their business”. The court held that The use of carve-outs based on changes in a MAC had in fact occurred but that the laws was even more dramatic, increasing MAC was caused by a general decline in from 10 percent to 79 percent over the the economy and the target’s industry. This same period. Similar increases can be seen transaction stands as a stark example of in each of the other commonly-used carve- the importance of MAC carve-outs: without outs. the carve-out, the buyer and its lender would have been excused from closing the The overall effect is to make it more and transaction, but with the carve-outs, the more difficult to establish that a MAC has deal was compelled to move forward. occurred, thereby increasing deal certainty for the seller but putting the buyer and the buyer’s lender at greater risk in the event of unforeseen changes, regardless of their cause. The lender in the leveraged buyout can be placed in a particularly difficult position when a MAC occurs that is excused Recent transactions have shown how important MAC by a carve-out. The lender still needs to carve-outs can be. make the loan (and try to sell a portion of the risk to other institutions) at closing but the company may be in a substantially worse condition than when the lender signed its commitment letter.
Recent transactions have shown how Several other troubled deals moved important MAC carve-outs can be. In forward based on similar fact patterns. In June 2007, Finish Line, Inc. entered into light of these experiences, we would not an agreement to acquire fellow footwear be surprised if buyers began to push back seller, Genesco Inc. Shortly after the parties against the use of carve-outs. However, signed the purchase agreement, the in the current market, there are still many target’s earnings slid significantly to a level buyers pursuing few high quality targets. among its lowest in 10 years. Importantly, As a result, sellers’ negotiating power the businesses of other companies in the continues to be high. We can expect footwear industry and the general economy lenders to push to delete MAC carve-outs similarly declined. At the same time, the both in the purchase agreement and their credit markets dried up. The deal stalled commitment letters. and the target sued the buyer and its lender
98 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
Bring-down of representations offering or agreeing to the MAE bring-down standard; we will watch to see if this trend The concept of MAC and the corresponding levels off. We expect these points to be phrase ‘material adverse effect’ (MAE) are hard-fought and to test negotiating power central to another key closing condition from deal to deal. known as the ‘bring-down’ condition. Typically, the seller and target make a Financing contingencies and reverse series of representations and warranties break-up fees at the time of the signing of the purchase agreement. The bring-down condition The financing contingency or ‘financing measures the extent to which those out’ permits the buyer to refuse to close representations and warranties remain the transaction if it is unable to raise the accurate at closing. The bring-down necessary third-party funds to pay for the condition usually utilises one of two acquisition. In the typical leveraged buyout, subjective standards. The more buyer- the target’s own financial condition serves friendly standard would excuse closing as the basis for the acquisition financing. unless each representation is true and Therefore, if the condition of the target correct at closing in all material respects. falters, the financing is that much more The less stringent, more seller-friendly likely to fail. standard would excuse closing only if the inaccuracy of the representations and Our survey is based solely on private warranties taken as a whole would result acquisitions that are funded by 144A debt in an MAE. Not surprisingly, buyers prefer transactions, which can often take months the materiality standard because it ensures to arrange, so it is not surprising that that the business will look much like it did at the vast majority of transactions in the signing. The MAE standard permits greater survey (78 percent overall and all deals in changes in the business between signing 2006/2007) include a financing contingency. and closing without permitting the buyer to refuse to close the transaction. The pervasiveness of financing contingencies has led to a common practice Traditionally, the MAE bring-down was in public-to-private transactions in the used in public company deals, while the US known as a ‘reverse break-up fee’. The materiality standard was used in private reverse break-up fee provides that the transactions. Our survey shows that the buyer must pay a fee to the target if the MAE bring-down standard has become financing contingency is exercised and more pervasive over time. In 2004, only 43 the deal does not close. However, as the percent of the transactions in the survey recent credit crunch unfolded, we saw that used a MAE standard and the remainder some buyers used the reverse break-up used the stricter standard. Transactions fee to their advantage – some buyers and signed in 2006/2007 used the MAE standard their lenders believed it was economically 71 percent of the time, a two-fold increase advantageous to pay the reverse break-up from 2004. fee and terminate the agreement rather than to proceed with an acquisition they In recent years of frenetic activity, buyers viewed as over-priced in light of troubled have sought to stand out in auctions by market conditions. In other cases, the www.financierworldwide.com | FW 99 INTERNATIONAL MERGERS & ACQUISITIONS 2008 threat of termination of the agreement are likely to result in an increased focus based on a combination of the financing on the entire package surrounding deal contingency and a claimed MAC condition certainty. In the current environment, the (whether or not such claim was justified) led main players are even farther apart than to renegotiations of price and other deal ever. Sellers are seeking as much certainty terms. to closing a deal as possible. Buyers are still eager to do deals, but may be unwilling Sellers have been fighting for removal of to take the risk of funding the entire financing contingencies altogether, but transaction if the debt markets continue may find buyers increasingly unwilling to their dislocation again or if earnings of remove them. One alternative is to rely the target fall off. Lenders have more on reverse break-up fees at levels that LBO loans on their books than they can create significant incentives to close the syndicate and are reluctant to sign on to transaction. new deals unless they can be assured the debt can be syndicated at closing. We can Effect on deal dynamics expect all three to fight their corners as hard as possible. The large number and high-profile nature of transactions that have turned sour recently Derek Stoldt is a partner at Kaye Scholer LLP.
100 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Drafting and negotiating purchase agreements to anticipate challenges
by Marc C. D’Annunzio and Wayne N. Bradley
‘Nothing good can happen between agreement is signed. It is also customary to signing and closing’. This time-worn adage include a list of exceptions to events that makes the point that the longer the period would otherwise constitute a MAC − for between the time a deal is signed and its instance, effects caused by force majeure closing, the greater the likelihood that events or changes in generally accepted some circumstance arises that gives a buyer accounting principles. second thoughts or creates grounds for a renegotiation of the price or other material A number of recent Delaware court terms. decisions have addressed a buyer’s use of a MAC clause to walk away from a signed This saying has been amplified by recent deal. These decisions have solidified the events. After the tightening in the credit notion that a MAC clause generally covers markets that began in the summer of 2007, only those instances where (i) events were buyers, financial sponsors and lenders unknown by the buyer at the time the alike have scrutinised their agreements agreement was signed, (ii) those events for ways to avoid or renegotiate deals that have a long-term, significant negative looked less appetising in the new, uncertain impact on the target’s business, and (iii) had market. This reality makes the negotiation the buyer known of them, it would not have and drafting of these agreements even agreed to the deal. As a result, most M&A more important, so that parties can ensure practitioners agree that relying on a general that these risks, and their consequences, MAC clause to cover known, specific risks are appropriately addressed. is not the best approach, and advise that where a buyer is aware of a specific risk, This article will briefly identify and discuss that risk should be addressed and allocated certain common issues and the ways in elsewhere in the contract. which agreements can address them. In recent years, the availability of affordable The material adverse change condition credit and the boom in private equity fundraising, coupled with a lack of quality The ‘material adverse change’ (MAC) acquisition targets, have resulted in an clause is a fixture in acquisition agreements M&A market where sellers have enjoyed − and for the majority of its existence, considerable negotiating leverage. This its basic recitation has been remarkably has manifested itself in the negotiation of standardised. Conceptually, it provides several additional MAC carve-outs − such that a buyer is not obligated to close a as for ‘changes in securities markets’ and transaction if the target has experienced, or ‘changes in the trading price or volume is reasonably likely to experience, a material of target’s stock’ − which further limit adverse change in its business after the instances where a skittish buyer can allege www.financierworldwide.com | FW 101 INTERNATIONAL MERGERS & ACQUISITIONS 2008 that a MAC has occurred. board of directors’ ability to consider and take competing, and possibly superior, In today’s uncertain environment, buyers offers. Omnicare, coupled with the seller- have attempted to walk away from signed friendly market conditions of the last few deals, and a number of them have relied years, has greatly enhanced a target’s on the MAC clause as a basis for doing so. ability to negotiate more latitude to Take, for instance, the proposed purchase consider competing offers. of Genesco Inc. by Finish Line Inc. After Genesco’s second quarter 2007 earnings A prime example of this leverage is the ‘go- announcement, which was well below shop’ provision. It enables a target, rather expectations, Finish Line and its lender, than engaging in a traditional auction or UBS Securities, alleged that a MAC had market check prior to signing a definitive occurred and sought to use that as a reason agreement with a buyer, instead to conduct to walk away from their obligations. In that market check after the definitive response, Genesco sued Finish Line seeking agreement is signed. In effect, the target to compel it to close the deal. In awarding takes its signed deal to the market for a in favour of Genesco, a Tennessee judge predetermined period, using the buyer as noted that the material adverse change in a stalking horse. While the legality of go- Genesco’s earnings was part of an industry- shops have not been challenged to date, wide slowdown in shoe sales and thus they represent an interesting response to was carved out of the definition of a MAC. recent Delaware case law and the changing While this dispute has not yet been finally market environment. resolved, it illustrates the importance of the MAC clause and its various exceptions. Break-up fees
Go-shop provisions In public company acquisitions, it is common practice that a break-up fee A related issue is the extent to which a is paid to the buyer if the deal does not target − usually a public company − can close because of certain events − most agree to a ‘locked up’ deal, where the target frequently, if a competing offer for the is compelled to close the deal even where a target emerges from a third party, and third party makes a superior offer to acquire the target terminates its agreement with the target after the initial acquisition the buyer to enter into the new deal. After agreement is signed. years of evaluation and scrutiny by courts, it is commonly accepted that, in most The Delaware Chancery Court’s 2003 circumstances, these break-up fees will be Omnicare decision injected much enforceable if they are in the range of 2-3 uncertainty into what had been a fairly percent of the total transaction value. well-settled area of M&A practice. While Omnicare’s facts were somewhat unique, Again, however, given the leverage that and Delaware judges have narrowed its sellers have recently enjoyed, increasing application in subsequent decisions, it numbers of targets have successfully generally stands for the principle that negotiated the inclusion of a ‘reverse break- a public target cannot agree to deal up fee’ payable to the target if a deal does protections that effectively preclude its not close. Initially, these fees applied only
102 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS to terminations caused by the buyer’s weakness of the US dollar in world markets failure to procure financing; however, they − purchase price adjustments may be used have since been broadened to include other to mitigate other risks, such as foreign termination events as well. exchange risk. A US target, for instance, could insist on a purchase price adjustment Indeed, in 2008 a remarkable trend has to protect it from further devaluation in occurred. Of the seven largest private the dollar after an acquisition agreement equity deals announced in the first two is signed. Typically, these adjustments are months of 2008, none provide for the not infinite, meaning that there is some remedy of specific performance. Instead, in ‘collar’ after which no further adjustment is these transactions the reverse break-up fee made; however, they can provide additional is the sole remedy of an aggrieved seller. protection to parties in an uncertain In these circumstances, it can be argued market. that the purchase agreement effectively becomes an option, with the reverse break- In sum, while the above provisions of up fee being the cost of that option. acquisition agreements have always been important, their importance has been Purchase price adjustments renewed and invigorated by the uncertain market conditions that M&A players must The effects of a choppy market can navigate. Careful drafting and negotiation be mitigated through purchase price of these and other provisions can ensure adjustments. A common example is a that companies protect against these risks net working capital adjustment, which to the extent practical. adjusts the final purchase price to be paid up or down depending on the target’s net working capital as of the closing date. Marc C. D’Annunzio and Wayne N. Bradley However, given the current economic are partners at McKenna Long & Aldridge environment − and in particular, the marked LLP.
www.financierworldwide.com | FW 103 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Effective earn-out provisions in sale & purchase agreements
by Murray Landis and gregg mcconnell
Earn-out provisions are a powerful tool out is that it, and the manner in which it when determining the purchase price is calculated, is sufficiently objective to in the sale of a business or company. A provide a certain outcome for both parties. successfully negotiated earn-out provision will help to bridge the expectations gap The SPA should specify: (i) the mechanism, between the positions of the buyer and defined with sufficient detail (for example, seller and link the purchase price to the an earn-out measure based on a multiple of future performance of the business. EBIT should define EBIT to avoid dispute); An earn-out can be linked to any number (ii) any inclusions and/or exclusions from of business performance indicators or the calculation which are unusual (for measures (including EBIT, sales and example the treatment of non recurrent total revenue). Where an earn-out is or extraordinary items). The seller may linked to the earnings of a business more argue that certain expenditures associated difficult considerations arise in relation to with long term planning by the buyer determining the net profit which is more should be excluded from the calculation of likely to be negatively impacted by factors EBIT; (iii) whether and if so how separate within the control of the buyer. management accounts for the business sold should be prepared to properly reflect There are many reasons for the parties to its performance if the buyer acquires other include an earn-out in a sale and purchase businesses or integrates the business agreement (SPA). These reasons include: acquired into wider operations; and (iv) the (i) creating an incentive for the seller procedure for calculating and verifying the to remain involved in the business for a earn-out measure, including the dispute period following the sale; (ii) creating an resolution procedure. incentive for the seller to ensure transitional arrangements, including maintenance of Parties often find it useful to annex to the existing customer and supplier relationships, SPA an example calculation of the earn- occur with minimal disruption; (iii) reducing out measure. In addition to assisting in the the risk exposure of the buyer should the subsequent interpretation of the earn-out business not meet the required performance provision, annexing an example calculation indicators or measures; and (iv) increasing causes the parties to give due consideration the benefit to the seller should the business to the earn-out procedure prior to achieve or exceed required performance execution of the SPA, thereby minimising indicators or measures. the potential for a dispute.
Certainty of the earn-out measure Balancing the interests of seller and buyer
An essential element of an effective earn- A common problem facing a seller in
104 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS cases where the parties have agreed motivated to maximise the performance of to a component of the purchase price the business after sale, the buyer is in the comprising an earn-out payment is that better position to avoid paying the seller the seller is likely to have no or limited what he expects if the calculation of the control over the operations of the business earn-out is not adequately documented. In following the sale. As such, the seller practice, negotiating the terms of an earn- will not be in a position to maximise the out is a balance of the inherent risk tension earn-out by controlling or influencing between a buyer and a seller. the performance of the business. For this reason, a seller should ensure that the SPA Commonly the fixed sale price will be lower provides it with appropriate protections for where there is no earn-out mechanism. the earn-out. Removing the risk of the upside or downside also removes the cost/reward. Typical protections take the following In some cases the opposite can be true forms: (i) the seller or its nominee taking (for example a business sold with rising a position on the board of the company performance expectations or in a hot and/or continuing as a key manager; (ii) market). the buyer agrees to conduct the business in accordance with a business plan (which Earn-out provisions like other post should be annexed to the SPA) at the time completion adjustments are one of the of sale; and (iii) agreement on a list of more common areas for dispute between decisions that must be approved by the buyers and sellers and appropriate dispute seller before they are made by the buyer resolution mechanisms should always be (for example, a change in the focus of the included in the sale agreement to deal with business or an acquisition or divestment of these. a major asset or investment).
The seller’s desire for protection of the earn-out is, in most cases, in conflict with Murray Landis is a partner and Greg the buyer’s desire to control the business it McConnell is a senior associate at has acquired. Although both parties may be Middletons.
www.financierworldwide.com | FW 105 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Risk allocation – driving force behind the M&A process
by Walt Lemanski
Although the purchase and sale of a business is a complex process driven by The first, and most obvious, tool for many different, and often competing, allocating risk is the purchase price itself. concerns of the buyer and seller, one of In the ideal world, the purchase price the most important functions of the M&A agreed upon by the parties would take into process is to allocate the risks inherent account all known risks associated with the in any M&A transaction between the proposed transaction and the quantifiable transaction parties. Depending on the exposure associated with those risks. structure of the transaction in question and Certain types of unquantifiable exposure can the circumstances surrounding it, M&A also be allocated by making some portion practitioners have access to a number of the purchase price contingent on the of different tools to assist the parties in occurrence of certain events. Contingent risk allocation. Once specific risks have price mechanisms (often referred to as been identified, creative combinations of ‘earn-outs’) are usually used to allocate these tools can often be used to bypass business and financial risk and are often negotiation deadlocks and create a risk tied to the target’s quarterly or annual allocation structure that permits the deal financial results (e.g., earnings, revenues, to go forward in a manner acceptable to all etc.) for some period following the closing parties. of the transaction. Often, the additional purchase price paid in connection with an In order to properly allocate risks, the earn-out is calculated using a formula based parties, in particular the buyer, must have on the specific performance measures with a common and detailed understanding of a minimum level of performance required the various legal, financial and business for any payment and an overall cap on the risks affecting the M&A transaction. The total payment amount. Earn-outs can also primary source of this information is usually be tied to specific business goals such as the the buyer’s due diligence of the seller. Other retention of certain employees or customers important sources are often the buyer’s or meeting production targets during a knowledge of the seller’s industry and the defined period. In truth, an earn-out can be associated legal and financial environments. tied to any risk factor associated with the Once risks are identified, each party must target business as long as the results on evaluate the potential exposure inherent in which it is based can be adequately defined each identified risk and the impact of that and verified. exposure on the overall value of the M&A transaction from the point of view of that Another effective pricing tool is the post- party. Risks can then be allocated among closing purchase price adjustment. These the parties using the tools described in this adjustments are used to increase or decrease article. the purchase price (via a ‘true up’ payment
106 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS from one party to another) at some point hybrid will, as a matter of law, affect whether after the closing of the M&A transaction in the buyer acquires or the seller retains a order to allocate risk associated with one number of risks. Asset acquisitions generally or more matters, usually financial, that favour the buyer with regard to most risks affect the value of the target and cannot while equity acquisitions are usually more be precisely determined prior to closing. favourable to the seller. To a large extent, Frequent uses include adjustment for risk allocation in mergers is defined by the unexpected changes in the current assets applicable state statute. While in many and/or liabilities of the target (often referred circumstances the structure of an M&A to as a ‘working capital adjustment’), transaction may be predetermined by valuation of inventory or even the costs overriding factors such as tax, regulatory associated with certain events expected to or contractual considerations, the parties occur after the closing, such as settlement of should nonetheless be mindful of the risk litigation. allocation effect of the deal structure and, where possible, adjust the structure to meet While in theory adjustment of the purchase risk allocation considerations. Even where price would seem to be the ideal way the overarching structure is predetermined, of handling risk allocation in an M&A it may be possible to take advantage of a transaction, in practice many factors affect multi-step or hybrid transaction to allocate this tool’s utility. First, the purchase price is specific risks. As an example, it may be often agreed upon early in the process (often possible to assign certain assets or liabilities in a letter of intent) when a significant part of (and thereby allocate the attendant risks) to the information necessary to determine risk a subsidiary of the target and subsequently is not yet available to the buyer and, in some spin off the subsidiary or distribute the assets cases, may not even be known by the seller. and/or liabilities directly to the target’s Once this information becomes available, owner. sellers are usually reluctant to accept any reduction in the agreed upon purchase If a risk cannot be allocated through either price. Also, many risks may not be known a purchase price or structural tool, there are at the time of the closing or the potential also a number of contractual tools available. exposure may not be quantifiable in a way To the extent that allocation of a risk requires that lends itself to a pre-closing purchase one or more parties to perform certain price adjustment. Even contingent price actions after the closing of the transaction, mechanisms and post-closing purchase price the transaction documents should contain adjustments are inherently limited in the covenants specifying the actions to be taken types of risks they can effectively allocate, and the associated timeline for compliance. and can be very difficult to implement in Allocation of unknown or general risks public company acquisitions. As a result, and confirmation of actions required to be practitioners often need to look to other risk performed prior to closing can normally be allocation tools. accomplished through appropriately devised representations and warranties. To be most Risk can also be allocated through the legal effective, representations and warranties structure of the M&A transaction. Whether should not be generic but should be tailored a transaction is structured as an equity or to the applicable industry, regulatory and asset acquisition, merger or some type of financial environment and specifics of www.financierworldwide.com | FW 107 INTERNATIONAL MERGERS & ACQUISITIONS 2008 the target identified through buyer due percent of the costs to the buyer of such diligence. litigation up to a fixed amount after which the buyer will be liable for 50 percent of any Contractual representations, warranties further costs. While certain studies suggest, and covenants allocate risk by providing and some practitioners will assert, that a contractual remedy to the injured party. certain combinations of indemnification While a breach of contract claim is one terms and limitations are ‘market’ for way to enforce this remedy, a far more particular transactions, parties should common approach in M&A transactions is resist relying on such a crutch and carefully for the parties to provide indemnification in consider indemnification terms in the the event of a breach. The indemnification context of the desired overall risk allocation. tool is very flexible and can be tailored to further allocate transaction risk. The intent As a practical matter, contractual of indemnification is to make a party whole indemnification or similar remedies are only for damages suffered in connection with as valuable as the ability of the obligated the occurrence of a risk it did not assume. party to pay. In transactions where the However, indemnification is generally obligated party will have deep pockets subject to limitations on the minimum after the closing, satisfaction of a claim is amount of damages required to make a not usually a problem. In situations where a claim (usually referred to as a ‘deductible’ party’s ability to pay is less certain, various or a ‘basket’ depending on its structure), mechanics are available to protect the the maximum liability of the paying party interests of the other parties including in connection with the transaction or, less purchase price holdbacks (which provide a commonly, each claim (usually referred source of remedy for a buyer) or escrows to as a ‘cap’), and the period of time after (which can be used to protect a buyer or, less the closing during which indemnification commonly, a seller). Terms for the release claims can be made (usually referred to of funds from either of these payment as the ‘survival period’). The values of the mechanisms are also very flexible and can be deductible or basket, cap and the length of tailored to fit into the overall transaction risk the survival period have an important effect allocation. on the overall allocation of risk between the parties and are usually the subject of heavy Risk allocation in an M&A transaction is negotiation. Allocation of specific risks can one of the driving forces behind the M&A be tailored with an individual deductible, process. Many tools are available to the basket, cap and/or survival period or by practitioner to allocate transaction related agreement that indemnification relating risk between the parties. The key is to to a specific matter will not be subject to consider all of the tools available and to any limitation at all. In addition, special carefully tailor them in the context of the indemnification mechanics can be created entire transaction to achieve the desired for known risks to handle a claim in a way result. tailored to a party’s exposure to the specific risk. For example, a special indemnification provision relating to an ongoing litigation Walt Lemanski is a partner and co-chair of the matter of the target might provide that Securities and M&A practice at Patton Boggs the seller will indemnify the buyer for 100 LLP.
108 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Directors’ duties in M&A transactions
by Shardul S. Shroff
The Indian Companies Act is modelled or part of an undertaking of the company on the Companies Act, 1948 of England. requires an ordinary resolution of the The directors of a company, as natural shareholders in general meeting. The persons, are entrusted duties, functions and law mandates that a complete disclosure obligations to be discharged for the benefit is made in the Explanatory Statement of the company and its shareholders. A accompanying the Notice for the meeting director in modern company law has duties convened for approval of the proposed of a fiduciary to the shareholders, but in transfer. This position also inures in relation times of adversity or impending insolvency, to a Scheme of Amalgamation, demerger, they have an obligation to act fairly slump sale or exchange through courts and protect the interest of the secured or otherwise or when the undertaking is creditors also. As directors, they have sold as a going concern. In the absence of the duty to exercise reasonable skill and full and fair disclosure in the Explanatory diligence expected of an ordinary person, Statement indicating all nature of interest in the carriage of the duties and functions of the directors, an aggrieved shareholder owed to the company, other directors and could petition the company court or the shareholders. Company Law Board (expected to be converted to a Company Law Tribunal) for In an M&A transaction, which concerns action to set aside the decision and sue either a sale of shares, or a sale of directors for misfeasance, malfeasance or undertaking or a takeover bid, or a related nonfeasance, as the case may be. party transaction or stock options in the course of the M&A as consideration for Indian law does not recognise that a directors, the duty of fairness, good faith shareholder is conflicted in casting his vote and honesty is paramount. Indian law in support of a corporate decision carried recognises that it is not merely pecuniary out through a vote. Thus though directors interest which determines the contours may be entrusted with a fiduciary duty and of conflicts of interest. Any angularity obligations of fairness, honesty and good or skew brought to bear on matters of faith, a shareholder can vote in its own interest whether of a pecuniary nature or interest. of relationships are also abhorrent. The directors have a duty to disclose their The law recognises that a director with an interest, the degree of relationships and interest has to recluse himself from the their financial shareholding and stake in the process of decision making at the level company and in any transaction or transfer. of the board or any committee of the board. This also holds true when takeover Under Indian law, any corporate transaction of management and control in a listed involving the sale or transfer of the whole company is attempted and there are www.financierworldwide.com | FW 109 INTERNATIONAL MERGERS & ACQUISITIONS 2008 common directors of the transferor and nor can they tip such information to an transferee entities. outsider. Any abuse of inside information by a director would invite liability under For independence in decision making, Securities Exchange Board of India especially in listed company, a listing (Prohibition of Insider Trading) Regulations, agreement has prescribed functions to be 1992. undertaken by an independent committee of directors or audit committee. Matters One of the ways around the sensitivities of of valuation, post-merger concentration of sale of shares or a controlling interest is to promoter control, augmentation of such offer the same amount of information to control, unfair treatment to minority are qualified bidders who passed the financial all matters to be considered by the audit and technical tests for a relevant buyer of committee. The independent directors majority control in a listed company, but have a duty to advise members of the that is not a universal solution. public selling shares in a takeover offer between competing parties, of the merits Requirements under the takeover code or demerits of each proposal. In case of takeover or acquisition of a listed Insider trading and tipping of price company, SEBI (Acquisition of Shares & sensitive information Takeovers) Regulation, 1997 – or Code – lays down mandatory provisions governing There are significant issues of concern for the role and responsibility of directors a board of directors of a listed company, of the target and acquirer company. For which is proposing to engage in mergers or instance, in relation to the directors of a acquisitions. At the preparatory stage, any target company, the Code lays down that, information of a listed company, which is from the date of public announcement not in the public domain, and which has the of the offer, directors shall not enter into effect of facilitating price discovery, could any material contract; shall ensure that constitute insider information. The matters a director who is also a director of an of business planning, pipeline discoveries acquirer company does not participate in in pharma companies, confidential any matters in relation to the takeover; information on risk management are not shall send their unbiased comments and matters of public disclosure. recommendations on the offer to the shareholders, keeping in mind the fiduciary The directors of a company that is involved responsibility of the directors to the in an M&A transaction owe a duty to curb shareholders and for the purpose of seeking insider trading and should ensure that the opinion of an independent merchant there is no abuse of inside information banker or a committee of independent for any purpose not in the interest of the directors. company and its shareholders. Further, it flows from the fiduciary nature of the The Code also lists out the role and obligations that a director should not responsibility of the directors of the exploit corporate opportunities for his own acquirer company. Though the Code does use. Therefore, directors cannot use price not expressly detail the responsibility sensitive information for their own benefit, of a director of an acquirer company, it
110 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS does expressly lays down the role of an directors are required to perform merely acquirer and a person acting in concert to comply with the law. Clearly, there is (defined to include directors of the absence of requirements which obligate acquirer company). The responsibility directors to undertake affirmative action. of a director in the instant case includes This is in stark contrast to the recent director responsibility statement in amendment to the UK Companies Act, relation to all offers, brochures, circular, 1985 wherein directors have been given advertisement in relation to the offers; a positive duty to promote the success in the event the director of acquirer of the company, exercise independent company is a director on the board of judgement, exercise reasonable care, skill the target company, abstention from and diligence, avoid conflicts of interest, participation in any matters concerning the not accept benefits from third parties, etc. offer including preparatory steps leading Further, in order to fortify the enforcement to the offer; ensuring that firm financial of law to ensure compliance of the new arrangements have been made for fulfilling set of duties, it has been made easy for the obligations under the public offer and shareholders in the UK to sue directors on suitable disclosure in this regard. behalf of the company for a much wider range of deeds than are presently possible Possible defences to a takeover under common law. Similarly, unlike the UK Takeover Code, India’s Code does not The duties of independent directors detail at length the precise role of directors and interested directors in the case of a through every stage of the transaction i.e., hostile bid differ. A director nominated from inception, to execution and finally or appointed with the support of the through integration. Even on the judicial promoters, even without any shareholding, front it is seldom argued that the common can work in tandem with an interested law principles of fiduciary duty and care shareholder for developing defences such are inadequate as they do not clearly lay as poison pills, selling the crown jewels, down the scope, level and the ambit of such golden parachutes and the white knight fiduciary duty and care. defence. Given that the Indian economy is one Conclusion of the fastest growing economies in the world and in light of the increasing spate In India, the duties of directors in relation to of M&A transactions in recent years, it is M&A can be traced to the various provisions desirable to reconsider the present legal of the Companies Act, Code and judicial framework to ensure that the duties of pronouncements. Though the present legal directors involved in an M&A transaction framework seems robust in relation to are enunciated clearly and the risks role and responsibility of directors in M&A associated with directorship are adequately transactions, law in India does require an appreciated. in-depth scrutiny. For instance, directors’ responsibilities are covered under various sections of the Companies Act; however, upon examination it is evident that all Shardul S. Shroff is a partner at Amarchand are mostly in the nature of activities that & Mangaldas & Suresh A Shroff & Co. www.financierworldwide.com | FW 111 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g M&A – an insurable risk?
by Susanna Norelid and Christer A. Holm
Despite the risks associated with M&A, Insurance could be useful both on the seller- the number of deals is increasing. The side and the buyer-side of a prospective upturn in M&A activity has led to increased transaction. The premium cost could competition and higher prices on the either be taken by one of the parties, or market. Due diligence investigations split between both parties. The fact that made prior to the presentation of final insurance is obtained could also simplify the bids increase costs for bidders who may process – questions might be settled easier not complete a deal. Due to the high and the parties could reach a closing more competition, sellers are sometimes able to quickly. give away few or no warranties, which also increases the risks. Some years ago, M&A insurance was rare, at least in the Scandinavian market. But is it possible to minimise financial Today the market has changed, due to risk? Is it possible to pass on that risk to an the entrance of many foreign insurance insurer? Is there an appropriate M&A-risk companies on the Scandinavian insurance insurance product already available on the market, the increased competition between market – or is it an expensive, tailor-made those companies, and of course due to solution only available at an unacceptably the increased number of transactions. high premium? Insurance covering some or all parts of a transaction are increasingly popular. The market for M&A insurance However, it all comes with a price, and it is The term ‘M&A insurance’ is not the formal up to the parties to the insurance contract name for a particular insurance product. to agree upon the terms and conditions for Instead the term could be used as a name specific insurance coverage. Furthermore, for an insurance covering several different M&A insurance is not always trouble-free. parts of a transaction. Insurance can be agreed to cover all or some exposures and Different kinds of M&A insurance risks that arise in the context of an M&A transaction. It may include the seller’s Representation and warranty insurance representations and warranties concerning (RWI) is the most common type of the corporate, environmental liabilities, insurance associated with M&A. The buyer accrued balance-sheet liabilities and failure might need coverage in case the seller of tax treatment of the transaction. It could does not provide any warranties, or fewer also cover certain guarantees regarding warranties than desired. It is also useful a minimum of income of a merger, or to when a buyer is uncertain about how to cover the costs of a transaction which later reinforce an indemnity. On the seller- fails. side, RWI could be used to compensate
112 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS a buyer that is claiming reimbursement The advantages of M&A insurance for an inaccuracy in the warranties and indemnities made by the seller. This could The use of M&A insurance provides a be helpful when the seller needs to free possibility to pass on the risk of an M&A itself of any claims for a period after a transaction to an insurer, allowing the transaction, or when the seller needs the parties to walk away after an agreement profit from a transaction to pay a debt. At closes with no further entanglements. the moment, buyers’ RWI is dominant in The seller has the possibility of a simple the market. exit, and the buyer does not have to be concerned about potential future costs. In numerous transactions, tax treatment M&A insurance also provides the security to is a deciding factor in whether a deal create partner confidence, since it transfers is closed or not. Disputes concerning the unpredictable liabilities to a third the responsibility of post-transaction party. For example, a company that buys tax liability risks can be avoided with a producer of goods with a long lifetime appropriate insurance. Tax insurance could might require M&A insurance because of also cover unforeseen additional taxes the uncertainty of future liabilities. owed after the transaction has completed. Also, in situations where the parties are Environmental liability issues can also get unable to agree on specific liability matters, in the way of completing a deal. Insurance insurance companies offer coverage can cover situations where the cost of targeted at facilitating the completion of future cleanup procedures has not yet been the deal. Insurance companies might work estimated, or when the buyer does not as a third party setting a fixed present price want to be liable for pollution caused by a on the deal, which might otherwise result in former owner. a large, unknown future cost for one of the parties. Less common is credit enhancement insurance. This insurance guarantees a Some negative aspects to take into certain minimum income as a result of an consideration acquisition. The insurance might cover situations in which a buyer’s forecasted Insurance is designed for a specific purpose. income does not materialise, which is A provider of M&A insurance probably has practical when there is a need for a security a greater knowledge about transactions to loan money. and consequently of this special insurance product than a traditional insurance Furthermore, so-called ‘aborted bid’ provider. Since not all insurance companies insurance is available, intended to cover the offer this product, competition is not costs of corporate transactions which fail. particularly high, which means premiums Finally, there is also director and officer’s tend to be quite high. liability insurance, frequently used to cover claims made against the directors of a Another negative aspect is that the company about the management of the insurance company might ask for a corporate transaction. significant amount of information about the parties and the transaction before it can www.financierworldwide.com | FW 113 INTERNATIONAL MERGERS & ACQUISITIONS 2008 issue the insurance. Sometimes the parties event of a dispute. would prefer to keep this information confidential. A buyer that has covered the risks with M&A insurance might also be concerned M&A insurance demands that employees of about the implied uncertainty surrounding the insurance companies have knowledge the target, although this issue should of the policyholder’s business, and since decrease as M&A insurance becomes more M&A insurance is relatively new, this is widely accepted and dispersed. quite rare. An inexperienced insurer will need quite some time to underwrite this Conclusion type of risk, so the underwriting process might be time consuming and even delay The future of M&A insurance depends the deal. on many factors, such as premiums, one party’s willingness to rely on warrants given A further difficulty is the possibility by the other party, or the general trends of misusing the insurance. It may be of the M&A market. Problems associated exercised as a tool for manipulating and with this insurance are likely to lessen as strengthening the policyholder’s balance the coverage becomes more frequently sheet, resulting in misrepresentation of the underwritten, and insurance companies corporation’s financial condition. Naturally develop better knowledge about the this would not be appreciated by the market and are able to estimate the actual investors and creditors. risks. Moreover, the high premiums should be viewed in light of the high risk that M&A Moreover, M&A insurance does not cover transactions entail. all losses from a merger or acquisition, but only those explicitly stated in the policy. Therefore it could be difficult to foresee all the situations that need to be insured, and Susanna Norelid and Christer A. Holm are to interpret the insurance agreement in the partners at Advokatfirman NorelidHolm.
114 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Exploring the potential of joint ventures to create value as opposed to outright M&A
by Christoph Reimnitz
Whichever way you look at it, 2007 was cost-effective route to creating significant a record year for M&A activity. While additional value for a business, particularly transactions tailed off towards the end when compared to cost of M&A, they are of the year, sponsor and institutional not entirely cost or risk free. Entering a JV acquisitions still reached unparalleled is a major business decision. This point is heights – with nearly $5 trillion worth of as critical as avoiding irrational exuberance M&A deals announced, almost a trillion when making acquisitions. more than 2006. That is a huge level of investment by anyone’s standards. Businesses of all sizes can use JVs as a tool to create long-term relationships or However, the outlook for 2008 paints a very deliver on short-term projects. Without different picture. M&A activity is already exception, successful JVs make strategic noticeably subdued by comparison to business sense for all parties. Partnering last year. While LBO deals are still taking with another business, whatever the size, place, the current market conditions can be time consuming and complex. It is are challenging, forcing sponsors and important to have a complementary set institutions to compete for a smaller pool of requirements, shared objectives and of opportunities. Finding market depth shared benefits. However, while it may for larger sponsor buyouts will be harder, seem counter-intuitive, it is as important to paving the way for strategic M&A and – as have clear ideas about the resolution and an increasingly effective way of creating potential exit of the JV as the framework for value – strategic alliances, partnerships and a partnership is being created. joint ventures. Partnership should be built on shared The case for joint ventures objectives and outcomes, while being similarly complementary to both parties. Like acquisitions, significant investment For example, a company may seek to widen in planning, strategy and due diligence its distribution channels in an overseas is required to maximise the chance of a market by partnering with a strong and successful joint venture alliance. There are well-respected local company that is many areas for consideration. The goal for looking to expand its range of products. a potential JV, such as business expansion, A successful joint venture could allow the access to new distribution channels, new company to grow strategically and cost product development, technology sharing effectively, increase its market penetration, or entering new geographies, must stay grow the client base and build its reputation at the forefront of the management in a new market. At the same time, the local team’s mind throughout the whole start- company may increase customer retention, up process. While joint ventures can be a gain new customers, generate increased www.financierworldwide.com | FW 115 INTERNATIONAL MERGERS & ACQUISITIONS 2008
profits from a new revenue stream, widen critical to success. Business cooperation in a its product offering and have a joint stake limited and specific way can be an effective in a growing product or area. Such criteria method for a small company with a new, must be spelled out at the beginning unique product for example, that wants of a relationship so that each party is to sell via a larger partner’s distribution comfortable and confident of the outcome. network. In other circumstances, a separate Fair sharing of the success, and risk, is JV business may be set up or even a new essential to a joint venture. company formed where the partners own shares in the company and confirm how it should be managed.
Again, agreeing the structure, strategy, Where parties have a common goal, a shared leadership, business plan and management of the JV with legally-binding commitment appetite for partnership with complementary from both parties, maximises the capabilities and resources, this could be a promising effectiveness and success of the partnership. Transparency and trust are starting point for JV discussions. essential ingredients of a good marriage. While benefits must be agreed in advance, so too must the risks. It is important to outline the key performance indicators for the JV and set a clear process for Joint ventures do not always have to be a dissolving the partnership, with defined 50:50 partnership or a typical JV format. roles and financial responsibilities, if results Seeking a minority investment in an do not meet the JV performance criteria. organisation, to create a mutually beneficial Establishing these parameters in advance relationship, may also enable a business not only gives comfort to all parties, but to achieve its objectives. For example, an also avoids potential confusion and unfair established company from a mature market cost at the conclusion. may take a minority stake in an emerging market company. This gives it a significant Stay strategic presence in a new and growing geography, while the strategic direction and decision- As with all business ventures, success is in making processes in the business continue the planning. Companies should explore to be led by the local management team, all opportunities to evaluate the risk versus which has proven market knowledge. benefits before making a commitment. Both parties can share expertise and Joint ventures are not a cure all, nor do they best practice, while being open for joint work in all circumstances. As discussed investments in new product development, earlier, where parties have a common goal, market entry and business growth. This is a a shared appetite for partnership with win-win for both parties, as long as clearly complementary capabilities and resources, defined benefits and risks are agreed at the this could be a promising starting point for outset. JV discussions. Given the cost of customer acquisition and customer retention, or How a JV is structured and approached is launching into a new market or geography,
116 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
JVs or white-label initiatives can provide a likely to remain challenging in 2008, JVs cost-effective solution. could create new growth opportunities for many businesses – as long as they stay M&A and JV opportunities are an important strategic. method of supporting business growth. They can allow a company to do business with more customers and increase its Christoph Reimnitz is head of business penetration in the market to achieve core development for the European corporate business growth. With economic conditions finance unit of GE Commercial Finance.
www.financierworldwide.com | FW 117 INTERNATIONAL MERGERS & ACQUISITIONS 2008
CHAPTER six: Accounting and financial challenges
118 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Valuing assets in M&A under IFRS 3
by Phil Antoon
Paramount to many acquisitions is the must measure the cost of a business reaction shareholders, and the markets combination as the aggregate of the fair in general, have to the announcement values of the assets acquired, the liabilities of a transaction and the corresponding assumed or incurred, any costs attributable movement in the buyer’s stock price. In to the combination, and equity instruments previous years the focus was typically placed issued by the acquirer; (v) specifies that on the implied transaction multiple and the acquirer must recognise the acquired the earnings per share effect. However, the company’s identifiable assets, liabilities, and implementation of International Financial contingent liabilities, regardless of whether Reporting Standard (IFRS) 3 has significantly they had been previously recognised in the increased the complexity of the projected acquired company’s financial statements; earnings per share calculation due to the (vi) requires that the identifiable assets, requirement to value and amortise acquired liabilities, and contingent liabilities must be intangible and tangible assets. The following measured initially by the acquirer at their summarises IFRS 3 and outlines the various fair values at the acquisition date. types of identifiable intangible assets and valuation methodologies. It also discusses For many companies intangible assets how companies are reacting to IFRS 3, and comprise the majority of the firm’s the effect this standard can have on the value. A quick comparison of the market acquisition decision making process. capitalisation of a company based on the stock price value relative to the net tangible IFRS 3 addresses financial reporting book value (tangible assets less liabilities) requirements pursuant to a business provides insight into the proportion of the combination. Very similar to SFAS 141, the value inherent in intangible assets. While US GAAP standard addressing business many simply refer to this intangible asset combinations, IFRS 3, among other things: value as ‘goodwill’, there are in fact any (i) requires that all business combinations number of individual, identifiable intangible be accounted for through the purchase assets included in the ‘goodwill’ bucket. method; (ii) prohibits the amortisation of goodwill acquired in a business combination Intangible assets that are commonly found and instead requires the goodwill to in companies, depending on the nature of be tested for impairment annually, or the operations and industry in which the more frequently if events or changes in company operates, may include: patented circumstances indicate that the asset might and unpatented technology; trademarks be impaired, in accordance with IAS 36 and trade names; trade secrets; customer Impairment of Assets; (iii) requires that the relationships; proprietary know-how; company obtaining control be identified as software; regulatory rights; in-process the acquirer; (iv) specifies that the acquirer research and development; non-compete www.financierworldwide.com | FW 119 INTERNATIONAL MERGERS & ACQUISITIONS 2008 agreements; databases; core deposits; royalty) method, the value of an asset is mortgage servicing rights; copyrights; reflected in the present value of after-tax film, music libraries; licensing and royalty royalties the owner of the asset avoids agreements; communications licenses; paying by owning the asset and not having reserves; backlog; contracts; and leasehold to licence it from a third party. Interests. Market approach. This measures the value of There are three generally accepted an asset through an analysis of recent sales methodologies to estimate the value of or offerings of comparable assets. Sales and intangible assets: the income approach, the offering prices are adjusted for differences in market approach and the cost approach. location, time of sale, utility and the terms and conditions of sale between the asset Income approach. This is typically the most being valued and the comparable assets. applicable approach when valuing income- Due to the general lack of publicly available producing intangible assets, as value is sale or transaction data regarding individual measured by calculating the present value intangible assets (with the exception of of future economic benefits to be derived communication licences, where auctions by the asset. The two most frequently used in Europe and individual licence sales and variations of the income approach are the swaps in the US do provide some market excess cash flow method and the royalty data), a market approach is often not savings (or relief from royalty) approach. applicable in valuing intangible assets.
The principle behind the excess cash flow Cost approach. This measures the value of an method is that the fair value of an income- intangible asset by the cost to replace it with generating intangible asset is measured another of like utility. The cost approach by the present value of its projected future recognises that a prudent investor would cash flows, over its remaining useful life. not ordinarily pay more for an asset than the To estimate excess cash flows, revenues cost to replace it new. The cost approach attributable to the intangible asset are first is often most applicable when valuing projected over the remaining useful life of intangible assets that are not income- the asset. Next, expected costs, including generating, (e.g., internally developed cost of sales, operating expenses and software that is used for internal purposes income taxes, are deducted from projected and databases). For income-generating revenues to arrive at after-tax cash flows. intangible assets, the cost approach is From after-tax cash flows, depreciation often not utilised because even if the is added back and after-tax contributory development effort associated with the charges (for the use of tangible and asset was distinguishable, the cost approach other intangible assets) are deducted to tends to understate the true value since the arrive at the excess cash flows specifically costs involved in developing the asset are attributable to the intangible asset. These typically not commensurate with the cash excess cash flows are then discounted to flow it may generate for the business. the present and summed to arrive at the fair value of the intangible asset. The implementation of IFRS 3 can have a dramatic impact on how companies Under the royalty savings (or relief from execute their acquisition process, as well
120 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS as affect day-to-day operations, even depreciate tangible assets) has a direct post merger. Thus, all companies planning affect on the EPS of the deal. An acquisition acquisitions should take steps to ensure that is EPS accretive – before consideration they are well versed in the requirements of intangible asset amortisation – could and implementation of IFRS 3, as it will in fact become EPS dilutive once the consume resources on a variety of levels. amortisation is accounted for. Some The acquirer’s management must be companies may actually decide not to able to articulate in the announcement move forward with the transaction to avoid of the transaction what the deal drivers dilution to their EPS. are, with the understanding there will be an expectation from the auditors and While the accounting treatment is regulatory authorities that those drivers required and thus avoidance of valuing and (e.g., strong brand name, customer amortising assets is not possible, many relationship) will be identified and valued companies will have an analysis conducted as part of the IFRS 3 analysis. The group prior to the announcement and/or the close tasked with implementing the IFRS 3 of the transaction in order to ensure that the accounting will likely need to identify and markets are well aware of the potential EPS engage an independent valuation firm effect of the deal, including all intangible specialising in IFRS 3 valuation analyses and tangible assets. While in many cases a (a company’s auditors are precluded from full IFRS 3 valuation may not be practical providing this service to their audit clients on a pre-acquisition due to lack of available due to independence restrictions), and access to information, confidentiality, they will spend significant amount of time etc., it is possible to conduct a high level complying with the required financial analysis. Although this approach will not reporting. A number of individuals across allow for a formal opinion of the values of the firm will likely be asked to participate the identifiable assets of the target, it can in discussions with the valuation expert to provide important information regarding better understand the nature, background, the potential range of EPS effects inclusive outlook, and specific details of the various of the tangible and intangible assets. intangible assets, all at a time when many resources are focused on their day-to- Regardless of the size or complexity of a day tasks as along with the post merger transaction, companies should ensure – integration. These are but a few of the early on in the acquisition process – that strains that will be placed on the acquirer’s they have a firm understanding of the resources and which should be considered in technical accounting requirements of IFRS advance. 3, and that they have allocated appropriate resources, engaged an independent firm to For companies that are sensitive to any execute the valuation, and can clearly and potential negative movements in earnings readily articulate the value drivers of the per share (EPS), IFRS 3 can also have a acquisition and relate those drivers to the significant impact on the decision to execute IFRS 3 valuation and EPS effect. a transaction. This is simply because the requirement to identify, value and amortise intangible assets over their respective Phil Antoon is global practice leader of the remaining useful lives (not to mention Valuation Services Practice at Kroll. www.financierworldwide.com | FW 121 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Growing influence of IFRS in M&A: why dealmakers should care
by Denise Cutrone, Richard Fuchs and Will Bryan
You are the CFO of a US company and are Canada, South Korea and China committed managing the divestiture of a profitable to adopting IFRS, eventually all major overseas operation. After months of due territories and capital markets will require diligence, your prospective buyer backs or permit IFRS as early as 2011. out, citing that the acquisition would be dilutive to its earnings. How can that Of the top 10 global capital markets (US, be? Your US GAAP (Generally Accepted Japan, UK, France, Canada, Germany, Hong Accounting Principles) carve-out financial Kong, Spain, Switzerland and Australia) statements show that the overseas the majority already use IFRS while division is profitable. As you investigate Canada and Switzerland are in the process the situation, you find that the prospective of converging to IFRS, according to the buyer reports under International Financial Economist Intelligence Unit. Reporting Standards (IFRS). At present, you do not have the time, infrastructure or Even in the US, which uses US GAAP, the knowledge in place to understand how a set Securities and Exchange Commission of accounting standards brought down a (SEC) has recently eliminated the need for multi-million dollar deal. foreign private issuers to reconcile to US GAAP as long as they use IFRS as issued With IFRS now in use in over 100 countries by the International Accounting Standards and the increasing globalisation of markets, Board (IASB), the international standard the likelihood that US GAAP and IFRS will setter. Many believe 2008 could bring an come face-to-face in M&A is real. Although SEC proposal allowing the use of IFRS by accounting standards alone do not US public companies. The SEC’s actions frequently dictate business decisions, they have increased the urgency for companies can be a key aspect of a prospective buyer’s to fully understand IFRS, the differences list of considerations. By being proactive in between IFRS and US GAAP, and how IFRS understanding the role IFRS could play in impacts their M&A endeavours. M&A decision-making, CFOs can position themselves to be better negotiators and Impact on M&A activity avoid situations like the one described above. IFRS has introduced a new set of challenges for dealmakers. As companies expand IFRS: the global financial reporting overseas through acquisitions or appeal to a language broader group of buyers for a division they are divesting, they are likely to encounter Today, more than 12,000 public companies IFRS and need to assess its impact on their around the world use IFRS as their primary transactions. The target may be located reporting framework. With markets such as in a country that already embraces IFRS
122 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS and, to get the highest price, sellers need parents may be required to report under to expand their buyer pool to include those IFRS or maintain both IFRS and US GAAP who report under IFRS. The impact of IFRS reporting. The conversion process may is felt throughout the M&A cycle from pre- require expertise in legal, risk management, to post-acquisition. Knowing how IFRS can treasury, sales, tax, IT, human resources and potentially affect a transaction enables investor relations. New financial reporting dealmakers to be both prepared acquirers principles could impact almost every aspect and sellers. of a company’s operations – from customer and vendor contracts and employee Pre-deal considerations. Structuring a deal compensation arrangements to income tax under IFRS can be quite different from structures. Furthermore, a change in GAAP that under US GAAP. For example, certain may require new or upgraded systems and items classified as equity under US GAAP controls and, often, multi-GAAP reporting may be classified as debt under IFRS, with capability. Companies may need to add associated payments treated as interest resources to understand IFRS. All these rather than dividends. This can limit an issues make it complicated and costly acquirer’s ability to meet debt covenants for companies to report their financial and, in some jurisdictions, pay dividends. results and communicate the impact of Failure to examine the potential impact the acquisition or divestiture to the market of this accounting in the pre-acquisition and their stakeholders. Therefore, having phase can jeopardise the success of a deal a good grasp of IFRS and the difference – particularly one that is cross-border. between it and US GAAP is essential for Financial statements under IFRS will likely multinational companies. be required. Early in the process, companies should assess the impact IFRS will have IFRS versus US GAAP: key differences on transaction multiples, hurdle rates and investment benchmarks. Although a number of countries have adopted IFRS as their local GAAP, the US Diligence considerations. IFRS principles continues its path of convergence by the may alter the timing of revenue and FASB (Financial Accounting Standards expense recognition, which can affect not Board) and the IASB. Their joint efforts only the price of a deal but also reported are to produce similar but not necessarily results, key performance indicators (e.g., identical standards, addressing key EBITDA), loan covenants and balance weaknesses in their respective accounting sheet ratios. Companies well-versed in frameworks. The issuance of joint IFRS will find it easier to analyse and standards takes an extensive amount of compare sales, net income and balance time. As a result, in the six years since the sheets of targets. The ability to adequately convergence program began, the only joint compare transaction multiples and other standards issued to date revolve around key benchmarking data will lead to a more business combinations – the newly issued effective diligence process. FAS 141R (FASB) and IFRS 3R (IASB).
Post-deal considerations. IFRS continues to Should the US continue with the play an important role after the successful convergence program rather than adopting closing of a deal. Companies with overseas IFRS, the differences between US GAAP www.financierworldwide.com | FW 123 INTERNATIONAL MERGERS & ACQUISITIONS 2008 and IFRS will likely take a number of years rather are expensed over an estimated to eliminate. CFOs and dealmakers should life, typically as the associated revenues familiarise themselves with some of the from the development activities are key differences between US GAAP and IFRS earned. Under US GAAP, both research and since they impact financial reporting and development costs other than software M&A activity. development costs are generally expensed.
Asset write offs. Under IFRS, impairment Liability versus equity classification. Under assessment of long-lived assets is a one- IFRS, classification of an instrument step process based on discounted cash as equity versus a financial liability is flows where no binding sale agreement stricter and based on the substance of or active market exists and, under certain the instrument, rather than on its legal circumstances, previously recognised form. Compound instruments generally impairments are reversed. Under US GAAP, have to be bifurcated between the liability impairment analysis is a two-step process and equity components. Under US GAAP, based first on undiscounted cash flows for instruments with both liability and equity long lived assets. Reversal of impairments characteristics can often qualify for is prohibited under US GAAP. Impairment treatment as mezzanine equity and are not charges may be recognised in different marked to fair value. The result of IFRS is periods and for different amounts under an increase in interest expense and greater IFRS. Combine those factors with the ability volatility in the income statement, and less to reverse impairments and the result is equity on the balance sheet than under US greater potential earnings volatility. GAAP.
Fair value accounting. Under IFRS, greater Conclusion use of fair value, and certain assets such as property, plant, and equipment; intangible IFRS is gaining global acceptance and it is assets; and investment property can be only a matter of time before it becomes carried and remeasured to fair value each the international reporting language. The period. US GAAP, in contrast, requires prospect of IFRS impacting transactions historical cost valuation of such assets. The is real and dealmakers need to be familiar implications of this are different balance with and understand the difference sheet amounts and depreciation, and a between IFRS and US GAAP to make clearer view for investors of the unrealised informed business decisions. Not having a appreciation in certain major asset full grasp of IFRS could lead to a scenario categories under IFRS. described in the opening of the article where IFRS spoiled a multi-million dollar Development costs. Under IFRS, the transaction. development portion of research and development costs is capitalised if certain criteria are met. Development costs do Denise Cutrone, Richard Fuchs and Will Bryan not hit the bottom line immediately, but are partners at PricewaterhouseCoopers.
124 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Valuation and solvency analysis in failing firm claims
by Boris J. Steffen
For firms pursuing growth through failing division defence posits similarly that M&A, regulatory constraints imposed by a merger is not likely to pose competitive the antitrust laws may pose significant concerns if the division: (i) has negative barriers. This is equally true for the operating cash flow after proper allocation strategic buyer pursuing a horizontal or of costs; (ii) has been unable to attract an vertical combination, a private equity offer from a competitively preferable buyer firm executing an industry roll-up, or a at a price above liquidation value; and (iii) control-oriented purchaser of the debt, would exit the relevant market if not sold. or corporate assets, of a financially distressed company, within, or outside of, Examining the Guidelines’ tests within the a formal plan of reorganisation. In cross- bankruptcy context – that a company be border transactions, government policies unable to meet its financial obligations as that differ with respect to consumer, they fall due – is consistent with the notion industrial, or trade considerations may of insolvency in the equity sense. Further, also exacerbate the obstacle posed the requirements that the company be by the concern that a transaction may unable to reorganise under Chapter 11, have the potential to create or enhance and unable to attract an offer exceeding market power. Notwithstanding, the US liquidation value, are together suggestive Department of Justice and Federal Trade of insolvency in the bankruptcy sense Commission’s 1992 ‘Merger Guidelines’ to the extent that they imply creditors provide a means of potentially resolving would receive more if the company were these obstacles using the tools of solvency liquidated than if it were restructured and valuation analysis employed under the and valued as a going concern. Given US Bankruptcy Code within the context these analogies, one possible approach of what has become known under the to asserting a failing company defence Guidelines as the ‘failing company’ and in support of a merger is to employ the ‘failing division’ defence. framework used to establish a fraudulent transfer under section 548 of the The failing company defence argues that Bankruptcy Code. a merger is not likely to create or enhance market power if the company: (i) is unable Under section 548, a transfer of assets, to meet its financial obligations when they or incurrence of an obligation, for less fall due; (ii) is unable to reorganise under than equivalent value, may be deemed Chapter 11 of the Bankruptcy Code; (iii) is fraudulent, if as a consequence, the debtor unable to attract an offer at a price above (i) was or became insolvent, (ii) was left liquidation value from a competitively with unreasonably small capital, and (iii) preferable buyer; and (iv) will exit the incurred debts it could not pay at maturity. relevant market absent the transaction. The In practice, these conditions are assessed www.financierworldwide.com | FW 125 INTERNATIONAL MERGERS & ACQUISITIONS 2008 using the balance sheet test, adequate purposes should only consider data and capital test, and cash flow, or ability-to- information known or knowable as of a pay test. The balance sheet test examines specific date. Consequently, the valuation whether the fair value of a firm’s assets date directly impacts what data and exceeds the face value of its liabilities; the information can be relied on, as well as the adequate capital test looks at whether the related assumptions. company’s capital is adequate to support its business activities; and the cash flow test In performing the balance sheet test, the asks if the firm can expect to pay its debts value of a company’s liabilities is taken as they mature. directly from the undiscounted face value of its debt, in recognition that insolvency When adapting the balance sheet test to would never occur if a company’s debts a failing company claim, a firm’s balance were valued at market. In contrast, the sheet is only the starting point for the fair market value of a company’s assets analysis as historical financial statements is determined from the present value do not reflect fair market values, and of its expected future cash flows, using may not include all assets and liabilities either an income (discounted cash flow, properly considered in determining capitalisation), market (comparable solvency. Beyond this recognition, the company or transaction), or cost first step is to determine an appropriate (replacement, reproduction) approach. premise of value, whether going concern If the face value of the company’s debts or liquidation. Generally, ‘fair value’ as used exceeds the fair market value of its assets, in the balance sheet test is interpreted to the company is deemed insolvent. mean fair market value, and indicative of a going concern premise. For an inoperative With respect to the ability-to-pay company facing imminent demise, the requirement of the failing company liquidation premise may be relevant, defence, a company will likely be able to however. The essential structural difference pay its debts as they mature under the is that the going concern premise assumes cash flow test if its capital is sufficient the sale of an organised, functioning, to support its operations over a range interactive group of income-producing of economic and financial conditions assets over a reasonable time period, pursuant to the adequate capital test. As while the liquidation premise assumes the might be expected given this symbiotic debtor’s assets are sold in a piecemeal relationship, the steps required to perform fashion, either in an orderly or forced the cash flow and adequate capital tests manner. overlap. For example, both might start with the projection of expected future The valuation date selected in applying free cash flows as is used in a discounted the balance sheet test to a failing firm cash flow valuation, with one scenario should take into account as appropriate and assuming management’s best estimate, feasible the circumstances of the failure. a second, with no changes in revenue or Changes in macroeconomic, firm-specific profitability variables, and a third, with and industry conditions can alter the value adjustments to items that may affect and/ of a company over time. Further, as in any or include revenue growth, gross margins, business valuation, a valuation for solvency operating profit margins, depreciation,
126 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS and capital expenditures, as appropriate debt covenants. When using these tests and reasonable given the facts and in combination with the balance sheet circumstances. test, however, it should be noted that the balance sheet test, being a valuation To test the ability of the company to rather than a matching exercise, may pay its debts as they mature, the firm’s suggest an alternative viewpoint due to scheduled debt payments are matched its consideration of the time value and risk with its balance of excess cash, free cash associated with a firm’s cash flows. flow, and available credit under existing facilities at each payment date per the In sum, though often used to assess cash flow test. The process used to test the solvency in fraudulent conveyance and adequacy of the firm’s capital then builds preferential transfer disputes under the on the foundation of the cash flow test bankruptcy laws, the balance sheet, cash with analyses that compare the company’s flow and adequate capital tests in part financial position and operating results over provide a relevant and reliable framework time on a standalone basis and in relation for use in addressing failing firm claims, to others in its industry, assessments of the the specifics of which are subject to ability of the company to obtain additional interpretation under the Guidelines. or new debt and equity financing, and Properly applied, the approach can assist examination of the potential for the acquirers in achieving antitrust clearance company to default under the provisions of for a transaction that may otherwise be its debt covenants. blocked, and avoid the costs of a broken transaction, which while likely significant A firm will fail the cash flow test if its in any event, are particularly prohibitive in scheduled debt payments exceed the today’s environment of tightening credit corresponding sum of its excess cash, markets, leveraged capital structures and free cash flow, and available existing economic uncertainty. credit. A firm will also fail the adequate capital test if it can be demonstrated that its capital structure cannot withstand reasonable fluctuations in its business Boris J. Steffen is a partner at Bates White, without triggering a default under its LLC.
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CHAPTER seven: Due diligence and integration
128 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g The evolution of diligence: how a multi-discipline approach gives buyers a competitive edge
by Greg Peterson and Mike Burwell
Capturing value from a merger, operations of the target and its market acquisition or divestiture continues to be strengths, weaknesses and risks will enable one of the most significant challenges dealmakers to make informed business dealmakers face. As companies become decisions. increasingly global and regulations evolve, diligence becomes more sophisticated Commercial diligence and encompasses so much more than financial performance. Seasoned deal Regardless if you are a buyer or seller or practitioners can attest, there are many whether the transaction is domestic or factors impacting deal value and not all foreign, early identification of potential are attributable to financial statements. deal issues leads to informed decisions and Financial diligence alone does not uncover better financial modelling. As companies the wide range of risks associated with a venture outsides their borders or expand transaction; especially if it is a cross-border into a new industry to drive growth, it deal where foreign jurisdiction, culture, is crucial to understand the market, the labour, transfer pricing, foreign market target’s market position compared with conditions and financial reporting come industry peers, potential opportunities into play. and alignment of opportunities to their business strategy. Commercial diligence Many faces of diligence enables companies to address the appropriate questions such as: What are Today, diligence covers the deal continuum the risks inherent in a business strategy? to include commercial diligence which What strategic and market-related value accesses the size of the market and creating opportunities exist? How sound critiques the target’s business plan; total are customer and supplier relationships? performance diligence which evaluates What is the sustainability of the company’s not only financial statements, accounting competitive advantage? How big is the and tax but also operations, systems, market? governance, vendor relations, internal controls, management integrity, human Often transaction risk arises from resources and insurance; and sell-side inaccurately assessing market growth diligence which helps sellers present drivers, industry trends, competitive the business to be sold from a buyer’s positioning and supplier relations. Deal perspective. To maximise deal and value will diminish if the commercial shareholder value, companies need to be viability of a deal cannot be supported. aware of and anticipate deal risks while Commercial due diligence is best used formulating an action plan to address when the buyer has reservations about them. Performing diligence on the entire key business plan assumptions. For www.financierworldwide.com | FW 129 INTERNATIONAL MERGERS & ACQUISITIONS 2008 example, a company recently needed compensation plans, employment and to assess whether a telecom target’s union agreements, equity compensation revenue and profit projections were programs (existing programs as well achievable. Diligence revealed the target’s as design and implementation of new market share and margin growth were programs), local regulatory approval unachievable since they implied the processes and any obligations an acquirer company would thrive in a price-driven, will have once the deal closes can have a slow-growth market where its competitors huge bearing on the deal. enjoyed a competitive advantage. Gaining insights on unfamiliar areas gives Tax and structure. Tax diligence has evolved dealmakers the confidence to make better from the assessment of tax compliance business decisions. issues to include the evaluation of potential deal structures and movement Total performance diligence of cash. Considering how to structure a deal early in the process can often give Although understanding the financial and buyers a competitive edge. For example, tax position of the target is important, the benefits of acquiring the stock of a S they are only two of the many factors Corporation by structuring the transaction that could derail a transaction. Other as an asset deal through a Section 338(h) factors impacting the value of a deal (10) election may add significant value are often more important. Companies – allowing the buyer to step up the tax are increasingly becoming more global basis of the acquired assets to fair market and diversified and have complex value, creating a benefit from higher tax operational structures. When acquiring deductions in the future. Other areas of a multinational company with multiple taxation which may have an impact on businesses, it is beneficial for dealmakers deals include proposed restructurings to expand their diligence to include other and valuation of goodwill, know-how and areas of the business such as employee other intangibles. Also, different states benefits, insurance, operations (including and countries have their own tax regime information technology), internal controls, and understanding the tax implications governance, tax structuring, valuation and on deals enables buyers to choose the others. right tax structure and move cash to the appropriate entity or territory to service Employee benefits. Compensation and debt as well as provide a tax efficient return retirement programs are getting more to investors. Furthermore, should a dispute complex, and they become even more arise with the tax authorities, appropriate complicated when unions or country documentation of diligence performed and specific regulations are involved. Benefits valuation issues encountered will facilitate a issues could prevent a deal from closing. swift resolution. For example, a pension liability that is significantly underfunded may reduce the Insurance. Companies face many risks, expected value of the transaction or the having an adequate insurance program deal may be abandoned. Therefore, having is important to limiting their exposures. a full grasp of the risks associated with Dealmakers should expand their traditional unfunded pension liabilities, management diligence to include insurance to ensure the
130 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS target has adequate self insurance reserves Both commercial and total performance and coverage, and access the impact on diligence continue to provide dealmakers the buyer’s insurance programs in terms value after the deal closes. Acquirers can of change in control, insurance program use the industry and market information structure, collateral and cost allocation. to increase their market position. Also, commercial diligence can provide Operations. Whether you are a corporate additional insights and ammunition to help buyer looking to understand the potential shape the acquirer’s business strategy. operational synergies of a deal or a financial Findings from total performance diligence buyer assessing the standalone costs of enable acquirers to develop an integration a division of an entity, diligence on the plan to capture synergies by identifying target’s operations will yield invaluable and resolving issues early for a smoother insights. Having insights on redundant transition. functions and how the target fits into the parent company (or portfolio) enables Sell-side diligence acquirers to make swift decisions and implement the appropriate integration Normally when we think of diligence, we strategy to realise synergies sooner. think of buy-side. However, when a division Information technology is the cornerstone or business is being divested, it is equally of most operations and understanding the important for sellers to undertake a sell- adequacy of the application environment side diligence on the unit being sold to and expenditure required is vital. How maximise value. This is especially important often have you heard of companies that are when the unit being divested is a carve-out unable to bill effectively because of system of an existing business where no standalone integration issues? financial information exists. It requires considerable judgement to apportion Valuation. Asset valuation and revenues and expenses to a specific unit or methodologies used can have a significant division when it involves shared corporate impact on deal value. The accounting services such as finance, legal, marketing, principles used may also have a bearing pension, taxes, interest and insurance. on the perception of value of a business or an asset. In particular, identifying the Even if a standalone business is being differences between US GAAP (Generally sold, it is necessary to adjust historical Accepted Accounting Principles) and IFRS information to reflect the post-sale (International Financial Reporting Standards) economics of the business which involves is becoming more important as more eliminating charges the buyer will not countries adopt IFRS. A buyer needs to incur. Also, potential buyers may be foreign ensure its approach to valuation is the same acquirers who have a different accounting as the seller’s. If the approach differs, it is reporting standard than the seller. To important to understand the differences and appeal to a wider pool of buyers, it is the effect they will have on purchase price. important to understand the differences IFRS requires a wider range of assets to be between US GAAP and IFRS. Reconciliation valued and re-valued on an annual basis. If between the two standards may be a buyer is not careful it can find itself paying required. for assets it has not anticipated. www.financierworldwide.com | FW 131 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Most importantly, supplying the to encompass other business areas such information from a buyer’s perspective as benefits, insurance, operations and limits the number of potential inquiries others. Additionally, diligence expands to from acquirers so management can focus the commercial aspect when companies on running the business. Sell-side diligence question the sustainability of a target’s enables sellers to identify and resolve growth and sell-side diligence when information gaps as well as value detracting dealmakers are ready to harvest their issues, and provides the right information investments or part with non-core assets as to buyers for a smoother sales process. their business strategy changes. Diligence enables dealmakers to make confident Conclusion business decisions which may entail substantial reworking of a transaction prior As companies’ transaction needs evolve to close. to capture global opportunities, diligence also progresses to meet their growing complex transaction needs. Diligence Greg Peterson and Mike Burwell are partners has gone from solely financial diligence at PricewaterhouseCoopers LLP.
132 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Commercial due diligence and the nine levers of corporate growth
by Christopher ‘Kit’ Lisle
Consistently successful corporate growth strategic or balancing tests include strategic is not the result of being in the right place planning, wild cards and value proposition. at the right time. Nor is it attributable Without pulling the internal levers, and to the latest management craze. Some keeping them in balance, a company CEOs, regardless of industry or timing, are may be ineffectively executing a chosen able to achieve lasting growth. Ongoing strategy. Without pulling the external processes are used for discovering growth levers, and keeping them in balance, a opportunities. Internal competencies, company may be effectively executing the systems, people, and capital are developed wrong strategy. The nine levers, or tests, to take advantage of those opportunities. facilitate diagnostic indication of growth And value propositions and brand promises potential and a quick understanding of are created to convey unique capabilities to organisation’s weak links. the customers who value them. The result is predictable growth. External tests
The complexities and challenges of 1. Competitive analysis can serve three international mergers and acquisitions distinct roles for buyers. First, assessing raise the due diligence bar. Cross-border the capabilities and competencies of commercial due diligence (also known as competitors. What are the competitors’ business strategy due diligence) benefits strengths, relative to the acquisition target? from a systematic test of nine simple Are they more efficient in production, do predictors of corporate growth. they have access to more resources or people skills, or do their competencies and When used in a commercial due diligence brand promises better match customer process, the ‘nine levers of corporate needs, for example? growth’ consist of nine assessments of acquisition targets – three tests of Second, understanding the intentions and external strategic opportunities and future directions of competitors. Plotting the company’s positioning relative to the likely strategic paths of competitors these opportunities, three tests of the against known customer needs and company’s internal capabilities to execute purchase decision criteria reveals that some against these opportunities, and three competitors are heading in a very logical tests of the acquisition target’s strategic direction while others are driving off a cliff. planning processes. The external tests The next step is to decide on the level of involve competitor awareness, customer comfort with the strategic direction of awareness, and market awareness. Internal the acquisition target, given the strategic tests include operational competencies, direction of its competitors. Is it acceptable, human capital and growth capital. The for example, to try to compete head-to- www.financierworldwide.com | FW 133 INTERNATIONAL MERGERS & ACQUISITIONS 2008 head against a larger competitor with more of the company. Market due diligence resources and competencies? is focused on answering two questions. First, how attractive is this market, from Third, competitor due diligence can also the standpoint of growth, profit potential, be used to assess the broader competitive customer needs, competitor positioning, dynamics of the market. Michael Porter industry trends, opportunities and threats, suggests evaluating the attractiveness of critical success factors, etc? Second, how a market based partly on an assessment well positioned is the acquisition target in of the risks of new entrants, substitutes, this market – is it competing in the most competition from competitors, competition attractive segments or the least attractive from suppliers, and the internal rivalry of segments? Conducting market due market participants. diligence in obscure, niche sectors means conducting primary research of customers, 2. Customer awareness involves a competitors, and third party industry disciplined, systematic process of gaining experts. awareness of customer needs, interests, purchase decision behaviours, perceptions Internal tests of suppliers, and the current state of relationships. Calls to customers may be 4. Core competencies and operational the single most basic element of external efficiency reviews offer insight into due diligence. The calls are relatively easy, potential competitive advantage (of an quick, and they can provide tremendous operational, cost, or service nature, for insights. Where most acquirers believe they example) that may bring incremental value are maintaining control, learning first-hand to the customer. Here, the due diligence insights and saving money by conducting focus is on identifying unique capabilities these calls internally, they fail to understand and operational efficiencies. These core that outsourcing has tremendous benefits. capabilities may involve any operation or Using a research-based consulting firm that function of the business that contributes makes the calls ‘blind’ (without revealing to the efficacy of the business model. the name of the acquisition target or the Operational examples include procurement true purpose of the call) ensures that the efficiency, internal communications insights are objective. Research firms between functional areas that contributes are also efficient, and produce reports to operational efficiency, logistics and which are not only full of quantitative distribution efficiency, inventory efficiency, and qualitative insights, but also analysis, outsourcing utilisation and workflow options and recommendations. A good process. The aim is to assess how unique research firm will go well beyond the basics and differentiated a company’s operational of how the customer chooses a supplier processes are, relative to competitor and how they rate and rank the various capabilities. suppliers. 5. Human capital assessments explore 3. Market knowledge helps determine if the recruitment, selection, training and acquisition target is in the most attractive development, leadership development, segments that it could be, given core culture, systems for performance competencies and the strategic direction management and feedback loops. In
134 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS due diligence it is important to examine and core competencies. With the input of the company’s talent acquisition and external knowledge, decisions and choices retention success, check out training are based on facts, not internal perceptions. and development capabilities, look for Strategic planning is all about seeing cultural and ethical consistency, try to options and then choosing a path which find compensation systems that reward will most likely lead to accomplishment of behaviours that connect to the strategy corporate goals. and the corporate goal, and test for performance feedback programs. The result 8. Wildcard analysis is about gaining an is an understanding of the relative strengths awareness of the potential for disruptive, and weaknesses of the acquisition target, disintermediating, playing-field-altering from a human capital perspective. opportunities and threats. Technology, operational efficiencies, global supply 6. Growth capital analysis does not chain management and channel strategy involve looking in the rear view mirror improvements, for example, have enabled at financial performance. Financials are some companies to fundamentally change merely symptoms, not the core strength traditional business models. Rapidly or weakness of the business. Due diligence growing companies keep a constant should be used to investigate whether the lookout for ways to influence markets. company has the resources it needs to Opportunities for growth are created that achieve the goals, objectives, strategies and may not be visible to the casual participant tactics it has laid out for itself. – capitalising on inefficiencies many players assume to be ‘givens’. It is a good idea to Strategic tests investigate the wildcards that may exist, and assess the company’s ability to plan for 7. Strategic planning assessments involve the possible realisation of these wildcard investigations into the direction the events. Wild card analysis is partially company is heading, the process utilised to dependant on external knowledge, but the arrive at this direction, and the company’s ability to react to potential opportunities perceived value of strategic planning as is a direct function of executing on the an ongoing process. Too many executives internal levers. rely simply on an annual strategic planning meeting to make choices. They are 9. Value proposition and brand strategy destined to miss opportunities and unlikely assessments are used to determine if a to account for internal competencies, company has a unique selling point, if that relative to their competitors. Conducting uniqueness is valued by target customers, strategic planning as an event relies on and if those target customers are actually the perceptions of managers, rather than receiving the message that the company on the facts and realities of the market, has the ability to offer that unique value. including the positioning of a company Brand strategy serves as the bridge that within the market. A never-ending connects internal and external levers of planning process, on the other hand, forces corporate growth. Specifically, it connects executives to maintain an awareness of internal competencies to awareness of external opportunities and an appreciation customer opportunities through a discreet of relative internal strengths, weaknesses promise of value. www.financierworldwide.com | FW 135 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Without an effective brand strategy, the that should be pursued in the first few carefully developed core competency months. Companies are more likely to see does not necessarily translate into the appropriate opportunities to focus on growth because target customers may for strategic planning. They will be more not believe, understand or realise this likely to have the requisite skills needed to competency exists. And without a thorough execute their chosen strategy. Finally, their understanding of customer needs, the strategy should be continuously course- communication may be promoting corrected, given the changing realities of awareness of a service or product that is their own company and their marketplace. irrelevant to the target customer. Balancing internal realities and external opportunities not only facilitates improved Conclusion strategic planning, it improves the odds of consistent revenue growth in the near term Every one of the ‘nine levers’ tests has by focusing management’s attention on the the potential to ‘kill’ a deal, so they are weakest link. all quite important. Utilising this model also helps management of the company determine where the weak links are post- closing, so that management and the Christopher ‘Kit’ Lisle is managing partner at new owners can agree on the initiatives Acclaro Growth Partners.
136 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Sell-side online datarooms
by Angus Bradley
Online datarooms are finally being constructed. All paper documents will need recognised as the best way to increase to be labelled meaningfully to make sure deal speed and reach more bidders, while they can be scanned. Some documents may saving money and travel time. Many large need to be redacted. This preparation phase firms refuse to work any other way. Perhaps is the most time consuming and error prone the days of paper-strewn rooms, coffee element of the process. The team should stained documents and flying a team to resist temptation to start and add content Frankfurt to visit a dataroom are drawing as it goes; far better to prepare well, and to a close. This article addresses issues launch the room with most materials ready around set up and choosing security levels, for review. and also introduces important concepts like metadata cleansing and long term storage. Scanning in-house or outsourcing? Most firms have some in-house scanning More paper, higher cost. Dataroom capability, so they may consider this is providers’ costs vary, but they rise the best option to reduce costs. For cases depending on the amount of data and involving a handful of documents, the in- number of reviewers. If most of the house option is usually preferable, and an information required for due diligence is easy way to add new documents as the deal already available electronically (‘soft copy’), progresses. But when the pages number in then setting up an online dataroom is much the thousands, and time is tight, it may be easier. Documents can be uploaded directly wise to engage professionals to scan and and bidders invited to review them, with index the documents. Of course, there is a relatively low set up cost. On the other risk that the originals may be lost in transit, hand, if there are boxes of paper to be so the vendor should send copies to be scanned, the costs of going online could scanned, if possible. be considerable. In cases involving large amounts of paperwork, and only a few To print or not to print? Reviewing reviewers, a conventional dataroom may be documents on screen is tedious. Most much cheaper. reviewers will request print privileges. But the vendor should be aware that when Preparation is key. A better dataroom it allows someone to print, that person means a better transaction. Even though can choose ‘print to PDF’ and make an the dataroom is online, all the usual electronic copy of the document. Even if preparation work must still be done. The the printout is watermarked, the vendor vendor should prioritise the collection loses control and cannot later revoke of electronic and paper documents, and this permission. It is prudent to allow ensure its team understands exactly print access to non-sensitive documents, how the master index document will be restrict other documents to ‘read onscreen www.financierworldwide.com | FW 137 INTERNATIONAL MERGERS & ACQUISITIONS 2008 only’ and withhold extremely sensitive should remain undisclosed, vendors should documents until later stages in the deal, strip documents of metadata by either when the vendor is more comfortable with printing them out or using a ‘cleaner’ before a bidder’s intentions. handing them over.
For security, passwords may not be enough. Excel documents are hard to secure. There Traditionally, reviewers use a username and are several document types that can be password to access the dataroom. There is difficult to secure online, Excel is the reliance on the terms of the deal, as well as most common. Most datarooms protect ethics, to prevent the password from being documents by converting them to an shared with friends. Recently, stories have ‘image’ type format, which resembles a emerged of dataroom passwords being printout. Most financial Excel documents sent to competitors for their review. Even if will secure easily, but some sheets, such as ethics is not the issue, there have also been complex engineering sheets or those with reports of keylogging on major deals, which interactive features, cannot be secured means hackers log every key stroke from online if their function is to be maintained. a computer and can obtain a password. There are options to resolve this, but a Vendors should explore all available options vendor should be prepared in some cases for extra security, such as location-based to share certain files without copy and print restrictions in which users can only review protection. from one office, or secure tokens. Storing closing bibles on CDs or DVDs may Metadata – cleaning ‘handwriting’ from be unreliable. Post-deal, many people keep documents. When the British government copies of the dataroom and audit trail on published a report on Iraq’s non compliance CD or DVD. Estimates for the lifespan of with weapons inspectors, hidden metadata a DVD range widely from 30 to 100 years in the document revealed that the report – but it is quite likely that someone will was plagiarised, and had been written three scratch or damage the disk when checking years previously by a US student. When files. In either case, the ‘dataroom master’ SCO Group filed against Daimler Chrysler disk may become unreadable. It is highly in 2004, a Microsoft Word copy of the suit recommended that disc-based closing had metadata which showed that the bibles are distributed to IT staff who can company had originally targeted Bank Of store them on servers – rather than kept America instead. So how does this impact exclusively on CD or DVD in a filing cabinet. a deal? Upon completion, it is common to deliver the closing bible electronically, often with documents in formats like Microsoft Word. So to protect details like the author, Angus Bradley is managing director at version history, and other information that Projectfusion.
138 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Utilising the extended customer chain to enhance due diligence
by David Soley and Michael Sarlitto
Investment professionals recognise and methodical and repeatable technique appreciate the legal practicality and designed to improve an acquirer’s ability protections offered by the safe harbour to quantify and qualify the future value of warning: past performance does not a target’s products and services, markets, guarantee future results. Likewise, the and revenue streams. This article introduces universally time-honoured buyer beware dealmakers to the ECC perspective in dogma embraced by both financial conducting due diligence and supplies and corporate strategic acquirers is of a basic understanding of ECC methods instructional value to new entrants and a and techniques used to analyse customer useful reminder to even the most seasoned information, technologies, select business of dealmakers operating in an increasingly and work processes, key industry data, competitive M&A market. These generally and internal and external resources in a accepted operating tenets are of particular way that cultivates discovery of previously interest to those dealmakers conducting undetected business value. When transactions in high risk, rapidly changing employed in conjunction with routine due or operationally complex industries, diligence techniques, acquirers emerge technologies and company frameworks. better prepared to execute their deals with confidence, particularly those deals How does a dealmaker, operating in today’s that are not simply exercises in financial fiercely competitive environment, conduct reengineering and whose very success investment or M&A due diligence in a depends on the ability to create genuine way that adapts and adjusts to a rapidly business value. The practicality and value changing marketplace fraught with risk? of ECC in shaping business transaction Are there any enhanced due diligence decision-making is demonstrated in methods or techniques better suited to a relevant case study based upon an quantify and qualify new and unanalysed application of the model and results transactional risks deemed ‘material’ achieved. to a proposed transaction? What value would an acquirer place on an analysis What is ECC? technique capable of identifying and quantifying latent, heretofore undiscovered Simply stated, ECC is a repeatable, opportunity to create business value predictable pre-deal analysis and associated with a pending investment or, modelling technique capable of exploring, as a minimum, result in a more competitive leveraging, realigning and optimising the purchase offer / terms and conditions? customer chain in which a target company operates. This analysis oftentimes yields Extended Customer Chain (ECC) Analysis is undiscovered, sustainable, adaptable and rapidly emerging as an extremely efficient, incremental business value. While typical www.financierworldwide.com | FW 139 INTERNATIONAL MERGERS & ACQUISITIONS 2008 investment assessment analysis focuses to optimism in the firm’s ability to realise value a great extent on identifying value chain from market development opportunities. improvements intended to deliver better In certain circumstances, ECC can help margins or scouring revenue projections to avoid wasted time and effort in pursuing come up with ideas designed to spur top permanently sub-optimised investment line growth, ECC zeros in on the company’s opportunities while in other instances, it capability and capacity to service can unearth previously undetected, less unique and rapidly changing customer obvious, dealmaking value that turns a requirements – whether direct or indirect, walk-away deal into a portfolio maker. primary, secondary or tertiary. The building blocks of ECC Most traditional due diligence relies on a financial assessment and valuation of a There are five building blocks comprising target’s management processes and the the economic instrument of the ECC model: resources controlled by these processes market insights, data, process, relational (i.e., labour, material, machinery) in capital and technology. While these key order to establish an initial company components, taken independently, are value. This exercise in number crunching not and should not be new to dealmakers, is immediately followed by generous their integrated use in analysing both adjustments for yet-to-be-realised, the target and the target’s direct and self-identified business development indirect customers is core to the ECC opportunities, investment thesis analysis technique. This simultaneous conjecture, and non-repeatable artfully examination of the target, in conjunction calculated synergistic benefits. ECC with the target’s customers, provides the picks up where this financial and SWOT core market structure context necessary analysis leaves off in analysing sources to assess opportunity and to exploit new of incremental business value. Its unique economic growth models. perspective views the target company’s value proposition in the context of broader, Market insights give a transaction team interrelated customer relationships; a broader view into the trends, value relationships that when focused through a drivers, market forces and industry lens of change, innovation and integration, dynamics necessary to formulate creates opportunities for new, unanalysed strategic solutions to a target’s critical and previously undetected accretive challenges, each of which constitutes a company growth. value creation opportunity. However, by also conducting a market assessment In addition, ECC applied during the early from a target’s customer’s perspective, stages of transaction processing provides the transaction team may discover investment practitioners with critical, new business opportunities, alternative time-sensitive insight into the rationale for commercial agreements, different business a target’s claims to prospective revenue transaction models, and buying and growth potential; validity of purported consumption behaviours more indicative underlying root causes for a growing, of the constantly changing and evolving stagnant or declining customer value marketplace. proposition; and justification for continued
140 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
These insights are a critical component and cumulative trends, and descriptions of an ECC model and typically include of qualitative and quantitative changes the following six impact variables: (i) occurring within a target’s extended emerging technologies: understanding environment. new technologies, their applications and how to effectively utilise them to increase Process frameworks internal to the the value of existing products or services; company can provide useful information (ii) emerging markets: identifying new into understanding how well the company markets to sustain the core business has defined, architected, managed and or create an opportunity to offer new positioned existing products and services services to customers; (iii) industry in the market-wide value chain. However, challenges: recognising the issues that an acquirer’s understanding of the ‘as- may impact future revenue performance found’ strategic thinking displayed by and competitive position; those who can company leadership may also provide not identify trends, risk losing customers valuable insight into how well they have, or to firms that can adapt to dynamic will, embrace exploration into the broader environments; (iv) regulatory implications: customer environment to mine additional government regulations and legislation opportunities for supplying its products often impact a target’s efforts to conduct and services. In the context of ECC, the business and protect its competitive term ‘process’ collectively represents position; (v) industry event analysis: the steps involved in performing work, effectively identifying the competitive and specifically, how people, machines landscape and precipitating events are and resources are utilised in performing essential for effective business strategy production tasks. ECC also provides a formulation and execution; and (vi) regional framework for examining how a target’s focus: recognising local market activity core business and its products and services and events, and micro-market variations interface with customers and partners. in customer behaviour may provide practitioners with insights on which new Relational capital represents current and markets to enter and how to do so. potential capital resources (i.e., financial, human, intellectual) embedded within Data is crucial to developing a meaningful existing or future relationships with understanding of a company’s value business partners and customers. Relational proposition. In order to be useful in capital is categorised and aligned by conducting valid ECC analysis, high quality company product or service in order to data can be characterised as relevant, gain maximum leverage in the company’s historically accurate, updated, retrievable, aggregate value proposition. Relational source-traceable and accessible. ECC capital may also include indirect sources, data sources may include key information such as ongoing collegial relationships concerning all company inputs and outputs, with consultants and publishers who selected processes and operations, and in turn possess significant business is particularly exhaustive in the areas relationships with key contacts within a of the company’s products and services certain company’s target market. These and end users or customers served. Data relationships oftentimes yield valuable forms include referenced facts, individual influence in sourcing new business and can www.financierworldwide.com | FW 141 INTERNATIONAL MERGERS & ACQUISITIONS 2008 also contribute to successfully entering new markets are defined, the results realised markets. will quickly demonstrate a return on the assessment effort. Technology can be a key enabler to innovatively enhancing the value of a Case study: consumer goods company’s product and service offering, manufacturer naturally broadening its value proposition. Technology is often used to effectively A financial sponsor was performing due expand the relevancy of a given product or diligence as part of a plan to determine service resulting in a more comprehensive if continued investment or extension of connection to adjacent products, processes, an existing product/service was viable. people and organisations. Technology plays The target had recently introduced a new a critical part in achieving scale objectives wireless communication product to the by enabling simultaneous delivery of value consumer market place. The product’s added services for multiple customers, original platform was designed to allow whether part of the same customer or its customers to contact a centralised call value chain or not. Finally, advancements in centre to alert service representatives technology-enabled processes can provide of particular issues concerning product a rapid and responsive means for managing applications. Customer Service would direct and executing new product and service immediate and geographically dispersed development initiatives. responders to correct the customer’s situation. Though the customer problem In the context of M&A due diligence, the resolution function was of particular ECC perspective extends conventional importance to its customers, there was due diligence beyond a targets’ core a sense that new market applications business and into its customer’s customers were not being pursued and as a result, and consumers. This broader, holistic the company was interested in taking approach into understanding a company’s action to pre-empt entrance of potential position in the extended customer chain competitors. helps to cast a wider relationship-driven net across organisations that may offer Facing continued pressure to reduce product, services, IP, or relational capital competition and increase market share, resources that would otherwise remain off the financial sponsor was also searching an investor’s radar. The inclusion of an ECC for opportunities to increase business perspective in conducting due diligence value, rationalise a higher valuation and may be the first time an organisation is multiple, and differentiate the company’s exposed to this broader perspective. In product within a crowded asset class. To these cases, the acquirer would be well better understand and develop actionable advised to pay particular attention to solutions and define a new product or results that, when properly bundled, create services model, the transaction team considerable negotiation leverage. While utilised ECC. implementation of ECC may challenge the company’s basic assumptions and In defining the market context for applying conventions about how business value is ECC, external industry and customer created, customers are serviced and new analysis was conducted and revealed
142 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS market gaps, new market segments, the financial sponsor was able to commit the linkage opportunities between unique significant capital investment necessary market segments, market incongruities, to continue market expansion and revenue streams, and unmet market needs. systematically implemented the ECC due Customer and product application data diligence recommendations. The company was abstracted from this analysis and enjoyed rapid market growth acceleration then broken down into key components with product sales increasing over 800 using system analysis methodologies. percent during the five year investment These components derived from analysis horizon time period. As a result, ECC were then utilised to build new product meaningfully contributed to creating a models and identify related external market product to market success story enabling entities and technologies, adding a further for better than average investor return. dimension to a qualified and quantified strategic plan for a more expansive product Conclusion platform. ECC provides financial and strategic The improved product platform productised acquirers with a means for defining and information, captured and modelled establishing new market positions, business customer information, and functioned as models and strategies. Due diligence that a wireless platform model for enabling utilises ECC is enabling more insightful and customers to acquire new products and competitive decision-making. The value services in near real time from remote that ECC delivers to investors is becoming locations. The wireless communication of critical importance as growing volatility model created new market space, services, in the economic and national political business intelligence and integration climates, increasing competitive dynamics, opportunities with retail, services, media, weakening capital and liquidity markets, and hospitality markets. The new product and tighter valuations continues to impact platform would also be linked to other deals of all sizes and across all industry business models, allowing the products sectors. vendor to analyse customer behaviour in near real time.
Based on the ECC analysis, previously David Soley is a senior consultant and unknown and undetected business value Michael Sarlitto is managing partner at was discovered and quantified. The SummitPoint Management.
www.financierworldwide.com | FW 143 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Due diligence trends in Europe – commercial, operational and cultural twists
by C. Schindler
Subprime’s tightening of credit markets and gathering the data that leads to sound has ushered in a new phase of European conclusions. M&A. Gone are the days of quick, financial investor-led deal flow with ever-rising In such cases the due diligence team must multiples. Process and scrutiny have be highly effective in managing hypotheses replaced arbitrage in driving transactions. testing starting from a broader, less As value creation becomes the new transparent base. Missing the key message buzzword, due diligence methods need to or getting off on the wrong tangent leads to respond. inaccurate assessment of the opportunity and to a flawed transaction. The primary focus for change resides in commercial, operational and cultural due European due diligence teams, therefore, diligence, as these are the areas of value have to be creative, disciplined and focused creation and not just risk assessment. to drive toward the right results. Experience Knowing what can be done and how to is more important than following a go about it separates the men from the cookbook, and the right message boys in this roll-up-your-sleeves market capsulated in 10 pages is far superior to a environment. Forget ‘defining the equity 100-page fact cemetery. story’. It’s now all about managing the value equation, which in Europe means Operational – do as I do, not just as I say taking a professional look at commercial, operational and cultural issues prior to the It is harder to drive ROI these days just transaction. on market growth and buy-and-build strategies. Even healthy targets can be Commercial becomes the band leader optimised, while weaker candidates need restructuring. The substance in a With private equity retrenching and transaction, therefore, is often found on strategic buyer coffers filled with recent the shop floor. If an acquirer wants to find profit gains, European buyers are taking the value prior to purchase, they need to a harder look at their targets, thereby do more than just kick the tires on a few softening once rigid auction processes. machines. They need an expert, in-depth This means more access to the company look into the risks and opportunities. and a heightened awareness of commercial issues. In Europe, where management Whether healthy or distressed, most controls and systems are often less European targets today are in the midst advanced than in the Anglo-Saxon world, of some growth, market, technology, or commercial due diligence needs to be more regional transition that, depending on how creative in identifying key value drivers it is managed, will either make or break
144 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS future performance. Modern operational a two-tiered management structure, the methods such as Value Stream Mapping, managing director of a mid-sized company Six Sigma, 5S or Lean have a lot to offer in will think very differently than his Anglo- creating success stories. For due diligence, Saxon counterpart. As an example, one the team needs to have experience with should not assume that a German manager such tools and how they are applied. Many is looking to do an MBO, which is still seen times, the effectiveness of these measures by many as a minor form of blasphemy is determined by not only how the methods in the church of shareholder loyalty. Of are deployed but also how effectively course, some do cosy up to the idea of organisational and cultural nuances are sweet equity over time, but only if the addressed. This is a key factor in Europe, concept is introduced with proper timing where each country has its own language, and discretion. The better short term hook culture and mindset. to get a manager on board is to appeal to his need for continuity and new challenges. Automotive is one of the most challenging Devotion to duty and company will lead manufacturing environments around. most managers to talking about the many It is important to recognise causes and strengths and weaknesses they see – effects early in a due diligence and make invaluable in due diligence. experience-based assessments of what can be accomplished at what expense. During Shareholders in Europe think differently the evaluation phase, this often requires too. On the surface, many are less mapping to industry benchmarks and infatuated with the prospect of cashing out calculating the resulting ROIs in financial than one might expect, a by-product of less terms that can flow into a valuation model. value other cultures place on conspicuous consumption. In order to open the doors for Correct identification and assessment of a transparent transaction, the initial appeal improvement areas are not enough though. needs to be to other values – assuring They need to be implemented to be worth the continuity of the legacy through new something. Words need to turn into actions. (wise) ownership, recognition of the moral A common flaw in operational due diligence obligation to employees, etc. Playing procedures is that the team assessing the the human piano well can make all the potential is no longer available or desired in difference between getting comfortable post-acquisition implementation. This may with a deal and not having one at all. result from an organisational lapse or, as is often the case, from the fact that many Shifting markets imply increased emphasis consultants like to write reports but don’t on commercial, operational and cultural want to get their hands dirty. elements of due diligence. Winning the race is all about knowing where the currents are At the end it’s all cultural and applying the right strokes – especially in Europe. The backbone of Continental Europe’s corporate infrastructure is represented by privately held, technocratic family businesses. In Germany, for instance, a Christoph M. Schindler is a managing director country whose commercial law prescribes and European Practice lead at BBK. www.financierworldwide.com | FW 145 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Due diligence and integration planning in cross- border transactions
by Mark Thompson
Due diligence is undoubtedly one of regulations are increasingly expanded to the most critical steps in the acquisition include successor liability in areas such as process. Used properly, diligence is an environmental, employment / benefits, effective tool to enable decision makers money laundering, and international trade to evaluate the risks and benefits of a issues, acquisitive companies have been potential transaction. The advantages forced to examine their targets more of a properly constructed due diligence closely. process, however, do not end simply at the completion of a transaction. The due The dominance of private equity funds as diligence process and integration planning both buyers and sellers has also created a should go hand in hand to ensure a larger role for the due diligence process. successful acquisition. As a buyer, a private equity fund needs to be aware of every issue that can affect The rise of due diligence cash flow in order to be able to service any acquisition financing and provide a return Due diligence has grown in importance in to their investors. Since the liquidity of a recent years. Although some would argue fund is limited, when making an acquisition, this is due to the influence of the US style there is scarce room for costly liabilities. of transactions, there are, in fact, several Further, as a seller, private equity funds more important contributing factors. As frequently provide very limited claims evidence has shown, many acquisitions protection to potential buyers. Funds often have had a negative impact on the financial try to structure their sell-side transactions position of an acquiring company. There to mimic a public transaction where there is concern by several constituencies are no surviving warranties or indemnities. about companies making hasty decisions Consequently, buyers must seek protection to grow in size or prestige without truly through diligence, as claims protection will understanding exactly what it is that be limited. they are buying. Consequently, increased scrutiny on companies making acquisitions Team coordination by shareholders, governmental entities and creditors is a major factor in the importance A thorough diligence investigation requires of due diligence. input from a number of different sources. Due diligence is typically divided by This issue is magnified by the ever business function – usually financial, legal, increasing liabilities associated with accounting and tax – and shared between acquisitions. In many cases, the target the advisers and the acquiring company. company’s past problems can result On large cross-border transactions, and in significant ongoing liabilities. As even on smaller deals, dozens of people
146 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS and a handful of different outside firms integration process and create costs or and sub-specialists can become involved. liabilities for the combined companies Coordination of these functions is therefore further down the line. crucial from the outset, particularly in terms of putting together a due diligence plan Once the goals and objectives of the and protocols that establish the working due diligence investigation have been relationships among participants. established, it is equally important to be sure that there is an organised chain of The first step in creating such a plan is command when it comes to reporting the to determine the goals and objectives findings. If the results of the diligence do of the investigation – essentially, what not reach the appropriate decision makers, information will help the decision makers the entire effort will have been wasted. A determine whether to proceed with the protocol must be devised from the outset transaction and at what value? Each which establishes not only the reporting acquirer will have different sensitivities chain, but also the timing and format of the about this – for example, some companies reports. In addition, a process should be set are particularly concerned with up to flag significant issues to the decision employment issues, while others may focus makers immediately. more on potential environmental liabilities. It is important to sit down with the decision It is also useful to work closely with the makers from the beginning to develop a integration team leaders to create a plan focused on their concerns. Surprisingly, product that can be used for integration this step is often overlooked as advisers planning pre- and post-completion. If the frequently charge forward with a so-called diligence and integration are not done standard due diligence investigation hand in hand, the diligence frequently will without taking into consideration what the be duplicated later and valuable time will acquirer really needs. be lost. Of course, this sounds easier than it actually is in practice, and while some As a general matter, one of the most companies are very good at integration on important things to recognise is the their own, the vast majority will or should difference in approach to due diligence look to their advisers for assistance. between strategic buyers and private equity funds. The short term approach to Indemnity protection and warranties an investment typically taken by funds (generally three to five years) means their It is often asked whether the need for due financial models may not tolerate much diligence can be eliminated by protecting of a cushion to cover potential liabilities, the acquirer with warranties or indemnity even if they are ultimately indemnified protection. While there is great appeal down the road. Therefore, it is important in taking that approach as it saves the that they are aware before execution of an upfront diligence costs, it is a very risky agreement of any issues that could impact alternative. Fundamentally, due diligence cash flow. Although strategic buyers are could turn up potential liabilities or business also concerned with immediate financial issues that would cause the acquirer to returns, they are typically more focused walk away from the deal, or at least adjust on identifying issues that may stall the the pricing. Furthermore, often the most www.financierworldwide.com | FW 147 INTERNATIONAL MERGERS & ACQUISITIONS 2008 important representations, warranties and get the business running more quickly. indemnities in a transaction are specifically crafted to deal with issues identified during It is frequently debated whether warranty the due diligence. Simply stated, if a insurance can be useful in mitigating these company does not know what is out there, types of risks. In many cases, insurance is it is hard to protect itself adequately. extremely helpful, particularly if there is a gap between the acquirer and vendor in In addition, there are certain liabilities the cap on claims protection. Insurance, where indemnification cannot provide however, is not a substitute for due adequate remedies, particularly if common diligence. In fact, the insurer will review caps and limitations are applied. For the acquirer’s diligence report and often example, when a US company is the will want to conduct its own diligence acquirer, liabilities raised due to violations investigation. Furthermore, it is important of the Foreign Corrupt Practices Act by the when using insurance in a transaction to target company, or parties contracting with review the exclusions to the policy very the target company, may pass through carefully as key risks will often be excluded to the acquiring company, even if post from the policy. In practice, insurance is completion such illegal activities are halted. most effective when purchased in order to In addition, liabilities relating to issues such bring a transaction together when it covers as environmental, money laundering, and specific risks uncovered in due diligence. employment / pensions raise significant successor liability issues that should be Whether the acquirer is gaining protection identified in diligence pre-completion. through representations, warranties, indemnities or insurance it is important A further risk is the credit-worthiness of the that the decision makers know the results party providing the coverage. Frequently, of the diligence investigation and all protections gained in a purchase agreement of the data provided by the vendor has are neutralised because the party providing been thoroughly analysed. Contractual the protection is effectively judgement protections in a purchase agreement can proof, particularly if the vendor in the be voided if the acquiring company learns transaction is an individual. In addition, about a problem or a breach of a warranty even if the acquirer is able to obtain a before the execution of the purchase judgement, resolution of such matters can agreement or, in some cases, before take significant time and expense. completion. Further, in some jurisdictions, courts will not allow a recovery for damages Simply stated, diligence provides the if the acquirer should have known about acquirer with the opportunity to learn a breach or a problem based on the everything there is to know about the information provided by the other side. target’s business before being bound to Consequently, it is important for acquirers the transaction. That way, whether the to include language in the purchase target is a stand alone acquisition or will be agreement that limits its knowledge in integrated into a larger organisation, the some manner or identifies the universe acquirer can determine whether it wants to of information about which it will be proceed and at what price and knows what accountable. to expect post completion, allowing it to
148 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
At one end of the spectrum, the purchase knowledge of a potential liability prior to agreement can contain a provision that all execution of the purchase agreement can information learned during diligence is held prevent a successful claim if such liability against the acquirer. Often referred to as an turns out to be a breach of a warranty. ‘anti-sandbagging’ provision, such provision Consequently, it is important for the provides that anything the acquirer learned diligence team to be in contact with the prior to signing cannot be used as the negotiating team to be sure there is a subject of a claim or to prevent completion. proper understanding of the consequences At the other end of the spectrum, some of the diligence investigation and how it purchase agreements state that the only relates to the overall agreement. knowledge an acquirer is deemed to have is included in the purchase agreement Due diligence is an integral component of itself and its schedules. A compromise the acquisition and integration process. position often seen limits the universe of Although often complicated, expensive and information about which the acquirer is time-consuming, it is extremely important accountable, but also requires the acquirer for acquirers to conduct an organised and to state that it has no knowledge of facts thorough investigation in order to complete that amount to a breach of warranty or transactions successfully and ultimately create a claim. integrate the target efficiently.
Even when the purchase agreement is crafted appropriately, unless known problems are specifically addressed in an Mark Thompson is a partner at King & indemnity, many courts have held that Spalding International LLP.
www.financierworldwide.com | FW 149 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Breakthrough value creation in M&A
by Vikram Chakravarty and Navin Nathani
Mergers and acquisitions often fail. Studies days plans, value-extraction plans, synergy have shown that close to half of all mergers calculation plans and so on. However, these failed to create any value and perhaps plans remain relatively high level, partly due only a few of them outperformed their to legal barriers but mostly since there is industry benchmarks. However this has not uncertainty about whether the deal will go diminished the appetite for M&A. Indeed through. with private equity funds in the mix, the quantum of merger activity has hit record A bulk of activities in the pre-deal phase highs. With astronomical prices the onus on remains linked to getting the deal through. generating value is even higher than before. Anyone who has been in the midst of a negotiation process can testify to the Studies often point to the poor process highly charged atmosphere and the driving of bringing the firms together and rationale that without the deal there really organisation disruption as the root causes would be no ability to create value. So it of failure. We believe that the typical is not surprising that the task of thinking process of merger integration – which through how the deal will create value merely drives towards standardising is often neglected and the plans remain processes and practices – is inadequate. It rudimentary. is important for firms to use the ‘event’ as a catalyst for step change and to embark on a Our experience suggests that typical program of significant transformation. management objectives after the merger process focus on: (i) getting a budget done Background and ensuring decent allocation of resources (capital, labour, research, training); (ii) a M&A deals are complex undertakings desire to stabilise the firm; (iii) reducing that take centre-stage in the lives of the disruption; (iv) imposing a consistent firm parties involved for a significant period culture; (v) ensuring that the ‘right’ people of time, well before the actual deal. This are in the right roles; and (vi) starting the pre-deal phase can range from months to value creating process by activating some years, during which the parties engage in initiatives (typically the low hanging fruit). planning for the deal – selecting a viable target, running strategic, commercial, The trouble is that this is a relatively timid operational and legal due diligence, approach focused on incremental changes. developing a valuation range, and starting A merger offers the chance to ‘change the the negotiation process. rules of the game’. The merged entity is encouraged to re-think its strategy and In some well planned mergers there is positioning based upon its new position, growing emphasis on chalking up 100- and should implement a process of
150 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS transforming its organisation to ‘best in opportunities (low prices or cheap debt) class’. are often the triggers for initiating a takeover bid. But true value creation lies Value creation – planning the post-deal in the mundane world of improving the phase early organisation and its operations. Therefore the merger event is a time to push through Since there are very few good bargains significant change that will set the merged around to justify a deal on the back of entity on a significantly different course. ‘simple’ financial reengineering, acquiring This is equally true for strategic buyers as or merging entities are clearly forced to well as buyout funds. focus on post-deal value creation. Lessons from successful merger Synergy extraction is often spoken about transformations but not typically understood or planned for. Most mergers have synergy calculations During merger activities it is prudent to done at a very high level in the pre-deal spend a lot of time getting the basics right. phase with little emphasis on exactly Standard hygiene factors for planning a how they plan to extract the value. The merger integration include: (i) establishing realisation of this synergy will likely occur clear goals, managing expectations and after stabilisation of the new entity, but communicating openly; (ii) selecting often the extraction rate slows down after the leadership quickly; (iii) focusing on a while or disappears altogether. Our customers; (iv) establishing a strong research shows that mergers generate a integration structure; (v) proactively certain momentum, and unless synergies addressing cultural issues; and (vi) creating are extracted within the first 12 months an internal sense of urgency. But companies they are unlikely to be extracted at all. are also urged to consider radical solutions to the age old problem of value creation The pre-deal phase is usually passive with through M&A, as outlined below. primary objectives such as assessment, identification and planning. Couple this Setting new ambitions. Shift the mindset of with access hurdles for regulatory or the senior management from attempting confidentiality reasons, and the value- to just get the best of the two firms, with creation opportunities that arise out minimal disruptions, to attempting to shift of this stage are neither concrete nor to a higher level of productivity. In general, easily realised. In comparison, after the this notion is met with scepticism as the completion of the deal, the single emerging merger process is cumbersome and there is entity will be able to make plans from a a fear of ‘biting off more that we can chew’. better vantage point, as well as make plans However M&A events tend to loosen age that are likely to yield tangible benefits. old corporate thinking and make radical But pre-deal planning is still important and change possible. In recent mergers we have must be attempted as much as possible seen firms shaken out of their standard within existing limitations. ways of doing things and setting new goals to become the best player in their industry. In summary, we have found that industry The stock market has rewarded these consolidation trends and financial efforts and the companies are on their way www.financierworldwide.com | FW 151 INTERNATIONAL MERGERS & ACQUISITIONS 2008 to becoming global industry champions. of transformation. Although cost cutting is necessary, if the objectives of the merger ‘Jump-start’ the clean room. For too long become a transformation drive, then the clean room has become a dumping the areas of cost cutting migrate from ground for data with managers rarely SG&A toward marginal plants, improving having good access to it to ensure detailed procurement and logistics improvement, study. Data must be kept confidential but complexity reduction, manufacturing consultants also need to have access to optimisation and the like. both data and people to start the planning process. Multiple teams may need to work Carrots and sticks. Detailed planning on multiple functions simultaneously, to and responsibility allocation needs to plan for the merger in great detail before be reinforced with a clear performance the actual closing of the deal, including management system. This sharply allocates joint studies. The planning stages should responsibilities, sets measurable KPIs and be carefully calibrated with the approval tracks performance. The system should process, with more detail and access have a strong incentive structure to ensure provided after each acquisition hurdle is that individuals and teams are motivated. crossed. There should also be some ‘headline punishment’ events to let the employees Detailed planning / responsibility allocation. know that slack will not be tolerated. Ensure that there are detailed execution plans with people allocations and KPIs Discrete value creation opportunities exist completed and ready for execution on ‘Day at every juncture. Mastering the integration 1’. Short term plans, like 100-days plans, are process is a critical success factor in critical for setting a sense of urgency and capturing merger value, as most mergers demonstrating the possibility of working and acquisitions typically fail due to a together to generate positive results. few consistent factors that relate to poor execution rather than strategic rationale. Selecting / moving to best practice. For Fundamentally, mergers are a useful and processes and practices, be open about valuable option for improving the fortunes challenging the current status quo and of a firm. But the root cause of failure pick a path to achieve the best in class. of M&A goes beyond weak execution of Benchmarking, all too often an ignored plans – often companies are not aggressive aspect of setting strategy, can be a enough in their ambitions. Indeed, firms powerful tool for forcing a re-think or fail because they set their sights too low encouraging out of the box thinking. on incremental improvements and not on ‘jumping the queue’ to best in class. Avoid short termism. It is sometimes imperative to produce short term gains to show immediate results in order to Vikram Chakravarty is a principal and Navin pacify the investing public, creditors to Nathani is a consultant at A.T. Kearney. The the deal, regulators and others. Sadly, authors would also like to thank Phil Dunne, this is often achieved by cost cutting key a partner at A.T. Kearney, for his support and functions which might hinder later stages advice.
152 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Cross-border M&A: downstream implications
by David Eaton
Mergers and acquisitions have dominated from Bucharest, he thought about his the global stage for many years, cycling latest meeting with the local team that had up and down based on market conditions, been assigned to him by the Integration yet always serving as an accelerant of Management Office (IMO) to integrate profitable growth, and ultimately, enabling the manufacturing process. No one could globalisation. Worldwide M&A reached explain why scrap rate and slow cycle times record levels in 2007, with $4.83 trillion on the production line continued to escalate; worth of announced deals, according to customer deliveries were now a significant Dealogic. worry, and the sales team was climbing all over his back for delays in order delivery. But, as previous statistical summaries have The merit-based incentive system which was indicated, the M&A failure rate continues used successfully for years in Europe and to range between 60 and 75 percent. Why North America was having little or no effect do three-quarters of all M&A deals fail to with these new employees in Romania. deliver the intended benefits? The following Hans’ ability to gather high quality data on example illustrates some underlying issues. this last trip was limited; every question he asked seemed to generate confusion For global executive Hans Kommer, trying and mountains of excuses for why that to focus his EMEA manufacturing team on information was not available. There seemed getting this international acquisition back to be so many layers added to the decision on track was proving to be more challenging making process, with a hierarchical, power than he had anticipated. Based on early hungry reaction from some folks, while scope and due diligence assessment, it others hung back and seemed to avoid the appeared fairly straightforward. The deal conversation. It also seemed to be difficult made sense; bolting on a mid-market for some members of the new management manufacturing operation in Eastern Europe to accept their fate, to understand they to his company’s global manufacturing needed to join the European manufacturing footprint should have mapped beautifully. team and demonstrate ownership of the The target was already on board with the integration strategy laid out by senior principles of Lean Manufacturing and Six leadership at headquarters in Europe. Sigma, based on a previous joint venture with another competitor of Hans’ firm. Even Hans has the challenging task of successfully geographical synergy should have been easy, integrating this acquisition into his global since the company was less than a 1000km functional responsibilities, while achieving from its headquarters in The Netherlands. So the ROI predicted and communicated to why was everything falling apart? shareholders and the board. Cost savings and supply chain synergies based on As Hans sat on the two-hour flight back supposed geographical advantage would not www.financierworldwide.com | FW 153 INTERNATIONAL MERGERS & ACQUISITIONS 2008 pan out as the corporate development team Fourth, manufacturing and supply chain had expected unless he got his act together integration. “Closing redundant plants quickly. and merging supply chains into one robust system will be a relatively straightforward It’s all about integration consolidation exercise.” In many regions of the world, personal ties to employees There are five misconceptions that continue and long time suppliers, along with deep- to plague cross-border deals in particular, rooted organisational systems, can lead to even those consummated by the most highly charged debates that make supply brilliant officers of corporate development chain rationalisation surprisingly difficult to or M&A, and talented integration teams achieve. assembled from some of the strongest talent within each function of both companies. Finally, human integration. “Our corporate cultures seem to be pretty compatible.” First, functional integration. “Manufacturing Acquiring companies consistently is manufacturing, IT is IT, and finance is underestimate the challenges of post- finance.” While some functions do share merger integration of human capital. Often common terminology and professional the most critical success factor in making training around the globe, in the post- a deal work is not the financial projections, acquisition period standard practices for the strategic plan, or the organisation developing prototypes or deploying the IT chart, but the ability of the principals to function may not be so compatible. mesh as a new team. Different personal styles, thought processes and informal Second, geographical integration. patterns of communication shaped by both “Geographies will meld together. My organisational and national cultures can all Western European headquarters will have make human integration a challenge. no issues of compatibility with its new Eastern European colleagues.” Even in an Building a third culture era of transnational management, many employees are still very much culturally Come on, we’re all smart people, we’ve conditioned by their national backgrounds, read the articles, we know we need and may leave a post-integration entity if to concentrate on these issues as we their legacy culture is not incorporated into contemplate a joint venture, a merger or the the new operating environment. acquisition of another organisation. So why do these issues continue to challenge us? Third, customer integration. “Customers Why can’t we anticipate these challenges who previously used one supplier from and develop a plan to minimise the ‘noise in their home market will be fine receiving the system’? shipments from the other side of EMEA. Our customer support centre now based in North It is quite common for employees from an Africa will serve our EMEA customers just as acquiring organisation or a new partner to well.” Customers tend to have their own way think “For years we have been successful of looking at the world, and may not see the with our methods of manufacturing, new set-up as a plus from their standpoint. financial reporting, and staff training. If the other organisation’s ways were so superior,
154 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS wouldn’t they be in better financial shape?” place where they can successfully navigate stylistic differences. The challenge lies not so much in whether one way is more right than the other. The Follow the rapids challenge is creating a mutually-respectful environment where exchanging ideas and To minimise the costs inherent in explaining processes creates the opportunity unsuccessful cross-border M&A and to build an even better post-M&A culture joint venture activity (longer cycle times, without ‘giving up’ the asset value of opportunity costs, and even business failure), the target or the non-negotiables of the Hans could consider the following seven acquiring company. steps to successfully navigate the rapids and resolve his current predicament in the Experience suggests that one good way downstream integration phase. out of this perpetual hurricane is to build a ‘third culture’, or a third way of operating, Scope the activity. Hans needs to be very which rises above either party’s traditional focused on the problem he is trying to methods. solve. For example, what will be the key initiatives he needs to implement to get It has been said many times that the the manufacturing streamlined and realise whole is greater than the sum of its parts. the savings for the region promised by the But the whole is not simply gathering all acquisition, what systems need to be built components to make a big heap in the or installed, or which components need to center of the warehouse floor. The whole be integrated? In other words, how does is actually the cumulative effect of the best this acquisition impact his overall strategy ideas derived from the individuals, teams in EMEA, and the roll-up to the company’s and organisations involved, as well as the global requirements? contribution of new, innovative thinking arising from the synergies of the acquisition. Metrics that move. If he achieves a successful outcome as a result of bringing In other words, the best success stories begin key individuals or teams together, what when a topic is placed in the centre of the metrics will move as a result? Examples table. All the best minds available gather of ROI include improved cycle times, cost to discuss and brainstorm great ideas and reductions, increased sales, customer or innovative solutions, and if an element from employee retention, one fully integrated key a previous system or organisation should account or reward system moving forward, contribute to the final solution mix, fantastic. and so on.
Building a third culture requires humility, Human interaction touch points. Who needs open mindedness, flexibility, creativity and to be invited to the party? Hans must comfort with risk. It also depends on the identify key stakeholders per category, ability of group members to value other and involve them in the process by which opinions, fresh thinking and the potential a creative, innovative solution will be to create something original. But most of developed to achieve the desired state. This all, the team, or pair of individuals, can only could be called a ‘human interaction across achieve third way solutions if they are in a cultures’ audit. In essence, it means looking www.financierworldwide.com | FW 155 INTERNATIONAL MERGERS & ACQUISITIONS 2008 for the places within the newly combined internal or external facilitator who can not organisation where two or more people only guide the team through the process will interact across multiple definitions of of developing an innovative solution to ‘culture’ – company, national, functional, the business challenge, but also serve as geographical, industry, headquarters versus a process coach. The facilitator helps to subsidiary, etc. – in a way that impacts the enforce, and reinforce, the newly-created challenges, and the expected synergies. team culture, ensuring that team members stick to their agreements and utilise shared Personal styles inventory. Each individual processes to drive problem resolution. arrives at the incubator table with his or her own styles of ‘human interaction’. It is Loop back around. All good processes contain vital to understand their ‘pile of styles’, the an element of self-reflection and evaluation. hard wiring they have received that shapes Companies should undertake a process of their behaviours. Team members must review against the previously mentioned achieve a level of acceptance/respect, to ‘metrics that move’. Measuring progress gain awareness of each other’s styles, and to toward stated goals and experiencing understand the ‘why’ behind their behaviour, improved results is a powerful elixir with so they can appreciate each individual’s which to motivate any individual, team or starting point. organisation.
Building team systems. Before it is possible Summary to navigate the business issues that need to be solved, we must create a ‘human Successful mergers, acquisitions and joint operating system’ that will drive a team’s ventures depend on the eventual integration interaction going forward. The team must of two or more organisations. The net define a shared vision of what goals it seeks deliverable of the seven steps described to achieve, the key business problems it above is nothing less than the creation of must address, and individual roles and a third culture within the newly combined responsibilities. In addition, the team organisation. An acquirer is ultimately needs to co-author a number of key shared judged on how well it achieves the stated systems, the components of which tend objective: to buy, merge or collaborate with to vary widely according to national and another entity – sooner, faster, cheaper, organisational cultural norms: decision- better. When bringing together diverse making system; project management; colleagues and cultures, and merging communications (virtual and face-to-face); systems, processes and procedures into one meeting management; conflict resolution; organisation, specific steps can be taken and other group norms (email, conference to enable these teams to rise above their calls, agenda setting, relationship building, competing styles and develop a third culture etc.). Out of the array of individual styles – one that can fuel integration and superior present at the table, team members need to business performance. create the most appropriate team culture to achieve a successful outcome.
Solve the problem. A business work-out can David Eaton is a managing director and be accelerated in the initial stages by an founder of Aperian Global.
156 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Integration – the key to a successful merger
by Richard Lieberman
No buyer acquires another company success of the transaction, buyers should anticipating the transaction will fail. commence integration preparations as far Nevertheless, a surprising number of in advance of the transaction as possible. mergers and acquisitions yield results Many purchasers delay integration far below projections. Many acquired planning until just before the closing, to companies are later resold to new buyers save effort and expense. Their limited staff or spun-off within a few years, allegedly resources are often otherwise engaged. because the new business was not a Confidentiality considerations may limit the ‘strategic fit’. Regardless of the reasons ability to introduce necessary personnel to given, many of those transactions the potential transaction. Similar reasons underperform because the buyer did are offered for why the integration efforts not devote sufficient attention to the are postponed. integration of the businesses. Delay, though, can exacerbate the Ideally, a successful integration permits difficulties in achieving a smooth and the combined enterprise to operate as prompt synthesis of the companies. a synthesised unit on the closing date, Frustration caused by the disruption in with minimal disruption to customers, the integration can result in loss of key personnel, productivity and operations. employees, customers and good will. Employees are motivated and cross- Failure to properly assess the impact of trained on the products and services of disparate methods of operation could the combined enterprise. Employees can result in delays in production or delivery of communicate with each other, customers services. Ignoring the impact of foreign laws and vendors through compatible systems could result in false starts in implementing in the appropriate languages. Policies and new procedures or wasteful litigation, procedures are synthesised and incorporate leading to further delay and expense. best practices. Compensation and benefit programs recognise and reward retained Buyers can commence integration planning personnel in effective ways. Disruptions early, without undue expense, and focus from the elimination of redundant positions additional resources as the transaction are minimised and consummated promptly. progresses. Purchasers should seek relevant Service levels to customers equal or exceed information during negotiation and due prior levels. Financial results improve and diligence to assess integration aspects continue over a sustained period. needing attention. A cohesive acquisition and integration plan should be seamless. The danger of delay Buyers that have never acquired another company should commence the process Due to its critical importance to the earlier than those who have completed the www.financierworldwide.com | FW 157 INTERNATIONAL MERGERS & ACQUISITIONS 2008 process multiple times, to provide sufficient programs available to the combined time to develop an approach to each issue. enterprise. Additional integration planning Nevertheless, every transaction will have is appropriate for transactions between its own particular aspects that warrant companies in different industries or with attention, even for experienced buyers. foreign operations.
The integration team Employees. Perhaps the hardest but most important aspect of integration planning is The integration team should have the determining the compatibility of employee capacity to effectively identify and cultures. Some employers have prospered develop solutions to the integration with results-oriented ‘survival of the issues. Often, the acquisition team will fittest’ systems, while others foster more contain many of the personnel qualified collaborative, nurturing environment. to analyse those aspects: executives, Buyers may mistakenly assume that the attorneys, human resources, accountants same incentives for their employees and tax professionals, operations experts, will also motivate the new workforce. information technology personnel, and Compensation works for some, while others. If in-house expertise does not recognition and intellectual challenge are exist, or confidentiality or other reasons necessary components for others. Proper prevent including those personnel in the assessment of employee cultures can help early analysis, outside consultants can be buyers implement effective programs. engaged on a confidential basis. Employee training will also help to educate new workers on accepted methods of Care should be taken to be sure that the operation and expected performance levels. integration team evaluates the ability to achieve projected results on the anticipated Compensation and benefit programs of timetable. The acquisition team may the target company should be evaluated to have incorporated assumptions into the determine which model should survive and projections that are not achievable due to for how long. Buyers should not assume delays caused by the integration process. that their existing programs are necessarily the best, and should consider adopting the As noted below, if the acquisition team best practices of each group. will be diverted to other transactions shortly following the closing, buyers might Buyers should also evaluate the impact consider designating one or more persons of the transaction structure and terms on responsible for the integration who will executive and employee motivation. For continue to focus on those efforts after the example, if earn-out performance targets closing. are difficult to achieve, the sellers may have little incentive to help drive performance Aspects of integration as planned. Buyers may achieve better long term results by offering the seller’s Proper integration planning should review executives a significant incentive to help all aspects of the business, focusing achieve maximum performance, rather on implementing the best employee, than trying to keep the purchase price to a administrative, operational, and marketing minimum.
158 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
Administration and operations. answers to as many of the anticipated Communication, accounting and questions as possible. Similarly, they may information technology systems will need want to develop a small team prepared to to sync as soon and seamlessly as possible. respond to unanticipated issues, to help Those issues may be particularly difficult maintain consistency in approach. to achieve if the companies operate in different countries and in different Sustained efforts help generate success languages. Converting the accounting, tax and information technology systems into Integration efforts should continue a cohesive, technologically compatible well beyond the consummation of the system may involve significant time and transaction, to help assure that the two expense. Meanwhile, an effective interim companies are merged in more than name solution will need to function before a more and financial results. The integration permanent solution can be implemented. of employees and cultures takes time. Too often, companies focus on the next Policies and procedures of the enterprise transaction and fail to complete integration should be introduced to the employees with of prior deals. Executives may leave proper training. If the business combination integration to their operations personnel, brings the enterprise into a new jurisdiction, who may have different incentives in the new policies and procedures should making integration decisions. For example, be reviewed for legal compliance as well administrators may make personnel as their conformity to local customs and decisions favouring co-workers whose methods of operation. Personnel from skills are known to them, rather than to the seller’s operations can help identify thoroughly evaluate all qualified candidates potential roadblocks and solutions. from both organisations.
Significant time may be required to obtain required licences and permits necessary for the purchaser to operate the business. The parties can often structure the transaction Integration efforts should continue well beyond the to minimise the impact of the delay. consummation of the transaction, to help assure Customer and vendor relations. Proper that the two companies are merged in more than integration planning will enable the company to communicate with its name and financial results. customers and critical vendors promptly following the first public announcement of the transaction. Customers should be educated on new products and services available to them. Vendors will seek Companies can facilitate the integration assurance that their receivables will be paid process in a variety of ways. They might and will want to know the impact of the designate a liaison who offices at the seller’s transaction on their relationship with the location. The liaison could be responsible company. Although many issues may not be for the successful integration of the two known, buyers are well advised to prepare businesses and be given appropriate www.financierworldwide.com | FW 159 INTERNATIONAL MERGERS & ACQUISITIONS 2008 authority to help facilitate the combination. Regardless of the methods undertaken, He or she can serve as a resource for the buyers who devote attention to integration employees of the acquired business and early in the process, and who sustain a help instil in them the new cultural values focused effort on it, can greatly enhance the of the buyer, while advocating for the new prospects for success in their acquisitions. employees and their needs, as appropriate. Moreover, the efforts expended should result in improved results and more Devoting time and resources to allow satisfied customers and employees. key executives and employees to meet personally and to see the operations of the other can help strengthen intercompany relationships. Buyers have often met with success by conducting strategic meetings Richard Lieberman is chairman of the with the seller’s personnel at all levels of the Corporate, Securities and Finance organisation, listening to their suggestions, Department of Jennings, Strouss & Salmon, concerns and aspirations. PLC.
160 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Protecting your cultural assets through an integration
by Kate Lye
If you are looking for clues to the tried and tested solutions, there are six likely success of a particular merger questions any integration plan needs or acquisition, then take a look at the to answer if it is to address the cultural integration plan. Research has shown integration conundrum, as outlined below. time and time again that the quality of the integration planning, particularly around 1. What is the strategic value we believe we the softer cultural issues, is a reliable can create through this deal? Few mergers predictor of future shareholder value. or acquisitions are undertaken without a clear vision of business outcomes that Ironically the M&A process tends to be become possible through a deal but that weighted towards the front end; think neither party could achieve independently. of all the energy and attention that goes These may be to deliver new products or into target identification, due diligence services, to benefit from economies of and the actual deal negotiations. Post- scale, to rejuvenate a mature company by deal planning; by contrast, can seem like a injecting new thinking or talent, to increase secondary consideration. market share or rapidly access foreign markets. Whatever the original strategic Certainly, organisations are quick to rationale for the deal, this needs to be the execute the basic operational, financial, focal point for all subsequent integration people or market changes that are decisions and plans. M&A stalwarts rightly necessary to unite two once separate judge that 60-80 percent of a deal’s value businesses. But many seem content to rely is won or lost in the first 12 months. In the on unsupported assurances of ‘cultural fit’ many cases where the shareholder return or hope they can deal reactively with the is a loss, businesses have often lost sight of thornier questions of cultural integration. the underlying strategic rationale in all the This is foolhardy given the wealth of data upheaval and discord of the integration. that highlights the integration period as the point at which shareholder value is most 2. What are the true measures of success likely to be destroyed. The soft integration for this integration? So be sure you have a issues are where merging organisations are clear statement of the ultimate strategic most likely flounder. This failure to manage value that the merged organisation needs cultural contention can transform a once to deliver and make this the bottom line for market focused business into one that the integration team and executive team. becomes internally obsessed and on a slide towards mediocrity. Another recommendation is to determine some distinct operational, customer, Leaving aside the technical integration people, cultural and financial metrics to issues, for which there tend to be more focus the integration plan. It is possible www.financierworldwide.com | FW 161 INTERNATIONAL MERGERS & ACQUISITIONS 2008 to track many integration aspects such When full integration is the appropriate as operating efficiencies, productivity, option, be clear about who is leading the customer retention, service disruption, process and who is integrating into whom. talent retention, employee trust, speed of For the sake of appearances, leaders can implementation and brand loyalty. The key fall into the trap of giving false assurances is to identify those that are most closely about the integration being an opportunity tied to the strategic rationale and devise an to co-create entirely new working practices integration scorecard that keeps the new and take the ‘best from both’. In practice, organisation on track. it is hard to dispassionately judge whose processes or people are best. The reality is 3. What form of integration approach will often that the acquiring company’s norms best deliver these outcomes? Integration and practices will be the blueprint for the can be compared to organisational surgery; new organisation. While the organisation painful, unpredictable and not to be should take the opportunity to learn and undertaken unless absolutely necessary. improve from their new colleagues, few Integration teams must draw distinct businesses want to start again with a blank boundaries around how and where the two piece of paper. organisations need to come together and where there is benefit in remaining apart. 4. What cultural assets and risks do you Integrate only where it serves to add value need to manage to safeguard the post-deal or reduce friction. The assumption that strategic value? The due diligence process the full integration (i.e., integrating all the can be woefully deficient in identifying processes, teams, locations cultures and those softer assets the buyer hopes to structures is always better) is a common acquire or create through the deal. This mistake. A more studied approach is to is a serious oversight. Integration teams consider the different forms and levels of need to be rigorous in assessing what integration possible, the pros and cons cultural, people or reputational assets they of each and how they support the deal must preserve, sustain and build into the rationale. It is more helpful to think of new organisation. Many an acquirer has integration choices in terms of a gradient discovered to their cost that cultural assets and the varying integration activities they believed to be integral to the value of required for each level: (i) minimal the target organisation can quickly diminish integration; (ii) partial integration; (iii) full if not identified and managed from the integration into the acquiring business; and start. This is especially true when large (iv) co-creation of a new business. mature organisations use their financial muscle to buy an edgier market brand or an There may be real benefit, for example, in alternative talent pool. Once again, being maintaining a standalone entity and brand, clear about the strategic rationale for the if the acquiring partner is unknown in the deal helps an integration team to focus target’s market. In this the integration on the cultural assets or risks they need to may be limited to joint financial and legal manage from day one. reporting structures. Other situations can call for a partial integration around a 5. What plans and resources do we have particular function or operating process. for shaping the culture the new business needs? There will be cultural surprises at
162 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS many points in the integration process. is also possible to track cultural alignment Experienced integration teams recognise over time and pinpoint problem areas that this, but also know the importance of going need more support. into play with a clear point of view about the type of culture the new business needs 6. Where does the buck stop for making our to thrive and a working plan to put this into culture work for the business, its employees place. Being ready and able to move quickly and shareholders? The best laid integration on cultural issues is important because an plan will not be effective if it is working organisation, like nature, abhors a vacuum. without the full support and cooperation In the absence of the new cultural direction of the senior leaders in the business. a ‘de facto culture’ can emerge. This may Leadership behaviour is the single most have been shaped by early integration powerful and visible force for shaping the decisions, unplanned events, key individuals culture of a business. In the heightened or third parties and can prove difficult to environment that follows a deal, what override. leaders pay attention to, reward and role model is disproportionately important, as There are any number of models and well as how they react to critical decisions tools on the market for assessing the or events. current cultures and helping create some shared expectations and language about One misplaced comment or action from the cultural differences. However, there a leader can send a contradictory cultural is no ‘silver bullet’ cultural methodology. message that will reverberate around the The real value is in how the integration business. Senior leaders must recognise team uses the data to plan and manage that they are a key ingredient to the future the softer integration issues. Even using culture and be guided by their integration a straightforward model such as Johnson team on how they can support the cultural and Scholes, to map the current and future integration process. culture, provides integration teams with a framework for understanding where the Conclusion two existing cultures are naturally aligned and where there is likely to be conflict. Anyone who doubts whether ‘culture’ exists or matters need only take a ring-side seat The team can then develop a systemic at a poorly orchestrated integration to see approach that combines hard tactics the cost cultural problems can inflict on a (organisation structure, compensation business. Culture can work as an asset or incentives, and a shared decision-making liability for any organisation, but during system) and soft tactics (symbolic actions, integration, managing softer business leadership communication, employee assets is critical to delivering the strategic involvement, people development) to rationale and enhanced shareholder value. demonstrate to employees what the expected behaviours, assumptions and values are of the joint organisation and then Kate Lye is an independent integration to reinforce and embed them over time. It consultant.
www.financierworldwide.com | FW 163 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Human resources – a fundamental part of the planning phase
by Sean Wells and Samantha Barklam
Although recent surveys show an external branding, caused by weak encouraging trend towards HR involvement messages coming from employees of the at an early stage in M&A there is still more merged entity; slower communication and to do. Some businesses do not involve HR consultation processes; and employees quickly enough – perhaps due to a heavy remaining mentally tied to their pre-deal focus on commercials or a low regard for company, rather than working together for HR’s capability. A strong HR presence at the merged organisation. board level helps, but is not the panacea. Successful M&A transactions use HR to A company can take steps to mitigate these help shape some of the major decisions issues. It should invest time to understand and ensure big cost items can be budgeted, both companies’ views of the world, such as pensions and restructuring. But measure culture at the start, analyse where these are not the only factors to consider. the merged company needs to be and how to get there, implement regular cultural Culture. Culture can be viewed as the temperature checks, respond quickly to internal brand of an organisation; how any concerns raised, and set clear links people feel about the company and the to the return on investment (which really principles used to address issues. Culture is possible). It is hard to imagine an area is such an integral (albeit subtle) part of an within M&A that is not affected by culture, organisation that common sense suggests so it is crucial to address this early on. it should be a fundamental consideration. So why is it often overlooked? Among the Communication and buy-in. Human nature reasons cited are that culture is too difficult can lean towards voicing negative, rather to analyse and there is no tangible return on than positive thoughts. It is therefore investment for doing so. Neither of these imperative that communication with assumptions is correct. employees is not left to chance, to avoid unhelpful messaging. The aim should be to Cultural differences can arise in many take employees through the engagement areas, including: companies placing greater steps of awareness, understanding, buy- emphasis on employees than shareholders; in and then ownership of the changes. At retaining control rather than delegating the start of discussions, a clear, structured autonomy; operating a lean, rather than communication plan should be in place large employee-driven operational centre; which covers identification of stakeholder or being cost, rather than employee-driven. groups, positive communication The risks associated with these differences ambassadors, appropriate communication include: different interpretations of channels and estimated communication company strategy from board-level dates. Getting business buy-in is vital, downwards, dividing leadership; poor particularly given the sensitive nature
164 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS of HR changes. Aside from employee performance and a focus on resignations communication, roles and responsibilities surreptitiously geared to pay-out dates. across the integration team should be All in all, this is not a sure-fire way to clearly defined, to eliminate cross-over or improve morale, and definitely not a time gaps. to take a broad-brush approach. The company should ask itself what the new Linked to culture again, two merging entity wants from its employees. It should companies can place different levels decide whether its employees are central of importance on communication. For or peripheral to the organisation’s goals. If example, one may have 90 percent of its the former, an employee retention strategy communications focused externally while is a must. Even if the latter is the case, the the other has 90 percent focused internally. company should make a conscious decision This indicates opposing views of the to let employees resign, rather than leave importance of employees versus market attrition to chance. Finally, the company views, and appreciating such differences is should identify the major concerns key. employees have and how it can help to resolve them. To harmonise or not? Some terms lend themselves easily to harmonisation while Other issues. There are too many additional others do not, so a hybrid of the two HR issues to detail here, but three approaches is often sought. However, others are worth noting. Legal issues: companies may have the required systems it is important to ensure both parties to enable them to take on a large number have a common understanding of legal of different terms without the need for implications and timeframes, and that HR change. It depends on the business model. is used to provide a balanced, rather than Considerations include the financial costs purely legal, view. A common viewpoint of harmonisation; whether current HR should be sought. Change fatigue: a Information Systems (HRIS) are able to company should be mindful of people’s handle a variety of legacy terms; whether workloads and know when to bring in current processes lend themselves easily external support to ease the strain. If to harmonisation; and whether employees people strategies are at the heart of the are used to change or likely to have an business, the warning signs are more adverse reaction that outweighs any gains apparent. Project management skills: this of harmonisation. includes understanding costs, benefits, milestones, risks, issues, dependencies, Reward / retention. A common mistake resource planning and stakeholder buy-in. when devising retention strategies is to The same rigorous standards should be focus solely on financial rewards. This can applied regardless of whether the company backfire, with employees viewing bonuses is being acquired or vice versa. as a ‘given’ rather than something that really addresses their concerns, such as Are people strategies the responsibility of recognition from management, better HR or the business? communication or personal development. A poorly considered retention plan can The answer is both – most companies result in greediness, little improvement in speak about the need for HR to act as a www.financierworldwide.com | FW 165 INTERNATIONAL MERGERS & ACQUISITIONS 2008
‘business partner’. The reality is that few about all parties thinking commercially organisations achieve this, either because enough to actively support the business the HR team is not ready to take on this strategy. By thinking in these terms, the role, or the business has not bought into the implementation of people strategies concept. While time is spent debating this becomes a combined effort between the model, is the business receiving the support business and HR, rather than a painful it really needs? afterthought.
Putting the HR business partner model Although the financials may be the primary to one side, the key questions for HR are drivers for mergers and acquisitions, the quite simple. Are you close enough to the people are the fuel. By forgetting to address business to understand its drivers, peaks people-related issues at an early stage, a and troughs? Are you helping the business company is forgetting to fill the tank up achieve its goals? Are your business with petrol before it starts a long, and often relationships formed out of a defined arduous, journey. structure, or an ability to proactively engage with people, regardless of a prescribed role? Sean Wells is a partner and Samantha A ‘good’ HR approach is about more Barklam is HR M&A lead in the Financial than dealing with legal issues. It is Services Practice at Atos Consulting.
166 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Maximising deal value through the human side of M&A integration
by Timothy Galpin
After the downsizing and cutbacks of 2002 Among the most critical, but under- and early 2003, M&A activity now rivals managed aspects of integration, the dealmaking pace of the late 1990s. are: (i) development of an effective Executives who were part of that earlier Newco culture based on the integrated M&A period may believe they know how to company’s strategy; (ii) the retention and execute a successful merger or acquisition, ‘re-recruitment’ of key talent; and (iii) but M&A deals often do not achieve the communication about integration progress. strategic objectives trumpeted in their initial announcements. Indeed, numerous A vivid example of culture issues hindering deals result in a net loss of value, from deal performance is the 2000 AOL-Time Quaker’s ill-fated acquisition of Snapple Warner merger, which has yet to add to the failed DaimlerChrysler merger that shareholder value in large part because dominated recent headlines. But why? of a culture clash between the two companies. Given the key role cultural Although subpar M&A results can be integration plays in the overall success of attributed to several factors, from too high an M&A deal, executives must achieve an acquisition price to a bad strategic fit, better performance in this critical area. the central problem is poor integration, The merging of two cultures depends first particularly on the organisation and and foremost on a clear articulation of people aspects of the deal. Integrating one the Newco’s strategic goals. Once those business with another is highly complex, goals are set, they provide the foundation even for the most experienced acquirers, for the Newco culture. For instance, a and companies must manage the process company with a strategy focused on service exceedingly well to succeed. Unfortunately, excellence will want its employee and in the University of Dallas Graduate School management behaviours to consistently Of Management’s recent M&A survey reinforce that commitment. (including 124 executives and managers from 21 different industries), 63 percent Shaping organisational culture, however, of the respondents rated their company’s can seem like a frustratingly vague task. To integration efforts ‘average or below reshape culture in order to serve a Newco’s average’. Equally troubling, two-thirds of strategic goals, management can employ the executives said their newly merged an operational description of culture company took at least one year and in that segments it into 10 key elements: some cases three to five years or longer to organisational structure, staffing and achieve full integration, during which time selection, communications, training, goals employee anxieties and misaligned cultures and measures, rewards and recognition, damaged productivity, performance, and rules and policies, ceremonies and customer relationships. events, decision making, and the physical www.financierworldwide.com | FW 167 INTERNATIONAL MERGERS & ACQUISITIONS 2008 environment. A focus on integrating these on during integration. To maintain their 10 cultural components, as well as on the engagement, the company should keep more informal aspects of culture (e.g., key people in the loop by involving them executive teaming and social networks), in the integration process. Moreover, provides management with a tangible and employers make a big mistake when they comprehensive approach to moulding the do not share information just because some culture of the Newco. integration decisions have not yet been made. Accordingly, frequent updates on In addition to the cultural issues that are the integration process and progress can created by mergers and acquisitions, when go a long way toward retaining and re- a company announces a deal, the ensuing recruiting key talent. Finally, people need turmoil leads managers and employees to feel both pride in their day-to-day work alike to turn inward. They focus far less on and satisfaction in playing an important their job responsibilities and customers role in the Newco’s success, making it than on their ‘me issues’ (Will I have a critical to recognise significant employee job? What about my pay and benefits? contributions to tough integration tasks. Who will my boss be? What about my location?). In this uncertain environment, An excellent example of retention and re- headhunters seize the opportunity recruitment results that can be achieved to lure away key talent. And even if comes from the integration of two major good performers stay, their emotional software firms. Silicon Valley-based commitment to the organisation often Macrovision set a target of 80 percent for fades, which can be as devastating on employee retention during its acquisition Newco performance as actual departures. of Chicago-based InstallShield. Using the Therefore, management needs to make retention and re-recruitment approach, retention and ‘re-recruitment’ (emotional Macrovision actually achieved a retention re-engagement) of top performers a central rate of over 95 percent – a remarkable priority during mergers or acquisitions. figure that accelerated integration A five-part retention and rerecruitment and saved the company considerable approach is critical: (i) identify key people; expenditures. (ii) quantify what the impact of their departure would mean (e.g., a loss of key Finally, when it comes to deal clients or knowledge about a core product); communications, management must first (iii) identify their needs; (iv) develop and act be aware of the ‘killer phrases’ frequently on a plan to meet those needs; and (v) draft used during M&A. Unfortunately, these a contingency plan in case key people do phrases are voiced time and again from leave. management about the deals they are doing. The most common killer phrases Too often the easy answer to retention – and the realities behind them – are and re-recruitment is a ‘stay bonus’. But identified below. Any of these statements the process cannot end there, as key talent alone can be a value killer. Two or more of have other needs that may go overlooked, these statements together are a quick and leading to frustration and resentment. powerful route to destroying deal value. Beyond stay bonuses, key people want As soon as one or more of these phrases is to feel included and know what is going uttered by anyone who has a direct impact
168 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS on the success of a deal, a caution flag progress provides people with a sense that should go up: management has the integration effort under control. (i) “This is a merger of equals.” – There is no such thing. In order to get the most value out of deals, (ii) “It is too early in the deal to begin the mandate is successful integration of a planning for integration.” – It is never too target’s operations, systems and people. early. The key risk is that the organisations fall (iii) “We don’t need to tell the employees apart rather than join together – destroying anything until there is something to tell.” value. And, the market is unforgiving. – There is always something to tell, if not Given the resurgence of M&A activity decisions, at least integration progress today and the high volume of deal activity along the way. expected in the future, organisations (iv) “We’ll freeze the organisation for at must reassess both their existing M&A least a year, and once things settle down integration capabilities and future plans we’ll start integrating.” Or, “We’ll ease to include the people matters. Companies’ the changes in.” – Slow integration only deal processes cannot simply be limited elongates the inevitable productivity drop. to assessing and integrating the financial, (v) “Now that the transaction is complete, operational and technological aspects of the deal is done.” – Nothing is further targets. Companies must also be able to from the truth. In fact, the real deal is just conduct thorough cultural due diligence beginning. and integration. Likewise, companies must possess the ability to quickly and effectively In any merger or acquisition, it is virtually develop and execute M&A retention and re- impossible to be seen by everyone involved recruitment plans that fully account for the as being totally fair. The difficult issues needs and concerns of key talent, enabling that must be dealt with during integration them to keep the best people on board. include making and communicating key Moreover, management must frequently decisions about: organisational structure, communicate integration progress or risk reporting channels, spans of control, roles the rumour mill taking over and distorting and responsibilities, as well as the selection the information that employees, customers of people, processes, and systems. There and shareholders receive. Building strength are hardly ever straightforward answers in these areas paves the way for faster, to these and other integration decisions. more effective integration, and better But senior management must make overall Newco performance, ultimately decisions quickly (with ‘prudent speed’), maximising deal value. communicate those decisions, and stand behind them. Otherwise, employees, investors and customers get the message that top management is disorganised Timothy Galpin is an associate professor at and indecisive, and that the merger lacks the University of Dallas Graduate School leadership. Even if key decisions have of Management and a senior fellow at not yet been made, communicating Katzenbach Partners, LCC.
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by Nick Hood
Contemplating a knock out acquisition in in the new location. First, the acquirer must a gloriously tempting market in a growth question the ability of its IT department economy in Eastern Europe, Asia or or support function to carry out this task. Africa? Salivating at a non-price sensitive It needs to be honest about their skills, commercial environment, where there if there are any doubts, turn to outside is no pressure on margins and where the specialists who can demonstrate a track competition is either non-existent or totally record. disorganised? Dreaming of a world where there is no ridiculously employee-friendly Most of all, the acquirer should be gentle legislation and where money-laundering or with the staff in its new acquisition, who antitrust rules are not even a twinkle in the may not be comfortable in cyberspace eye of the local politicians? or even Excel. Not everyone checks their emails constantly and understands why Doing the due diligence and closing deals their acquiring firm might be impatient at in emerging markets can be tough – but the slightest delay in replying to questions. the upside is the endless high returns and They are also highly unlikely to understand interesting places to make business trips. the intricate politics and protocols of email Isn’t it? circulation lists and blind copying.
Actually, the most important and really IT is only the start of the communications challenging part is: making it work. And the agenda. How will the acquirer keep in questions are endless. touch with the management of its far-flung acquisition? The one absolute rule is that How far should the foreign acquirer try to somebody has to go somewhere, because a integrate its new toy? Imposing its standard strategy of video- or tele-conferencing can of financial and commercial reporting is one only send one message: that the acquirer thing (and not an easy one), but what about does not believe its new colleagues are IT, HR and all the other elements of how the sufficiently important to see face to face, mothership is run? or their market isn’t worth keeping in touch with first hand. IT and communications dominate business life in all developed jurisdictions, but even The next issue is whether the acquirer will in these sophisticated days, replicating the go there regularly or decide to disrupt instant access and hyper-speed interaction local management by asking them to visit we all take for granted will be difficult. The instead. Psychological common sense more complex or modern an acquirer’s suggests that the constructive thing is to systems are, the greater the risk they give the subsidiary the advantage of home cannot be introduced easily or effectively turf, if only because it will be more at ease
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and the acquirer will gain huge insight uncomfortable acquirer should facilitate from seeing them operate in their own open discussion with local management environment. It is also extremely important and try to find another way of preserving to avoid the ‘seagull’ management key relationships, or toning down the worst technique: flying in briefly and dumping excesses. Sometimes local management toxic management waste from a great share these concerns and may welcome height. assistance in changing things.
Language is a key issue. Using English as Management structures can be puzzling. an example, even if local staff can speak it The tendency is for quite flat hierarchies, well, there will be subtle differences in the with many people apparently reporting to use and meaning of words, which takes one or a small number of decision makers. time to understand and may cause major Simplistic reviews of job specifications can misunderstandings. No one likes using be wildly misleading. An acquirer must not interpreters, but there are times when it accept what it is told initially at face value; is more sensible than forcing local staff it must dig deeper and find out what is to struggle along in their third or fourth really going on. There will be community language. and family considerations, many of them unstated. In one example, the key individual in a vital section of a textile mill was not the foreman, but the cleaner, who was more senior in the relevant religious community.
Many such acquisitions falter because Corporate governance norms need to be reviewed in buyers fail to transfer their skills. In the context of local best practice. emerging markets, this is a strange oversight, which condemns the local management to frustration and the acquirer to endless disappointment at ongoing underperformance. So creating a workable program for training and upgrading local staff is a must. This does Corporate governance norms need to not require the involvement of a large be reviewed in the context of local best number of people if key individuals are practice. An acquirer may not like what it identified who can pass on what they sees – especially how the wheels of business learn, preferably down through a number relationships are lubricated – but a knee- of management generations. Short or jerk rejection of ‘commission’ arrangements medium term staff secondments back to will be highly counter-productive. The the buyer’s home base can be particularly acquirer should try to understand the true effective. nature of these practices and judge them against the market in which they operate. An acquirer has a serious decision to make Are they out of line? How they would about whether it is going to deploy a ‘spy be perceived if they reached the public in the cab’, possibly by sending one of its domain in a media-unfriendly way? An own people to work in the local structure.
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Alternatively, it can hire an independent if local management feel a genuine part local. If it decides to use this technique, the of the process, their active and positive individual will have to be a special animal participation is much more likely. with an unusually well-developed ability to empathise with local concerns while The motivation and behaviour of staff are remaining objective. at the root of all business success. If this is true, then how much more important If the acquirer opts for an outsider, it should it must be to get the human side of an think twice about choosing a classic ‘ex pat’ acquisition right in the emerging market who originates from its home jurisdiction. context. Some are very good and provide the ideal mix of understanding both environments The first concern that local staff will have and acting as mediator over the inevitable is whether their jobs are safe and if their disputes. But far more are past their sell-by pay will change. Next come the usual dates and have a distinctly short shelf life rush of questions about changes in the on any particular assignment. Far better to management and reporting structures, use a good, independent local executive. whether they will be expected to learn another language, and so on. These are the The pace of integration needs careful easy issues. consideration. Two instincts predominate. The first is to throw all the balls in the air at once, like some sort of demented management juggler. Dictats and policy pronouncements rain down indiscriminately Many emerging jurisdictions have delicate from head office, usually causing panic and community and family structures, entrenched confusion. concepts of honour and face, fundamental Other acquirers seem dazzled by the thrill religious principles and impenetrable local political of the chase and paralysed at the moment of capture. The gruelling due diligence considerations. process and interminable price and contract negotiations are followed by… very little. Days stretch into weeks and then months, with local management wondering what Much more complex is what the acquirer to expect and not knowing whether they is not asked or told. Many emerging should be doing something different. jurisdictions have delicate community and family structures, entrenched concepts of The sensible strategy lies somewhere honour and face, fundamental religious in the middle. A pre-deal dialogue is principles and impenetrable local political necessary to explore what needs to be done considerations. These are just as important quickly, what is a medium term objective in business as they are in local micro- and what is pie-in-the-sky fantasy. They economies in the developed world, where may not agree with everything that an a major enterprise can dominate a village acquirer wants to do, and these objections or a small town, or indeed a major city like should not be accepted at face value, but Detroit with its auto industry culture.
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These considerations are why using implementation is a phase which never experienced but independent local ends, it just changes as familiarity with the business people and professionals as acquisition increases. intermediaries can be essential and why rushing into decisions affecting local staff An acquirer should remember that it is not is often so unwise. Time must be invested just buying a business and a bag of assets in understanding these aspects and being and liabilities. It is investing in people and seen to respect cultural imperatives, while the success or failure of the deal will depend still making sensible decisions. But be firm on how it treats them. It will also dictate as well as reasonable, because weakness how stressful the stewardship will be. will not be respected. Investing time and quality resource in pre- planning and implementation, will allow The final recommendation to buyers is to the acquirer to earn a considerable return, start the planning for the implementation not just in financial terms but by avoiding phase as early as possible and to take it damaging management distraction. seriously. Experienced players say that they allocate as much time to planning the post-deal phase as they do to the due diligence and contract negotiation Nick Hood is executive chairman at Begbies processes combined. They also believe that Global Network.
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by Graham Smith
In 2007 over US$4 trillion was spent on and quality expectations therefore weigh M&A activity across the EMEA region heavily from the top down. and the US alone, according to Dealogic. Alongside the expertise, synergies and M&A is often highly visible and failures are economies of scale driving M&A deals, well documented. This holds both positives hidden risks lie just beneath the surface. and negatives for the implementation of IT Failure to address these risks before systems. Making sure IT systems go live at committing to a merger can see companies the date stipulated is vital to avoid media waving business benefits goodbye and criticism. However, this can mean that time being left holding a poisoned chalice. allocated for testing is reduced, which may lead to the deployment of systems that are Business reports estimate that between fraught with problems. The negative impact 50-70 percent of transactions fail, with of failure can be catastrophic. This prospect two problems cited most frequently. First, is usually enough to deter companies from cultural disparities and an inability to allowing such an outcome and, more often integrate different working styles. Second, than not, testing is undertaken. But what the post-merger integration of IT systems. are the key areas to address?
The integration of IT systems is a tough Organisations often encounter problems challenge; three-quarters of companies maintaining business continuity and involved in M&A report problems. IT is reducing disruption throughout the central to the business function, supporting transition period. Irreparable reputation both operational and ancillary activities. damage can be done as customers Lost revenue resulting from a poorly suffer from using unsteady, inefficient executed IT integration strategy and applications that are the result of poor subsequent non-functioning systems integration. can be huge – up to $10m a day for some organisations. Industries solely reliant The situation is exacerbated by the fact that on IT businesses can come to a complete new users may be using unfamiliar systems standstill. and further slowing down transactions. Sufficient staff training is required to The main issues that organisations face overcome this and manage consumer when merging their IT systems include delays. Having new users on a system maintaining continuity, data migration and that is under the strain of redevelopment compliance (including the related security must be managed in a structured way and political implications). Merger ROI is of or the business will suffer. This can be the utmost importance, so the integration compounded by additional ‘defects’ being simply has to succeed; pressure deadlines reported that are, in fact, modifications to
174 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the systems. Furthermore, additional staff achieve this, security testing must be a key put an increased load on systems, which component of the testing phase. may cause them to crash under the weight. Sufficient load and performance testing Protecting consumer data goes further than ensures that systems are equipped to cope retaining customer satisfaction – it is also a with unexpected numbers of users. Without legal requirement. Adhering to mandatory it, hidden problems may be uncovered regulations is becoming increasingly when it is too late. important as more domestic, European and global legislature must be adhered The operational change that must occur to. The Markets in Financial Instruments during or after an acquisition involves Directive (MiFID) and Sarbanes-Oxley significant data migration, whether are just two financial examples, while to an existing or entirely new system. the Payment Card Industry Data Security The information will consist of sensitive Standard (PCI DSS) is central to retail corporate and customer details, the payment security. Management must also integrity of which is of the utmost be aware of laws in place which govern importance. When integrating systems any markets it may be acquiring in. It is there is potential to lose data upon transfer the organisation’s responsibility to enforce and organisations should do everything in these regulations by having systems their power to ensure this does not happen which enable compliance. The integration to avoid negative repercussions. process must therefore take into account mandatory legal requirements and build Loss of data can occur due to them into development or modification of incompatibilities in the way in which the systems. different systems store information. Data must be converted into a format which will be recognised by both systems and usable when necessary. Ensuring the systems are capable of achieving this requires careful definition of requirements and a Protecting consumer data goes further than structured data migration process. Testing at each stage of the program highlights retaining customer satisfaction – it is also a legal problems and helps to protect against data requirement. corruption and subsequent loss of crucial information.
Another concern in migration projects is the security vulnerabilities that can be created when developing new systems. This The desired result of an integration is especially pertinent to financial service program is to have an IT operation that organisations due to their copious amounts is effective for both internal users and of sensitive personal information. Migration external customers. Usability, functionality of data must therefore be carefully and providing the required data output are executed in order to maintain integrity and vital elements of the IT systems. Assuring ensure security weaknesses do not occur. To quality is essential to meeting this target www.financierworldwide.com | FW 175 INTERNATIONAL MERGERS & ACQUISITIONS 2008 and must be conducted continually, and it is communicated efficiently. lest problems go undetected and cost substantially more to rectify at a later date. Top-level management of a merger or acquisition is very stressful, involving due Involving the Chief Information Officer as diligence, integrating corporate cultures early as possible in M&A deals ensures that and defining the future direction the new decision makers are fully informed about company. Outsourcing the IT integration technological requirements. is one way of alleviating the pressure and providing objectivity. Whatever the In past mergers, up to 50 percent of decision, acquirers should take time to integration costs have been incurred by IT, fully consider what is required from an IT massively impacting returns generated by standpoint, as this can mean the difference the deal. As such, the realisation of benefits between success and failure. post-merger can largely be attributed to the successful management of IT integration. Companies need a thorough implementation plan to ensure that IT is a Graham Smith is European head of client central consideration in the M&A process engagement at AppLabs.
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CHAPTER eight: Environmental issues
www.financierworldwide.com | FW 177 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Climate change and the cost of carbon: incorporation into M&A deals
by William Butterworth and Jaideep Das
While global markets remain uncertain, new emissions trading regimes in Europe there seems little doubt that the need for and in the US. long term carbon reductions and a more robust management of climate change Inevitably this conjecture, alongside issues in general is now firmly entrenched existing carbon constraints, is starting to on political agendas. This was evidenced have an impact. In our experience, climate by the run up to the United National change is a material issue in around one in Climate Change Conference in Bali and in five deals. A variety of approaches can be the constraints which emissions trading used to address climate change risk, not schemes and other measures are starting to only in the most energy intensive sectors impose on different business sectors. such as power generation, metal and cement manufacturing but across a whole A key question for investors is how might swathe of other businesses, which both new, post Bali carbon reduction measures, consume large amounts of energy and have impact on target businesses. This is most a pronounced carbon footprint. Questions notable in the US, where the political may cover anything from the potential climate looks certain to change on this cost of emissions trading for US power issue, but in other parts of the world the generators to the impact of flooding from pressure to take action also continues to storm events in China. grow. It has been estimated that, globally, it would cost about US$1.6 trillion a year to A growing number of deals now include reduce carbon emissions by 50 percent by at least an element of carbon and climate 2050. change risk screening. Initially this screening revolves around asking questions Perhaps not surprisingly, given the above, to determine the importance of energy use the due diligence process surrounding and carbon emissions as well as evaluating M&A can be an important catalyst for the wider potential physical impacts of screening the potential impact and cost of climate on the business. Flood, sea level climate change issues on different facilities rises and drought, for example, are all as well as the scope for achieving new relevant in this context. Where issues look efficiencies going forward. Purchasers and material a more detailed analysis with vendors will increasingly find themselves projected costings is likely to follow. taking account of energy and climate change risks which were previously The initial screening will depend on the deemed either not relevant or material in nature of the business and will consider the context of a successful transaction. As energy and climate change risks alongside such, they may have to make assumptions a range of others. In the case of a power about the impact, for example, of tough utility or energy intensive manufacturing
178 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS company, for example, the introduction or introduced going forward. tightening of emissions trading could have a significant impact on the business plan. Insurance costs may also become an issue If a company is not currently subject to a as part of this climate change screening trading scheme this may become the case process. Premiums may be affected not in the future, for example with the UK’s only by serious climate risks – for example carbon reduction commitment and similar a facility’s location in or near a flood plain schemes in other countries. – but also by the risk of serious business interruption. Another recent M&A project The cost of carbon regulation takes on related to an oil refinery which relied an even greater significance in the face on its local river as a primary means of of rising energy costs. A business which transporting raw materials and products. effectively manages the former is likely After two consecutive summers of very low to have an influence on the latter with a water levels in the river, the business was growing number of companies asking for facing material additional distribution costs advice in this direction as part of the M&A and potential delays using alternative road process. In one example, an energy price and rail links. These issues were factored in trend analysis recently looked at what a as part of the transaction. company’s current annual energy bill of approximately US$50m would look like in In summary, climate change issues are the face of projected increases over the now relevant to the M&A process across a next few years. The analysis was relevant range of business sectors. If political intent not only to the transaction value of the is turned into genuine action there will business but also to the consideration of inevitably be a cost to business as well as future investment decisions to achieve opportunities for those who plan for, and greater energy efficiency and carbon where appropriate invest in, a future carbon compliance. Where energy may once have constrained economy. simply been a line item on the balance sheet, there is now a fundamental need to understand where it is coming from, future costs and sources, how it is being William Butterworth is a partner and Jaideep used and what alternatives and new Das is a senior consultant in the Corporate risk mitigation approaches could be Risk Team at ERM.
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by Tim Clare
As recent renewable energy acquisitions investment opportunity as shown by, show, there is opportunity and not just for example, Montagu Private Equity’s liability in the challenge of tackling climate involvement in Cory Environmental and change and implementing strict new waste now in Biffa. The waste management and chemicals legislation. Environmental industry has the enviable position of being due diligence in the future will extend to able to capitalise on increasing strictly become part of the target selection and levels of legislation that are forcing both business plan appraisal process. households and businesses to recycle more. However, whereas with waste the Scottish & Southern Energy plc’s legislation is currently forcing greater acquisitions last year of the Irish wind farm levels of recycling than public or business developer Airtricity and Segro’s Slough Heat participation would do on its own, the & Power, made it the British Isle’s biggest explosion of interest in ‘carbon’ over the renewables generator. It demonstrated the last two years as individuals and business increasing value seen in the ‘green’ power seek to reduce or neutralise their carbon sector and the fact that it now forms a key footprints has fuelled the market for part of the strategies of the tradition power renewable energy beyond the level which generating companies. Indeed it was a sign current legislation or policy would trigger of it now being mainstream. alone.
Prior to this, Terra Firma’s development of The above, and the development of the Infinis business for example, showed specific energy saving equipment, are that many foresaw a significant area of among some of the more obvious areas opportunity. In 2003 it acquired the Waste of opportunity. The investor will still find Recycling Group and a year later Shanks’ opportunities here, ranging from lower risk landfill and power generating arm. To investment in the ever increasing number many this appeared to be primarily the of specialist funds (although some have creation of a significant waste management recently experienced some falls) to higher business, but the sale of the waste recycling risk provision of venture capital to new, operations to Spanish construction untested technologies. With the latter some company FCC for £1.4bn, showed that in are drawing parallels with the dotcom era fact Terra Firma had created a renewables as more opportunities are being sold at the business just as market demand was idea or concept phase. The green pound growing. Flotation is now likely to reveal will provide many strategic opportunities the true value of the investment. over the next decade. But spotting them requires a clear framework and also a great This is not to say that waste management understanding of both sustainability and does not still represent an attractive the market as well.
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Do not think carbon is gone. Maybe some who can eliminate likely ‘substances of very of the opportunities for renewables seem high concern’ from the supply chain today – less attractive today. But low carbon and tell customers about it. products provide a great opportunity and the opportunities for innovation and Perhaps the optimum scenario is spotting different brand proposition are huge. an existing business with existing products Reducing carbon emissions by 60 percent that have the potential to see significantly in the UK by 2050 is so radical that many increased demand due to climate change. struggle to conceive what this will require. Again the greatest rewards should go to But those who can think differently those who react quickest, be it to modify and beyond the immediate day to day their product or simply communicate its pressures will create strategic value environmental credentials. Suppliers of in spades. In the commercial property heating, ventilation and air conditioning sector, Energy Performance Certificates equipment who have been quick to market will provide a consistent rating scheme more efficient products are currently seeing across the industry. How long before dividends as legislation and market demand rateable values are based on the EPC? In (what you might call the Marks & Spencer the electronics sector, creating innovative (M&S) factor) have together forced the end to end carbon stories for products design of increasingly efficient commercial will demonstrate real leadership and new buildings. Those who have invested in LED markets. And how much opportunity exists lighting systems are enjoying a particularly for the firms to commercialise robust positive period. The technology is now in carbon capture, zero emission vehicles, and vogue as suppliers extol the twin benefits the next generation of IT that reduces the of low energy demand and low production need for travel. of latent heat, meaning that less cooling is also required in those buildings in which it is Carbon is the game in town today, but installed. there will be other drivers. The UK launched its water strategy in March. The Code In searching for the next areas of for Sustainable Homes which all new opportunity, investors also need to developments will need to follow will consider which businesses will benefit require radical low water products as well from the environmental and societal as low carbon. With the UK forecast to changes that climate change will bring, become much drier in summer, how will rather than simply focusing on the this provide opportunities for low water technologies being developed to reduce consuming equipment and for companies carbon, waste and other pollutants. At that can produce products using low water the extremes, dependant on geographical techniques? location, flooding or water shortages (or both) will require major expenditure on In chemicals, the EU’s REACh regulations infrastructure. At a general level, milder and provide the most substantial changes to shorter winters in temperate climates may, chemicals legislation seen in the last 50 for example, increase productive time for years. REACh creates opportunities for the the construction industry but reduce the manufacturers of safer chemicals. It also need for specialist winter equipment. The provides strategic opportunities for firms possible individual results and opportunities www.financierworldwide.com | FW 181 INTERNATIONAL MERGERS & ACQUISITIONS 2008 of climate change are potentially endless issues, usually occurs at a late stage of and will require a significant amount of the transaction and only rarely extends future gazing. Crucially, it will be essential into an assessment of the business’ to ensure that ‘good science’ forms the strategy. Environmental due diligence in basis of that analysis to ensure that only the future will also form an element of the viable opportunities are pursued. initial appraisal of a business and focus on strategy rather than facilities. In the Beyond the specific search for direct last 18 months a number of household carbon related opportunities, the analysis names, most notably M&S, have seemed of any target business should now involve to seize and driven forward the agenda. an assessment of its vulnerability to and But there are vast differences between the awareness of environmental issues, and ground occupied by the likes of Marks & carbon in particular, at the earliest stage. Spencer, who have developed a proactive While the legislative drivers, although strategy based on good science and the spreading in coverage, are not yet directly chasing pack for which many buying carbon affecting significant elements of the neutrality via offsets has effectively been economy, the potential impacts on demand done as a defensive strategy. Not every caused by the changing environmental company can or indeed should embrace conditions described above, have the environmental issues in the way that M&S potential to affect all. A truly forward has; but it will be crucial that an investor thinking management team should have becomes comfortable that a target has looked at climate change and asked the undertaken that risk analysis and that the question as to whether it provides an area value judgements it has ultimately made of opportunity or more crucially, a threat are robust and leaves the company fit for to its current markets and therefore its the future. business plan.
Traditional environmental due diligence, Tim Clare is technical director, Environmental primarily focused on site based Due Diligence, at WSP Environment & contamination and end-of-pipe compliance Energy.
182 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g The affect of market turmoil on the treatment of environmental liabilities in transactions
by John Simonson
Although private equity deals may have which support compliance – not to mention slowed down given the recent credit the staff and resources that may be needed squeeze, corporates have remained now and in the future. This is true for remarkably active; not only as acquirers in facilities in a whole range of sectors, from current transactions but also as would-be power generation to food manufacture. vendors which are preparing for a return to normal business in 2008. New players are coming into the market, notably from BRIC countries (Brazil, Russia, While the market is clearly more cautious, India and China) and from the Middle East. there is little sign of stagnation. Rather, in Companies from these countries, including certain areas there is a change in emphasis those backed by state-owned sovereign and new concentrations of activity. Mega funds, are well financed but need to private equity deals, for example, may have address EHS regulatory and reputational disappeared, but clients are retaining a pressures in different parts of the world. sharp mid cap focus and paying attention Understanding the timing of EHS costs and to key issues which will ultimately provide the assurance systems which need to be put them with a successful exit when the time is in place has become an important part of ripe. the process.
Trade buyers are doing deals in a less In our experience, around one in five deals competitive environment. There is a now have material climate change issues growing trend among corporates, most and this trend is expected to continue notably in Europe, to seek advice on issues whatever the fluctuations of the market. prior to a sale, in expectation of a market Issues can range from energy use and upturn in 2008. By ensuring that facilities tighter emissions regulations to the are compliant, and making themselves location of facilities. The challenge for aware of EHS and climate change issues investors is to factor in climate change as that could become material, vendors are part of the overall investment. A company seeking to ensure full control of a future may need to look at holistic regional or sale once the process is underway. country climate change risks, particularly companies in extractive industries which Focus on assurance are under pressure to meet the demand for scarce resources. New approaches and Companies are taking a longer, harder look screening tools are being developed to at environmental issues. Rather than simply mitigate these risks. As markets tighten ticking off compliance items, there is a there is a greater onus on cash flows with growing desire to look behind the scenes EHS costs and future requirements are at EHS assurance systems and processes receiving more scrutiny. www.financierworldwide.com | FW 183 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Another upshot of the credit squeeze is that or too little) water, are helping, for example, some private equity houses are feel more to bring the last of these issues sharply into exposed on EHS liabilities because they are focus. investing more of their own money. This in turn is starting to have an impact on the In short, the market as a whole is taking way they look at EHS issues – again with stock and buyers are paying close attention attention to the timing of individual cost to the timing of individual costs and items and assurance issues. assurance issues in a whole range of areas. Furthermore, new players are coming into In fact, the market slowdown offers the market, all of whom must at least take the opportunity to look in more detail EHS and climate change issues on board as at how a business could benefit from a part of the dealmaking process. more strategic EHS focus. This can cover resource-related issues such as energy use, waste and emissions to wider, areas such as trading carbon credits and the geographical location of key facilities. Concern over John Simonson is the global director of M&A climate change and particularly (too much at ERM.
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CHAPTER nine: Sector analysis
www.financierworldwide.com | FW 185 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Trends in independent oil company M&A
by Terry A. Newendorp and nicole Weygandt
Following a strong year for oil and gas of 40 percent, the $19.6bn Kerr-McGee M&A in 2006, last year saw the aggregate acquisition was notable for being financed value of deals remain steady, rising only in part by concomitant divestitures of 0.4 percent to reach US$292.2bn, while the Anadarko assets in Canada for $4bn. Upon number of deals dropped by 2 percent to completion of the deals, Anadarko not 893, according to PricewaterhouseCoopers’ only increased its proved oil reserves by 32 ‘Oil & Gas Deals Annual Review 2007’. percent and its proved natural gas reserves Although these figures suggest little by 45 percent, but also more than tripled its change in the industry over the past year, undeveloped acreage. The company is now the dynamics in the oil and gas sub-sectors a leading producer in the Rockies and the have changed significantly. deepwater Gulf of Mexico, with share prices reportedly rising nearly $10 to over $60 In 2007, the refining and marketing – or since the acquisition was announced. downstream – sector witnessed average deal values grow by 120 percent, led Developments on AIM by the largest M&A deal of 2007, the $20.1bn leveraged buyout of Lyondell In contrast to Anadarko, the 109 oil and Chemical Company by Basell. In contrast, gas producers listed on the Alternative the average deal value in the exploration Investment Market (AIM) of the London & production (E&P) – or upstream – Stock Exchange are exclusively small- and segment fell by 27 percent, according to mid-cap independents operating early PricewaterhouseCoopers. Although this stage upstream assets, with an average difference can be partially attributed to market capitalisation of £94m ($184m). the lack of mega deals on the scale of the This places these companies squarely into $32.2bn Statoil-Hydro merger in 2006, the the range of the fastest-growing segment overall decline in deal value in 2007 also of the oil and gas M&A market – the deal reflects a shift away from industry majors range below $250m accounts for nearly 80 towards greater M&A activity among percent of all oil and gas M&A deals, with independents – non-integrated oil and gas 25 percent year-on-year growth in the value companies that receive nearly all of their of deals. M&A among these companies is revenues from production at the wellhead. motivated both by financing needs and the desire to develop economies of scale. Even among high-priced deals, independents are playing a significant role. With upstream development costs having Anadarko’s acquisitions of Kerr-McGee nearly doubled since 2005, according to and Western Gas Resources each ranked the IHS/CERA Upstream Capital Cost Index, among the 10 largest oil and gas M&A deals the smaller independents with limited of 2006, totalling $25bn. With a premium cash reserves are having greater difficulty
186 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS developing their acreage and establishing number of exploration blocks it holds in the positive cash flow. The global credit crunch UK offshore, according to Reuters. Encore has greatly reduced access to capital Oil has already expressed is intention to from debt markets, while poor shares continue to expand via both corporate and performance of the AIM-listed oil and gas asset M&A in 2008. companies makes it difficult to raise capital from new issuances. Ernst & Young reports Market opportunity for NOCs that, as of the third quarter of 2007, nearly 50 percent of AIM-listed E&P companies In addition to the growing number of M&A are trading below their initial listing price. transactions between independents, both Combined with the fact that, at the same corporates and assets are also proving time, nearly 65 percent of AIM-listed E&P to be attractive acquisition targets for companies hold less than £10m ($19.4m) in national oil companies (NOCs) – oil and cash, the small- and mid-cap independents gas companies fully or majority owned by – particularly those with low capitalisation state governments. Although NOC activity and no producing assets – are highly dropped off somewhat in 2007, NOCs spent vulnerable to takeover. over $55bn in 2006, or nearly 35 percent of global oil and gas M&A spending. Demonstrating this vulnerability, Wham Energy was acquired within two years This drive to acquire – particularly of listing on the AIM after share prices among Asian NOCs – reflects the dropped to half of their initial listing price strategic advantages M&A can provide after the company’s first well came up dry. to less efficient or inexperienced NOC With insufficient capitalisation to absorb buyers. Apart from enabling geographic this loss, the company was purchased diversification and entry into new asset by Venture Production PLC, a better- classes such as unconventional oil and capitalised firm with its own production, in gas, corporate acquisitions allow NOCs to August 2007. Tristone Capital Ltd. predicts bring in experienced personnel and gain that nearly two-thirds of AIM-listed oil and access to new technologies. Additionally, gas companies will disappear from the the acquisition of existing assets can allow market over the next two years as a result NOCs to develop international operating of their financial weakness. experience, enabling them to compete effectively in bids for exploration blocks. Not only are AIM-listed companies Finally, by taking over existing assets, potential targets of larger independents particularly in the downstream sector, and integrated companies, but there NOCs can gain access to infrastructure and have also been a number of corporate potential customers, allowing them to more acquisitions within the AIM, with AIM-listed rapidly expand in new markets. companies acting as aggressive buyers. In early 2007, for instance, Encore Oil acquired Despite the reduced level of overall NOC four E&P companies (AIM-listed subsidiary M&A spending, some state-owned energy of Grove Energy, privately held Virgo Oil investors remained highly active in 2007. & Gas and Virgo Energy Ltd., and the UK TAQA, an energy investment company subsidiary of Nido Petroleum) for a total of that is majority-owned by the government £8.6m ($16.9m), thereby quadrupling the of Abu Dhabi, spent over $10bn on seven www.financierworldwide.com | FW 187 INTERNATIONAL MERGERS & ACQUISITIONS 2008 transactions in 2007. These deals expanded high prices, independents and NOCs are the company’s presence internationally taking the opportunity to integrate their into Canada, Germany, India, Morocco, operations. Saudi Arabia, Ghana, and the UK, while also increasing the company’s role in The urge to integrate appears particularly conventional upstream oil and gas, strong in North America, where operators Canadian oil sands, and power generation. of Canadian oil sands projects are seeking The company has indicated that it intends to secure capacity in complex refineries to increase its assets to $60bn by 2012, up capable of processing their crude. These from $21bn at present, as part of its long- transactions take the form not only of term growth strategy. outright acquisition of refineries, but can also involve capacity purchases or Most notable among TAQA’s deals are the exchanges of shares. In the case of Husky Canadian corporate acquisitions, which not Energy, the company not only made a full only introduced the company into Canadian acquisition of a 165,000 barrels-per-day oil sands – a source of unconventional oil refinery for $1.9bn plus net working capital, production – but also brought with it the but also purchased a half-share in a BP technology and experienced personnel refinery while granting BP a stake in its to operate these types of projects. As a Canadian upstream operations. result, TAQA has become a leading player in Canadian oil sands, becoming one of the top 10 companies in Canada in terms of proven natural gas reserves and one of the top 12 companies in terms of oil and gas production. It has also enabled the M&A in oil refining and marketing is undergoing company to pursue an aggressive reserve rapid expansion in the wake of strong refining replacement level of approximately 140 margins, supported by a tight capacity-demand percent – well above the levels many majors have been able to achieve. balance, and escalating capital costs.
Refining sector opportunities
M&A in oil refining and marketing is undergoing rapid expansion in the wake In Western Europe, independent refiners of strong refining margins, supported have been taking advantage of integrated by a tight capacity-demand balance and oil companies’ divestures to increase escalating capital costs, which reached their scale and geographic diversification. record highs in the third quarter of 2007, Petroplus Holdings AG, for example, according to the IHS/CERA Downstream has purchased 521,000 barrels per day Capital Cost Index. As a result of these of additional refining capacity from dynamics, purchasing and upgrading ExxonMobil, BP, and Shell over the past existing plants has in many cases become year, becoming the largest independent cheaper than greenfield development. refiner in Europe with total nameplate As majors divest of their refining assets capacity of 864,000 barrels per day, as and optimise their portfolios at a time of reported by Fitch Ratings. In contrast,
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Central European refining M&A has been John S. Herold Inc. show that activity in led primarily by large regional players 2006 reached new records, with asset such as Austria’s OMV and Hungary’s transactions topping $60bn along with MOL, which seek opportunities in the less corporate transactions of approximately competitive Eastern markets. Apart from $100bn. Although aggregate M&A figures lower competition, these markets have the have not changed significantly, there has additional advantage of offering higher been a dramatic shift towards lower-value profits from price differentials between transactions involving independent oil Brent and Urals crude oil. Privatisations and companies – both as buyers and targets – as westward expansion of Russian and Kazakh global credit markets and escalating capital oil and gas firms are adding additional costs push the industry towards greater momentum to the European M&A markets. consolidation.
Conclusions
M&A in the oil and gas industry entered a growth phase in 2005, when upstream Terry A. Newendorp is chairman and CEO, transaction value more than doubled and Nicole Weygandt is an analyst at Taylor- from the previous year. Figures from DeJongh.
www.financierworldwide.com | FW 189 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g European airline industry: value creation through M&A
by Dr. Jürgen Ringbeck
With long term market growth forecasted acquisitions by Air France, which took at 5 to 6 percent and benefits accrued from over KLM, and Lufthansa, which acquired globalisation, it seems that the European Swiss, were not significant enough to airline industry should be highly profitable. change the overall picture: M&A activity However, the intra-European airline market in the European airline industry has been deregulation in the early 1990s brought relatively weak during the last 10 years. a wave of competition, and even with an infusion of private capital, the sector’s However, over the coming years, that financial results are not up to par. Over picture might change. With further the past decade, the European airline liberalisation and deregulation of the association (AEA) members (mainly flag European airline industry we might soon carriers) have seen net losses on average, face a significant wave of consolidation. and thereby have been unable to recoup In this article, we highlight the major their expenditure. Even in 2007, which was industry trends and drivers of a potential very successful, all AEA members will not consolidation scenario and take a deeper earn more than an estimated operating look at how value might be created by M&A profit of €3bn, which is only about 4 percent in the European airline market. For this of revenues (on average) and far below the purpose, we will use the Lufthansa / Swiss 7 to 8 percent typically required to cover merger to highlight the key factors that the cost of capital. This is too little to satisfy drive the success of cross-country airline future investors. mergers in Europe.
In any other sector, market consolidation Clearing the way for further consolidation would have occurred long ago. In the European aviation industry, however, the There are three major trends that could number of airlines grew steadily between be the driving factors of a wave of the time the intra-European market opened consolidation in the European airline for EC carriers in the 1990s until 2002. market. Despite the fact that low-cost carriers, such as Ryanair, have entered the European The next downturn of the industry cycle. market successfully and captured more It is becoming more apparent that such a than 30 percent market share on intra- downturn is on the horizon. IATA, the global European routes, only some consolidation airline association, corrected its profitability has occurred. Due to ongoing heavy outlook for its members three times regulation (e.g., intercontinental traffic between June 2007 and December 2007, rights) and state subsidies, weak carriers for a total decrease of around 50 percent. (e.g., Alitalia and Olympic Airlines) have The credit crisis in the US and increased fuel been prevented from exiting. The recent prices also drive up the risk of an industry
190 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS downturn after a strong 2007. The major On top of these market shifts, regulatory flag carriers might be the potential winners issues are coming into play: competitive in such a downturn, thanks to their long- dynamics on transatlantic routes are term development of economies of scale fuelled by a new Open Skies Agreement and marketing in hub-and-spoke systems. between the US and the European Union By shaping their global alliances in the that will come into effect in April through 1990s and making more recent acquisitions, June, 2008. This agreement allows every the three leading European airlines – British EU and US carrier to fly to any destination Airways, AirFrance/KLM and Lufthansa/ in either region. The upcoming opening of Swiss – have captured a market share of 47 the EU-US air market will kick start a new percent of passengers carried by European game – making transatlantic cross-border flag carriers. deals even more compelling. For example, European carriers might consider opening New emerging competitive dynamics in the up their own US feeder service in a major intercontinental business. This business US hub. Lufthansa has just bought a 19 has traditionally been a goldmine for the percent ownership in the New York-based European network airlines. Fuelled by carrier JetBlue Airways, which has a strong globalisation and resulting increased travel, intra-US network out of John F. Kennedy especially in Asia, these markets have Airport, which may serve as feeder system experienced high growth rates. Regulation, for Lufthansa in that market. As airlines including restricted traffic and ownership introduce the Airbus A380, they will need rights, has also benefited European flag to ensure that they have sufficient hub carriers, as has the comparative weakness feeds to keep aircraft seat load factors high. of players in the emerging markets and Moreover, Air France/KLM now has strong the US, whose carriers even today are still incentives to build up an intercontinental suffering from the effects of September business out of London Heathrow in joint 11. However, we expect that European flag partnership with Delta. They have even carriers’ dominant position in this sector will signed a specific joint venture agreement change soon. to share revenues and costs on their transatlantic routes. A consolidation of the The major US flag carriers are currently US carriers might give these types of JVs a seriously discussing how to consolidate the larger role; it could even result in minority intra-US industry, driven by early merger ownerships of European carriers in the negotiations between Delta and Northwest emerging US mega carriers. or United and Continental, and thereby strengthen their competitive position in Continued growth from European low- the transatlantic business. In addition to cost carriers. We expect LCCs to continue this development, strong new players are expanding their role in the intra-European emerging in Asia and the Middle East: market and thereby drive up further Emirates is desperately trying to get more competition. Realistically, LCCs could traffic rights in Europe, and even Air China gain around 40 percent market share is planning to expand its European network in continental passengers by 2012. quickly, seeking 12 new connections to the These private carriers have a significant US and Europe in 2008 and 2009. opportunity if they quickly consolidate their own market segment and thereby capture www.financierworldwide.com | FW 191 INTERNATIONAL MERGERS & ACQUISITIONS 2008 economies of scales in their business to However, the upcoming consolidation strengthen their competitive positioning game might become even more complex against the major flag carriers. These and allow convergence of the two European economies will be increasingly necessary: industry segments: the intercontinental Fuel price, even today, constitutes more network carriers and the low cost carriers. than 30 percent of the total costs; price The current talks between TUI and elasticity is high; and there is almost no Lufthansa about a merger of their LCC/ room left to drive down margins through charter businesses (Hapag-Lloyd and operational cost improvements alone. German Wings, respectively) might result in a fourth significant low cost player under The shape of what’s to come Lufthansa´s leadership. Air Berlin has acquired the long haul charter carrier LTU All three of these trends will clearly create and is in the process of acquiring Condor, a difficult burden for the many smaller with the hope of creating an international players in the European airline market. network out of Germany that combines its strong European network with a growing Several of the European LCC niche players, number of intercontinental destinations. such as SkyEurope, are at risk of becoming Finally, other private carriers – like AirOne takeover candidates or being washed in Italy or Ryanair, which took shares in out of the market. Moreover, most of the Air Lingus – are amenable to looking smaller European flag carriers, which are beyond their narrow business segment. mostly unprofitable and undercapitalised, The upcoming wave of consolidation may are burdened by suboptimal networks and therefore not only drive consolidation in the the legacy cost structures of a traditional old business segment; it might stimulate flag carrier. Therefore, they too are clear the emergence of innovative hybrid candidates for further intra-European business models with an even higher rate of consolidation; these include Alitalia, Iberia, return. and LOT. Many of these carriers and their owners are considering privatisation now The face of successful European and are looking for private investors. consolidation: Lufthansa/Swiss
The three major flag carriers are the What are the drivers of a successful cross- obvious candidates to drive this next border merger? How can the synergies be consolidation round of smaller flag carriers. captured best? What are the real levers Air France is interested in acquiring Alitalia, of value creation for cross-border M&A British Airways may expand its minority deals in the airline industry? The best way stake in Iberia, and Lufthansa would most to study these questions is to take a closer likely be open for discussions with its STAR look at perhaps the most successful cross- members. border merger to date: the Lufthansa-Swiss merger. Likewise, the three major LCCs – Ryanair, Easyjet and Air Berlin – will probably One of the prerequisites for its success was drive consolidation in their sector, as they a great cultural fit between the players; currently offer more than 60 percent of the another was the positive motivation of seats available in the European market. the Swiss management and employees
192 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS to cooperate in the takeover: Swiss had to an estimated CHF 4.4bn in 2007. It also always considered itself a premium carrier transformed its losses of CHF 140m in 2004 in Europe, with several customer awards to an estimated profit of more than CHF thanks to its extreme customer focus and 500m in 2007. commitment. But after the bankruptcy of Swissair at the end of 2001, the company went through a deep painful restructuring in its battle for survival as newly founded Swiss. This difficult period opened the company to the idea of a win-win As a result of this deal, Lufthansa and Swiss have opportunity through a merger with a larger player. Former emotional and political significantly extended their market and customer doubts became less and less important coverage. when Lufthansa started the negotiations again in 2005.
At the beginning, the deal did not focus on expanding the airlines’ network, rather than on operational integration and As of September 2007, Lufthansa and cost synergies. However, it was clearly Swiss have realised more than €420m in crafted around ‘win-win’ opportunities, as financial synergies thanks to this merger; Stephan Gemkow, the CFO of Lufthansa more than €230m of these savings were Group, emphasised in a discussion with realised in the first 18 months after the us. It allowed Swiss to keep its brand deal. More than 60 percent of the synergies and its intercontinental hub in Zurich, are based on revenues. Nearly 60 percent and expand its business as part of a of the synergies have been realised at Swiss comprehensive Lufthansa multi-hub and therefore directly contributed to its network. The continental traffic as well as financial turnaround. intercontinental traffic has been aligned carefully and Swiss customers quickly took As a result of this deal, Lufthansa and Swiss advantage of their broader choices in flying have significantly extended their market with Swiss or Lufthansa to international and customer coverage. However, while a destinations (via Zurich, Frankfurt, or lot of value has been created in the short Munich). Customers also enjoyed the term by integrated network planning and rapid improvement of ground services sales and marketing, there are significant and the investment in a new three-class other levers that have not been exploited intercontinental product with modern fully until now. The merger clearly offers equipment. The fact that the airline now the opportunity for further functional has one of the world’s largest frequent-flyer consolidation in areas including aircraft programs (‘miles and more’) is another maintenance or IT. If the time is right to compelling benefit to the customer. pull these levers in the interest of both companies, these areas will be addressed as As a consequence, Swiss was able to well. expand its revenues from CHF 3.6bn in 2004
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Conclusion the Lufthansa-Swiss case shows that even a merger with an international partner The consolidation wave in the European can be a real win-win opportunity for airline landscape has just started, and everyone. A merger may create value for the urge to merge will probably become all stakeholders: the financial shareholders, stronger. With market power and scale the employees, and the customers. being the major drivers of future survival, There is no longer any reason to dismiss M&A will be an important weapon in consolidation as the next move for a winning the battle for profitability and number of European carriers. growth in the European airline industry. In an industry in which organic growth is difficult to achieve, acquisitions and financial stakes in smaller industry players Dr. Jürgen Ringbeck is a senior vice president – including smart integration strategies – at Booz Allen Hamilton. The author would will differentiate the winners and losers of like to thank Mr. Stephan Gemkow, CFO tomorrow. of the Lufthansa Group, for his willingness to share his personal insights on the value In the highly political flag carrier drivers of the Lufthansa–Swiss merger. environment, public pride about a country’s Many thanks to Dr. Stephan Gross, Senior flag carrier and government interest in Associate at Booz Allen Hamilton, for controlling air capacity and air service have supporting the author with research and created large hurdles to takeovers. But insights on the European airline market.
194 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g M&A boom in the CEE telecommunications market
by Dr. Karim Taga, Oliver Lux, Christian Niegel and Evgeny Shibanov
Strategic and financial acquirers have their empires further in 2007, Telekom driven intense M&A activity in Central & Austria/mobilkom was active. It already Eastern European telecommunications held operations in Slovenia, Croatia, markets. We have observed 10 major Serbia, Macedonia and Bulgaria. To expand transactions with a total value of €3.9bn. that footprint further, Telekom Austria/ Strategic investors were buyers in four of mobilkom secured the second largest CEE these transactions with a total value of telecom deal by acquiring 70 percent in €1.9bn while financial investors dominated Cypriot SB Telecom Limited. CB Telecom slightly with six acquisitions totalling €2bn. owns Belarus mobile operator MDC which operates under the Velcom brand in Transactions are driven by growth Belorussia. perspectives and a desire for ongoing empire building by strategic buyers. The acquisition market is further fuelled Financial investors seek short to mid term by CEE and Middle Eastern operators. In value creation potential. Three trends early 2007, the Serbian incumbent Telekom should lead to increased M&A activity in Srbija snatched 65 percent of the shares of CEE in the mid to long term. Telekom Srpske for €646m. A consortium including Turk Telekom acquired a Strategic buyers controlling stake in the Albanian incumbent Albtelecom for €145m. Hungary’s Strategic buyers from Western Europe Telephone and Cable Corp. bought 100 are heading east in search of growth. percent of the Hungarian fixed line operator For example, Vodafone’s CEE footprint Invitel from Mid Europa Partners for €470m, includes operations in Hungary, Albania, with multiples of 1.4x revenue and 3.9x Czech Republic, Romania and Turkey. EBITDA. Saudi Oger, based in the United France Telecom has subsidiaries in Poland, Arab Emirates, also moved into CEE when Moldova, Romania and Slovakia. Telefonica/ it bought Turk Telekom for €5.5bn in 2005 O2 has a presence in Czech Republic and and a 45.8 percent stake in Romanian Slovakia, while Deutsche Telekom holds specialised mobile operator Zapp for an subsidiaries in Hungary, Slovakia, Croatia, undisclosed amount. Macedonia and Montenegro. Telenor has expanded its Nordic roots by moving into Financial buyers Hungary, Montenegro and Ukraine and it holds a significant stake in one of Russia’s The largest telecommunications mobile operators. transaction in 2007 was conducted by AIG Capital, which acquired 65 percent of the While Vodafone, France Telecom, Bulgarian incumbent BTC for €1.1bn, taking Telefonica/O2 and Telenor did not expand it over from another financial investor. AIG www.financierworldwide.com | FW 195 INTERNATIONAL MERGERS & ACQUISITIONS 2008 also acquired SC Digital Cable systems in long awaited exemplary transactions Romania for €45m. Mid Europa Partners which should take place in 2008. First, the acquired the Baltic mobile operator Bite sale of 49.13 percent of Telekom Slovenije for €450m from TDC and also acquired to either of two remaining bidders in the the leading Serbian cable and broadband bid process: Iceland telecom incumbent provider SBB for €200m. Providence Skipti or the private equity consortium led Equity Partners took over the Ukrainian by Bain Capital even though the process cable company Volia Cable for €200m. was recently halted by the Slovenian GML has announced its intention to sell government and therefore will be 100 percent of the shares in GTS CE to a delayed. This project is at risk as recently consortium of private equity funds, led by the Slovenian government threatened Columbia Capital. GTS CE operates a group to withdraw the process. Second, the of alternative telecom service providers in privatisation or IPO of Lattlecom in Latvia. Czech Republic, Poland, Hungary, Romania Third, the potential sale of a share in the and Slovakia. Ukrainian incumbent Ukrtelecom.
The activity of financial investors Licence issuance. Investors acquiring new proves they expect to be able to create licenses will set-up businesses which may substantial value through a future be involved in future M&A activity. CEE exit. Their focus is no longer solely on regulators continue to issue a number of telecommunications operators but also licences. For example, a number of CDMA includes cable operators. licences have been awarded, some of which led to the establishment of new, specialised Future trends operators. Recent examples include the fourth mobile licence in Bulgaria which has The slowing growth rate in many CEE been awarded to CDMA-Operator RCE. In markets suggests saturation. The Czech Republic, Mobilkom, a startup set-up number of ‘obvious’ acquisition targets is by Czech based private equity house Penta declining, which may lead to a slowdown Investments and not related to mobilkom in M&A activities by strategic investors. Austria, launched a CDMA network The financial crisis, which has made branded U:fon. Also, in Poland, Nordisk financing for financial acquirers more mobiltelefon, a Finish mobile operator, difficult, may also reduce their activity. recently received a CDMA licence. Warsaw However, the potential for value creation based Sferia also owns a nationwide CDMA through consolidation prospects, licence. operating cost reductions and remaining growth areas should continue to drive In mid-March, Romania’s national the interest of financial investors in CEE regulatory authority launched a draft telecommunications assets. decision on the procedure for granting a licence allowing the provision of mobile Overall, three fundamental trends should services in the 410-415/420-25MHz bands. drive mid-term M&A aspects in the The tender will only be open to bidders that telecommunications sector in CEE: do not currently hold an GSM, UMTS or CDMA license in the country. This might be Privatisation. Privatisation is driving three quite attractive for investors searching for
196 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS greenfield operations in the region and will We expect M&A activity in the CEE further increase competition. telecommunications markets to continue in 2008 and 2009. But the merger and Greenfield opportunities. Companies do acquisition process has become more not require a huge excess of cash in order challenging. As the number of obvious to swim with the big fish. There are vast opportunities has declined, competition opportunities for those with a smaller for high-value transactions, such as in pocket and an innovative spirit. Companies privatisations, is particularly intense. A can team up with other small players and buyer therefore needs to be fast, well- create broadband accesses either in new prepared and take into account the buildings or to cover whole city districts. dynamics of competing bids to determine In the Czech Republic, for example, there the amount it is prepared to pay. Bids for were 800 Wi-Fi ISPs offering services to future licences may also decline since the over 350,000 subscribers in early 2007. We markets are relatively saturated and future expect to see some consolidation among licences will mainly address niche areas these ISPs. There is a similar situation in such as CDMA. Acquisitions of specialised Bulgaria, where many small LAN operators greenfield start-ups certainly require a have emerged and successfully attracted 60 thorough technology understanding. The percent of the fixed line broadband market. transaction process is further complicated by the current situation in global financial New businesses addressing these markets, which are certainly affecting broadband opportunities as greenfield financial buyers. start-ups are likely to become the object of future M&A activity. Airbites, a Swisscom- backed ISP, is one strategic investor waiting to pick up successful start-ups. It specialises in acquiring local ISP operations in CEE Dr. Karim Taga, Oliver Lux, Christian Niegel countries, especially small, LAN/Ethernet and Evgeny Shibanov are consultants at based neighbourhood networks. Arthur D. Little.
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CHAPTER ten: Regional view – The Americas
198 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g The M&A world comes to the United States
by John Brantley and Martin Hunt
The United States has become a focus Security Act of 2007 adds a new element of merger and acquisition activity for of political exposure to foreign direct companies and investors from around investment transactions. While the the world. Of the $1.5 trillion in US M&A American economy remains largely transactions during 2007, as measured open to foreign investment, the new law by Thomson Financial, non-US acquirers increases the risk that domestic political made nearly one-quarter of the total – a considerations will influence the approval percentage double that of 2006. Sovereign or rejection of a foreign bid to acquire an wealth funds in Southeast Asia and American company. The Act revises the especially in the Middle East (the latter process by which the Committee on Foreign with investment assets estimated at Investment in the United States (CFIUS), more than $2 trillion) received the biggest an executive branch body, reviews foreign headlines in this ‘buy American’ boom, direct investment in the US for national but European based companies drove the security concerns. In so doing it allows majority of inbound business purchases members of Congress, competing bidders and combinations. These companies were for targets, labour unions and advocacy spurred by solid business fundamentals: groups to shape, delay or prevent proposed favourable exchange rates from the falling acquisitions. dollar, favourable company valuations from lower equity prices, and favourable The increased role of politics in the opportunities in a country with the best CFIUS process is apparent from the growth opportunity in markets as varied as expanded number of ways that a review technology, energy and consumer goods. or investigation may be triggered. The Act requires a CFIUS review of any The inbound acquisition surge is not without foreign government-controlled covered its concerns for offshore purchasers. From transaction. Parties to a covered transaction the litigious nature of doing business in the must certify that the information they US, to a variety of heightened regulatory provide is correct, and CFIUS may negotiate concerns, investment in the US can involve a any provision or even create new terms of wide range of special considerations. Non- a covered transaction in order to mitigate US companies need proper due diligence a national security threat. A covered and planning when structuring their deals, to transaction may not be exempted from help ensure that a potentially profitable deal further review and investigation until the does not turn into a costly mistake. report and findings are approved by a majority of CFIUS members and signed CFIUS national security review by the secretaries of Treasury, Homeland Security, and Commerce. Most importantly, The Foreign Investment and National the results of CFIUS standard and national www.financierworldwide.com | FW 199 INTERNATIONAL MERGERS & ACQUISITIONS 2008 security reviews must be provided to the Foreign Corrupt Practices Act appropriate House and Senate committees for their own review and assessment. The That US companies must comply with likely result will be public hearings at which the Foreign Corrupt Practices Act of any economic or political interests can 1977 (FCPA) is sometimes overlooked oppose a given acquisition. by inbound acquirers. US regulators and prosecutors are aggressively enforcing Recognising the importance of foreign FCPA financial reporting requirements investment in the US, Congress and the and prohibitions on payments to foreign Administration have emphasised that their officials, but many other countries have also intent is not to allow the new law to disrupt stepped up anti-bribery enforcement on or block routine foreign investments and their corporate nationals. Anti-corruption acquisitions. The new law will, however, compliance programs are now a virtually raise the cost and lower the chance for global requirement for multinationals, and approval of some acquisitions by foreign compliance officials in most OECD countries investors and could discourage or defeat share both a similar understanding of what some investments. Foreign investors should constitutes corporate criminal conduct and exercise all necessary caution regarding the the legal infrastructure to detect, report political ramifications of their proposed US and prosecute it. Rigorous anti-corruption acquisitions. Although a CFIUS application due diligence (particularly on offshore for review remains mostly voluntary, distribution arrangements and financial failure to seek a CFIUS review may leave reporting) can reveal problems early in the a transaction open to future scrutiny and acquisition process so that remedial action even to dissolution. The decision to seek a can be taken prior to closing. review should be part of transactional due diligence, particularly in industries with Litigation risk national security implications. However, the serious nature of the remedies available FCPA compliance and the possibility of under the law will cause most foreign regulatory action and shareholder lawsuits acquirers to file, even for transactions over noncompliance is just one form of US with only tangential national security litigation risk that inbound acquirers often implications. Acquirers also should build find troubling. US companies and their legal strategies and structures to support officers and directors have much greater the deal – such as management techniques liability in both federal and state courts to minimise the effect of foreign ownership, than foreign acquirers are accustomed control and influence. Proactive strategic to in their own countries. For example, communications to educate stakeholders, a director of a Delaware company living frame debate and influence policymakers is anywhere in the world can be sued in crucial in major acquisitions. Taking these Delaware, and the CEO of a corporate steps and developing a general appreciation entity based offshore can be subpoenaed of the heightened US sensitivities to foreign to appear in any state court hearing a direct investment transactions are practical product liability or negligence lawsuit (a ways to facilitate successful approval and risk that BP’s chairman faced in litigation consummation of inbound investment over that company’s Texas refinery fire). deals under the new CFIUS rules. Enforceability of non-compete and
200 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS confidentiality agreements is also a major transaction, the SEC and other regulatory concern for non-US acquirers. There is no bodies may give the report considerable overall solution to litigation risk – acquirers weight in approving the transaction. Such must rely on due diligence and advice of US an innovative advocacy strategy shows counsel to manage it. the preparation that future major inbound acquisitions may need. Competition enforcement
Despite increased public and political concern over foreign acquisitions of US businesses, national security concerns Despite increased public and political concern over are largely separate from competition enforcement as a regulatory factor for foreign acquisitions of US businesses, national inbound acquisitions. Although acquisitions security concerns are largely separate from that meet certain thresholds are subject to competition enforcement as a regulatory factor for antitrust reporting requirements under the Hart-Scott-Rodino Act, the vast majority inbound acquisitions. of reportable transactions faces no hurdles after the parties report the transaction. The FTC and DOJ do not typically take steps to stop non-US acquirers from acquiring Unique financial and operating concerns US companies unless there is some significant evidence that the transaction Beyond the courts, Congress and the will have a substantial negative impact on regulators, inbound acquirers face a competition. Similarly, informal and non- variety of unique financial and operating reportable business combinations generally concerns when they acquire US companies. are not challenged by the US government None of these are typically dealbreakers, without some evidence of an illegal purpose but all should be considered as part of or conspiracy. due diligence review: (i) the heightened government scrutiny of immigration and Public policy advocacy expatriate employment, particularly in light of complex visa restrictions for expatriate Acquirers must often combine regulatory executives and their families; (ii) the insight with public policy advocacy to prevalence of employee stock ownership gain approval for complex investment plans and equity incentive compensation and business combination transactions. plans for executives, and how an acquirer For example, if a foreign company faces not traded on a US exchange must shareholder, regulatory and political deal with them; (iii) the more extensive opposition in the US over a proposed regulation (from the SEC to the Sarbanes- major investment, it may be prudent to Oxley Act) and shareholder rights issues commission an independent assessment that publicly owned US companies must of its proposed transaction. If the report contend with; a complication that leads concludes that the parties have fully many foreign acquirers to rely more heavily and completely complied with all laws, on debt rather than equity financing; (iv) rules and regulations applicable to the compliance with the double tax treaty www.financierworldwide.com | FW 201 INTERNATIONAL MERGERS & ACQUISITIONS 2008 network that the US has with many inflows of offshore capital, and the countries, thereby ensuring efficient recognition of that fact means that there cross-border flow of capital, earnings and is no substantial public policy bias against dividends; and (v) the importance of local foreign investors. With proper due diligence economic and political considerations on each transaction, adequate preparation as they translate into extensive media to deal with potential problems, and a attention that could delay or derail a deal close working relationship with US counsel (as in the concerns of the 12,000 Hershey, to navigate the legal and regulatory Pennsylvania residents over the company’s complexities, acquiring companies based potential purchase by Cadbury). outside the US have every reason to continue and expand their efforts to exploit Final thoughts market opportunities and capital market advantages through the purchase of US Despite all the cautions and potential business assets. problems, inbound acquirers should continue to find in the US an open and accepting environment for business purchases. The country’s balance of John Brantley and Martin Hunt are partners payments situation virtually requires at Bracewell & Giuliani.
202 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Taking advantage of the weak US dollar
by Gary W. Marsh, Michael J. Cochran and Ann-Marie McGaughey
‘America is on sale’ is a common sentiment terms or may require significant monetary expressed by bankers, investors and or other assurances to continue supply; commentators these days. The relative and (iii) employees – distressed businesses weakness of the US dollar undoubtedly will risk losing key employees because of the attract the capital of not only US buyers, pressure surrounding a troubled company. but also non-US buyers in search of possible Business culture also may be damaged due investment opportunities in the US. One to attempts to achieve short term liquidity such area of opportunity, particularly with at the expense of good business practices. the current state of US credit markets, is the market for distressed companies. Buying assets from a US company in bankruptcy The acquisition of distressed companies in the US involves aspects that are unique Both buyers and sellers may prefer for from transactions involving financially the sale of business to occur in a court- healthy businesses. Below are some of supervised bankruptcy process (as opposed those issues and the ways in which a buyer to outside of the bankruptcy process, may resolve them. discussed below). Typically, asset sales under Section 363 of the US Bankruptcy The value of rigorous due diligence Code involve a Chapter 11 debtor-seller and a prospective buyer presenting a fully A critical component of any transaction negotiated asset purchase agreement to is the need for comprehensive due the Bankruptcy Court for approval. The diligence on the business, even more so drawback being that Section 363 sales are when evaluating a distressed business. then subject to a court-supervised auction Determining the underlying causes of the process where additional buyers may bid insolvency is vital to understanding the for the business. Other potential acquisition viability of the business going forward. A methods include a friendly foreclosure, a potential buyer should focus its attention sale by a state court appointed receiver, an on the seller’s key consituents: (i) customers assignment for the benefit of creditors and – distressed businesses may have delivery a Chapter 7 Trustee liquidation sale. or quality problems in their product areas. Key customers may find alternative There are several benefits to purchasing suppliers and the seller’s business may a distressed business in a bankruptcy be substantially eroded; (ii) vendors – context. First, a buyer of assets from a distressed businesses may create short seller in bankruptcy eliminates fraudulent term financing by stretching the terms of conveyance risk that might otherwise exist their trade payables. Following the sale, in a purchase prior to bankruptcy. Second, existing vendors may be unwilling to extend the transfer of assets through a Section www.financierworldwide.com | FW 203 INTERNATIONAL MERGERS & ACQUISITIONS 2008
363 sale is typically free and clear of all and warranties or to negotiate a purchase liens, claims and interests and eliminates price based, in part, upon post-acquisition successor liability. The ability to be relieved metrics. These mechanisms must be of all future claims is more uncertain and approved by the Bankruptcy Court. depends upon the facts and circumstances. Third, the sale of assets pursuant to Buying ‘distressed’ assets in a non- Section 363 to a good faith purchaser bankruptcy context for value cannot be set aside, modified or reversed. Fourth, a seller is required Buyers of troubled companies outside of to file, under penalty of perjury, detailed the bankruptcy process face two major schedules of all of its assets and liabilities, risks: successor liability and fraudulent a detailed statement of its financial affairs conveyance. and periodic monthly detailed operating reports. Finally, a seller may reject Successor liability burdensome contracts and may assign contracts and leases to a buyer without the Most buyers of troubled businesses consent of the non-debtor party to such structure their transaction as an asset agreement and notwithstanding anti- purchase, thereby attempting to avoid assignment provisions. assuming liabilities of the troubled business. However, there are some However, there are two principal important exceptions to consider. First, disadvantages to a buyer in a bankruptcy the buyer will have successor liability if it context. First, the Bankruptcy Court will expressly or implicitly agrees to assume the require an auction sale of the debtor seller’s liabilities of a seller. The purchase and sale assets to ensure that the seller is realising agreement should establish excluded and the highest price possible. Thus, the buyer assumed liabilities. Second, a buyer has has the unavoidable risk that it might be successor liability if the buyer is deemed to outbid in the auction process. Second, the have engaged in a ‘de facto merger’ with assets usually will be sold ‘as is, where is’ the seller. While this doctrine is a creature with few representations and warranties, of state law, the risk is generally the highest leaving the buyer with minimal recourse. if there is a continuity of shareholders such that the shareholders of the seller With respect to the auction issue, the initial become shareholders of the buyer. Third, buyer can attempt to negotiate a break-up a bulk transfer generally involves a sale, fee (usually 1-5 percent of the purchase not in the ordinary course of business, of price) as compensation in the event that a substantial portion of the inventory of it is not the high bidder and can request the seller. Compliance with these statutes expense reimbursement up to a cap. The requires notice to all of the seller’s creditors Bankruptcy Court does not have to allow and other specified procedures. Failure these protections. to comply with these statutes generally permits the seller’s creditors to sue the As for the condition of the business, the buyer for a period of up to 6-12 months buyer can attempt to negotiate a ‘hold following the transaction. Finally, certain back’ of a portion of the purchase price federal and state statutes may create to secure certain limited representations successor liability, including federal labour
204 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS and employment claims, environmental conveyance risk. Care must be taken claims and/or product liability tort to ensure that the surviving entity has claims. These claims may have their own reasonable expectations of meeting its ‘successor’ standard to which a buyer may fixed obligations following the transaction. become subject. Generally, transactions will not be fraudulent conveyances if some of the Fraudulent conveyance following elements are present: (i) no prejudice to existing creditors; (ii) the seller The doctrine of fraudulent conveyance was solvent following the transaction and may be applied to impose liability on had adequate capital; or (iii) the transaction buyers. Generally, there are two types of involved adequate consideration. Good fraudulent transactions: (i) actual fraud, in faith also may be a defence. which there is an actual intent to hinder, delay and defraud creditors; and (ii) ‘failure In sum, those buyers seeking to take of due consideration’, in which the buyer advantage of the current market conditions does not receive fair consideration from in the US will have an advantage if they the insolvent seller. A successful fraudulent understand and appreciate the dynamics of transfer claimant may, among other things, acquiring a business in financial trouble. set aside the transfer or obligation to the extent necessary to satisfy such creditor’s claims. Gary W. Marsh, Michael J. Cochran and Ann- There are several ways of structuring Marie McGaughey are partners at McKenna transactions to mitigate fraudulent Long & Aldridge LLP.
www.financierworldwide.com | FW 205 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Deal or no deal
by Frank A. McGrew IV and Dunn Mileham
As investment bankers focused on the pursued by strategic buyers. Where have all middle market, this past year provided the good times gone? plenty of drama both here in the US and around the world. The stock market entered After three strong years, the US economy 2007 a bit sluggish, but by March all three has clearly slowed, and there is an primary stock indices seemed to hit all-time overriding fear of a recession due to high levels on a weekly basis. Following housing and mortgage turmoil, rising on the heels of what was then the largest oil prices and overall anxiety by both leveraged buyout in history (Blackstone consumers and businesses. The impact Group’s $39bn buyout of real estate of a series of interest rate cuts by the Fed investment trust Equity Office Properties and a falling dollar have proved to be in early February), the first half of 2007 only somewhat effective in strengthening included the announcement of several consumer confidence and boosting exports. notable M&A transactions: a consortium All this uncertainty on the eve of one of of financial buyers purchased TXU Corp. the most important presidential elections for $44.5bn in the largest LBO in history, in recent history. Financial markets hate First Data Corp. was purchased by KKR for uncertainty, and nothing appears certain nearly $29bn and a Goldman Sachs-led today. group purchased Alltel Corp. for $28bn. As the second quarter ended, it appeared Market pundits argue that Wall Street runs that 2007 would be a record breaking year in cycles and this period is no different than by all standpoints – the stock market was past bubbles with the pendulum having up 7 percent, ample capital (both equity swung toward fear rather than greed. and debt) was available to consummate Robust fundraising efforts by private equity transactions at increasingly higher funds over the past five years led to over valuations and the economy appeared to $500bn being raised due to large alternative be on solid footing. Private equity firms investment allocations by pension funds were even talking about the prospects of a and other wealthy investors. The insatiable $100bn buyout transaction. deal appetite displayed by financial buyers led to an explosion of liquidity in the However, the balance of the year was quite leverage finance markets – low default rates different, beginning with the mortgage and confidence that equity sponsors could and related credit turmoil in July that write cheques to support disproportionately put the brakes on a rising stock market, high leverage caused traditional diligence reduced transactions by financial buyers and underwriting practices to fall by the and lowered overall acquisition multiples. wayside. Numerous M&A transactions have been shelved or delayed, including those being Owners of both public and closely held
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businesses who witnessed peak valuations emerge as victors in competitive auctions. being paid for competing companies After years of strong financial performance, now wonder if liquidity options still exist. cash-rich strategic buyers can use cash Large banks (and investment banks) on hand or public stock (which allows have been forced to lay off employees in sellers to participate in future upside) as the wake of ill-fated trading and fixed- currency. Sellers will be appreciative of income operations and deteriorating more conservative leverage multiples and profits. The consumer has shown initial a greater certainty of closure due to less stages of hibernation given continued reliance on finicky debt markets. uncertainty surrounding the economy, falling consumer confidence related to the Private equity transactions will slow but subprime mortgage debacle and curtailed not cease in 2008 – there is just too much discretionary spending. Furthermore, the money to be invested and managers run continued erosion of the US dollar, renewed the risk of forfeiting management and concerns regarding budget and trade transaction fees. After years of strong deficits and the upcoming election loom returns, pension funds, endowments and large. other institutional investors have allocated large portions of their capital to alternative investments, such as private equity. Until the returns on this asset class experience a significant fall, managers will continue to Private equity transactions will slow but not cease in allocate funds. Sound deals will continue to get done; however, leverage to finance 2008 – there is just too much money to be invested these transactions will be based upon how and managers run the risk of forfeiting management much debt a company can reasonably handle, not how much an underwriter can and transaction fees. sell in syndication.
Competing with financial buyers for deals will be Special Purpose Acquisition Companies (SPACs), which are public shells If there is a bright spot, the middle market, of ‘blind pool’ capital designed to acquire defined as transactions less than $1bn, or merge with an operating business. has been somewhat more resilient due to SPACs currently have over $18bn of capital typically lower leverage and transactions at available for acquisition deployment with relatively reasonable multiples. an additional $12bn in registration. Similar to private equity funds, these pools of What might this wave of uncertainty mean capital have a set time horizon in which for the transaction environment in 2008 a transaction must be consummated, and beyond? otherwise, funds held in trust are returned to the investors. As private equity buyers will be forced to contribute more equity and rely less Foreign investors will be able to use their on ‘excessive’ leverage, strategic buyers stronger currencies to make aggressive and (particularly those outside the US) will re- opportunistic acquisitions in the US market
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– particularly related to divestitures of non- Strategic options should be evaluated, core or underperforming assets by public and regulatory and governance affairs companies. Against a basket of foreign (SEC filings) should be current in order to currencies (including the euro, the Japanese quickly raise capital to take advantage of yen, the British pound, the Canadian dollar transaction opportunities. Importantly, and others), the US dollar is down in excess companies should raise funds when market of 20 percent versus five years ago. conditions permit, not when funds are needed. Lastly, companies and executives The market will remain active although should exercise discipline and patience, as highly volatile in the days and months transactions will take longer to negotiate, ahead. Both buyers and sellers will be finance and close. forced to demonstrate their skills in a competitive international environment. Corporate boards and management teams should review the state of their Frank A. McGrew IV is a managing director M&A preparedness and should attempt and Dunn Mileham is a vice president at to capitalise on M&A opportunistically. Morgan Joseph & Co. Inc.
208 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g A brief glossary of US M&A terms
by Richard Lieberman
Mergers and acquisitions involve complex Break Fees. Corporate laws in many business and legal transactions, which carry jurisdictions may impose a duty on the an entire lexicon that may be unfamiliar board of directors to consider a superior to buyers and sellers, particularly parties offer, notwithstanding a contractual from other jurisdictions. The following prohibition on negotiating with other glossary includes terms commonly potential bidders. Some agreements used in US acquisition transactions. The provide for the payment of a fee to the descriptions are intended to be descriptive, proposed buyer if the seller accepts a better rather than to constitute legal definitions. offer from another bidder. That fee is often Because similar terms may carry different called a ‘break fee’. connotations in other countries, it is advisable to check with experienced Data Rooms / Virtual Data Rooms. A professionals on proper usage in the ‘data room’ is a place where a company’s relevant jurisdictions. records and other due diligence materials are placed for inspection by prospective Accretion / Dilution. An accretive buyers. Data rooms can be a physical acquisition increases earnings per share. location. Alternatively, companies may scan Conversely, a dilutive one decreases those documents into a website, called earnings. a ‘virtual data room’ to permit inspection from a distance through secure internet Baskets and Caps. In negotiating indemnity connections. provisions, the parties sometimes agree that a party need not indemnify the other Defensive Measures / Shark Repellant. unless the damages exceed a minimum Companies may implement ‘defensive amount, called a ‘basket.’ Sometimes measures’ (sometimes called ‘shark baskets are a ‘true basket,’ where a seller repellant’) to help resist being acquired by is not liable for damages below that another company, or to permit a greater amount. Other times, the basket is merely opportunity to negotiate better price and a ‘threshold’ or ‘tipping basket,’ in which terms with the bidder. Common defensive case once that level of damages has been measures include ‘poison pills,’ which often reached, the buyer can seek indemnity permit the target company’s shareholders for all of its damages, including for those to purchase additional equity to dilute the below the threshold. The parties may bidder, ‘staggered boards,’ which provide for agree that certain liabilities (often for the the election of directors in annual tranches, breach of some of the representations and making it more difficult for the bidder to warranties) will not exceed a maximum replace a majority of entire board quickly, level, called a ‘cap’. and supra-majority voting requirements. Business entity and securities laws may www.financierworldwide.com | FW 209 INTERNATIONAL MERGERS & ACQUISITIONS 2008 govern the adoption of defensive measures. proposed transaction. The filing fees can Companies should consider their duties to be quite steep and are payable by the seller equity holders and others in determining unless the parties agree otherwise. whether these measures are in the company’s best interests. Investors often Holdbacks. Buyers may withhold payment resist defensive measures, due to their of a portion of the purchase price (or impact on potential sale transactions. that portion is placed into escrow with an escrow agent) to provide security for Dilution. See ‘Accretion / Dilution’ above. the seller’s indemnity obligations. The withheld amounts are often referred to as a Disclosure Statements. See ‘Proxy ‘holdback’. Statements / Disclosure Statements’ below. Hostile Takeovers / Hostile Tender Offers. Earn-Outs. Buyers sometimes agree to only A process whereby a bidder attempts to pay a portion of the purchase price if the acquire a target company when the target’s business performs at specified levels over management does not wish the company time. The deferred portion of the purchase to be acquired on those terms. In a hostile price is referred to as an ‘earn‑out’. Earn- transaction, the bidder will seek to acquire outs are often measured on sales, revenue ownership of the company directly from its or net income targets. Earn-outs can be equity owners. A ‘tender offer’ is a process used to help bridge disagreements over in which shareholders tender their shares a target company’s value, as well as to to a bidder in exchange for an offered motivate the sellers to help contribute to amount of consideration. Tender offers are the future success of the business. regulated by business entity and securities laws, especially for public companies. Fairness Opinions. A ‘fairness opinion’ is issued by an independent valuation firm Lock Up Provisions. Buyers attempt to to provide comfort to the equity owners of prevent target companies from selling a seller that the consideration offered for to another prospective buyer through their shares is fair. contractual restrictions sometimes known as ‘lock up’ provisions. Lock ups can include Greenmail. Some bidders for a company use of voting agreements by significant will acquire a large block of the target’s equity owners, ‘no-shop’ provisions equity and then threaten to launch a discussed below and other methods. hostile tender offer for more shares unless the target purchases that block of stock Management Agreements. See ‘Transition at a premium. That tactic is often called Services Agreements / Management ‘greenmail’. Agreements’ below.
Hart-Scott-Rodino Approval. The Hart- Mini WARN Acts. See ‘WARN Act / Mini- Scott-Rodino Antitrust Improvements Act WARN Acts’ below. requires larger companies to provide the US government with advance notice of a No Shop Provisions. Contractual pending acquisition, so the government can restrictions on engaging in negotiations review the anti-competitive impact of the with other bidders are called ‘no shop’
210 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS provisions. If the sellers have a fiduciary 338(h)(10) Elections. This section of the US obligation to consider unsolicited offers Internal Revenue Code of 1986 allows the and eventually accept another, they may parties to treat a sale of stock as if it were a be required to pay a break fee, discussed sale of assets, which may be beneficial for above. tax purposes.
Poison Pills. See ‘Defensive Measures’ Transition Services Agreements / above. Management Agreements. Transition services or management agreements Proxy Statements / Disclosure are frequently used to enable a seller to Statements. A proxy statement is a provide services to the buyer for an interim disclosure document describing the period until the buyer is able to assume material features of a transaction to be those duties. The agreements set forth voted on by the equity owners when they the rights, obligations and terms under are asked to give a voting proxy to another. which those services will be performed. If the equity owners are not being asked to Transition services agreements are often approve the matter, applicable law often used while buyers obtain necessary licences requires that they be furnished with similar and permits, or implement technological information through a disclosure statement. conversions necessary to operate the newly Proxy solicitations and disclosure acquired company. statements are regulated by business entity and securities laws. Virtual Data Rooms. See ‘Data Rooms / Virtual Data Rooms’ above. Reverse Mergers. A reverse merger is a process in which an active, non-public WARN Act and Mini-WARN Acts. company merges into a shell company The Worker Adjustment and Retraining with no significant operations but has a Notification Act requires that companies class of equity securities registered with provide the employees and the US the securities administrators (such as the government with advance notice of mass US Securities and Exchange Commission). layoffs before those employees may be In that manner, the private company can terminated. Many states have similar laws rapidly become a public one. (called ‘Mini-WARN Acts’), but the thresholds for when the notices are required may differ. Shark Repellent. See ‘Defensive Measures’ above. Richard Lieberman is chairman of the Corporate, Securities and Finance Staggered Boards. See ‘Defensive Department of Jennings, Strouss & Salmon, Measures’ above. PLC.
www.financierworldwide.com | FW 211 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Recent developments in Canadian M&A
by Frank P. Arnone
In recent years merger activity in Canada Recent changes to tax legislation has reached record highs. Growth in M&A transactions has been most significant On 31 October 2006 the Canadian federal in the energy and mining sectors with government announced proposed changes Canadian proven oil reserves, dominated to Canadian tax laws that will significantly by the oil sands in Alberta, providing a reduce or eliminate the tax advantages major source of M&A activity. In spite of the previously enjoyed by Canadian income recent tightening of credit availability, there trusts. Prior to the announcement, income is optimism about the outlook for M&A funds could be structured in such a manner activity in Canada. as to avoid paying ‘entity level’ tax (unlike corporations) as long as they paid out all Current state of the M&A market in their income by way of distributions to Canada their unit holders. The new proposals, when implemented, will create a tax Several trends have emerged in regime for most publicly-traded trusts this historic period of growth and and partnerships and their investors that consolidation. Private equity continues will, in effect, be similar to that for public to play a significant role in Canadian corporations and their shareholders. For transactions with both foreign and income trusts with units listed on a stock domestic private equity dealmakers active exchange before 1 November 2006, the tax in Canada. The majority of foreign private changes will commence beginning in the equity firms have been based in the US, 2011 taxation year, providing a four-year while at home, Canadian institutional ‘grandfathering’ period. investors have been allocating greater portions of their assets to Canadian private Until these legislative changes were equity funds, both internally managed, announced, income trusts had served as a and those managed by others through liquidity vehicle; including as an exit vehicle investment in other funds. There is also for private equity funds, and an attractive an increasing prevalence of companies vehicle into which certain corporations from countries such as Brazil, Russia, India could convert. But, with income trusts and China as buyers in Canadian M&A set to lose their tax advantage over transactions and income trusts continue corporations in 2011, the Canadian M&A to play a significant role as both buyers marketplace has seen an upswing in income and targets. Going forward, developments trust M&A activity, largely spurred by in the regulatory environment impacting financial sponsors looking for stable income Canadian M&A should have a positive buyout opportunities. effect on the volume of transactions in Canada. A recent study we commissioned in
212 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS association with mergermarket identified and potential purchasers want to make stable and predictable cash flows and a bids with as few conditions as possible). capital structure that is designed to pay out The Labatt decision means that the dividends on a regular basis as the most Competition Act restrictions should not attractive characteristics of income trust hamper these mergers with undue delay businesses. and unnecessary bureaucratic obstacles. In fact merger review in Canada will, as a Developments in competition regulation result of this decision, increase certainty and reflect market realities. On 22 January 2008, the Federal Court of Appeal released its decision in Commissioner of Competition v. Labatt Breweries Limited. The significance of this decision is in its affirmation, with appellate Deal certainty in the current credit environment authority, of the Competition Tribunal’s has become very important, as evidenced by the earlier decision to allow Labatt to conclude its takeover bid for rival Lakeport Breweries emphasis on material adverse change clauses in on its original timeframe. acquisition agreements and on reverse break fee The Competition Tribunal, in making provisions. its decision, held that extensions of the 42-day statutory review period for M&A transactions are not to be granted lightly. Indeed, extensions (with consequent The impact of private equity on deal delays in closing) should only be granted activity in Canada in situations where the Commissioner can show that closing will substantially impair Canadian private equity has seen record the Tribunal’s ability to remedy the merger buyout activity in the past two years. This at a later point. has been fuelled by Canadian and US based institutional investors allocating greater As a result of the Labatt decision, it is more percentages of their portfolios to private likely that parties to a merger that raises equity funds. competition issues may be able to close on the basis of a negotiated hold-separate The recent tightening of financial markets arrangement some time shortly after the has, however, dampened activity in initial 42-day waiting period. In this manner, leveraged buyout transactions especially it is clear that the Canadian Courts are in the consumer products, industrial mindful and facilitative of M&A market manufacturing and financial services realities: timing and certainty of closing sectors. Deal certainty in the current credit are critically important features in certain environment has become very important, transactions (e.g., transactions involving as evidenced by the emphasis on material public companies, in deals involving foreign adverse change clauses in acquisition jurisdictions where only part of the deal agreements and on reverse break fee involves Canada, and in corporate auctions, provisions. The mid-market nature of where vendors seek an expeditious closing the Canadian marketplace has, however, www.financierworldwide.com | FW 213 INTERNATIONAL MERGERS & ACQUISITIONS 2008
placed Canada in a position well suited of 2007 and into 2008, it is expected that for the year ahead. Although the decline growth in private equity transactions will in large M&A transactions is predicted outpace growth in M&A activity in Canada to continue, transactions in the mid- generally. In light of the recent dramatic market are expected to present the most appreciation of the Canadian dollar against opportunities. the US currency, in particular, increased outbound investment and acquisitions by Canadians is also likely.
Controlled auctions in Canadian M&A
It is expected that growth in private equity In recent years the Canadian M&A market has seen a significant increase in the use transactions will outpace growth in M&A activity in of ‘controlled auctions’ by sellers. The Canada generally. prevalence of this auction process was the result of numerous factors, not least of which, was the existence of a ‘sellers market’.
Although there are various permutations in The year ahead will likely also see the the process, generally controlled auctions continued widespread participation of in Canada involve the following elements. Canadian pension plans; a relatively unique At the outset a Confidential Information characteristic of the Canadian private Memorandum (CIM) describing the business equity M&A marketplace. Private equity for sale is prepared. Potential buyers are investments by these plans cover a wide then identified and contacted. Bidders then spectrum, including LP investments, co- sign confidentiality agreements with the investments with private equity funds and seller before they review the CIM. At this direct and co-sponsored buyouts. These point bidders are generally given access to are expected to continue in the mid- additional due diligence materials. Non- market. Canadian pension plans have also binding expressions of interest are then diversified their private equity investments submitted from which the seller narrows to include a number of different sectors, the field to create a short list of bidders. including infrastructure. Due to foreign Further access to more detailed due ownership restrictions in certain industries diligence material is usually granted to the in Canada, Canada’s pension plans have short list at this stage. Bidders then submit proven to be valuable strategic partners. an offer. Consideration and clarification of Canadian pension plans are well positioned offers results in the selection of one bidder to continue this trend of active investment, (or more than one) and the parties entering with many allocating an increased amount into negotiations (which can be exclusive), of capital to private equity investment with the hope of concluding a binding strategies over the coming years. agreement.
Although the credit environment has Throughout the process the seller may dampened M&A activity in the latter part maintain control and the flexibility to
214 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS negotiate with one or more bidders and recent Labatt ruling indicates that there accept any offer, regardless of price or is a favourable antitrust environment terms. The predominance of sophisticated for M&A activity in Canada. With these parties in the process and emerging developments, a new face has been placed technology have come together to create on the deal landscape in Canada. For non- a positive climate for controlled auctions Canadian buyers, this landscape has made in Canada. This is a trend that will likely the Canadian market an attractive place continue in the Canadian M&A marketplace to shop for businesses; particularly those where circumstances warrant. businesses in the mid-market.
Conclusion Frank P. Arnone is a partner and co-chair of The announced income trust taxation the Private Equity Group at Blake, Cassels & changes have brought about M&A Graydon LLP. The author would like to thank opportunities in the form of business Caroline McGrath (Student-at-Law, Blake, with stable cash flows that are designed Cassels & Graydon LLP), who assisted in the to pay regular dividends. In addition, the preparation of this article.
www.financierworldwide.com | FW 215 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g New rules of the game in Canadian antitrust
by Subrata Bhattacharjee
A recent ruling of the Canadian Federal guidance as to the length of time it will Court of Appeal suggests that the antitrust require to perform its substantive analysis review of mergers in Canada may be subject of a transaction, notwithstanding the to new rules of the game, in which parties in waiting periods. Notifiable transactions some cases may seek to close transactions are classified by the Bureau as being non- more aggressively than in the past. The complex, complex or very complex, with decision in Commissioner of Competition maximum service standard for completion v. Labatt Brewing Company Limited (2007 of its substantive analysis of 14 days, 10 Comp. Trib 9; aff’d 2008 FCA 22.) may weeks and five months, respectively. As make it more difficult for the Canadian can be seen, other than for non-complex Competition Bureau to seek temporary transactions the service standard is much orders to stop parties from proceeding longer than the statutory waiting period. with a merger after the expiration of waiting period contained in the Canadian This ‘disconnect’ between the statutory Competition Act. waiting period and the service standard period leads to situations where the parties Canadian merger review are permitted to close by statute but the Bureau has not completed its review. The Canadian merger review regime Notwithstanding that the parties in such a requires parties to transactions that exceed situation are legally entitled to close (and certain financial thresholds to notify the be subject to any post-closing remedies Bureau prior to completing the transaction. the Bureau deems necessary) many parties Following notification, the parties must choose to wait for the Bureau’s review observe statutory waiting periods. It is before they complete a transaction. This a criminal offence to close a transaction is largely because the Commissioner of prior to the expiration of the applicable Competition has the power to ask the waiting period. These waiting periods are Competition Tribunal to issue an interim dependent on the form of filing chosen by order under section 100 of the Act, the parties, being either 14 days for ‘short- preventing the parties from closing until form’ filings, or 42 days for ‘long-form’ the review is complete. It was customarily filings. thought that the standard for securing such relief was relatively low. However, the result The Bureau has taken the position that in Labatt may have altered this belief. in some cases (in particular, complex and very complex cases), it requires more The Tribunal’s decision in Labatt time to review mergers than provided in the waiting periods. The Bureau has In early 2007, Labatt Brewing Company, one issued service standards which provide of Canada’s largest brewers, announced its
216 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS proposed acquisition of Lakeport Brewing, until after its substantive review was a smaller niche brewer. The parties complete and refused to agree to Labatt’s expected the transaction to close at the end proposal. of March, 2007.
The Bureau classified the transaction as ‘very complex’, subjecting it to a service standard of five months. However, the Bureau had a statutory obligation to complete the review in 42 days (as the In Canada, merger remedies only have to restore parties used a long form notification) failing competition to the point there is no substantial which the parties were entitled to close lessening of competition as a result of the merger. the transaction unless the Tribunal issued a section 100 Order.
Initially, Labatt planned to close the transaction after the expiration of the 42 waiting period. Labatt apparently With the Commissioner firm in her stance feared that if the deal was not closed in that a hold separate arrangement would a timely manner, other competing bids not be consented to, and with Labatt could have been made for Lakeport, uninterested in allowing the transaction with the possibility that Labatt would to remain outstanding for the five-month lose the acquisition. Court filings suggest service standard period for very complex that Labatt had lost a target in an earlier transactions, Labatt and Lakeport decided transaction, when, during a lengthy review to exercise their statutory right to close the by the Bureau, Sleeman Breweries was transaction at the end of the 42 day waiting snatched away by a rival. period. They were met with an application from the Commissioner seeking a section It became clear in its review of the Labatt/ 100 Order from the Tribunal to prevent the Lakeport deal, however, that the Bureau brewers from closing or taking steps to would not be able to complete its review close the deal for 30 days. within the 42 day period. Labatt offered to enter into a consent agreement with the The Tribunal surprised observers by Commissioner, allowing the transaction to dismissing the Commissioner’s application. close into a hold separate arrangement in The Tribunal noted that any merger remedy which Labatt and Lakeport would be kept ordered by the Tribunal (in the event of under different management and run as a contested transaction) did not need to two separate corporations until the Bureau restore the pre-merger situation (as in the completed its review. US). Rather, in Canada, merger remedies only have to restore competition to the While the Bureau historically permitted point there is no substantial lessening parties to close into hold-separate of competition as a result of the merger. arrangements, just prior to the Labatt This result is typically obtained through transaction the Bureau issued guidelines structural remedies such as divestiture. The stating it would not consider hold separates Tribunal found that the Commissioner had www.financierworldwide.com | FW 217 INTERNATIONAL MERGERS & ACQUISITIONS 2008 failed to address how these post-merger a section 100 Order as a rubber stamp, remedies could not be implemented as a thereby emboldening merging parties to result of closing. insist that review be conducted closer to the statutory waiting periods. Though this The Commissioner appealed the Tribunal’s may not be as significant in the context ruling, but the Federal Court of Appeal of multi-jurisdictional deals, where other dismissed the appeal without even hearing jurisdictional waiting periods may be the argument of the brewers, delivering longer, for purely domestic deals, Labatt its judgement after submissions by the sets the stage for a more aggressive Commissioner’s counsel. approach to merger review.
Implications
The decision in Labatt confirms that the Subrata Bhattacharjee is a partner at Bureau cannot look at the issuance of Heenan Blaikie LLP.
218 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Canada’s foreign investment review process
by Subrata Bhattacharjee
Recent developments suggest that none of which explicitly refer to the state the landscape for foreign investment affiliation of the investor or to national review in Canada is changing in a manner security. The Guidelines do not alter these consistent with trends in other G8 nations. factors, or amend the ICA; however, they Responding, perhaps, to a number of clarify what the Minister should consider high-profile transactions, some of which when applying the factors in reviews of involved state-owned enterprises (SOEs), investments by SOEs. the Federal Government has now: (i) issued new guidelines for foreign investments In particular, the Guidelines suggest the by SOEs; (ii) announced its intention to following as being relevant. First, the SOE’s institute a ‘national security’ screening adherence to Canadian laws, practices, mechanism for foreign investments; and and standards of corporate governance, (iii) asked a blue-ribbon Competition Policy including commitments to transparency Review Panel to review federal policies and disclosure, independent members of relating to competitiveness, including the board of directors, independent audit foreign investment regulation. committees and equitable treatment of shareholders. Second, the nature of and Guidelines for foreign investments by extent to which the SOE is controlled by state-owned entities a foreign government. Third, whether the acquired Canadian business will On 7 December 2007, the Minister of continue to operate on a commercial basis Industry announced new guidelines regarding: where to export; where to applicable to foreign investments by process; how Canadians participate in its SOEs. The Guidelines were issued under operations; how ongoing innovation and the Investment Canada Act, R.S.C. 1985, R&D is supported; and what level of capital I-21.8 (ICA), which is the statute containing expenditures is appropriate to ensure global Canada’s foreign investment review regime. competitiveness. Pursuant to the ICA, if a foreign investor proposes to acquire control of a Canadian The Guidelines suggest that foreign business, and the asset value of the businesses should submit specific Canadian business exceeds certain financial undertakings to IRB in support of a thresholds, the investment is subject to proposed transaction. Examples of possible review by the Investment Review Branch undertakings include: (i) appointing (IRB) and the Minister must determine that Canadians as independent directors on the the investment is of ‘net benefit’ to Canada board of directors; (ii) employing Canadians before it can proceed. In assessing whether in senior management positions; (iii) an investment is of ‘net benefit’ to Canada, incorporating the new business in Canada; the Minister examines six economic factors, and (iv) listing the shares of the acquiring www.financierworldwide.com | FW 219 INTERNATIONAL MERGERS & ACQUISITIONS 2008
company or the Canadian business on a continue to attract foreign investment that Canadian stock exchange. benefits Canada.”
The Guidelines essentially confirm the The Guidelines will likely be based on approach taken under the ICA in previous the tests currently in place in other reviews involving investments by SOEs. G8 countries, such as France, which Although SOEs will have to satisfy the requires foreign investments in specific Minister’s concerns regarding corporate sectors (defence, security, weapons governance, commercial objectives and and ammunition) to be formally the extent and nature of state control, the approved by the French Treasury prior to Guidelines do not otherwise restrict the implementation. As well, they will likely scope of possible investments. be sufficiently narrow in scope to prevent against protectionist pressures, since the previous national security test proposed by the government was met with significant opposition due to its vague definition of national security and the resulting amount The government has established a committee of discretion granted to the Cabinet with to develop guidelines for a national security test respect to allowing transactions subject to such review to proceed. that will apply to foreign investors, and plans to announce the guidelines by mid-2008. The competition policy review panel
The Panel’s mandate is, in part, to recommend changes to the ICA in order to ensure that Canada will continue to attract National security test foreign investment and that Canadian businesses will invest both domestically On 9 October 2007, the Minister and internationally. To this end, on 30 announced that the government would October 2007, the Panel produced a consider how best to respond to national consultation paper, ‘Sharpening Canada’s security concerns in the context of Competitive Edge’, which poses a number investments by foreign investors. The of questions. The Panel invited interested government has established a committee parties to provide written submissions on to develop guidelines for a national the questions, which would help inform the security test that will apply to foreign recommendations that it aims to present by investors, and plans to announce the 30 June 2008. guidelines by mid-2008. In a January 2008 article in The Globe and Mail, the Minister The Panel is considering two issues stated that “[t]hese new guidelines will particularly relevant for foreign investors in no way create obstacles or signal any contemplating acquisitions in Canada, change in the government’s openness though much of its mandate in this regard to foreign investment in Canada…Their has been superseded by the release of the intention is in fact to provide clarity to Guidelines and the announcement of the investors around the world so that we can intention to institute a national security
220 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS screening mechanism. First, the Panel for a proposed transaction to be viewed is examining the question of whether as a ‘net benefit’ to Canada. It also seeks a purported increase in acquisitions of to ensure that foreign investors fulfill any Canadian businesses by foreign companies undertakings that they make. Finally, it has resulted in what the media has intends to examine the issue of reciprocity commonly described as a ‘hollowing in connection with acquisitions of Canadian out’ of Corporate Canada. In particular, it enterprises by foreign businesses based in has asked interested parties to consider jurisdictions in which a Canadian enterprise the importance of the following factors cannot make a corresponding acquisition. on Canada’s economic prospects and ability to create jobs and opportunities The Panel’s recommendations will likely for Canadians: (i) domestic control and introduce practical and constructive ownership of Canadian business activities; changes to the ICA that will increase the and (ii) company headquarters and global clarity of the Investment Canada review divisional head offices. process and the net benefit test, as well as increase the degree of certainty with which Second, the Panel is also examining the foreign investors can approach the process. net benefit test under the ICA. It intends to address concerns regarding the lack of predictability in how the test is applied and Subrata Bhattacharjee is a partner at what combination of factors is required Heenan Blaikie LLP.
www.financierworldwide.com | FW 221 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g New developments spur M&A growth in Latin America
by Amauri Costa
For the past few years, Latin American economic stability. These initiatives, countries have seen a high level of M&A coupled with improvements in their legal activity. According to some statistics, the systems, have helped raise the confidence value of Latin American M&A transactions of business investors, particularly those approached $110bn in 2007, with more than from other parts of the world. Peru 40 percent of acquiring companies based and Mexico, for example, are pursuing outside the region. Acquisition targets responsible fiscal policies and economic range from small family owned businesses liberalisation efforts, and even Argentina, to major corporations, all in a wide range of which had many problems early in the industry sectors – with industrial, energy, decade, has a much improved business transportation and logistics, technology climate. Brazil has stayed the course of and telecommunications being among the the last decade’s economic advances since business areas with most activity. controlling its rampant inflation, and the country hopes to achieve ‘investment Although the global tightening of liquidity grade’ status soon. can be expected to slow M&A activity somewhat, Latin America appears well Improvements in legal systems positioned for cross-border and domestic market business combinations to continue As companies seek market expansion expanding because of several fundamental beyond their original borders, they also factors. Many countries in the region have help influence developments in the local established a perception of political and legal systems. This phenomenon has not economic stability that provides a strong been different in Latin America, where foundation for investment. These countries the influence of the common law systems have also taken steps to modernise their (particularly from the US) is very strong. legal systems, seeking to create additional This influence has been greatest in the confidence in local institutions and reduce areas of corporate governance laws and the burden on foreign investors. In addition, commercial finance regulations. some of the challenges still presented to countries in the region (e.g., shortage of Corporate governance. As part of their natural gas) may offer opportunities to spur effort to attract and maintain foreign investment activity. investments, many Latin American countries – including the two largest Economic advancement economies in the region, Mexico and Brazil – have updated or are in the process of With a few notable exceptions, the updating their corporate laws and have countries of Latin America have largely implemented other rules to modernise and made the commitment to political and strengthen their capital markets.
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Brazil’s ‘Novo Mercado’ Program, and perfection of security interests. Those implemented by the country’s securities innovations include a more frequent use regulatory agency – CVM – has created of trusts, express permission to create more transparency and professionalism in floating charges, or other mechanisms corporate governance for publicly-traded allowing more effective pledges of accounts companies in Brazil. Companies following receivables. Most of these secured its rules benefit from improved treatment transaction concepts, or their different of their minority shareholders and enjoy applications, are not typical for countries better overall market acceptance. As with a civil law tradition. a consequence of this strengthening of Brazil’s capital markets, the country Laws in Mexico, for example, now validate witnessed an explosive growth in the the concept of floating liens. In addition, volume of IPOs in 2006, followed by both Mexico and Honduras have instituted healthy numbers in 2007. These publicly legal reforms that make possible the traded companies have used a large creation of trust estates to secure a loan, portion of the proceeds of such IPOs and this alternative is used in long term to fuel expansion, either organically or and/or large transactions (e.g., aircraft through acquisitions. In some cases, the finance). Brazil has not yet adopted the M&A activity has also crossed borders to trust concept, but its new Civil Code has other countries in the region or even in the made it easier to create floating liens Northern hemisphere, a trend that should on accounts receivable without the continue in the near future. Keeping pace burdensome requirements of the previous with the need for continued improvement, law. Brazil has recently introduced additional updates to its corporate laws, bringing It is important to note that Latin American reporting requirements more in line with countries are not abandoning fundamental internationally adopted standards. civil law concepts. Rather, they are modifying them to incorporate some Mexico is currently studying changes to its concepts existing in the legal systems corporate laws also addressing corporate of other countries. While some of the governance pitfalls still encountered in the modifications have not been fully tested country’s laws. Mexico is also seeking to in court, they have helped boost lending strengthen its domestic capital markets, activity in countries like Mexico, Brazil, currently the second largest in Latin and those in Central America and present America. good opportunities for additional cross- border credit facilities. This is particularly Credit transactions. Along with an true for transactions involving international improved environment for capital markets commercial banks, giving acquiring activity, countries in Latin America have companies access to a much wider range of strengthened and modernised laws credit facilities. affecting commercial lending activity. In recent years, a number of jurisdictions in Brazil has also revised its bankruptcy code Latin America have provided enhanced with the goal of improving the chance of support for commercial lending by recovery for insolvent companies seeking updating their laws governing creation court protection. In this case as well, Brazil www.financierworldwide.com | FW 223 INTERNATIONAL MERGERS & ACQUISITIONS 2008 looked to other countries’ experience competition laws or regulated industries) when preparing its new bankruptcy code, for the licence-holder’s change of control although it is still too early to feel confident is mandatory. Acquisitions that involve real about the application of the law by Brazilian estate can pose a different set of issues; courts. countries such as Guatemala prohibit foreign investor ownership of land, while in Remaining challenges Brazil, foreign land ownership may require prior government approval or a carefully Despite advances in the legal systems considered structure. in Latin America, a foreign investor will still face many challenges. This often means that acquiring companies should spend additional time structuring the transaction and negotiating agreements to ensure that all parties are in accord. For Despite advances in the legal systems in Latin instance, representations and warranties and legal opinions relied upon in common America, a foreign investor will still face many law countries can cause a great deal challenges. of confusion in Latin America. As the enforceability of representations and warranties has not been extensively tested in local courts in Latin America, it is safer for the acquirer to rely on a thorough due diligence rather than contractual Potential opportunities representations and warranties. Looking ahead, it is likely that the regional In addition, acquiring companies can still energy sector will continue to be a primary expect some level of bureaucracy to obtain focus of M&A deals. One example is the necessary regulatory approvals for renewable energy in Brazil. In the past acquisitions in Latin America. While the few years, the government has sponsored degree of transparency in the application various incentives and policy initiatives process, the sophistication of the regulator to spur the growth of alternative energy and procedural complexity may vary from sources. The increased oil prices and the one country to another, the approval world’s search for alternative energy process throughout Latin America can pose sources has also created a favourable a considerable challenge, and delays are environment for the unprecedented common. development of the ethanol industry, attracting acquisition capital from both The energy sector provides a good foreign and domestic investors (including example. Many developers have sought as a result of the increased IPO activity to acquire interests in energy companies mentioned above). In 2007, Brazil saw already holding licenses and permits. an intense level of M&A activity that is However, in countries such as Brazil, prior anticipated to continue in 2008. Other approval from one or more governmental countries, such as Peru, are considering agencies (such as those that regulate their own incentive programs to foster
224 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS growth of their renewable energy sector. direction of the region is toward fuller integration in the global economic system, Ironically, the recent announcement of and greater political and economic record-breaking oil and gas reserves in liberalisation (with a few exceptions). Brazil and last year’s shortage of natural gas Today, Latin America represents an in Argentina and Chile may also contribute excellent example of how a developing to growth of M&A activity in the region. region can transform itself to make possible a level of business expansion that is poised Challenge and potential to take full advantage of its vast potential.
Latin American economies are highly diverse, and each country faces many Amauri Costa is a partner at Bracewell & economic challenges. But the overall Giuliani.
www.financierworldwide.com | FW 225 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g New incentives for investing in private equity in Chile
by Eduardo de la Maza
After publication of the so called ‘Second There is also a tax benefit for those that Capital Market Reform’ on 5 July 2007, have previously been shareholders of investors and investment managers have companies in which the abovementioned good reason to celebrate. The reform funds have acquired shares for an amount amended the banking law, the insurance greater than 25 percent of the total capital, law and the securities market law. It also permitting these other shareholders to addressed the subordination of debts and consider as the cost of their shares for the custody of securities and pledges. taxation purposes the highest price paid Further, it introduced significant measures by one of these funds in the most recent to promote investment in private equity placement of shares of the respective by way of investment funds, an area which company, in order to reduce the taxable currently represents only 3.6 percent of capital gain. the total portfolio of Chile’s investment funds, with investments that amounted to New forms of finance US$167m in 2006. The capital markets reform also Tax benefits contemplates other promotion measures, such as authorising banks to invest up to One of the main incentives is tax exempt 1 percent of their assets in venture capital income received by contributors to and private equity. This could inject more investment funds registered before the than $1.5bn into the asset class. securities market regulatory authority. This benefit only applies to income obtained In addition, the reform introduced by the fund through the sale of shares of measures aimed at enhancing the role of companies that do not trade on a stock the state agency CORFO, an organisation exchange. To access this benefit, the created in 1939 to contribute to economic total assets of the fund must be destined development and growth. It currently exclusively to investment in stock portfolios concentrates on the promotion of and debt issued by companies that comply competitiveness and innovation of private with a number of requirements, including: companies, especially small and medium (i) it has been constituted within seven size companies, which annually receive years prior to the investment; (ii) it carries from CORFO close to $127m in loans placed out its activities mainly in Chile; (iii) it has a through the private banking system and net annual income of less than $17m; and close to $81m in financial assistance. (iv) it is not involved in the real estate or investment markets, utilities, roads or other Currently CORFO performs an important concessions. role in private equity, providing lines of finance to funds that make capital
226 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS contributions or grant loans to small and in companies whose shares will be medium size companies that are in their acquired by the funds, the program will creation or expansion phases, and whose establish the obligation to agree upon equity is less than $4.2m at the time of the shareholder agreements that consider first fund investment. These credit lines an active participation of the fund in the are bullet loans, with up to 15 year terms, financial, administrative and commercial and may be expressed in local currency management of such companies, in or US dollars, for an amount between addition to mechanisms of takeover by the $1.5m and $17m. They generally permit fund in certain critical situations. leverage of up to two times the amount of the contributions paid and committed to As CORFO authorities have indicated, the the respective fund. The interest rates are program will contemplate call options favourable: 2 percent as the base rate in in favour of private contributors of the local currency (the current interest rate of funds in which the institution invests. notes issued by the Chilean Central Bank It will permit them to purchase, from a being 2.6 percent) and LIBOR as the base determined term, the fund’s shares owned rate for loans in dollars, considering in by CORFO, at a price that includes an both cases an additional interest rate of 3 implied interest rate dependant upon the percent if the earnings obtained from the focus of the fund, which may even reach financed fund exceeds this figure. zero in the case of specific areas that are being incentivised. The reform establishes a new system that will permit CORFO to be a contributor in In this way, the private contributors of private equity funds, through a program funds may receive the full benefit of upside that is scheduled to be implemented in earnings, ultimately transforming the March 2008. The program will consider a contribution of CORFO into a type of loan. total amount of up to $150m that may be increased by the Ministry of Finance up to a We are certain that the existence of this total of $260m. tool will constitute a strong incentive for the participation of private investors The contributions of CORFO may be made in these types of funds, as for them it in funds that invest in shares of closed distributes the value created by the fund in corporations that comply with same an optimal manner. requirements referred to above in respect of the tax benefit and may represent up to 40 percent of the total capital of the fund. Eduardo de la Maza is an associate at Grasty To strengthen the effect of investments Quintana Majlis & Cía.
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CHAPTER eleven: Regional view – Europe
228 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Managing pan-European transactions for US buyers
by Robin Johnson
In May 2007 the world of M&A was such strong, the actual role of the lawyer was that credit was cheap and financial becoming almost meaningless. engineering had gone beyond the furthest imagined process. In one deal, no interest But today, strategics are back in town. at all was payable on debt – it was all rolled Financial buyers now have to compete up in PIK (payment in kind) instruments against synergistic benefits and cannot for five years. Leverage was at all time simply rely on cheap credit. Deals that highs, synergies counted for little and every closed as recently as the summer are day secondary, tertiary or even quarterly already being renegotiated. A number institutional buyouts were taking place. of financial buyers, however, had agreed such limited covenants that some deals A seller could dictate all the deal terms, can only be renegotiated in the case of as well as impose ridiculous timetables. a major event of default due to the lack Acting for the seller, a legal representative of financial covenants that were put into could insist upon limited due diligence, deals. Banks and financial institutions, as general disclosure and limited warranties. well as strategic buyers, are insisting upon For example, in one deal, two financial focused due diligence. The role of vendor buyers were happy to sign the first draft of due diligence remains important, as vendor a vendor friendly auction process sale and financial due diligence reports, as well as purchase agreement provided they were updates, are being sought, and detailed given exclusivity. One financial institution reviews are taking place. A proper balance said they felt they could do away with between risk for the purchaser and reward external lawyers and could just have an for the seller is being put in place and deals internal lawyer to double check the drafts now have realistic timetables. This does that had been produced by bank’s lawyers, not mean that lawyers can simply go back seller’s lawyers, etc. The same institution to increasing fees but it does mean that said it was happy to rely upon vendor the role of a lawyer in deals is now being financial due diligence; a vendor having recognised again. commissioned an accountant to produce a longform report on the business, even It seems there were a number of deals though typically an accountant limits their done in the early part of 2007 which could liability to a buyer. cost general partners a significant amount of money and which bankers would be The role of the M&A lawyer both on the embarrassed about by mid 2008. While sell-side and the buy-side seemed to be there will be a role for PIK deals, these will limited to doing the basic commoditised only now become more appropriate on formalisation of a stock transfer form or lower leverage; quasi equity instruments transfer of assets. While deal flow was deals. The following top ten issues are www.financierworldwide.com | FW 229 INTERNATIONAL MERGERS & ACQUISITIONS 2008 arguably the most important to be Third, process and timetable. Scoping addressed on a European transaction if the due diligence is vital. Europeans hate purchaser is based in the US. duplication of due diligence from different vendors. Agreeing and scoping upfront First, culture, culture, culture. Can an and spending some time with each acquisition be managed from 4000 miles provider is key. Having a central point away? Do not underestimate the difference of contact at the buyer who coordinates in lifestyle approach, social protection and everything and avoids duplication is a history. Job security is often key in Europe vital role. The seller needs to have control, and the entrepreneurial spirit is not as proper communication, proper reporting live as it is in the US. A number of Eastern structures and time must be built in to European assets have been acquired from reflect the distance between travel and state-owned businesses as recently as 10 time zones involved. The need for physical years ago. The culture of social protection meetings must not be underestimated, as – the culture of the state providing for all – this could take three days out of a week, remains alive in a number of key European and the disproportionate amount of time territories. and energy that will be expended compared to a domestic deal. Dealing with ‘other Second, while more typical US style jobs’ could become difficult and there are agreements are getting more recognised higher costs associated with travel and in Europe the difference in transactional management compared to a domestic deal. documentation approaches must be understood. There is a lack of litigation Fourth, in a structured way, do not be post-deal. This does not mean due diligence afraid to ‘due diligence to death’ to replace was done better, but it means that settling contractual comfort. Use due diligence matters out of court and in a ‘handshake as part of the integration plan. Do not way’ is more prevalent in Europe. Escrows underestimate the value of vendor financial or holdbacks have become commonly or legal due diligence. Rely upon it, use it, accepted to deal with issues that arise out update it, comment on it. Use due diligence of due diligence but unlimited indemnities as part of integration. Integration together, are rare. Most European deals have closing with cultural issues, is key to the success of balance accounts dealing with net working a European M&A deal from a US buyer. capital and debt, and a lot of Europeans see this as a way of settling warranty Fifth, antitrust is a big issue in Europe. and indemnity claims such as through Build enough time into the project plan completion accounts mechanism. There to assess antitrust. Each EU jurisdiction are too many deals which completed more has different rules on antitrust, so do not than a year ago where completion accounts assume that a ‘one-stop shop’ in Brussels have not been settled. Finally, the approach is an easy solution. Most Europeans do not to disclosure is very different. While specific understand the need for good compliance disclosures are included there is a general going forward. If they have not been acceptance in Europe that the buyer exposed to a US purchaser before, their has to acknowledge general disclosure compliance policies, particularly in relation of information provided to it during the to antitrust and FCPA, will be completely disclosure process. inadequate for a US buyer’s purposes.
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Sixth, taxation. Buyers should look at early uncommon to discover six months down structuring of deals to create a tax efficient the line that a key integration cost has basis. There is no equivalent of the 338 in been underestimated. Businesses that are Europe. A mixture of asset deals and stock required to become ‘standalone’ upon sale deals should be considered. In addition, – leaving behind a group and its licences, transaction costs associated with the permits, consents, real estate, IT and deal, notary fees and stamp duty should share of pension costs – should address not be underestimated; these often come long term structural issues upfront as they as a surprise to a US purchaser. How are cannot be dealt with through the S&PA. future profits repatriated? This may not be straightforward as there may be local Ninth, taking security on a leveraged deal withholding taxes. In Europe, transfer is not as straightforward as it is in the US. pricing has become a hot topic when selling There are rules against targets granting businesses out of a group. Also, do not security, often called financial assistance. underestimate the tax cost of stock options, There are registration costs associated with which may be terminated on a sale. taking security and other tax and there are antiquated processes about registering Seventh, most US buyers do not security, which often take time to put in understand labour and social law place. protections that are in place. Europe has wide social legislation and most companies Tenth, establishing compliance processes will have works counsels or unions. There is post-deal needs to be worked on no single European law. On the whole, this immediately. Preventative and proactive issue needs to be addressed on a country legal care is the only way an acquisition by country basis. Compliance programs can be properly managed. Getting in relation to labour law should not be immediate buy-in to a compliance ethos underestimated. This could be in relation to – from a cultural perspective – is key. Few data privacy, whistle blowing and a general European organisations with a US arm have need to ensure that what is trying to be compliance structures that are as robust as imposed through US exterritorial reach can a US company. work in Europe.
Eighth, separation issues need to be Robin Johnson is a corporate partner at planned early in the sale process. It is not Eversheds.
www.financierworldwide.com | FW 231 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Glimmers of optimism: better times ahead for the UK M&A market
by Matthew Middleditch
Unlike liquidity, bad news about the M&A raising financing, even though its bid came market is in plentiful supply. Deal volumes in July as the markets were beginning to sank to their lowest level in four years experience extensive volatility. It raised during the first quarter of 2008 as the credit a record breaking $40bn to fund the squeeze slammed the brakes on private takeover: the largest loan raised by a UK- equity and corporate chief executives kept listed company, according to Dealogic, potential deals in check. and a bold move that created the largest aluminium producer in the world. A year ago it was a different story. During the first half of 2007 a deal boom, fuelled by Material changes easy credit, was in full-swing. This came to an end in late June and during the second So what has changed in the M&A market? half of the year credit came at a premium There is still no consensus on whether we following the rapid constriction in the debt will see a hard or soft landing for leveraged markets. M&A, but there are signs that the price expectations of corporate sellers are lower One year on from the peak, it is clear that than they were before the credit markets tight credit conditions are continuing experienced difficulties and that debt to constrict the M&A market. With US multiples are lower. economic woes spreading across the globe, and credit markets showing little sign of In the US market there are some high a recovery, headline-grabbing deals seem profile examples of investors pulling away likely to stay muted throughout 2008. from deals. KKR and Goldman walked The conditions that have provoked a rapid away from their $8bn deal to buy audio slowdown in UK M&A deal volume are and electronics manufacturer Harman unlikely to improve significantly before the International, claiming that a material third quarter of 2008. adverse change (MAC) gave them a contractual excuse not to buy the company. While the big ticket line has gone quiet, This scenario remains exceptional outside there have been exceptions in the last the US, largely because UK sellers expect six months. RBS sold Southern Water in to see ‘certain funds commitments’ on October 2007 for £4.2bn to a consortium their buyer’s financing and have been of JPM Asset Management and Australia’s reluctant to agree MAC wording in their Challenger Fund. Furthermore, Rio Tinto’s sale contracts. bid for Canadian aluminium producer Alcan proved that the credit squeeze will not However, we foresee that this situation prevent mega-deals, as long as conditions might change for two reasons. First, as the are right. Rio Tinto did not have problems seller’s market disappears, buyers will look
232 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS for more ‘outs’ in their purchase contracts. regard this as a buyers’ market where Second, banks are now looking more they can unlock opportunities previously closely at any conditionality in the sales unavailable to them at reasonable terms. contracts to allow them to get out. There are plenty of cash-rich FTSE However, there is plenty of motivation – companies that are eyeing potential aside from hefty break fees – to see deals acquisitions at the moment while prices through, including the need to put money are affordable. Many of their targets’ share to work, guarding hard-won reputations prices are depressed, so this year is likely to and the danger of legal action if parties pull see some knockdown bidding. out.
Terms of deals
The terms of M&A deals remain broadly the same now as before the credit squeeze. But There are plenty of cash-rich FTSE companies who for acquirers needing leveraged finance, the covenants and terms are stricter. are eyeing potential acquisitions at the moment while prices are affordable. The days of ready access to private equity’s favourite investment tools such as cov-lites, equity bridges and PIK notes are over. In this sense, we have shifted from sponsor- friendly terms to a renewal of tensions between sponsors and lending banks. This Sovereign wealth funds are also starting looks set to continue for some time. to pick up some of the slack in the market. These funds began to make inroads into the Another significant shift is that we are M&A space and established themselves as a seeing more equity inserted into deals. major market force during the first quarter of 2007 with investments that, at a total of Picking up the slack $25bn globally, reached nearly half the size of the global volume registered by private Although the honeymoon is over for easy equity investors. SWFs are still expected to liquidity, this does not mean that M&A will play a key role in UK deals this year. dry up. While private equity dominated the market in 2006 and the first two quarters The number of infrastructure funds in the of 2007, there is now more appetite from UK market has also expanded and they are trade buyers who face less competition playing a stronger role in M&A. Over the from the large buyout houses. last few years, funds entering the UK and European market have raised in excess of Thus, a tricky market for some creates £16bn in new equity capital, according to advantages for others. We should see Deloitte. corporates looking to maximise these opportunities in the coming year. Big-cap Where else should we expect activity? companies are still eager to invest and Many predict consolidation in the banking www.financierworldwide.com | FW 233 INTERNATIONAL MERGERS & ACQUISITIONS 2008 sector, particularly among the second and is what will follow the correction of 2007/08. third tier. The drivers for this are greater difficulties in accessing capital and the Smaller deals are still being done in the UK ongoing effects of Basel II requirements, and the bankers and lawyers are still very which impose rigorous risk and capital busy, particularly with deals in the media management requirements on lending and and infrastructure sectors. Stable cash flow investment practices. The rules mean that businesses such as these remain attractive some banks need greater sums of capital to targets and there is no shortage of safeguard their solvency, making mergers corporates, or even private equity houses, attractive. with war chests of cash to invest. It is access to debt that poses the problem. Cautiously optimistic Deals are still out there and innovative deal The full effects of the crunch remain unclear doers will ensure that the credit crunch but we are optimistic for 2008 and beyond. does not kill the M&A market. The world economy remains essentially strong and many opportunities for dealmakers remain. The correction in 1998 was followed by very strong M&A activity in Matthew Middleditch is a global co-head of the following two years, and we believe this M&A at Linklaters.
234 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g The German M&A and private equity market
by Frank Becker and Dr. Jörn Schnigula
2007 was not a homogeneous year in the and Macquarie’s acquisition of Techem German M&A and private equity market. for €1.5bn. This compared to eight buyouts During the first half, it looked like another in the first half of 2007 and eight in the record breaker with a total value of second half of 2006. disclosed buyout transactions of €20.7bn, according to an Ernst & Young study. The Though it seemed that small and mid cap first multibillion takeover of a listed German deals were less affected by this market company, foreshadowed by rumours of a break, statistics published by Ernst & Young bid from a consortium led by Bain Capital, showed a decrease in the number of buyout did not seem far away. deals in the second half 2007 compared to the first half for all categories – except Some €1bn-plus transactions took for deal values between €500m and €1bn. place, such as Siemens’ sale of its VDO Interestingly, the value of M&A transactions division to Continental for €11.4bn, the actually increased in the second half of 2007 largest German transaction in 2007, the to more than €35bn, and reached its highest acquisition of Depfa Bank by Hypo Real peak compared to previous years, partly Estate for €5.7bn, Blackstone’s purchase driven by the huge VDO deal. There were of Klöckner Pentaplast for €1.3bn and the 686 M&A transactions involving a German sale of ProSiebenSat.1 to KKR and Permira company in the second half of 2007, for €3.1bn. Such transactions were also compared to 428 in the first half of the year, facilitated by the average debt to EBITDA according to figures from VC-facts. ratio for leveraged buyouts rising from 4.2 in 2002 to a record high of 5.7 in the first The emphasis among industry sectors quarter 2007, as shown in the Ernst & Young did not change much. The highest buyout study. activity took place in real estate, industrial, services and consumer, with the first two But in August 2007, the credit crunch, defending their places from 2006. initiated by the subprime-mortgage market crisis in the US, hit Germany. Suddenly, Shortly before the subprime crisis spread to obtaining bank financing became much Germany, financing conditions for financial more difficult. Some banks even closed investors were arguably more favourable books for the rest of the year and debt to than ever before. Debt to EBITDA multiples EBITDA ratios declined. Consequently, in reached record levels. Banks had sufficient the second half of 2007, the total value of liquidity, were highly competitive and able buyouts fell to its lowest level since 2003. to quickly syndicate loans. Covenant-lite Only two additional buyouts over €1bn agreements developed, limiting or even took place in Germany: CVC’s acquisition excluding lenders’ rights to accelerate of Dywidag Systems International for €1bn debt as a result of a borrower’s default. www.financierworldwide.com | FW 235 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Such provisions disappeared immediately sector, including the potential sale or when the crisis broke – debt to EBITDA mergers of Deutsche Postbank, Dresdner multiples were cut back by 1-2 points to Bank and Commerzbank. Furthermore, due match 2006 levels, and syndication became to lower purchase prices, strategic buyers more difficult if not impossible, resulting are expected to increase their presence in huge loan backlogs which strained in the M&A market. Also, private equity banks’ balance sheets. The psychological players willing to invest more equity in effects were probably greater, as market their deals and work with lower leverage uncertainty made banks reluctant to grant levels are likely to find interesting targets financing even on moderate terms. This at an attractive price. In addition, foreign primarily concerned mega transactions, but state funds are predicted to invest further also increasingly affected mid-cap deals. in the German market, following on from previous deals such as Dubai International This downswing continued in the beginning Capital’s buyout of Mauser-Werke. One of of 2008, with the volume of M&A the industry sectors expected to be active transactions in Germany reaching an eight- in 2008 is real estate – in particular, listed year low of €4.1bn during the first quarter, real estate. One reason is that shares of compared to €15bn in 2007, according to companies like IVG are traded at a discount Thomson Financial. EBITDA multiples – the compared to their net asset value. Another most common method used to calculate reason is that rents are expected to rise in enterprise values in buyout transactions – Germany during this year and next. are widely expected to fall further due to lower debt to EBITDA multiples. Moreover, it is widely assumed (in the absence of concrete data) that the number Nevertheless, the outlook for 2008 of distressed or nearly-distressed situations in Germany is more ambiguous than will increase, especially of buyout targets. pessimistic. The biggest problems seem According to market rumours, even the to be the banks’ financial situation, as senior debt of larger buyouts often trades nobody seems able to assess which risks far below 100 percent. Of course, not all of are still hidden in their balance sheets, and these companies will become insolvent, but the general economy, which is about to financial restructurings, sales of distressed weaken on fears of a recession (although companies or their debt, or the need to in March, the German business cycle index, inject further equity may occur more Ifo climate, reached its highest level since frequently. This is particularly likely given August 2007). Apart from buyout investors the pessimistic prospects for the buyout facing difficulties on the financing side, and market. The trend is underlined by the fact sellers facing lower sale prices, public M&A that around €24bn is currently being raised transactions will struggle in the wake of for distressed debt funds, according to lower share prices and fears of a decreasing Private Equity Intelligence. Many private stock market. Despite this, fewer financing equity sponsors such as Texas Pacific Group opportunities will make it difficult for and JC Flowers are reportedly building such buyout firms to realise large takeovers of funds, which up to now have been mostly public companies or even (strong) minority smaller, more specialised funds. investments. On the other hand, we may see consolidation in the German banking From a regulatory perspective, there
236 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS are two predominant issues that may regulatory uncertainties surrounding the affect the German transaction market. buyout industry. However, the current First, Germany has lowered its aggregate draft laws only deal with narrowly defined tax rate for corporations (corporation venture capital funds and would be of little income tax and trade tax) from about 40 relevance to the industry as a whole. Due percent to about 30 percent. The positive to criticism, the legislative process has now effect of this is, however, partly offset by been delayed and the final outcome, as well the introduction of a so-called interest as its timing, is unclear. barrier rule, which limits, in general, the amount of interest expenses that are tax Given these conditions, 2008 continues to deductible to 30 percent of the borrower’s be an interesting and rather unpredictable tax adjusted EBITDA. Whether these time for the German M&A and private changes will have a significant effect on equity market. Though it may be far from the German buyout market remains to be a record year, it will definitely not be a seen. In any case, the interest barrier rule standstill period. has made it considerably more difficult to structure highly leveraged transactions in a tax efficient manner. Second, the current government announced quite some time Frank Becker is a partner and Dr Jörn ago its intention to pass a private equity Schnigula is a senior associate at Kirkland & law to deal with many tax and other Ellis International LLP.
www.financierworldwide.com | FW 237 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g The Spanish M&A market: entering a tunnel?
by Fernando Vives
The past 12 months have seen a significant the legislation governing public tender level of activity in the Spanish M&A market, offers (Law 6/2007, of 12 April 2007 and continuing the trend set in recent years. Royal Decree 1066/2007, of 27 July 2007) Nevertheless, a line can be drawn between transposing the thirteenth EU Directive into two periods, marking a turning point and Spanish law. The new regime replaced the coinciding, approximately, with the period prior regime based on intentional tender between March and September 2007, offers with a system based on mandatory and the period from late summer 2007 and total tender offers launched after to the present date. The first period was control is taken up. For such purposes, characterised by intense activity in the ‘control’ has been defined as 30 percent of M&A market, with standout deals such as the voting rights of the target company. Imperial Tobacco’s €14bn tender offer for The new legislation ought to work to the Altadis. advantage of the tender offers market, with the introduction of mechanisms such as the Although the M&A market remained active, possibility of agreeing on a break-up fee of largely due to the closing of deals started up to 1 percent of the total offer value for before the summer, the second period the first offeror, the obligation to disclose reflected a shift in the trend. The subprime equal information to all offerors and the crisis and its spread to the so-called possibility that the first offeror can bring ‘real’ economy brought about significant the tender offer process to a close provided changes in the M&A market. Rather than the existing blind bidding process results to generalise this as a ‘sharp downturn’, in a tie. Moreover, the interplay between it is more accurate to look at some of mandatory tender offers and voluntary the market’s distinguishing features. For tender offers opens the way for fresh example, there was a fall in the number of planning alternatives for deals of this type. highly leveraged, large scale private equity deals, whereas smaller Spanish private Another legislative development was the equity transactions, usually with a debt to introduction the new Antitrust Law (Law equity ratio of less than 50 percent, enjoyed 15/2007, of 3 July 2007), which, among something of a boom. Real estate deals also other changes, revamps the legislation experienced a decline in volume. Volatile applicable to merger control by widening stock market conditions led to a dramatic the concept of ‘concentration’, establishes drop in the number of public offerings, and a simplified procedure for deals less virtually all the transactions planned for the likely to affect competition, and relaxes first quarter of 2008 have ground to a halt. the rules on mandatory notification with suspended effects until the authorities On the legislative front, new legislation was give their clearance. Moreover, the role introduced on 13 August 2007 to amend of the body created under this law, the
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National Antitrust Commission, is further As for the banking industry, crises at a strengthened in scrutinising and overseeing significant number of US and Eurozone these types of transactions. financial institutions will give rise to new opportunities for consolidation and leave Transparency requirements for listed many with no choice but to sell off their companies have also been tackled in industrial investments. greater depth, with the threshold triggering the obligation to notify significant The real estate industry crisis, on the other holdings being lowered to 3 percent from hand, will see a flurry of deals to refinance 5 percent under previous legislation, the debt taken on by groups in recent years. and comprehensive provisions being Sometimes these deals will go hand in hand established to govern the requirements to with mergers, spin-offs and asset sell- provide a breakdown of derivatives which offs. Taking place against the backdrop of can be settled in kind, the underlying insolvency or pre-insolvency proceedings, assets of which are voting shares in listed these deals will undoubtedly become companies. There is little doubt that the a particularly prominent feature in the rationale behind these amendments can coming months. be found, at least in part, in the experience resulting from the procedure followed in On another note, the fall in the share prices the tender offer for Endesa. of many companies will make them a target for tender offers. It should not be forgotten The outlook for the market has been that many hedge funds and private equity considerably affected by a credit crisis that firms had raised their funds just before the looks set to lead to ever harsher credit subprime crisis hit. Such funds will have to conditions and availability. It appears that, be put to use, and the current situation is as things stand, we are still at the mouth of little more than an interlude before prices the tunnel. Nevertheless, we believe this adapt to dearer credit conditions. tunnel will not be as gloomy for the M&A market as some are predicting. Indeed, It does not, therefore, appear that M&A the market will be affected not so much in activity in Spain is set to undergo a drastic terms of the number of transactions but decrease. Rather, cyclical change will rather in the changes to the behaviour of affect the type of deals that are done and the market players and to the nature of the the behavioural patterns of operators. deals. Nonetheless, it will be necessary to wait and see how the financial crisis – the On the one hand, LBO transactions will effects of which we are only just beginning continue to take place, albeit characterised to detect – eventually plays out, before by their smaller average size, lower reaching any conclusions on future trends in leverage ratio and the ‘safe-haven M&A activity. industries’ in which they are carried out, such as food, security or other industries Fernando Vives is a partner at Garrigues, which provide basic goods and services. Abogados y Asesores Tributarios.
www.financierworldwide.com | FW 239 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Trends and prospects for the Spanish M&A legal market
by Christian Hoedl and Javier Ruiz-Cámara
As in other areas of the world, M&A circumstances, decisions were adopted by activity continued to boom in Spain a simple majority of syndicate banks. As a during the first half of 2007. The market further factor, consent was presumed by was dominated during this period by the the lapse of time, yank-the-bank provisions sell-side and its advisers. The result was were increasingly common and mortgages that most, if not all, of the Anglo-Saxon and other liens were replaced by the inventions that favoured the seller in an borrower undertaking to create the security M&A transaction continued to be used interest at a future, potential-default- in Spain. These transactions included related event. As a result, the enforceability auctions that replaced buyer-driven of these undertakings is arguable. This proprietary deals, vendor due diligence is particularly true for insolvencies or exercises aimed at substituting the seller’s bankruptcies. representations and warranties with the liability of the advisers and locked-box After the credit crunch that began in the rather than traditional post-closing net summer of 2007 (which paved the way debt / EBITDA adjustments. for the severe crisis of the Spanish real estate sector), the situation changed As a result of the favourable market rapidly and Spanish involvement in M&A conditions, the first half of 2007 was also activity slowed significantly. Private equity another record year for M&A financing. buyouts have almost entirely vanished. In such a highly competitive market, Large private equity exits have also dried banks were willing to finance an ever up as IPOs and secondary LBOs have increasing multiple of the target EBITDA. been postponed until market conditions In contrast, bank covenants were either improve. Regardless, expectations in the reduced or their enforcement was made mid-market and below remain relatively more difficult. As in most other European sanguine. Market conditions could also jurisdictions, financing became more affect the type of businesses sold as and more stratified. This resulted in an owners hold their top performers for increasing number of senior, mezzanine, later in the business cycle. Acquisition second lien, profit sharing and other finance activities are also much lower as tranches and facilities. Certainty of funds compared to the same period a year ago. was imposed by borrowers and sellers even The mood in the market has changed in private transactions and ratio defaults noticeably in recent months: even the could be cured during the course of several most competitive banks (RBS, HBOS, ING consecutive periods. Representations and and Banesto among others) have become warranties in respect of the target were more cautions about acquisition financings subject to increasingly generous clean-up due to either specific targets or to more periods. Except in particularly exceptional general industry concerns.
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The industry that has arguably suffered that has fundamentally modified Spanish the most severely from the credit crunch in takeover rules. The key developments relate Spain has been real estate and industries to the thresholds, timing and scope of the closely related to it. Following several years takeover offer. Now, the offer becomes of a robust and liquid market and the rapid mandatory, and at an equitable price, once rises of property prices, the industry is the investor has acquired control of the now facing an uncertain future. Although target, which is considered to exist whenever Spanish banks have not been directly the investor reaches 30 percent of the voting affected by the subprime mortgages crisis, rights of the target or, in the event that the world’s adverse financial situation the investor appoints half plus one of the coupled with the rise in interest rates and directors of the target within 24 months excessive mortgage backed indebtedness from the offer. The new Takeover Regulation have brought an abrupt end to the therefore replaces the (exclusively Spanish) industry’s ‘golden age’. compulsory ex ante, in whole or in part, takeover bids by ex post bids which must be made toward 100 percent of the shares and certain other securities. Nevertheless, voluntary (either in whole or in part) offers remain possible. For the first time in Spain, The legal framework governing capital markets in the new Takeover Regulations include squeeze-out and sell-out rights provided Spain underwent a significant transformation during that: (i) as a consequence of the offer, the the course of the previous year. offeror holds at least 90 percent of the capital-carrying voting rights; and (ii) the offer has been accepted by at least 90 percent of its addressees.
Competition law. Spain has implemented Legal developments a new competition law which, among other things, provides for a higher filing Corporate and takeover law. The legal threshold linked to market share (increased framework governing capital markets from 25 to 30 percent) while the turnover in Spain underwent a significant threshold remains unchanged gives the transformation during the course of the ultimate decision on merger control to the previous year. The Stock Market Law of competition authorities rather than the 1988 was amended in crucial areas such as government, established a simplified form market abuse, official listings and public for the filing of concentrations unlikely to offerings, the information to be disclosed cause competition concerns and aligns by listed companies and their shareholders, the Spanish merger control rules with the the clearing and settlement of market EU merger regulation in respect to joint transactions, other regulated markets and ventures. investment services firms, among others. Prospects for the coming months More importantly, however, Spain introduced a new takeover regime in 2007 The impact of the credit crunch will
www.financierworldwide.com | FW 241 INTERNATIONAL MERGERS & ACQUISITIONS 2008 probably have a more marked effect on in which the bidder cannot raise enough the value of M&A deals rather than the debt to acquire 100 percent of the target actual number of transactions in Spain. company. Investors may therefore The difficulties for raising bank financing explore other alternatives (less common will most likely lead to deals characterised in the recent ‘golden years’) such as co- by lower leverage but not necessarily to a investment schemes with other bidders and dramatic reduction of midcap deals. acquisition of minority / majority stakes to the sellers (retaining a significant stake in Some private equity houses may suffer the target). from excessive prices driven by auctions and the obscurity in the debt market in recent years. Christian Hoedl is a partner and Javier Finally, the reduction in the availability Ruiz-Cámara is a senior associate at Uría of financing may also lead to scenarios Menéndez.
242 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Developments in the Netherlands’ corporate and takeover law
by willem calkoen
Before 2000 the average Netherlands companies and foreign institutions invested listed company had quite a few legal heavily in Dutch companies. At present 80 defence mechanisms. Many companies did percent of Dutch shareholders are foreign. not list shares but depository receipts. A Gradually, companies voluntarily dropped foundation friendly to the board owned the some of their defence mechanisms, partly shares which had the voting rights. There due to substantial pressure from the were mechanisms for the company to Amsterdam Stock Exchange. issue preference shares at a low price to a friendly foundation, which could then vote In 2004 the Corporate Governance Code on these preference shares. There were ‘Tabaksblat’ was issued. It emphasised also stipulations in articles of association responsibility of supervisory directors to such as co-optation of supervisory directors shareholders, more power of shareholders, and managing directors. Sometimes mandatory proxies to depository receipt special priority shares owned by a friendly holders so that they can vote on the shares foundation were the only shares that could that they held beneficially and ideas to nominate new directors. In addition, most eliminate defence mechanisms. In addition, large companies were subjected to the two- it was made possible to have one-tier tier board regime, where the supervisory boards in the UK style. directors by mandatory law co-opted themselves. On 1 October 2004 an important change to the Dutch corporate law was In short, there was a very defensive and introduced with the following items. protected situation for the managing and First, in companies with the two-tier supervisory boards. Shareholders meetings board regime (large companies) the were characterised by absenteeism; supervisory board no longer co-opts itself. on average about 15-20 percent of The shareholders’ meeting appoints and shareholders came to shareholders dismisses the supervisory directors. There meetings. There was little communication is still a situation where the supervisory between boards and shareholders. Large directors nominate their successors with Dutch pension funds held many shares in some influence for the works councils in Dutch companies, but did not want to try to these nominations, but the shareholders influence directors. Shareholdings in Dutch may refuse to follow the nomination. companies were mainly owned by Dutch The fact that shareholders may dismiss institutions and Dutch individuals. the complete supervisory board was an important shareholder power in the Stork Over the years, the percentage of foreign deal in 2008. shareholders has grown drastically. Dutch pension funds invested in foreign Second, shareholders who own 1 percent, www.financierworldwide.com | FW 243 INTERNATIONAL MERGERS & ACQUISITIONS 2008 or in very large companies, shareholders important decisions. The Dutch Supreme who hold at least €50m, may force the Court overturned this decision, because board to put certain points on the agenda article 2:107a of the Civil Code provides of a shareholders meeting. This also proved an exact threshold on when to request to be an important shareholder power in shareholder consent, which is one-third of the Stork deal, and the VNU deal of 2007. A the value and not less. The Supreme Court draft law proposes to raise this threshold to therefore decided that the article should be 3 percent. interpreted restrictively, to provide clarity of law for boards and companies. Third, shareholders have the power to consent to the policy for payment of As mentioned, foreign shareholdings of salary and fringe benefits and share option Dutch listed companies have increased schemes for executive directors and tremendously in recent years. At present supervisory directors. This proved to be 80 percent of the shares in Dutch listed important in the Ahold case. There is much companies are owned by foreigners. debate about high CEO incomes. About 10 years ago the majority of Fourth, Article 2:107a of the Civil Code managing directors and supervisory obliges the board to request consent at the directors of Dutch companies were Dutch. shareholders’ meeting for decisions which There has been a substantial change change the character of the company, here too. Many CEOs and CFOs of Dutch such as: (i) the disposal of nearly the companies are now foreigners. Interestingly complete enterprise (which was already many CEOs of the largest companies are applied as a rule of practice in the merger still Dutch, such as Shell, AKZO and Philips, of P&O and Nedlloyd); (ii) a joint venture but the CFOs are often foreign. At present of high importance; (iii) and the disposal the CEO of Fortis, ING and Unilever are or acquisition of a subsidiary which has foreign. There are many supervisory board or would have a value of one-third of the members who are foreign as well, such as company. However, if this consent is not the chairman of the supervisory board of given, it does not block the power of the ABN AMRO. board to represent the company towards third parties in such matters. In addition to the legal changes of 1 October 2004 which favoured shareholders, Article 2.107a of the Civil Code was a central the trend of foreign shareholdings has aspect in the case of ABN Amro selling also increased shareholder activism. A LaSalle Bank. LaSalle Bank had a lower shareholder activist argued that Shell value than one-third of the total value of should review its board structure, which ABN Amro, but nonetheless the Enterprise led to the merger of Royal Dutch and Shell Court of Amsterdam decided that ABN UK into a UK public company with its head Amro should have asked the shareholders’ office in the Netherlands. The advantage consent to sell LaSalle because ABN of a UK public company is a better trading Amro was in that period for sale. The platform in London. There are substantial Enterprise Court used arguments of English tax advantages of keeping the head office and US law where a company that is up in the Netherlands. for sale has to request consent for any
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Shareholder activism forced the boards are special committees and foundations of VNU and Stork to seek acquisitions by in the Netherlands to promote the quality private equity. Other companies were of services and infrastructure, so the forced to undertake necessary disposals Netherlands can maintain its position in the by shareholder activists, and also sell to financial and service areas. private equity, such as the sale by Philips of its chips division to KKR. Notwithstanding all of the above, the Netherlands remains an open economy. There is debate in the Netherlands about It has always realised that it is more the ‘sell out’ of Dutch companies, which important that the work of highly qualified gained impetus from the Stork and ABN specialists is done in the Netherlands than AMRO deals. The Minister of Finance has the owners of a company remain Dutch. been in favour of an open economy and wishes to promote acquisitions by foreign entities of Dutch companies, provided the Willem Calkoen is a partner in the Mergers & work is still done in the Netherlands. There Acquisitions Group at NautaDutilh N.V.
www.financierworldwide.com | FW 245 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Forced unbundling of Dutch energy companies
by Harm Kerstholt and Miriam van Ee
On 3 August 2007 a Royal Decree was vertically integrated energy companies in published in the Netherlands to implement the Netherlands are (once again) publicly the so-called ‘group ban’ as laid down in owned by municipal and provincial an amendment to the Dutch Electricity Act shareholders. This will not change in the and Gas Act. Although no other European foreseeable future as the Electricity Act and country introduced similar legislation Gas Act do not allow the sale of network with regard to the unbundling of energy businesses outside the current circle of companies, as from 1 July 2008 Dutch (public) shareholders. energy companies must fully separate their networks business from their commercial No later than 1 January 2011, commercial activities. After an extensive legislative and network companies can no longer be history the forced unbundling of the part of the same group or hold shares in the Netherlands energy companies is a fact and capital of each other’s group companies. goes beyond the unbundling requirements This means that from the commencement currently under debate in the European date of the Act the integrated energy Union for vertically integrated energy companies have two and a half years to companies. The European debate focuses finalise the separation. on the separation of transmission network companies only and does not extend to The procedure for a legal split of the distribution networks. business starts with the preparation by the management of a split-off proposal. This In this article we focus on the consequences proposal defines, among other things, which of the separation of the energy companies assets and liabilities will be acquired by in the Netherlands, because it will increase the respective companies. In other words, M&A in the Netherlands energy market. which assets and liabilities are related to network activities and which are related to Timeframe the commercial business. The proposal has to be approved by the Minister of Economic The Act requires the separation of Affairs, after advice of the Netherlands integrated energy companies – such as Competition Authority has been obtained. Nuon, Essent, ENECO and Delta – into Approval has to be granted before 1 July separate companies: (i) a commercial 2009. After approval the companies can start company which engages in the sale, the split in conformity with the proposal. distribution and/or production of energy and (ii) a network-company operating Europe gas and/or electricity networks. Since RWE sold its network business last year One of the main reasons for the forced to the Municipality of Eindhoven, all unbundling is to create a level playing
246 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS field in the energy consumer market widened, so that from now on all regional in the Netherlands. Separation should and local authorities can hold shares in safeguard that it becomes impossible network managers. An enumeration of all to cross-subsidise commercial activities public legal entities that can hold shares in a through (monopoly) network activities. network manager is recently laid down in a The Act has been and still is controversial. ministerial regulation. Several integrated energy companies have instituted legal proceedings or have The debate about the possibility to sell announced their intention to seriously a minority of the shares in the network consider doing so. Furthermore, the two operator to private parties (i.e., outside the biggest incumbent players, Nuon and circle of the authorities) did not make it Essent, attempted a merger last year to to a legislative proposal due to resistance create a national champion. The merger in the House of Representatives. The was not completed because public public shareholders might however seek shareholders could not agree on the terms. opportunities to refinance the network business to free cash, which creates In the midst of this turmoil, large utility opportunities for banks. companies appear to be very interested in the Dutch commercial parts and it is Exit commercial activities expected that these parts will become subject to takeovers after unbundling The separation of energy companies within the next couple of years. implies that shareholders can freely transfer their shares in the commercial companies Public shareholders to third parties. Many shareholders indicate that indeed they are planning to At the moment, public shareholders sell or investigating the possibility to sell are examining their options concerning these shares. Often heard reasons for the the possible sale of their shares in decision to sell the shares in the commercial commercial energy companies. Until the companies are that: (i) share ownership is full implementation of the separation is a no longer the obvious means to secure the fact, the shareholders cannot freely transfer public interest involved with the trade and their shares in the integrated energy supply of energy; (ii) the local authorities companies because these companies do not have enough expertise to give include the network business. After substance in a good manner to their share separation, the sale of the commercial ownership; (iii) the financial risk of the business is expected as the rationale for participation in the commercial company public shareholders to keep their shares in will strongly increase due to the separation; the commercial business disappears. The and (iv) the sale of the shares will release a sale of the network business will, however, considerable sum of money at once. still require the consent of the Minister of Economic Affairs. Such consent will only It will be interesting to see how the sales, if be given if the alteration in the ownership any, are being structured. The expectation of the network or the shares in a network is that the commercial businesses will be manager remains within the current circle offered in controlled auctions not long of shareholders. This circle has recently after the separation is implemented. This www.financierworldwide.com | FW 247 INTERNATIONAL MERGERS & ACQUISITIONS 2008 is, however, by no means certain. In the in the European energy market with last two years, smaller companies that competitors such as RWE, E.ON, Suez and voluntarily split up were sold without EdF. auctions. Minority shareholders could also decide to sell their shares while other The developments in the Dutch energy shareholders retain their shareholdings. The market will inevitably influence the province of Gelderland (a major shareholder European unbundling discussion, as did of Nuon) recently indicated that it will E.ON’s recent decision to voluntarily retain its shareholding in the commercial separate its transmission network business. business for several years. None of The coming period will be important for the current shareholders has strongly shareholders, management and those indicated interest to actually increase their companies looking to buy commercial shareholding, but this cannot be ruled out. positions, as they each have a part to play in the unbundling process. Since various Our expectation is that the commercial stakeholders have different interests, business will be sold sooner rather than the period leading up to the actual later. This is mainly because public implementation of the unbundling will be shareholders will not want to bear challenging for everyone involved. responsibility for the enormous risks involved with the commercial energy business. Moreover, after separation the Harm Kerstholt is head of the Energy & commercial energy companies may lack Utilities Industry Group and Miriam van Ee is the size and power to effectively compete a senior associate at NautaDutilh N.V.
248 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Private equity and public takeovers in Switzerland: finally a happy marriage?
by Frank Gerhard
Last year, the first leveraged public have long been reluctant to operate in the takeover was successfully closed in public M&A market because the typical Switzerland. Unilabs, listed on the SWX financing structures often conflicted with Swiss Exchange, was acquired by the the interests of minority shareholders of the Swedish-based and private equity-backed target. Indeed, for purposes of the public healthcare provider Capio, creating a takeover offer, the private equity investor leading laboratory services group in will set up an acquisition vehicle to be Europe. Approximately 40 percent of the funded by a mix of equity, senior debt and offer was financed through equity, while subordinated debt. As the debt portion will approximately 60 percent was financed trigger interest payments, proceeds need to through a syndicated credit facility. be generated in order to enable the acquirer This transaction followed a series of to service such interest and amortisation unsuccessful attempts by private equity payments. Furthermore, in order to investors to take private Swiss listed achieve tax savings, the acquirer will want companies (e.g., CVC / Forbo in 2004/05 or to allocate interest payment obligations CVC / SIG in 2006/07). on the level of a fully-taxed subsidiary company. In other words, the acquirer will This successful LBO of a public company want to balance the acquisition debt with has raised the interest level of various the operating profits in order to (re-)finance private equity investors for Swiss listed the debt with minimal corporate and tax targets. This interest has been enhanced consequences. by share prices coming down in the last six months. In addition, while it appears that Swiss legal particularities the credit crunch has resulted only in the private equity deals in the CHF 1bn-plus Swiss law has three particularities which are bracket struggling to find any acceptable important to understand when structuring finance, deals worth less than CHF 1bn efficient acquisition financing. seem still to be flowing. Finally, LBOs in Switzerland benefit from changes in the First, Switzerland knows no group tax legal and tax framework which came into consolidation, except for VAT. Each force in 2007 and 2008. The conjunction company is tax-assessed on a standalone of these elements should open new basis. Therefore, a tax-efficient structuring opportunities in the mid-market segment in of acquisition financing usually involves Switzerland for private equity investors. some kind of an upstreaming of profits or assets from the target group to the Challenges of LBO financing acquisition vehicle (financial assistance) or a pushing down of the acquisition debt from In Switzerland, private equity investors the acquisition vehicle to the target group www.financierworldwide.com | FW 249 INTERNATIONAL MERGERS & ACQUISITIONS 2008
(debt push down). Particularly if not at public offer, such cooperation is in fact arm’s length, such transactions can trigger rarely given for retail shareholders. adverse tax consequences on the level of the Swiss assisting or benefiting company. Upstream loans as financial assistance
Second, Swiss corporate and bankruptcy Arm’s length principles and corporate law law does not recognise the overall implications legal concept of an integrated group of companies. This explains why the law Usually, a target would upstream profits protects assisting companies against or assets to the acquisition vehicle by distributions and financial assistance that way of a formal distribution of dividend could harm the creditors of the assisting or by a capital decrease. Both necessitate company by unduly decreasing assets or shareholder approval and include minority increasing debt. Consequently, the board shareholders in the distribution. Another of directors of a Swiss target may not take way of financial assistance by the target a consolidated view and fulfil its fiduciary would be to grant an upstream loan to duty by merely considering the overall its parent. The funds for making this loan interests of the entire group. can come from existing undistributed cash or from dividend proceeds by the Third, the capital gain realised in a sale by operational subsidiaries. Besides making an Swiss residents of shares held as private upstream loan, the target can also provide assets, is, in principle, tax free. However, financial assistance by other means, such this favourable tax treatment is only as providing security for the obligations of upheld if the restrictions emanating from the parent vis-à-vis third parties. If there are the concept of ‘indirect partial liquidation’ minority shareholders, the granting of an are respected. Under the ‘indirect partial upstream loan to the majority shareholder liquidation’ concept a tax free capital gain is subject to the protection of the interests is re-classified into taxable income in three of the minority shareholders. situations. First, a sale of a participation of a least 20 percent of a company’s In any event, such loan must meet arm’s share capital from the private assets of length conditions, as they would be an individual investor to the business requested by an unrelated third party assets of an individual or a company takes when granting the same loan to the same place. Second, if within five years after the borrower. In addition, an upstream loan acquisition, the acquirer distributes funds by a Swiss lender must be examined in from the target which, when the sale took the light of the restrictions and conditions place, were contained in the target, were imposed by certain general principles of not needed for operational purposes and corporate and tax law. This is particularly were distributable from a corporate law important where there are reasonable standpoint. In this context, a merger of the doubts as to whether the terms of an target and the acquirer, as well as financial- upstream loan are at arm’s length. First, assistance transactions entered into by the if the loan is not entirely at arm’s length target, are considered as a distribution of it is advisable for the Swiss lender to such funds. Finally, if the seller and buyer extend the purpose clause of its articles cooperate in the financing. In case of a of incorporation to provide explicitly for
250 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the granting of financial assistance to minimal interest rate requirement not met group companies. Second, the upstream or even the total loan amount if the loan loan must comply with the principles of was fictitious) may be subject to dividend adequate risk diversification and diligent withholding tax of 35 percent of the fair liquidity management of the lender (duty market value of the gross distribution. of care). Third, unless the upstream loan Second, the withholding tax is in general clearly meets the arm’s length test, the fully recoverable if the borrower is a Swiss upstream loan must be limited to the company. Foreign recipients can fully or freely disposable equity of the lender. An partially recover the withholding tax based upstream loan exceeding such amount on double taxation treaties, including could be deemed to be an unlawful return the agreement between Switzerland and of the shareholder’s capital contributions the EU on the taxation of saving income and to violate the statutory limitations which also covers dividends to EU parent on the use of the company’s reserves, in corporations. Third, the distribution particular if the upstream loan has been received by a Swiss company or target is fictitious or where it was clear from the largely exempt from corporate income beginning that the borrower will not be tax if the benefiting company is a major in a position to repay the loan when due. shareholder in the assisting company. Fourth, an upstream loan which does not clearly have arm’s length terms could be Debt push down deemed a constructive dividend. As a consequence, the board of directors of By way of merger the lender would be forced to demand immediate repayment of the loan. In If the acquisition company and the target this context, it has become customary to effect a statutory merger, their assets and require formal approval of the upstream liabilities are combined in one legal entity, loan not only by the board of directors, with the effect that the target’s assets can but also by the shareholders of the Swiss be used to repay or service the acquisition lender. debt. Such a merger requires at least two- thirds of the capital and the votes of the Non-compliance with the preceding may shareholders of both companies. If the lead to the invalidity of the upstream loan acquisition company controls 90 percent or as well as to directors’ and officers’ personal more of the target’s votes, it can squeeze liability. Furthermore, non-compliance may out minorities against payment of cash. qualify as a criminal offence or as fraudulent conveyance under bankruptcy laws. A statutory merger is usually not accepted by the Swiss tax authorities. Hence, the Tax implications for assisting and benefiting interest expenses cannot be deducted companies from the taxable income for a period of usually five years. In addition, it may lead From a tax perspective, should the to a reclassification of the formerly tax free conditions of the upstream loan not be capital gain of Swiss retail shareholders at arm’s length, the loan will be treated into taxable income based on the theory of as a constructive dividend. This has three indirect (total) liquidation. implications. First, the distribution (e.g., www.financierworldwide.com | FW 251 INTERNATIONAL MERGERS & ACQUISITIONS 2008
By way of dividend neither triggers Swiss withholding tax nor corporate income tax. In addition, Dividends may be a straightforward way such a reduction is exempt from income to refinance the acquisition vehicle or to taxation for Swiss private investors. As a push down debt (by assumption of certain consequence, the theory of indirect partial loans). Dividends require shareholder liquidation should not apply. approval and can only be made from freely disposable reserves as evidenced in audited Sale of activities within the target group financial statements. Remaining minority or to third parties shareholders are entitled to a proportional dividend and may challenge the resolution. Upstreaming revenues or assets up to the acquisition vehicle can also be achieved by A dividend paid by the target to a non-Swiss the sale of assets, which can be structured acquisition vehicle triggers withholding in various ways. For example, the target tax of 35 percent unless a treaty provides can be split with the effect that parts for relief or refund. A Swiss acquisition of the target’s business activities will vehicle receiving the dividend may benefit be transferred to a new sister company from the participation exemption largely (Newco). The acquisition vehicle would exempting dividend from corporate income then sell Newco either to a third party tax. As dividends may be seen as an indirect (if the activities are no longer desired) or partial liquidation, the target’s Swiss retail to a profitable operating subsidiary. The shareholders’ tax free capital gain may purchase price may be used to repay the to that extent be reclassified as taxable acquisition debt or, if sold to a subsidiary, income. remain unpaid for the moment, thus resulting in an interest-bearing loan of the By way of capital reduction acquisition company to the subsidiary.
After the takeover offer, the target’s Conclusion share capital can be reduced in order to distribute the corresponding amount to Leveraged takeover offers – including the acquisition vehicle to repay the debt. financial assistance and debt push down The capital reduction requires a resolution – are possible in Switzerland, provided of the shareholders’ meeting, creditor they are carefully prepared and structured. notification and an auditor’s certificate. A Additional transactions in the near future capital reduction is likely to require three to will demonstrate the proof of concept. six months.
A reduction of nominal share capital Frank Gerhard is a partner at Homburger.
252 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Current state of the Nordic M&A market
by Peter Sarkia, Erik Swartling and Philip Heilbrunn
In recent years, the Nordic M&A market lot of activity since it is still possible to find has boomed, mostly due to the active reasonable financing. private equity houses and the availability of attractive financing. However, the subprime Another trend is the increased activity of fallout has in some respects affected the trade buyers, possibly as a consequence of financing options for financial acquirers, lower valuations and the fact that the trade and there has been some impact on the buyers are generally less dependant on Nordic market as a consequence. highly leveraged financing.
Trends in the Swedish M&A market During 2007 there was a lot of attention on the top individuals at leading private equity Prior to the subprime fallout, we saw the houses, and their salaries. This attention following trends, especially in private equity seems to have subdued lately. The extent related transactions. Opportunities for of negative publicity in Sweden has not thorough due diligence were very limited. reached the levels seen in the UK during Especially in secondary buyouts, private 2007. To the contrary, the general opinion equity to private equity, very few reps and seems to be more favourable towards warranties were provided by vendors and private equity at present. in some cases the representations and warranties would not survive a closing of As indicated above, deal activity in the the transaction. Acquisition financing was mid-market seems to have declined highly leveraged and controlled auctions only slightly. How much of this decline is were very competitive, which led to high attributable to the credit crunch is difficult purchase prices. to say. It has definitely not been as severely impacted as international leveraged mega During 2007, several of the major Swedish deals. private equity houses raised substantial funds. Our impression is that there is a lot In Sweden, investors have shown interest of capital available for investments. When it in a wide range of sectors. In recent years, comes to financing larger buyouts and other there has been a lot of focus on the real investments, private equity players have estate market, but this seems to have stated that whereas previously they could decreased slightly. Further, financial talk to only one or two banks, today several institutions and media related companies banks have to be approached. Consequently, appear to be in focus at present. Interest for there are increased difficulties for primarily investments has been shown from many private equity houses to find attractive jurisdictions, but chiefly from investors high leverage acquisition financing. At the domiciled in the US, Norway, Iceland and mid-market level, however, there is still a Germany. www.financierworldwide.com | FW 253 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Competition between strategic and is the level of liability taken on by the seller. financial acquirers in the M&A market Private equity sellers do not retain much of the purchase price consideration. Funds In the Nordic region, there are currently need to be closed and proceeds distributed few deals that do not have a private equity as soon as possible following an exit. On component. However, the presence of the other hand, the trade buyer needs to trade buyers has definitely increased and be able to recover on a warranty claim. An private equity houses seem to prefer trade escrow arrangement in which private equity sales to initial public offerings. sellers accept to hold back approximately 10 percent of the purchase price is not an Due diligence. Private equity houses unusual solution to the problem. generally acquire businesses on a standalone basis, as opposed to trade Purchase price adjustments. The purchase buyers, and therefore their concerns in price adjustment mechanism typically acquisitions usually involve a narrower falls into two main categories: the ‘locked assessment of liabilities and financial box’ which is normally what private equity performance. Consequently, the different houses prefer as sellers, and post-closing approaches compared to trade buyers can pricing adjustments in the form of, for lead to some frustration on the private example, completion accounts. equity side at the pace of a trade buyer’s review. The purchase price when using the completion account mechanism is Private equity sellers normally prepare calculated as the agreed headline price vendor due diligence reports, drafted by (enterprise value), adjusted for actual net accountants and lawyers covering financial debt at completion and for the excess and legal aspects of the target’s business. or shortfall of actual working capital at This speeds up the due diligence process. completion, in comparison to target working capital or the target net asset Representations and warranties. In value. This method is usually preferred by secondary buyouts, private equity to trade buyers, since if any adjustment is private equity, it was previously common needed, it is normally to the detriment of to see warranty cover limited to the the seller in the form of a reduction of the ability to transact, title to shares and no purchase price. encumbrances. In extreme circumstances, the warranties provided have not even On the other hand, the ‘locked box’ survived closing. This trend has recently mechanism entails a fixed equity price subsided. At least basic business warranties calculated on the basis of an agreed now seem to be the main trend. Private balance sheet, accompanied by ‘locked box’ equity sellers seem to acknowledge that protection for the buyer to prevent loss of the internal compliance rules of trade value (‘leakage’) from the target business in buyers necessitate at least limited business the period from the reference balance sheet warranties. date to completion. Completion accounts are thus not required in this solution. Another issue always discussed, once the scope of warranty cover has been agreed,
254 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
Prospects for 2008 the state owned distributor of i.a. Absolut Vodka. Due to the present volatility of the market, the prospects for 2008 are difficult to Clearly, adoption of the euro as the lawful predict. However, as regards mid-market currency in Sweden would facilitate cross- deals, we do not foresee any major impact border acquisitions into Sweden. However, from the international credit crunch. Deal this does not seem to be likely in the near structures and the level of leverage in the future. Further, it would naturally facilitate financing of private equity acquisitions may acquisitions into Sweden if Swedish be affected, but at present deal activity accounting principles fully corresponded to does not seem to have declined. The international accounting standards. ongoing privatisations of large companies owned or controlled by the state will probably contribute to some PE activity. For example, Sweden’s largest PE house EQT Peter Sarkia, Erik Swartling and Philip has expressed an interest in participating Heilbrunn are partners at Advokatfirman in the controlled auction of Vin & Sprit AB, Hammarskiöld & Co.
www.financierworldwide.com | FW 255 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Financing options and capital structures
by Peter Sarkia, Erik Swartling and Philip Heilbrunn
Up until June 2007, when the credit crunch used to govern acquisition finance started to affect global markets, including documentation but this depends on various Sweden, there had been a constant growth circumstances, mainly the size of the in the number of private equity investments transaction, the original lender’s origin and in Sweden. The increasing expertise the targeted syndication market. In any and sophistication, and the increasingly event, leveraged transactions not governed aggressive approach of sponsors active by Swedish law require significant input in the Nordic market, contributed to this from Swedish lawyers in many areas, when steady rise and development of a borrower- a Swedish SPV is involved. friendly leveraged finance environment. Even though the credit crunch has had Standard structure some affect on liquidity and leveraged finance in Swedien, interest from European The standard starting place is a draft buyout houses has remained high, even tax structure paper prepared by the when it seems to have waned in other sponsor’s tax accountants. As tax advisers, regions of Europe. the accountants will have prepared the structure to maximise tax efficiencies. As in other jurisdictions, leveraged However, they often do not consider transactions in Sweden involve the lending corporate and financial law issues and the of funds to a SPV controlled by an equity impact of the structure on the borrower’s sponsor (often a private equity sponsor and lenders’ legal position. and, in some cases, the management of the purchased company) to acquire the target Generally, investors set up a newly company and refinance its existing debt. incorporated SPV, irrespective of the The acquisition facility is paid with the cash nationality of its shareholders. In the basic flows generated by the target company, structure, the SPV tends to be a company which are upstreamed to the purchase resident in Sweden and subject to Swedish vehicle through dividend payments or other corporate income tax. In this structure, available methods. the SPV raises the finance to purchase the stock of the target company. The SPV is Swedish based leveraged transaction usually a private limited liability company, structures are similar to those in the UK which limits the shareholders’ liability and certain parts of Europe (in particular to the capital invested and requires few the Nordic countries), although some formalities to be set up. An asset deal as particularities in Swedish law may require opposed to a share deal is rarely used in tailoring the structure of the transaction Sweden by private equity sponsors. and the finance documents to be in compliance. Swedish law is sometimes The acquisition is usually funded by a
256 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
mix of senior and mezzanine bank debt terms and solutions has ceased. The credit (or independent mezzanine debt) and crunch has provided the banks and other shareholder funds, both pure equity lenders on the European leveraged buyout and unsecured shareholder loans. The market with an opportunity to reconsider shareholder loans are treated as equity certain terms upon which pre-credit crunch between the lenders and the shareholders. acquisition deals were made and to take In the vast majority of cases, banking a new look at certain terms on which facilities are used. Most private equity lenders have committed funds to mergers acquisitions have been financed with credit and acquisitions. Lenders and their legal facilities provided by banks, combined advisers seem to take the opportunity to with mezzanine provided by banks or by reconsider some of the borrower-driven specific independent debt providers. Unlike terms found in the most aggressive certain other jurisdictions, debt security leveraged acquisition deals before the instruments are not commonly used to credit crunch. finance acquisitions. Security
In UK and US based leveraged transactions, the lenders – from a Swedish legal In Sweden, limitations on the security available perspective – seem to expect to obtain as close to full security from the target group to the lenders arise due to, among other things, as possible. In Sweden, limitations on the financial assistance and dividend restrictions. security available to the lenders arise due to, among other things, financial assistance and dividend restrictions, corporate benefit requirements, and other Swedish specific requirements, such as Swedish perfection requirements under Swedish law imposing inter alia difficulties to obtain security over Trends following the credit crunch assets which are used in the day to day business. Security is normally granted on Much has been said and written about a cost / benefit analysis and there is no the impact of the credit crunch on the Swedish equivalent of the UK whitewash European leveraged lending market. In procedure. In UK based leveraged the Swedish market, certain trends are transactions, we have noticed the lenders’ identifiable in recently negotiated deals, increased requests for additional or other but it is in our view too early to conclude security. Due to the aforementioned whether any significant changes in the limitations to provide certain types of previously borrower-friendly environment security under Swedish law, it does not have occurred. Prior to the credit crunch, presently appear as if the credit crunch leveraged lending was, and has for a few will have any long term effects on security years been, characterised by borrower- provided by Swedish entities in leveraged friendly terms. There is however no doubt transactions. The effect experienced so that the recent year’s development towards far has been that the lenders’ previous even more sophisticated borrower-friendly occasional acceptance of share pledges as
www.financierworldwide.com | FW 257 INTERNATIONAL MERGERS & ACQUISITIONS 2008 the sole security when providing financing with other equity sweeteners seem to have has decreased substantially, at least if increased significantly during the last six alternative security is available and can be months. Specialist mezzanine lenders and justified based on a cost / benefit analysis. other mezzanine and debt / equity hybrid financing providers have returned with an Capital structure interest in taking a larger portion of the pure equity as well as quasi equity of the The capital structures in recent deals are SPV. The reawakened interest of specialised reverting to traditional senior / mezzanine mezzanine providers in the Nordic region arrangements. Furthermore, we have noted has also led to the return of certain that that pricing and leverage levels have intercreditor discussions which usually are clearly been affected. The credit crunch not relevant in acquisition deals without has resulted in decreased levels of leverage equity sweeteners, since the mezzanine which in turn has affected the pricing lenders’ will more frequently be acting both negatively. as lender and investor.
Warrants / equity sweeteners
Independent warranted mezzanine has in recent years more or less disappeared from the Swedish leveraged buyout market. Peter Sarkia, Erik Swartling and Philip The demand for warranted mezzanine and Heilbrunn are partners at Advokatfirman also for mezzanine financing combined Hammarskiöld & Co.
258 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Directors and officers duties according to Swedish law
by Susanna Norelid and Christer A. Holm
M&A is a difficult and sometimes the right company body. unsuccessful undertaking. There are many risks, some of which are quite difficult As of today, D&O insurance is common in to foresee. Statistics show that failure Sweden. D&Os are facing high demands rates are high. Yet directors and officers from owners, shareholders, competitors (D&Os) of companies carrying out M&A are and consumers, not least in M&A willing to take the risk, even though they transactions. The relatively new possibility personally face potentially costly lawsuits of bringing a class action in Sweden has for actions taken while performing their also contributed to the sharpened business duties. environment. Moreover, courts have recently shifted towards a stricter view on D&O liability insurance in Sweden liability issues for D&Os.
D&O liability insurance protects D&Os The scope of the liability of D&Os from legal responsibility for wrongful acts connected with their positions. A The Swedish regulation on the liability of standard D&O insurance product may D&Os consists primarily of the Companies cover damages and defence costs in the Act and a Code of Conduct compiled by event that D&Os are sued by stockholders, major companies on the Swedish stock employees, clients or competitors. Without market. The purpose of the Companies such insurance cover, a director or officer Act is primarily to encourage business in may be held personally liable for acts of general by allowing limited liability for the the company and thereby put his or her owners. Other purposes are the protection personal assets at risk. D&O insurance of creditors and minority shareholders of cover provides economic security for the the company. The regulation covering the directors, and facilitates the recruitment personal liability of D&Os aims to prevent of skilled directors. The sufferer would also D&Os from causing financial harm to the be more certain to receive reimbursement, company, its shareholders or any other since an individual director or officer may third party, and to compensate the legal be incapable of paying large amounts of entities who suffer loss in the event of non- damages, whereas an insurance company compliance with the rules. can. The general rule in the Swedish Companies Usually D&O insurance is purchased Act (which is the same as liability in tort) is and paid for by the company/employer, that a managing director, member of the although it is for the benefit of the D&Os. board, founder, auditor, shareholder or This is permitted in Sweden as long as the other individual is liable for damages that decision to buy insurance cover is taken by he or she intentionally or negligently causes www.financierworldwide.com | FW 259 INTERNATIONAL MERGERS & ACQUISITIONS 2008 while fulfilling his or her duties for the with some exceptions, be granted discharge company. from liability through a shareholders’ meeting. The decision is made for each The board or the directors may be held individual director, and not for the group as personally liable if they fail to fulfil duties to a whole. If it is decided that the directors take action if the share capital is less than shall be granted discharge from liability, it one-half of the registered capital, if they constitutes a waiver from the company, but fail to pay the company’s taxes in time or if only to the extent that the discharge was they provide incorrect information to the based on full and complete information. tax authority. However, D&Os are not held Should that not be the case, the decision personally responsible for any violation of to grant discharge from liability is just an the employment legislation. This liability empty formality without providing any rests on the company. legal protection.
Liability for damages can also be based If D&Os are not granted discharge from on crimes according to the Swedish liability and thus could be exposed to Penal Code. According to Swedish law, liability claims, D&O insurance cover will be a legal entity cannot commit a crime. brought into force. Therefore, there is always a natural person that will be held responsible if a crime is Who and what is covered by D&O liability committed. Possible crimes in the Penal insurance? Code that a director or officer might be guilty of, relating to his or her position in D&O liability insurance is governed by the the company, are fraud, embezzlement, Swedish Insurance Contract Act (2005:104). disloyalty and diverse kinds of economic The Act sets minimum standards that crime. may be deviated from only if it is to the benefit of the insured, but it also contains As a general rule, D&Os are expected to act several parts that can be set aside through in the best interest of the company. There is consensus by the parties. The Act is of course room for risk taking while making applicable if the damage occurs in Sweden, business decisions, and for all practical since the principle of lex loci delicti is purposes Sweden applies the ‘business applicable to such claims. judgement rule’. Again, D&Os may be held liable to pay damages to the company if In Swedish law, the only D&Os that are they cause financial loss to the company regulated are the board of directors and the intentionally or as a result of negligence managing director, including the deputy falling outside the scope of normal business managing director. The company’s auditors risk taking. If the company is obliged to and other executives (e.g., the CFO) are not pay damages to the shareholders and legally defined as D&Os in Sweden, and other third parties as a result of a director’s are therefore not covered by a D&O policy. negligence, it could in turn make claims Coverage for other persons, such as a CFO against the director for the loss suffered. who is neither a member of the board nor a managing director, can of course According to the Companies Act, the board be achieved by way of specifically adding members and the managing director can, him or her to the policy. The auditors must
260 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS follow their own rules and have their own to claim damages from its D&Os due to liability insurance. negligence. Such liability should be covered by D&O insurance. If damage is caused intentionally by the insured director or officer, the insurer is In relation to this, the Swedish Supreme normally not liable since a D&O insurance Court, in a new procedure in 2006, held does not provide cover for intentional that flawed annual reports duly signed by acts. There is no legislation regulating the the board of directors normally falls within formalities of claims handling, therefore it the liability scope of the D&Os (with the is the policy wording that will govern this possibility of joint liability with its auditors). area. In a typical M&A transaction the buyer normally relies on a number of annual M&A transactions related liabilities reports to scrutinise the profitability of the target company, its sustainable profit In Sweden, as well as in most other generating level, and so on. Needless to European countries, M&A transactions say, the liability exposure for the contents have increased substantially in recent years. of the annual reports is increased in M&A This has opened up a new field of liability transactions and also increases the need for for D&Os. Increasingly M&A transactions a D&O insurance cover for D&Os. include a due diligence investigation by the potential buyer. It normally ends up with Conclusion a report stating the shape of the target company. The D&Os of the seller that Being a director or an officer is risky, due to participates in providing information to the increasingly tougher business climate representatives of the buyer must do so in a in Sweden, the relatively new possibility to truthful and comprehensive way. In the final bring class action against D&Os, and the agreement there is, of course, possibility for courts’ stricter view on the responsibilities the seller to limit its liability for information of D&Os. It is thus increasingly common provided, but normally the seller is forced that companies buy D&O insurance. In to issue certain guarantees regarding the addition to the steadily rising volume of status of the target company. Deviations M&A transactions, involving ‘new’ scopes of from the guarantee above a certain amount liability for the sellers, the market for D&O normally entitles the buyer to reclaim part insurance should expand further. of the purchase sum in some way (e.g., tax related claims, labour or law related extra costs, environmental liabilities discovered after the purchase, etc.). The seller could, Susanna Norelid and Christer A. Holm are in such a situation, find that it is entitled partners at Advokatfirman NorelidHolm.
www.financierworldwide.com | FW 261 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Takeovers of Norwegian listed companies
by Terje Gulbrandsen
As party to the European Economic Area foreign investors 41 percent; private Agreement, Norway has implemented citizens 4 percent; and funds 4 percent. the MiFID, the Takeover Directive and the Of the foreign investors, US and UK based Transparency Directive in a new Securities investors accounted for close to 60 percent. Trading Act (STA), which came into force in two steps on 1 November 2007 and 1 Due diligence. A target company may give January 2008. Consequently, the Norwegian a bidder access to non-public information takeover rules to a large extent correspond for the purpose of conducting due to the rules within the EU. Notwithstanding diligence investigations, as long as the this, there is some local variation within the target company deems this to be in the EU and EEA. Further, there are always some best interest of the company. A target cultural differences, as well as differences company would normally not accept giving in market practice. Below is an outline of a bidder access to detailed information certain key topics in a typical process of about its operations unless there is a high acquiring a company listed on the Oslo probability that an offer will be successful. Stock Exchange. Consequently, the most common approach is for a bidder to conduct its due diligence There are two regulated markets in after the offer has been made. Norway, the Oslo Stock Exchange and the Oslo Axess. There are 218 companies listed Disclosure to a bidder is subject to on the Oslo Stock Exchange, of which 178 procedural rules and strict insider trading are Norwegian companies, 12 are based in provisions. To the extent the bidder the EU and 28 are based outside the EU. On receives ‘inside information’ (i.e., precise the Oslo Axess 29 companies are listed, of information about the company or other which 22 are Norwegian companies, four circumstances that may noticeably are based in the EU and three are based influence the pricing of the financial outside the EU. The Norwegian takeover instruments), this would prevent the regulations also apply to foreign companies bidder from trading until the information is listed on one of the Norwegian regulated made public. The disclosure requirements markets (exceptions may apply if such for listed companies refer to the same company is also listed on another regulated definition, i.e., a listed company shall market). immediately disclose to the market any inside information related to the company At the end of January 2008, the ownership as soon as it receives such information, of the companies listed on the Oslo unless the rules on delayed publication may Stock Exchange was split as follows: the be applied. In theory this should mean that Norwegian State and municipalities 30 due diligence should not uncover any inside percent; private companies 22 percent; information. In reality, this is not necessarily
262 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
the case. Finding positive information In the Norwegian market, a bidder will about the company, which is regarded normally contact major shareholders as inside information, would prevent the with the intention of obtaining hard bidder from trading until the information (unusual) or soft (fairly usual) irrevocable has been shared with the market. pre-acceptances, and will also inform Therefore, the scope and structure of due the company on a more general basis of diligence investigation varies. The bidder its intention to make an offer. In some will usually require the target to disclose to instances, the bidder enters into a dialogue the market, or permit the bidder to disclose with board members of the target company in the offer document, any finding, thereby to explore the possibilities for a successful eliminating the bidder’s position as an offer and seek the board’s backing of the insider in relation to the company. contemplated offer. Such processes involve complex considerations as to what time the target company’s disclosure obligation, with respect to inside information, is triggered. The target may have a different view on this than the bidder, and should Such processes involve complex considerations always act with caution. The company as to what time the target company’s disclosure may delay disclosure if disclosure would obligation, with respect to inside information, is prejudice its legitimate interests, provided that a delay is unlikely to mislead the public, triggered. and provided that the company is able to ensure confidentiality. The target would need to immediately inform the Oslo Stock Exchange of the delayed publication and the reason for it. The Oslo Stock Exchange Stake building or voluntary offer. A bidder may, at least in theory, choose to disclose may choose to acquire shares in the the information if it does not agree with market up to a certain level. The bidder the decision of the target. In friendly will need to comply with the disclosure takeover processes, the bidder and target requirements, giving the market notice will generally have ongoing discussions when its ownership reaches or passes either on these disclosure issues. The company of the relevant thresholds (5, 10, 15, 20, has an ongoing obligation to maintain lists 25, 33⅓, 50, 66⅔ and 90 percent). Further, of all persons that have access to inside a mandatory offer obligation is triggered information about the company. at one-third of the voting shares. Most takeovers, however, start with a voluntary Pursuant to the STA, the Ministry of offer. Voluntary offers may be conditional, Finance may provide further regulations and usual conditions include two-thirds or on mandatory offers, to regulate if and to 90 percent acceptance (usually 90 percent what extent interests in and rights to shares to allow for a subsequent squeeze-out of may trigger a mandatory offer obligation. the remaining minority shareholders), MAC, The current regulations state that where a due diligence and regulatory approvals. The person’s acquisition of rights to shares has offer period in a voluntary offer shall be no to be regarded as an effective acquisition of less than two and no more than 10 weeks. shares, the regulated market may impose
www.financierworldwide.com | FW 263 INTERNATIONAL MERGERS & ACQUISITIONS 2008 a mandatory offer obligation if such person are considered equal to a shareholder’s would pass the threshold by exercising said own shares. A mandatory offer obligation rights. will apply whether it is the shareholder or a close associate that acquires shares, However, a green paper has been provided resulting in the mandatory offer threshold by the Oslo Stock Exchange with a proposal being passed. for new regulations, and the process to amend the regulations is still ongoing. Pursuant to the proposal from the Oslo Stock Exchange, an acquisition of certain interests in and rights to shares may trigger a mandatory offer obligation, irrespective A green paper has been provided by the Oslo Stock of whether it must be deemed an effective acquisition of shares or not. The green Exchange with a proposal for new regulations, and paper explicitly states that pre-acceptances the process to amend the regulations is still ongoing. with respect to offers that are not subject to public approvals will represent a right to shares that may trigger a mandatory offer obligation. This means that if the bidder obtains irrevocable undertakings from shareholders for shares that, together with The mandatory offer must be made without any shares held by the bidder, represent undue delay and no later than four weeks more than one-third of the voting shares after the obligation was triggered. The in the target, a mandatory offer obligation offer shall be for all outstanding shares and is triggered, and the bidder may come in cannot be made conditional in any respect. a position where it is required to make a The offer price must be at least equal to mandatory offer even before the voluntary the highest price paid or agreed to be paid offer is completed. by the bidder during the six month period prior to the obligation being triggered. Mandatory offer obligations. Any person Protection clauses given to selling who through an acquisition becomes shareholders having given irrevocables may the owner of shares representing more raise pricing issues. The offer shall be cash than one-third of the voting rights in a settled, however, alternative consideration Norwegian company whose shares are may be offered, as long as there is a cash listed on a Norwegian regulated market is alternative. The offer period must be no obliged to make an offer for the remaining less than four weeks and no longer than six shares in the company, or to dispose of weeks. a sufficient number of shares so that the person owns one-third or less of the voting Public approvals. Approval from the rights. The offer shall be made or shares Norwegian Competition Authority is usually disposed of within four weeks after the required. The threshold to trigger such obligation was triggered. requirement is very low, and generally it should be expected that it will be triggered Under the mandatory offer rules, shares unless the bidder has no operations in owned or acquired by close associates, Norway. Further, there may be a need for a
264 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS competition filing with the EU Commission. the remaining shares through a squeeze- If this is in fact required, there is no need to out. If the price offered for the shares seek the Norwegian competition clearance. is not accepted by all shareholders, an With respect to financial institutions and independent valuation may be required, investments firms, further approval from and this shall in the outset be conducted the Ministry of Finance/The Financial at the bidder’s expense. Provided that the Supervisory Authority of Norway will bidder initiates the squeeze-out within four be required, if the bidder will reach the weeks after the completion of the voluntary relevant thresholds (10, 20, 25 (financial offer resulting in the 90 percent threshold institutions only), 33 and 50 percent) of the being passed, the bidder may (on certain capital or votes. further conditions) do so without first making a mandatory offer. Squeeze-out. If a bidder acquires more than 90 percent of the share capital and voting rights of a Norwegian limited Terje Gulbrandsen is a senior lawyer at liability company, the bidder may acquire Advokatfirmaet Steenstrup Stordrange DA.
www.financierworldwide.com | FW 265 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g M&A in Finland
by Andreas Doepel
In September 2006 Finland took a major de-merger or split will also be introduced by step towards liberalising company law the same amendment. along freedom of contract principles with its adoption of a new Companies Act. Amendments to the Finnish Companies The new law also impacts merger and Act acquisition activity and its effects were gradually seen in the Finnish marketplace in The new Finnish Companies Act entered 2007. into force on 1 September 2006, increasing the operating freedom of limited liability More than a year after the introduction companies by removing different of the 2006 Companies Act, amendments restrictions and formal requirements and by to the Finnish Tax Code have not yet been introducing new operating methods. At the implemented, effectively preventing the same time, provisions aimed at protecting use of many innovations provided by the creditors and minority shareholders were Companies Act. Unfortunately, the much enhanced. awaited changes will not be implemented before 2008. The most fundamental change, by far, introduced by the 2006 Companies Act In July 2007, the Finnish Accounting Act was is the elimination of the requirement amended, introducing a requirement that to stipulate a par value for each share. limited liability companies must appoint Although the previous Companies Act only chartered accountants (or accounting recognised shares without par value, firms) for financial statement accounting. the shares were nevertheless assigned Smaller businesses are released from the a counter-value (the total share capital requirement to appoint an accountant divided with the number of registered altogether. shares).
Another major development affecting The new act abolishes the counter value M&A activity in Finland will be the of shares, allowing companies to sever implementation of EU cross-border the connection between shares and share rules (Directive 2005/56/EEC) through an capital. This reform enables companies to amendment of the 2006 Companies Act, amend the share capital and issue shares which is expected to come into force by 15 independently. Bonus issues are possible December 2007. The changes will enable without having to increase the share capital Finnish limited liability companies to merge and, for example, a share split can be put to with companies situated within the EU effect simply by issuing new shares for free. and vice versa. As a Finnish peculiarity, the possibility to implement a cross-border The previous prohibition on issuing shares
266 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS for a consideration less than the par value assistance to the extent it would be used to (or counter-value) of the shares was also finance the acquisition of that company or abolished. The positions of creditors or any of its parent companies. minority shareholders are safeguarded by the rules concerning full payment for the The rule is based on Article 23 of the EU share capital and the permanent nature of Capital Directive and, compared to the the capital. previous rules, its field of application is more restricted. The Financial Assistance Investments made in the unrestricted prohibition only applies to acquisitions of equity of the company are separately the providing company’s own shares and regulated. Such investments are held those of its parent (the previous prohibition separate from the profit fund, clarifying applied to acquisitions of shares in any the somewhat unclear application of the group company). previous act on investments into the free equity. This means that a Finnish Ltd. can participate in financing the acquisition of, Even directed bonus issues of shares, for example, its subsidiary, provided the without observing other shareholders’ pre- general corporate interest requirements are emption rights are possible, provided that met (e.g., that the transaction is compatible there is an exceptionally weighty reason for with the purpose of the company and the issue, e.g., incentive systems directed that the transaction does not breach the at key employees or situations where principle of equality). shareholders of a more ‘valuable’ class of shares (e.g., due to a greater number of Furthermore, the financial assistance votes per share) need to be compensated prohibition does not, as a rule, apply to when combining different classes of shares. earlier acquisitions. In a management buyout scenario, it is possible to merge The 2006 Companies Act introduced a the acquiring company with the target new requirement that no funds may be company. distributed if, when making the decision on the distribution, the persons knew or Breach of the Financial Assistance should have known that the company was prohibition will not, generally, lead to insolvent or that it would become insolvent an obligation to return the funds or be as a result of the fund distribution. deemed as a Corporate Law Offence as the acquisition does not usually constitute Furthermore, a limited liability company distribution of funds. If the intent of the cannot give financial assistance in the form arrangement has been to distribute funds of loans or other securities for the purposes from the company, the arrangement may, of a person acquiring shares in the company in such exceptional cases, be deemed to be or a parent company (the ‘Financial an illegal distribution of funds. Assistance prohibition’). The prohibition covers the acquisition of issued and In connection with the upcoming outstanding shares as well as new shares amendment due to EU cross-border rules, to be issued. In practice this means that no the rules governing the loss of equity will Finnish group company can give financial also be adjusted. According to the current www.financierworldwide.com | FW 267 INTERNATIONAL MERGERS & ACQUISITIONS 2008 proposal, the obligation to convene a about if the proportion of voting rights shareholders’ meeting whenever the equity increases purely due to the company’s or falls below 50 percent of the share capital other shareholders’ actions (e.g., through will be restricted to apply only to public the acquisition or redemption of own shares companies. Further, the rules on calculating by the company). the equity for the purpose of ascertaining whether the equity has been lost (triggering a requirement that the loss of equity be reported to and registered with the trade register) will be amended to allow for a more balanced view of the equity situation. The Finnish legislation does not distinguish between Finally, the Finnish Securities’ Association hostile and friendly public tender offers. has established a working group to assess the needs to update the Finnish Corporate Governance recommendation and the possibility of establishing common corporate governance principles for the Nordic countries. In conjunction with the implementation of Amendments to the Finnish Securities the Takeover Directive a new special Panel Markets Act has been set up in connection with the Finnish Central Chamber of Commerce. The The provisions of the Finnish Securities Panel gives non-binding recommendations Markets Act (statute 495/1989) were primarily regarding company law issues amended on 1 July 2006 in order to arising in public takeover situations. The implement Directive 2004/25/EC of the Panel has issued a general recommendation European Parliament and of the Council on on the procedures concerning takeover Takeover Bids, also known as the Takeover bids and a couple of opinions to the Directive. Financial Supervision Authority (FIN-FSA) on questions such as insider registers for Pursuant to the amended Securities projects and disclosure obligations for listed Markets Act, a shareholder whose holding companies and shareholders. in a listed company exceeds 3/10 or 5/10 of the total voting rights attached to Typical for the Finnish takeover legislation the shares of the company, after the and rules is a neutral approach to public commencement of a public quotation of offers. The Finnish legislation does not such shares, must make a public tender distinguish between hostile and friendly offer to purchase the remaining shares and public tender offers. other securities entitling holders thereof to shares in the company. In addition to the Securities Market Act and the Panel, public takeovers and mergers The obligation to launch a mandatory bid are mainly regulated by the FIN-FSA, which is triggered only by a shareholder’s own monitors and controls compliance with the actions. In other words, it does not come SMA. The FIN-FSA also issues standards,
268 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS regulations and guidelines that supplement the price to be paid for the shares in a the provisions of the SMA. Other essential mandatory offer. provisions are the Rules of the Helsinki Stock Exchange, The Act on Competition Typical market practice in takeover Restrictions, which provides national situations is for the target company and merger control, and The Companies Act. the bidder to enter into a combination or similar agreement in a friendly takeover, There are also special regulatory control where the board of the target usually provisions designed to control ownership recommends the bid. According to in certain industry sectors, for example, recommendation number six of the Panel, banking and insurance. Whenever holdings the board may enter into a combination in a listed company reach, exceed or fall agreement with a bidder, if it considers below certain thresholds, the shareholders the agreement to be in the main interest of listed companies must disclose the of the shareholders. However, the target’s changes in their holdings by notifying the board should reserve the opportunity to company itself and the FIN-FSA. reconsider the offer in case a competing offer is made, and it should disclose the Under the Companies Act, the bidder must information concerning the signing and the without undue delay notify the target when main terms of a combination agreement to its holding exceeds or falls below 90 percent the market. of the shares and votes of the target. The price paid by the bidder when building a stake in the target before announcing Andreas Doepel is a specialist partner at the bid may affect the determination of Borenius & Kemppinen.
www.financierworldwide.com | FW 269 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g In search of deal security – the Finnish version
by Jyrki Tähtinen
The M&A market in Finland has been effectively continued to take the risk that particularly noteworthy. From the autumn banks may utilise the material adverse 2006 leading up to the spring of 2007, change clause in the finance agreements to deal volumes were at record levels. Asset halt the deal. prices were high and terms and conditions seller-friendly. Banks competed for In the current environment, liquidity is acquisition financing and loan terms were tighter, lending covenants are back to what accommodating. It was, in short, a heated can be considered a more normal level, period of deal activity. prices have fallen and sellers are beginning to look to more strident deal protection Representations and warranties in share to secure the transaction. What happened purchase agreements were limited, and in other jurisdictions much earlier in the many times sellers effectively represented market cycle in terms of seller-side deal solely that they were the legal owner and protection is only now gaining momentum that they had the authority to sell. in Finland.
The market reached a point where This phenomenon is very particular to bidders in controlled auctions marked Finland and shows, in some respects, how representations and warranties against the Finnish market is often a bit slower themselves just to make the point that to adopt the latest trends. Sellers’ refusal they were very keen to sell. These were to grant buyers any finance-related walk heady times. That said, the terms of away movement spread from the US to representations and warranties during this our neighbouring Sweden in spring 2007, a heyday mirrored events that transpired country that is traditionally quicker to adopt in other markets. Representations and new ideas than more-conservative Finland. warranties were lax elsewhere, too, and were a reflection of the seller-friendly deal Comparisons can be made to the environment. dotcom boom in the early part of the new millennium. Finnish venture capital The harder they fall firms were hesitant to invest in newfound dotcoms; Swedish VC firms, in contrast, But where events in Finland differed were quicker to provide financing. When considerably in 2007 from the UK and the the bubble finally burst in 2000, numerous US relate to deal protection issues. Even Swedish VC firms went belly up, but no at the height of the M&A boom, buyers Finnish VC firm shut its doors. in Finland were in most instances able to walk away from the deal if they could This statement is not intended to wave the not drawdown on bank financing. Sellers Finnish flag. As a consequence of Finnish
270 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS hesitance, market players may often be The state of affairs on the other side of the unable to reap the highest returns at the Atlantic during the pre-credit crunch period height of a bubble. But, on the upside, was quite different. Sellers negotiated ‘no Finnish investors also may not fall as far if financing out’ and specific performance the cycle ends abruptly. Dexterous market clauses as a prerequisite to deal signing. plays are something Finns have yet to learn. Sellers refused to accept any MAC risk The poker game in this particular Nordic that resulted from financing availability market, in that sense, is at times less high on behalf of the buyer. This tendency also stakes. gained hold in Sweden and effectively resulted in shifting the risk of MAC clauses Show me the money in financing agreements to the buyer.
Deal security is vitally important for sellers All went well in the US until the spring and buyers. The media regularly publishes credit crunch. Banks stopped providing news items on an impending acquisition financing and buyers tried to use the MAC at the time of signing and little mention is clause to halt the deal. Buyers, in turn, sued made of conditions precedent to closing based on no financing out language and the deal. The deal is effectively done in the demanded specific performance. Costly eyes of the public. Buyers that walk away litigation ensued (See United Rentals, Inc. v. before closing can create havoc for the RAM Holdings, Inc., Civil Case No. 3360-CC). seller. A new buyer has to be found, and the investing public may begin to wonder if During this same time period, parties something is wrong with the seller’s assets. agreed to ‘reverse termination fees’ as Lower prices are possibly negotiated, and a means to deter costly litigation and the seller’s brand potentially tarnished. payment of damages should banks prevent drawdown on loan financing. This From the buyer’s perspective, a condition strategy was effectively used in at least one that is buyer-friendly allows it to walk instance to thwart potential litigation. On 4 away if it cannot drawdown on the agreed January 2008, it was announced that PHH upon financing without fear of impending Corporation reportedly received $50m in litigation. In public auctions with private reverse termination fees from Blackstone equity bidders, especially, acquisition Capital Partners V L.P resulting in a failed financing is an important part of the merger that stemmed from the inability of purchase price, making availability of bank the buyers to receive acquisition financing. liquidity a vital prerequisite to closing the deal. And in Finland during this 2007 boom, For many international banks, the credit private equity investors, indeed, took the crunch meant that they were left with large leading role on the buy-side. The principles loans that they were unable to syndicate, that “We will buy you at the agreed terms thus preventing the issuance of further and conditions if we can drawdown on bank loans for new deals. The market abruptly financing” prevailed in Finland throughout came to a halt. 2007, and sellers most of the time accepted this important condition precedent Meanwhile, in Finland, deals continued even though the market was otherwise to progress quite smoothly until July and extremely seller-favourable. August 2007 when banks temporarily www.financierworldwide.com | FW 271 INTERNATIONAL MERGERS & ACQUISITIONS 2008 halted deal financing. The history of this alternatives to costly litigation should occurrence is traceable to the subprime financing fall through. mortgage crisis in the US and the subsequent backlash to international Predicting the future is always difficult, and banks. A number of pending transactions it is quite possible that spring of 2008 in were temporarily delayed; but, interestingly Finland will end up resembling the spring enough, starting in September, banks of 2003 when the M&A market dried up (either the same or competing ones) started and deals were very limited. At this point, providing financing anew, and the terms however, there is still some room for and conditions started to shift back to what optimism. had been seen some 18 months earlier. It has now been reported that Nordic banks Private equity interest in Finnish assets operating in Finland do not have significant still remains. PE houses have been able to US subprime mortgage holdings. sell assets at good prices and have raised new funds. For banks, the smaller size of The party is almost over – or is it? deals in Finland means that there is not the same need for syndication as exists in larger Even in the autumn 2007 very few, if any, markets. This is important, as syndication deals in Finland died as a result of the buyer in this post-credit crunch environment is not being able to drawdown on financing. difficult. There are about eight to ten banks in Finland that are willing to do acquisition Market participants certainly no longer financing under Finnish law. None of the expect a repeat of spring 2007, but how banks in this group have written-down big a volume drop-off will be experienced loans in any meaningful way even post- remains to be seen. At the moment, no credit crunch. public deals in Finland have ended up in litigation as a result of deal protection But following in line with international issues. If there are disputes, those are being trends, by the end of 2007, Nordic banks handled in confidential arbitration, which is expressed concern that buyers were the norm for M&A in the Finnish markets. paying too much. Lending covenants became stricter and liquidity less available. Where we are seeing M&A litigation A number of sellers still stuck to valuations increasing is where buyers are alleging that that were no longer possible; deals were assets are not as represented. In contrast pulled by sellers at times, and buyers to events in the US, litigation surrounding expressed disinterest in the high-end price deal protection issues have not come to the terms of the good old days. forefront, at least not yet – and due to the possible future use of reverse termination Only now are sellers looking to secure deal fees coupled with no financing outs, may protection at signing through ‘no financing not come to fruition in the future, either. out’ clauses. It is possible that buyers in Finnish markets may have to agree to the full risk of financing in the near term. In this environment, pre-set reverse Jyrki Tähtinen is the managing partner of termination fees look like attractive Borenius & Kemppinen Ltd.
272 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Practices, trends and acquisition structures in the Finnish property market
by Niklas Thibblin
The interest of foreign investors in the area but also in medium size cities and Finnish property market has remained municipalities that have busy retail and high in recent years leading to a quick commercial businesses. It appears that internationalisation of the sector. foreign investors often concentrate on a The Finnish property market is today niche, be it warehouses, hotels, retail and characterised by high levels of transparency shopping centres outside the city centres, and liquidity as well as fairly attractive or large commercial properties whose growth prospects. tenants are large and reliable corporate entities. In particular, retail properties According to market studies, the aggregate have recently attracted foreign investors volume of property transactions in Finland in smaller cities and municipalities since amounted to around €6bn in 2007 up from these investments tend to offer a fairly €5.5bn in 2006. For comparison, in 2002 high return in circumstances where the the transaction volume was as low as €2bn. cash flow is secured by a long term lease. Last year, foreign investors accounted It is generally expected that foreign for more than 64 percent of all property investors will sell parts of their Finnish transactions by value. holdings in 2008 and that the restructuring of the property portfolios by traditionally From a global perspective, the prevailing dominant Finnish investors will continue, view is that returns on property will be which enhances market liquidity further. lower in 2008, based mainly on declines in capital appreciation, which will only be Investment practices partially offset by holding rental levels. Nonetheless, it is generally believed that The emergence of new players in the the Finnish property market will continue Finnish property market (including an to be attractive in 2008, although no major increasing number of domestic private increase in the transaction volume is equity real estate funds), in combination expected. Contrary to property markets in with the increased internationalisation, many other European countries, Finland is has resulted in new market practices in the still expected to have fairly good prospects property investment process. Sophisticated for total returns. Also the risks associated due diligence reviews as well as auction with the Finnish property market are procedures have become standard considered to be moderately low and the approaches, especially in transactions risk/return prospects are considered to be involving larger property portfolios among the best in Europe. and international players. In smaller transactions and among domestic investors Foreign investors are today not only familiar with the Finnish property market, interested in the Helsinki metropolitan more traditional and less formal transaction www.financierworldwide.com | FW 273 INTERNATIONAL MERGERS & ACQUISITIONS 2008 procedures may still be applied. A MREC does not normally aim to show any profit. The operating costs and Another trend in recent years is the expenses of a MREC are usually covered increasing role of leverage and, generally, by maintenance and management fees external financing. It seems more like a rule payable by its shareholders to the MREC than an exception that properties are being whereas the rental revenue is channelled purchased by highly leveraged investors. directly to the shareholders of the MREC From a foreign investors perspective, from the tenants. In general, a MREC may this together with the lack of any specific for all intents and purposes be used in Finnish thin capitalisation rules enables, Finnish property investments to minimise inter alia, tax efficient debt push down the overall tax burden. In particular, in structures for Finnish property investments circumstances where the amount of tax (although harsh intra-group debt financing deductible depreciations of a MREC can could, at least theoretically, be challenged be matched with the amount of its loan by the Finnish tax authorities by virtue of instalments (which are included as a part general tax avoidance provisions). of the maintenance and management fees received from the shareholders), the Finnish property structures total tax burden is effectively reduced. Accordingly, a MREC is basically in a From a legal point of view, owning property position to deduct for tax purposes the in Finland means, in essence, owning the acquisition cost of its underlying property. A underlying plot and the buildings located REC, as opposed to a MREC, can in principle thereon (although the plot may also, not benefit from the corresponding instead of freehold, be leased). In reality, matching of loan instalments with property ownership is often organised depreciations. through a Finnish real estate company (REC) or a Finnish mutual real estate Property acquisition structures company (MREC), whose sole objectives are to own and manage the underlying Income from Finnish property, including property. Both a REC and a MREC are income (gain) derived from the disposal of by definition Finnish limited liability Finnish property as well as shares in a REC companies with more or less similarly and a MREC, is taxable in Finland as Finnish organised governance. source income. Therefore, it is generally not feasible for a foreign investor to hold However, a specific feature of a MREC is property directly. As Finland under most that the lease income is allocated directly tax treaties similarly is entitled to tax such to its shareholders whereas in a REC the gains, a Finnish holding-structure is more lease income is allocated to the REC itself. or less necessary to enable a tax-efficient Accordingly, in a MREC-structure the exit. The reason for this is that shares in an lease contract is concluded between the ‘ordinary’ Finnish limited liability company shareholder of the MREC and the tenant, as (such as a pure holding company) are in opposed to a REC-structure where the lease Finland by definition considered as movable contract is concluded between the REC and property, why the gain derived from the the tenant. disposal of such shares is generally not covered by the provisions of tax treaties.
274 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
However, there is no case law whether taken for the launch of such a vehicle. general Finnish tax avoidance rules could Although certain amendments to the become applicable in a clear tax avoidance Finnish property fund and mutual fund situation causing Finland to claim the right legislation were recently made, they appear to tax regardless of the formal status of not to bring about any significant benefits the holding company in question. Such an for the property industry (at least from a tax outcome would, however, seem farfetched perspective). where sufficient business reasons can be found behind the selected holding As a result of the declining stock market, structure. Holding structures have to date increased uncertainty and general been widely used for Finnish property overpricing of many asset classes, property investments. investments can, however, still provide an opportunity to achieve higher returns. Why Domestic Finnish property investments then invest in Finnish the property market? have, in turn, increasingly followed the international trends of indirect property There are a number of reasons for this. investments through private equity real Undoubtedly, the ability to obtain higher estate funds. The funds targeted for yields in combination with a highly liquid domestic investors are most commonly market and large transaction volumes structured as partnerships. Partnerships should qualify as motivating factors. In are able to utilise debt financing, which addition, the Finnish property market offers often is an important incentive for such a solid framework for doing business, along structures at least from a tax perspective. with virtually no corruption. Also a modern, In addition, partnership-structures facilitate dynamic and understandable legal structure a third party management. However, pure supports the property market. The market and direct Finnish partnership-structures is open and investors can obtain virtually cannot, as a rule, be beneficially applied all the necessary information they desire in property investments where foreign about specific companies and properties. investors are involved. Last but not least, there is a surprisingly large number of experienced domestic and Recent amendments and future prospects international professional players on the Finnish property market providing depth to The Finnish property industry has long the same. aimed for a REIT type tax-transparent property investment vehicle. Yet, in practice, no concrete actions have been Niklas Thibblin is a lawyer at Waselius & Wist.
www.financierworldwide.com | FW 275 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Regional regulatory features of M&A deals in Russia
by Tatiana Kachalina and Svetlana Dubinchina
The recent volume of both domestic and (AO) subdivided into open AO and closed foreign capital attracted by the Russian AO. Most Russian companies targeted economy has grown demonstrably. The by investors as targets exist within one of volume of M&A deals and a sizeable these two main corporate structures. number of professional investors on the market inevitably resulted in a gradual Much of the regulation depends on a displacing of raider methods for more corporation’s structural set up. Proper civilised mechanisms for organising and consideration must be paid to statutory executing M&A deals. requirements providing the pre-emptive right to buy shares of closed AOs sold The prevailing practice of dealmaking in to third parties as well as that of OOOs’ this area increasingly permits investors participants to buy shares in OOOs’ charter to gain the most clear-cut insight into a capitals when they are sold to third parties, potential target, avoid blind purchasing, non-participants of the OOOs. Generally, consider identified risks in the context of the procedure for exercising pre-emptive a proposed transaction, go through all rights is set by a business entity’s charter, necessary preliminary target acquisition which can also fix the pre-emptive right for approval formalities at administrative the entity itself to buy shares. authorities and hit the mark while forecasting projected resources, time and Most heavily regulated deals are still costs associated with a deal. acquisitions of stocks in an open joint stock company’s charter capital. Particularly, There are a number of specific features Chapter XI.1 of the Federal Law ‘On in the regulation of M&A deals in Russia Joint Stock Companies’ sets forth special that prospective investors must consider requirements for the procedure of when designing deals, to protect their acquisition of a large stock by investors. own interests on the capital market and to Thus, an investor planning to purchase exclude competition blocking. more than 30 percent of the total number of voting shares has to take into account The Russian legislation acknowledges a that: (i) prior to purchasing the said holding wide spectrum of corporate structures of shares he has the right to send to the within the bounds of which a proprietary open joint stock company a voluntary (bona organisation may exercise its business fide) offer addressing shareholders who activity. Two corporate structures have own shares of corresponding categories or gained greater acceptance. The first types with a public offer to purchase their structure is the limited liability company shares; otherwise (ii) within 35 days after (abbreviated in Russian to ‘OOO’) and the buying the said holding of shares he will second form is the joint-stock company have to send to owners of the rest shares
276 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS of corresponding categories or types and of a stock market trade institutor for six holders of other securities convertible into months prior to the date a mandatory offer such shares a mandatory offer containing a is sent to the federal executive authority public offer regarding the purchase of the for the securities market. If securities are securities from them. On acquiring more traded by two or more trade institutors, than 95 percent of shares the investor is their weighted average price is determined obliged at the request of shareholders to upon trading results of all stock market buy the remainder of shares placed by the trade institutors when the said securities company (hereafter the specified course have been traded no less than six months. of action by the investor is referred to as If securities are not traded on the stock ‘tender offer’). market or have been traded for less than six months, the purchase price of securities The procedures indicated above are not cannot be lower than their market value unique to Russian corporate law, as legal estimated by an independent appraiser. systems of other countries also incorporate Notably, the market value in this case is similar institutions. To a foreign investor the calculated for a single corresponding share practical application of the cited chapter of (another security). If within six months prior the Federal Law ‘On Joint Stock Companies’ to the date a mandatory offer is sent to an in 2006-2008 is of utmost interest. open company, the sender or its affiliates have bought or taken a liability to purchase It is essential to note that the tender offer the corresponding securities, the price procedure is controlled by the FFMS of for securities due to the mandatory offer Russia, a state authority regulating Russian cannot be lower than the maximum price financial markets. The order of exercising the sender has bought or taken a liability to the tender offer is regulated by the Order purchase these securities at. of FFMS of Russia as of 13 July 2006 No 06-76/пз-н (ed. as of 16 October 2007) ‘On Affirming the Provision for Requirements for the Procedure for Specific Actions While Purchasing more than 30 percent of Shares in Open Joint Stock Companies’. The strict The practice of exercising mandatory and and orderly observance of the procedure voluntary offers has revealed cases when minority is a prerequisite of validity of a transaction related to the purchase of shares by the shareholders disputed the price estimated by investor within the procedure itself. independent appraisers.
Fixing a redemption price of shares determined within the tender offer is a question that arises frequently in the application of the Chapter XI.1 of the Despite the consistent approach to Federal Law ‘On Joint Stock Companies’. determining a redemption price, the The law strictly stipulates the procedure for practice of exercising mandatory and determining a price for shares which cannot voluntary offers has revealed cases when be lower than their weighted average price minority shareholders disputed the price calculated with basis on trading results estimated by independent appraisers. www.financierworldwide.com | FW 277 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Specifically, such a case is reflected in oneself with the legislative requirements, Decree of the 9th Arbitration Appeal both in terms of time cost and financial Court as of 07 November 2007 No 09АП- planning. 14428/2007-ГК on Case No А40-23719/07- 34-161. In future such disputes are likely Applying business entity shareholder to bring about still more strict and formal agreements criteria for determining the redemption price within execution of mandatory and Another significant factor one has to bear voluntary (bona fide) offers procedure, in mind in contemplating M&A deals in the including more stringent requirements for Russian market is primacy of the federal independent appraisers estimating the legislation and foundation documents redemption price. in regulating relationships between shareholders (participants) of business The second essential point a prospective entities as to the management of the investor is to bear in mind is the company. requirement for the investor to secure payment of the share price to shareholders The international practice recognises who have accepted the tender offer. agreements negotiated between and Pursuant to Paragraph 2 of Article 84.1 entered into by participants (shareholders) and Paragraph 2 of Article 84.2 of the that provide the parties with regulation Federal Law ‘On Joint Stock Companies’ a for the company management issues. tender offer should be supplemented with This cannot be applied to a full extent in a bank guarantee which should secure the the Russian context, as according to the guarantor’s liability to pay the price of sold federal laws ‘On Joint Stock Companies’ securities to their former holders in case a and ‘On Limited Liabilities Companies’ sender of voluntary (bona fide) offer fails to the management of a business entity is carry out his commitment and pay for the exclusively governed by the company’s securities on time. Need in the guarantee charter. is conditioned, on the one hand, with the necessity to protect rights of a company’s The participant agreement can regulate minority shareholders who have accepted only certain questions related to rights the tender offer and, on the other hand, of the company’s participants that to avoid numerous lawsuits of minority are explicitly stated by the law. For shareholders in case a sender of the offer instance, Paragraph 4 of Article 21 of fails to carry out his commitment and pay the Federal Law ‘On Limited Liabilities for the securities transferred to him. Hence, Companies’ sets regulation for execution the requirement results in higher standards of pre-emptive right to purchase shares. for solvency and creditability and financial It is inadmissible to regulate matters status of a prospective share acquirer, as concerning (i) the status of a Russian legal potentially he must be ready to purchase up person and rights and obligations of its to 100 percent of an open AO’s shares. participants as to the OOO’s activity, and (ii) meetings of the OOO’s participants Thus, in planning acquisitions of a large and other company’s authorities with blocks of shares in open joint stock agreements regulated by foreign laws, as companies it is necessary to familiarise these matters are subject to the Russian
278 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS legislation, which is explicitly stated in 2109/2005(14785-А75-11) on Case N А75- Article 1202 of The Civil Code of the RF. 3725-Г/04-860/2005). This is also reflected by the emerging court practice in similar cases related to Under the circumstances, potential joint stock companies set up under the investors need to take into account the Russian legislation dealing the question regulations on a wide spectrum of issues of applying provisions of shareholder related to the company management with agreements governed by foreign laws regard of the foundation documents of a (Decree of the Federal Arbitration business entity. Court for West-Siberian District as of 31 March 2006 No Ф04-2109/2005(14105- А75-11), Ф04-2109/2005(15210-А75- 11), Ф04-2109/2005(15015-А75-11), Tatiana Kachalina is a partner and Svetlana Ф04-2109/2005(14744-А75-11), Ф04- Dubinchina is an associate at Liniya Prava.
www.financierworldwide.com | FW 279 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Antimonopoly policy in Russian M&A deals
by Tatiana Kachalina and Svetlana Dubinchina
In Russian M&A, it is essential to meet (its group of persons), equity interest, the requirements of the antimonopoly shares, rights or property of which are law aimed at ensuring sound competitive acquired exceeds 3bn rubles; or (ii) their environment on the commodity and service aggregate proceeds from selling goods market. For this reason most deals implying in the last calendar year exceeds 6bn redistribution of capitals are subject to the rubles with assets in recent balances of antimonopoly regulation. In Russia the the business entity (its group of persons) main law governing the area is the Federal equity interest, shares or property of which Law ‘On Competition Protection’ No 135- and/or rights over which are acquired ФЗ as of July 26, 2006. This law stipulates exceeds 150m rubles; or (iii) if any of the regulation for M&A deals both on the indicated persons is put on the register, run financial service and commodity markets. by the Federal Antimonopoly Service, of In this article we dwell upon controlling business entities with a market share on a the purchase of equity interest (shares) in specific commodity market of more than 35 the charter capital of business entities and percent. purchase of fixed assets and intangible assets of business entities. This form of control is practiced when an investor or a group of persons, including While carrying out transactions for the an investor, purchases in a non-financial purchase of equity interest in the charter organisation: (i) more than 25 percent capital of a limited liability company of shares on condition that prior to the (abbreviated in Russian as ‘OOO’) or shares acquisition such a person (a group of in joint-stock companies (AOs) of non- persons) was not in command of this joint financial organisations, attention should stock company’s voting shares or was in be paid to the following forms of control command of less than 25 percent of voting over this category of deals executed by the shares of the joint stock company; (ii) antimonopoly bodies on the territory of the more than 50 percent of shares provided Russian Federation. that such a person earlier was in command of no less than 25 percent and no more Obtaining preliminary approval than 50 percent of shares of the joint stock company; (iii) more than 75 percent A preliminary approval must be obtained of shares on condition that before the for investment deals involving purchase of purchase the investor had the right over equity interest in charter capitals of OOOs no less than 50 percent and no more than and shares of AOs if: (i) the aggregate 75 percent of shares of the company; (iv) assets cost in recent balances of purchasers more than one third of equity interest in of shares (equity interest in charter capitals, the charter capital of an ООО provided rights, property) and the business entity that prior to the purchase the investor
280 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS did not have any equity interest in the which a minority shareholder of a foreign charter capital of the ООО or such interest holding gets the right to make decisions as amounted to less than one third; (v) more for forming a position in the name of the than one half of equity interest in the holding company while voting for specific charter capital of an ООО on condition agenda items at the stockholders meeting that before the purchase the investor as a shareholder of a Russian company, owned no less than one third and no more it may be subject to the antimonopoly than one half in the charter capital of the control of the Russian Federation, including ООО; (vi) more than two thirds of equity cases when it leads to competition restrain interest in the charter capital of an ООО (Paragraph 2 of Article 3 of Federal Law ‘On on condition that before the purchase the Competition Protection’). investor owned no less than one half and no more than two thirds in the charter Subsequent notification capital of the ООО; (vii) acquisition, usage or ownership over fixed production-related When equity interest in the charter capital assets and/or intangible assets of another of an OOO, shares of an AO or property of economic entity, if the balance value of Russian organisations as well as rights in the property rendering subject to the deal respect of such organisations are acquired, (or interrelated deals) exceeds 25 percent this form of control is executed in the same of balance value of fixed production- volume and in the same cases a preliminary related assets and intangible assets of the approval is applied. Though subsequent economic entity alienating or transferring notification is applied in respect of deals property; or (viii) as a result of one or involving companies with less asset volume several deals (also pursuant to the property and proceeds, than it is established for a trust contract, agreement of cooperation preliminary approval, namely, if aggregate or contract of agency) an investor acquires asset cost in the last balance or aggregate rights enabling him to specify conditions for proceeds from selling goods of the business operation of the economic entity acquirer (its group of persons) as well as or to act as its executive body. of the company in respect of which rights (shares, equity interest and/or property) The last category of deals is the greatest are acquired in the calendar year prior to challenge for law enforcement. Thus, the the year of executing such deals (other regulatory control does not deliver any clear transactions) exceeds 200m rubles, and criterion for identifying a circle of deals aggregate asset cost in the last balance that as a result provide the investor with of the entity (its group of persons) whose rights enabling him to specify conditions shares, equity interest and/or property for business operation of the economic are acquired or in respect of which rights entity. It is very important to consider are obtained exceeds 30m rubles, or one this form of antimonopoly control while of such persons is put onto the register of drafting agreements between shareholders business entities with a market share on a of foreign holdings that are already specific commodity market of more than 35 shareholders or are just planning to acquire percent. a controlling share (equity interest in the charter capital of an OOO). Assuming such Such a notification is to be issued within 45 an agreement contains provisions under days (no later) since the execution of the www.financierworldwide.com | FW 281 INTERNATIONAL MERGERS & ACQUISITIONS 2008 corresponding deal or transaction. By and large a list of deals related to acquiring interest equity, shares and/or Failure to meet requirements of the banking assets that require a preliminary antimonopoly law on the procedure of approval of the antimonopoly authorities endorsement of deals for acquisition agrees with the similar list above regarding of rights in respect of commercial deals involving non-financial organisations, organisation, shares (equity interest in with the exception of when credit charter capitals) or/and property can lead institution assets are acquired. Thus, a to a situation where the court may find preliminary approval is required for deals such deals ineffective at a lawsuit of the when, as a result of one or several deals, antimonopoly authority, provided that such the investor acquires financial organisation deals have brought about or bring about assets if their volume exceeds 10 percent competition blocking including cases of of the asset cost according to the balance emerging or strengthening dominance sheet of the financial organisation as of (Paragraph 2 and 4 of Article 34 of the the last reporting date, prior to the date of Federal Law ‘On Competition Protection’ submitting the application. No 135-ФЗ as of July 26, 2006). Control of the Central Bank of the Russian Special regulation for acquiring blocking Federation shares in banking Presently, foreign investors acquiring There are specific forms of control over shares (equity interest in the charter concentration of capital on the financial capital) of existing credit institutions are service market, which includes a segment subject to the national regime, which that has become particularly popular means they can acquire equity interest in recently: banking. the charter capital of credit institutions under the same regulation as provided for Acquiring equity interest in charter capitals companies set up under legislation of the (shares) of credit institutions investors Russian Federation. While acquiring large have to meet both special requirements shares in credit institutions a preliminary of the antimonopoly law in respect of approval of the Bank of Russia is to be financial organisation like banks and special obtained or subsequent notification is to requirements for acquiring blocking shares be delivered. / equity interest in charter capitals of credit institutions established by the Federal Law According to Paragraph 8 of Article 11 of ‘On Banks and Banking’. the Federal Law ‘On Banks and Banking’ the purchase and/or asset management Control and approval of antimonopoly of more than 1 percent of shares or equity authorities interest of a credit institution resulting from one or several deals by a legal or private This form of control is applicable to deals person, or a group of legal and/or private with assets or/and equity interest in the persons constrained with an agreement, or charter capital (shares) of a bank if the cost by a group of affiliates dependent on one of assets of the credit institution according another, is subject to the notification the to the last balance exceeds 3bn rubles. Bank of Russia. If more than 20 percent is
282 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS acquired the deal is subject to a preliminary institution for the future and is provided approval of the Bank of Russia. with a general demand of Paragraph 5 of Article 11 of the Federal Law ‘On Banks and Within 30 days from receiving the Banking’, which prohibits use of the raised application the Bank of Russia informs funds for constituting the charter capital of the applicant on its decision – approval the credit institution. or refusal. A refusal should be reasoned. If the Bank of Russia does not inform Today, M&A in Russia is subject to rather the applicant on its decision within the consistent control, both inter-corporate and indicated period, the purchase of shares administrative. Companies contemplating or equity interest in a credit institution is M&A deals in Russia have to develop a considered to be approved. It should be detailed implementation plan for such noted that considering acquisitions of large deals, allowing for material, time and shares in credit institutions for approval costs and the ability to address specific the Bank of Russia places emphasis on regulatory demands under laws of the the financial stability of the acquirer. The Russian Federation. criterion here is the sufficiency of the acquirer’s own funds for the payment of a corresponding share or equity interest in the charter capital. The aim is to ensure a Tatiana Kachalina is a partner and Svetlana sustainable financial position of the credit Dubinchina is an associate at Liniya Prava.
www.financierworldwide.com | FW 283 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Recent trends in the Russian M&A mid-market
by Oleg Mikhailovsky
As the Russian economy continues eyes of potential, cash-rich buyers. its impressive growth potential and gradually becomes more sophisticated, With respect to inbound activity, we M&A has largely replaced the plain ‘asset expect continued strong demand from accumulation’ that marked the 1990s. foreign players. Moreover, although a few years ago interest stemmed mostly from M&A has quickly become the driving force multinationals, we are now seeing ‘a second of the country’s third redistribution phase wave’ whereby smaller international players of property and assets. The privatisation are trying to get a foot in the door of the process of the early 90s was a ‘crude Russian market. This desire to establish affair’, but it created myriad investment presence in a quickly developing market opportunities that are now beginning to with high growth potential will increase due bear fruit, especially in the flourishing mid- to expectations that developed markets will market sector. underperform and experience slow growth.
We expect to see in the near future Investors can generally be divided into continued and growing activity in the two major categories: strategic and Russian mid-market, with a focus on the financial. Strategic investors usually seek a retail and consumer goods sectors. Both controlling stake in a business. They usually sectors are still fragmented, and Russia also have a longer investment horizon and is a large consumer market. This offers are often reluctant to pay higher prices. tremendous opportunities for both large The major advantage of a financial investor Russian as well as international acquirers. – from a seller’s point of view – is that they provide access to capital to capture Russia is often perceived primarily as a growth opportunities, do not always destination for inbound M&A activities, demand a majority stake and typically and as a developing market with a huge exit within three to five years. Their major growth potential. However, there is also disadvantage is that the strategic value-add an increasing volume of outbound M&A they offer can be limited. transactions in the recent years. We expect that outbound activity will continue to In the last two years the Russian M&A grow. One reason is the need for larger mid-market experienced a boom in private Russian players to diversify their businesses equity, as more foreign players entered. or improve their geographic diversification. Russia not only offers higher returns than Moreover, the global credit squeeze many other markets, it also has a thriving and expectations of a possible recession and comparatively young ‘population of in developed markets have resulted in entrepreneurs’ that prefer to keep control. appealing valuations of some assets in the Consequently, PE players are welcome to
284 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS provide capital for the further development public via an IPO. Even though an IPO of the company. might be an option for a medium sized business, the choice in terms of the ‘listing When dealing with this new generation place’ is usually limited. of Russian entrepreneurs it is important to understand the key issues. Most of There are many potential rewards of the major deal drivers resemble those in conducting an M&A transaction in Russia, mature M&A markets, but some are unique but dealmakers should be aware of, to Russia. First, owners conclude that they and sensitive to, common acquisition cannot ‘survive on their own’ in a market and post-acquisition risks. Those risks, that is increasingly competitive, particularly if not addressed or mitigated, can be in the mid-market. At the same time, strong dealbreakers or ruin potential synergies. consolidation trends are underway. Second, there is a need for additional capital. Fast growing businesses require significant investments to keep pace with competitors and to achieve ambitious targets. Third, there is a necessity to get access to When dealing with this new generation of Russian Western know-how and best practices. Increasingly, Russian small and medium entrepreneurs it is important to understand the key sized businesses would like to implement issues. best practices to increase their growth potential, productivity and business value. Finally, there are succession issues. While the average age of the typical Russian entrepreneur is close to 40, quite a number are above 50 and many of them realise First, company cultures can be very that they need to sell while the timing is different, which may create impediments favourable. to people working together smoothly. It is critically important for an acquirer Of course, the most frequent deal driver for to become familiar with the people it Russian mid-market entrepreneurs is the is going to close a deal with. Cultural need for finance to grow their businesses. differences between western investors and Currently, a variety of financing options Russian entrepreneurs can sometimes be exist in the Russian market, ranging from significant. Also, personal relationships plain vanilla bank debt to an initial public in Russia play a much more important offering (IPO). Obviously, the financing role then in Western Europe or the US. choice depends on various factors: the You can solve some important deal issues maturity of a business, the needs of the much more efficiently if you have already current owners, market conditions, etc. established a good personal contact and if For medium-sized businesses, it is easier, there is a mutual understanding with the simpler and cheaper to finance business potential Russian partner. growth through retained earnings, bank debt or by bringing in an equity partner Second, many Russian entrepreneurs still through a trade sale, compared to going bank on an outdated asset-based approach www.financierworldwide.com | FW 285 INTERNATIONAL MERGERS & ACQUISITIONS 2008 to company valuation rather than on more Finally, reporting processes and IT systems sophisticated valuation approaches such as tend to be very different. As a result, proper discounted cash flow. alignment is needed.
Third, due diligence is a critically In summary, we believe that the emphasis important part of the M&A process. on return on capital (i.e., commercial Many Russian companies still use various considerations in doing transactions) is tax optimisation schemes, and there becoming a clear trend in the Russian M&A can be significant differences between market. This will inevitably help redistribute management and statutory reporting. property and assets to professional Prior to entering into a deal, due diligence, stakeholders. accounting and reconciliation issues need to be understood properly to Oleg Mikhailovsky is a manager in avoid destroying deal value due to poor the M&A Lead Advisory practice at preparation. PricewaterhouseCoopers.
286 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Nature and scope of M&A in Ukraine
by Bogdan Borovyk and Cameron Hall
Ukraine is in the midst of an M&A surge, market where many sectors remain largely with growth in transactional numbers undeveloped. continuing to escalate on a yearly basis since the start of the boom in 2004. Attractive sectors During 2007, an estimated 683 deals were announced, with a total value around The banking and finance sector was the US$15.6bn, according to ISI Emerging most active in 2007. Most of these deals Market. Broken down by market sector, involved share acquisitions, with several investors largely focused on financial, premier Ukrainian banks being acquired mining and real estate, which made up by Western European multinationals, about 72 percent of all transactions for including Bank UniCredit (Ukrsotsbank), the year. The financial sector led in terms Commerzbank (Bank Forum) and Intesa of investment, with $4.8bn, followed by Group (Pravex Bank). Overall, the the mining sector at $4.3bn, and then real industry experienced a record number of estate with $2.2bn. transactions in 2007, with 51 announced deals. The National Bank of Ukraine noted Despite the prolonged political instability that 35 percent of investment in the surrounding the snap election and banking sector consisted of foreign capital subsequent formation of a new Parliament at 2007 year’s end, including 17 banks in 2007, foreign and cross-CIS investors wholly owned by foreign investors are showing more confidence in Ukraine as an accessible market with hidden value With this, however, the banking industry and substantial growth potential. Overall, has largely topped out. Relatively few the growth in M&A activity is forecasted to top Ukrainian banks are still up for grabs, continue, although the relative monetary although smaller and medium sized value will likely diminish slightly as much domestics may be the subject of future of the large scale M&A activity in the most consolidation. That said, Ukraine’s approval developed sectors has passed. as a member of the WTO in February 2008 may generate further interest in the sector, Relative to western targets, purchase with Ukraine committing to providing prices in terms of present value are high, non-discriminatory access to the financial particularly in view of the balance sheet service sector, and accession paving value of the assets acquired, many of which the way for foreign banks to establish are in disrepair and/or not in conformity representative branches in the country. with present day business standards. However, valuations are justified by the Other sectors have not strictly been the pace of development and the prospect target of M&A per se, however, insurance for substantial future market growth in a and retail and commodity food industries www.financierworldwide.com | FW 287 INTERNATIONAL MERGERS & ACQUISITIONS 2008 are predicted to be up and coming sectors. legislative regulation of M&A remains For example, the aggregate value of deals relatively poor and reform slow. To date, in the food industry in 2007 was estimated Ukraine has no specific law regulating M&A, at $1.3bn, including the acquisition by Pepsi requiring an investor to consider and comply Co. of a 100 percent interest in Sandora, with a multitude of laws and regulations. Ukraine’s leading juice producer, valued at Because of the combined novelty and lack $760m. The arrival and expansion of larger of effective regulation of M&A in Ukraine, multinational hypermarket chains will foreign investors will often conduct a share also lead to the consolidation of profitable deal under foreign law, and provide for domestic chains. Insurance M&A is driven disputes to be resolved by international by low competition at present, and will commercial arbitration abroad. likely grow with Ukraine’s forthcoming WTO accession.
Foreign investors: potential risks and their minimisation Despite the M&A volume in Ukraine, legislative Foreign investors play a significant role in the M&A sphere in Ukraine. According regulation of M&A remains relatively poor and to ISI Emerging Markets, 297 of the 683 reform slow. announced M&A deals in 2007 involved a foreign party. In terms of investor origin, the main sources of M&A investment are Russia (43 deals), Poland (18 deals) and the Netherlands (18 deals), with the popularity of the latter partly due to favourable tax The lack of familiarity with the M&A conditions between the two countries. process itself is further exaggerated by the chaos and disorder in which many prior Both Ukrainian and EU counterparts corporate ownership rights were achieved. will form holding companies in Cyprus A foreign investor will discover that for the purpose of financing Ukrainian Ukrainian companies are unable to produce operations, largely due to the favourable tax the necessary evidentiary and economic treatment on many forms of passive income support for a transaction, i.e., in terms of established by the Double Taxation treaty legal due diligence and valuation. Ukrainian between Cyprus and Ukraine. However, in owners may also express consternation 2007 the Ukrainian Government initiated with the legal demands of their foreign renegotiations of the Double Taxation counterparts, particularly with regard to the treaty with Cyprus. The draft of the new number of representations and warranties convention on Double Taxation presented sought by a foreign buyer. by the Ukrainian Government does not establish zero withholding tax on some sorts Additionally, the foreign investor should of passive income as the present agreement expect to face substantial bureaucratic does. A new treaty on Double Taxation may conditions and requirements, particularly be adopted in 2008. in terms of state issued permits, approvals Despite the M&A volume in Ukraine, (e.g., Anti-monopoly Committee), and
288 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS document authentication, among others. international commercial arbitration; and (iii) non-competition agreements However, recently the High Commercial between shareholders of Ukrainian Court of Ukraine threw corporate companies. While other jurisdictions may governance in M&A into limbo. On 28 enforce such agreements or clauses, the December 2007, the High Court passed a recommendations instruct that such recommendation ‘Regarding the Practice of agreements should not be recognised, Applying Legislation during Consideration as they are contrary to the imperative of Cases relating to Corporate Governance,’ norms and public policy of Ukrainian law, which cut deeply into the ability to use regardless of obligations which Ukraine has foreign law to govern corporate relations in as a signatory to the New York Convention Ukraine. on Recognition and Enforcement of Foreign Arbitral Awards. Much confusion has been The principle points of the recommendation expressed in the legal field regarding this render null and void: (i) shareholder recommendation. agreements regulating corporate relations between shareholders of Ukrainian corporations governed by foreign law; Bogdan Borovyk is co-head of the Corporate (ii) shareholder / participant agreements Law Practice Group and Cameron Hall is an providing for dispute resolution by attorney, at Beiten Burkhardt.
www.financierworldwide.com | FW 289 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Sector-specific M&A in Ukraine
by Bogdan Borovyk and Ekaterina Katerinchuk
Ukraine’s rising M&A market has driven insurance companies, due to the growing some notable developments in a number potential and relatively low competition. of sectors. Those with the most activity International insurance groups including are banking and finance, agriculture, Vienna Insurance, Generali, Fortis, BNP telecommunications and IT, and consumer Paribas and Allianz have already entered products. the Ukrainian insurance services market, mainly through acquisitions of Ukrainian Banking and finance insurance companies.
The banking and finance sector occupies The following specific features are pertinent the leading position in terms of M&A to M&A transactions in the banking transaction volume in the Ukrainian market and finance sector: (i) high transactions and is expected to remain active in 2008. prices in comparison to other sectors; (ii) The most attractive investment targets in involvement of investment banks, financial 2007 were banks: 51 M&A transactions were and legal advisers; (iii) due diligence conducted with the shares of Ukrainian procedures in the acquisition process; banks. According to the official statistics and (iv) acquisition of decisive control of the National Bank of Ukraine, as of 1 (from 75 to 100 percent of share capital). January 2008, 47 Ukrainian banks had Among the legal regulations affecting such foreign capital, with 17 being solely owned transactions, it should be mentioned that by foreign investors. The most notable M&A the applicable laws require approval from transaction of the year was acquisition of the National Bank of Ukraine for acquisition Ukrsotsbank, one of the leading Ukrainian of a substantial portion (10 percent or more) banks, by Bank Austria Creditanstalt AG of a bank’s share capital, as well as approval which belongs to the UniCredit group, for from the Anti-monopoly Committee of US$2.2bn. Ukraine (should the transaction satisfy certain quantitative thresholds, which is Although a number of the top 10 Ukrainian usually the case in the banking and finance banks have been already acquired by sector M&A). foreign investors, experts predict more acquisitions in 2008 as the banking Agriculture and finance sector has not yet reached saturation. Moving forward, investors are The Ukrainian agricultural industry is more likely to acquire mid-level banks and believed to have considerable potential small local banks. for M&A transactions. Currently, this sector is characterised by a low level of Investor demand has also increased in consolidation and competition as the non-banking financial institutions and majority of agricultural market players (up
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to 90 percent) are small retail companies and oil-producer) and Astarta Holding N.V. possessing small agricultural land areas. (a leading Ukrainian sugar company). In addition, due to weak development of the real estate market in Ukraine, many Target companies in this sector are experts believe that land is substantially mostly small agricultural enterprises with undervalued. The Ukrainian agricultural no modern technology and machinery, industry suffers from a lack of funds and sizeable liabilities and low profitability. investment, in particular, the northern and Major legal flaws are often discovered in western regions of Ukraine are considered the land and real estate title documents of to have good development potential with such companies. For these reasons, target a large number of investment targets companies in the agricultural sector may be available for acquisition. Another important acquired for moderate prices. factor is the increasing demand in the food market, which is experiencing a substantial Telecommunications and IT lack of high quality raw materials from the agricultural industry. Due to increasing consumer demand for communications services and the rise in GDP in Ukraine, the telecommunications and IT sectors have demonstrated rapid Due to increasing consumer demand for developments in recent years to become communications services and the rise in GDP in more attractive to potential investors. Segments with the most potential for M&A Ukraine, the telecommunications and IT sectors are mobile communications and internet have demonstrated rapid developments in recent services. Investor interest is also growing in media businesses and cable broadcasting years to become more attractive to potential services. investors. The most notable M&A transactions of the last year were the domestic acquisition of Optima Telecom, the Ukrainian fixed line Investing in the agricultural industry telecom operator and internet services carries certain risks, such as dependence provider, by System Capital Management on climatic and weather conditions, and for US$130m, and the cross-border uncertainty in the Ukrainian land market acquisition by US buyout firm Providence due to the moratorium imposed on the sale Equity Partners of Ukrainian cable of agricultural land. Nevertheless, experts television group Volia Cable for US$200m. predict several M&A transactions in 2008, particuarly in the fat-and-oil and sugar A number of large M&A transactions in the industries. last year have brought major consolidation and intensified competition to the The most notable M&A transactions last Ukrainian mobile services market, including year were domestic acquisitions made by the substantial acquisition of UMC, a Kernel Group (the leading Ukrainian oil leading mobile communications provider, producer), Allseeds Ukraine company (a by MTS, the leading Russian-based CIS major Ukrainian seeds trading company mobile communications provider. This has
www.financierworldwide.com | FW 291 INTERNATIONAL MERGERS & ACQUISITIONS 2008 decreased investment opportunities in the leading juices producer Sandora by Pepsi sector. Moreover, due to time consuming for $US758m, dairy company Fanny by and complicated licensing procedures, Lactalis Group at for US$45m, mineral and the absence of any regulations on water company Rosinka by Orangina Group new communication standards, the for US$65m, cheese manufacturer Shostka mobile services market bears certain by Bel group for US$50m, and cheese administrative risks for potential investors. manufacturer Klub Syru by Renaissance Capital for US$197m. Experts estimate that the profits of internet services providers have grown Despite a large number of acquisitions, by 90 percent over the last year, making the food industry is still considered to them attractive targets for M&A. Experts have major investment potential as the note investor interest in the acquisition of level of consolidation and competition is local internet providers and small phone low compared to developed economies. companies with values around US$4- However, a number of sub-sectors (e.g., 5m. When acquiring Ukrainian internet beverages, beer and alcohol) have already providers, investors favour asset deals, thus seen consolidation as the most attractive acquiring only real estate and equipment to targets have already been acquired, so they avoid corporate and financial risks. do not offer many opportunities for new investors to enter these markets. Consumer products One of the main risks in consumer products The increasing wealth of the Ukrainian M&A is the lack of high quality raw population and the development of the materials (which must be imported) and consumer credit market have provoked the increasing competition which is likely to a consumer market boom. The most follow WTO accession, as Ukraine opens up considerable M&A transaction volume has to a large amount of imports. occurred in the food industry, which experts estimate at around US$1.3bn, putting it in fourth place in terms of M&A transaction value. Bogdan Borovyk is co-head of the Corporate Law Practice Group and Ekaterina The most notable M&A transactions of Katerinchuk is an attorney at Beiten 2007 were the acquisition of Ukraine’s Burkhardt.
292 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Due diligence in Ukraine
by Bogdan Borovyk and Ekaterina Katerinchuk
Generally, due diligence may be described summarises the findings and risks in as the process by which a potential investor the executive summary. The executive evaluates a target company or its assets summary should reflect the basic findings for the purpose of its acquisition. This is relevant to the envisaged transaction made through conducting an investigation and estimate the identified risks either in and audit of the potential investment. Due a quantitative manner (e.g., amount of diligence plays prominently in nearly all penalties, fines which may be imposed on M&A transactions, with the subsequent the target company for non-compliance outcome serving as a basis for the potential with the certain legal requirements), or in investor’s decision on whether to go a qualitative manner (e.g., the potential through with a deal, as well as how to risk of contesting certain agreements or structure the deal and define the material property title may be estimated as minor, terms of acquisition. moderate or high).
The due diligence process varies depending While drafting transactional on the different areas concerned, which documentation, it is particularly important may include financial and accounting, legal, to consider the outcome of the legal due tax, environmental, technical due diligence, diligence and minimise the uncovered risks etc. This article deals with certain aspects of by providing in the acquisition agreement, legal due diligence. as the case may be, the seller’s obligation to eliminate flaws (if applicable) as conditions In the course of the legal due diligence precedent to closing, any pertinent review, the availability of a data room, representations and warranties of the seller, a sufficient level of documents available indemnification and remedial provisions. for review, and proficiency of the legal due diligence team are considered to be Due diligence is quite a new notion for essential for a successful legal due diligence Ukrainian business practices. As a matter of review. In some cases it may be necessary fact, the Ukrainian market for due diligence to agree with the investor on a certain services started its active development threshold, meaning that any document in 2004, to satisfy the massive inflow raising risks below the agreed threshold of foreign investments into Ukraine’s shall be disregarded while conducting the economy, and consolidation of assets of legal due diligence. It allows investors to major Ukrainian business groups. optimise the expenses related to the legal due diligence and conduct the review within Due to the fact that a practice of legal a shorter time limit. due diligence in Ukraine has only been established within the past few years, there The final stage of legal due diligence are certain difficulties and specific features www.financierworldwide.com | FW 293 INTERNATIONAL MERGERS & ACQUISITIONS 2008 to be considered while conducting legal due a negative impact on legal due diligence diligence on a Ukrainian target company. practices. It has resulted in extremely irresponsible and negligent attitudes First, the specific character of the towards proper documentary execution of acquisition and allocation of property in business operations, titles to property, etc. Ukraine – which is more likely to be the Thus, in the course of a legal due diligence result of certain historical developments, on a Ukrainian target company, it is often combined with a rather young and discovered that, while outwardly financially developing legal system, and even the lack healthy and operating effectively, the of legal regulation of particular issues – has company has no duly executed title affected the approach to legal drafting documents, registrations of intellectual and execution of official documents. In property rights, or formally reflected particular, this has resulted in a large relations with its owners or management. amount of discrepancies and deviations from Ukrainian statutory requirements As a general rule to minimise the contained in the documents, and even risks, investors should obtain as much the absence of certain documents of information about the target company the target companies. These flaws are as possible. Thus, a full-scale legal due often discovered in the documents while diligence review of the target company conducting legal due diligence of the is recommended, as the most efficient Ukrainian target company, particularly way to protect and secure the interests with regard to having all title documents to of the investor. However, in some assets and real estate, non-compliance with instances, conducting a comprehensive privatisation procedures or a failure to fulfil legal due diligence review may appear privatisation obligations. difficult under Ukrainian conditions. Due to the abovementioned factors, when Second, additional legal obstacles cause conducting the legal due diligence the difficulty in the legal due diligence process, investors often have to face problems and are mainly connected with the lack of related to poor organisation of data rooms, sustainability of the legal framework (i.e., absence of necessary documentation, frequent revision and amendments of laws, and/or failure of the target company’s absence of the unified court practice, etc.), managers or employees to provide the and ambiguity and contradictions of the requested information. These issues, legal provisions, which causes problems though of a technical nature, should not even for companies with the highest be underestimated as they substantially legal standards in terms of compliance. influence the effectiveness and timing of Consequently, Ukrainian companies are the legal due diligence review. As data room often not in compliance with currency, tax, arrangements are usually the responsibility anti-monopoly and corporate laws. of the seller and/or target company, it is important to agree in advance upon the Third, the mentality and legal manner of providing documents (copies or consciousness in Ukraine, mainly electronic form), availability of data room characterised by a neglectful attitude index, data room working hours and rules, towards the legal standards and obligation the possibility and form of submitting to comply with their requirements, also has additional requests and interviewing
294 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS certain officers of the target company, diligence. While buyer due diligence has appointment of the contact persons of each become quite common for Ukrainian party and a person in charge of the data transactions, vendor due diligence is room, etc. conducted by a sellers’ legal advisers and is intended to present information about the One more issue to be taken into account is target company to any potential buyers. that the applicable laws and regulations of Vendor due diligence usually expedites Ukraine generally do not stipulate liability auction procedures and facilitates for providing false information during the buying the target company at a more legal due diligence review. For this reason, favourable price. Moreover, vendor due investors should pay particular attention diligence enables the seller to discover to the pre-due diligence negotiations potential risks and legal flaws of the target and arrangements as described above, company and eliminate them if possible. the participation of investment advisers Although, Ukrainian laws and regulations representing the target company and/or do not expressly charge the seller with an the seller, and make sure that the seller obligation to inform the buyer of potential representations and warranties regarding risks pertinent to an acquisition of the the correctness, credibility and authenticity target company, the seller should inform of the documents and information the buyer of the rights of third parties to the provided for the legal due diligence review target company, if there are any. by the seller, target company and/or its representatives and officers, are included in the acquisition agreement. Bogdan Borovyk is co-head of the Corporate Law Practice Group and Ekaterina The latest trend in the Ukrainian M&A Katerinchuk is an attorney at Beiten market is the inclusion of vendor due Burkhardt.
www.financierworldwide.com | FW 295 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Antimonopoly laws in Ukraine
by Bogdan Borovyk AND Ekaterina Katerinchuk
The antitrust laws and regulations of obtaining direct or indirect control over one Ukraine are aimed at protecting economic or several business entities, or parts thereof, competition and precluding monopolisation by means of direct or indirect acquisition of of the Ukrainian market. In recent years, a property complex or a business entity’s the increasing investment of foreign subdivision, or appointment of a person capital in Ukraine and consolidation occupying a managing position in one among major Ukrainian financial groups business entity to a similar position in other has resulted in a huge amount of M&A entities; (iii) establishments of new business transactions having a substantive effect on entities by two or more business entities; the competition and consolidation of the and (iv) direct or indirect acquisition Ukrainian market. Consequently, they fall resulting in the acquirer obtaining or under the requirements of the antitrust exceeding 25 or 50 percent of the voting laws and merger regulations of Ukraine. rights of the business entity, which is the The purpose of this article is to give most common type of concentration under investors an overview of the antimonopoly cross-border transactions in Ukraine. laws and regulations of Ukraine and basic information on the requirements to be Should an M&A transaction fall within met and procedures to be followed by the either of the abovementioned criteria, it parties to M&A transactions. shall be considered as a concentration. In such cases, the AMC’s prior approval of The principal legal act regulating anti- such transaction shall be obtained if the monopoly control is the Law of Ukraine certain quantitative thresholds are met. ‘On Protection of Economic Competition’. In particular, the AMC’s prior approval is The Competition Law is intended primarily required if during the last financial year to prevent the monopolisation of product the combined asset value or total sales, markets, abuse of monopoly positions, and including those abroad, of the participants the creation of limits on competition. In of concentration, exceed an amount fulfillment of those goals the Competition equivalent to €12m, provided that: (i) Law grants the Antimonopoly Committee the combined asset value or total sales, of Ukraine (AMC) the legal authority to including those abroad, of at least two approve or disapprove of ‘concentrations’ participants of concentration exceed of business entities, as well as certain an amount equivalent to €1m for each contractual and other activity. The participant; and (iii) the combined asset Competition Law provides a non-exhaustive value or total sales in Ukraine of at least one list of the types of transactions which participant in such concentration, exceeds qualify as ‘concentrations’. In particular, an amount equivalent to €1m. these are: (i) mergers or consolidations of business entities; (ii) acquisitions or The AMC’s prior approval must be obtained,
296 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS irrespectively of the abovementioned application shall be filed with the AMC. In thresholds, if the market share of one, ordinary cases, the AMC requires 45 days or the combined market share of all, the to review an application, consisting of an participants of concentration exceeds 35 initial ‘preview’ 15-day period during which percent. the application can be rejected for formal non-compliance, and 30-day maximum Should the parties close a transaction period for substantive evaluation. The without the AMC’s prior approval or in case AMC’s failure to commence evaluation of post-closing filing, the AMC is authorised by the end of this period is deemed to to impose fines on the participants of constitute an approval, dated as of the last unauthorised concentration. Namely, day of this period. according to the Competition Law, the AMC may impose a fine of up to 5 percent of a However, in some cases, the AMC may participant’s revenues from the sales of require an in-depth investigation which products (services, works) accrued within may take up to three months, whereby the preceding financial year. the AMC will ask for the provision of additional information or an expert There are also types of transactions that appraisal. Consideration of the application do not fall under the AMC’s approval may be also suspended should certain requirements. The following transactions circumstances prevent its consideration are expressly exempted from obligation to (e.g., pending resolution of other related obtain the AMC’s approval: (i) acquisition of and concurrent cases before courts, the shares by the company specialising in international tribunals, or agencies). financial or securities operations, provided, however, that the shares are resold no later As to the filing procedure itself, filing entails than one year after such acquisition; (ii) preparation of the application, supporting transactions between the related business documents and payment of the filing fee. entities provided that the relations of Usually, a few weeks may be required for control between those entities were initially preparation of the application due to the established with the AMC’s prior approval; volume of data, information and documents and (iii) acquiring control over a business that must be processed and compiled entity by the appointed bankruptcy in the appropriate form. The supporting receiver. documents shall be submitted together with the application (depending on the type Should an M&A transaction not satisfy of concentration this may be constituent the criteria of an exemption, the AMC’s documents, financial statements of the approval of such transaction must be participants of concentration, copies of obtained prior to its closing. Once the the acquisition agreement, etc.). Any approval is granted it remains valid for one documents issued abroad shall be notarised year. If the transaction is not closed within and, in certain circumstances, apostilled one year, a new AMC approval must be or legalised. Moreover, foreign language obtained. documents shall always be supported by an official Ukrainian translation. At present, In order to initiate the procedure of the filing fee for an ordinary application is obtaining the approval, the respective approximately €760. www.financierworldwide.com | FW 297 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Ukrainian laws and regulations grant the on the whole Ukrainian market or at its AMC a broad scope of general competence considerable part. and a large authority in considering concentration applications; in particular, The approval granted by the AMC may the AMC is authorised to request any be conditioned on certain requirements additional information, the absence of or obligations being fulfilled by the which prevents the AMC from considering participants of concentration in order the application. In practice, this approach to decrease the negative impact of has resulted in the AMC, at any time and at the concentration on competition in its discretion, requesting information, data the relevant market. In particular, such or documents which it deems necessary obligations may provide certain restrictions for the consideration of application. related to the management or disposal of Moreover, the AMC is entitled to dismiss property, or obligations to alienate certain the application without deciding on the property. merits because of the failure to provide the requested information within a specified term, even though the submission of such information may not be expressly provided by applicable laws and regulations. The refusal may specify certain recommendations for While considering an application, the AMC has the authority to request any the participants of concentration to follow, in order information, including confidential and for approval to be granted. restricted access information. In particular, it is common practice of the AMC to request information on the shareholding structure of the participants of the M&A, including information on the beneficial owners, information which foreign If the AMC refuses to approve a investors are usually reluctant to disclose. concentration, such refusal shall Nevertheless, the applicable laws and always be supported by stated legal regulations of Ukraine stipulate the AMC’s grounds. The refusal may specify certain non-disclosure obligations, provided that recommendations for the participants the information submitted to the AMC is of concentration to follow, in order expressly stated to be confidential and to for approval to be granted. The AMC’s be treated as restricted access information. refusal may be contested in court. The Otherwise, the AMC is entitled to disclose Competition Law also grants authority certain information on the envisaged to the government of Ukraine to approve concentration, in particular, by publishing it concentrations disapproved by the AMC, on its website. under condition that the positive impact of such concentration on the public interest According to the Competition Law, the will exceed the negative consequences AMC shall always grant its approval, unless on the limitation of competition in the the concentration causes monopolisation Ukrainian market. or substantial limitation of competition
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According to the Competition Law, the approval decision and the non-exhaustive AMC is also entitled to revise its own list of grounds for such revision causes a resolutions (approving or disapproving situation of legal uncertainty. However, as a concentration) either at its own initiative, or matter of practice, the AMC does not tend under application of any person. However, to use its revisionary powers, unless the such revision may be made only on the abovementioned grounds occur. Moreover, following grounds: (i) discovery of material the Competition Law also provides for circumstances unknown to the AMC, if such statute of limitations for revision of the circumstances result in the unwarranted AMC’s decision of three to five years or unlawful resolution of the AMC; (ii) (depending on the grounds for revision) discovery of false information unknown from the date of the respective AMC’s to the AMC if such information results in resolution. the unwarranted or unlawful resolution of the AMC; (iii) non-compliance of the participants of the concentration with the obligations conditioning the AMC’s Bogdan Borovyk is co-head of the Corporate approval of concentration; and (iv) other Law Practice Group and Ekaterina grounds provided by applicable laws. Katerinchuk is an attorney at Beiten The powers of the AMC to revise its Burkhardt.
www.financierworldwide.com | FW 299 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Legal issues in Romanian M&A
by Cătălin Micu and Nicolae Hariuc
Foreign acquirers targeting all or part of a statement of the company. company incorporated in Romania should A person that, as a result of its purchase be aware of various capital market, labour, or those of the persons acting in concert environment, competition and fiscal law with it, holds more than 33 percent of implications. the voting rights in an undertaking must launch to all shareholders of a company Capital market issues around takeover listed on BSE a public offer addressed to offers all securities holders for all their holdings as soon as possible, but no later than two The Law no. 297/2004 on capital market months from reaching this holding position. establishes two types of takeover offers: Until such mandatory takeover offer is the voluntary takeover offer and the made, all the rights related to the securities mandatory takeover offer. exceeding 33 percent of the voting rights within the issuer are suspended, and the The voluntary takeover offer represents a said shareholder and the persons acting in public purchase offer that results, for the concert with it may no longer purchase, by entity that launches it, in the purchasing of other operations, the shares of the same more than 33 percent of the voting rights in issuer. a company. This public purchase offer (i) is addressed to all shareholders of a company In a mandatory takeover offer the price listed on the Bucharest Stock Exchange offered shall be at least equal to the (BSE), for all their holdings and (ii) is highest price paid by the offeror or by the launched by a person that does not have persons with whom it acts jointly within this obligation. the 12 months prior to the offer. If no such price exists, the price offered shall In a voluntary takeover offer the price shall be determined in accordance with RNSC be at least equal to the highest price from: provisions, at least taking into account (i) the highest price paid by the offeror or the following criteria: (i) the average the persons acting in concert with it during weighted price of trading for the last 12 the period of 12 months prior to the date months prior to the offer being made; of submitting to the Romanian National (ii) the value of the company’s net assets Securities Commission (RNSC) the public according to the latest audited financial offer documents; (ii) the average weighted statements; (iii) the value of the shares, as it price of trading, referred to in the last 12 results from an expert’s report made by an months prior to the date of submitting to independent valuator, in accordance with RNSC the public offer documents; and (iii) the international valuation standards. the net assets of the company per shares in circulation, according to the last financial Any person may launch a counter-offer for
300 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the same securities, under the following or parts of the undertaking or unit, and conditions: (i) it addresses the same the assignee the person that acquires amount of securities and targets, at least, the capacity of employer towards the the same share capital holding; and (ii) employees mentioned). it offers a price that is at least 5 percent higher than the first offer. This counter- The European Court of Justice regulated offer shall be carried out by submitting to that the notion of economic entity RNSC the required documentation within a represents an organised aggregate of maximum of 10 working days from the date persons and elements permitting the when the first offer was made available performance of economic (essential or to the public. Through the decision to secondary) activity pursuing an own authorise the counter-offers, RNSC shall objective. In other words, the economic establish once the same closing term for entity is construed as being a unit or all the offers, as well as a deadline for the a part of the unit, that establishment submission for approval of the supplements and/or sector (division) of activity of an regarding price increases within competitor undertaking that has or may have an offers. The single term for closing autonomous activity, the necessary and competitor offers may not be longer than sufficient human, technical and logistic 60 working days from the date when the capital. first offer has been made. Pursuant to the above-mentioned legal Labour issues provisions, the employees’ rights in case of transfer of the undertaking, unit or Law no. 67/2006 on the protection of parts of the undertaking or unit shall be the employees’ rights in case of transfer protected by informing the employees’ of the enterprise, unit or parts of the representatives with regard to the legal, enterprise or unit transposes into Romanian economic and social consequences of the legislation the Directive 2001/23/EC on transfer and by establishing the rule that the appropriation of the legislations of the the employees’ rights and obligations member states relating to the maintenance entailing from the individual labour of the workers’ rights in case of transfer agreements or the applicable collective of the enterprise, unit or parts of the labour agreement, existing on the date of enterprise or unit. operation performance, shall be integrally transferred to the assignee. According to the law ‘the transfer’ means transferring from the assignor’s Environmental issues ownership into the assignee’s ownership an undertaking, unit or part of the undertaking The Emergency Government Ordinance no. or unit as a result of an assignment or 195/2005 regarding environment protection merger, for the purpose of carrying on provides that the notice for establishing the main or secondary activities, without the environment obligations, meaning the considering its obtaining or non-obtaining technical and legal document issued by of any profit (the assignor being the person the competent authority for environment that loses its capacity as employer towards protection, must be obtained in case of the employees of the undertaking, unit the change of the holder of an activity with www.financierworldwide.com | FW 301 INTERNATIONAL MERGERS & ACQUISITIONS 2008 significant impact on the environment, community dimension if the following the sale of the majority block of shares, conditions are met: (i) the combined the sale of assets, merger, split-up, aggregate worldwide turnover of all the cessation of activity, having as purpose the undertakings concerned exceeds €5bn; and establishing of the environment obligations (ii) the aggregate community-wide turnover as provisions of a compliance plan in order of each of at least two of the undertakings that the parties involved in the situations concerned exceeds €250m, unless each previously mentioned undertake them. of the undertakings concerned achieves more than two-thirds of its aggregate The issuance of the environment notice community-wide turnover within one and is the first step in order to obtain a new the same Member State. environment authorisation. Also, a concentration that does not meet Competition issues the thresholds specified in the paragraph above has a Community dimension if: (i) the The specific issues pertaining to the combined aggregate worldwide turnover economic concentrations resulted from of all the undertakings concerned exceeds international mergers and acquisitions €2.5bn; (ii) in each of at least three Member are regulated by the Council Regulation States, the combined aggregate turnover (EC) No. 139/2004 on the control of of all the undertakings concerned exceeds concentrations, which is applicable to €100m; (iii) in each of at least three Member the economic concentrations with a States included for the purpose of point (ii) Community dimension. In such cases, the the aggregate turnover of each of at least European Commission is the competent two of the undertakings concerned exceeds authority for applying the provisions of €25m; and (iv) the aggregate community- the above-mentioned Council Regulation wide turnover of each of at least two of the subject to review by the Court of Justice. undertakings concerned exceeds €100m, unless each of the undertakings concerned For the economic concentrations that affect achieves more than two-thirds of its the competition on the Romanian local aggregate community-wide turnover within market, the provisions of the Competition one and the same Member State. Law no. 21/1996 are applicable. The competent body for applying these The above-specified thresholds are subject provisions is the Competition Council. to the Council’s modification following the proposals submitted to it by the Specific thresholds are set up by the Commission. applicable laws for starting the procedure of notifying the European Commission or As per the Romanian competition law, the Competition Council. In this respect, the the thresholds are the following: (i) the parties involved in an international merger combined aggregate turnover of all the and/or acquisition will notify the competent undertakings concerned exceeds the authorities. equivalent in RON of €10m and (ii) at least two of the concerned undertakings The Council Regulation states that an achieve, in the Romanian territory, a economic concentration has an EU turnover exceeding the equivalent in RON
302 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS of €4m each. The equivalent in RON is authorities, depending on specific criteria, calculated at the exchange rate RON/EUR namely the form of incorporation of the communicated by the National Bank of company whose shares are the object of Romania in the last day of the financial year the transaction, respectively the person previous to the year when the merger or obtaining the revenue (Romanian or foreign acquisition occurs. natural person or Romanian or foreign legal person, as the case may be). Should the economic concentration not be notified by the undertaking that had the Moreover, both the trade registry and the obligation to submit the notification, the independent registry company that holds Commission or the Competition Council the shareholders register shall deny the can apply penalties that shall not exceed 10 registration of transfer of ownership over percent of the undertaking’s turnover. the shares, as provided by the Companies Law, in case proof of the due tax payment, Fiscal issues as per the above criteria, is not presented.
For the revenues acquired as a result of the acquisitions of Romanian companies, Cătălin Micu and Nicolae Hariuc are the Romanian Fiscal Code establishes associates at Zamfirescu Racoţi Predoiu Law certain taxes to be paid to the fiscal state Partnership.
www.financierworldwide.com | FW 303 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g The Baltic M&A markets
by Raminta KarlonaitE
M&A emerged only 17 years ago in remain high in 2008. The Bank of Lithuania Lithuania, Latvia and Estonia, at the predicts that Lithuania’s average annual beginning of privatisation involving state- inflation will be around 7.9 percent this owned businesses. From 1991, M&A year, dropping to 4.9 percent in 2009. markets in the Baltics have grown rapidly Last year, inflation in Latvia reached 14 for a number of reasons including fast percent while the forecast is 12.8 percent economic growth, an influx of foreign direct for 2008. In Estonia, inflation has actually investment, consolidation of the economies started declining: an average of 8 percent of the three Baltic States, and ongoing is expected in 2008. Notably, such high integration into the European Union. inflation rates might cause further Transaction practices have undergone postponement of the euro in the Baltic significant changes in the Baltics, adopting countries. many standards compatible with M&A in developed markets. From nothing they Experts indicate a number of reasons for a have evolved to achieve global recognition. slowdown in the Baltic economies. These include the cyclical downturn, turbulence 2007 was a record year for Baltic M&A. in global financial market, the large current According to disclosed deal size, the account deficits of Lithuania, Latvia, and largest M&A deal was the acquisition of the Estonia, low exports, high pay increases in Lithuanian Telecommunication Company recent years, and high domestic demand. by private equity firm Mid Europe Partners But despite the cooling period, economic for €450m. growth in the Baltic countries is expected to remain significantly higher than many other In recent years, the economies of the three European countries. The Baltic currencies’ Baltic States have been among the fastest euro pegs should survive. growing in the European Union. GDP in the Baltic countries last year reached 10.5 Prospects for the Baltic economies are percent in Latvia, 8.7 percent in Lithuania bright. The economies of Lithuania, Latvia and about 7 percent in Estonia. However, and Estonia are flexible because they are there has been a recent slowdown that puts small, open and offer many opportunities. 2008 and 2009 forecasts at 3-4 percent for An economic slowdown should be Estonia, 7.2 and 5.5 percent for Latvia, and temporary, giving way to a fast recovery. 6.5 and 6 percent for Lithuania respectively The Bank of Estonia estimates that in 2008- in 2008 and 2009, according to SEB 09 economic growth will drop more than Economic Research. expected, but this would help to decelerate rising prices and trade deficits. Inflation in the Baltic countries has increased considerably, and is expected to When the adjustment period ends, the Baltic
304 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS countries will have good chances to continue be active acquirers of less efficient Baltic their rapid growth. The forecasted long companies, whose shareholders now have term sustainable growth rate of the Baltic fewer illusions about the value of their States would still be about 6-7 percent per business. Also, relatively strong Lithuanian year. However, future growth and economic companies that benefit from a stronger expansion will have to be more balanced domestic economy could acquire weaker with a need to promote exports. It will be Latvian and Estonian companies. necessary to promote the private sector to invest in industries primarily focusing Private equity in the Baltics has picked on the foreign markets. Moreover, taking up only very recently, much later than in into consideration the current economic Western Europe. The credit crunch has adjustment stage of Estonia, Latvia, and imposed limits on the leverage of private Lithuania, strict and prudent fiscal policies equity investments and therefore their are vital to maintain economic balance and global activities are expected to slow down. support investments. In the Baltics, this hurdle is reduced because transaction values are relatively small. In recent years, trends in Baltic M&A Furthermore, international private equity practice have included an increase in funds are now showing increasing interest auction sales, growing activity by private in Central & Eastern Europe, including the equity funds and a higher volume of local Baltics, where economies are growing or cross-Baltic investments. All these faster than those of the Western Europe. trends should persist, albeit at a reduced For these reasons, the Baltic private equity scale. M&A activities should not be market should continue to grow. heavily influenced by a slowdown in the Baltic economies, since even struggling The economic deceleration of the Baltic companies can provide attractive targets. States should open new opportunities for M&A activity. Currently, legislation and In this deceleration phase, the leading practices are comparable to developed companies will have strong cash flows markets because they are harmonised with that are not too dependent on domestic the EU. Certain EU Acts covering M&A demand, but rather exporting. They have been fully implemented in Lithuania, will have healthy balance sheets and Latvia and Estonia, such as the Directive on strong management capable of acting Takeover Bids (2004/25/EC; the Takeover on opportunities. On the other hand, Directive) and the Cross-Border Mergers struggling companies will have weak Directive concerning limited liability cash flows that are highly dependent on companies (2005/56/EC; the Cross-border domestic demand, or highly leveraged Directive). balance sheets. The Takeover Directive creates a common In terms of M&A, winning companies set of rules for all EU Member States and will have a better chance of buying thus promotes the idea of unifying the underperforming companies at a lower common market in the European Union. price, thus expanding their activities The Takeover Directive was aimed at and strengthening their position in the creating efficient takeover mechanisms, market. Nordic or Polish companies could a common regulatory framework, strong www.financierworldwide.com | FW 305 INTERNATIONAL MERGERS & ACQUISITIONS 2008 rights for shareholders, including minority amendments in the Estonian legislation shareholders, and to remove some of the related to the MiFID provide for the main company-related obstacles which creation of deregulated multilateral were permitted under national company trading facilities which will provide new law (these obstacles meant that takeovers opportunities for small to medium size could not be undertaken under equal growth companies seeking to raise capital. conditions in the different Member States). After implementation of the Takeover Finally, as of 1 March 2008, amendments Directive in the Baltic States, acquiring to the Law of the Republic of Lithuania companies are able to rely on the same on Collective Investment Undertakings mechanisms to tackle probable challenges were adopted. The main novelty under the when acquiring companies on a pan-Baltic law is that besides harmonised collective scale. investment undertakings within the meaning of Council Directive 85/611/EEC, All three Baltics States have also adopted special collective investment undertakings measures to transpose the Cross-Border – investment funds and investment Mergers Directive. The purpose of the companies whose operation are not cross-border merger legislation was to harmonised at the EU level – might be set simplify the procedure for mergers between up in Lithuania. Thus, the law provides legal limited companies registered in the grounds for establishing in Lithuania private Member States of the European Union. The capital, real estate, alternative investment, cross-border merger legislation establishes and other special collective investment general requirements for merger undertakings, allowing investors to make agreements and related documents and indirect investments in perspective and procedures that are uniform for all parties. growing companies whose securities are The cross-border merger legislation could not traded on regulated markets as well facilitate company mergers in the Baltics. as in real estate objects and financial derivatives. In addition, the Estonian Parliament recently adopted amendments to the Although the growth rate of Baltic Securities Market Act transposing economies is experiencing a slowdown, the provisions of the Markets in Financial M&A market remains attractive, especially Instruments Directive (MiFID), the Takeover for corporate buyers. Legislation and Directive, and the Capital Adequacy of practices are comparable to developed Investment Firms and Credit Institutions markets and harmonised with the EU. So Directive. The amended Securities Market despite the slowdown, the Baltic economies Act imposes significant new requirements will have a good chance of continuing their for investment advisers, investment funds, rapid growth. fund managers, stockbrokers, and banks with activities in Estonia as well as new rules pertaining to takeovers and capital Raminta Karlonaitė is a senior associate at adequacy requirements. In addition, the Sorainen.
306 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Completing a successful deal in the Baltic States
by Veikko Toomere and Jacob Strandgaard Andersen
The Baltic States are three different in a significant increase in the standard of countries. A general misconception is living. that the Baltics can be regarded as one region of countries, which share a common Economic growth and inflation. Since the cultural background and which have similar re-independence of the Baltic countries, languages, institutions and mentality. all of them have seen an extraordinary Foreign acquirers planning a business growth in GDP, with some of the highest venture in Estonia, Latvia or Lithuania must growth rates in Europe. The disposable address this misconception. There are not income for consumption is high. There are only differences in languages, but also signs of a slowdown, although there is no historical and cultural differences. Doing consensus on how abruptly or by how much your homework to achieve a prior basic the economies will cool down. Inflation knowledge of the relevant Baltic country is is increasing and reached double digits an important part of success. in Latvia and Estonia in 2007. This must be seen in light the virtually non-existent Post Soviet legislation versus modern unemployment and growing concern European legal systems. The legal systems among companies, which are desperately in all three Baltic States are relatively new. looking for employees to fill vacancies. This Less than 20 years ago, sale or purchase is a contributing factor in pay increases. For for profit was a criminal offence and example, the increase in Estonia averaged the legal systems were an echo of the 20 percent from Q4 2006 to Q4 2007. It communist Soviet legal system. However, means Estonia is losing the competitive the development of the legal systems advantage it had because of low manual is a reality, and EU legislation has been labour costs. largely implemented following accession to the EU in 2004. Judiciaries that function Challenges with long term planning. Long relatively well have been established, term planning is not a top priority, and is offering protection of contractual rights, still new to most companies in the Baltic enforcements of claims, etc. States. Most businesses are much younger than 15 years, and their managers and Business culture. When looking closely owners are much more impatient than their at the business cultures, most foreigners counterparts in Western Europe. When find that the pace is high, and that the coming from a background where long Estonians, Latvians and Lithuanians term strategic and visionary planning is the are looking for fast returns on their norm, and where a pragmatic approach investments. Part of the reason for this is is often chosen to ensure steady growth that the region has only seen progress in over the coming decade, it takes some the last 10-15 years. This is also reflected time to get used to and appreciate the www.financierworldwide.com | FW 307 INTERNATIONAL MERGERS & ACQUISITIONS 2008
entrepreneurial atmosphere aimed at fast employees or other unusual agreements. returns today rather than tomorrow. Not all of these are registered in the books. These practices appear to be decreasing, Patriarchal style of leadership. When but they will still arise for some years to entering negotiations it is always a good come. idea to approach the owners directly, as they will be the real decision makers. In Management interviews and written most cases they will also be the managers. evidence. The challenges with disclosure Contact with managers who are not and the existence of unwritten practices the owners is inadvisable. The style of underline the importance of management management is patriarchal and major interviews. This is important as it partly decisions, particularly concerning sale of a compensates for slow or challenging business, will rest solely with the owners. disclosure of written information. Secondly, it often gives an insight into how customary unwritten or unusual practices are.
It should be stressed that it is unwise to rely on oral agreements. Information Until agreements are in writing an acquirer cannot obtained in an interview should always be confirmed in writing. This becomes even be confident that the outcome of a discussion will be more crucial as negotiations progress and the actual final result. a final agreement is within reach. It has caused problems for buyers who have relied too much on an oral discussion ‘that only needed to be written down’. Until agreements are in writing, an acquirer cannot be confident that the outcome of Issues to consider in M&A in the Baltic a discussion will be the actual final result. States This is not due to foul play, just an aspect of business culture and negotiations. Disclosure challenges and unwritten established practices. When a foreign Pricing. Setting the price for a business acquirer comes to one of the Baltic is often influenced by emotions and countries, they often encounter problems speculation. Although sellers today are with disclosure of information. Companies more likely to use external advisers when are generally not keen to disclose as appraising the company, many still base much information as may be customary the price on their own feelings, which are in other regions. This is particularly true often unrealistic. This is further complicated for sellers with a Russian background. The by the fact that the price of goodwill is still main reason is not necessarily because valued very conservatively. These factors there are things to hide, but because of make transactions more challenging, and a general suspicion towards buyers, who a potential buyer needs to take them into may also become a future competitor. account. Another reason is that unwritten practices exist, such as special benefits to certain Not for sale does not always mean not for
308 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS sale. Not only is the price often set based most requested information will be made on emotions. Upon contacting a potential available. target with a preliminary inquiry, an acquirer will likely be met with a “Not for Professional valuations. Emotions are sale”, followed by a “Who told you we are seldom part of the pricing in the Nordic for sale?” This should not be taken as a full countries. The value of the company – and final ‘no’. The ‘not for sale’ is rarely both the internal value and the value final, and can just as easily be interpreted of the goodwill – is in most cases set by as a ‘maybe’. “Who told you?” can often be professional advisers. This also makes explained by the size of the Baltic markets. the price negotiations more difficult as As the business community is small, an acquirer will need to point out specific everybody seems to know each other in a reasons, before it will be able to change the particular business sector, so this is likely professional valuation significantly. Finally a a defence mechanism to stop any sales ‘not for sale’ is exactly what it means. rumours and not show signs of weakness. The essence is that an initial negative Recommendations response should not immediately stop an acquirer from planning an acquisition. Local representation. Working with a local adviser is strongly recommended when The Nordic perspective and comparisons considering acquiring a company in Estonia, Latvia or Lithuania. The levels of spoken Verbal agreements followed by written foreign languages are quite high, and many contract. It is much more normal to use potential business partners work well in oral agreements in Nordic markets, which English, German and/or Russian. There are, will be confirmed in writing without much however, other good reasons to work with a difficulty or delay. This is not an approach local adviser. The cultural differences in the that is likely to succeed in Estonia, Latvia or business environment are different so the Lithuania. Pressing forward with drafting risk of failure due to misunderstandings is the sale and purchase agreement is quite high. necessary during the entire investigation and negotiation process. The typical Generally an acquirer will be met with decision makers in the Nordic countries are scepticism if approaching a seller in a typical managers, although the final and formal Nordic manner. They may have a good idea decisions are made by the owners, which of exactly what they want and what the reflect a much less patriarchal management terms should be. Slamming such a proposal structure than in Estonia, Latvia and on the table may offend the target, and Lithuania. portray the acquirer as a ‘know-it-all’ type. Furthermore, nuances in spoken English Disclosure levels. Another difference is a are often lost when not all parties are native much more open approach to disclosure. speakers, and this combination of cultural Both the management interviews and the differences and language barriers can end data room information are typically more an otherwise lucrative business opportunity informative in the Nordic area. There is at an early stage. Representatives and not as much suspicion towards buyers. negotiators are more respected when they Unless the purchaser is a fierce competitor, speak the local language. www.financierworldwide.com | FW 309 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Be ready for fast decision making. As return is the aim, an acquirer should not the pace of doing business in the Baltic sit and wait until a company is officially for States is often found to be much more sale. The acquirer should be honest and hectic than in the Nordic region, acquirers direct, and refuse to take no for an answer should be prepared for the process to right away. become extremely hectic when the closing approaches. In this phase it is still important Keep it in writing. The final advice is to keep to get written confirmation of issues a written track record. Conversations and discussed in meetings or via telephone. This interviews should always be confirmed in can help to keep the process focused on a writing. If not, it will be extremely difficult final result. to push towards a final agreement.
Try to approach before the company is officially for sale. As the pace is high in the Jacob Strandgaard Andersen and Veikko Baltic States, and since a fast and large Toomere are lawyers at MAQS Law Firm.
310 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS
CHAPTER twelve: Regional view – Asia Pacific
www.financierworldwide.com | FW 311 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Recent trends in Japan’s M&A market
by Masakazu Iwakura, Yoshiaki Sakurai and Juan L. Ramirez
Decreasing population and continued Over the past 12 months, practices relating economic stagnation, together with intense to hostile takeovers have developed. The competition among Japanese and foreign decision of the Supreme Court of Japan companies alike, have exacted a heavy toll in Bull-Dog Sauce Co, Ltd. v. Steel Partners on Japanese financial markets. In 2007, Japan Strategic Fund (Offshore), L.P., was the Nikkei average fell nearly 11.8 percent the most important legal precedent with as the subprime crisis spread from the regards to M&A during this period. Steel United States to the rest of the world. The Partners, a US based activist fund, launched market decline has only accelerated in the its bid for Bull-Dog on 5 May 2007, which first quarter of 2008 with the Nikkei falling was opposed by Bull-Dog’s board of another 17.3 percent as the strengthening directors on 7 June 2007. On 24 June 2007, yen added to the Japanese economy’s more than 80 percent of the shareholders woes. Given the market situation, there of Bull-Dog approved a defensive measure were approximately 3000 M&A transactions whereby the company issued and allocated involving Japanese companies in 2007, the three new share warrants to each of total value of which was about ¥16.8 trillion its shareholders with discriminatory (roughly US$168bn), representing a slight conditions, such that Steel Partners and its increase compared to 2006 in both deal affiliates could not exercise the warrants. volume and transaction value. The most Bull-Dog reserved the discretion to active market participants over the last repurchase and did repurchase the warrants 12 months included financial institutions, from Steel Partners and its affiliates based department stores and the pharmaceutical on the tender offer price which Steel industry. Partners initially offered to the shareholders of Bull-Dog, resulting in a drastic reduction Although 2007 was not a significant year of Steel Partners’ ownership in Bull-Dog. with regards to market growth, it was The Supreme Court, on 7 August 2007, notable for several important developments dismissed Steel Partners’ appeal, for the in the legal arena. These include: (i) the first time endorsing a defensive measure endorsement by the Supreme Court of adopted in the face of a hostile takeover Japan of, essentially, a kind of poison pill by bid. The Court held that the issuance of a Japanese corporation; and (ii) provisions the share warrants did not violate the of the Financial Instruments and Exchange principal of shareholder equity or any Law (FIEL) and the Japanese Corporate other applicable laws and regulations. It Law becoming completely effective. The also held that the share warrants were transactions and cases described below not issued in a significantly unfair manner. highlight some of these developments and In addition, the decision of the Supreme will help illustrate the latest market trends Court suggested that pre-bid measures in Japanese M&A. improve the predictability for shareholders,
312 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS investors, possible bidders and other which was on the verge of being delisted related parties. Such measures typically due to an accounting scandal. The total include a rights plan using share warrants transaction value (including the tender-offer with discriminatory conditions, where made before the triangular share exchange) only certain shareholders can execute the was about ¥1.6 trillion (about US$16bn), warrants and so on, structured so that the largest deal in Japanese M&A history. the company simply notifies in advance The initial tender offer alone ranked the possibility of using this defence, and as the largest ever in Japan. Citigroup after a bid is made the company has the Japan Holdings Ltd., a direct, wholly- right to allot warrants to its shareholders. owned Japanese subsidiary of Citigroup, Though approximately one-sixth of listed completed the acquisition of the Nikko companies in Japan have already adopted shares through a triangular stock-for-stock similar measures as of the end of 2007, exchange, in which the parent company’s the Supreme Court’s suggestion may shares are used for consideration (i.e., encourage other Japanese companies to do Nikko shareholders received Citigroup the same. shares). Such triangular stock-for-stock exchanges and triangular mergers (in which The year also saw a rare example of a a subsidiary absorbs and merges with the successful hostile takeover of a Japanese target, and provides shares of its parent investment firm in Ken Enterprise’s bid company to shareholders of the absorbed for Solid Group Holdings Co., Ltd, a used target), which are common in the US, have car dealer. It would be unwise to draw only been permitted since 2007 under the any conclusions from this deal, however; Japanese Corporate Law. By using this despite opposition from Ken Enterprise’s deal structure, a Japanese subsidiary of a board, approximately 48 percent of the non-Japanese company is able to absorb shares were owned by Lehman Brothers a Japanese company by using its parent Japan Inc., which supported the deal. company’s shares, whereas a merger Although almost all hostile deals in Japan between a Japanese company and non- are unsuccessful, hostile bids may still Japanese company is still prohibited under increase in the years ahead, mainly due the Japanese Corporate Law. Nevertheless, to the dissolution of deep-rooted cross- due to, among other things, uncertainty shareholding among Japanese companies over the tax treatment with respect to and an erosion in the cultural resistance triangular transactions, the Citigroup deal to hostile bids or takeovers in Japanese is the first and the only one to be structured society, especially as activist shareholders in this way. Whether this is the beginning attempt to takeover the companies with of a new trend in the coming year remains low price book-value ratios, such as Steel uncertain. Partners’ ongoing proposed tender offer for Sapporo Holdings Limited, a major Other notable deals include the merger of Japanese brewer. Mitsubishi Pharma Corporation and Tanabe Seiyaku Co. Ltd., valued at about ¥525bn The largest M&A transaction by value in (about US$5.3bn), and the strategic alliance the last 12 months was Citigroup Inc.’s between the Kyowa Hakko Kogyo Co., Ltd., acquisition of Nikko Cordial Corporation, Kirin Pharma Company, Limited and Kirin one of the top Japanese securities firms, Holdings Company, Limited – the value www.financierworldwide.com | FW 313 INTERNATIONAL MERGERS & ACQUISITIONS 2008 of the integration is approximated to be which new regulations regarding disclosure ¥300bn (about US$3bn). Both transactions under FIEL applied. The regulation requires are in the pharmaceutical industry, which an issuer of new shares delivered in is experiencing drastic changes, including connection with a corporate reorganisation the revision of Japanese national medical (including a merger) to submit a security treatment fees and pharmaceutical price registration statement with the regulatory reductions, increased global competition authority and to make the ongoing and increased research and development disclosures as prescribed in the FIEL costs of new drugs, which have motivated under certain conditions. These disclosure these companies to enter into alliances with duties may also be applicable to non- one another. Japanese companies in certain triangular transactions. Economic pressures have also led to increased competition in the retail shops As practitioners of the law, it is difficult to market, involving not only department forecast the particular industries or sectors stores, but also general merchandise where M&A activities will increase for the stores, drug stores and large scale discount year ahead. However, current negative stores. The largest department store market conditions persist. Thus, we expect transaction was the business integration of that restructuring and consolidation will Isetan Company Limited and Mitsukoshi, remain at the forefront in Japan. Ltd. through the establishment of a joint holding company by share transfer, creating the largest Japanese department store operator. The transaction value of Masakazu Iwakura is a partner, Yoshiaki this deal was approximately ¥292bn (about Sakurai is an associate and Juan L. Ramirez is US$2.9bn). This deal was also the first in foreign counsel, at Nishimura & Asahi.
314 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Buyouts, takeovers and surrounding legal issues in Japan
by Paul O’Regan
While the credit squeeze has impacted throughout the world turned Arysta into severely on the large buyouts seen in 2007 a successful worldwide business. This is a in other parts of the world, it was expected good example of how private equity buyers to have little effect in Japan. This is can turn businesses around. Permira has no primarily because the size of deals in Japan doubt taken the view that there is still room has traditionally been smaller than the for value enhancement in Arysta. mega deals in the US and Europe, and also because leverage levels have traditionally The biggest M&A transaction in Japan in been lower. However there have been no 2007 was the takeover of Nikko Cordial substantial buyouts announced in Japan in by Citi. These two corporates already had the first quarter of 2008. a relationship through a joint venture investment bank trading under the name In the past 12 months there have been Nikko Citi. Again the pattern of distressed two buyouts at prices in excess of US$2bn: assets being the targets foreign companies Arysta LifeScience Corporation’s acquisition can successfully acquire was followed by Permira and Tokyo Star Bank’s here in that Nikko Cordial had been the acquisition by Advantage Partners. Both of subject of an investigation by the FSA and these were in effect secondary transactions, was found to have intentionally falsified with the vendors being other private equity its accounts resulting in a heavy fine, an firms. Thus these can be differentiated from apparent loss of confidence in it by some of other transactions involving a Japanese its customers and a deflating share price. seller where there is a perceived animosity While not exactly distressed, Nikko Cordial towards private equity funds in general, was certainly on the back foot and Citi took and foreign ones in particular. Foreign PE advantage of this to mount a successful firms thus often find it worthwhile to team takeover bid. It was forced to increase its up with Japanese funds in a consortium price because of the hostility to the original structure to bid for Japanese companies. offer of several hedge fund shareholders, some of whom refused to accept even The major successes of foreign entities in the higher offer but Citi declared its offer Japanese M&A have been with distressed unconditional once it had reached 66 assets. Even Arysta was a company put percent. together out of the respective agro-science businesses of two trading companies Subsequently Citi became the pioneer of which had foundered during the 90s. the new triangular merger law which allows Olympus, the US buyout fund, joined the shares in a company other than the bidding two businesses and progressively bought company, including a foreign company, out the former shareholders and by to be used as consideration for a takeover following an aggressive acquisition strategy offer when its local bidding vehicle made www.financierworldwide.com | FW 315 INTERNATIONAL MERGERS & ACQUISITIONS 2008 a further all Citi scrip offer for the minority The trend of increasing shareholder hold out shareholders. This looked at one activism in the US has been followed in stage to be in trouble because of Citi’s own Japan, and TCI was not the only activist share price weakness but the takeover was shareholder endeavouring to improve eventually successfully completed. the lot of shareholders in Japan. The US fund Steel Partners, which holds shares Apart from this lone use of the triangular in several Japanese companies, has made merger law by Citi, there was no evidence business improvement proposals to several of the wholesale takeover of Japanese of them but with no apparent success to companies predicted by the japanese date. However, it has been noted that business federation (Nippon Keidanren) in an ever increasing number of Japanese its strident opposition to the law coming companies have embarked on share into force. As wiser heads had predicted the buy back programs and, in some cases, limitations inherent in the law as a result of have increased dividends, so perhaps the the way it was eventually enacted ensure pressure is starting to tell. that it will be able to be used for takeovers in Japan by foreign companies only in On the other hand the Nikkei, the Tokyo agreed bid situations. Stock Exchange’s (TSE) main stock index, has declined severely over the past few Furthermore the government considerably months and this may be due in part to a widened the number of companies subject perceived bias against shareholders in to a requirement that consent be obtained Japanese companies. Over 450 Japanese before a shareholding in excess of 10 companies have introduced takeover percent can be acquired by a foreign entity. defence mechanisms and recently a Previously the prior consent requirement financing package involving Sumitomo was confined to companies operating in a companies introduced a form of warrant limited number of sectors such as defence, which would enable the ‘friendly financiers’ nuclear power, telecommunications and to take significant equity stakes thereby the like. Even that resulted in a long list diluting the unwanted shareholder but of companies but now, citing concern also all other shareholders. However, to about the potential for leakage overseas date only one of these formal defence of Japanese technology, the net has been mechanisms has been activated (Bull- widened considerably. Dog Sauce) and ironically its effect was to reward the unwanted bidder (compensated One company for which such an application in cash for being severely diluted) better has been made is J Power, the electricity than the other shareholders who were left company, in which an activist hedge fund, holding much less valuable shares. This, The Children’s Investment Fund (TCI), though, and the recent confirmation by holds 9.9 percent. It has applied to increase shareholders in Sapporo, the brewer, of its stake to 20 percent but to date no that company’s poison pill in opposition decision has been announced. It is generally to another Steel Partners initiative, shows assumed that the required consent will not that shareholders in Japanese companies be granted. Meanwhile TCI’s proposals to are quite prepared to back management in J Power to improve efficiency and increase rebuffing unwanted foreign suitors, even at dividends were rejected by J Power. their own cost.
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The equities sell-off accelerated in February but to date its controlling shareholder, 2008, possibly because of a statement NEC Corporation, has been unmoved. The made by a government minister that subsidiary’s share price performance has shareholders were too fickle to control been abysmal and Perry Capital alleges the companies they hold shares in. In that related party dealings with the order to slow down the exodus of foreign parent have been at the expense of the investors from Japan, Mr. Atsushi Saito, subsidiary. Related party transactions are the head of the Tokyo Stock Exchange, not regulated by the TSE and accordingly called on Japanese companies “to consider are very common in Japan, usually to the their shareholders’ rights” warning that detriment of shareholders. otherwise “Japan’s capital markets will not develop”. The Financial Services Agency As long as these sorts of regulatory gaps certainly is encouraging better corporate exist and allow Japanese companies to governance too and is keen to see Tokyo ignore basic rights of shareholders, there become a leading financial centre again will be a continuation of the pattern (both Hong Kong and Singapore have of minimal foreign direct investment a much greater claim to such a status and Tokyo’s declining influence as a than Tokyo now does) but unless there global financial market centre. Japanese is a change in attitude among Japanese companies are looking to invest overseas companies (as compliance with basic and are increasing their takeover activity in rules of corporate governance, including Europe and the US but may face a backlash the TSE’s own Corporate Governance if the situation in Japan remains so heavily ‘Principles’ are, for the most part, voluntary weighted against foreign investment in only), or the TSE and the government’s Japanese companies. What this all means regulators regulate to force change, this is for M&A in Japan in 2008 though, is that the unlikely to happen. outlook is not strong and M&A activity is likely to be less in 2008 then it was in 2007, It has been popular in Japan for subsidiaries perhaps improving in the second half of the to be listed but with controlling stakes year. retained by the parent, and the takeover and de-listing of some of these would be welcome. One such company (NEC Paul O’Regan is head of the Corporate Electronics Corporation) is subject to attack Department in the Tokyo office of Clifford by Perry Capital, an activist US hedge fund, Chance.
www.financierworldwide.com | FW 317 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Australia’s foreign investment framework: a more challenging landscape emerging for M&A
by Matthew Latham and Weyinmi Popo
Australia’s foreign investment regime with national interest concerns. is made up primarily of the Foreign Acquisitions and Takeovers Act 1975 (FATA) Takeovers by foreign persons of foreign and sector/company specific legislation. companies which own Australian assets The FATA provides legislative backing (comprising less than 50 percent of the for the Australian Government’s foreign target’s total assets) valued in excess of investment policy and screening of foreign $200m also require the approval of the investment into Australia. The FATA is Treasurer under the FATA, as do asset administered by the Foreign Investment acquisitions and investments in urban land Review Board (FIRB), a non-statutory body (including via companies or trusts). Direct which was established in 1976 to perform investments by foreign governments and an advisory function only. their agencies must also be approved by the Treasurer, irrespective of their size. Under the FATA, a foreign person (or an entity in which foreign persons individually Australia’s policy is to encourage foreign or in aggregate have ‘substantial interests’) investment, such that in the last five must notify and seek the approval of years it increased by $168bn to reach the Federal Government Treasurer for $244bn in 2007. Notwithstanding this any agreement under which that person inflow, like other nations Australia seeks acquires a ‘substantial interest’ in an to balance these economic benefits Australian corporation (or an offshore against community concerns about foreign company whose Australian assets ownership of Australian assets. However, comprise more than half of its total assets) compared with the US and UK, foreign whose gross assets exceed AU$100m (or investment in Australia remains closely AU$913m for US investors not investing regulated. in prescribed sensitive sectors). A foreign person is deemed to have a substantial National interest test interest if they control voting power in or hold (legally or beneficially) 15 percent or The FATA does not define what the more individually or 40 percent or more ‘national interest’ constitutes, and past in aggregate of the issued shares in an governments have been loath to disclose Australian corporation. The Treasurer policy guidelines for any national interest can make orders prohibiting a proposed test. The most guidance that the former acquisition, or requiring a divestment where coalition Federal Government issued was the acquisition has already occurred, if he that it determined what is ‘contrary to the considers it to be contrary to the ‘national national interest’ by having due regard to interest’. Alternatively, the Treasurer can the community concerns of Australians. impose conditions on any approval to deal
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The failure of the FATA and successive incidence of cross-border investment governments to define or provide guidance consortia and the use of corporate on the national interest test has been structures which (even unintentionally) often criticised because it is opaque and avoid triggering the mandatory notification allows foreign investment decisions to be thresholds; (ii) increasing geo-political made based on prevailing political winds of and strategic importance of Australia’s change. In 1994, a Senate Select Committee non-renewable natural resources driven recommended that the FATA be amended by demand from rapidly industrialising to include national interest criteria which economies in Asia, but particularly China; would be applied in determining foreign and (iii) advance of sovereign wealth funds investment applications. Successive and sovereign controlled corporate entities federal governments have chosen not to into Australian markets. implement this recommendation. Certainly, in an M&A context, where it is mandatory These three factors will likely make for for acquisitions above the FATA thresholds a more complex foreign investment to be made conditional on FIRB approval, regulatory climate in Australia in the the ambiguities around the national interest coming years when compared to the test can sometimes lead to significant relatively benign foreign investment execution uncertainty. challenges of the last decade. This means that the balance between foreign The uncertainty around the national investment (and international trade interest test is not helped by the fact that competitiveness) on the one hand, and there has only been one high profile M&A Australia’s strategic interests and populist transaction blocked in recent times on concerns about ‘iconic’ and strategically national interest grounds. In 2001, Royal important assets being controlled by Dutch Shell attempted to acquire Woodside foreign persons on the other, will become Petroleum, an Australian company that more challenging for the Australian held strategic interests in Australia’s North Government to achieve. The controversy West Shelf LNG project, from which large in the US raised by CNOOC’s proposed Australian exports were earned. The then purchase of UNOCAL, Dubai Ports World Federal Treasurer blocked the acquisition acquisition of P&O’s US port facilities and on the grounds that Shell’s ownership the hostility in certain European countries and control of Woodside would not have to the cross-border flows of capital driven guaranteed the promotion and sale of by hedge funds, all show to some extent North West Shelf products over competing that similar issues are common to all international exports. Western nations.
Foreign investment in the Australian M&A Corporate structuring context: recent trends and challenges The unsuccessful bid by the Airline Australia has traditionally had a liberal Partners Australia consortium (APA) to stance towards foreign investment in the acquire Qantas Airways in 2007 provides a M&A context. However, foreign investment recent and apposite example of corporate policy is likely to face new and evolving structuring by a consortium comprising challenges due to the: (i) increasing foreign investors which, on initial analysis, www.financierworldwide.com | FW 319 INTERNATIONAL MERGERS & ACQUISITIONS 2008
obviated the need for foreign investment the FATA when faced with corporate approval. It also illustrates the practical structuring which complies with the limitations of such structures when letter (but perhaps not the spirit) of the confronted with the political reality which legislation. It also showed that in the case surrounds transactions involving ‘iconic’ of acquisitions of politically sensitive assets, assets. complying with the letter of the law is by no means determinative of whether the Government believes FATA approval is required. The APA precedent suggests that in such acquisitions a ‘voluntary’ application Coupled with the recent investments by sovereign to FIRB would be politically expedient, wealth funds in major US and European banks, this irrespective of whether the legislative thresholds are triggered. has led to some apprehension in Australia as to how Australia’s foreign investment regulatory regime Strategic resources and SWFs should respond to these developments. The unprecedented demand for Australian non-renewable natural resources by rapidly industrialising Asian nations such as China has fuelled Australia’s economic In December 2006, APA (a consortium growth and prosperity in recent years. which comprised Australian and foreign It has also highlighted – for itself and its investors) announced a takeover offer trading partners – the strategic importance to acquire Qantas. The structure of the of Australia’s natural resources. This has consortium bid vehicle meant that no led to an increased interest by countries foreign persons had voting interests above such as China in securing the supply of the relevant FATA thresholds (either such resources by acquiring interests individually or in aggregate), although in Australian mining entities, including the economic interests of certain foreign more recently through bids for outright consortium members exceeded such control of public companies. Chinalco’s thresholds. While APA argued that it did acquisition in February of a significant not require the Treasurer’s approval for the minority stake in Rio Tinto has also raised acquisition under the FATA, the intense the political temperature in respect of political pressure and media interest in foreign ownership of economically strategic the acquisition of an iconic Australian Australian assets. Coupled with the recent company in a Federal election year investments by sovereign wealth funds eventually resulted in APA having to make in major US and European banks (such as a ‘voluntary’ submission to the Treasurer. Citigroup, UBS and Morgan Stanley) this APA then had to give binding undertakings has led to some apprehension in Australia to the Government as part of the foreign as to how Australia’s foreign investment investment screening process about regulatory regime should respond to these Qantas’ continued Australian ownership developments. and control. The recently elected Labor Government The APA bid exposed the limitations of has been relatively quick to respond to
320 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS some of these challenges. In February, the commercial considerations and may current Treasurer, Wayne Swan, clarified instead pursue broader political or strategic the national interest tests he would apply objectives that could be contrary to to sovereign fund investments in Australia Australia’s national interest, and reiterated by releasing six principles he would apply that all such acquisitions must be notified to when approving investment applications the FIRB. from such funds, namely whether: (i) an investor’s operations are independent from Concluding thoughts the relevant government; (ii) an investor is subject to and adheres to the law and The recent trends and challenges of observes common standards of behaviour; foreign investment in the M&A context in (iii) an investment may hinder competition Australia discussed above highlight the or add to undue concentration or control complexities facing Australia’s foreign in the industry or sectors concerned; (iv) investment regulatory regime in the near an investment may have an impact on term. The response by the Australian Australian government revenue or other Government to these complexities will be policies; (v) an investment may have an crucial in determining whether Australia impact on Australia’s national security; remains a competitive destination for and (vi) an investment may have an cross-border capital flows internationally. impact on the operations and directions The initial response by the newly elected of an Australian business as well as its Australian Government is positive, and contribution to the Australian economy and shows that Australia’s foreign investment broader community. regulatory environment is still welcoming of foreign investment and that Australia The Treasurer has explained that Australia is not adopting a potentially damaging “maintains a welcoming stance towards protectionist stance. However, it also foreign investment”, but also appears shows that the regulatory framework and to distinguish between transparent and the manner in which it is interpreted will commercially driven sovereign investors inevitably need to evolve – perhaps with and those which are not. Proposals by greater policy guidance around the national foreign government owned or controlled interest criteria than has historically investors that operate on a transparent occurred – to address the key issues raised and commercial basis are less likely to by market developments such as the raise additional national interest concerns increasing presence of SWFs. than other proposals. The Treasurer also acknowledged that investors with links to foreign governments may not Matthew Latham is a partner and Weyinmi operate solely in accordance with normal Popo is an associate at Jones Day.
www.financierworldwide.com | FW 321 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Control of foreign investment in Australia
by Rod Halstead, John Elliott and Michael Parshall
Foreign investment into Australia has complying with Australian law. long been subject to a statutory review and approval procedure. The Foreign What have changed over the years have Acquisitions and Takeovers Act (FATA) was been the monetary thresholds below which enacted in 1975. Despite several changes proposed investments are exempt from of government since then, the processes notification or examination. In keeping established by the Act have remained with the (again bipartisan) official policy largely unchanged. There is bipartisan of welcoming foreign investment, these support for the Act’s major objective – to thresholds have been raised by several ensure that the Australian Government factors since the Act came into operation. retains the ultimate legal right to prohibit The most recent general increase was proposed investments which are contrary in late 2006, when the thresholds were to the national interest. doubled.
Of course, the existence of the power is In practice, therefore, FATA is not a major not the same as the exercise of the power. hurdle to the overwhelming majority Although the Act requires the notification of inbound investments. Nevertheless, and examination of a large number of because of the sovereign sensitivities proposed business investments, outright around foreign investment, compliance prohibitions of such proposals are very rare: with the notification procedures is the last prohibition of a foreign takeover regarded very seriously by the Australian was in 2001, when the government acted Government and corporate lawyers. In against Shell Australia Investments other words, the fact that a proposed Limited’s proposed acquisition of Woodside investment is extremely unlikely to raise Petroleum Limited, the operator and part- concerns for the government does not owner of the North West Shelf, Australia’s mean that the legal requirement to notify largest developed energy resource. The that proposal is to be treated lightly. government’s action was prompted by concerns about the resulting foreign Another important aspect of the FATA ownership of North West Shelf and the regime is that it operates at the interstices potential for underdevelopment of that of law and high government policy. To resource. understand how it works, one needs to consider both the statutory requirements Conditional approvals are more common of the Act and the governmental policy than rejections, but are still only a which governs its operation. That policy is small percentage of total applications. readily available in published form, which Conditions typically relate to such matters means that: (i) the processes of the Act are as maintaining an Australian presence and predictable and largely transparent; and
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(ii) the Act is applied in accordance with recommendations to the Treasurer. existing published policy, thus mitigating the potential for ad hoc interventions by the The Act empowers the Treasurer to prohibit legislature such as characterised the Dubai any proposed foreign investment on the Ports affair in the US. grounds that it is contrary to the national interest. However, a foreign investment The only policy matter which is not publicly would only come to the Treasurer’s defined is the ‘national interest’ criterion. attention in one of three circumstances: The national interest, and what is contrary (i) the value of the proposal is above a to it, are matters for the government of the statutory threshold, in which case the day to decide. However, as noted above, it Act requires that it be notified to the is rare for a proposed business investment Treasurer; (ii) government policy requires to be rejected on the grounds that it is that the proposal be ‘voluntarily’ notified contrary to the national interest. under the Act (because it is in a designated sector of the economy, for example); and In addition to FATA, there are a number (iii) although notifiable under one of the of industry-specific statutory controls on two categories above, the proposal was foreign investment. These are discussed not formally notified in accordance with below. the Act (in which case, the investor faces the possibility of an order to unwind the transaction if the Treasurer subsequently declares that the investment is contrary to the national interest).
Which foreign investors are affected? The national interest, and what is contrary to it, are matters for the government of the day to decide. FATA applies to investors who are natural persons or corporations. Natural persons fall under the Act if they are ‘not ordinarily resident’ in Australia. A person is ‘ordinarily resident’ if they were in Australia for at least 200 days in the 12 months preceding the transaction. Investments by corporations How is FATA administered? fall under the Act if: (i) a single non-resident controls at least 15 percent of the voting Nominally, the Act is administered by power in the corporation; or (ii) total non- the Treasurer of Australia (the Australian resident voting power in the corporation is equivalent of the Chancellor of the at least 40 percent; or (iii) a single foreign Exchequer in the UK or the Secretary of the corporation controls at least 15 percent; or Treasury in the US). In practice, most of the (iv) total foreign corporation voting power administrative work is done by the Foreign in the corporation is at least 40 percent. Investment Review Board (FIRB). Although formally addressed to the Treasurer, What is notifiable? notifications under the Act are lodged with FIRB. FIRB assesses notifications and makes FATA has two notification and review
www.financierworldwide.com | FW 323 INTERNATIONAL MERGERS & ACQUISITIONS 2008 regimes. One covers the acquisition of real Domestic aviation. Foreign persons estate in Australia. The other, the subject (including foreign airlines) can generally of this article, covers foreign investments expect approval to acquire up to 100 in Australian businesses. Legally, there percent of the equity in an Australian are two broad categories of notifications: domestic airline (other than Qantas), unless those required by the Act and those this is contrary to the national interest. required by policy. In practical terms, this means that the following transactions International aviation. Foreign persons by foreign interests must be notified. (including foreign airlines) can generally First, acquisitions of a substantial holding expect approval to acquire up to 49 percent in an Australian corporation where the of an Australian international carrier (other acquisition involves more than a statutory than Qantas) individually or in aggregate, threshold dollar amount. A substantial provided the proposal is not contrary to holding is 15 percent of the voting shares the national interest. In the case of Qantas, in the corporation (if controlled by a total foreign ownership is restricted to a single person) or 40 percent if controlled maximum of 49 percent in aggregate, with by two or more associates. Broad anti- individual holdings limited to 25 percent avoidance provisions extend the Act to and aggregate ownership by foreign airlines arrangements which deliver de facto, rather limited to 35 percent; a number of national than legal, voting control. Second, the interest criteria must also be satisfied for establishment of a new business involving Qantas, relating to the nationality of board a total investment of AU$10m or more. members and operational location of the The establishment of new businesses by enterprise. US investors, except an entity controlled by a US government, do not require Operators of major airports. There is a notification. Third, takeovers of offshore 49 percent foreign ownership limit, a 5 companies whose Australian subsidiaries percent airline ownership limit and cross or gross assets exceed the statutory ownership limits between Sydney airport thresholds. Finally, direct investments by and Melbourne, Brisbane and Perth foreign governments and their agencies airports. irrespective of size. Shipping. Under the Shipping Registration Industry-specific foreign investment rules Act 1981 a ship registered in Australia in Australia must be majority Australian-owned, unless the ship is designated as chartered by an There are a number of industry- or Australian operator. company-specific foreign investment regimes in Australia. Some of these arise Telecommunications. Australia’s largest under FATA policy; others are the result of telecommunications company, Telstra, specific statutes: was progressively transferred to private ownership over the last decade; part of Media. Portfolio investments in the media the sale process involved the imposition of 5 percent or more and all non-portfolio of limitations in foreign ownership of the investments irrespective of size must be company: aggregate foreign ownership notified under FATA. is restricted to 35 percent and individual
324 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS foreign investors are limited to a holding of foreign governments and their agencies no more than 5 percent. are notifiable. In September 2007, the Australian Government reportedly raised What are the statutory monetary the issue of investments by sovereign thresholds? wealth funds with FIRB. Subsequently, in February 2008, the government announced The monetary thresholds above which new guidelines that would be applied to notification is required depend upon the the examination of investments by foreign type of acquisition and the nationality of government agencies such as state- the acquirer. As a result of the Australia- owned enterprises (whether or not partly USA Free Trade Agreement, many US privatised) and sovereign wealth funds. The investors enjoy higher thresholds than guidelines focus on the separation of the other nationals (although there is provision commercial objectives of the investor from for these higher thresholds to be extended the policy objectives of its government. to other countries as Australia enters other The greater the separation between the free trade agreements). two, the less likely it is that the proposed investment would raise national interest For non-US investors, US investors in concerns for Australia. prescribed sensitive sectors and US investors which are controlled by a US What happens when a notification is government, the current thresholds for made? notification are set as follows: (i) for the acquisition of substantial interests in an Although very few business acquisitions Australian corporation, the value of the fall foul of FATA, the process of compliance corporation’s gross assets is $100m (non-US must be taken into account when planning investors) or $105m (US investors); (ii) for a transaction. When a notification of the takeover of offshore companies with a proposed acquisition is lodged, the Australian subsidiaries that account for less government has 30 days in which to reach than 50 percent of the offshore company’s a decision on whether to approve it (this assets, the threshold value of the Australian can be extended by up to 90 days). The subsidiaries’ gross assets is $200m for non- government’s power under FATA is on a ‘use US investors and $210m for US investors; it or lose it’ basis. If, by the end of the 30 and (iii) for the takeover of offshore days or extended period, the government companies with Australian subsidiaries that has not prohibited the acquisition or account for more than 50 percent of the approved it subject to conditions, the offshore company’s assets, the threshold government loses the power to make value of the offshore target company’s orders in relation to the acquisition. gross assets is $100m for non-US investors and $105m for US investors. For other US As a matter of commercial reality, few investors, the dollar threshold is $913m. US major commercial transactions can go thresholds are indexed annually. into stasis for up to four months while the Australian Government decides whether to Foreign government investment approve them. This problem is addressed by two procedures. In the initial planning As mentioned above, all investments by stages of an acquisition, FIRB can be www.financierworldwide.com | FW 325 INTERNATIONAL MERGERS & ACQUISITIONS 2008 contacted directly to discuss the impact persuasions have retained the FATA of FATA and policy on a specific proposal. process, largely unaltered, for over 30 Later, when an acquisition is announced, years. Nor has the relative paucity of the parties will usually state that it is prohibitions resulted in any lessening conditional upon FATA approval. Where of the rigour that FIRB applies to the the acquisition is by private contract, this evaluation process. Although they have condition is necessary to avoid a breach of developed considerable expertise in lodging the Act through the acquirer’s signing of the notifications and negotiating with FIRB, contract (and hence making the acquisition) Australian commercial lawyers know that before the lodgement of notification. Such each business proposal and notification is a condition also allows the acquirer or unique and that the FATA outcome cannot bidder to walk away if its deal is ultimately be treated as a forgone conclusion. ruled to be against the national interest.
Conclusion Rod Halstead is chair of Mergers & Regardless of the fact that foreign Acquisitions, and John Elliott and Michael takeovers are only rarely prohibited, Parshall are joint heads of Mergers & Australian Governments of all political Acquisitions, at Clayton Utz.
326 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g M&A in emerging Asia
by Nicholas Assef
Although China captures much of the Second, many of the economies, such as world attention, other Asian nations also Vietnam, have been under political regimes present incredible opportunities. In India, where state ownership of businesses has for example, the Telecom & Regulatory been the norm. Therefore, the ability to Authority released statistics in January even transact has been effectively non- 2008 which revealed that mobile phone existent. subscribers in that country grew by around 84 million in 2007, with growth in the later An acquirer entering a Tiger economy for part of the year ramping up to around the first time must be patient. They must be 8 million a month. Unsurprisingly, telco quiet in their approach, and invest the time executives are keen on the prospect of to understand the cultural subtleties that entering such a high growth market. each nation possesses. CEOs need to get to know the market intimately and avoid Conducting business in the Asian region making assumptions. Approaching Asia as presents unique and ever evolving ‘one nation’ is a sure-fire path to failure. challenges. In addition to the mature Despite the fact that borders are often markets of Australia, South Korea and shared, nations are incredibly unique. Singapore, there is growing activity in the emerging markets of Vietnam, Legal frameworks. The first thing for the India, Malaysia, Indonesia, Thailand, the CEO to appreciate is that a legal contract Philippines and Cambodia. We believe the is generally cold comfort in an emerging opportunities in these explosive growth Asian economy. Any acquirer that believes economies justify the investment of time it will be able to enforce warranty claims, and capital that needs to be dedicated in contractual rights and so on, will often be order to establish and develop a presence disappointed. in what are undoubtedly the markets of tomorrow. This is a key a reason why Westerners regularly fail. Rather than having a Traditional M&A. Taking the traditional, fundamental acceptance of a collaborative highly structured, strict approach to approach to taking a business forward, the a transaction rarely wins the day in typical ‘us and them’ approach is applied developing Asia. There are a couple of at the outset of a potential corporate fundamental reasons. First, many of the transaction. Many deals simply stall and Tiger economies are not places where deep wither as a result of a failure to accept experience in M&A has evolved among a quieter, and in many ways a more either corporates or the professional sophisticated, approach to doing business. community. The CEO should also become familiar www.financierworldwide.com | FW 327 INTERNATIONAL MERGERS & ACQUISITIONS 2008 with the ‘licensing’ regimes of conducting case typically needs to be built up by the business in each market. There are often acquirer and its advisory team – which requirements (such as in Vietnam) for can be a difficult and drawn out process every company to be licensed to conduct in itself. Even government data can lag by business. This is before one considers the considerable time periods. requirement of local joint venture partners. Often these issues are not complicated, just Although a traditional due diligence time consuming. framework provides parameters by which any opportunity can be investigated, the Political and environmental landscapes. commercial drivers of where a business can Another matter that Westeners need to be taken in the future should be the priority gain comfort with is the ever changing of any assessment, rather than focusing on political landscape that typifies many yesterday’s risks. jurisdictions. Such ‘instability’, however, is not new to the region. Political change Financial data. One challenge that has to be at either the government or the individual pointed out is the difficulty in reconciling bureaucratic level can materially disrupt the financial data of a target. This happens business activities. for a variety of reasons, many of which are widely publicised, although often with a The associated matter is environmental touch of urban myth around them. A simple stability. Over the last decade there explanation relates to the maturity of have been a number of potential health markets and the fact that most businesses ‘pandemics’ across the Asian region – are private. Yes, there are often multiple including SARS and avian flu. The potential ‘sets of books’. To overcome this, the CEO for such occurrences needs to be accepted must build enough trust with the target by any potential market entrant. Their company to understand the real potential reoccurrence may have a devastating of the opportunity. impact on operations and demand in the short term across a wide range of The job for the acquirer will often involve industries. And of course, they cannot be building a robust financial model to such an modelled. extent that the acquirer may think that it is drafting the business plan and associated Due diligence. Another point of frustration financials for the target, which in reality it for Westeners is the due diligence process. often is. Material from business plans to financial data is not typically produced on a day to Can the business scale? During the financial day basis in hardened form by many Asian and commercial assessment CEOs should companies. Therefore the process of due critically analyse the ability of any target diligence needs to be flexible and tailored company to leverage its operational base, to the individual case. more so in developing Asia than mature economies. Associated with this is credible market and sector data, which is unavailable In particular, the quality of the physical in most emerging Asian countries. The assets that may be purchased must be data to support an acquisition business assessed. This is because in most Asian
328 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS jurisdictions entrepreneurs will favour factors in these markets, the entrepreneurs second hand equipment to reduce costs, themselves are generally highly educated, and maintenance can be lacking. The academically or commercially. The internet useful life of this equipment may be less has educated them about the potential than expected – which means that capex wealth that can be derived from having a and opex might be materially higher just a successful business. few short years following the acquisition’s completion. Wary of professionals. Many emerging markets (such as Vietnam and Indonesia) Again, these issues are not unique. But have a reasonable mistrust of professional more time should be spent investigating advisers, often stemming from the fact the business case for scalability of that the use of such professionals is not operations. all that common for facilitating corporate transactions. For this reason it is important Support and control. Flowing on from that the bidder aligns itself with groups the need to build financial data is the that understand the framework of any requirement to effectively control matters marketplace. The use of a senior local such as cashflow following completion of an figure can also be useful in smoothing over acquisition. Seasoned acquirers will often potential bumps in deals. seek to interpose an intermediary if they have no permanent local management Valuation. Rapid growth markets pose a in place. This intermediary can control all great challenge in establishing the value aspects of cashflow and reporting of KPIs. of acquisition candidates – particularly when an educated entrepreneur believes Young teams. Many entrepreneurs are the potential value the company may young and highly ambitious, but they reach tomorrow is what should be paid are not particularly experienced. This can today. Seasoned CEOs should agree to mean a certain amount of almost irrational a value based upon specific milestones behaviour from time to time – which is being achieved over periods of up to five a natural result of believing one is more years. Although a structured transaction is experienced that one is. In particular, this nothing new, the levels of structures used in can affect the time it takes to do a deal. emerging Asia can be highly beneficial for Founders have a habit of regularly changing the acquirer. their minds, for example. Skill shortages. Enthusiasm in business Acquirers need patience and a level does not replace experience. Many rapidly head. This also links into the requirement expanding Asian companies hit a major of having earn outs. Without ‘golden hurdle in the recruitment of skilled and handcuffs’ attaching the individual to the experienced professionals. A basic issue target there is little chance they will be is that experienced Asian executives are there post acquisition. Many will invariably themselves opting for the path of growing be off doing another deal, if they don’t have their own businesses rather than being multiple deals underway already. employees.
Despite the immaturity of economic Therefore, a key attractor that a bigger www.financierworldwide.com | FW 329 INTERNATIONAL MERGERS & ACQUISITIONS 2008 offshore player can give is the infrastructure immature by many western standards. and systems by which the entrepreneur Consumers are enjoying increasing can quickly expand in a controlled fashion. standards of living. Technology is assisting In the media sector in particular, the in driving both consumer demand and the winning factor in a deal is often the career maturing of these markets. In the event opportunities that the acquirer can offer. an acquirer can adapt its business model Although Asian entrepreneurs are typically to deal with such a fluid environment, it happy growing their businesses to a certain may open itself up to opportunities which level, they often acknowledge that there have the prospect of delivering exceptional is a real attraction to being part of a larger shareholder value. organisation.
Opportunity exists. These markets are Nicholas Assef is an executive chairman at big. They are growing rapidly but are still Lincoln Crowne & Company.
330 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g How to speed up M&A deals in China
by Fei Guoping
A foreign acquirer entering the Chinese they are likely to suffer communication market needs to know how to conduct problems and may be unable to complete efficient negotiations, understand China’s the transaction. legal system and familiarise itself with the various due diligence requirements. To overcome this, an acquirer should build trust, tell its Chinese partner how they will Conducting an efficient negotiation in benefit, and grant its team freedom to China manage the deal.
Foreign investors often complain that Build trust transactions with Chinese companies will take them more time than similar Chinese entrepreneurs have a saying which transactions with European and US advises them to ‘conduct oneself first companies. But the length of time should before running the business’, meaning that not be blamed solely on Chinese companies in a deal they need to assure themselves or the government’s complicated scrutiny that their potential business partner is procedure; in most cases the foreign reliable. After this confirmation, they investor must share the blame. When doing will tend to take a more active role in business in China, investors are always forthcoming negotiations. It is therefore carrying out their M&A plans according to strongly recommended that acquirers some fixed code without paying attention make the effort to establish trust. The to what their Chinese partners are really widespread notion that an acquirer cannot concerned about. It follows, unsurprisingly, make a deal without having a personal that the Chinese sellers are always slow to relationship with government officials has nod their heads at the negotiation table. As substantially distorted the importance of a result, it takes more time to conclude a the Chinese philosophy on relationships. deal. The underlining essence of the relationship structure is the trust among people in When negotiating, a Chinese entrepreneur China. is always taking several issues into consideration. What benefit can he get from Chinese culture stresses that individuals a deal? Is it imperative to take part? After should ‘listen to his words and watch his the takeover, will the acquired company deeds’. It means, when building trust, be turned into a SOFE? Unless all these people should not only listen to what issues are agreed by both parties, it will be others say, but take note of what they do, difficult to proceed with the deal. If foreign because their actions are just as important. buyers carry out the deal as they planned, So how is it possible to judge whether a and close their eyes to such concerns, potential business partner is reliable before www.financierworldwide.com | FW 331 INTERNATIONAL MERGERS & ACQUISITIONS 2008 cooperating? Clever Chinese businessmen be considerate. When negotiating, they find the answer at the dinner table (one usually inform their prospective partners of more thing a foreign party may complain their intentions and interests at the outset. about). The Chinese entrepreneur will invite That way, they can always easily catch the his potential partner for lunch or dinner, attention of Chinese businessmen. It is wise and during this period, listen carefully to for a foreign investor to explain early and in what the potential partner says and watch detail their future profit estimates, which closely what he does at the table. From will accelerate the transaction process. that, the Chinese businessman will assess his trustworthiness. Foreign investors have Grant the team freedom to manage the deal a tendency to ignore China’s profound wine and food culture when they complain that To conduct a deal which strictly conforms the dinner process take too much time. In to norms is never wrong. However, as far as fact, it is at the dinner table that the parties the value of a merger is concerned, the key will get to know each other and build trust. is to maximise the shareholders’ benefits. It Of course, there are also other Chinese is therefore important to grant your team ways to built trust. the necessary right to conduct the M&A in a feasible way, which normally shortens the It is only partly true to say that the time needed to complete the transaction. relationship comes before the deal; more accurately, if there is no trust, there will be no deal.
Tell the Chinese partner how they will benefit
Chinese managers and shareholders are It is only partly true to say that the relationship born experts at weighing options. They are comes before the deal; more accurately, if there is no also acutely aware of the saying ‘lose at trust, there will be no deal. sunrise and gain at sunset’. Hence, when they are going to sell their companies, they are considering what they will get in the deal. It is natural that in an M&A negotiation, a Chinese manager will care about nothing but ‘the essence of the deal’ An enterprise which made numerous global – the actual value and benefit he will gain. deals once imposed a rule that it would never participate in cross-regional or cross- He may also express concerns about cultural M&A markets. But it moved into whether the deal will harm his vested China’s M&A market two years ago, and has interest or have an adverse effect on his surprisingly completed three acquisitions future rewards. Unless this material matter successfully. Not only did the transactions has been agreed by both parties, Chinese themselves go smoothly, their post-merger managers and shareholders cannot turn integration turned out favourably. One of their attention to other issues. the reasons for this success was that the enterprise had every confidence in the M&A On this matter, financial investors tend to team and gave them the right to make
332 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS quick and feasible responses according to interpretation and enforcement of the law. the specific context of a deal as long as it To understand such a legal system, not benefited the M&A value. Such a team need only is legal knowledge required, but also not be restricted by the fixed processes and the knowledge of Chinese culture and rich procedures of M&A. social practice in China.
Understanding China’s legal system The long-delayed Carlyle and Xugong deal is just one example. In that deal, the parties Foreign investors often complain that they have failed to get the approval document in did not receive fair treatment in China. They over two years. The most significant reason investigate China’s law carefully to comply for this is that the acquirers have failed to with the procedures. They also grasp the fully understand China’s legal system and most authoritative and latest detailed regulatory mechanism, and as a result they M&A strategies supplied by international have drafted a legal structure to the deal advisory agents. However, when dealing which does not conform to the laws and with relevant PRC regulatory authorities, regulative rules in China. many find China’s legal environment highly confusing. An acquirer’s inadequate grasp Therefore, foreign investors need to of PRC laws and regulations is often a understand fully the construction of the greater weakness than its M&A strategy. PRC legal system. They should not only pay attention to the documents officially In line with the findings of some foreign termed ‘law’ or ‘regulation’, but also to investors, even if an acquirer stays in those polices or documents that help them line with all laws and regulations, the to understand the application of the law. transaction may not be conducted as scheduled. One reason is that the principle Due diligence in China of ‘no prohibition in law means admission’ was not followed entirely in China, and When it comes to the due diligence whether a law can be carried into execution process, there are three main issues: (i) the will be decided by a definitive rule problem of non-transparent information, concerning the details of implementation. (ii) the complexity of China’s tax, labour Another important reason is that when and IPR problems; and (iii) the problem of PRC authorities are supervising deals, oversimplified Chinese contract clauses. they will not only follow the law but also the definitive rules or directive principles The problem of non-transparent information called ‘Red-Title Documents’. Furthermore, the Chinese Government allows these In the due diligence investigation, it regulatory agencies to draft supervising is difficult to investigate the legality, rules by themselves. There are other integrity and veracity of information on a documents which an acquirer should pay target company in China. This is because attention to, including speeches made Chinese courts cannot supply such by senior officials of the governing party. investigative services when needed and Even though these documents are not some information is difficult to obtain, followed directly by regulatory agencies, such as details on the target company’s their contents exert influence on regulators’ underlying litigation, arbitration and www.financierworldwide.com | FW 333 INTERNATIONAL MERGERS & ACQUISITIONS 2008 execution. Furthermore, it is difficult to related laws, such as labour contract law. collect desired information on the target’s A violation, if serious, could mean a risk of management because the social trust administrative punishment but seldom will mechanism described above has not been it constitute a crime. completely established. A typical example is that when commercial banks in China provide a loan, in addition to the pledges they always ask for the other companies to guarantee the credit of the borrowing Because of the irregularities, some companies with corporations as guarantor. The inter- tax problems do not want regulatory authorities or processing of a credit guarantee may combine several corporations together in others to have access to their information, afraid one area by mutual guarantee. Banks often that exposure will subject them to an economic fine fail to register such information timely and correctly, which means the acquirer or even criminal liability. cannot obtain and thus is unable to forecast the contingent pledge risk. The situation becomes even worse when a company provides credit guarantee for others Addressing tax problems is slightly without recording it. complicated. For tax problems in due diligence, buyers will ask for patching- The complexity of China’s tax, labour and IPR submittance or accrued preparations, even problems re-valuation, which seems reasonable to them, but not to Chinese companies, When buyers excitedly agree on a which understand the realities in China cooperative intention and start to review and do not believe they are at risk of being the details of the target company, they punished. As a result, they cannot accept will be concerned by China’s tax and the condition to pay tax owed or do accrued labour problems, which exist in Chinese preparations and lower the deal value. corporations universally but with varying Indeed, because of the irregularities, some degrees of severity. These problems companies with tax problems do not want are connected with the legal system regulatory authorities or others to have and social environment of China. The access to their information, afraid that universal irregularity, as well as the abuse exposure will subject them to an economic of administrative power, means that the fine or even criminal liability. Many costs of compliance are higher than that companies in China will therefore choose to of infraction. Therefore, in order to reduce avoid M&A opportunities. However, if these costs, companies will take action which problems are tackled appropriately, it will more or less amounts to breaches in tax and help to conclude a deal more smoothly, and labour laws. more M&A candidates will emerge.
In China, addressing the labour problem is Another common problem in M&A due not as difficult as that of tax. One just has diligence is the infringement of IP rights. to draft the labour contract and undergo all Although the Chinese Government the employment procedures according to has struggled to tackle the continued
334 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS infringement of IPRs in recent years, there it difficult for enterprisers to forecast are still numerous IPR infringements in potential risks buried in simple contracts. most Chinese enterprises. If the target For example, one reason for the conflict company is the victim, it is easy to handle between the French company Danone – just leave that issue to legal action. If the and the Chinese company Wahaha in 2007 acquirer is working with a capable legal was oversimplified contract clauses. In team, it may also manage to recover any the joint venture contract, Wahaha was loss, which will add share value. But if the bound to an anti-competition clause, target company infringes others’ IPRs, while Danone was not. The situation in the situation is more complicated. In any China’s underdeveloped market economy event, this should be dealt with tactfully to leads some companies to start up without avoid harming the interests of the target attempting a thorough forecast of the company’s shareholders and managers. future, which would probably explain why Wahaha took the view that nothing was The problem of oversimplified Chinese more important than cooperation with contract clauses Danone.
When foreign investors investigate a It is hard to obtain the necessary Chinese company’s contracts, they will information for complete due diligence. often find that the contract clauses are It is even more difficult to forecast oversimplified. This has much to do with its effect on the transaction and take China’s culture and stage of development. pertinent countermeasures. If an acquirer and its advisory team want a satisfying As mentioned earlier, under Chinese outcome from M&A, they need a thorough culture, people prefer dealing with those understanding of Chinese law and its they can trust and are not accustomed to market, backed up by extensive practical consider a business partner untrustworthy. experience in China. When negotiating, they are reluctant to raise questions because they believe it will harm their friendship. Fei Guoping is vice chairman of China M&A In addition, China’s young market and its Association and partner of Long&Field, the less developed commercial culture make M&A Department of Grandall Legal Group.
www.financierworldwide.com | FW 335 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Will cross-border buyouts in China ever be feasible?
by Marcia Ellis and Jay C.S. Tai
Every week it seems a new buyout fund is buyouts continue to be very difficult if not opening an office in China or announcing impossible for private equity investors. a new Asia-focused initiative. In the last Several recent inbound China buyouts, couple of years, smaller funds and the funds most famously the Carlyle Xugong deal, of international investment banks that are have been announced but never closed well-established in Asia have been joined by due to difficulties in obtaining required larger buyout funds such as KKR, Bain and government approvals. In general, buyout Blackstone, which have opened offices in shops have had to content themselves Hong Kong in the last few years from which with significant minority stake investments they plan to source and manage China and (for example, KKR’s investment last other Asian investments. year in Tianrui Cement), and even these investments have become increasingly The numbers tell the story. In 2006, eight difficult due to regulatory changes. Asia-focused buyout funds raised a total of US$6.44bn, while in 2007 18 Asia- Impediments to private equity focused buyout funds raised a total of investments US$15.67bn. Despite the subprime crisis and the resultant dampening of buyout The last few years have presented a rocky activity in the US and Europe, 2008 already and ever-changing regulatory landscape promises to be a boom year for buyout for inbound private equity investments in activity in Asia. Blue Ridge Partners already China. In some ways, China has come a has announced it has raised a US$1.45bn long way in constructing a framework for buyout fund focused on Asia and JP Morgan acquisitions by foreign investors of interests Asia Partners has announced it has raised in Chinese companies, a framework that a US$750m fund to invest in mid-market did not exist before 2003. Unfortunately, buyouts in Asia. In fact, there is every regulations on foreign M&A that came into indication that buyout funds are shifting effect in September 2006 have created greater attention to the Asian markets a major impediment to inbound private as the types of LBOs that they have been equity transactions. accustomed to doing in the US and Europe have become more difficult to accomplish. Prior to September 2006, the primary means used by private equity funds A question still remains, however: how to invest in non-state-owned Chinese much of this money will they be able companies was for the individuals who to be put to work in China? Inbound owned the companies to incorporate a private equity deal flow to China is still special purpose vehicle in an offshore tax a tiny fraction of that in most other haven such as the Cayman Islands and for countries by any measure, and inbound that special purpose vehicle then to acquire
336 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the equity of the Chinese target company. Domestic Enterprises by Foreign Investors’ After that, the fund would subscribe for – or M&A rules – require that a roundtrip shares of the offshore special purpose investment be approved by the Ministry vehicle. of Commerce at the central level and, thus far, since 8 September 2006 when the M&A This structure, commonly referred rules came into effect many have applied to as roundtrip investing or red chip for such approval and apparently none have restructuring, offered many advantages to received it. both the fund and the Chinese investors. Funds generally prefer to hold shares The government has many concerns in an offshore company in which their with this structure, but the fundamental agreements with the Chinese founders factor at the core of all these concerns is can be governed by law other than that control. The funds and the founders like of China. Unlike in a Chinese company, in this structure as it effectively situates their which equity comes in only one class, funds relationship and any future exit outside of can hold preferred shares in an offshore the control of the Chinese government; special purpose vehicle. This permits the the Chinese government does not like fund to receive any and all preferred rights this structure for the very same reason. that it is able to negotiate and to put in In addition, this structure raises tax and place a value adjustment mechanism that currency control issues with respect to the would be triggered if the Chinese company Chinese founders. Finally, the government does not meet certain specified metrics. dislikes the structure because it facilitates This structure also provides the advantage offshore listings at a time when the to the fund of making it possible for the government is promoting listings on China’s fund to be granted a pledge of the shares stock exchanges. of the Chinese founders in the special purpose vehicle as security for all of the Impediments to buyouts obligations of the Chinese founders. Finally, the greatest advantage of this structure for Buyouts and control transactions might at both the fund and the Chinese founders is first glance appear to be shielded from the that it provides a ready-made means of exit issues surrounding roundtrip investments. that does not require Chinese governmental That is because they do not necessarily approval. The shares of the special purpose entail bringing the Chinese founders vehicle can be listed on an offshore stock offshore as investors in an offshore special exchange or sold in a trade sale with (in purpose vehicle and thus do not fit under most cases) no Chinese governmental the definition of roundtrip investment in approval. the M&A rules. However, despite the fact that most buyout and control transactions However, after gradually chipping away at do not require Ministry of Commerce this structure for a number of years with approval at the central level as roundtrip legislation that made it increasingly difficult investments, they often require such to implement, in August 2006 China issued approval under separate provisions of the regulations that all but put a complete stop M&A rules that govern foreign investor to implementation of this structure. The control transactions which may impact the ‘Provisions on Mergers and Acquisitions of economic security of China or involve a www.financierworldwide.com | FW 337 INTERNATIONAL MERGERS & ACQUISITIONS 2008 target company in a key industry. Foreign the urban inhabitants of China and about acquisitions of control in companies China assuming its appropriate place on the that own a well-known trademark or an world economic stage. In addition, in some established Chinese trade name also require cases, the internet has allowed domestic central level approval. competitors of target companies to use the serious and emotionally charged concerns These provisions (and similar provisions reflected in these debates to increase that appear in China’s recently enacted public and official sentiment against foreign Anti-Monopoly Law) appear to be modelled acquisitions in order to eliminate foreign on the so-called Exon Florio provisions acquirers from the playing field. pursuant to which the Committee on Foreign Investment in the United States In addition, there is certainly some sense in (CFIUS) reviews proposed acquisitions by which the security-related review provisions foreign investors of US assets to determine in the M&A Rules and the Anti-Monopoly whether the foreign investor might Law and their use against primarily US- take actions that threaten the national based funds are a legislative tit-for-tat, security of the United States. As is the aimed at paying the US back for its CFIUS case of the Exon-Florio provisions (and the review of the proposed acquisition of implementing regulations promulgated Unocal by China National Offshore Oil thereunder), the relevant provisions in Corp. (CNOOC) and most recently the the M&A rules provide for the parties proposed acquisition of 3Com by Huawei, to the transaction to notify the relevant a Chinese telecommunications equipment authorities (the Ministry of Commerce, company, and Bain Capital. China has in the case of China) if they believe their learned from the US that in a post-WTO proposed transaction may be subject accession framework the permitted ways to to review under these provisions and if control certain types of foreign investment they fail to do so leaves the transaction are through anti-monopoly control and open indefinitely to the requirement of national security review. divestment or other remedy. Finally, beyond the regulatory impediments The factors that would trigger a notice to foreign control transactions, there are requirement under the M&A rules are cultural factors that limit such transactions. sufficiently broad and the potential In China, fundamentally, most founders of impact of failing to notify the Ministry of private companies and even CEOs of state- Commerce is sufficiently onerous that few owned enterprises regard trade sales of buyout funds would risk proceeding with a their companies, even at what objectively significant transaction without notifying the would be viewed as a very good valuation, Ministry of Commerce. Unfortunately for as a less attractive exit option than an buyout funds, the consideration of foreign IPO. This position partially stems from the control transactions has become enmeshed desire for the prestige that the founders/ in a debate that is going on within China CEOs believe they will only achieve if they about whether economic reforms have complete any IPO, and partially stems been beneficial for Chinese in general in from the relatively underdeveloped level light of the increasing gap between the of understanding of valuations in China. well off and the poor and the rural and Because founders/CEOs have a very unclear
338 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS idea of the actual market value of their become significantly more complicated companies and the inflated valuations than it used to be. Investors must not being achieved in IPOs, they almost only worry about pleasing an effectively inevitably believe that any offer made in a monolithic local government but must trade sale is too low. lobby at both the local and central levels at various agencies that will have a say in Financial investors are good for China whether a particular transaction receives all required approvals – and may have The main task of financial investors in the markedly different views on fundamental next couple of years should be to work issues regarding foreign investment in with the Chinese government to convince China. In addition, investors must consider policymakers that financial investors are how their proposals will be viewed by the good for China and in fact, in many cases, management of the target companies, better for China than strategic investors. how they will impact the employees of Whereas strategic investors are primarily the target companies, how they will be interested in rolling up Chinese businesses viewed by opponents of reform, how into their existing global operations and they will impact competitors of the target imposing their internationally recognised companies and how those competitors brand on Chinese businesses, financial can be convinced to support the proposed investors are more often than not merely acquisitions. The financial investors must concerned about restructuring and grapple with the issue of how the proposed rationalising Chinese enterprises so that acquisition can be structured so that it is these companies – which employ millions of good for the financial investors but also Chinese workers and are important forces clearly good for China. in the local economy – are realising their ultimate value under their existing brands. Convincing all the relevant players that Financial investors could be key to ensuring financial investors in general and the that companies from China take what current investment being proposed by Chinese regard as their rightful positions on the relevant financial investor is good for the global economic stage and make their China, good for the target company and brands into internationally recognised and good for the current owners of the target respected names. company is not something that is going to happen overnight. However, it is a task that Financial investors, and particularly buyout financial investors must undertake if they funds, need to get better at structuring intend to continue to make investments in their investments and their investment- China. related lobbying and positioning of their investment proposals to ensure that they are appealing to all the right interest groups Marcia Ellis is a partner and Jay C.S. Tai is a related to the transactions. China has senior associate at Morrison & Foerster LLP.
www.financierworldwide.com | FW 339 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Rules and issues surrounding M&A with Chinese companies
by Stephen Chan
On 7 January 2008, the China Mergers Foreign investors are also pursuing assets and Acquisitions Association released the despite restrictions imposed by the top 10 most influential cross-border M&A MOFCOM. Arcelor Mittal, the largest iron bids in 2007. Among the bids, the Chinese and steel manufacturer which accounted corporations benchmarked the emerging for 10 percent of the world steel output in significance of the Chinese financial 2006, acquired a 28 percent equity stake industry players in the global M&A market. in China Oriental Group Company Limited, Chinese financial institutions played a major a Hong Kong listed company, through its role – half the top 10 cross-border M&A subsidiary, Mittal Steel Holdings AG, for a bids related to Chinese banks and insurance consideration of HK$5.02bn in November companies in the outbound M&A market as 2007. US economy slowed due to the subprime crisis and global credit crunch. Unlike However, not all foreign investments go outbound M&A deals transacted previously, smoothly in the M&A market. Chinese corporations, especially stated- owned enterprises in the financial industry Group Danone, a Global Fortune 500 sector, are interested in any opportunities company, has developed its foods and in the developing countries. beverages business in China since 1987, selling its products not only in China but During the fiscal year ended 31 December also exporting them to other countries. 2007, foreign direct investments in China Group Danone has formed joint ventures rose 13.8 percent to US$82.7bn (including under certain operating and licensing foreign investments in banks and securities agreements with Wahaha Group and totalling $7.9bn), as reported by the became the majority shareholder of the Ministry of Commerce (MOFCOM). This joint venture in 1996. Wahaha, one of is despite Beijing authorities executing its four leading brands, is also the most certain measures to cool down the boom, popular in China. In April 2007, Group especially the spending on real estate and Danone has planned an acquisition of other assets. Wahaha Group’s remaining assets for RMB 4bn. Unfortunately, the planned acquisition The growth of foreign direct investments is opposed firmly by the Chinese parties of in the real estate sector is tremendous and Wahaha Group. Since then, Group Danone is expected to continue. In 2006, it reached and Wahaha Group have been engaged in $8.2bn compared with $5.4bn in 2005. a series of disputes and lawsuits. Foreign Overseas property funds (REITs, etc.) were investors should be aware that some the ‘hot money’ providers, driven by the Chinese lawyers might call for protection to rise of China’s property market and the avoid any loss of controls of major brands appreciation of the Renminbi. when cooperating with foreign investors.
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Another mega bid in May 2007 came from approvals from the National Development Singapore Airlines Limited and its parent and Reform Commission and the Temasek Holdings Pte Limited, which State-owned Assets Supervision and offered US$930m for a 24 percent equity Administration Commission of the State stake in China Eastern Airlines Corporation. Council are required in respect of M&A and They are struggling to get an equity stake restructuring of state-owned enterprises. since China National Aviation Corporation In the event that the target company is proposed a counterbid to strengthen its operating in a regulated industry or market, presence in the market on 6 January 2008 the approval of the relevant industry- – one day before the shareholder vote. The specific regulator should be obtained. For deal was rejected by substantial votes in the instance, if the target company is a listed shareholders’ meetings. Chinese bank, the approval of both the China Securities Regulatory Commission Approval of M&A transactions and the China Banking Regulatory Commission will also be required. The Chinese government has offered a number of different ways to facilitate Restrictions by industry sector foreign direct investments. Acquiring a domestic company is the quickest way to The Chinese government issued the first enter China’s market. Foreign investors version of the Catalogue for Guidance of have recently expanded into China by Foreign Investment in Industry in 1995. accelerating their M&A transactions in Since then, it has been revised several accordance with the rules and regulations times. The latest version of the Catalogue stipulated in the Provisions on Mergers and became effective on 1 December 2007. Acquisitions of Domestic Enterprises by The Catalogue classifies industries into a Foreign Investors since 8 September 2006. number of categories. Industries which are The Chinese authorities play a substantial not specified as ‘encouraged’, ‘restricted’ role in M&A transactions, especially or ‘prohibited’ by default fall under the in terms of examination, approval and ‘permitted’ category. The classification supervision. Foreign investors should be affects the regulatory approval process and aware that the completion of M&A deal also the tax and other incentives available. might require the approval of several Chinese authorities, depending on different Structuring M&A transactions circumstances. It may take considerable time and effort to reach completion. An offshore M&A transaction is the most efficient method. The change of ownership In accordance with the present Provisions is simpler if the investment in China is held on Mergers and Acquisitions, MOFCOM by a special purpose vehicle in an overseas is the approval authority, the State country. This does not technically trigger Administration for Industry and Commerce any approval of M&A transactions in China, (SAIC) is the registration administrative other than those straightforward changes authority and the State Administration of of any items under the Articles of the Foreign Exchange is the foreign exchange investment in China. administrative authority. Under certain exceptional circumstances, In the past few years, foreign direct www.financierworldwide.com | FW 341 INTERNATIONAL MERGERS & ACQUISITIONS 2008 investments have entered China directly liabilities and so on. Records and financial through onshore M&A of domestic information is also kept in different Chinese companies, typically via an equity languages. All this make legal, financial acquisition, an asset acquisition or a and commercial due diligence impractical. statutory merger. Of these methods, equity Foreign investors therefore seek acquisition is the quickest. Upon signing comprehensive representations, warranties the equity acquisition agreement or new and indemnities from the vendors or equity subscription agreement, the target owners of domestic companies, but it takes company will be transformed into a foreign- time to negotiate terms and conditions invested enterprise (FIE) subject to the acceptable to the relevant parties. China’s approval process. Foreign investors should be aware that foreign investors Financing arrangements. Banks are often will acquire the rights and assume the unwilling to finance onshore M&A of obligations of the domestic company. domestic Chinese companies, subject to a statutory leverage ratio and provision of Unlike equity acquisitions, asset sufficient security. Foreign investors may acquisitions are time consuming. Through consider bringing in offshore funds for the the ‘peel off’ process, foreign investors purpose of M&A. Further, foreign investors acquire the ownership of the assets from should be aware that once the new offshore the target companies and leave the funds registers in the capital account of obligations, unusual and potential liabilities FIEs, repatriation of funds will need to be with the target companies. Unfortunately, dealt with. foreign investors cannot directly operate the acquired assets without having an Taxes. The Unified Enterprise Income establishment in China. Foreign investors Tax Law was introduced on 1 January must establish a FIE for the purpose of asset 2008. It unifies the income tax rates for acquisition. domestic companies and FIEs at 25 percent, but retains a low tax rate of 15 percent In accordance with the Regulations on applicable to new and high technology Merger and Division of FIE issued by the companies. More tax incentives are Ministry of Foreign Trade and Economic provided to venture capital investments Cooperation and SAIC, FIEs are allowed and to certain industries in environmental to merge with each other. This may take protection and infrastructure. Foreign the form of either absorption or new investors should be aware that tax holidays establishment, subject to multi-stage of two-year tax exemption, followed by approval processes. a three-year 50 percent reduction, are gradually being eliminated, except in Some practical issues western China where reduced tax rates are still available. The law also contains transfer Due diligence. Often the public records pricing considerations. Foreign investors of domestic Chinese companies are should also evaluate the impacts on unavailable or unreliable. Yet foreign contingent liabilities in respect of business investors need such information to operations of the acquired company. determine the legal titles of assets, potential or pending litigation, priority of Closing. Simultaneously closing the
342 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS acquisition of a domestic Chinese company clauses in anti-monopoly examination is almost impossible. The transfer of when planning M&A deals. ownership is effected when an approval certificate is granted by the Chinese On 30 August 2007, China passed the Anti- approval authorities. Both M&A parties will Monopoly Law which will come into effect not fulfil their obligations in accordance on 1 August 2008. The law stipulates that with the acquisition agreements until MOFCOM will need to approve M&A of the legal transfers of ownership of assets domestic companies which may affect are effected. Foreign investors may be national economic security in China. eager to take the associated risks. Some Foreign investors should review the list foreign practicable measurements and of strategic sectors of which the Chinese arrangements are expected to fill in the government will retain control. gap, however the existing laws governing these are not well established. The Danone-Wahaha disputes and Singapore Airlines’ struggle for a stake in Anti-monopoly review. The anti-monopoly China Eastern Airlines – the two mega M&A review clauses are stipulated in the bids of 2007 – triggered the two critical Provisions on Mergers and Acquisitions areas that impact customer welfare and to stabilise the economic activities of the national economic security in China. It domestic market. MOFCOM and SAIC have seems the Chinese government will prevent responsibility for discretionary examination traditional private equity giants from and approval, but with no clear guidance acquiring its major brands outright. on the impact of a deal, regardless of size, on competition or welfare in China. Foreign investors should evaluate the exemption Stephen Chan is a partner at LehmanBrown.
www.financierworldwide.com | FW 343 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Necessities in a cross-border Indian deal
by Bijesh Thakker
India registered more than US$55bn worth India has exchange control regulations. of M&A transactions in 2007, the most ever. Moreover, although the foreign investment The nature of M&A has undergone drastic norms are substantially liberalised, change. Cross-border deals have become a approvals could be required in certain cases common feature in the Indian M&A market. (e.g., where a company has an existing Although issues involved in a cross-border trademark licence agreement or a technical deal are not very dissimilar to those in a collaboration in the same field). The domestic transaction, it is the complexity evolving competition law and its impact of issues that is both interesting and should also be assessed. Highlighted below surprising. The essential difference between are three key legal issues. an internal merger and a cross-border transaction is that the evaluation process Deciding the structure. In the process of in a cross-border transaction involves a identifying the target, it is important for the detailed analysis of the target’s country (its acquirer to decide the main objective of the economic, cultural and political situation). transaction, i.e., whether it is to acquire an Moreover, a cross-border deal requires existing business completely or whether it is familiarity with new procedures and to buy into an existing business and run it as frameworks involving regulatory bodies, tax a joint venture with the existing promoters. authorities and new accounting practices. This would help determine matters such as the seller’s expectation. Moreover, the Increasing cross-border M&A has helped nature of the transaction, such as an asset make the Indian market more sophisticated sale or share transfer, would be dependent and the Indian seller more flexible in on this fundamental question. adapting to the global business culture. However, India is a sub-continent in itself Structuring the transaction from a tax with 29 distinct languages and culture, perspective. When structuring an M&A customs, traditions and habits varying transaction, tax plays a crucial role. (almost) every few kilometres. Hence, Although most equity investments India adds special complexities to a cross- (whether by private equity funds or venture border transaction. In this article, we have capital funds) are being made through highlighted potential areas for a foreign investments by Mauritius based entities, we acquirer to monitor. find that most M&A acquisitions are being made directly from the country of origin. Understanding the regulatory This is because the objective of M&A is long environment term synergy and business development, not short term exit. Hence, finding an Understanding and knowing the regulatory investment route which is tax efficient at environment is a key starting point. the time of exit may not be essential or
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important to a strategic buyer. However, if Indians are deeply religious and connected the objectives are more short term and exit to their historical and cultural roots. A driven, finding an investment route which multinational corporation entering India is tax efficient at time of exit is of immense must recognise this. For example, in many importance. jurisdictions the position of director may not be rated as the highest, but in India, a director is on top of the corporate ladder whether or not in actuality he has any powers. The work environment in Indian businesses, especially those run by families, Any changes should not overwhelm, or create is still very traditional, conservative and insecurity in, either the local management or the centred around the promoter. Employees are often treated as family and hence, employees. implementing new ideas like a hire-fire policy or a ‘modern professional work environment,’ has to be handled subtly and carefully. Any changes should not overwhelm, or create insecurity in, either the local management or the employees. Exchange control implications. India has exchange control regulations, and foreign Due diligence direct investment, although substantially liberalised, is still regulated. Prior Central Very often a deal has failed to deliver the Government approval may be required if an value envisaged due to failure to conduct acquirer is investing above the prescribed thorough due diligence. A careful and sectoral caps in certain regulated sectors elaborate due diligence process helps to (such as insurance, single brand retail, ensure that there are no surprises later. For telecom, etc.) or if you have an existing a good due diligence to be conducted, it is joint venture or technical collaboration imperative to have an experienced team in the same field in which investment is with a proper understanding of the market proposed. Further, matters such as price and regulations – and with sufficient time to at which the shares of the Indian company do a thorough job. could be bought as well as the instrument of investment may also be regulated Integration (e.g., whereas a convertible preference share is considered as share capital from a How to transition the target into the corporate perspective, it is considered as multinational company’s fold, attune it to debt under exchange control regulations). its business practices, work culture and environment, and teach its people reporting Cultural issues and information requirements, is a question management of the acquirer must ask Cultural issues are one of the most before the acquisition. Acquisition by a commonly cited factors for failure of an foreign multinational is not always seen as a M&A deal. India’s vastness, population and positive step and hence, management must years of history make it culturally unique. have a transition plan in place prior to deal
www.financierworldwide.com | FW 345 INTERNATIONAL MERGERS & ACQUISITIONS 2008 closing and executed immediately upon well as the integration process. Acquisition closing. of the Indian company should be seen not as the final destination, merely a step along There are no secret formulae for successful the road. M&A. Each situation is unique and presents its own set of potential problems and solutions. However, a better understanding of each legal issue could mitigate the risks Bijesh Thakker is a managing partner at posed in both the transaction process as Thakker & Thakker.
346 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g Mergers under India’s new antitrust laws – challenges ahead for enterprises
by Farhad Sorabjee
Now highly visible on the global corporate a dominant position will be unacceptable. scene, India has become a hotbed of both Competition agencies have very limited cross-border and domestic corporate scope to ban mergers outright, but a mergers and acquisitions. Starting with merger, acquisition or takeover could be information technology, it has made rapid prohibited if it is likely to substantially and often surprising strides in biosciences, lessen competition or prevent access to a pharmaceuticals, telecommunications, market. aviation, minerals and a host of other sectors. 2006 and 2007 have signalled The Competition Act 2002 is poised for a terminal departure from the hitherto implementation around late spring in stately pace of Indian corporate expansion. 2008. So enterprises, both existing and Cross-border transactions increased from prospective, will now have to negotiate 40 in 2002 to more than 180 in 2006. Last with a competition watchdog: a prospect year topped the lot with the total value that sends shudders down the spines of of cross-border M&A standing at roughly many old India hands who are aware of the $55bn, including some of the highest profile track record of its existing watchdogs. global deals. The new regime One of the basic economic reasons for the spurt in cross-border and internal The Act provides for the regulation of consolidation is the pressure of increased combinations and provides for the financial competition from new and nimble Indian limits of thresholds which parties to enterprises and the fact that foreign players ‘combinations’ would require to consider are finally able to enter and play in the before notifying the transactions to Indian market with relative ease. the Competition Commission of India. Combinations which are likely to attract Every rose has its thorn though, and the scrutiny of the Commission under India needs an effective competition law the Act are mergers, amalgamations and to curb the possible adverse effects of acquisitions. Joint ventures could also be this economic explosion on competition investigated. within its markets. But the old shibboleths first need to be vanquished. Dominant Regarding thresholds, companies with enterprises are no longer bad news, global assets of more than US$2bn or sales only the abuse of their position is. At the of more than $6bn, and assets in India same time, a proper competition law of more than $125m (Rs 500 crores) or enforcement regime needs to signal to sales in India of more than $375m (Rs 1500 enterprises that alliances and structures crores), would be required to notify the that are motivated by the eventual abuse of Commission. www.financierworldwide.com | FW 347 INTERNATIONAL MERGERS & ACQUISITIONS 2008
The new law may consider combinations The Commission is empowered to to be void only if they are found to cause or allow, modify or reject a transaction or be likely to cause an ‘appreciable adverse combination and to impose penalties effect on competition’ in the relevant for non-compliance of its orders or the market. furnishing of false information. The Act does not seek to eliminate combinations, Compulsory notification to the Commission only their harmful effects. The Commission and application for approval must be made also has the general power to enquire within 30 days from the date of proposal into and pass orders in relation to anti- to combine. Failure to notify may result in competitive practices taking place beyond the imposition of a penalty up to 1 percent India, which may affect the Indian market. of the total turnover or assets of the combination, whichever is higher. Where Challenge or chaos? the parties to the combination include a foreign acquirer, it is necessary to notify the Unnerved by many provisions of the Commission if the parties or group crosses new law, various industry associations, the asset or turnover threshold jointly. foreign trade commissions, and even the International and American Bar Association have represented variously to government that several provisions of the new law raise Unnerved by many provisions of the new law, serious cause for concern. various industry associations, foreign trade There is an inordinately long waiting commissions, and even the International and period of 210 days for clearance. Breaking American Bar Association have represented variously this into two phases (Phase I for simple clearances in say 30-45 days, and Phase to government that several provisions of the new II potentially utilising the whole 210 days law raise serious cause for concern. for more complex situations) has to some extent been addressed in the Commission’s regulations, though there is more than a hint of a suggestion that legally this needs Thereafter, the Commission is required to be embodied in the Act itself and cannot to decide within a maximum of 210 be done by regulation. Add to this the days whether or not the merger has any possibility of an appeal to the Competition appreciable adverse effect on competition, Tribunal, and days could easily turn into else the merger will be deemed to have years. been approved. The Commission’s draft regulations for combinations indicate that The introduction of the mandatory it would approve simple cases of mergers notification of transactions in the recent within a period of 30 to 60 days from receipt amendment to the law, coupled with the of the application, and only in mergers low thresholds for local (Indian) assets requiring more detailed investigation would and turnover involved is another concern. the Commission utilise the entire 210 day In theory, mergers and acquisitions that limit. have no or de minimis connection with India could require Indian clearance from
348 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the Commission. The fact that the new suspect? What would be the division of law as it stands requires compulsory powers between the two? The relationship filing even if just one of the parties has a between the competition agency and threshold interest in India is also a cause the individual sector regulators is likely for concern, though the regulations now to be a complex and uneven one, and a clarify that a two party interest minimum rollercoaster of uncertainty looms, at least requirement would be required. Add to this in the near future. the absence of any provision for pre-merger consultations, and the situation becomes There is no doubting the commitment and even more rigid and opaque. integrity of the current Commission or of the government to the establishment of The regulations also appear to require the an effective competition regime, but there filing of excessively detailed information is already talk of a further delay in the that may be redundant and in fact cause implementation of the law due to hiccups in unnecessary harassment at the procedural the selection process for new members of level. Serious concern also exists as to the Commission. the level of protection of confidential information that may be filed. The The law itself is adequate if not elegant, and prescribed filing fees of up to $150,000 will evolve with judicial interpretation. But are among the highest in the world, any law is only as good as its implementers, and a payment is to be made in stages, and there is no guaranteeing the quality which could incentivise protraction of the of future enforcers. The reliance upon clearance process. transferable civil servants to man the Commission is a cause of concern. And then Then again, the effective implementation there is the possibility of protracted legal of merger control requires the availability challenges to the provisions of the Act and of sophisticated and reliable economic the regulations framed. data concerning products and geographic markets, market structure and shares, Interesting times, uncertain times. The and likely effects. Much of this is only present Commission has made it clear that rudimentary as yet in India. it will principally adopt a light touch, but go in hard where necessary. An admirable And what of the existing regulators approach, if maintained. and indeed, the common law courts? For instance, the power, oil & gas, and telecommunications sectors all have their regulators. Who does one go to? Or do both Farhad Sorabjee is a partner at J Sagar exercise jurisdiction? And is that legally Associates.
www.financierworldwide.com | FW 349 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g US-bound acquisitions by Indian companies
by Anil Kumar
Companies such as Nirma, Wipro, Gitanjali, Highlights in 2007 GHCL and Hindalco not only represent the changing economic face of India, they 2007 raised a number of highlights. Indian represent a new league of Indian companies companies accounted for a total of 83 going global. Each of these companies US-bound acquisitions with a cumulative acquired large companies in the US in their transaction value of over $10bn. This quest to become truly global. represents a 73 percent increase over the 48 transactions of 2006. The mega deals With 83 US-bound transactions worth over comprised Hindalco’s acquisition of Novelis $10bn in 2007, India has suddenly emerged for $6bn, Rain Calcining’s acquisition of CII as a serious contender in the cross-border Carbon for $595m, Wipro’s acquisition of M&A space. Neither the global credit Infocrossing for $568m and Firstsource’s crunch and or economic slowdown in the acquisition of MedAssist for $330m. IT/ITES US seems to have impacted this trend. was the most acquisitive industry capturing over 51 percent share of the total US- Increasing competitive pressures, emerging bound transactions by volume, followed by global opportunities and the decline in healthcare (11 percent); chemicals, textiles, overseas trade and investment barriers and automotive (5 percent each); metals are encouraging Indian companies to seek & mining, jewelry, travel, and media (4 acquisitions in the US. Factors supporting percent each). Other industries accounted this trend are strong balance sheets, easy for less than 2 percent each in terms of access to capital, business confidence and volume. a relatively stable economic and political regime. Deal sizes of less than $25m accounted for 76 percent of US-bound acquisitions Developed economies like the US are volume, followed by transactions in the attractive to Indian companies because $25-$50m range (8 percent). This reflects of their large consumer markets, the increasing pressure to gain scale transparent business processes, robust among smaller companies. Deal sizes in legal environment, advanced technologies, the $50-$100m; $100-$500m, and greater skills and knowledge capital. Moreover, as $500m range each accounted for less than the markets in these economies tend to 6 percent of the 2007 transactions. Most be mature and saturated, it often proves transactions involved the acquisition of 100 difficult for Indian companies to gain percent stock for cash consideration. These market share without acquisitions. transactions generally had an earn-out structure, where a portion of the deal value is paid on future milestones.
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Factors fuelling US-based acquisitions by overseas. In addition, with the rupee rising Indian companies against the dollar, Indian companies are required to spend less to acquire overseas. Although the strategic rationale for US- based acquisitions varies by industry and Meanwhile, regulatory changes in India the individual company, there are a few have made it easier for Indian firms to common drivers. US-based acquisitions become more global in their operations. provide easy access to the world’s largest As foreign exchange reserves have grown, market and customer base through the Reserve Bank of India has progressively marketing and distribution channels of the relaxed the controls on outbound acquired company. Indian companies are investments, making it easier for Indian able to acquire well-established brands, a companies to acquire or invest abroad. wider product portfolio, and readymade distribution networks, thus, globalising Analysis by sector and augmenting their competitive asset base. An organic approach to building Information technology / ITES. With 42 US- customer base and gaining market access bound acquisitions in 2007, information in the US could otherwise take many technology is the most acquisitive industry years. In addition, many Indian companies in India. The IT industry accounts for over are seeking to expand their distinctive 51 percent of US-bound transactions capabilities by acquiring specific skills, from India. Within this industry, the sub- knowledge and technology abroad that are segments focused on healthcare and either unavailable or of a lower quality at financial services are most attractive home. Indian companies are able to identify for acquisitions, given their untapped foreign firms with value-added offerings, opportunities in the US market. While which complement their own low cost large-size companies such as Wipro products and services to create an efficient and Firstsource are seeking to add new integrated global business model. service capabilities through US-bound acquisitions, mid-size companies such as Due to the lowering of import tariffs, Logix Microsystems and Cranes Software Indian companies are facing increased are seeking to strengthen their current competition within the domestic market. capabilities. In order to compete effectively, these companies are under pressure to access The high rate of US-bound acquisition global markets and operating synergies. US activity in India is being propelled by the companies provide one of the best global need to gain scale in terms of size, product platforms in the world. In addition, low offerings and geography. This, coupled interest rates and tariffs coupled with easy with the availability of acquisition targets, access to external commercial borrowings sufficient liquidity, favourable exchange provide Indian companies with sufficient rate and competitive pressures is pushing liquidity for global acquisitions. Sustained Indian companies to pursue an inorganic growth in corporate earnings has improved path to building scale. their profitability and strengthened balance sheets. This has, in turn, strengthened their Healthcare. The healthcare industry credit ratings and ability to raise funds captured 11 percent of the transaction www.financierworldwide.com | FW 351 INTERNATIONAL MERGERS & ACQUISITIONS 2008 volume with nine US-bound acquisitions in manufacturing space were Ashok Leyland’s 2007. Jubilant’s acquisition of Hollister Stier acquisition of Defiance Testing for $17m and Laboratories for $122m and Wockhardt’s Sintex’s acquisition of Wasaukee for $20m. acquisition of Morton Grove for $38m was Higher valuation of available acquisition not only about gaining market access in targets and a general industry compression the US but also accessing firm-specific in the US has forced Indian automotive & strategic assets like internationally certified manufacturing companies to be slow on the manufacturing facilities, new products, acquisition trail. However, as demonstrated research capability, brands, etc. and by Ashok Leyland and Sintex, there are benefiting from operating synergies. certain sub-sectors such as engineering design and plastic product manufacturing As a target location, the US has traditionally which remain attractive. With US lagged behind Europe in pharmaceutical companies moving their basic auto- outbound acquisitions from India. But component production to China and India, this could change based on the upcoming assemblies and finishing sub-industries generic opportunities and the size of the US represent the interesting segments. market. Relying on third party marketing agents may not be a good strategy in Others. The largest transaction in 2007 the long run, thus, Indian companies are was Hindalco’s acquisition of Novelis expected to acquire export-supporting for $6bn. This acquisition was driven by networks in the US. Hindalco’s desire to access global markets and gain complete integration of its Consumer goods. In consumer goods, the value chain. Calcined petroleum coke need to acquire US companies is driven maker Rain Calcining’s acquisition of US- by the desire to acquire new supplier based CII Carbon for $595m has enabled relationships and distribution channels and the company to become the largest not for manufacturing capacities. Front-end manufacturer of calcined petroleum coke in distribution is a common theme in many of the world. As seen last year, the metals and these deals. specialty chemicals industries continue to demonstrate the potential for billion-dollar In recent years, Indian textile and jewellery transactions. companies have built new manufacturing facilities and special economic zones Key considerations (SEZs). These companies are looking to acquire distribution and retail channels to Typically in these deals, the Indian utilise the additional capacity; Himatsingka companies have paid for their US Seide’s acquisition of Divatex follows acquisitions in cash, for a variety of reasons. commissioning of a facility in Hassan SEZ Because most Indian companies are still and Gitanjali Gems’ acquisition of Samuels owned and managed by the families who Jewelers and Rogers Jewelers follows founded them, they are often reluctant to commissioning of their SEZ factory in bring other parties into the shareholding Hyderabad. structure. Moreover, regulatory issues make it difficult to issue stock to foreigners Automotive & manufacturing. The for considerations other than cash, while key transactions in the automotive & the capital markets in India may require
352 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS onerous lock-in periods when new stock culture, regulations, legal framework, and is issued. With respect to financing, a tax consequences of the target country combination of internal accruals and debt are fundamental considerations. There / equity financing is generally used. Of the certainly are pitfalls but these are becoming multiple factors that need to be considered less serious as Indian companies gain more for determining the acquisition structure, experience in making foreign acquisitions. jurisdiction, tax incidence, accounting, India’s accomplishments in liberalising access to funds and local regulations are regulation, modernising the business the most important. Generally, US-bound environment and boosting the country’s acquisition structures include an earn-out growth over the past decade has created a clause where a portion of the enterprise self-sustaining pace. And this bodes well for value is to be paid over a period of time Indian companies looking to go global and based on achieving milestones. innovate.
Indian companies looking at the US market for acquisitions are generally advised to know the market, the culture and quality Anil Kumar is a managing director at Virtus of the management. Understanding the Global Partners.
www.financierworldwide.com | FW 353 INTERNATIONAL MERGERS & ACQUISITIONS 2008 g Legal issues and regulatory issues in Indonesia’s M&A market
by Tasdikiah Siregar and Setia Nadia Soraya
Indonesia’s M&A activity has recently At the initial stage, foreign investors need increased. Factors contributing to this to observe which businesses are open or include the global resources boom and the restricted for foreign investment as set out single presence rules of Bank Indonesia in the negative list and other rules of the prohibiting a controlling stake in more technical departments. For example, the than one bank. Below are some general maximum foreign shareholding in a bank is observations and advice on certain 99 percent, while in a finance company it is Indonesian legal and regulatory matters 85 percent. In some cases, although certain concerning M&A. businesses are not restricted under the negative list or other rules, by policy, the Regulatory matters authorities may impose certain restrictions.
The legal framework covering M&A is M&A must satisfy certain regulatory provided primarily in the new Company requirements including preparation of Law that came into force in August 2007 an M&A plan, corporate approvals and and legislation on takeovers, mergers and announcements. Acquisition can be foreign investment. Specific regulations through purchasing shares directly from apply to M&A in certain sectors. existing shareholders or by approaching the management of the target. The latter No single government agency is presently involves a lengthier procedure than the responsible for the supervision of all M&A former. The former bypasses the acquisition activity. Rather, different government plans jointly prepared by the management departments are involved in M&A of banks, of the target and investors for approval by finance companies, foreign investment the supervisory boards of the target and companies and public companies. M&A the investors. The acquisition requirements involving foreign investment companies under the Indonesian Company Law will are subject to approval from the Capital also apply to a capital increase resulting Investment Coordinating Board. For M&A in a change of control of the company. in the financial and insurance sector, However, the applicability of the acquisition approval from the Ministry of Finance is requirements to the capital increase required. The Capital Markets and Financial remains unclear. Institutions Supervisory Board (BAPEPAM- LK) must be consulted when the target is a As a general rule, M&A should not be public company. M&A of banks is subject to detrimental to the interests of the target, approval from Bank Indonesia. The Minister minority shareholders, employees, of State Owned Enterprises is involved in creditors or the public, or lead to M&A of state enterprises. monopolistic practices or unfair business competition.
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Minority shareholders. M&A must not acquisition may also give certain severance prejudice the right of minority shareholders compensation entitlements to employees. to sell their shares at a reasonable price. While the Company Law does not Creditors. Investors also need to consider specifically regulate how the “reasonable creditors’ rights to object to M&A within price” is determined, in practice it can be a certain time limit. Creditors include all based on the market value of shares or parties having receivables payable by the determined by independent appraisals. target regardless of value. As a result, suppliers of the target can also be classified Employment. Investors should take as creditors. The target needs to reach proper measures to deal with employees a settlement with objecting creditors, as they have the option to discontinue otherwise M&A cannot go ahead. No their employment with the target specific settlement method is determined following a share acquisition and to by law. It is reasonable to assume that claim severance. Severance is payable settlement will involve payment of debts by by investors unless otherwise agreed in the target. the acquisition documents. Although there are conflicting views among the Antimonopoly. Other than in the banking authorities on the applicability of the sector, there are no clear guidelines to option, if the acquisition will not result in assess monopolies resulting from M&A a change in the terms and conditions of in Indonesia. The Antimonopoly Law employment, in most cases, the option prohibits M&A if it will lead to monopolistic still remains applicable. The monetary practices or unfair business competition. value of the overall benefit received by M&A resulting in the target’s assets or sales employees following the acquisition turnover exceeding a certain value must be should not be less than the existing reported to the Supervisory Commission overall benefits package. There have been on Business Competition. Unfortunately, frequent occasions where employees the value threshold remains unclear as have ‘lobbied’ for ‘ex-gratia’ entitlements the expected implementing regulation on even where there was no termination antimonopoly has not yet been issued. The of employment upon the acquisition. implementation of laws in Indonesia often Although there is no legal basis for requires implementing regulations to give these demands, employees make these full effect to the laws. overtures for a payment as a ‘sweetener’ simply because their acceptance of the A party is no longer able to have control acquisition is considered necessary. in more than one bank as a result of Bank Employees may hint that without their Indonesia’s ‘single presence rules’ of 2006. acceptance, they may consider initiating Certain controlling stakes are exempt from termination or withdrawing cooperation the rules inter alia controlling stakes in two with management. The employees banks with a different banking business usually treat these entitlements as an basis. The rules force existing controlling appreciation from the employer for their parties to take certain options, including willingness to continue their work with to transfer their shares or merge or the new management. The ‘transfer’ consolidate the banks or establish a holding of employment in an asset or business company. www.financierworldwide.com | FW 355 INTERNATIONAL MERGERS & ACQUISITIONS 2008
Fit and proper test. Investors in banks must offer process. pass the Bank Indonesia fit and proper test before the acquisition. Bank Indonesia will Privatisation. The acquisition of state assess the investors up to their ultimate owned limited liability companies (known shareholders. Bank Indonesia has wide as Persero) for privatisation is subject latitude in any circumstances to examine to prior approval from the House of the investors and their controlling stakes. Representatives. Investors must comply Bank Indonesia does not allow the funds with guidelines for privatisation determined for the acquisition to be sourced from loans by a privatisation committee established or other forms of financing originating by the government. The Minister of State from Indonesia, or from crimes. The fit Owned Enterprises has authority to cancel and proper test may also apply to a new or postpone the acquisition on certain, controlling party of the existing controlling including commercial, grounds. shareholders. Investors in insurance companies are also subject to the fit and proper test conducted by the Ministry of Finance.
Capital market rules. Additional rules under capital market regulations apply to M&A Investors in banks must pass the Bank Indonesia fit involving public companies. A report on and proper test before the acquisition. the negotiation of the acquisition must be made by the investors to BAPEPAM- LK, the Indonesia Stock Exchange, the target and the public. The acquisition of at least 25 percent of a public company will require the investors to conduct a tender offer for the remaining shares. Even if the Searches. It is not practicable to conduct acquisition is less than 25 percent of the searches to ensure there is no pending or shares, the investor will also be subject threatened litigation against the target, its to a mandatory tender offer if it results in assets or its ability to continue business. investors having direct or indirect control, such as ability to control amendments to In Indonesia, claimants may submit claims the target’s articles of association or over against another party in the District Court the management and supervisory board of having jurisdiction over the domicile agreed the target. Certain acquisitions are exempt in an agreement, or the District Court from the mandatory tender offer, inter where the party is domiciled or the District alia, the acquisition of shares owned by Court where the party’s assets are located. governmental institutions in the target and There is no centralised filing system for the the acquisition of up to 5 percent of shares judicial process in Indonesia. Rather, each issued by a publicly listed company within a District Court manually maintains its own period of 12 months. The tender offer rules filing system. A power of attorney from the also apply to acquisition at the controlling target is required for a court search. stake level. Consultation with BAPEPAM- LK is recommended throughout the tender Currently, there is no effective public
356 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS registration of corporate information. diligence enquiry. For example, warranties Indonesia presently also lacks any registry and representations in the acquisition of security interests with the exception documents may be more detailed and other of land mortgages, fiduciary securities enquiries, such as with lenders, clients and vessel hypothecs. Searches over real or customers of the target may also be property can be undertaken at the relevant undertaken. Indemnities from sellers and Land Office. However, in most cases, that certain officers against the target’s past Land Office will not grant access to records liabilities (particularly unrecorded liabilities) without a power of attorney from the and security in the form of guarantees or registered owner of the property. purchase price retention may also need to be obtained. Other Matters Finally, it may not be easy to give precise Consultation with the authorities is forecast of how long a deal may take always recommended prior to M&A. in Indonesia. It is not uncommon in the Investors should take into account certain Indonesian context for M&A to take peculiarities of the Indonesian legal longer than similar procedures in other system, how matters are interpreted by jurisdictions. This should be taken into the authorities as a matter of written or consideration if a multi-jurisdictional M&A unwritten policy and also be aware of what is being considered. competitors are doing in practice.
In acquisitions, almost inevitably foreign Tasdikiah Siregar is a partner and Setia Nadia investors will want to obtain comfort Soraya is a senior associate at Makarim & from methods other than a normal due Taira S.
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CHAPTER thirteen: Regional view – Middle East
358 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS g The Middle East as an emerging market
by Eleanor Kwak, Antony Turton and Phil O’Riordan
In the restaurants and shisha cafes of Dubai, interventions and the world’s increasing conversations among the ever growing demand for energy resources has ushered expatriate population almost inevitably turn unprecedented growth and change across to the topic of sky rocketing property prices the region. and the latest announcement for a mega project. While such individuals often tend In many countries, increased wealth has to get carried away (as in Hong Kong in the sparked investment in major infrastructure 1980s) it does seem that something quite projects to upgrade facilities, and coupled remarkable is occurring in the Middle East. with this has been a shift towards In turn, certain Middle Eastern countries diversification of economies and fostering seem to exude confidence at the moment growth and development of various and are keen to play a larger role on the industries through state investments. The world stage, as economic powerhouses. overall result is that for many countries This article considers legal, procedural across the GCC, the modernisation process and socio-economic factors that should has been compressed into decades rather be considered in M&A transactions in the than centuries. Middle East. Some examples of recent mega projects The Middle East in this context quite often in the GCC include the World Islands means the countries that are members of and the Palm Jumeirah off the coast of the Cooperation Council for the Arab States Dubai in the United Arab Emirates, King of the Gulf (GCC), namely Bahrain, Kuwait, Abdullah Economic City in Saudi Arabia, Oman, Qatar, Saudi Arabia and the United Dubai International Financial Centre, Qatar Arab Emirates. Financial Centre, and Bahrain Financial Harbour. There is no doubt that in many respects the traditional way of life in GCC countries has The revenue generated via the sale changed dramatically since the discovery of of energy resources, investment in energy deposits. It is estimated that these infrastructure and economic diversification countries hold 55 percent of the world’s initiatives has procured unprecedented known oil reserves and are producing just economic and population growth in the under one-third of the world’s daily output. GCC and broader Middle East region. For In addition to oil reserves, the region is rich example, in the United Arab Emirates, the in natural gas and it is estimated that the 2005 government census found that the region houses 40 percent of the world’s population had grown by 74.8 percent in the known natural gas reserves, according years 1995 to 2005. This is accompanied by to the United States Energy Information estimated economic growth of 7.8 percent Administration. External political in 2007 and predicted growth of 6.6 percent www.financierworldwide.com | FW 359 INTERNATIONAL MERGERS & ACQUISITIONS 2008 in 2008, according to the Central Bank of partner. However, it is essential that careful the United Arab Emirates. thought is given to the drafting of these arrangements, as there are often criminal Recently, the international media has penalties for transgressing the law in this focused on massive outward investment regard. In the case of local acquisitions, from sovereign wealth funds based in the any existing schemes to assign control and GCC region. With investment markets profits need to be carefully reviewed to such as Wall Street hunting instant capital, ensure that they are compliant with the GCC sovereign wealth funds are seen law and also that they may be effectively as a much needed source of liquidity. A assigned to the new investor. recent example of a sovereign wealth fund acquisition is the Abu Dhabi Investment Licensing and consents. Business in the Authority’s purchase of a $7.5bn stake in GCC countries generally operates within Citigroup. a culture of consents. Whereas in western jurisdictions, most acts are permitted Investment is also flowing the other unless expressly prohibited, the assumption way, and on an enormous scale. Rising in the GCC should be that an act must be economies in the Middle East, particularly expressly permitted. in the GCC countries, have spurred interest from a broader class of international For many foreign investors, it comes as investors and others seeking to establish a shock to learn that a number of official a presence in these emerging markets. consents are required for such things as an In many countries, diversification of acquisition of shares, a change of directors the economy and investment has been or the establishment of a joint venture. The encouraged by favourable government red tape and delays that result from the policies and initiatives, such as those requirement for these consents can also relating to free trade initiatives, taxation be frustrating and bewildering for foreign laws and import duties. investors, although most will conclude that the rewards outweigh the headaches. Ownership and structuring. Although there are exceptions, for example in the UAE’s Careful planning can minimise these free zones and in respect of certain business problems. In particular, completion of sectors in Saudi Arabia, any investment acquisitions should always be conditional into the GCC countries (whether in the form on the obtaining of official consents, and of an acquisition, start-up joint venture the flow of funds should reflect this. Escrow or otherwise) will need to account for the arrangements are frequently the preferred requirement that most local companies route. must have a majority of their shares held by a national of that country or (in some In most cases, companies operating in the circumstances) the GCC. Where a foreign GCC will need to obtain a trade licence investor is seeking to control more than 49 permitting them to carry out their specific percent of a local subsidiary, it is usually business. Generally it is not possible to possible to put in place arrangements operate a ‘general objects’ commercial which effectively assign rights to control company, and there are frequently and profits in a company from the local complications on the transfer of a licence,
360 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS for example in the case of an acquisition. decrees in the Emirates of Dubai, Abu Dhabi and Sharjah, in practice at the Financing. Where an acquisition or joint date of publication these decrees are not venture is to be financed, local law issues enforced and with exception of banks and may arise. These mainly relate to the taking oil companies there are currently no direct of security, especially in relation to shares taxes levied on the profits or incomes or and more general charges over a company’s individuals or businesses. In the free zones, assets. a tax-free environment is guaranteed for a defined period. The law and practices in the region relating to enforcement of security are largely Law and practice. Another crucial difference untested. Generally, enforcement of between the GCC region and many western security must be pursued solely through jurisdictions is the degree to which the the courts. This contrasts with the position current practice of the authorities (for in jurisdictions such as England and the example, in relation to the criteria for United States where the financier has a the granting of consents) may be just as wider range of self help remedies available, important as written laws. Entrants to the together with more certainty in relation to market need to thoroughly research the the types of security available. current practice and, where necessary, seek pre-approval for their proposed investment Although it is possible to have financing and before committing extensive time and sometimes security documents governed resources to implementing plans. by foreign laws more favourable to a lender, in practice the enforcement of foreign Conclusion law provisions before the local courts is often problematic. Courts in many GCC The GCC is enjoying an unprecedented countries will frequently seek to apply local boom and represents an enormous laws notwithstanding a choice of foreign opportunity for foreign investors. However, law, and the court process can be slow and the region does have a distinct business costly. culture which presents challenges but also great opportunities for growth. It is vital A growing trend is the use of Islamic that any plan accounts for complications financing and given the complex nature of which may arise as a result of the local this type of financing it will be necessary to business law and practice, and that consult both Islamic scholars in addition to sufficient time and resources are dedicated obtaining specialised legal advice. to ensuring that any investment may be safe, secure, legal and profitable going Taxation. Taxation requirements vary forward. across the region. However, generally it is considered that countries in the GCC region host favourable taxation regimes. Eleanor Kwak and Antony Turton are associates, and Phil O’Riordan is a partner, at In the UAE, while there are income tax Clyde & Co.
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by Nasser Ali Khasawneh
Real estate has always been the investment compared to some other regions, it is vehicle of choice for the Arab investor. catching up. In the UAE, more than one- Whether it is the individual investor who third of the population is now connected puts all his savings into buying land, no online. matter how small, or the large investment funds that are fuelling the towers of A law firm’s role in an IT-related dizzying heights in the Gulf, land has always acquisition is pivotal. Typically, a law had its special allure in this region. A fund firm’s involvement starts just before manager who specialised in information the due diligence exercise. Ideally, a technology recently spoke of an impatient lawyer should be involved at the very investor who wished he had bought a piece beginning of the negotiations between of land instead of a stake in a software the parties in order to make sure that company. contractual arrangements are set in place in a well defined and orderly But that mentality is gradually, though manner. Unfortunately, in many cases, slowly, changing. It is driven by a growing a lawyer will only get involved after number of young and technology the parties had exchanged a number of literate entrepreneurs. M&A, and private important communications or signed an investment funds focused on the IT overrated piece of legal documentation: sector, are on the rise. And while the the Memorandum of Understanding aforementioned investor is right to suggest (MOU) or Letter of Intent (LOI). Arab that real estate in the Gulf and the rest of businessmen have an extremely intense, the Arab world can secure fast and huge often inexplicable, passion for MOUs and returns, there is a deepening understanding LOIs. Many entrepreneurs in the region of the long term benefits of investing feel that the first step must be an MOU. in other sectors, particularly in new When faced with a request for an MOU technologies. or LOI, it is important to clarify that an MOU is inherently a legally non-binding Behind this growth is an ever expanding agreement. They should not be trusted IT industry in the region. According to the implicitly. What is the point of spending industry research company IDC, IT spending hours and days negotiating a document in the Gulf region will grow by 11.6 percent that is non-binding? Parties are much to US$8.56bn in 2008. The largest market better off investing that time in exploring is in Saudi Arabia where IT spending will all the major issues with a view to agreeing reach $3.76bn in 2008 (an 11.28 percent the final and binding agreement, or growth), and the UAE’s spending will grow including all the initial points for discussion from $2.66bn in 2007 to $2.99bn. Also, in a binding Non-Disclosure Agreement while internet usage remains disappointing (NDA) or other such contract.
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The due diligence process in an IT is automatic and registration cannot be investment must be conducted in a a condition for protection. Copyright is particularly careful and measured manner. defined as any expression on any tangible The DD exercise must of course cover medium of expression, and once a work is all the usual areas, such as corporate, expressed it immediately gains protection commercial and financial matters, as copyright. Therefore, when reviewing the properties, employees, and litigation. copyright owned by the target company, it However, in most IT deals, the most crucial is important to form a clear understanding element of the DD is intellectual property. of the subject matter that constitutes the The DD exercise must include a detailed copyright in question. This usually requires analysis of all the IP that resides with meetings with the target company’s the company. A careful analysis must be employees who deal with R&D and the conducted of the patents and trademarks technical side of the operations. There is that are owned by the target company, no definitive formula for identifying, for as well as any copyright that resides example, the copyrightable software. therewith. Therefore, the lawyer must The key is to analyse the elements of the compile a diligent list of all trademarks, program developed by the target company patents and/or copyrightable subject with a view to determining whether this has matter that is owned by the company under indeed originated from the company and review. In this regard, a list of IP owned by has been properly expressed in a tangible the company cannot be sufficient to satisfy format. the lawyer and, more importantly, the client that is making the investment. It is of In this regard, it is important to note that paramount importance to insist on viewing the legislative infrastructure around IP in documents such as trademark registration the region has been constantly improving certificates confirming the completion of over the last 10 years, particularly in the the registration process. If a trademark area of copyright laws. As countries in the is still in process, evidence should be region joined the WTO, they were required presented confirming the submission of the to meet their obligations under the TRIPS application and its acceptance or approval Agreement. Furthermore, countries that by the trademark office. have adopted, or are in the process of negotiating, free trade agreements with While software and other IT products are the United States have had to upgrade their subject to patent protection, copyright law IP legislation and enforcement practices. is also relied upon to provide protection. This has led to new and improved IP laws This makes the DD exercise particularly in countries such as the UAE, Saudi Arabia, difficult in IT transactions. Copyright Egypt and Jordan. Furthermore, key protection, unlike patent and trademarks, players in the IT industry, particularly the is not conditional upon any registration. software industry, actively enforced their In fact, according to the Berne Convention rights throughout the region. This has led (the underlying treaty on copyright first to a maturing process whereby rates of adopted in 1886) and TRIPS Agreement of IP infringement and piracy have steadily the World Trade Organization (Agreement dropped in the region. on Trade-Related Aspects of Intellectual Property Rights), copyright protection Another aspect of the legislative www.financierworldwide.com | FW 363 INTERNATIONAL MERGERS & ACQUISITIONS 2008 infrastructure that bodes well for the While the improving IP and e-commerce future of IT investments in the region is legal infrastructure is laying solid the growing focus on legislation regarding foundations for an IT industry boom, electronic commerce and signatures. Laws there are of course additional challenges that give legal effect and value to electronic in this field that are common to all transactions are crucial to the growth of a sectors. In structuring an IT transaction viable industry based on e-solutions and in the UAE, an ever-present issue is the other forms of e-commerce. Most countries ownership limitation imposed by the UAE’s in the region do not yet have laws or Commercial Companies Law (Law No. 8 of regulations in this regard but countries such 1984). This law stipulates that any company as the UAE and Jordan are taking the lead. must have a local majority stakeholding, The Emirate of Dubai was one of the very i.e., a UAE national must own 51 percent first counties in the region to adopt such a of a company that is established in the law, with the Electronic Transactions and UAE. Therefore, any acquisition of shares Commerce Law (Law No. 2 of 2002) making in a UAE company must be structured it to the Statute book in 2002. This law on this requirement. Furthermore, in the gave substantial legal effect to electronic UAE, there is no developed concept of communications and transactions. In preferential shares. Therefore, in most principle, it enshrined various principles cases, any acquisition would involve a that support electronic commerce. For complex agreement that would spell in example, Article 7 states that “an electronic detail the relationships between the parties. mail does not lose its legal effect or its For example, in terms of limited liability capacity for enforcement purely because it companies, the UAE Companies’ Law allows was in electronic format”. the shareholders to distribute profit in a way that does not reflect the stakeholding, Dubai’s Electronic Transactions Law fast and it allows the parties to nominate became a model in the region, with the the general manager (hence, if there is report of efforts aimed at adopting such agreement, the minority shareholder can a law through a treaty at the level of the nominate the general manager). Therefore, Arab League. Furthermore, a similar law, an agreement between the parties is always Federal Law No. 1 of 2006 concerning necessary to define the rights within the Electronic Transactions and Commerce confines of the Companies Law. Law, was adopted by the United Arab Emirates at the Federal Level in January A feature that is particularly relevant in 2006. Another related development is the the Gulf is the proliferation of free zones. growth in improving laws around issues Usually, a free zone is an area in which of cybercrime. It goes without saying certain exemptions are allowed from that those who invest in IT / e-commerce various aspects of local law. Using Dubai as solutions need to know that they can an example, there are tens of free zones in protect their rights against the growing which companies are exempted from the threat of hacking, phishing and other local ownership requirement laid down in internet-based crimes. Once again, the the Companies Law. Consequently, non- UAE has shown strong leadership with UAE nationals are free to own 100 percent the passing of a law against cybercrimes of companies formed in the various free (Federal Law No. 2 of 2006). zones, such as the Jebel Ali Free Zone and
364 FW | www.financierworldwide.com 2008 INTERNATIONAL MERGERS & ACQUISITIONS the Dubai Airport Free Zone. The Dubai all economic fields especially … practice Internet City is a particularly attractive of all economic, investment, and service option for IT companies. However, activities.” This means that companies in companies in free zones do not have the the GCC and nationals thereof will be able right per se to conduct business in mainland to operate freely within all the countries of UAE. Free zone companies are a good the Common Market and that all ownership option for a regional operational centre that restrictions for such nationals will be will manage business in the whole region. If removed. While the Common Market came the purpose is to set up an entity focused on into effect on 1 January 2008, the necessary UAE business, then a UAE company must implementing laws and regulations are be formed that respects the 51 percent rule. not yet all in place. However, the reality of the Common Market will be reflected in all Finally, in the years ahead, particular aspects of the legislative framework in the attention must be paid to the Common region. Market of the Gulf Cooperation Council (GCC), the union of the Gulf states of Saudi The years to come will prove pivotal in Arabia, Bahrain, UAE, Qatar, Kuwait and the IT sector in the region. As highlighted Oman. The growing economic ties between above, the legal infrastructure is constantly the Gulf countries are fast approaching improving in the region, and this provides the levels of economic cooperation in a foundation for further growth. Or will the the European Union. The GCC Common attraction of sky piercing towers overwhelm Market is predicated upon the GCC the growing belief that investment in ideas Economic Agreement which stipulated is the cornerstone of a new and vibrant inter alia that “The council countries’ Arab market? natural and legal citizens are treated in any country of member countries with the same treatment of their citizens without Nasser Ali Khasawneh is a partner at any differentiation or discrimination in Khasawneh & Associates Legal Consultants.
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CHAPTER FOURTEEN: Contributor glossary
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A.T. Kearney Aperian Global
Vikram Chakravarty David Eaton Navin Nathani
AppLabs Acclaro Growth Partners Graham Smith Christopher ‘Kit’ Lisle
Arthur D. Little Advokatfirman Hammarskiöld & Co. Oliver Lux Philip Heilbrunn Christian Niegel Peter Sarkia Evgeny Shibanov Erik Swartling Dr. Karim Taga
Advokatfirman NorelidHolm Atos Consulting
Christer A. Holm Samantha Barklam Susanna Norelid Sean Wells
Advokatfirmaet Steenstrup Stordrange Bates White, LLC DA Boris J. Steffen Terje Gulbrandsen
BBK Alvarez & Marsal Christoph M. Schindler Eric Benedict Shepard Spink George Varughese BearingPoint
Matthieu Baudouin Amarchand & Mangaldas & Suresh A Stephane Cohen-Ganouna Shroff & Co. Natalia Danon-Boileau Olivier Sibenaler Shardul S. Shroff
Begbies Global Network
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Beiten Burkhardt Clifford Chance
Bogdan Borovyk Paul O’Regan Cameron Hall Ekaterina Katerinchuk Clyde & Co.
Berwin Leighton Paisner LLP Eleanor Kwak Phil O’Riordan Rachel Cuff Antony Turton David Harrison
Dealogic Blake, Cassels & Graydon LLP Salim Mohammed Frank P. Arnone
ERM Booz Allen Hamilton William Butterworth Justin Pettit Jaideep Das Dr. Jürgen Ringbeck John Simonson
Borenius & Kemppinen Ltd Eversheds
Andreas Doepel Robin Johnson Jyrki Tähtinen
Garrigues, Abogados y Asesores Bracewell & Giuliani Tributarios
John Brantley Fernando Vives Amauri Costa Martin Hunt GE Commercial Finance
Clayton Utz Christoph Reimnitz
John Elliott Rod Halstead Gibbons P.C. Michael Parshall Robert Coyne Kevin Evans
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Grasty Quintana Majlis & Cía Katzenbach Partners, LCC
Eduardo de la Maza Timothy Galpin
Heenan Blaikie LLP Kaye Scholer LLP
Subrata Bhattacharjee Derek Stoldt
Homburger Khasawneh & Associates Legal Consultants Frank Gerhard Nasser Ali Khasawneh
King & Spalding International LLP Kirkland & Ellis International LLP Mark Thompson Frank Becker Dr Jörn Schnigula Kroll
Phil Antoon LehmanBrown
Stephen Chan J Sagar Associates
Farhad Sorabjee Lincoln Crowne & Company
Nicholas Assef Jennings, Strouss & Salmon, PLC
Richard Lieberman Lincoln International, LLC
Darren N. Redmayne Jones Day Saurin Y. Mehta
Matthew Latham Weyinmi Popo Liniya Prava
Tatiana Kachalina Kate Lye (independent consultant) Svetlana Dubinchina
Kate Lye
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Linklaters Middletons
Matthew Middleditch Murray Landis Greg McConnell
Long&Field Milbank, Tweed, Hadley & McCloy LLP Fei Guoping Drew S. Fine Alexander M. Kaye Makarim & Taira S
Tasdikiah Siregar Morgan Joseph & Co. Inc. Setia Nadia Soraya Frank A. McGrew IV Dunn Mileham MAQS Law Firm
Jacob Strandgaard Andersen Morrison & Foerster LLP Veikko Toomere Marcia Ellis Jay C.S. Tai Mazars LLP
Oliver Hoffman MVision
Mounir Guen McDermott Will & Emery LLP
Nick Azis NautaDutilh N.V. Patrice Corbiau Abigail Reed Willem Calkoen Jeffrey Rothschild Harm Kerstholt Dennis White Miriam van Ee
McKenna Long & Aldridge LLP Nishimura & Asahi
Chris G. Baugher Masakazu Iwakura Anthony M. Balloon Yoshiaki Sakurai Wayne N. Bradley Juan L. Ramirez Michael J. Cochran Marc C. D’Annunzio Gary W. Marsh Patton Boggs LLP Ann-Marie McGaughey Richard R. Willis Walt Lemanski
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PricewaterhouseCoopers Thakker & Thakker
Will Bryan Bijesh Thakker Mike Burwell Ian Coleman Denise Cutrone Uría Menéndez Richard Fuchs Oleg Mikhailovsky Christian Hoedl Greg Peterson Javier Ruiz-Cámara
Projectfusion Virtus Global Partners
Angus Bradley Anil Kumar
Sheppard, Mullin, Richter & Hampton Waselius & Wist LLP Niklas Thibblin Tom Hopkins Jason Northcutt WSP Environment & Energy
Sorainen Tim Clare
Raminta Karlonaitė Zamfirescu Racoţi Predoiu Law Partnership SummitPoint Management Nicolae Hariuc Michael Sarlitto Cătălin Micu David Soley
Taylor-DeJongh
Terry A. Newendorp Nicole Weygandt
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