M&A deals are on the up globally and in Asia in particular; 2014 saw the region present the highest total value of deals on record. What are the important legal, financial and organisational factors in making a deal and what role can the treasury play to ensure success?
The point of mergers and acquisitions (M&A) is often to ensure growth and stability; in the current economic climate both are attributes that sit well with boardrooms and investors alike. Perhaps this is why the level of M&A activity has increased significantly in the past couple of years as corporates that have stockpiled cash in a low interest world seek to bring on board new customers, products and R&D effort through acquisition.
The growth of M&A itself is confirmed by Dealogic’s ‘M&A Review Full Year 2014’. It reports that global M&A volume reached $3.60trn in 2014, up 26% year-on-year (from $2.85trn). This was the third highest volume ever recorded, behind 2007’s $4.62trn and 2006’s $3.91trn. The figures for Asia Pacific (excluding Japan) show a market very much alive to the opportunities of acquisition. Although Japan’s M&A volume of $74.3bn was the lowest since 2002, the region’s overall figure realised a targeted M&A volume of $656.8bn; the highest total on record. China dominated with $307.4bn of deals, its appetite for acquisition not letting up on overseas deal-making activity (including many in Europe). According to data from research firm, Mergermarket, China registered a 21.3% increase in the value of its total M&A activity during 2014.
However, increased activity means more failed deals too. The FT Press book ‘The M&A Paradox: Factors of Success and Failure in Mergers and Acquisitions’, states that “many research studies conducted over the decades clearly show that the rate of failures is at least 50%.” In April 2015, China Daily News (CDN) reported “a slew of troubled overseas deals” for the country; this exposes the increasing risks and potential losses faced as M&A activity increases.
One of the causes of the breakdown of outward bound deals is the failure of companies to fully understand the cultural, legal and political environment of their foreign target businesses. Of the 120 failed outbound Chinese deals between 2005 and 2014, CDN claimed that about a quarter were due to political reasons. The China Centre for International Economic Exchanges cites a “lack of talent familiar with international practices” as being a “major shortcoming” for Chinese companies in overseas markets. This signals the need for qualified input from a range of functions.
A legal perspective
The complexity of international commercial law is such that it requires expertise not just to get the best deal but also to avoid making potentially costly mistakes. A frequent error of judgement is to try to iron out contractual details of a merger before legal counsel has had a chance to advise on suitability. “Not involving counsel early enough can mean issues are not raised in good time which can lead to later difficulties,” warns Emma de Ronde, Partner and corporate lawyer for Norton Rose Fulbright Hong Kong. Businesses are understandably reluctant to incur legal fees before they know they have got a commercially viable deal in place but agreeing to any commercial or legal terms without recourse to legal advice could ultimately prove more costly. It is often the case that once a client has sent a set of pre-agreed terms to its lawyers, it then falls to the lawyers to point out the consequences of going ahead under such terms and even try to extricate the client from unfavourable terms.
Even with this in mind, some companies may still be comfortable tackling the preparation of key high-level commercial terms themselves, only bringing in legal counsel when they want to document what has been agreed commercially. For others, there may be a need to consult at an earlier stage, particularly if there are complex structuring, legal, regulatory or taxation issues, or if there is a cross-border element with which to contend.
Of course, each deal will have its own legal peculiarities but there will be some commonalities too, notably when structuring a deal from a due diligence perspective. There will be an initial investigation of the scope of the business being bought or sold, looking at areas such as ownership, how the sale will take place and the regulatory requirements that must be met to enable the sale to go ahead. The target business will be subject to commercial and legal due diligence, typically including considerations such as its financials, business model, existing legal contracts (with key suppliers and customers, for example), employee and pension issues, intellectual property rights and, increasingly, any anti-bribery and corruption issues. The latter, notes de Ronde, is a big issue in Asia right now, especially in China. Once these point have been satisfied, the preparation of documents may commence.
In addition to the sale and purchase agreement, other documentation may include the acquisition financing agreement with banking partners, and perhaps a transitional service agreement where the seller provides services to the buyer, post-sale, for an agreed period. The final stage for counsel would be signing and completion. “Often there will be a gap between agreeing terms and completion where there may be a series of further external conditions that must be satisfied,” notes de Ronde. “These may be regulatory; for example, we might need to make Merger Control filings if there are competition or anti-trust issues, or there may be conditions specifically related to the business that need to be resolved; a financial services business, for example, may require prudential regulatory approval for the sale to go ahead.” Satisfaction of all conditions should lead to completion of the transaction at which stage counsel can advise on the mechanics of the transfer, guiding the new owner through a number of responsibilities it now has around filings, registrations, how it implements its own governance structure within the new business and so on.
Most developed jurisdictions with stock exchanges will have separate rules that apply to the acquisition of a listed company, notes de Ronde. The Hong Kong Takeovers Code, for example, is regulated by the local Securities and Futures Commission which governs the terms under which a buyer can acquire a listed company. It covers aspects such as the timing of the transaction, what has to be documented and what can and can’t be said to shareholders pre-sale. In addition to Takeover Code rules there are also controls on insider dealing and market abuse issues that must be adhered to.
The process is far from straightforward though, the diversity of legal systems found in Asia often presenting issues for cross-border mergers. “On private deals, where parties are in different jurisdictions, each side will typically want to use the law of its own jurisdiction as governing law,” notes de Ronde. Some jurisdictions might dictate the applicable governing law for transfer of a particular asset, so it is essential to be aware of local rules.
However, it is when a deal takes a turn for the worse that the real “hot debate” starts. It can be a major challenge to agree which jurisdiction will hear a claim; although arbitration is increasingly used in preference to the court system, even this raises the question of where arbitration will be heard and under which arbitration rules. It is strongly recommended that guidance on dispute resolution is tackled and finalised in the initial contract phase.
On the regulatory side, Charlotte Robins, Partner and financial services regulatory lawyer at Norton Rose Fulbright Hong Kong, notes that whilst buyers and sellers are much more aware of their regulatory obligations around M&A than they were a few years ago, some still do not think about them “fully enough and early enough.” Where companies need to secure change of ownership approval from the regulator, for example, they should understand that this can take time. And where outsourcing is deployed, either at the transitional services stage or as part of the subsequent integration, it will inevitably invoke rules around the transfer of data – another hot topic in Asia.
Tackling the breadth and depth of regulation means that M&A teams will have more people and agencies to deal with. But, says Robins, it is as much about getting the timing right as it is knowing the regulators and the best approach to take with them. Whilst she acknowledges that it may sometimes be more appropriate that the business, not the lawyers, deal the authorities, she believes that knowledge on the ground “can be key in getting the necessary approvals in the time that you need them.” Ultimately, Robins feels that the diversity of legal and regulatory environments across Asia does not necessarily make M&A more difficult, “it’s just different.” Having the right legal counsel onside is clearly an advantage.
How can the banks help?
In terms of preparation for a deal on the finance side, there are many different dynamics to consider, explains Alexandre Huet, Global Head of Strategic and Acquisition Finance, Société Générale. As a banker, he naturally considers it more provident for buyers to prepare well in advance wherever possible, allowing time to consult a number of internal and external advisors – including banks – who can help draw out the most appropriate deal structure. However, he acknowledges that sometimes a deal runs short of time and although this can often make the process “very challenging,” a sense of urgency can help “crystallise” the terms of engagement. From a tactical point of view, he comments that a short time frame is thus “not necessarily a bad way” to approach M&A.
That said, although each deal must be tackled on a case-by-case approach, Huet believes that seeking bank advice ahead of a deal, besides early engagement with the preparation work, allows their involvement much earlier in the process on the financing side. This is of particular benefit in the case of a hostile takeover or where there are competing bids as funds “must be accessible at the point of need.” Where a listed company is the acquisition target, he notes that the process will almost certainly benefit from advanced planning to head off the kind of regulatory demands seen in the UK, for example, where a buyer’s proof of funds is essential for approval to be granted (it becomes a case of ‘put up or shut up’ in order to protect the target from destabilising exploratory approaches). On the buyer side, such a need illustrates the importance of drawing together as much information as possible pre-deal, says Huet. Treasurers obviously have a key role to play here, (whether the target is listed or not) but banks can also play a vital part in the practical management of an M&A deal, as financier or advisor (or both).
When bank finance is required it may come in many forms but a common way to fund a merger is to use a bridge loan, says Huet. This allows an interim phase that supports the bid and any regulatory requirements to prove funding. If the merger is successful, this facility can either be entirely refinanced on the bond or equity markets or subsequently partially syndicated and turned into term loans. The large corporate and investment banks that typically seek out positions as the book-runners or lead arrangers for a financed merger will steer the funding process, managing refinancing following a bridging loan or securing the participation of other banks where the loan is syndicated.
Ultimately, for Huet, if the terms are agreeable and the market supports those terms, and if the shareholders find the deal attractive, the industrial rationale is there and there is chemistry between the management team, then the deal has a good chance of success. But he accepts that there are many ‘ifs’ here and suggests that failure on any one of these points can reduce even the best laid plans to rubble.
The treasurer’s role
Anecdotal evidence suggests that some treasurers are not involved in deals as early or as deeply as they would like or feel necessary. Just knowing the geography of a deal, for example, means being able to better manage bank relationships. Firms such as AstraZeneca, the Anglo Swedish pharma giant, know the importance of treasury involvement. It has a targeted M&A strategy to build upon its scientific work, said Ian Brimicombe, Group Head of Tax & Treasury, AstraZeneca, speaking at last year’s annual ACT event in Glasgow. Part of that approach demands that its treasury personnel are ready to position the function for each proposal that comes along. These ideas tend to happen very quickly because it is an extremely competitive market, he explained. “If the treasury team isn’t ready to stand together with the management executing and implementing these acquisitions then we will lose out.”
Brimicombe believes that treasury must adopt a collaborative stance, not only with the management teams of the business development and corporate strategy groups that formulate the ideas on what they want to buy and how they wish to implement the acquisition, but also with specialist colleagues in areas such as tax, insurance and group reporting. “It all has to be linked together in order to create a coherent finance perspective on the deals.”
Finding the right seller or buyer and putting the finances in place involves much work but the failure rate of deals must be borne in mind. Tom Greene, Group Treasurer at another pharmaceuticals firm, Shire, knows this only too well. He pointed out at the same ACT event that as a pharma company, Shire uses the acquisition of early stage products as a key source of product development. At any given time it may have up to 20 opportunities on the table, covering companies of various sizes and stages of development, without knowing which will come to fruition. “Acquisitions can be a bit like busses; there’s nothing and then several come along at once.”
For treasurers, not knowing about deals in advance is a disadvantage; forewarned means forearmed and being able to position finances in good time can facilitate a successful deal. “I’d rather be in the loop than outside it,” said fellow panellist, Alan Dick, Director of Tax & Treasury for international engineering firm, AMEC. However, Dick also believes treasurers should seize the initiative. “It requires proactivity; you can’t sit and wait to be invited to take part.”
Until a deal has been completed, understandably, the level of data imparted by the company being acquired may be limited; this could frustrate the acquiring treasurer’s good intentions to move forward. It may be possible to include a contractual element of disclosure post-signing but prior to completion that provides for the needs of treasury. To this end, John Grout, Policy & Technical Director of the UK ACT suggests that it should be part of the training for a company’s M&A negotiators to understand treasury needs and to try to incorporate these at the earliest stage. He also suggests that whilst normal due diligence processes may to an extent be paper-based, a face-to-face meeting of respective treasurers (and between counterparts from other functions) can reveal so much more, potentially heading off any unpleasant surprises.
Communication is the key
Ensuring the timely communication of all relevant information to all the parties involved in the deal is essential. Achieving a satisfactory result may be more difficult for a business that has either not engaged in an M&A deal before or does so infrequently. This raises the importance of finding reliable advisors to supplement internal resources. Internally, treasury has come to play a crucial role as the intermediary between external bank partners and the other business units involved, acting not just as the risk advisor and efficient expeditor of funding but also as the informed challenger for any advice that is forthcoming from those external partners. Working as a team is essential throughout the M&A process; it is not a stretch of the imagination to suggest that a merger without the input of treasury could be a risk too far.