This guest post is by Jaya Gupta, Head of India Desk, Corporate at Allen & Overy LLP
In 2019, global M&A activity switched down a gear although it was still the third-strongest year in a decade in terms of value and transaction volume.
With macroeconomic issues such as continuing trade wars between the US and China, tensions in the Middle East and, to some extent, Brexit, impacting cross-border activities, many investors resorted to strategic domestic megadeals.
At Allen & Overy, we regularly identify the trends that we are seeing on our deals. Over the past eight years, for example, we have analysed more than 1,250 private M&A deals that we have acted on globally to discern trends relating to deal dynamics, execution risks and share purchase agreement terms. Some of the trends that we saw in 2019 are highlighted in this article. Read more.
Auction activity and competition starting to cool
We saw fewer auctions in 2019 (less than half of our M&A processes were conducted in this way) and less fierce competition between bidders – perhaps an early indication that the overheated private M&A market may be starting to cool. Auctions which were highly competitive usually involved 'hot' assets such as data- rich businesses, 'green' assets, digital solutions and health products.
Regionally, we saw higher levels of auction activity and competition in North America compared to elsewhere – 86% of our North America deals were auctions and 83% of those were highly competitive throughout. Next in the running order was the UK, where just over half of our transactions were auctions and 62% of those processes were highly competitive.
In Western Europe, CEE and MENA and Australasia, 50% or less of our deals were auctions and less than 40% of those were highly competitive. In Asia, we saw relatively few auctions in 2019 but three-quarters of those were competitive throughout.
Private equity waiting for price expectations to align
With private M&A valuations at a high last year and the economic outlook uncertain, private equity investors appeared to be more cautious about doing deals in the expectation of a market price adjustment in the first few months of 2020.
For some PE houses, acquiring a minority investment has become an alternative strategy given the need to deploy capital in the face of high prices to control the asset.
We also saw some funds looking to reacquire a business that they previously owned having the advantage of already knowing the asset and their relationship with management giving them a head start in the auction process.
A more general trend has been for PE funds to focus on environmental, social and governance (ESG) issues both when carrying out due diligence and, more broadly, when managing their portfolio.
PE sellers seemed happy to test the market but had no hesitation in pulling an auction if a stand-out bid did not materialise, often coming to the view that they could create more value by holding onto the business for the time being.
With public market multiples lower than those in the private M&A market, IPOs did not represent an attractive exit route for PE investors last year. On the other hand, public to private deals were a popular way to deploy unspent funds.
Regulatory landscape and economic uncertainty influenced deal terms
Increased regulation and economic uncertainty have been influencing deal terms.
Regulatory issues were a significant issue in almost half of our private M&A deals in 2019. Often the challenges lay in managing antitrust or foreign investment approval processes but we also saw a range of sector-related and other issues, such as works council or state aid requirements.
Last year, antitrust regulators were focussed on a few key areas including how to deal with digital and data-driven transactions. Regulators have been concerned that large organisations have been acquiring much smaller technology businesses or even start-ups as part of their digitalisation strategy with the target turnover too low to trigger traditional filing thresholds. To deal with this situation, some countries are considering introducing alternative thresholds, for example those based on deal value, to bring these transactions within the net.
From a procedural enforcement perspective, gun-jumping continues to be a key focus for regulators. While this is a risk in countries which have mandatory suspensory merger control regimes, even authorities in the UK and Australia, both of which have voluntary filing regimes, have taken enforcement action.
Antitrust regulators have also continued to step up their requests for internal documents during merger reviews, with disclosure extending to several million documents in some cases and penalties being levied for incomplete production of documents.
As many as 12% of our deals were conditional on foreign investment approvals last year, a figure that has been increasing over the years and a trend that looks set to continue. For example, new foreign investment controls become effective in Japan in the next few months and the UK government has indicated that its national security proposals will return to the table. New EU rules requiring co-ordination of foreign investment screening were also adopted last year and will apply from later this year.
Separately, we have seen economic uncertainty influence deal terms. For example, we have witnessed a trend towards fixed price deals and away from earn-outs (the latter featured in 9% of our deals in 2019 as compared with 20% of our deals in 2018) and price adjustments (these featured in 46% of our deals in 2018 as compared with 37% of our deals in 2019).
Shift in dynamics as buyers reclaim some lost ground
In 2018, we saw the peak of an extremely seller-friendly market for M&A deal terms, but in 2019 we saw buyers beginning to reclaim some lost ground. For example, we noticed stronger warranty and indemnity packages (with fewer deals where most or all of the warranties were subject to general materiality qualifications or to the seller's knowledge) and longer time limits for bringing claims against sellers (the most common time limit for notifying a seller of a claim under the operational warranties across all our deals globally being 18 months but with regional variations).
Marked differences in developed, emerging and frontier market M&A
Protectionism remained a key theme in a number of markets in 2019, including the US and parts of Europe. However, in many emerging and frontier markets, the drive to attract foreign investment in sectors such as technology, infrastructure and socially vital areas, like education and healthcare, continued.
As might be expected, we saw buyers exercising greater caution when investing in a frontier market and the least caution when investing in a developed market. Protections for a buyer between signing and closing including material adverse change clauses, full warranty repetition and termination rights for material breach of warranty became more common as the risk associated with the market increased. Similarly, buyers insisted that sellers provide higher liability caps and longer time limits on claims in riskier markets. However, our analysis also indicated that sellers too had their concerns and these tended to relate to post-deal value erosion at the lower end of the scale. For example, we saw more locked box arrangements in riskier markets and higher de minimis levels and thresholds.