The Hindu Business Line : Scouting for M&As in Europe

One potential tactic for Indian companies that have an appetite for European acquisitions is to look towards failed M&A deals from the past that may start to resurface.

Mohan Murti

Global merger and acquisition activity is still struggling and Europe is feeling the sting more than others. M&A activity across the world is at its lowest ebb in terms of the number of deals.

In this scenario, European mergers and acquisitions have plummeted by over 50 per cent so far this year compared with 2008, amid the ongoing liquidity drought and fears about the economic recovery.

The past four years have witnessed dramatic changes in the M&A market — both highs and lows. Here is a brief update on current market trends in private M&As in Europe and an overview of the tools currently being used to bridge the gap between buyers and sellers.

I see in Europe an unprecedented wave of financial restructuring of private equity-backed companies, with banks ultimately taking control and ownership of over-indebted companies.

In my observation, European banks continue to remain unpopular as they are imposing high fees to reset covenants and high margins on renegotiated debt.

But, in spite of the present difficulties, I see that the private equity industry seem more upbeat and optimistic than in previous quarters. There is certainly more optimism in the financial markets which is spilling over into deals as I am seeing a gradual pick-up in activity.

However, the key question being asked by many people is whether this is sustainable into 2010.

Deal terms

Given the turmoil in financial markets and the unwillingness of banks to provide credit, companies with deep pockets that want to snap up smaller rivals are in a much more powerful position to dictate deal terms than they have been in past years.

I am seeing a shift towards more buyer-friendly contract provisions and this trend is likely to become more pronounced as buyers demand even better acquisition terms. If Indian companies have the money ready to fund M&A deals, they can leverage better contract terms.

I see equity investors and strategic buyers opting for different methods to increase their security when negotiating deals in Europe because of a combination of cultural, regulatory and legislative considerations.

Buyers are negotiating better terms through the following methods:

Cap on warranty claims: Buyers often seek to exclude certain key areas of concern from the overall liability cap for warranty claims. Not surprisingly, in a buyer’s market, liability caps on warranty claims have been increasing.

Time limit for warranty claims: In the UK, two-thirds of deals had a general time limit for warranty claims of 18 months or less, but elsewhere in Europe, the opposite was true with most deals containing a time limit of 18 months or more, and more than 24 months in Spain and Italy.

Earn-outs: The use of earn-out mechanisms, where the purchase price is dependent on the future performance of the target business, was relatively even in the UK and Europe.

MAC clauses: Material adverse change (MAC) clauses give the parties — usually the buyer — the right to rescind the transaction if a material ‘negative event’ provided for in the agreement occurs before closing.

Such an event could include the loss of a major customer, or an investigation carried out by a regulatory or prosecuting authority, such as the Financial Services Authority or Serious Fraud

Price adjustment mechanisms: In the UK, two-thirds of deals included a completion accounts or other similar price adjustment mechanism, usually based on levels of debt, cash, net assets or working capital or a combination of these. One explanation is that English law does not provide a clear and quantifiable measure of damages for breach of warranty, so the parties must negotiate an operative provision to avoid uncertainty.

In mainland Europe, deals included such price adjustment mechanisms only about half the time, companies preferring instead the ‘locked box mechanism’ which provides for a fixed purchase price at signing.

Conditions to completion: Majority of continental Europe deals included conditions such as competition clearance, regulatory approval, shareholder approval and securing finance by the buyer. France and Germany have strong worker representative groups and their influence can make or break a deal.

Scout for failed M&As: One potential tactic for Indian companies who have an appetite for European acquisitions is to look towards failed M&A deals from the past that may start to resurface. Several high-profile multi-euro mergers have fallen through over the last five years and these could well come back to the fore now that valuations have dropped.

The German Opportunity

With an economy that is expected to contract by 5.4 per cent this year, according to the European Commission, Germany has not escaped the global downturn. It is fair to say that overall deal activity has gone down by 40-50 per cent from a year ago. Despite that, it seems like a perfect time for Indian corporates to make deals in Germany.

Price expectations are at a more realistic level and German companies are well-positioned in the world market. Cash is king. Indeed, as companies have been largely unable to do deals with their paper due to their sunken valuations, only those with plenty of cash have been snapping up the bargains. A number of these fortunate entities are investment companies. In recent months valuations have hardened a little, but people are not averse to taking shares now.

Reassessment of Risks

Inevitably, the European recession is bringing about some distressed deals, where beleaguered companies teeter into the arms of an acquisitive saviour for a bargain price. Clearly, there has been a reassessment of risk in the past year or two.

Investors are looking for investments that have a lot less risk attached to them. Understandably, they want a greater certainty on returns, but at the same time there is only so long that you can leave your money in the bank earning 1 per cent a year.

(The author is a former Europe Director, CII, and lives in Cologne,Germany. blfeedback@thehindu.co.in)

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