LVMH purchasing Tiffany and TechnipFMC splitting are the two M&A transactions that have been widely discussed recently. However, these deals are far from been representative of the current global M&A activity.
The trade war between the USA and China resulted in disrupting supply chains, impacting M&A activity, and increasing the risks of a global recession. The upcoming elections in the USA and controversial political environment create ambiguity regarding the direction the country will follow. At the same time, another notable trade dispute between Japan and Korea is also fueling geopolitical uncertainty and weakening economic activity. The World Trade Organisation facing a major crisis as of this Wednesday, 11th December, its appellate body has only one judge, and it needs three judges to rule on a dispute case. The USA has blocked the appointment of new judges.
Chinese outbound M&A deal activity drastically dropped in 2018 and continued to fall in 2019, mostly due to a decline in investment in the USA, in turn contributing to overall decline globally, as these investments are focused on asset acquisition, rapid market entry, portfolio expansion, market share increase, and protection.
Regulators in European Union, USA and Australia significantly impacted Chinese M&A activity by voicing antitrust and national security concerns and consequently adopting a stricter stance on approval of transactions in sectors such as energy, infrastructure, and technology. This harsh attitude exemplified by failed China Three Gorges Corp takeover of EDD Energies de Portugal SA (Portuguese Utility Company) and exclusion of Huawei from participation in 5G rollout. NASDAQ, this August, made changes to the rules governing IPOs (initial public offering), in part, directed at curbing small Chinese companies using IPO regime to raise funds from Chinese investors and not the USA investors.
However, how geopolitical uncertainty and weakening economic activity impacts the business environment?
Well, corporations need to rethink their strategies carefully: after three decades of globalization with trade barriers coming down, the same corporations are now facing an environment where boundaries are going up hand in hand with geopolitical instability. Thus, businesses need to reconsider where they have their supply chains, consequently leading us back to the effects of the trade war between China and the USA. Companies, such as Dell, HP, Apple, Nintendo, Google Pixel, etc. that enjoyed cheap labour, economies of scale, and availability of technology now considering or in the process of moving their production facilities outside of China to get access to the USA market without tariffs.
And the big winner is……. Vietnam, followed by other South East Asian countries (Thailand, Malaysia, Taiwan etc.); after years of trying to compete with China, these countries becoming new manufacturing hubs. Interestingly, the Chinese companies themselves move some of their operations to these new hubs (TCL, Sailun Tire, etc.). Nonetheless, the big question on everyone's mind: can these new hubs replace the operational capabilities offered by China and is the cost of relocation is sufficient enough incentive to counterbalance effect on revenue due to increase in tariffs if the business keeps its manufacturing in China?
Besides reduction in the volume of in the outbound Chinese M&A activity, has the current geopolitical situation had any other impact?
The signs seem to indicate that the focus has shifted to the entertainment industry: Melco Resort & Entertainment buying a stake in Australia's Crown Resorts and equity interest in the City of Dreams Mediterranean Project. Hong Capital Ltd (buyout group) invested as part of a consortium into STX Entertainment (US filmmaker), and Songcheng has made a DA for preliminary approval of the Australian Legend World theme park Development. Also, the Chinese companies looking at expanding and consolidating their activity in China through the acquisition of the local operations of international companies e.g., Suning.com Co (an appliance vendor) looking for diversification and benefit of distribution hubs through buying Carrefour operations in China.
Can we try to predict what will happen in 2020?
One possible worst-case scenario is that Brexit and various trade wars becoming a potential catalyst for a recession. However, on the optimistic side, it is most likely that the 2020 M&A activity will be driven, firstly, by start-ups that have disruptive technologies impossible to recreate in-house; these start-up most likely focusing on two aspects: alternative energies combating global warming and assistance type of technologies for the aging population.
The second driver for M&A in 2020 most likely will be the Activist Investors, especially the ones focused on the environment and social responsibility, as can be seen from the activity of Follow This Group. All listed companies need to understand the impact of activist investors on their M&A deals as their aim to purchase a number of shares of a public company that allow to obtain seats on the board and influence company`s operations. The board of directors and company management team should know where their vulnerabilities lie and to have in place an action plan in the event an activist investor will like to take control, to ensure the company is prepared to respond quickly and efficiently, and in a manner tailored to the situation. The effective preventive measures for companies to implement are regular review of shareholder engagement strategies, implementation of a clear line of communication with key investors and continuous assessment of investors’ issues and concerns. Related: The Free Money Bubble Is About To Burst
Private equity will also be a key feature of the market in 2020; they've presently raised and have available liquidity in the region of $1.3 Trillion, and we expect this cash deployed. Furthermore, we think that the possibility of an economic slowdown could bring additional opportunities for private equity to use those funds, particularly in take-private transitions.
Effectively, 2020 M&A activity is likely to be driven by companies looking to strengthen their businesses, especially during periods of prolonged uncertainty. There are many smaller, mid-cap publicly traded companies that find themselves landlocked in the current environment. Companies in 2020 will look for more mergers of equal opportunities, using the stock as potential acquisition currency to create an enhanced credit profile for the combined company. Investors are rewarding deals that build strong companies and penalizing those deals that add undue risk. If, in 2020, we experience continued periods of uncertainty, the companies will stick to their core competencies, the businesses they know very well, as opposed to adding new growth legs or entering into unproven markets.
As we consider that geopolitical uncertainty will diminish in 2020, and economic growth indicators show that companies will continue to gain strength and liquidity available for investment, we can expect them to deploy once again a more aggressive M&A strategy by the end of 2020.
We are optimistic, and it's difficult to image a year where there's been so much regulatory, trade and economic uncertainty.
By Polina Chtchelok and Luis Colasante
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