Features : Dealbreakers

Sharply increasing M&A; deal volumes mask some very real problems in the cross-border M&A; market.

At first glance 2005 appears to have been a record year for worldwide M&A.; In the third quarter the volume of worldwide M&A; deals was almost 50% greater than the same period of 2004. According to Thomson Financial, Europe saw a staggering 75% increase in M&A; activity in the third quarter, with the US market experiencing a 37% increase in deal volume. Standard & Poors anticipates that industry consolidation in Europe and the US will continue to fuel a worldwide surge in M&A; throughout 2006.

The outlook for cross-border M&A; appears just as rosy, with Dealogic reporting that cross-border deals had tripled to $75 billion in the first quarter of this year. Some of the more notable cross-border European M&A; deals in 2005 included French drinks maker Pernod Ricards bid for UK rival Allied Domecq, UniCreditos bid for Germanys HypoVereinsbank, Spanish telecom company Telefnicas bid for British mobile operator O2, and the largest-ever single cross-border acquisition by a Spanish company, Spanish property firm Metrovacesas $10 billion takeover of French real-estate company Gecina.

The numbers are remarkable, but there are still questions over whether all really is well in the world of cross-border M&A.; Arguably, Europe has not seen some of the megadeals that have characterized the US market in recent months, more notably Proctor & Gambles $57 billion takeover of Gillette. Some maintain that those deals are yet to come, particularly in the telecom, utilities, banking and energy sectors, where market liberalization and privatization of formerly state-owned companies suggests that European companies are ripe for the picking.

But Jeremy Dickens, a senior partner in the London office of legal firm Weil Gotshal & Manges, says cross-border M&A; between European companies and US firms contrasts with the somewhat rosier outlook for worldwide M&A; in general. He points to figures published by Bloomberg that indicate that most of the cross-border M&A; deals in Europe were led by European companies. In the UK, British firms accounted for more than 40% of M&A; deals, followed by the French and Germans at 26%, while US firms accounted for a paltry 8%. If you look at it on a market-by-market basis, there is a high degree of intra-European M&A;, but not a lot of M&A; with non-European buyers, says Dickens.

However, Jos Manuel Campa, a research fellow at the Center for Economic Policy Research (CEPR), says that was not always the case. He points out that in the past decade there had been surprisingly more deals between EU and US companies but that in the past year there had been more pronounced activity within Europe than in the US, which he attributes to the role played by venture capital funds.

Euro Fails To Trigger Wave Of Deals


Germanys ruling Social Democratic Party leader Franz Muentefering compared private equity investors to a swarm of locusts

With the advent of the single currency in Europe, most observers anticipated a surge in cross-border consolidation, particularly in the banking sector, but that has not really materialized. A 2004 study of cross-border M&A; among European financial institutions conducted by Allen & Song found that domestic M&A; and intra-continent M&A; was more prevalent than cross-continent M&A.; But in its 2005 Global Banking Industry Outlook, Deloitte sounds an optimistic note, saying that the traditional reluctance to engage in cross-border mergers in Europe may finally be fading. According to Deloitte, the value of M&A; deals in the European banking sector in the first 10 months of 2004 was $204 billion, double the level achieved in 2002.

However, the Deloitte report notes that the obstacles that have hampered cross-border mergers in the past still loom large. The European financial services industry is still fairly fragmented, with country-specific taxes, regulations and cultures making it difficult to transplant banking services cross-border, Deloitte writes. These obstacles are further compounded for potential acquirers from outside of Europe.

And if the recent scandals in the Italian banking sector are anything to go by, the issue of national pride is still very much alive in European cross-border M&A.; Earlier this year it was discovered that the Italian central bank had intervened to try to prevent foreign takeovers of two of its local banks, Banca Antoveneta by Dutch bank ABN Amro, and Banca Nazionale del Lavoro, which Spanish bank BBVA bid for. ABN Amros bid has since been approved, but controversy surrounding the deal garnered the attention of the EU commissioner for internal markets and services, Charlie McCreevy, who has threatened to use existing laws to prevent such obstacles from re-occurring.

Although ABN Amro persisted with its bid, Dickens says a lot of companies cannot afford to be that highly principled, which leads him to conclude that the Dutch banks success will not necessarily open the floodgates to more cross-border M&A; involving companies from countries such as Italy. While some may be tempted to view the Italian banking fiasco as an isolated incident, recent pronouncements from German and French politicians suggest that economic patriotism, to borrow French prime minister Dominique de Villepins phrase, is alive and kicking.

In August, de Villepin announced that the French government would take a protectionist stance toward strategic economic sectors to prevent foreign takeovers. His sentiments soon played out on the French economic stage with a rumored bid by US drinks giant Pepsi for French yogurt manufacturer Danone. The French finance minister, who greeted the bid with an emphatic non, said the government would do everything in its power to protect the interests of employees. In the summer, Germanys ruling Social Democratic Party leader Franz Muentefering also made a jibe at outside investors, describing private equity firms as a swarm of locusts that graze on underpriced businesses, lay off staff and then resell the firm for a profit.

Dickens predicts that these demonstrations of economic patriotism will continue to hinder some mega-cross-border deals within Europe, but he says it is less prevalent in mid-market deals involving lower-profile takeover targets. I wouldnt be surprised if not in every transaction, but in more key transactions, we start seeing these same sort of issues arise, he says. Campa of CEPR says economic patriotism significantly influences the likelihood of whether cross-border M&A; is even attempted. Firms are reluctant to engage in a cross-border deal if they feel that opposition from the host government may be an issue, he says.

Although economic patriotism may be a worldwide phenomenon, Campa says it is more likely to occur in Europe because of the range of industries that are present there. However, earlier this year the US appeared to engage in its own demonstration of economic protectionism with the attempted takeover of US oil and gas company Unocal by the China National Offshore Oil Corporation (CNOOC), resulting in Senator Byron Dorgan introducing a bill prohibiting the merger of the two companies. Congress took a leaf out of Frances book, arguing that oil and natural gas resources were strategic assets critical to national security. Others, however, saw it differently. It was China-bashing, says Dickens, but I dont think the US is, broadly speaking, anti-FDI. So many US companies are buyers themselves, so you cant have it both ways.

US Adopts More European Approach


George Kleinfeld, Clifford Chance, says national security concerns could be used as an excuse to prevent foreign takeovers

George Kleinfeld, counsel in Clifford Chances Washington practice, says that unlike Europe any official remonstrations surrounding national security interests in the US are based on a rule-of-law approach. He is referring to the Exon-Florio amendment adopted in 1988 in response to an influx of Japanese high-tech investment. The amendment gives the US administration the right to review, where appropriate, foreign acquisitions that could give rise to national security issues. Traditionally, we have not applied the concept of investment screening or economic chauvinism beyond the boundaries of national security, unlike our friends to the north, the Canadians, as well as the Australians and others in the OECD club, Kleinfeld says. Yet in the past four years, Kleinfeld says, the Exon-Florio amendment has been more aggressively applied as a result of the terrorist attacks of September 11, 2001, and concern that Chinas economic expansion may threaten US interests.

In the context of CNOOCs bid for Unocal, Kleinfeld says that political opposition was based not only on economic patriotism but also reciprocity concerns if US companies cannot invest in Chinese oil and gas companies, why should it work the other way? This reaction from Congress imposed a risk premium in domestic bidder Chevrons favor, because the timing and outcome of an Exon-Florio clearance could not be taken for granted. Closure of the deal with CNOOC was not a sure thing, Kleinfeld says. If Unocal had wanted to take the risk, they could have accepted CNOOCs offer, undergone an Exon-Florio review and sought to mitigate concerns by divesting certain assets. This is very different from what appears to be happening in European countries such as France and Italy where, he says, foreign takeovers may be influenced by completely non-transparent considerations without recourse to an established administrative process.

Kleinfeld worked on Chinese company Lenovos acquisition of IBMs PC business, which he says attracted the attention of Congress. He says the transaction was excruciatingly reviewed under the applicable regulatory procedures and went forward on that basis. Unlike the CNOOC/Unocal deal, there was no rival domestic bidder and political opposition was restrained. However, he acknowledges that fervent nationalists could in the future use national security as an excuse to prevent foreign takeovers. The problem is that it is hard to objectively define a national security threat. Politicians who have an economic nationalistic agenda could use national security as an excuse to defend parochial interests, he points out.

So with economic patriotism and national security interests coming to the fore in cross-border M&A;, will companies considering taking the plunge think twice? While potential acquirers in such deals need to spend a lot of time and money exploring the political and cultural implications of cross-continent or cross-border M&A;, Dickens says if the deal is important to them, they will factor that into the cost of doing business.

But the problem is unlikely to go away. Campa anticipates that there will likely be more FDI from Chinese and South Korean companies and that the reaction to these investments will be similar to that in the 1980s when Japanese companies were intent on world domination. In general, greenfield investment will be perceived to be better than acquisitions of existing companies, he says. The biggest problem with economic patriotism will be for cross-border integration of European companies, which is highly needed in certain industries.

Anita Hawser