Does Brexit spell doom for London’s future mergers and acquisitions? Going by what transpired in the days shortly after cessation, one would be right to think so. London has now approached every M&A deal with political suspicion. First, there was Peugeot’s offer to buy GM’s European auto business; immediately London got the whim of this secretary Greg Clark rushed to Paris to seek assurance about the future of the two Vauxhall plants in Britain.
Shortly followed a £115bn offer by US conglomerate Kraft Heinz to acquire Unilever. Even though Unilever, later on, rejected this deal, panicked UK ministers were already questioning policy issues such as the future of Unilever’s headquarters, UK listings, and jobs.
So what is the driving force behind the mega-takeover bids?
Currency devaluations
After the Brexit vote, the sterling pound dropped from about $1.50 against the dollar to less than $1.20, fuelling foreign investor’s lust for UK companies. Many buyers reacted opportunistically to try and acquire UK companies. Despite the protectionism put up by the British government, the decline of the sterling pounding has made UK assets attractive to investors.
According to analysts, we are still going to see more large-cap mergers and acquisitions shortly. More so investors expect a further drop of the pound after Theresa May triggers article 50. Then there is the Trump effect. All these factors are responsible for the animal spirits returning to company boardrooms.
Continued Availability of funds
In the recent past, there has been a regular availability of capital that has even put big targets in reach, as in the case of Unilever. The US economy is undoubtedly on track for considerable growth, after Trump promised to lower taxes and invest more in infrastructure. It is a no-brainer that US companies will be looking to deal because of the promise of growth at home, and a fallen currency abroad.
However, despite the few big deals like Peugeot, Softbank and the merger of London Stock Exchange and Deutsche Borse, many foreign investors have steered away from British assets. It all boils down to the political, legal and financial uncertainties associated with Brexit. And now we are witnessing unsuccessful Brexit transitional negotiations. The longer the talks drag on, the more foreign buyers sit on their wallets.
Political uncertainty still an issue
Political instability is the big elephant in the room, and many buyers are concerned about the future impacts of Brexit. In the second half of 2016, there was a 30 % drop in M&A deals for UK companies by foreign buyers, as compared to 2015. Political uncertainty has by far outweighed the allure of the collapsing sterling pound.
Tensions are high in the UK, as two recent takeovers have pushed the UK government towards protectionism for its companies. The big uncertainty in investors’ minds is how the government can deal with an M&A boom at a time when they are also trying to navigate the murky waters of the exit. The exit itself is expected to see many corporate relocations and job losses.
The UK government is concerned about control. Exactly how far ministers will go to protect UK companies is an issue. According to Theresa May, last year’s Brexit vote showed that people wanted to be in control of their lives, and this includes seeing the government protect them from predatory foreign acquisitions.
The prime minister has hence committed to a new industrial policy Unveiled in Birmingham last July. Through this industrial policy, the prime minister has guaranteed to defend essential sectors in the British economy from a takeover frenzy by raiders. One crucial industry that could see increased protection from mergers and acquisitions is the pharmaceuticals industries.
Despite the UK’s political uncertainties, two major British companies — chip designer Arm Holdings and pay-TV broadcaster Sky — have agreed to be acquired since the Brexit vote. Could any further increase in takeovers by international buyers mean that there is a contradiction in Mrs. May’s industrial strategy? Don’t think so.
Look at it this way; regardless of the measures to protect UK companies from foreign takeovers, the prime minister has emphasized the need for policies to champion free trade. When Japan’s SoftBank launched a £24.3bn takeover of Arm last summer, Mrs. May let them through, but with commitments on jobs and the UK headquarters.
For the coexistence of protectionism and free trade under one Brexit, Theresa May is expected to come up with a framework for assessing foreign takeovers in the coming days. The structure will define what critical national infrastructure is, and how to evaluate foreign investment for the same. The Prime Minister ordered this review of policies amid concerns of a Chinese takeover in Britain’s nuclear power sector.
The 2002 Enterprise Act only allows ministers to stop mergers on the grounds of national security, media plurality, and financial stability. Mrs. May’s framework is expected to increase the government’s leverage for intervention, but at the same time attract foreign investors. That is where the rubber hits the road.
Currency volatility spells fear for investors
The unprecedented downturn of the UK currency after the Brexit vote failed to boost foreign takeovers. Apart from the large-cap deals, investors are uncertain of profitability after the UK finally leaves the EU. The truth is that the speed of economic growth in the UK does not seem favorable. Even though the UK is a significant contributor to the EU, after Brexit, the country might feel the burden that comes with lack of agricultural subsidies and tax rebates from the EU.
If immigration is cut, public finances also stand to sustain a significant dent. Migrants contribute immensely to the Treasury, and they supplement the aging population. Perhaps unsurprisingly, foreign buyers also worry that the unsteady British pound could plunge the value of the dividends they repatriate.
Because of the political and financial uncertainties, developed nations are having second thoughts about mergers and acquisitions. The US was first on the line with restrictions for buyers attempting to make purchases in the high tech and energy sectors. The German government followed suit, seeking to block Chinese buyers from acquiring of sophisticated engineering firms.
Still, individual investors are willing to sail through such uncertainties. China, for instance, appears to have an insatiable appetite for UK’s assets. Even after Britain postponed China’s $20 billion-plus nuclear power deal, Chinese buyers are more than willing to invest in the UK. London is a hot destination for big Chinese investments including China’s CC Land buying the iconic “Cheesegrater” skyscraper for £1 billion ($1.29 billion) earlier this year.
As the Brexit negotiations continue, close to $15.6 billion worth of M&A deals by Chinese buyers are presently waiting for confirmation in the UK. If successful, these deals alone would surpass all of the transactions made by Chinese entities in 2016.
Legal issues
Brexit is likely to have significant implications on buyers from a legal perspective. The scope of these impacts will largely depend on how Brexit is implemented. At this time major foreign buyers are in a wait and see mode until after the final exit of Britain from the EU. Potential buyers may cancel deals since they are cautious about Brexit’s impact on exchange rates, the value of what they are buying and the direction of Brexit negotiations.
A hard Brexit could cause ambiguity and a further drop in mergers and acquisitions. However, Theresa May could try to rectify the downward trend by organizing an orderly and profitable Brexit to boost investor confidence.
Impacts on Free trade
To start with, there is no clarity on what trading arrangements will exist between the EU and Britain. Even though Britain will seek to arrange an appropriate free trade agreement with the EU, the exit will undoubtedly impact the profitability of target companies. The restrictions on free movement of workers will affect the operations of many businesses too, and this has kept foreign buyers at bay. On its part, the EU has many free trade agreements with countries all over the world, after the exit though, Britain will have to negotiate its new contracts with nations.
Change in assets valuation
Foreign buyers are worried that the nature and value of assets in an M&A transaction through virtual data rooms may change once the UK exits the EU. If this becomes the case, valuation for such assets could be impacted. The cessation might also mean a decline in profitability and disruption of operations of the target business. In light of these expected changes, foreign buyers have become reluctant to acquire British companies.
Changes in administrative and operative guidelines
Contractual definitions under the current scope of the EU are expected to be impacted by Brexit. For instance, a non-compete clause in transactions entered into before the exit may not apply after Brexit happens. As if that is not enough, companies might also see changes in operational and administrative regulations.
Currently, mergers and acquisitions in Britain are governed by the Companies Act of 2006. Many provisions of this act are derived from the EU directives that regulate shareholder rights, transparency, and accounting. Investors fear that a majority of these guidelines will be repealed after Brexit. These expected changes are some of the reasons where there is a declined M&A activity by foreign buyers in Britain right now.
Any European publicly traded company can have its headquarters in any EU member state. This will no longer be the case for Britain’s corporations after the exit. Buyers, therefore, have to grapple with the question of where they will situate their headquarters. Acquisitions in the UK might turn out to be a costly affair that requires relocation of offices and operations.
Share price and asset deals
Share price and asset deal contracts is also an aspect that might experience shake ups. There is a lot of questionability, considerably, about UK and EU border agreements. Also, because of the higher British pound volatility and weaker share prices, there might be stricter regulations on UK stock market shares to cover risks faced by sellers and buyers.
Intellectual property registration
After the exit UK companies might also see changes in intellectual property registration. EU registrations of IP may no longer cover both the UK and EU. An IP registration with the European Trademark Office may no longer apply the UK after Brexit. Because of this, parallel listings in the UK and the EU may be necessary after Brexit. This translates to the increased administrative burden for businesses seeking to acquire or merge with UK companies.
Working and living permits for foreign employees
Working and living permits for foreign employees in the UK will see shake-ups as well. International buyers that would need to send their employees to work in the UK have to deal with the fact that that working and living permits may be required when the UK exits the EU. Employees might face double taxation ad double Social Security contributions.
The European Social Security Regulation streamlines the process so that taxpayers working abroad pay contributions to social security rights only in the country where they are working in. That may not be the case for Britain after the exit. Companies wishing to acquire or merge with UK companies have to consider this topic with keen attention. It all comes down to an increased operational and labor costs.
Contract provisions that can be triggered by Brexit
Another issue foreign investors have to contend with is whether the legal contracts that are of substantial importance to a business might contain provisions which can be activated by the Brexit. An agreement that includes material adverse change clauses allows one or both parties not to full fill certain obligations if the circumstances of the contract change dramatically. Buyers, therefore, need foolproof agreements that will not see the other side walking away from the deal after Brexit.
Specific financial and legal implications can encourage opportunistic mergers and acquisitions to make a move on UK companies. Fluctuations in exchange rates for instance, together with changes in share prices and asset valuations may mean well for some foreign buyers. However, with Theresa May’s new policy regulations, it might be hard to take advantage of these. Some buyers are totally moving away from M&A, and starting up offices in the UK instead. Opening up new branches in Britain is a way to get around the protectionism currently in place, and a horde of other legal and operational dilemmas associated with Brexits
