Chapter 2: Global Outlook
Will the next wave of m&a create more value?
After the M&A activity slowdown of the early 2000s, the market is experiencing a new surge of mergers and acquisitions. It is largely known that in the past, two-thirds of M&A transactions have destroyed value, often resulting in abject failure. In this context, the key question today is:
Will the new wave of M&A create more value than the previous one?
Lessons from the past, we have tried to identify the reasons driving value creation and value destruction in M&A deals by analysing 2500 M&A transactions that took place over the past 10 years in Europe. Four lessons jump out of this study and from our experience. First, there is no statistical correlation between the value creation and the size of the transaction. However, large scale transactions (more than $1bn) tend to destroy value whereas small scale transactions (less than $50m) tend to create value. During 2004-2005 periods, for instance, small scale transactions in our sample have an average positive return after one year of 6 percent, compared to -5 percent for the large scale transactions. Furthermore, the average return weighted by transaction amount is below the average non-weighted return, which means that large scale transactions are obviously tending to destroy more value than small scale ones.
In this respect, it is interesting to mentionthe existence of some country specificities regarding the average transaction size. Although M&A operations are much more numerous in the UK than in other European countries, France is the place where large scale operations occurred most frequently. Between 2000 and 2005, the average value of transactions was $1.2bn in France compared to $1bn in Germany and $500m in the UK.
Second, an acquirers’ previous M&A experience has an influence on value creation. Our study indicates that frequent buyers (involved in one or two acquisitions a year) are more likely to create value. On the other hand, a company which carried out less than one M&A transaction over the past 10 years will risk destroying value.As a matter of fact, previous experience will allow a company to better evaluate potential synergies with its target. A more realistic approach on future synergies will be translated into appropriate pricing. Previous experience also implies greater capitalisation of knowledge about the integration process (tested integration methods in the pre- and post-acquisition phases) and nurtures a more open, less selfabsorbed company culture.
Third, a merger or acquisition can act as a catalyst in uncovering significant savings which were previously concealed. These unforeseen savings could theoretically have been identified regardless of the M&A operation. We have found that only half ofthe synergies publicised in the past were indeed true synergies, implying that the integration of these companies had actually produced a greater result than simply adding these entities together. The other half consisted of savings that could have been made without the M&A operation.
Finally, value creation depends on how the merger preparation and post-merger integration process is managed. In fact, although the market is positive about value creation after five days in 54 percent of deals, the average rate of value creation decreases to reach only 40 percent one year after the announcement, reflecting, among other issues, integration failure or insufficient realisation of planned synergies.Best practices and advanced approachesThe key to efficient management of the M&A process is the optimum use of ‘traditional’ best practices: evaluation of the target’s strategic interest and of the potential synergies, retention of key people, preparation of an integration plan, massive use of internal and external communication and, obviously, speed of integration. In fact, it is imperative to keep the ongoing business under control during the integration period, as there may be one, two or even three years between the date of closing and the completion of the merger.
While some teams are working on the establishment of the new group, other (different) teams must remain focused on sales and customers: this requires transitory management systems.Some companies now go beyond those practices, improving their chances to create value. What are these advanced approaches to merger?
Better evaluation of the management and the human capital during the due diligence process. Another point of attention during the due diligence process is an in-depth evaluation of the management team and the human capital of the target. In fact, some groups start copying LBO practices and taking into account – from the due diligence phase – HR assets and cultural differences, as a valuable input to structure the forthcoming merger preparation and integration.
Realistic evaluation of the synergies and their efficient implementation by dedicated line people. In some companies, line people work together with the due diligence team to carry out evaluations of the expected operational synergies, thus producing a better evaluation of the target.During the integration phase, devoted teams of dedicated line people follow up on the realisation of synergies and ensure their fast and full-scope implementation. Efficient management of the antitrust notification process. The ongoing consolidation process in many industries leads to an increasing number of large scale cross-border mergers. For these kinds of operations, winning the approval of antitrust regulatory bodies has become a critical issue. The companies’ M&A capabilities will also depend on their ability to articulate structured and professional approaches to address antitrust issues; e.g., analyse their need to notify, define their notification strategy, prepare their associated dossier and draw up contingency plans in case the operation fails (such as Schneider/Legrand, GE/Honeywell). Such an approach will help anticipate as much as possible how negotiations with authorities will evolve to better control the approvalprocess and its impact on the operation.Preserving the value of human capital.
The staff’s motivation is indeed the most critical component in a merger’s success. Maintaining staff’s dynamism will ensure continuity in the company’s management at a transitional time when the new group can be unstable operationally. Boosting motivation will require appointing the topmanagement very fast, within a few days, before or after the closing. In this matter, again speed prevails over perfection. Our survey shows that in 60 percent of cases, key managers are actually appointed within 30 days before or after the closing.
Adoption of standardised acquisition and integration processes. Some frequent acquirers have developed an extremely formalised process, a sort of ‘acquisition and integration machine’.
Based on theirprevious acquisition experience, these companies have defined and adopted a standardised M&A process helping to address all operation’ phases in a coherent and coordinated way. Also, they define tools, methods, checklists and a team to mobilise in case of a forthcoming M&A transaction.The advanced practices mentioned above are only emerging. Even if the value creation remains highly unpredictable, the generalisation of those new practices should lead to better value creation and better value capturing in future mergers and acquisitions.
International M&A takes centre stage
With the increasing globalisation of business coupled with the protracted weakness of the US dollar, M&A activity is now playing out on a much larger stage, creating new opportunities for international investors and growth-oriented companies in emerging market countries looking to penetrate Western markets. Unlike earlier periods, such as the 1980s, which saw a spike in international transactions, evidence suggests that recent activity is indicative of a more permanent global trend, with M&A targets of the past becoming the acquirers of today and tomorrow.However, while market forces such as increasing access to global capital and favourable currency valuations are providing transactional tailwinds, inherent challenges remain. For new global business ventures to be successful over the long term, acquiring companies will need to find ways to not only leverage strengths, such as low cost manufacturing, but overcome relative inexperience managing complex global enterprises.
Driving forces
The buyers
While worldwide M&A volume has plunged from the historic highs reached in recent years, deals continue to get done. Even as the US continues to see major declines, overall activity is down just over 6 percent compared to 2005’s January-February total, with international activity, particularly in Asian markets, showing more stability, according to Dealogic. Buyers and sellers are still demonstrating an appetite for deals, with foreign buyers, buoyed by financial strengths, becoming more active participants in what they perceive to be a fertile environment for acquiring US assets. Currency valuation is one driving factor. For the last several years, foreign currencies have been stronger against the US dollar. Leading the pack is the euro, which hit a record high against the dollar in late February, exceeding for the first time $1.50. Many economists predict further weakness ahead for the dollar, as a number of US economic factors, including declining home prices and waning consumer confidence, continue to pressure the greenback. With US assets now roughly 20-30 percent cheaper than they were a decade ago, foreign buyers see an opportunity to bargain hunt. This is especially true of those in oil-rich nations which are flush with liquidity.
For companies in countries not enjoying ‘petro capital’, another important factor has been the increasing willingness of local banks to provide funding for deals. With the balance sheets of many US and international banks suffering as a result of the subprime mortgage crisis, local banks in emerging markets, which had far less exposure than their US counterparts, are stepping up to provide debt financing for deals. The trend is likely to continue. At the same time, local governments, which in thepast often tended to frown on international expansion, are showing greater support for companies looking to acquire foreign assets.
The maturation of foreign companies, both in terms of size, sophistication and experience, has also been a catalyst in driving recent M&A activity. Historically, foreign companies with the necessary market presence and management depth to be serious international acquirers have been few and far between. This has changed dramatically in recent years, particularly in the wake of significant growth in the Asian market. A new universe of capable, cash-rich and strategic-minded buyers, who have successfully developed a critical mass in their domestic markets, have emerged and begun to make their presence known.
Netherlands-based ArcelorMittal, the world’s largest steelmaker by output, provides a case in point. In 2006, CEO Lakshmi Mittal – an Indian steel mogul who ranks among Forbes’ 10 richest CEOs in the world – further expanded the steel empire he established over several years with the acquisition of European steel giant Arcelor. Since then, ArcelorMittal has continued on an aggressive acquisition spree, announcing 35 acquisitions around the world in 2007 and indicating the pace would continue this year.
The sellers
From a sellers’ perspective, international deals have emerged as an important option for US companies navigating a challenging economic environment. With the US credit markets virtually shut off and the overall domestic economy continuing to show signs of weakness, pure US transactions have become much more difficult to execute – as evidenced by recent data.
Beyond financing, however, combining with companies outside of the US has become a viable strategic option for many growthoriented businesses. US companies, which have developed a strong domestic market presence, are seeking to attract foreign buyers with an eye toward leveraging cost advantages in foreign markets, such as raw material access or labour rates. And again, because the pool of foreign buyers has expanded beyond Europe and Japan to now include emerging markets such as Brazil, Russia, China and India, among others, M&A opportunities have increased exponentially.
Looking ahead
Even when the dollar rallies, the US capital markets relax and the economy strengthens, we are likely to continue to see significant interest in US assets among foreign buyers. In the past, companies with the strength and the staying power to engage in significant acquisitions have primarily been based in the US and Europe. Now, companies in markets outside the US – and in nearly every industry – have reached a critical mass and the number of active buyers is likely to continue to increase. In addition, as the geographic boundaries of global capital fade as investors pursue areas of highest return and workforces become more international, national corporate identity will become less and less relevant.
Within this environment, however, significant challenges remain and how international buyers deal with these hurdles will be a key factor in determining the ultimate success of these transactions. At a time when more foreign governments areshowing greater support for international
M&A, the US could begin to take a more isolationist stance – particularly if the economy weakens further or national security concerns heighten. Already we have seen a number of potential deals scuttled or postponed. National security concerns among lawmakers, for example, postponed 3Com Corp.’s transaction with Chinese technology company Huawei Technologies Co.
A greater test will be how this new group of corporate acquirers overcomes relative inexperience entering new markets and running global enterprises. Simply leveraging strengths such as low-cost manufacturing bases will not be enough to achieve success and staying power. Management will need to be equipped to deal with a range of regulatory issues and prepared to quickly develop global capacity in critical operations, such as information technology systems, supply chain and distribution, as well as enhance their capabilities in areas such as brand management and sales and marketing.
Steering through the US obstacle course – which in many cases requires extensive experience, knowledge and relationships in the marketplace, community and government – will be a challenge for even the most skilled executives if they are mainly accustomed to operating overseas. Utilising valuable resources within the acquired company or bringing in new executives with deep knowledge of the US, forming alliances with US partners, and retaining individuals with the expertise to navigate the range of management and regulatory issues – will all be important factors in executing a long-term business strategy.
Conclusion
International M&A activity has been a relative bright spot in an otherwise doom and gloom deal environment. Rather than a short term phenomenon, the activity – and the driving forces behind it – suggests a more permanent trend of large and middle market US and European companies being acquired by sovereign funds or companies with global ambitions that are located in strong emerging markets.
But as foreign buyers take advantage of market conditions and leverage their strengths and acquire US assets, they must be mindful of the challenges inherent to entering any new market and take steps to position the business for the long term. Many have already discovered that creating meaningful value through M&A transactions, particularly when premiums have been paid, comes down to properly executing the strategy and actually realising the anticipated synergies.

Recent developments and their implications for m&a in 2008
It was the best of times; it was the worst of times. So might Charles Dickens have described the acquisition financing markets in 2007. Fuelled by private equity sponsored buyouts using readily available credit, the number and value of M&A deals in the US reached record levels in 2006 and the first half of 2007. Private equity sponsors doing mega deals, including The Carlyle Group, Kohlberg, Kravis & Roberts and The Blackstone Group, received unprecedented media attention.
Several recent developments, however, make it likely that strategic buyers will return to prominence in 2008 and beyond. Also, partially as a result of the impact of less activity by private equity sponsors, sellers are likely to have less leverage at the bargaining table.
During the recent M&A boom, extensive liquidity in the credit markets created intense competition among lenders. Borrowers found themselves able to obtain acquisition financing cheaply – at more aggressive leverage multiples, at lower spreads, and with fewer and less restrictive covenants than ever before. As a result, private equity sponsors often were able to pay higher valuations and offer more cash than their strategic counterparts.The ability of private equity sponsors to outbid strategic buyers is likely to lessen as a result of several recent events.
First, the much-publicised credit crunch that began in mid-2007 will make it more difficult for private equity sponsors to obtain competitive financing to outbid strategic buyers. The steep increase in defaults in the US subprime market led several lending institutions to fail or file for bankruptcy and has had broad effects throughout global credit markets. In response, lenders have become more cautious by increasing credit spreads, decreasing leverage ratios, and insisting upon more restrictive covenants from their borrowers. Despite Federal Reserve attempts to increase liquidity by cutting the fed funds rate by 225 basis points between September 2007 and January 2008, we expect lenders’ risk tolerance to remain relatively low. Private equity buyers will have to readjust their expectations with regard to financing terms and lower their valuations of targets. Strategic buyers, by contrast, often are cash rich or able to rely on existing lines of credit to fund acquisitions.
Second, differences in the ways in which private equity buyers and strategic buyers tend to view and analyse companies may also lead to greater competitiveness by strategics. Private equity sponsors have finite holding periods and only want companies that can deliver an internal rate of return in excess of 25 percent over the investment horizon. Private equity sponsors are further limited by credit pricing and financial models that forecast their anticipated returns and determine their willingness to proceed with a transaction. Strategic buyers, by contrast, often have a longer horizon and intend to integrate them into their existing business lines.
Additionally, strategics often include non-financial factors in their transaction analysis, such as synergies, defensive advantages and other competitive factors. Non-financial aspects of an acquisition agreement such as time to close, allocation of risks and lack of closing contingencies can also play a significant role in determining the winning bid for a company. Because strategic buyers often have a strong grasp of the fundamentals of the target’s industry (and possibly of the target itself), they are often better positioned to assess the scope and magnitude of potential risks posed by the target’s business. Private equity firms, however, often have to educate themselves about the target’s industry and specific business, which is a time consuming process. Further, since a private equity firm is compensated only if its returns are in excess of a hurdle rate, sponsors often take a more hardline view of the target’s potential risks, which results in transaction agreements that allocate greater economic risks to the sellers.
Most private equity firms do not have the human capital required to operate their portfolio companies day-to-day. Private equity buyers often require management stockholders to ‘roll over’ a significant portion of their equity rather than cashing out 100 percent of their holdings. They will also likely insist that most or all of the key management sign long-term employment contracts as a condition to closing. Even though the selling stockholders will continue to hold a stake in the target going forward, the private equity firm will control the company and the sellers will find themselves as minority stockholders. For a selling stockholder that is looking to ‘cash out’ and move on to the next venture or retire, these requirements can be unattractive. Strategic buyers, however, have operational executives and systems in place to run the business and are less sensitive to keeping management in place.
Third, amendments to Rule 144 and Rule 145 by the US Securities and Exchange Commission (SEC) that became effective on 15 February 2008 will also likely benefit strategic buyers. Strategic buyers often issue their securities to sellers as part of the merger consideration. Sellers, understandably, prefer liquidity and want the ability to resell these securities as soon as possible. The changes to these rules reduce or remove restrictions on secondary sales, which should allow strategic buyers to use their stock as transaction currency to increase the valuations of the targets.
Below are summaries of some of the primary changes to Rule 144 and 145 which are most likely to benefit strategic buyers.Rule 144 provides a safe harbour for resales of restricted and control securities. Restricted securities include securities issued in a transaction not involving a public offering, such as where a strategic buyer issues unregistered shares to the stockholders of a target in a private placement. Control securities are securities of an issuer held by an affiliate of the issuer.
To qualify for a Rule 144 resale of restricted securities, several conditions must be satisfied. These conditions limit the ability of holders of restricted securities to resell the securities, and therefore reduce their value to the holders. The Rule 144 amendments most significantly affect secondary sales of restricted securities by non-affiliates and make it easier and faster for sellers to get liquidity for their company. As amended, Rule 144 (i) shortens the holding period for restricted securities of reporting companies to six months from one year; (ii) allows non-affiliates of reporting companies to freely resell restricted securities after the six month holding period if the issuer satisfies the public information condition; and (iii) allows non-affiliates of reporting or non-reporting companies to freely resell restricted securities without complying with any Rule 144 conditions after a one year holding period, rather than two years.
Affiliates of reporting companies will still need to comply with the Rule 144 limitations and requirements when selling equity securities of the issuer under Rule 144. The holding period for affiliates of nonreporting companies remains one year, and will still need to comply with the Rule 144 limitations and requirements when selling equity securities of the issuer under Rule 144.Simultaneously with the amendment to Rule 144, the SEC also substantially eliminated the ‘presumptive underwriter doctrine’ in Rule 145. Under prior law, an affiliate of a target who received securities in a registered transaction was deemed to be an underwriter. Even though the securities were not restricted securities (because they were sold in a registered transaction), to negate this underwriter status, the resale had to comply with Rule 145 (which mirrored the Rule 144 requirements, without the holding period and Form 144 requirements). Now, except in limited circumstances, affiliates of a target who receive shares registered on Form 4 will be able to freely resell them immediately, unless the holder is also an affiliate of the issuer (in which case the rules governing control securities will continue to apply).
In addition to strategic buyers regaining competitiveness over private equity sponsors, the ongoing credit crunch is likely to reduce the overall number of bidders; therefore, we expect sellers to have less leverage generally against buyers in the negotiation process. We expect fewer auctions, resulting in lower valuations.
Where auctions are commenced, we expect an increase in preemptive bids with ‘goshops’ – a limited ability of the target to search the market post-signing for other potential buyers. As a result, target boards of directors will have to be increasingly mindful of their fiduciary duties relating to business combinations. Agreement terms will likely become more buyer-friendly, such as more conditions to closing for buyers and lower indemnity baskets and higher indemnity caps and escrows.In conclusion, we think the continuing credit crunch and the associated deal execution risks involved in selling to private equity sponsors will result in increased competitiveness by strategic buyers. Also, the recent relaxing of rules regarding secondary sales should increase the value to sellers of receiving a buyer’s securities, especially if the buyer is a reporting company. Less activity from private equity sponsors is likely to lower the valuations and otherwise lead to more buyer-friendly terms in deal agreements.
Emerging markets and m&a activity
There are numerous trends currently affecting the cross-border M&A market. Investors from emerging economies are increasingly interested in developed economies. Activity by private equity funds is growing in emerging economies. National investment strategies are growing. New hot sectors are emerging, particularly financial services and infrastructure. Valuations are rising as a result of emerging market investments.
Acquirers looking to complete M&A transactions in emerging markets face many challenges. Fiscal and legal regimes are often unpredictable. There is a need to identify key tax issues. Buyers must choose the appropriate method of market entry. Cultural differences can be a major hindrance. Finance facilities are limited. There are differing approaches to business valuations and accounting policies. Political risks must be assessed.
Key trends
International investment flows are changing. Whereas in the past the direction of flow was almost universally from the developed to the developing markets, this is no longer the case. Last year, for example, saw the Anglo-Dutch steelmaker Corus acquired for £6.2bn by Tata Steel of India, which outbid a Brazilian rival. While this changing environment creates opportunities for businesses in developed markets seeking new investment finance, there are associated threats. Companies seeking to complete M&A deals in their home markets face fresh competition from investors in the developing world. As competition grows, so do the prices that must be paid.
Notable among the new investors from the developing markets are sovereign wealth funds, which are likely to have a considerable impact on future investment flows. In 2007, the value of such funds grew by around $1.3 trillion, while new issues of government gilts worldwide totalled just $600bn. Seeking a home for their surplus cash, sovereign wealth funds have begun turning to new, higher risk investments – including listed companies and private equity. This trend seems set to continue. For example, as long as energy prices remain high, sovereign wealth funds from oil-producing states will continue to grow in size. If sovereign wealth fund investments quadruple over the next 10 years, as has been suggested, their influence on crossborder M&A will increase further.
While investors from emerging markets are creating competition for deals in more developed economies, western private equity funds are similarly increasing competition in developing markets. PE funds already account for a large proportion of corporate acquisitions in established markets, and this phenomenon looks likely to be repeated elsewhere as PE houses seek new high growth opportunities.
The impact of PE funds in emerging markets is, of course, affected by the availability of debt finance. Hence the recent credit crunch has had an inhibiting effect, one which is encouraging some PE funds to look to sovereign wealth funds as alternative sources of finance to bank debt.
However, if this crunch proves to be merely a cyclical event, over time increasing PE involvement in cross-border M&A will fuel existing inflationary price pressures.
National investment strategies are also likely to shape future M&A trends. For example, the Chinese government announced at the seventeenth Communist Party Congress a new national strategy to make higher value investments. Initially, China’s outbound investment was largely focused on securing the country’s supply chain – delivering the raw materials, natural resources and energy needed to fuel growth. Now the Chinese are keen to explore opportunities in more knowledgeintensive industries. Such national investment strategies add additional competitive heat to the M&A arena, with acquisition decisions no longer being driven solely by traditional financial metrics. As a corollary, some countries are showing signs of a growing mood for protectionism – so-called ‘resource nationalism’ – to prevent domestic businesses and treasured national assets from entering foreign ownership. If such tendencies develop into confirmed national policies, cross-border M&A activity could stagnate or fall. For the moment, however, deal volumes remain high.
Some sectors, such as financial services and infrastructure, are enjoying particularly strong interest among investors from developed markets. Private bankers and insurance companies are increasingly investigating the service opportunities open to them in developing economies. Desire to upgrade infrastructure in emerging markets is also stimulating interest both in corporate investments and in the ownership of assets such as roads and bridges. 3i, for example, has launched an infrastructure fund on the London stock market.
There is, however, a potential inhibitor of M&A in developing markets going forward, and one which could affect all sectors – the increased valuations attached to companies and assets in those markets. In China, for example, high personal savings ratios, the relatively limited equity market and strong interest from overseas investors have pushed up equity prices. Western companies could find it increasingly difficult to find growth opportunities at valuations that are acceptable to their shareholders.
Key challenges
Businesses seeking to complete M&A transactions in emerging markets face numerous challenges. To begin with, emerging markets are inherently fast moving, and this can be true of their fiscal regimes. Until last year, for example, China encouraged foreign investors by offering more favourable tax arrangements than were available to domestic companies. This is generally no longer the case. Investors thus need to consider the potential for tax regimes to be altered, and not necessarily in a favourable way.
They also need to identify the tax policies that have the greatest impact on the relative success of an investment. Investors often focus primarily on the tax incentives available when making an investment, such as the availability of tax relief on debt interest costs. However, the long term investment success of a transaction may be more greatly affected by the investor’s ability to realise value from the investment in a tax efficient manner in the future. Given that some tax regimes penalise or inhibit capital or profit withdrawal more than others, this is an important issue for upfront consideration.
If assumptions cannot be made about the continuity of the fiscal regime, the same goes for legal systems. The presumption of contractual certainty is the bedrock of business in the developed world, but can break down in some emerging markets where political motivations sometimes appear to override the rule of commercial law. The longer term in nature an investment is, the more reliant it is on specific legal structures and institutional stability. The need to accommodate legal flexibility, as well as fiscal flexibility, in M&A deals is therefore an important issue for investors.
Another challenge is the most appropriate method of market entry – whether through forming a joint venture with a local party or going for sole control. Established practice has generally been to form a joint venture with a local partner. The inward investor benefits from the local partner’s cultural understanding and contacts, but may subsequently seek to buy out the partner if the venture proves successful. That model now appears to be losing favour, perhaps due to its associated problems. It can, for example, be hard to agree on shared objectives for the venture. If the venture is successful, the inward investor can have difficulty extracting full value – many agreements give the local partner preemption rights in the event of a sale. As a result, there are early signs of a trend – both in developing and developed economies – towards sole control investments and organic growth models,where local regulations allow.
Whatever the market entry model, cultural differences between domestic and developing economies need to be understood. The moral and ethical frameworks that exist in a number of emerging market countries are not the same as those in developed economies. In certainterritories a monetary reward for ‘assistance’ might be expected, whereas elsewhere this might be deemed a bribe.
These are serious legal issues, with potentially far-reaching implications. For example, directors can fall foul of the US Foreign Corrupt Practices Act as a result of actions that take place miles away from the US. Our survey of global chief executives found that cultural issues are considered the biggest impediment to cross-border M&A, particularly during the post-deal integration period. It is essential that cultural norms and expected business practices are made explicit prior to any transaction being completed. This extends to an understanding of the governance, control and reporting structures that will be established – the structural manifestations of corporate culture.
The options for financing and for successfully hedging M&A investments in developing economies can also be constraining. Although bilateral or syndicated bank finance may be available, corporate bond markets are generally less developed than in more advanced economies which may inhibit emerging market acquirers. This will change gradually – in India efforts are being made to create a financial centre in Mumbai, but this will take time.
Differing approaches to valuation methodologies can also arise. In some markets the standard basis for agreeing a price is depreciated cost, rather than discounted cash flow. Even where the latter is accepted, estimating risk and establishing the appropriate discount rate may not be straightforward. Variations in accounting policies can also create difficulties in interpreting reported figures. These and other technical issues all need to be overcome.
One other possible challenge for investee companies looking at opportunities in developing markets concerns their ability to assess political risk appropriately. High turnover rates among senior executives in developed economies are arguably resulting in rapid corporate memory loss. Awareness of problems that have previously arisen due to politically unstable regimes is being lost from the corporate consciousness. Companies may, therefore, be underestimating the political risks associated with emerging market transactions. This is a particular problem for cross-border investments involving major physical assets, which are relatively difficult to withdraw from without significant losses being incurred.
Even so, across all sectors, M&A activity with developing economies remains a high priority for companies from more established markets. Despite the many challenges involved, the need to find growth opportunities will continue to stimulate transactions.
Developments in merger control in the EU and worldwide
Review of a potential transaction by one or more competition authorities can seriously affect the structure and timing of a deal, whether it be an acquisition, merger or joint venture. Many jurisdictions prohibit implementation of a deal before merger clearance is obtained, and timeperiods for review of the transaction can be considerable. The impact of merger control worldwide is increasing as more jurisdictions introduce new, or revise existing, regimes. Such legislation is frequently produced in order to facilitate self-assessment of a transaction by the parties, and thereby to avoid prohibition by competition authorities of notified deals. However, the fact that outright prohibition of transactions remains relatively rare in many jurisdictions should not deflect attention from the emphasis that competition authorities such as the European Commission place on ensuring that their merger rules are respected, and their willingness to use their enforcement powers against merging parties (and even other countries) that attempt to circumvent those rules.
Development of merger legislation worldwideIn recent months, two industrial superpowers, India and China, have passed new merger legislation, bringing their regimes further into harmony with more mature systems such as those of the European Union and the United States. China adopted its first competition law in August 2007, introducing a merger control regime. The law has been a decade in the making, and will come into force in August 2008. Certain important elements, such as thresholds for merger control to apply, still remain to be finalised, but pre-merger notification will be required. Of particular concern is the requirement that acquisitions of Chinese companies by foreign companies go through national security checks, although details of this obligation are not yet clear. Inaddition,observers are keen to see how the new law will be applied to Chinese state-owned companies, and how the overarching requirement for behaviour to be appropriate for a socialist economy will be interpreted.India’s new regime introduces mandatory merger notification where specified assets or turnover thresholds are met.
However, the law incorporates a ‘domestic nexus’ element, with notification to the Competition Commission of India (CCI) only required where both parties have assets or turnover in India. Under the new Indian law, the ‘suspensory period’ following notification of the merger, during which the transaction cannot be implemented, is theoretically 210 days.
The relevant period under the previous regime was 90 days, and this change has caused significant concern. However, the implementing regulation for the new regime (currently only in draft form) introduces an interim period of 30 days for the Indian authorities to take an initial view, upon the expiration of which approval of the transaction canbe presumed. As the CCI is not yet fully constituted, the regime is not currently being enforced.Jurisdictions with well-established systems of pre-merger clearance have also been developing and clarifying their rules.
Such reforms are often driven by an aim of facilitating self-assessment by companies and their legal advise`rs, in order to minimise the amount of pressure put on the limited resources of competition authorities.
The European Commission has been continuing to review and develop its merger legislation. In April 2007, the Commission published a draft Notice on remedies acceptable under the EC Merger Regulation, with the aim of updating its current 2001 guidelines. The guidance relates to modifications that may be proposed by parties to a transaction in order to ‘remedy’ competition concerns identified by the Commission in its merger control review. The draft Notice has been subject to a public consultation, and is expected to be adopted in the first half of 2008. In 2007, the Commission also adopted guidelines on non-horizontal mergers, to complement its guidelines on horizontal mergers, which were introduced in 2004. The non-horizontal guidelines relate to both vertical mergers (between parties operating at different levels of the supply chain) and conglomerate mergers (between parties active in closely related markets).
The Commission also combined four important pre-existing notices (relating to the calculation of turnover, as well as to the concepts of ‘concentration’, ‘full-function joint ventures’ and ‘undertaking concerned’) into a Consolidated Jurisdiction Notice.
The Office of Fair Trading (OFT) in the UK issued revised guidance in November 2007 regarding situations in which it will view the markets affected by a merger as not of ‘sufficient importance’ to justify a referral to the UK’s Competition Commission. The de minimis market size threshold was raised from £400,000 to £10m. The OFT has applied the revised thresholds in a number of cases since their introduction, but has also clarified that, as a matter of policy, it will not apply the de minimis thresholds in cases where any harm to competition could, in principle, clearly be remedied by clear-cut undertakings in lieu of a referral to the Competition Commission.
Yet other countries are in the process of reviewing and amending their merger rules. The Federal Supreme Court of Germany has confirmed the geographic extent of Germany’s de minimis provision, confirming that the relevant geographic market for this provision refers to the German market, and not to a wider geographic market. Clarification of the de minimis exception in both the UK and Germany should better enable companies operating within relatively small markets to avoid becoming subject to the merger control regimes of these countries.
Norway has made proposals aimed at improving the efficiency of its merger review system, and is considering prohibiting implementation before clearance of any transaction that has to be notified. Currently pre-clearance implementation is only prohibited when a complete notification has been requested by the Norwegian competition authority or made voluntarily.
The Czech competition authority is in the process of creating best practice guidelineson pre-notification contacts between merging parties and the competition authority, and Australia is, at the time of writing, consulting on draft revised merger guidelines. As merger notification is currently voluntary under the Australian system, such guidelines are of particular importance in enabling companies and their legal advisers to ascertain whether voluntary clearance should be requested.
Merger control activity by competition authorities
While competition authorities work to improve their merger control legislation, they continue to review notified mergers and sanction companies that do not adhere to the rules.
The European Commission received a record number of merger notifications in 2007, with the figure exceeding 400 for the first time. With over 60 notifications received in the first two months of 2008, the level of notifications appears to be remaining reasonably constant.
The Commission’s approach in relation to merger control continues to be relatively non-interventionist. Of some 3700 notifications received since 1990, the Commission has prohibited only 20 proposed mergers, and only two since 2002, although a significant number have been cleared conditionally, after a first phase or a second phase investigation, on the basis of commitments by the notifying parties.
However, 2007 saw the Commission’s first prohibition decision since 2004 and the first of Competition Commissioner Kroes’s tenure, in relation to the proposed Ryanair/Aer Lingus deal. The Commission concluded that the merger of the two leading airlines operating from Ireland would reduce choice for consumers and ‘most likely [lead] to higher prices for more than 14 million EU passengers’ using the 35 routes on which the merger would create a monopoly or dominant position. Ryanair, whose chief executive accused the Commission’s decision of being “bizarre, illogical, manifestly inaccurate and untenable”, has appealed the decision to the European Court of First Instance (CFI).

The level of caution with which the Commission approaches a decision to prohibit a merger will only have been increased by the decision of the CFI in July 2007 to award partial damages toSchneider Electric for loss stemming from the Commission’s 2001 prohibition of its merger with Legrand. The CFI annulled the Commission’s prohibition decision in 2002, considering that the Commission’s analysis was riddled with “errors and omissions”.
The Commission has appealed the CFI’s judgement awarding damages.The Commission has, however, made it clear that it expects its rules relating to merger control to be respected, and in particular those relating to pre-clearance implementation of a deal, or ‘gun-jumping’. In December 2007, the Commission conducted surprise inspections at the premises of merging parties, INEOS and Norsk Hydro, looking for evidence that the companies had exchanged commercially sensitive information to such an extent that they could be considered to have already implemented the deal. This is the first time that the Commission has conducted raids in response to concerns about gunjumping and, although it has now closed its investigation and approved the merger, the inspection serves as a reminder that the Commission has significant investigative powers in this area, as well as the ability to impose considerable financial penalties.
Failure to comply with an authorised Commission inspection in the context of a merger investigation could lead to fines of up to 1 percent of a company’s turnover, while fines of up to 10 percent of turnover could result from implementation of a merger before approval is granted by the Commission.
Nor can the presumption be made that the merger regimes of smaller countries will not raise concerns and can therefore be disregarded. Jersey’s Competition Regulatory Authority, for example, has imposed its first fine on a company for failure to notify a merger until after the acquisition had been completed. The fine of £10,000 was imposed on the Italian travel restaurant company Autogrill regarding its acquisition of Alpha Airport Groups, clearly demonstrating that some smaller competition authorities will not hesitate to apply their powers to large international companies operating within their jurisdiction.
The Commission has also shown its teeth in its response to displays of economic patriotism by countries such as Spain and Poland regarding mergers with a ‘Community dimension’ and falling within the Commission’s sole competency under the EC Merger Regulation. For example, further to the Commission’s approval of the acquisition of the Spanish energy company Endesa by German-based E.ON, the Spanish National Energy Commission imposed conditions on the acquisition. Further to a number of formal requests and decisions, the Commission referred Spain to the European Court of Justice, which ruled in March 2008 that Spain had failed to fulfil its obligations under the EC Treaty.
The cost of flouting merger control rules can be high, leading to significant fines or even a requirement to undo a completed transaction. With more countries developing sophisticated merger regimes, companies need to ensure that, when assessing the benefits of a potential transaction, they are aware of the merger control obligations and risks in the jurisdictions relevant to the deal.