Diversification – The Buzzword of the 2022 M&A Market
2021 was a remarkable year for the M&A market. After a very volatile 2020, there was a significant bounce-back last year, following quick reactions from market stakeholders as they adapted to Covid-19 related disruptions. These profound changes have clearly reshaped the market - the M&A market has become increasingly defined by one common factor: Diversification.
Transaction Type Diversification: Outbound Dominated vs a Mix of Transaction Types
In past years, the M&A market in Asia Pacific was dominated by outbound transactions. Yet, driven by Chinese government policy, on dual circulation for example, as well as tightened FDI rules globally, since the second half of 2020, APAC has become a net inbound market.
Inbound deal flows into China are growing significantly, and more and more multinationals are investing into China, thanks to the country’s new opening up policy and attractive return potential. Activities are increasing around non-typical M&A transactions, such as restructurings. The divestment of non-core overseas assets by Chinese State-Owned Enterprises and carve outs / spin off activities by corporates in the region are also rising significantly.
A region previously dominated by outbound transactions has transitioned to a mix of more diversified deal types, including inbound, outbound, restructuring and the divestment of non-core overseas assets, either controlling or minority stakes, particularly in the regions with increasing geopolitical tensions.
Target Location Diversification: Shifting Geographies
As a result of the new FDI regulations in the EU which became effective in October 2020, the United Kingdom’s new FDI screening and regulation regime, and the CFIUS jurisdiction expansion and tightening in the US, Europe and the United States are no longer the only key acquisition destinations.
China, the biggest market in APAC, has increasingly focused on regions not impacted by FDI rules – particularly those in Belt and Road regions, such as the Middle East, Latin America and Southeast Asian countries.
In August 2021, Natixis, together with our affiliates Vermilion Partners and EFG Hermes in Middle East, advised a consortium led by China Three Gorges South Asia Investment Limited (“CSAIL”) to acquire 100% of Alcazar Energy Partners (“AEP”). This transaction is China Three Gorges Corporation’s (“CTG”) first investment in the Middle East and North Africa region and effectively establishes a key foundation on which to further expand their renewables footprint across the MENA region where the renewable energy sector is exposed to strong structural growth trends. Natixis also provided a sole financing commitment on a certain fund basis during the bidding process, and an acquisition bridge loan facility to support the transaction.
Transaction Structure Diversification: Tradition vs Innovation
Through the Covid-19 pandemic, more and more innovative transaction structures came to fore, in order to revive the market. Transactions moved from typical equity investment structures to either minority investments with a path to control, or creative earn-out structures given uncertainties around future financial performance. We also saw ESG linked KPI earn out structures and tailor-made bespoke transactions in order to meet the strategic needs of various stakeholders involved.
Sector Diversification: Favouring the New Economy & ESG
Thanks to the pandemic, and in a bid to remain competitive and stay differentiated in a competitive market, tech and healthcare have risen to be the hottest sectors for M&A.
With the broad spectrum of tech-related industries – infra-tech (including datacenters and sectors relevant to digitalization and energy efficiency), industrial tech (including EV, semiconductor and materials space), fintech (including blockchain and crypto), e-commerce, biotech, software – to name just a few, and high levels of venture capital and private equity cash on the table, investments and acquisitions are on the rise.
The pandemic also served as a wake-up call to society on the importance of ESG and a green and sustainable economic recovery, and so ESG factors are becoming more and more integrated into the M&A deal making and transaction execution process, as well as the post transaction management.
From a deal sourcing perspective, industries and corporates with more “ESG positive” features will continue to attract more attention in the M&A market, as the market in general, and its investors, are embracing and prioritizing ESG investments. Looking forward, ESG factors will increasingly play a critical role, with M&A itself is serving as an essential tool to create value in a sustainable way for corporates and overall economy recovery though a green path.
Investment Exit Route Diversification: Dual-track vs Triple-track
Previously, the focus was on dual track exits (M&A trade sale and IPO), but with the addition of SPAC, which is a hybrid between the traditional trade sale and the ECM solution, there is now a ‘triple-track’ of potential exit options.
Currently, there are more than 500 SPACs in the market looking for targets to combine with in next 24 months or less, representing an excess of US$100bn in capital to be deployed. The fundamental conditions underpinning the heightened SPAC activity are still present – liquidity, higher market volatility, institutional investors with dry powder, rapid innovation in technology and the evermore important ESG context.
However, suitable targets in the US are becoming more and more difficult to find, and the SEC has also taken regulatory actions to cool down and rationalize the SPAC activities in the US. SPACs will either have to settle for lower-quality targets, or pay a higher premium for better quality assets, at which point, returns will no longer make sense for shareholders.
Asia Pacific is still in the growth stage when compared to more mature markets, and SPAC mergers are a viable (and attractive) exit option. The recently introduced SPAC regimes in Singapore and Hong Kong were implemented with a significant degree of caution, following in-depth consultation periods and careful monitoring of other regimes. We expect this will lead to more global assets potentially merging with Asian SPACs, especially high growth assets in TMT, Healthcare, Green / ESG positive sectors.
SPAC activities, especially in Asia, remain viable exit options – but in a more rational manner, paving the way for SPACs to be used as a resilient tool for the M&A market. And we hope to see more market stakeholders coming up with innovative structures in response to market needs in future.
Current Robust Activities
There are a number of factors sustaining the current level of robust activities in the M&A markets. The environment is cash rich and debt financing at affordable rate remains readily available. Significant dry power and record level fund raisings by Private Equities – we have seen high levels of deployed capital accumulate at a faster pace and strong growth in leveraged buyouts and trade sales. Tech and healthcare sectors with long term growth potential and profitability will also remain active. The global themes of energy transition and overall industry digitalization will also continue to drive M&A transactions.
But that’s not to say that there won’t be challenges.
Uncertainties remain over the economy and markets – the slowdown in China, concerns that central banks will raise interest rates to keep rising inflation in check. Regulatory scrutiny and tightened FDI rules are also likely to remain for some time.
Looking to private equity, the biggest challenge is likely to be how to complete effectively when putting dry powder to work – GPs needs to bid high and early (though pre-empt) to win. Overall deal multiples are rising rapidly which may give some investors pause for thoughts – and come up with innovative transaction structures.
Covid-19 may present more disruptions too, should more outbreaks/variants emerge. Covid-19 induced global supply chain disruption and emergent inflationary trends will also need to be considered.
That said, we are optimistic on the overall outlook. Just as we are celebrating diversity for International Women’s Day (March 8), diversification too will be key to success for M&A.