The Great Rethink: M&A in a VUCA World

In the previous issue of M&A Pulse in APAC I looked at how the M&A landscape has been changing in Asia Pacific – or facing the “great reset”, due to VUCA – volatile, uncertain, complex, ambiguous – environment. Three months into 2023, and it’s clear the VUCA dynamic is here to stay.

Three major themes continue to dominate: China, India, and companies rethinking their Modus Operandi (MO), driving M&A dealmakers to pursue new strategies.

China is Back – With a New Playbook

The China playbook fundamentally changed during Covid – due to lockdowns – and it continues as a result of ongoing geopolitics. But make no mistake, China is opening up, as we predicted in various forums over the past year (read: here) or so, and there is a great deal of pent-up demand, which is now manifesting in the form of both in and outbound transactions. That said, outbound demand is unlikely to return to 2015 levels, at least not in the near-term.

From a macro perspective, at present, China (and Japan) is one of the only large economies in the world that is not tightening monetary policy, providing stimulus to consumers. China also has low to modest inflation while the rest of the world is experiencing higher inflationary pressure. Natixis economists estimate that three fifths of global growth will come from China/Asia in 2023.

With the reopening of China, there will undoubtedly be an impact on tourism and consumer spending. According to a recent research report by our Asia Pacific Chief Economist, Alicia Garcia Herrero, and Senior Economist Gary Ng, prior to the Covid 19 pandemic, Chinese tourists accounted for 16% of global tourism sector spending in 2019. With the reopening of borders, they estimate some additional $160bn in tourism spending to flow from China per year.

The reopening also implies a different playbook from a geopolitical perspective, which necessitates that China will develop its own domestic healthcare business, its own technology – and as such, there will be buying and selling of assets, and investment focused on domestic China.

Clients are beginning to resume, or are at least preparing to resume, outbound activity. But in a different way, targeting the more ‘friendly’ zones, Latin America, Middle East, Southeast Asia.

Yet the game is still unpredictable because the ‘rules’ of reopening can still be challenged by investors who, for example, may be concerned about a potential reversal. Likewise, some permanent behavior has already happened. MNCs have already divested assets and shifted supply chain reliance on China.

But what is important to remember, is that China is a long-term play. You cannot focus on the quarterly or even yearly play, as the Chinese government itself has a very long-term view.  Companies investing in China still have appetite to invest in China, that hasn’t changed – what has changed is the ability to get deals done with the lifting of Covid restrictions.

For certain sectors, China also offers a compelling opportunity given the immense drop in valuations. Companies that successfully use Technology to enhance competitive advantage while operating in classic sectors like Healthcare will be highly desired by investors too.

India is Taking a More important Seat at the Table

2023 and beyond will see increased activity in India. The demography in India – a younger and rapidly growing population that is accumulating higher GDP – mean that India is not only overtaking China in population dynamics, but also has a very vibrant economy.  Psychologically, Indians are looking for a better future, which is manifesting itself in many facets of life in India – infrastructure is improving, technology activity is increasing – and this is attracting foreign capital to India.

India is already a world leader in the renewable sector, with scale and leadership that are important to the world in certain sectors, such as energy transition. Same is true for Business Services sector which is the darling of private equity sponsors.

In the context of China reopening, India may be in fact a ‘loser’. But India in itself, if it continues to develop, will continue to attract capital on its own merits, rather than as a function of being an alternative to China.

That said, as an emerging economy, India is prone to ‘accidents’ that can impact investor confidence.

Market Players are Rethinking their MO in a VUCA World

M&A is inherently a confidence game, and right now, we are living in an unprecedented macro environment. Everything that we’ve known for the past 20 years has changed. Rising rates and volatility, the removal of Central bank liquidity, inflation simultaneously impacting earnings and cost of funds, and dollar strength. The Ukraine war. Further deteriorating China-US relations.

At the time of writing, Fed chair Jerome Powell had said that inflation was starting to ease but interest rates are still likely to rise through 2023, while the ECB had just raised the three key interest rates by 50 bps and stated its intensions for another such raise in March.

With all of these macro factors still going through earnings, investors will need to “rethink” their modus operandi. Capital markets will continue to experience volatility and so assessing the fair value of assets will require more robust preparation and analysis, especially on the downside simulations.

The locus of growth projections has a wide range of outcomes. For example private equity players, are less focused on growth, more on the protection of their portfolio.

The liquidity based financial engineering ‘game’ is dissipating and focus on operational enhancement is reappearing from the sidelines. Likewise from a sector perspective, defensive sectors like Healthcare or Food and other consumer staples will also offer opportunity for Asian investors as these sectors will perform better during a contracting economic environment.

Companies that are able to adapt to this new environment will have the opportunities. Resilient business models will be rewarded. Companies that have built their business on talent and have maintained that talent – particularly after the great resignation – will be rewarded.