This report explores how CFOs can drive well-structured, planned and executed cross-border mergers and acquisitions to create value and make a major contribution to their organization’s long-term growth.
Mergers and acquisitions (M&A) add value. While coverage in the mainstream press over recent years has featured commentary on value erosion as the result of poorly planned and executed transactions, this is not the full story. Recent research from Ernst & Young shows that, far from destroying value, companies that have completed three or more transactions over the past five years, beat average market return convincingly1. Where those deals were primarily domestic transactions, the average outperformance was 24% over five years.
Where the transactions were largely cross-border, that figure rose to 67%. This serial transactor advantage has profound consequences for the CFO and their contribution to their organization’s long-term growth. It also raises questions about the best approach in the current environment to maximize growth and minimize risk. Should CFOs continue to stockpile cash and take a cautious approach to major strategic choices, or should they loosen the reins and seek out opportunities that could enable their company to outperform its competitors?
Implications for CFOs
Identify potential wherever it lies in the world
The potential to create value through cross-border transactions is greater than ever. Having peaked at 27% and 26% of total global M&A activity in 2000 and 2007 respectively, cross-border deals are rising in prevalence again. In 2010, they accounted for 25% of all transactions. Acquisitions in rapid-growth markets are increasingly significant. Such deals accounted for 40% of global deal volumes in 2010, more than double the levels seen only a decade ago. Rapid-growth market companies are also increasingly likely to be acquirers themselves — accounting for 21% of deals in 2010.
Pay attention to valuation
The rising popularity of cross-border transactions is having a material impact on valuations and, in turn, the potential returns on investment that are required for transactions. As more and more companies seek growth opportunities in overseas markets, competition for assets is on the rise. Ernst & Young’s research suggests that prices begin to spike upward three to five years after M&A activity first emerges in a developing market. And in developed markets, the competition for good assets is also increasing, with acquirers from rapid-growth markets entering the fray. CFOs know that they need to pay for good assets, but they are also aware of the risk of overpaying, particularly at a time when financial markets and the global economy remain volatile.
Understand the risks
In a cross-border context, finance leaders need to be confident that they can access the right local knowledge, and gain insight into the regulatory, tax, treasury and talent environments. They need to understand the financial prospects of the target, and arrive at an appropriate valuation, but they also need to reassure themselves that there is a good cultural fit. Financial due diligence is important, but so too is integrity due diligence, particularly in the context of the Foreign Corrupt Practices Act and the Bribery Act.
Manage risks appropriately
Understanding the risks is just the first step in the process. CFOs at successful serial transactor companies also put in place processes and structures that enable those risks to be managed appropriately. A robust due diligence process is crucial, but risk management should not tail off once a deal has been completed. The business environment in many markets can change quickly and suddenly. Successful transactors manage risks throughout the entire business cycle and take steps to mitigate serious risks as they emerge.
Build the right team
CFOs planning cross-border transactions understand that they need a team with the right knowledge, experience and skills to make deals successful. This should encompass every stage of the transaction process. A good deal team is not enough. Finance leaders and other members of the management team also need to be confident that the integration process can run smoothly and that the company has the right mix of global and local talent to derive the maximum possible value from the deal.
Choose the right targets
For any CFO, the potential risk versus return on capital invested is a crucial calculation. Identifying which geographies represent the best opportunity for M&A is therefore an important challenge. Markets in which M&A transactions are relatively straightforward tend to offer less-attractive growth prospects. Rapid-growth markets are tougher to access but offer greater opportunities. Africa is currently the most extreme example of this, while Asia potentially offers more of a balance between ease of access and growth prospects — but prices are higher. The key for CFOs, especially where M&A ambitions are strategic rather than focused on a particular target, is to try to quantify these trade-offs. The maturity of a market is one way to address some of these issues — the greater the maturity, the fewer the risks. Conversely, less-mature markets may offer more generous rewards.
Analysis from Ernst & Young2, produced in conjunction with Cass Business School, ranked the maturity of markets for M&A based on the following characteristics: regulator and political; economic and financial; technological; socio-economic; and infrastructure and assets. The research suggests that the most mature markets for M&A are the most active; the US ranked first and the UK third, and Germany, Canada and France also appear in the top 10. Yet, while Asian countries have seen their economies slow marginally in recent months, five of the region’s most powerful economies have ended up in the top 10 of the M&A Maturity Index, led by Singapore in second and Hong Kong in fourth place.
Maturity average score by region
The rankings demonstrate the emergence of Asia as a leading hub for corporate finance activity, with South Korea also taking fifth place, and China ninth.
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Cost is crucial
One common mistake made by investors in rapid-growth markets is to assume that costs will be lower than in developed economies. That assumption may prove misguided — both when it comes to completing the transaction and on an ongoing basis. Moreover, for CFOs attempting to assess profitability, unexpected costs can prove particularly challenging in rapid-growth markets, where the business model is often based on high volumes but low margins. It is therefore crucial for the CFO to identify and understand potential costs very early on in the transaction.
Based on an Ernst & Young survey of 1,000 CFOs around the world,3 the six market-entry costs where there is greatest potential for overspend are:
- Financing costs: including rising inflation and currency fluctuations
- Mode of entry costs: the choice of business partner and the accuracy of valuations of targets
- Operational costs: R&D investment and finance function integration are common causes of difficulty
- Regulatory costs: licenses often cause problems and CFOs should seek to anticipate regulatory changes by assessing the costs involved
- Human capital costs: the pool of skilled workers may be small, pushing up wages and increasing staff turnover
- Political costs: there may be less political stability and bribery could be an issue
The CFO’s opportunity
One way to look at making the deal cycle work is to divide the disciplines that are necessary for CFOs to really drive shareholder value into the four components of the Capital Agenda:
- Preservation: the challenges involved in reshaping the operational and capital base. These might include implementing turnaround plans, restructuring debt or equity and resolving disputes, as well as basic tasks such as customer and supplier analysis.
- Optimization: the management of cash and working capital. This means, for example, delivering synergies as businesses are integrated, improving working capital to release cash and identifying the optimal tax, corporate and capital structures.
- Fund-raising: the assessment of future funding needs. The key is to identify what requirements the business is likely to have and how best to meet those needs. Part of the process may be the sale of non-core assets.
- Investment: evaluating future investments. These may include further acquisitions, as well as capital spending programs. Due diligence is key.
For a copy of the full report, please visit http://www.ey.com/GL/en/Services/Transactions/The-rise-of-the-cross-border-transaction-Cross-border-transactions-on-the-rise
1 - Market average defined as the MSCI World index of 1,600 stocks, total return
2 - M&A in a two-speed world: assessing risks and opportunities in rapid-growth markets, Ernst & Young, 2012
3 - What lies beneath? The hidden costs of entering rapid-growth markets, Ernst & Young, 2011