Are sellers beginning to lose the upper hand on the M&A market? Results of the CMS European M&A Study 2014
By Dr. Thomas Meyding, Dr. Maximilian Grub
CMS Hasche Sigle
Corporate decision-makers must know whether their own expectations of price and risk allocation of an M&A transaction are consistent with market conditions. Buyers and sellers quite often justify their request by referencing a “market standard.” The CMS European M&A Study 2014 takes an in-depth look at the issue.
In 2011 and 2012, the M&A market was a seller’s market. The seller had the upper hand in negotiations on a number of issues such as fixed versus variable purchase price or liability caps for warranty claims. One reason for this was the sluggish recovery of the M&A market in the wake of the Lehman crisis when deals were scarce, making robustly performing targets all the more attractive. However, the tide appears to have turned in 2013 and 2014. Continuing low interest rates make it easier and cheaper for buyers to borrow capital. Private equity companies are coming under increasing pressure to invest their available liquidity. On the other hand, low interest rates mean that the potential yield to sellers from reinvesting the proceeds of corporate sales is limited. Hence, the number of deals in 2013 dropped slightly by comparison with the previous year. Shareholders (still) apparently anticipated good returns from dividends on equity investments. However, some sectors saw a comparatively high number of deals with remarkable values, even in Europe. One recent example is the purchase of EPlus parent KPN by América Móvil ($22 billion) or Liberty Global’s takeover of Virgin Media ($18.9 billion). This M&A boom in technology, media and telecommunications (TMT) has persisted into the first quarter of 2014, as can be seen by Facebook’s takeover of WhatsApp
Implications for M&A deal negotiations
The development of the M&A market in 2013 has left its mark on many deal points. Despite signs that – buyers can afford to be more assertive in negotiations than in previous years, 2013 was nonetheless primarily a seller’s year. This is consistent with the findings of the CMS European M&A Study 2014 that analyzed 344 M&A contracts where CMS advised either the seller or the buyer. The previous year’s deals were then compared with deals going back to 2007. For the sixth edition of its M&A study, CMS was able to draw on extensive data from more than 2,000 transactions from all sectors and regions of Europe.
Purchase price mechanisms
The study shows that in 2013 sellers were able to obtain a fixed purchase price more frequently than in previous years (57 percent). In other words, buyers and sellers agreed to skip a mechanism to adjust the purchase price up or down to take account of cash, liabilities or working capital on the date of transfer. This reflects the reluctance of European sellers to take risks, with a preference to know when they sign the contract what final purchase price they will ultimately receive.
They also do not have to wait for the completion accounts, and they avoid any potential dispute that this involves. In the United States, by contrast, 85 percent of all deals contained purchaseprice adjustment mechanisms. The average level of earn-out clauses in Europe was comparatively low (14 percent). An earn-out is a mechanism in which the purchase price may continue to rise after transfer depending on the target’s post-acquisition performance. It is frequently adopted when the buyer and the seller differ substantially in their view of what a company is worth. German-speaking countries are now regarded as a European earn-out stronghold—one in four M&A transactions included an earn-out clause in 2013. And in sectors such as life sciences (28 percent) and real estate and construction (29 percent), they were distinctly more popular during the same period. In almost half of transactions with an earn-out mechanism, the criteria for a possible increase in the purchase price was post-acquisition EBIT/EBITDA (43 percent in 2013 compared with 36 percent in 2007-2012). Earn-out periods of more than 36 months (2013: 30 percent, 2012: 19 percent) were more popular than in recent years.
The negotiation of liability caps is a matter of great importance to sellers. It determines what proportion of the purchase price is shielded from warranty claims and hence how much the seller can be certain of receiving. In 2012, sellers were still able to obtain a liability cap of less than 50 percent in 54 percent of all transactions. But, in 2013, this was possible in only 47 percent of transactions. Buyers of southern Europe targets did better, where the liability cap was over 50 percent of the purchase price in 68 percent of transactions. However, not all sectors favor buyers to the same extent, and sellers’ liability caps of less than 25 percent of the purchase price were particularly common in the real estate/construction and the industrial sectors. U.S. M&A agreements were even more seller-friendly in this respect with 87 percent of deals providing for liability caps of less than 50 percent of the purchase price.
Security for warranty claims
There has been a seller-friendly decrease in the need to provide security for warranty claims. In M&A transactions, it is not unusual for buyers to initially retain part of the purchase price as security for warranty claims. In 2013, buyers used this type of security mechanism in only 35 percent of deals, a 7 percentage-point drop by comparison with 2007-2012. Where the parties broadly agree that security must be provided for warranty claims, they will generally have to negotiate the form of such security. The most common forms of security are retention of part of the purchase price or use of an escrow account, each accounting for 42 percent of deals in 2013 (2007-2012: 27 percent). The growth in the popularity of purchase-price retention is attributable to the lower costs involved. By contrast, bank guarantees were only used in 16 percent of deals in 2013 (2007-2012: 27 percent).
Prospective buyers have good reason for optimism as 2014 progresses. Research conducted by CMS indicates that private equity experts, investment bankers and CFOs anticipate a distinct upturn in the European economy until the end of 2015 at least. Private equity investors say the financing environment is buoyant with sufficient quantities of capital available for borrowing at continuing favorable conditions. Most bankers and financial experts therefore expect a marked increase in activity among private equity investors. CFOs point out that sellers and buyers often have widely diverging views on what a company is worth and the price at which it should change hands. However, as in previous years, genuine bargains are still likely to be in short supply in 2014. In the current favorable financing climate, investors are most likely to obtain a good purchase price by studying the structure of the target and feasible takeover scenarios before they sit down at the negotiating table.