Under the microscope: M&A faces new post-Covid world

As most European countries appear to have passed through the peak of the coronavirus pandemic, governments have turned their attention to how to bring the economy back to life. It is becoming clear across all countries affected by the virus that one of the consequences of lockdown will be a wave of businesses entering administration or facing a fundamental restructuring of their operations.

Governments, ranging from populists in Poland and India to fiscal conservatives in Germany, are concerned that the number of businesses looking for new ownership will lead to foreign buyers acquiring assets in bulk. To tackle this, they have turned to protectionist policies to keep prospective buyers out.

Protectionist tendencies were becoming more common before the coronavirus pandemic

The economic policy response to coronavirus is likely to continue to vary significantly across the Eurozone and beyond. However, one emerging trend is the number of countries, including the UK, that are introducing legislation designed to increase scrutiny of M&A transactions on national security grounds. Primarily designed to exclude foreign buyers from purchasing assets of national importance while prices are lowered by the coronavirus pandemic, the wider effects of these laws may make cross border M&A a more complex task for all investors in the future.

The willingness of governments to intervene in M&A has been increasing in recent years. Australia and the United States have been particularly interventionist and have been hawkish on the issue of Chinese investment, both banning Huawei from helping build 5G networks. Although the UK to date has not blocked an M&A transaction on national security grounds, in recent years the Competition and Markets Authority (CMA) and UK government has scrutinised an increasing number of transactions on national security grounds involving various kinds of acquirer, including financial investors. Acquisitions of Cobham, Northern Aerospace and satellite operator Inmarsat have all been investigated by the CMA and the transactions approved. In all instances, the acquirer offered several legally binding assurances to the government before the deal was approved.

The government is taking rapid action to protect strategic industries

Here in the UK, Boris Johnson, Rishi Sunak, Alok Sharma and Dominic Raab are currently developing new legislation that would make it easier for the government to intervene in M&A transactions on national security grounds. In the short term, amendments will be put forward to protect UK assets during the coronavirus pandemic, however, a more detailed plan for a new, more interventionist takeover system is being drawn up and will be presented to Parliament before Summer recess.

Two new proposals already tabled in Parliament will make it tougher for foreign buyers to acquire any assets related to the nation’s healthcare self-sufficiency and, separately, artificial intelligence and other tech. One amendment would drop the £1 million revenue threshold currently in place for screening takeover targets in AI and other areas that pertain to national security. This would allow the government to intervene in the takeover of loss-making start-ups developing medicines or technology of national interest. The other amendment will widen the government definition of sectors critical to national security to include the food and drink sector for the first time.

Crucially, neither of these amendments specify what kinds of investors will be targeted under the new legislation. While concern may rest primarily with state-owned buyers, investors should be mindful that the CMA has instigated action against several US funds in recent years, including in the sale of Cobham and Inmarsat indicating the importance of the asset will take precedence over the nationality of the buyers.

A new long term takeover regime will change how investors should approach UK assets

The new takeover regime being devised would require UK businesses to declare when a foreign company tries to buy more than 25% of its shares, assets or intellectual property. The plans are significantly more stringent than those drawn up under a similar scheme considered by Theresa May’s government, under which companies would have been expected to notify the government of takeovers voluntarily.

Reporting will only be required for businesses where a takeover would pose a risk that it could give a foreign company or hostile state the power to undermine Britain’s national security through disruption, espionage, or by using “inappropriate leverage.” The significance of this legislation will be determined by how this risk is defined. Legislation planned under Theresa May used an incredibly broad definition, which, if replicated, would allow any secretary of state to intervene in any M&A transaction if they were concerned about the security implication.

The sectors most likely to be affected are civil nuclear, communications, defence, energy and transport, however compulsory reporting of transactions would likely have the effect of slowing the pace of deals across all sectors. Investors, whether they deal with sensitive assets or not, are likely to have to get used to greater government interest in their activities, an increased reporting burden, and potentially greater media scrutiny of their activities as the government makes its investigations public.

Change in the EU brings challenges and renewed opportunity

Countries across Europe are also acting. Margrethe Vestager, EU Competition Commissioner and Executive Vice-President of the European Commission, has encouraged EU states to take action to prevent foreign takeovers. Describing the protection of EU businesses from takeovers as a “top priority,” Vestager has effectively encouraged states to act against any takeovers deemed to be a cause for concern.  While this fear relates primarily to Chinese investors amid concerns about intellectual property and national security, the political unwillingness to single out the Chinese for special restrictions could risk creating significant collateral damage. Plans put forward by the Commission would exclude all state owned buyers, potentially eliminating some of the competition for assets created by the increasing activity of Middle Eastern and Asian funds in Europe.

Poland’s populist government is among those planning changes. Legislation is currently being drawn up to allow regulators to block non-EU companies from taking stakes of more than 10% in businesses deemed to be providing critical infrastructure, goods or services for two years. This more stringent block on foreign investment is in part due to the comparative affordability and availability of Polish businesses. 30 years on from the end of communism in Poland, those who have built successful businesses are beginning to reach retirement age, while a drop in the value of the zloty has also pushed prices lower for foreign buyers.

The issue for investors comes back to Brexit. Much of the proposed legislation would impose additional restrictions on all non-EU countries. Proposals, such as those put forward by the Dutch government, would ensure governments could halt companies from buying EU competitors at inflated prices or undercutting them with artificially low selling prices. The Spanish government, meanwhile, is proposing that non-EEA investments larger than 10% in key domestic assets in the “strategic industries” such as infrastructure, technology and media be authorised by the Spanish government. The European Commission would also have the authority to demand greater transparency in foreign companies’ accounts.

These restrictions will soon apply to the UK, with the true impact likely to be determined by the extent to which the UK chooses to diverge from EU law relating to financial services. It may be possible to negotiate the UK’s exclusion from these additional barriers to investment if the UK and EU agree to a close trading relationship for the financial services sector. This would be unlikely to be completed by the time the UK leaves the transition period on 31 December and negotiations around the full financial services future relationship are likely to take years to complete due to their complexity.

Much of the legislation remains in draft phase across the EU and the UK as politicians continue to prioritise the immediate economic and health challenges and much will depend on whether governments can pursue such ambitious regulatory change in the coming months. If these laws do make it onto statute books, investors willing to deal with the additional bureaucratic burden may find greater choice and potentially lower competition for assets in areas of “national interest.” Regardless of sector, as the size of government increases and its post-Covid appetite for intervention grows, investors will need to adapt to greater government engagement in the future.