Crossborder M&A gets bigger – and riskier

In August 2017, McCormick, a US-based conglomerate that makes spices and food seasonings, closed a $4.2bn acquisition of UK company Reckitt Benckiser Group’s food business. One of the driving factors behind the deal was to add two of Reckitt Benckiser’s brands, French’s mustard and Frank’s RedHot sauce, to McCormick’s own array of products. 

It was a controversial bid, however, because the price was deemed to be very high, says Alex Miller, national certifying leader for KPMG’s strategy business. “McCormick definitely paid a premium for these brands and it took some criticism for it,” he says.

As it transpired, McCormick's decision would pay off. In its second quarterly earnings for 2018, it reported that the two brands added 13% to its overall increase in net sales.

Taking a chance

Even though results so far have been positive, McCormick took a risk by paying top price for the brands because it might have overpaid for them or underestimated their true valuations. Paying a premium increases the riskiness of a deal, says Jason Zeman, director of valuation and business analytics at BDO Consulting, because there is far less room for mistakes in execution and integration.

“Those two factors will need to be almost flawless. The more you pay, the more you need to recognise synergies from the transaction,” he says, adding that higher prices also usually mean riskier or more aggressive financing for the transactions.

McCormick is not alone in taking such a gamble, however, Paying top dollar is a risk that many companies are increasingly taking in a period of global M&A hypergrowth. In the current environment, according to Mr Miller, if a buyer wants to buy “the perfect business” it will have to pay an extraordinarily high price because there is so much competition.

For the first half of 2018, global deal-making reached $2500bn, according to Thomson Reuters data, a 65% increase on the same period in 2017 and an all-time high for the first six months of the year. There were 79 deals of more than $5bn signed during the period, and a record 35 deals worth more than $10bn.

There are several reasons for the frenzy of transactions, says Mr Miller. First, there is a considerable amount of dry powder waiting to be invested around the world by private equity in search of yield. Another reason is the constant drive to get faster and faster access to new markets or new pockets of customers. Yet another is the generally favorable macroeconomic conditions around the world, particularly in the US.

Heightened risk

However, as the pace of crossborder deals accelerates, these transactions are also becoming riskier. After two decades of corporate consolidation in mature markets, there are fewer viable targets – fewer “perfect businesses” as Mr Miller puts it – that are still attractive. Instead, companies are finding acquisition candidates that are more organisationally complex or possibly financially troubled. In other words, in some way the acquisition target does not check all the boxes. Such companies can be acquired at a lower price, Mr Miller says, but they will require far more active management and will likely bring in a smaller internal rate of return.

At the same time, the higher price that companies a paying for acquisitions comes with heightened risks that have always existed when it comes to global M&A, such as geopolitical and domestic political risk, according to Ingmar Empson, founder of market research firm Strange Markets.

Most Western democracies remain secure locations for investment, and while emerging markets can be a hotbed of risk, this has been the case for some time, says Mr Empson. “Where investors should really be concerned is in the select number of markets within countries continuing their slide away from democracy,” he adds. “Many Eastern European countries, including Poland, continue to show signs of political instability, an important indicator that business environments may soon reach similar levels of uncertainty.” 

For example, says Mr Empson, the Italian political scene continues to flirt with populism based in authoritarian dogma, and Turkey – once considered a rapidly expanding economy with unlimited potential – is now facing a beating from investors who are concerned about the independence of the central bank.

He adds that the best approach for a company is to take an active role in understanding the political trends within any potential market. “Lay out the process by which any decision will be made in writing and note any red flags that would kill an investment before engaging in market research,” he says. “No matter the general executive sentiment, stick by the decision-making process already outlined,” says Mr Empson, adding that political risk is a real force that can quickly stifle any business growth.

People power

Another heightened risk is the talent that a company acquires (or hopes to acquire) in crossborder M&A. 

As always, a successful acquisition is dependent on having the right management team in place, and the local leadership must fit with the company culture, according to Phil Friedman, CEO and founder of CGS, a global provider of business applications, enterprise learning and outsourcing services.

The rub, of course, is that when going into a new market, a company should rely on existing – that is, local – management. “Don’t bring, for example, US executives to run the newly acquired company in Asia,” says Mr Friedman. “The local team will better understand the business, employees, local market, politics and regulations.”

However, an acquisition that includes a local team without the requisite skills and corporate culture for global growth – or worse, one with a propensity to corruption or ineptitude – can easily go wrong. This has always been true, but now many crossborder M&A deals are being carried out precisely because a company wants to acquire talent in a new market. People have become a relatively new and important driver. As Mr Friedman says: “M&A has become necessary for acquiring large numbers of skilled employees.”