Trade Conflicts, Brexit & Co: Outlook for the M&A Market 2020

Dark clouds on the horizon of the global economy . Nationalism and protectionism are one the rise. China and the USA are entangled in an open trade conflict with both parties more or less trying to prevent the grand escalation –the effects, however, are still palpable. Also with Brexit,  the big fallout has not materialized so far . However, with the UK's withdrawal from the EU at the end of January, the actual negotiations on future relations have only just begun. It is quite possible that London and Brussels cannot complete the monumental task ahead of them in the required record time and we still end up with a hard Brexit. Meanwhile, economic growth in China is noticeably declining. And climate change is not only forcing the automotive industry to rethink.

Such uncertainties often put a damper on the M&A industry: strategic investors try to avoid risks, and financial investors can speculate on falling prices of takeover targets. But there are also positive aspects.

• Donald Trump's "America First" policy complicates imports into the USA. A similar scenario is looming over a post-Brexit UK : duty-free deliveries from the EU may soon be a thing of the past. Companies will therefore examine whether they can strengthen their presence in the US or UK through shareholding or takeovers in order to become less dependent on imports.

•  The German automotive industry is facing structural change. In addition to the search for alternative engine systems, autonomous driving is a key stimulant of innovation. A few years ago, the German economy seemed left behind in both sectors. Now, Germany surprised with a number one ranking in Bloomberg's innovation index. This is in no small part due to the considerable investments made by the German automotive industry. However, the German car manufacturers and their major suppliers likely cannot make up for lost time through own research and development. As in other sectors, many companies will only be able to maintain their competitiveness through acquisitions in key technologies.

• In times of uncertainty, companies will concentrate on their core business and divest peripheral areas when the opportunity arises. Before such a carve-out, restructuring is usually necessary to assign brands, patents, know-how and employees to an independent part of the company or to a separate entity. Until complete integration, newly created parts of the company often require services from their old group; Transitional Services Agreements are becoming increasingly important and complex.

• Some companies will consider a strategic merger with a competitor to create synergy effects and battle uncertainty with consolidation. After such a merger of equals, antitrust law often dictates that individual parts of the merged entity have to be divested. This also stirs the market.

• Deliveries to China were the driver for the golden years in the German core sectors of mechanical engineering and the automotive industry. In view of the lower economic growth in China, these industries will struggle. Distressed M&A, i.e. the purchase of companies from crisis or insolvency, will gain in importance.

• In healthcare and IT, especially IT security, there is no indication of any crisis. As in the past, companies in this sector are actively looking for new targets to increase their competitiveness.

• The financial assets of companies and large investment corporations will remain a key driver for M&A activities in 2020. Even cautious estimates put the collected ”dry powder” of private equity funds alone at more than two trillion US dollars – more than the sum of the national budgets of the US, France and Germany for 2020. The return expectations of investors will likely force investment companies to load the guns with their powder and take actuals shots. And even if the purchase price has to be financed: The European Central Bank's low interest rate policy will be continued for the time being and will facilitate investments – also in M&A transaction.

• Finally, a growing factor in the M&A business is succession in owner-operated companies. Many entrepreneurs of the baby boom generation do not have a “natural” successor, so external takeovers and management buy-outs are on the rise.

All in all, one cannot expect a dramatic decline in M&A transactions for 2020. However, the uncertainties from trade conflicts, the economic slowdown in China, Brexit, the structural change in the automotive industry or the climate crisis require particular caution in due diligence and in the drafting of contracts. Regulations beyond typical MAC-clauses covering, for example, increases in customs duties, currency fluctuations or foreign investment controls, and providing for purchase price adjustments or rights of withdrawal, seem advisable. A final thought: those using crisis as an opportunity must be prepared to brave out a restructuring of the target – and would be well advised to plan for appropriate management capacities.