By Partner Andra Rubene
If the world is always evolving, and with it the M&A market, the past year brought major geopolitical and economic developments that companies need to keep in mind for any business combinations. TGS Baltic Partner Andra Rubene offers some tailored tips, tactics and opportunities for M&A deals in the Baltics in 2023. They run from structuring transactions to bridge price gaps, to preparing for deals with well-focused due diligence, strategic divestments and early anti-trust advice, and to taking good advantage when relevant companies face distress.
[image src=”/assets/chart_MA.jpg” id=”5988″ width=”2000″ height=”3000″ class=”leftAlone ss-htmleditorfield-file image” title=”chart MA”]
1/ STRUCTURE TRANSACTIONS TO BRIDGE THE GAP BETWEEN THE PRICE THE SELLER EXPECTS AND THE PRICE THE BUYER IS WILLING TO OFFER
One of the biggest challenges in Baltic M&A in 2023, so that sellers and buyers can agree and M&A deals can take place, will be to bridge the expectation gap between sellers’ and buyers’ views on the value of the target company and, accordingly, the price of its shares.
The issue that sellers often seek to obtain the price at which they could have sold a company before Russia invaded Ukraine, while buyers will only offer a price they deem reasonable at present, given current inflation, rising interest rates and other changes that have occurred.
For transactions to take place, the parties will need to adapt to changed circumstances and/or structure deals in a way that builds a bridge between the price expected by the seller and what the buyer is willing to offer. This could be achieved, for example, by anticipating deferred payments or making a part of payment conditional on achieving certain results (“earn-outs”).
2/ DIVEST NON-PERFORMING PARTS OF THE BUSINESS BEFORE THE TRANSACTION
When planning the sale of a company, the seller can divest and dispose of poorly performing parts of the business to improve the value of the target company. Such less successful parts of the business may be of interest for strategic growth to investors operating in the same market or one that is similar or vertically related. Thus, a profitable competitor may be interested in acquiring a less profitable rival, and a strong player may be interested in acquiring a wholesaler it buys from or a retailer it supplies, seeing synergies and cost savings in consolidating supply and distribution chains.
3/ CONDUCT EVEN MORE ACCURATE DUE DILIGENCE, FOCUSING ON DETERMINING WHAT CREATES VALUE IN A TARGET COMPANY AND WHAT THE INVESTOR WOULD PROFIT FROM AFTER A TRANSACTION
Given the volatile circumstances (rising interest rates, inflation, labour costs, etc.), doing even better and more accurate due diligence is critical. The focus should be on determining what creates value in the target company and how the investor could realise a return after the transaction.
Potential investors will strive to ensure the stability of supply and demand, the rationality of operations, costs, revenue flow and profitability, innovation, the right partners, and growth.
The most critical aspects of due diligence will be: sanction exposure, a continuous and diversified supply chain, energy pricing stability, efficiency, emissions, cost of financing (given increased interest rates), proportionate leverage (to avoid over-leverage), resilient financial performance, pricing power so that prices can be adjusted for cost purposes if necessary (given cost increases and inflation), IP (differentiated brands, IP rights), IT performance and security, and data processing.
4/ DISTRESSED M&A: SEIZE THE OPPORTUNITY TO BUY A TARGET COMPANY THAT WOULD NOT OTHERWISE BE FOR SALE OR TO BUY AT A CHEAPER PRICE, ASSUMING ADDITIONAL RISKS AND SOLVING COMPLEX ISSUES
Due to geopolitical and macroeconomic reasons, situations may arise when target companies or their owners may start facing financial distress.
Operations may have become unprofitable and/or there may be a default on debt, negative equity, or an immediate need for liquidity.
In distressed M&A transactions, rollovers, earn-outs, vendor loans, and negative prices may be used as price-bridging mechanisms.
In financial difficulties, if it is not possible to attract additional financing, including by offering equity, the target company’s owners will be interested in selling the company before creditors use their enforcement mechanisms or insolvency. However, unless the owners manage to sell the company promptly, it may become available to secured creditors through the sale of collateral or as part of legal protection or insolvency proceedings.
As the financial difficulties of a target company worsen, the risks increase while the purchase price decreases. The possibility of doing comprehensive due diligence decreases as there is no more time, means, or sense to do so. Similarly, chances of obtaining appropriate representations and warranties decreases since, given the problems, the risks are more significant, or there is no coverage since the target company’s shareholders no longer have a right to direct recovery.
Suppose a solvent seller promptly sells a target company that does not yet show any signs of distress, providing proper due diligence and appropriate representations and warranties. In this case, the seller can get a reasonable price. The price will be lower if the target company shows signs of distress, but a solvent seller will still be able and have time to ensure a proper M&A process. However, if the seller is distressed and does not have time, the price will be relatively very low. And the only outlook is for even lower prices and higher risks if the company is sold by secured creditors selling the collateral or if the company or if its parts are sold in the framework of legal protection or insolvency proceedings.
Despite the additional risks and complexity, strategic investors may be interested, at any of the above stages, in acquiring a competitor struggling to achieve further growth and consolidation or upstream (manufacturers, suppliers) or downstream (distributors, wholesalers, retailers) market players.
5/ USE THE SELLER’S WARRANTY AND INDEMNITY INSURANCE TO FACILITATE AND EXPEDITE NEGOTIATIONS ON A SHARE PURCHASE AGREEMENT
Use W&I insurance to facilitate and expedite efforts to negotiate a share purchase agreement if that is commercially feasible. The feasibility of W&I insurance depends on the value of the transaction, while prerequisites for insurance include due diligence and appropriate seller’s representations and warranties, and a commitment to indemnification (W&I) in the share purchase agreement.
6/ INVOLVE ANTITRUST EXPERTS AT AN EARLY STAGE OF AN M&A TRANSACTION TO PROVIDE FOR OBTAINING MERGER CLEARANCE AS A PRECONDITION FOR CLOSING THE TRANSACTION AND TO PROVIDE FOR A HELL OR HIGH-WATER CLAUSE OR AGREED REMEDIES AND REVERSE BREAK FEES IF MERGER CLEARANCE IS NOT OBTAINED, AS WELL AS TO FIND TIMELY SOLUTIONS FOR OBTAINING MERGER AUTHORIZATION
Strong strategic investors or investors with broad portfolios of similar companies who buy target companies with turnovers above notification thresholds should develop a plan to secure merger authorization from the beginning of the M&A transaction.
If the transaction results in a significant increase in market shares in overlapping markets and those markets cannot be redefined more narrowly or broadly, the buyer should in due time develop appropriate remedies (binding commitments) that it could undertake to mitigate or eliminate the adverse effects of the merger on competition in the relevant markets.
To facilitate obtaining merger clearance without remedies, the buyer can argue that it is acquiring a failing firm which in any case would exit the market if the buyer does not buy it; therefore the acquisition (rescue merger) is in the interests of consumers, provided that the target company meets the criteria of a failing firm (see: AS Dobeles dzirnavnieks acquires AB Baltic mill ).
It is also important to agree in the transaction documents (share purchase agreement, business purchase agreement, or other documents) on obtaining merger clearance as a prerequisite for closing the transaction, as well as on risk-sharing arrangements in the event that this prerequisite is not met, such as a hell or high-water clause, or agreed remedies and reverse break fees if merger clearance is not obtained.
7/ CHECK FOREIGN DIRECT INVESTMENT CLEARANCE REQUIREMENTS FOR ACQUIRING TARGET COMPANIES OF SIGNIFICANCE TO NATIONAL SECURITY
Acquisition requires government permission if a target is a company essential to national security.
The target company may be essential to national security if it operates in the electronic communications, media, or natural gas processing industries, if it is a liquefied natural gas facility or a producer of electricity or thermal energy, or if it ensures electricity transmission, owns forest or agricultural lands, trades goods of strategic importance or dual-use, is a military manufacturer, or processes data included in the country’s critical infrastructure systems.
8/ IMPLEMENT AND COMPLY WITH ENVIRONMENTAL, SOCIAL, AND GOVERNANCE REQUIREMENTS AND SUSTAINABILITY
Given that investors increasingly demand effective implementation of and compliance with environmental, social, and governance (ESG) requirements, and that additional funding is available for sustainable businesses, adopt and implement ESG policies to ensure ESG compliance and sustainable development.
