Corporate trends were the talk of the hour at the third annual LB round table discussion in conjunction with McCann FitzGerald. But what does 2012 have in store for the corporate lawyer?
Creativity levels among global corporate lawyers appear to be at an all time high. With the eurozone crisis looming over the global M&A market, the new Takeover Code and the huge swathes of restructuring and refinancing work still to come through to the marketplace, never before have corporate lawyers had to think so differently.
With M&A deal levels continuing to struggle in the final months of 2011 after experiencing a superficial uptick during the third quarter of the calendar year, the mood among corporate partners at the third annual LB round table, in conjunction with leading Irish firm McCann FitzGerald, was solemn. We invited top corporate partners from Allen & Overy (A&O), Freshfields Bruckhaus Deringer, Ashurst, Cleary Gottlieb Steen & Hamilton, Herbert Smith, Slaughter and May, and Weil, Gotshal & Manges to share their views on the current state of the market and what the future holds in store for M&A in 2012.
McCanns corporate finance chief Barry Devereux kicked off the discussion, alongside fellow corporate partner Valerie Lawlor, with an outline of the current position in the Irish market.
‘In 2008 some of us thought that we had avoided the US credit crunch in Ireland. But then our government introduced the blanket guarantee of the debts of al Irish banks.’ – Barry Devereux, McCann Fitzgerald
‘In early 2008 some of us thought that we had avoided the US credit crunch in Ireland. But then in September 2008 our government, without warning, introduced the blanket guarantee of the debts of all Irish banks. What we had thought was a liquidity issue turned out to be an insolvency issue for some banks,’ he says.
The Dublin-based firm has one of the leading M&A practices in the region, notably advising BAE Systems on its E217m acquisition of Norkom Group in January 2011.
Discussion quickly turned to the dire situation engulfing the eurozone, but also touched on the development of the African market and the importance of Asia; the global success of UK law; the challenges facing private equity houses; how the changed UK Takeover Code will affect deals; and what the future looks like for M&A in 2012.
Eurozone woes
The debt problems facing eurozone countries have been closely watched by M&A lawyers for many months now. European deal flow, while already affected by the global financial crisis, came to a standstill when a raft of countries looked unable to deal with their debt.
But as Greece looked likely to default and the risk of contagion became a harsh reality at the back end of 2011, Portugal, Spain and Italy all confessed to being unable to pay their own bills. The subsequent knee-jerk reaction from the markets has left many corporate lawyers with little confidence that deal activity will be restored in 2012.
As LB went to press, politicians were still struggling to hash out a deal to decrease the risk of default among some of the worst-off countries and thwart the possible split of the eurozone.
‘There has not been a decent flow of M&A deals for three years in Ireland,’ comments Devereux. Ireland was also worryingly close to entering the deep end of the red zone until the Irish government stepped in and bailed out the country’s financial sector and worked hard to shore up its balance sheets.
‘The mood in the country following the European bailouts was one of despair and despondency, which has turned in some circles to one of antagonism and anger towards Europe,’ remembers Devereux.
While traditional forms of M&A have yet to pick up in Ireland, both Devereux and Lawlor point to the financial sector as dominating the firm’s work volumes currently. McCanns has spent the majority of the last three years working with Ireland’s banks and the government on recapitalisation issues, equity issues and asset disposals.
Irish assets have been attractive to foreign buyers because of their cheap prices and have delivered more than their fair share of work for corporate lawyers. The sale of real estate portfolios has been of particular interest, with the National Asset Management Agency (NAMA) already disposing of E3.9bn in property portfolios. In 2011 alone, NAMA sold E1bn worth of property portfolios.
‘None of us know whether at the extreme we are going to have euro in six months’ time, so how do you go about pricing a eurozone business.’ – Frances Murphy, Slaughter and May
But few partners around the table agreed that Greek assets would be as popular as Irish ones, despite being cheaper for investors looking to take advantage of a dire situation. The majority believed that the risk is too high (and the same can now be argued for Irish assets) because of the potential collapse of the euro currency.
‘People are very nervous with everything that is going on in the eurozone. None of us know whether at the extreme we are going to have a euro in six months’ time, so how do you go about pricing a eurozone business?’ says Frances Murphy, head of the corporate practice at Slaughter and May.
Weil corporate partner Peter King agrees: ‘It would be a brave person who goes and buys anything Greek at the moment.’
In the last year, the Athens General Index has experienced a 54.66% fall, according to Bloomberg, wiping billions off the value of Greek listed companies.
‘There will be a lot of Greek assets, such as telephone companies, potentially up for sale, but clients will be very circumspect,’ explains Ashurst’s Simon Beddow, who is managing partner of the firm’s European corporate practice.
Currency risk will remain a serious threat to deal levels and activity in Europe in the near future, even in Ireland, where Lawlor says that even if investors buy Irish state-owned assets they are still buying into the idea of the euro.
A&O corporate partner Don McGown says: ‘The currency risk is large in terms of what it’s going to mean to the business that has acquired that risk.’
While most corporate partners have not written off Europe as an important region for M&A work (indeed Murphy is confident that the euro will make it through the mess), greener pastures have been evolving in the emerging markets, including Asia and even Africa, for some time.
‘It is pretty evident with the eurozone crisis that we are in a global economy; it is affecting confidence from South America to China,’ says Cleary’s Michael McDonald, a corporate partner in the firm’s London office.
Emerging mature markets
McGown argues that global M&A activities are actually up by 27% this year compared to UK levels. ‘We are in the wrong market, as most of that is being driven by Asia,’ he comments.
He says that between 30-40% of A&O’s M&A portfolio emanates from the Asia region, while more than 50% of the M&A work Freshfields does out of London has an international nature, according to London corporate partner Bruce Embley.
‘Having a true international network has paid and we hope it will continue to pay dividends as globalisation continues,’ he says.
Similarly, more than 50% of Herbert Smith’s M&A partners are located outside of London, according to global corporate chief James Palmer, who also points out that more than 50% of those London partners are doing non-UK M&A.
‘If you were to look at a particular trend in the last four years, the PRC companies – which hitherto have not done very much outside of China – have now been allowed to do much more than they had been before,’ notes McGown.
Although the Asia markets maintained their strength throughout the global downturn, they are currently experiencing a slight slowdown in development. However, predictions are that China in particular is likely to see another growth spurt in the latter half of 2012.
‘I think that access to credit and market confidence are going to have an impact on Asia,’ argues Palmer. ‘But it is going to bounce back a hell of a lot faster because they do not have the same legacy systemic problems that there are in western Europe and potentially the US.’
More than a decade ago, says McGown, all of A&O’s M&A activity was inbound into Asia, but he says the firm’s latest statistics show that China has now moved from 17th position in the table listing the countries with the most acquirers of foreign businesses to sixth position.
‘There will be a lot of Greek assets, such as telephone companies, up for sale, but clients will be very circumspect.’ – Simon Beddow, Ashurst
The strength in Asian currencies, growing economies, financial stability and easy access to cheap credit are fuelling a busy M&A market, according to McCanns’ Devereux. ‘If you look at the European markets, most are missing one of those components in one shape or another, but in Asia they have all of those coming together, which is causing a perfect storm for transactions,’ he says.
It is no secret to the global law firm that Asia is currently the boom market and continues to evolve away from just Hong Kong and the PRC. Most partners point to Singapore, Thailand, Korea and Indonesia as emerging countries within Asia where work levels are beginning to rise. The increasing importance of the Asian market has seen a number of UK firms move into Australia in a bid to have greater access to Asia. In 2011 alone, DLA Piper, Ashurst and Clifford Chance all secured tie-ups with Australian firms. McGown says that A&O’s 2010 foray into the Australian market has already given the firm a number of transactions that it would not have ordinarily landed.
But Ashurst’s Beddow points to the outbound Chinese work as still very exciting for his firm. He says that in the last 15 years, the Chinese have been buying up African assets, entirely off the radar, and using cash to do so.
‘From our point of view that is a much more exciting prospect than us trying to get to grips with anything inbound into China. We could spend the rest of our working lives not making any money there because we don’t have the skills,’ he says.
The members of the panel all agree that Africa, and North Africa in particular, is already a hot bed of activity for their firms despite the fact that continued troubles with corruption and political unrest remain a challenge.
‘Africa still has huge challenges,’ comments Embley. ‘I see it taking a lot longer than a decade for it to realise its potential. The interesting thing with Africa is, and South America is similar, if you are going to do a big M&A deal there, you have to have a very firm eye on your disputes practice and/or your treaty protection.’
That being said, Palmer points to Africa as an important market for Herbert Smith. The firm advised on one of the largest telecoms deals in the region when it acted for client Bharti Airtel on its £7bn acquisition of Zain Africa in 2010. Palmer says that first it was the resources sector that drew the firm to Africa-based work, but that quickly moved into telecoms and subsequently into consumer goods.
‘The big development for Africa is that many of the international firms are realising now that the primary exposure to Africa was through our French practices, but the untapped potential many of us have seen and will continue to see is maximising the links through the Middle East,’ comments Embley, who spent three years in Dubai and led the firm’s Middle East and North Africa corporate practice.
The group says that the emerging markets will remain important to M&A activity in the future and as long as English law continues to reign supreme, UK law firms will see their fair share of instructions.
The rise of English law
A definite trend in the legal sector during 2011 has been the ever-increasing presence of the US law firm on a global scale, particularly in markets such as Europe, the Middle East and Asia.
But the corporate partners around the table say there has never been a better time to be an English-qualified lawyer.
‘As an English-qualified lawyer, I am biased and I always tell my American partners that English law is winning in our quiet understated way,’ jokes McDonald. ‘But it is great for English-qualified lawyers because most of the cross-border deals are governed by English law rather than New York law.’
Beddow says that the biggest change in M&A that he’s seen during his 22-year career has been the export of English law on M&A transactions across Europe.
‘That has been a huge thing for English law firms because we have managed to export many of our skills around the world. That has meant that so many of our deals are now international,’ says Beddow.
Murphy agrees and says that English law has been a great success story but warns that there are still plenty of ways to get caught out. In France, for example, McGown says that when working on transactions where French works council issues come up, it may be something that all local lawyers know well, but may not be so obvious to an English-qualified lawyer, therefore getting caught out is easy.
In some Middle Eastern countries, however, English law is favoured over local law. In Qatar and Saudi Arabia, for example, the use of English law to govern M&A deals is becoming increasingly common.
‘It is at the stage where some governments would prefer to do deals under English law than their own domestic law,’ comments Embley. He says that makes deal signing easier because often local governments can act as gatekeepers on a deal.
‘Having a true international network has paid and we hope it will continue to pay dividends as globalisation continues.’ – Bruce Embley, Freshfields
Despite this, there are some jurisdictions in which English law is not favoured. South America has historically used New York law to govern M&A deals, predominantly because the vast number of companies doing business in the region are American. However, the panel notes that deals in the region that don’t involve US corporates are now being done under English law.
Turkey is another jurisdiction that continues to present a challenge to English M&A lawyers. Most Turkish companies refuse to acknowledge English law, while a number of companies going into the Eurasian country refuse to sign a deal governed by Turkish law.
The corporate partners all agree that the export of English law is likely to be a continuing and developing trend in the future. Particularly because as a result of the downturn, so many companies are writing arbitration clauses into deal agreements that are typically governed by English law.
Changing faces
Deal making is going to look very different in 2012. Changes to the Takeover Code, which came into effect in September 2011, are the beginning of this.
The changes include a fixed ‘put up or shut up’ period of 28 days; publicly naming potential bidders; disclosure of bidders’ intentions regarding the target and its employees; disclosure of fees related to an offer; and giving target employee representatives a greater hand in expressing their views on a takeover.
All partners present at the round table agree that the changes to the rulebook will make doing deals harder. Palmer notes that the changes will affect timetables, approaches and risk assessment, giving less certainty and momentum ahead of a launch.
‘An aspect of the 28-day period that does worry some non-UK businesses is the very short time they now have to do due diligence,’ comments King. ‘They imagine they are going to have an opportunity to do a large amount of due diligence over a long period. Of course we tell them they do not have much of a chance to do due diligence in a UK public bid anyway. This is a problem for them psychologically.’
Even though the group was united in its belief that the changes to the code will affect dealmaking in the UK moving forward, each partner was concerned about different aspects.
Palmer doesn’t think the short time period for due diligence is the problem. He believes that the naming of bidders will be a big issue moving forward. Meanwhile McGown says the disclosure of fees by financiers means that the arrangers will find their fees and profits becoming much more obvious to the market.
McDonald says that the changes will have a negative impact on private equity houses, which will have a tougher time buying UK companies.
McCanns’ Devereux says that Ireland’s Takeover Code is modelled on the UK’s old rulebook and doesn’t think it will change any time soon. He doesn’t believe the new rules will get in the way of dealmaking but that it will be done differently.
‘Once we see the milk quotas end in 2014 we are going to see a lot more dairy production and processing in Ireland.’ – Valerie Lawlor, McCann Fitzgerald
‘I expect there will be less talk, fewer people involved and the 28-day financing issue will have to be confronted: it is just going to have to get done,’ he says.
While the Takeover Code changes will affect M&A deals in the future, the round table guests felt the biggest obstacle to overcome in the future will be potential shareholder revolt on large M&A deals.
Palmer says that already a number of potential deals Herbert Smith was working on were shot down by shareholders and fell apart. ‘It’s really scaring boards from doing deals where they need shareholder support,’ he says.
Murphy agrees: ‘You will see shareholders playing a much bigger role in M&A transactions, partly as a result of the changes in the Takeover Code, which is focusing just on public M&A. Taking away the deal protection means there is going to be more focus on what the shareholders are saying.’
The worry is that following Kraft Food’s takeover of Cadbury in 2010, where there were calls to make the takeover rules tighter so that not all UK plcs would be as susceptible to foreign takeovers, shareholders are likely to become more active in voting against deals that don’t work in their favour. The failed attempt by Prudential to take over AIA in 2010 is a prime example of how a large M&A deal can fall apart because of shareholder opposition.
‘This shows that pre-marketing is going to be critical in deals,’ says A&O’s McGown.
McDonald says that the US investment banks now have dedicated teams of people to deal with shareholder activism, advising senior management on how to deal with key shareholders.
‘Some of the banks are wondering whether that kind of business will take off in the UK to the same extent as in the US. I am a little sceptical about it,’ says McDonald.
Split personality
The corporate partners present all note the high levels of restructuring work they’ve already seen coming out of the financial crisis.
Devereux says that the majority of work that his firm has advised on during the last three years has been to help Ireland’s banks deal with their debt issues. ‘Corporate lawyers are pretty flexible people and when our traditional sources of work dry up we can turn our hands to anything, such as restructurings and recapitalisations,’ he says.
Restructuring, refinancing and rebalancing have been the reality of the corporate lawyer since the 2008 crash of Lehman Brothers. As the M&A markets were killed off, the corporate lawyer had to change hats.
‘I joined Weil, Gotshal & Manges one week before the Lehman bankruptcy happened,’ recalls King. ‘My introduction to the firm was when the head of corporate said that we’d all have to become restructuring lawyers.’
King says that since then the London office of his US firm has deployed huge swathes of corporate lawyers to advise on restructuring matters.
‘You could argue that what we are doing is M&A,’ says King. ‘We are selling parts of businesses; they have to be bankrupt businesses, but we are selling them.’
And this work is likely to continue. Beddow believes that consumer-facing companies such as Thomas Cook will continue to experience troubles as consumers become more squeezed by price increases in a range of sectors without experiencing wage increases.
Many of the partners present also suggest that a wall of refinancing is expected to arrive in 2012 when loans come up for maturity on deals penned in 2005 and 2006. Murphy believes this will be the perfect place for the entrance of the private equity houses.
‘I think that access to credit and market confidence are going to have an impact on Asia. But it is going to bounce back a hell of a lot faster.’ – James Palmer, Herbert Smith
‘They are expecting to find opportunities,’ she says. ‘The smaller houses that cannot refinance the loans, they may have to sell them on what the bigger houses will see as good terms.’
Beddow agrees that Ashurst’s private equity clients will see opportunities to buy up parts of failing consumer companies as the pricing will be much cheaper in 2012.
Devereux expects to see an increasing number of private equity and hedge fund clients walking the streets of Dublin in the next two years. He says there are already a number of them in Ireland looking to take advantage of cheap loan books and distressed assets that will need to be disposed of.
The panel, however, agrees that while private equity will play a large part in the future work they advise on, the private equity firms are still struggling in the current recessionary environment and don’t have the same firepower they once had.
‘In the pre-2007 environment, private equity firms were generally outbidding the trade buyers, even those with strong balance sheets because they were able to get cheap and extensive financing,’ says Devereux. ‘What has happened is the private equity firms are now finding it harder to obtain deal finance and they are having to invest about 50% of their own equity to finance deals.’
However, Embley argues that while this may be the case, the private equity firms know they have to plug the hole in acquisition funding that has been left by the lack of leveraged finance. And, he says, they do have the cash to pour into the emerging markets, where the majority of M&A activity is extensive.
Hope springs
The financial sector is going to keep corporate practices busy for the near future. As regulators and governments come down hard on the banks to shore up balance sheets and increase capital holdings, corporate lawyers will be in high demand to help sell off assets and parts of their businesses.
‘For the next two years we see several key strands for new work – disposals of non-core loan books by banks and the sell-off of state assets,’ says Devereux.
As the £747m sale of Northern Rock to Virgin Money in November 2011 demonstrates, consolidation among financial institutions is also expected by corporate partners.
‘There will be more disposals from the other major banks as they are required to sell off assets. I think that is going to be a big area,’ says McGown.
And while this is likely to keep lawyers in the UK busy, the round table guests agree that financial institutions work is global. King says the work will span across Europe, while McDonald says that banks disposing of certain arms of business is a global phenomenon as seen by the late 2011 sale of Santander’s Chilean business.
Whether it will be advising on the sale of loan books, distressed assets or parts of a bank’s business, the financial sector will keep law firms very busy.
Another sector expected to deliver work for corporate partners over the next decade is the food industry.
McCanns’ Lawlor says that already a number of Irish food companies have been busy acquiring smaller businesses. In 2010, Kerry Foods, which has a E5bn market cap, completed ten acquisitions. Similarly, Glanbia, which has revenue of E2.6bn and is listed in both Dublin and London, is already looking to do deals.
‘Once we see the milk quotas coming to an end in 2014 we are going to see a lot more dairy production and processing in Ireland,’ she says. ‘In Ireland we feed five times our population, so there are likely to be a lot of interesting models as to how this ramping up in production can be achieved.’
Embley says BHP Billiton saw the future in food when it made a bid for Canada’s PotashCorp. ‘The sovereign wealth funds have become far more active in the food sector and I think we will see government-led deals far more in the next decade,’ he adds.
All agree that emerging markets are going to be crucial to the development of the global corporate practice for law firms moving forward in a highly regulated, post-financial-crisis world. Funding will be hard to come by as the capital markets remain, for the most part, closed and leveraged finance is non-existent.
Embley has the last word: ‘Some regions are going to have to mature very quickly if they are to fill the leveraged funding vacuum, being felt in more developed markets, or are we going to be looking at other strategies? I can see a real funding disconnect over the next few years for leveraged M&A in the high growth markets.’
Corporate lawyers must continue to be creative in the coming year.