Conditions still ripe for cross-border deals, despite headwinds: Dentons Canada executives survey

Cross-border M&A will likely emphasize technology, emerging markets, and securing supply-chain

Conditions still ripe for cross-border deals, despite headwinds: Dentons Canada executives survey
Alex Farcas and Rachel Howie, Dentons Canada

Near-term economic conditions may be turbulent for cross-border M&A, given inflation, geopolitical risk and the spectre of a recession. However, a Dentons Canada survey of senior executives indicates they are optimistic and expect higher cross-border deal volumes over the next three to five years. 

“As valuations come down, companies and financial sponsors understand there are many opportunities upon which to seize,” the Shifting Tides of Cross-border M&A report says. There is also “strong motivation” to consider cross-border acquisition as the US dollar puts buyers using that currency at a competitive advantage.

The survey respondents also indicated that cross-border dealmaking will likely emphasize technology assets and emerging markets and secure “supply-chain resilience.”

“Given the environment we are in, with a certain amount of uncertainty, I was surprised at the number of people who expected cross-border activity to increase over the next 12 months,” says Alex Farcas, co-leader of the national M&A group for Dentons Canada.

The survey was done in the third quarter of 2022, “so it would be interesting to see if the results would be the same today,” says Farcas, “but speaking personally and hearing from colleagues, we’re seeing an uptick already in January.”

A survey of senior executives involved in cross-border M&A

The Dentons survey looked at the views of 150 senior executives involved in cross-border M&A. Half of the respondents were acquirers, based in the US and Canada, of targets based elsewhere in the world. The other half were acquirers, from elsewhere in the world, of US or Canadian targets. These two groups were divided equally between corporate and private equity respondents.

All PE respondents surveyed have a minimum of US$250 million in assets under management. All corporate respondents surveyed have a minimum enterprise value of US$100 million. In addition to having completed at least one cross-border M&A deal within 12 months of taking the survey, all respondents expected to participate in at least one such transaction over the next 12 months.

Just over a quarter of US and Canadian respondents report targeting a public company in their most recent cross-border M&A deal, as did 15 percent of respondents based outside North America. For more than 60 percent of all respondents, the target's enterprise value in their most recent cross-border M&A deal fell between US$50 million and US$250 million, with a third of them falling in the US$50 million to US$100 million range.

The most frequent EBITDA multiple paid by respondents in their most recent cross-border deal was 6x-7x. It was cited by 37 percent and 31 percent of US/Canada and non-North American respondents, respectively.

Key findings

The survey’s key findings include the following:

  • More than a third (34 percent) of executives in the US and Canada expect the volume of near-term cross-border M&A to increase compared to the last 12 months, a view shared by 40 percent of dealmakers surveyed outside North America
  • Technology, media & telecommunications (TMT) is the most appealing sector for potential cross-border transactions. It was cited by 72 percent of US/Canada respondents and 93 percent of non-North American survey participants
  • More than 80 percent of all respondents agree that stricter protections on foreign direct investment (FDI) will have a noticeable negative impact on their cross-border dealmaking strategy
  • Overall, 87 percent of respondents globally expect guidelines related to environmental, social & governance (ESG) principles to become more impactful on cross-border M&A over the next 12 months
  • Two-thirds of respondents based outside North America cite the US as one of the most appealing regions for buy-side cross-border M&A activity, far ahead of other markets. Their US/Canada peers, meanwhile, are especially keen to emphasize opportunities in Eastern Europe (47 percent)

The lure of Eastern Europe

Farcas says he was somewhat surprised at the level of interest in Eastern Europe.

“When you think of Eastern Europe, you think of Ukraine, and the uncertainty around the war there,” he says. “So, it was surprising to see a large number of respondents identify Eastern Europe as an area of opportunity.” Part of this interest might be the adjustment in risk tolerance that started with the COVID-19 pandemic, he says.

However, Farcas says, Canada remains a source for cross-border dealmaking due to the weak Canadian dollar and “our stable legal and regulatory environment.”

The survey also indicates cross-border dealmaking is getting a boost from a trend towards more parts of a transaction being done remotely because of the pandemic.

Says the report: “Since the onset of the pandemic and the rapid pivot to conducting remotely what used to be in-person or on-site due diligence, scouting out possible deals often requires less travel time than before, putting cross-border processes on a more level pegging with domestic dealmaking.”

As one senior director of M&A at a Chinese corporation said in his survey response, “The use of automation and artificial intelligence technologies can improve due diligence processes to a great extent.” 

Doubling down on risk protection

While M&A players seek to make deals, they want to minimize risks. The survey noted that acquirers are doubling down "on protective measures that mitigate against unwanted outcomes.”

One such tool is representations and warranties (R&W) insurance, which protects buyers against misleading statements or warranty breaches. Fifty-seven percent of respondents in the US and Canada and 60 percent of respondents elsewhere report that they are making use of R&W insurance in their most recent cross-border deal. 

“These percentages may have been even higher were it not for the unparalleled demand for R&W insurance observed through 2021,” the report says, “with underwriting capacity unable to meet transaction volumes.”

Earnouts are another way for buyers and sellers to settle on making a deal, as acquirers can be wary of overpaying for assets that may go on to underperform once an agreement has concluded, especially in a potentially weakening economic environment. These deferred payouts, meant to bridge the valuation gap, are being used more frequently and are typically based on profit or revenue targets or other milestones, depending on the sector.

Most survey respondents – 63 percent in the US/Canada and 55 percent elsewhere in the world – employed earnouts or similar deferred compensation and deferred payment mechanisms in their most recent cross-border transaction. And the use of earnouts is expected to remain popular, with 60 percent of respondents inside and outside North America saying they will likely use earnouts over the next 12 months in their cross-border deals.

Rachel Howie, a Dentons Canada lawyer whose practice includes international and domestic arbitration and litigation, notes that she has seen an increase in “the number of clients who are very savvy to the risk issues of operating internationally and wanting to get advice upfront.

She adds that “sometimes early in the process, even before the term sheets, clients want advice on what should be going in.” 

Increasing use of representation and warranties insurance

She also points out that the report indicates executives are increasingly considering what dispute resolution mechanisms to use internationally. “Where do we want to have a dispute settled? What is the process going to look like? And more importantly, can that mechanism or any decision arrived at be enforced.” 

Howie also says some disputes need to be shut down very quickly, such as in the case of breach of confidentiality, because there might be misuse of sensitive information involved. “And depending on where the other entity is in the world, there might be some very real enforcement issues that need to be considered.”

While litigation is still the most common way of dealing with disputes in the US and Canada, followed by expert determination, Howie says there is more use of dispute resolution boards, typically used more outside of North America.

“The increasing use of these boards in Canadian and US deals was a surprising theme,” Howie says, adding "it is possibly related to an increase in deals involving intellectual property and research and development.”

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