When we usually see cross-border deals, it’s a U.S. company acquiring a foreign business. But increasingly the reverse is happening, says Craig Lilly, corporate partner at the Palo Alto office of Baker McKenzie, and there are three primary drivers for that trend.
But cross-border deals with foreign buyers aren’t without their pitfalls, especially with newly enacted regulatory and anti-trust and merger controls – at that’s just the start. Just look at what is happening with Chinese telecom giant Huawei.
Cross-border M&A is far from a done deal. Foreign companies are still acquiring U.S. companies, says Craig, but just engaging experts like his company to shepherd the transaction.
We talk about where cross-border M&A is headed in 2019 and beyond, as well as…
- The two biggest concerns in cross-border deals
- How changes at CFIUS have vastly changed the playing field
- When a cross border deal isn’t really a cross border deal – and why
- How American companies are taking advantage of Asian company’s hesitancy
- And more
Mentioned in This Episode: www.bakermckenzie.com and Winning Strategies in Cross Border Deals Tips for Success Presentation
Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak to the leading experts in mergers and acquisitions and we’re all about one thing here. That’s a clean exit for owners, founders, and their investors. Today I’m joined by Craig Lilly, M&A and corporate partner at the law firm Baker McKenzie in their Palo Alto office. Craig’s practice focuses on acquisitions, divestitures, joint ventures, and strategic investments.
But it’s in complex cross border deals where he’s really developed great expertise and he’s now thought of as an industry leader. Craig’s been a regular contributor on Bloomberg, the Wall Street Journal, and other M&A specific publications. Craig, welcome to the program and thanks for joining me today.
Craig Lilly: Thank you, Patrick. I’m glad to be on the program.
Patrick Stroth: Well, Craig, now that we’re getting past the first quarter here in 2019 rather than just focusing on cross border deals which we’re going to get into in depth. Tell me what your perspective is as an expert on what the state of M&A is here in 2019.
Craig Lilly: Well, I think MNA is very strong and still in 2019, the values is increasing even though the volume may be slightly lower. 79% of executives say that the M&A will increase in or remain the same in 2019. We’re seeing record amounts of a private equity raise as well as venture raise which is really good for the ecosystem in mergers and acquisitions. In the last 12 months alone, we’ve seen over 3.6 trillion in deal value over 19,000 deals in US and Europe. So that’s a very strong technology M&A is up 20%.
Also, we’re seeing M&A more institutionalized. 20% of all targets, Pat, are backed by either private equity venture firms or professional investors. Also, there’s record levels of what we’d call dry powder or money to make acquisitions. The PE dry powder is estimated to be over 1.7 trillion and also, the top five tech companies alone have over 340 billion in dry powder. And that includes Apple, Google, Microsoft, Facebook, and Amazon. So the key M&A drivers that we’re seeing are really for strategics are customer expansion and diversification. And so those are all I think big drivers for M&A and which will continue in 2019.
Patrick Stroth: Well, we’ve got just a confluence of changes that have been happening over the world where you’ve got either the world getting flatter or a lot of capital looking for places to be put and maybe people aren’t looking at their backyards anymore. They’re looking overseas. They’re looking cross border. And which is why I wanted to come speak with you about this. But before we get into the technical issues on cross border and the ins and outs of it. Give us a little bit of context for you. What brought you into becoming an M&A attorney first and then to specialize in cross border acquisitions?
Craig Lilly: Well, I had a background in financing and accounting so I was always interested in M&A and investments which really drew me into it. I originally worked in private equity back in the cottage days of private equity when it was a very early industry. And then I started working in technology over the last 16 years or so. And one of the things to that really interests me about the technology and in M&A is that companies at earlier and earlier stages are expanding internationally which is a big driver of cross border M&A. So those are the things that really interest me is the international aspects, the complexity, and also getting to learn new industries and verticals.
Patrick Stroth: So what makes a deal a cross border transaction? Is it as simple as we think just anything outside the US borders?
Craig Lilly: Well, really it’s really any deal with foreign aspects. It could be the buyer or the seller or material assets or it could be a US company acquiring another US company that has material foreign assets as subsidiaries. So typically almost every kind of major US corporation has some type of foreign aspects. So all those acquisitions even though it may be a domestic acquisition really is a cross border because of the foreign aspects or subsidiaries that a US company may have.
And we’re seeing this in an earlier stages of the companies. A lot of early companies are young companies are expanding overseas whether to develop technology, develop manufacturing or to acquire customers through diversification.
Patrick Stroth: A lot of times we’re thinking of US going outside and looking to foreign markets for acquisition targets. But it’s also on the flip side, according to what you just told us where you’ve got foreign-owned companies coming to the US which intuitively we think that the US is too expensive a market for targets. But that’s not necessarily the case. There are things that must be driving these foreign-owned companies to come and invest in the US. What drives the demand from their side to come here?
Craig Lilly: I think it’s three primary drivers for foreign companies to want to make acquisitions in the US. The first one obviously is technology. We’re seeing the fourth industrial revolution happen here in United States where technology is embedded in almost every different vertical or industry whether it’s automotive or manufacturing or artificial intelligence within industrial manufacturing. And so that’s spurring a lot of the investments and acquisitions by foreign acquirers here in the US.
The second is just customer acquisition. Companies are looking to acquire customers and essentially diversify their base. And a third driver really is not only the diversification within a customer base but diversifying their own different revenue streams where they could be diversifying in a new analogous business that maybe is very synergistic with your existing line of businesses.
Patrick Stroth: I agree. One of the things that changed my perspective when we talked about this a while ago was that the focus always on customer basis and so forth. People immediately think China or India where they’re billions of potential customers out there completely overlooking the fact that while we may not have the largest population. We probably have one of the richest. So if you can make a stand here in America with a very friendly consumer base, you’ll do very, very well. And that was one of the things that really came up when you and I were talking about the US being such a great target for them. This can’t all be that easy. What are the challenges that are germane to cross border deals versus ups or domestic deal?
Craig Lilly: Well, there’s definitely changes or challenges in regulatory, whether they are antitrust or merger controls. Obviously, CFIUS which we’ll get into later is a major challenge for companies investing in the US and CFIUS is the Committee on Foreign Investments in the United States. And also, structure and tax issues. Furthermore, key issues when a foreign company comes here is complying with employment laws. It could be unions or the WARN Act. When you want to terminate employees. Intellectual property, data privacy, and security are a major concern as well.
You’re seeing often more and more companies are having inadvertent data breaches. So that’s a key issue for any company in any type of transaction particularly for cross border where you could have cultural issues and other different challenges in data privacy. Also, anti-corruption is always a big challenge for companies and having internal compliance programs implemented to correctly deal with those types of issues. And obviously, in any type of transaction diligence, culture, deal execution, and also, post-closing integration is a major issue. And in post-closing integration, something doesn’t start after closing. It really starts very early in the acquisition process.
Patrick Stroth: Can I ask you this is a little off topic but with all of those challenges that are there that’s probably a role that you and your firm will give guidance to if you can’t have absolute on the ground consulting recommendations you have resources or can provide resources to companies to address those various areas of concern?
Craig Lilly: All right. We have great breadth in over 45 countries around the world and have over 70 offices. So we have experts in all these areas. And really that’s what you need is a specialist or cross border specialist teams because of the numerous landlines involved in foreign deals and some of the really kind of two big areas that companies are very concerned a bit right now obviously is data privacy. But also the anti-corruption issues that are involved and because of the stiff penalties can be imposed and that’s really you outbound or inbound.
And so we see companies take a very in-depth look at that. One of the things we also look at every transaction, we try to very early on the process is sit down with a client and discuss what are the really high-risk areas, where is really the concerns for the company, where’s the value? It could be in the intellectual property and so we’re going to really take a deep dive in intellectual property to potentially a freedom operate analysis to make sure that they’re protected. And if they do buy the company that they have the freedom to use it the way that they intended to have synergies with their existing businesses.
Patrick Stroth: Talk about CFIUS a little bit. Should every company now be aware of it, not just the ones that are the traditional chemicals and military applications number one? And then number two, CFIUS is US. Explain what happens if other countries have something similar.
Craig Lilly: Well, the Committee on Foreign Investments in the US or CFIUS is where a foreign company proposes to acquire a target a US business that generally either produces designs, test, manufactures, fabricates or develops one or more critical technologies. And because of the recent changes in the law, even a 1% investment in a company with critical technologies could trigger a CFIUS filing. So its critical technologies has been expanded for CFIUS and includes such things as defense articles, and defense services, commodity software, and technologies on commerce control list or controlled for reasons relating to the national security, chemical or biological weapons, missile technologies or for reasons relating to regional stability or surreptitious listening.
It also can include energy and things subject to Department of Energy regulations such as nuclear equipment, software, and technologies, and also includes emerging and foundational technologies which is not to be defined which is very broad. There’s actually currently 27 pilot program industries identified by NAICS code which will require mandatory filings. Also, CFIUS applies if the target owns, operates or manufacturers or supplies critical infrastructure or real estate.
And critical infrastructure is broadly defined. It can include systems and assets so vital to the United States that the incapacity or destruction would have a debilitating impact on national security. For example, the purchase or lease or incession of a foreign person to a foreign person or any of real estate is located in the United States and is located within an airport or a maritime port or close in proximity to a US military installation that is sensitive for national security reasons.
And why should an acquirer be concerned about CFIUS? Well, US Treasury which oversees this can unwind the transaction or impose very harsh equitable remedies and fine. Also, each party can pay up to the amount of the purchase price for the fine. And yes, other countries do have similar laws. The EU also has a similar law. Seven transactions last year were blocked by the EU and we had over 14 deals either blocked or abandoned during the last few years. Over 240 deals were actually formally reviewed by the US in last year. And so CFIUS has very wide overreaching kind of application.
Previously before the recent changes, a company that was making an acquisition in the US could make an investment of 9.9% or less without being subject to CFIUS. But now it applies even to a 1% investment in critical technologies and that’s a mandatory filing. So it’s a very broad expansive type of law and it’s not just only in the US. EU also has these laws as well and a lot of people also are also concerned about China. And why is China’s such a huge presence in cross border here over the last decade? Well, in 2008, China inbound was 1 billion. However, eight years later, by 2016 inbound was 48 billion.
So that alone has led to a lot of the concern over CFIUS. Also, there are a lot of changes in capital markets and venture capital. Previously DARPA was very heavily involved if there was some type of sensitive technology being developed. But because of the expansion in private markets and venture capital, there’s all types of new technologies that are being developed where DARPA is not involved at all anymore. It used to be decades ago, DARPA would be almost involved in any type of development of critical technologies because it was usually done by larger companies. Because of the expansive venture capital over the last 20 or more years. Now we’re seeing critical technologies being developed even with very small companies.
Patrick Stroth: At what stage are you filing for CFIUS? Is this where you pass a letter of intent and you’re beginning to get things structured up there or is it something where it can be preemptively checked before advancing too far into an M&A transaction?
Craig Lilly: Well, generally, we will recommend clients to do a CFIUS assessment of the risk very early on prior to the letter of intent stage. Typically, companies will be even talking with the Treasury even during this letter of intent stage. And that’s generally what we recommend so that we can basically get some initial advice from the Treasury as to whether this is a very high-risk type of assessment which would require a filing. And in most cases, it can be a mandatory filing.
But typically, you will file this generally right around or medially before the execution of the contract. And that’s just to sign a contract where you may later do the acquisition usually in a two-step type transaction.
Patrick Stroth: The other question for you. Its something we didn’t talk about. But you triggered my thought process here. Compared to a US deal, I know every deal is different depending in industry and size and everything but are cross border deals routinely larger? And if so, how much larger than a domestic deal for technology or pick a case study?
Craig Lilly: Well, historically, we saw a lot of large investments but now we’re seeing even the very small investments. There has been just a rush of investments over the last decade of all types of foreign and Asian investors in the US it was particularly with technology companies and so that’s helped a big surge in venture capital investment as well. But we’re seeing across the board obviously, some of the investments by some of the Asian investors has decreased over the last year just because of some of the CFIUS concerns in the regulatory landscape. But there’s no particular size for cross border or a foreign investment we’re seeing across the board all different shapes and sizes just like you would see with a domestic acquisition.
Patrick Stroth: And assuming that CFIUS gets taken care of. There are the other kinds of risks out there that are germane to M&A. A lot of those risks can be mitigated or controlled or completely eliminated with ensuring a deal through rep and warranty insurance and it’s been used at an increasing rate in domestic deals. How has rep and warranty impacted cross border M&A?
Craig Lilly: Well, representation and warranty insurance actually was more expensive in the EU and in Europe before it really came to the US. And so it’s very prevalent in Europe and generally, there’s lower price premiums as well. As you know, representation and warranty insurance essentially allows sellers to walk away with more cash at closing while giving buyer’s interest protected in the form of an insurance policy against loss.
So typically whether it’s in domestic buyers in Europe or otherwise, there’s been the landscape for representation and warranty insurance and in Europe, particularly is fairly widely accepted. And because it’s a less litigious type environment to typically the prices and premiums and risk retention’s are much lower for a Europe-type acquisition.
Patrick Stroth: Craig, you mentioned China before and how they ramped up very extensively of going from a billion dollars in deals and then a very short term, they come up to $48 billion in transactions. What do you see aside from the slow down right now which could be temporary but what do you see going forward both in Asia and cross border M&A overall? What trends do you see there?
Craig Lilly: Well, it definitely a cross border M&A has slowed down because of CFIUS and you’ve seen with the recent trade restrictions that were imposed on the Huawei by the US that that’s a definitely an impact on perception at least for Asian investors here in the US. I definitely think it’ll probably be very slow for a lot of the Asian investments in the US. I do think you’ll see more and more US buyers throughout the world whether it’s in Asia or in Europe. I think some of the big drivers for that though is just because there’s a lot of dry powder available for not only private equity funds but also a lot of the large institutional and strategics.
As I mentioned before, the top five tech companies are 340 billion in dry powder. But also you’re seeing a lot of kind of old-line companies that are really trying to expand whether it’s through technology whether it’s a FinTech or an agricultural tech or some other kind of emerging tech or they’re trying to diversify their customer base or their revenue streams. And also you’re seeing obviously you see continued outsourcing whether it’s through manufacturing or assembling happen and that’s throughout Asia. And also we’re even seeing a lot more in Mexico and Latin America because of the close proximity and probably the more respect or for the cultural aspects of the United States including protection of IP.
So I think we’ll see kind of more and more US companies do a lot more cross border. The acquisition of tech is obviously a very driving aspect but obviously, the customers diversification, aqua hires, and other things too. And I think you’re seeing this across all different types of verticals whether its artificial intelligence or robotics, FinTech. Of course, auto tech’s been a very big area servicing a lot more of different transportation companies that are trying to expand and drilling through multiple verticals here. It’s a whole… Electric car, autonomous vehicles. The communication slash smart car and also ride sharing too as well. Those are all things that are kind of driving the transportation industry and I think we’ll continue to see that.
Patrick Stroth: So we’ll be doing a lot more US buying outside our borders as opposed to the last couple of years where we’ve had predominantly Asians coming and buying into the US. That trend looks supportive because it seems that there are more and more service providers out there and advisors such as Baker McKenzie that can make things easier for US buyers to go abroad where they probably were reluctant to do that because of a lot of the bear traps out there that they didn’t know what they didn’t know. And they’ve got resources like yours now that they can bring to bear that will help. At the same time, CFIUS is making it harder for the foreign-owned companies to come in and maybe easier for us to go out. So it may have not the same sustainability or robust outlook as you do domestic but it’s still fairly positive. Would you agree?
Craig Lilly: No, I agree. And also we’re seeing kind of a trend that’s really developed over the last few years is that you’ll see a US slash Delaware Corporation basically as a holding company but really their operations are really abroad and even though any M&A or acquisition is of the Delaware company as a domestic acquisition, essentially the company is a foreign company. And so we’ve seen a lot more of those types of transactions and that’s obviously been spurred by the not a venture capital investment here in the United States as well. And I think we’ll see that continue.
That’s why I’m saying M&A is also becoming more institutional-wise where 20% of all targets are backed by some type of institutional investor whether its private equity or venture capital. So I think we’ll see that continue. Obviously, we’ll see a lot of I think secondary private equity sales. And what that means is one private equity funds selling a portfolio company to another private equity fund. Now those type of exits account for somewhere close to 30% now of all private equity exits. I think that trend will continue as well.
Patrick Stroth: Well, you’ve got a lot there for us to consider, particularly just not the cultural differences but a lot of the other regulatory and compliance traps and so forth and just how things are different outside. But that shouldn’t stop you from taking advantage of some great opportunities out there. And if there are organizations like you and Baker McKenzie that can be brought to help smooth that transition, that’s all the better for a lot of owners and founders out there. Craig, how can our audience reach you? Because I’m sure they’ve got a lot more questions than I can give you.
Craig Lilly: Well, I’ll have a presentation which I’ll have on Rubicon’s website after this. And then also you can reach me at our website or my email address which is just firstname.lastname@example.org. Also, you can reach me through my phone number 650-251-5947 plus I’ll have a cross border presentation that I’ll post on Rubicon’s website that can be accessible and will have my information as well.
Patrick Stroth: Well, that’s absolutely fantastic. Thank you very much. And you can check the show notes here under the insights tab at Rubicon, R-U-B-I-C-O-N-I-N-S as in Sam, rubiconins.com. Go to the insights tab there and you’ll have the show notes along with a link to Craig’s presentation and you can also reach out to Craig directly. Craig, very informative. You cracked open a lot of different avenues of thought there so I greatly appreciate it. My audience will appreciate it as well. Have a good day. Thanks so much for joining us today.
Craig Lilly: Thank you, Patrick, very much.