This article was written by Neil Carabine and Ike Kutlaca.
COVID-19 has caused significant disruptions to the Hong Kong M&A market.
In this report, we examine the impact on the Hong Kong M&A market so far, outline some likely trends, and provide our top tips for future M&A deals.
What we've seen in the Hong Kong M&A market so far
- In January and February 2020, we saw a push to complete many long-running M&A deals – usually supported by both buyer and seller
- In March and April, we saw an increase in M&A transactions between existing shareholders of a company (or selective buybacks), but few transactions between previously-unrelated parties
- Several significant M&A transactions have been cancelled or indefinitely deferred
- Overall, M&A deal volume has substantially declined
- Due diligence has become more costly, lengthy and difficult in M&A deals as:
- physical due diligence and face-to-face management interviews are limited while travel bans persist
- assessing the full impact of COVID-19 on a target company requires enormous efforts
- material adverse change (MAC), force majeure and frustration clauses in key contracts demand greater scrutiny
- With Hong Kong Courts closed, some transactions have been unable to complete (ie, restructurings via schemes of arrangement and capital reductions that require court approval) – for many such transactions, Hong Kong law gives adequate court-free alternatives which should now be reconsidered
What we expect to see in the Hong Kong M&A market
- Cash-rich investors are already looking for bargains – both good companies undervalue and distressed assets – especially in jurisdictions that have seen the value of their currency fall significantly against the USD in recent months
- Buyers are likely to first emerge from the regions that conquer COVID-19 earliest, but those looking to acquire offshore assets are likely to face increased foreign investment approval scrutiny (and delays in receiving relevant approvals)
- Savvy institutional investors who are used to completing complex deals remotely will be among the early wave of buyers – provided they are comfortable completing deals with little debt financing
- Sellers will place great emphasis on ensuring certainty of buyers' funding – buyers should be ready to 'prove' their financial capabilities in future M&A transactions, especially as acquisition financing becomes more difficult or expensive to obtain
- Negotiation of the allocation of risks between buyer and seller will become more complex – we expect an increased focus on warranties, MAC clauses and force majeure provisions – while insurers will likely follow AIG's lead and include blanket exclusions for COVID-19 impacts in W&I policies – meaning greater diligence will be required to assess and allocate risks
- Buyers will likely demand increased (and exotic) conditions precedent (CPs), including:
- a "normalisation" CP – where the target's business must return to "normal" before the deal proceeds
- a key man CP – that certain key employees remain employed by the target and unaffected by COVID-19 (and possible vaccinated against COVID-19)
- Buyers will seek significantly greater information and control rights in the period between completion and signing, while pushing for shorter periods to satisfy CPs – deal teams should prepare to apply for approvals immediately after signing
- Sellers are likely to attempt to make broad discloses against warranties for COVID-19 impacts – buyers should be alive to this prospect and consider whether such issues have indeed been 'fairly disclosed'
- Valuations will become more difficult – traditional methods based on earnings or cash flow may struggle to accurately price targets that have suffered significant COVID-19 impacts
- Sellers will look for full payments in cash at completion, but buyers will want purchase prices linked to company performance and complex post-completion adjustment mechanics to account for COVID-19 uncertainty
- Parties will face increased regulatory scrutiny, and be required to seek additional approvals (and in particular, foreign investment approvals), while the predictability of such approvals will decline
- Parties will encounter deal logistics issues, including:
- the common daytrip from Hong Kong to Macau for signing or completing Hong Kong-law deals is off for as long as travel bans persist
- increased delays at the stamp duty office and Companies Registry (which we have already seen)
- longer waits for regulatory approvals (and in some cases, expiry of approvals already received)
- Share buybacks are likely to continue to be popular as companies take advantage of low valuations – but these may require a 12 month forward-looking solvency statement from directors who will understandably be reticent to make such projections – keeping directors fully-informed of COVID-19 impacts will be critical for companies intending to buyback shares or reduce capital
- Unsolicited takeover offers will increase (for listed and private companies), as will shareholder activism (for listed companies)
Our top tips
- As Hong Kong M&A transactions will take longer than usual to negotiate and complete, sellers should start preparing now to 'hit the ground running' when buyers emerge, including by:
- establishing and populating virtual data rooms
- considering how to value the relevant companies (and preparing evidence to support the valuation)
- undertaking any pre-deal restructuring work
- appointing advisors to undertake preliminary deal structuring work – and critically, to determine which approvals will be required and how to quickly receive them (and whether any 'new' foreign investment approvals will now be required, and the impact this will have on the buyer universe)
- Intending purchasers should start considering:
- the critical issue of how they will fund acquisitions since sellers will demand certainty of funding
- when and where to seek external financing – experience with the 2008 GFC shows that public companies that raised additional equity capital earlier in the crisis did so at a smaller discount compared to companies who waited – similarly, the longer that downturn persisted, the more difficult it was to raise debt
- how a different debt to equity mix will impact post-returns on new investments
- whether it is worthwhile to buy non-USD currencies now (or enter into deal-contingent FX swaps / forwards to lock in favourable FX rates) in anticipation of future transactions
- how they will respond to "sell-side" due diligence into the buyer and its financing undertaken by the seller
- whether additional foreign investment approvals are now required
- Management of companies who expect unsolicited takeover offers should prepare takeover defences (assuming the shareholders would be hostile) or prepare for the sale process (if the shareholders are supportive)
