National security threat to Asia Pacific M&A, say dealmakers

Dealmakers fear national security issues pose a growing threat to the completion of cross-border M&A in the Asia Pacific region, as governments voice concerns about overseas influences.

The sentiments were captured in the latest Global Dealmakers: Asia-Pacific M&A market update 2020 from Baker Tilly International, compiled in conjunction with Mergermarket.

Some 43 per cent of respondents feel national security will become an issue for dealmakers in the next 12 months, while a further 15 per cent were unsure. It was a sharp rise from just 10 per cent who said it had interrupted potential deals when assessing the last 12 months of M&A.

Global dealmakers:
Asia-Pacific M&A market update 2020
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National security has come to the fore as a deal making issue in recent months as government adopt an inward-looking focus and increasingly analyse foreign investment through the prism of seeking greater influence.

In Australia, changes to the Foreign Investment Review Board framework set to zero the threshold for FIRB review from late March, with the Government describing the changes as necessary to stop foreign buyers swooping on distressed assets.

Australia will also move ahead with additional FIRB changes, that come into effect from January 2021, will allow its Government to impose conditions or block investment by a foreign person on national security grounds, regardless of the value of investment.

It will require mandatory notification to be made to the Government for any proposed investment by a foreign person in a “sensitive national security” business.

India has increased scrutiny of investments in its companies from neighbouring countries, including China and Hong Kong, to stave off ‘opportunistic’ takeovers of companies weakened by the impact of COVID-19. The measures come despite Prime Minister Narendra Modi talking up the advantages of US foreign direct investment in Indian companies.

Prior to the pandemic, Japan had also tightened its investment rules, lowering the threshold that required foreign investors to gain approval from regulators from 10 per cent to 1 per cent. Foreign investors’ influence on the governance of companies in strategic sectors will also be more strictly monitored.

Coupled with the tighter scrutiny is the constant changing of rules, with 58.3 per cent of dealmakers cited regulatory and tariff changes as a factor that will inform their M&A strategy.

Baker Tilly Global Corporate Finance Lead Michael Sonego says there are growing concerns from dealmakers about the potential for deals to be interrupted while in progress.

“In recent years, we’ve seen a trend for increasingly more restrictive direct foreign investment rules because governments are examining cross-border deals through the lens of national security,” he says.

“The uncertainty created by the repeated changing of rules in some Asia Pacific countries is clearly starting to dent the confidence of some dealmakers to complete transactions.”

One respondent told Global Dealmakers there would not be issues for dealmakers if they were fully prepared but added: “Including political risks in due diligence would be important to arrive at practical and objective decisions.”    

But others are less optimistic.

“Pipeline deals are more likely to be reconsidered because the deal making situation has changed. The national security laws and threats will prevail, and even smaller transactions will be affected,” says one respondent.

Asia Pacific is not alone in the clamp down by governments on deals seen as potentially risky, with the UK paying closer attention to deals involving artificial intelligence, advanced materials and cryptographic authentication technology, and the US beefing up its Committee on Foreign Investment in the United States to review transactions that ‘threaten to impair the national security.’

But other security concerns were also cited by APAC dealmakers, including the risk of political tensions in the region such as protests in Hong Kong.

New national security laws in Hong Kong are seen as a distraction for private equity firms based in the Chinese territory, with 41.7 per cent of dealmakers believing those companies will begin relocating to other areas.

“Hong Kong’s new security laws has raised questions about its future as a hub for investment within Asia Pacific,” says Mr Sonego, a partner with Pitcher Partners in Melbourne.

“Dealmakers are divided on how it will shape investment trends, but many believe decisions should not be made hastily.

“If private equity funds based there start moving away, it creates opportunities for other countries in the region, but dealmakers also noted that the costs associated with relocation makes the option less likely, particularly when it comes to smaller funds.”

Keys to revving up the APAC investment engine

Technology and innovation have been the vanguard of business continuation strategies during the pandemic and Asia Pacific’s speedy update of digital solutions has not gone unnoticed by dealmakers.    

 There is a strong conviction that more Asia Pacific investment opportunities will emerge, with 58 per cent saying the region will recover faster in an economic sense from COVID-19 than other global markets.

Andrew Heng, the Group Managing Partner at Baker Tilly Malaysia, says prospects in the Asia Pacific region are improving for dealmakers – but timing is crucial.

“Although the deal activity in APAC has generally slowed in the current economic environment, we can still see an increase in activity in certain sectors,” he says.

“The current situation presents opportunities for those willing to build the right foundation.

“The question is, what are the right projection numbers to consider in order to complete the deal flow in this time?”

Respondents told Global Dealmakers that Asia Pacific markets has shown better resilience and stability to the global recession, and investment was viewed as safer compared to Europe and North America.

It was also noted that global financial companies have increased their presence in Asia Pacific, which would enhance funding opportunities. 

Technology remains a growth market

Within the region, emerging south-east Asian nations offer the best investment opportunities according to an overwhelming 90 per cent of respondents, following Australia and India who are favoured by 63.3 per cent of dealmakers.

Entry into south-east Asian markets has been streamlined and the development of technology solutions is keeping the emerging markets on the radar, while Australia’s technology, stability and infrastructure were qualities that made it attractive for investors.

India has emerged as a regional hotspot for M&A during 2020, with dealmakers taking advantage a growth market in technology, healthcare and infrastructure.

Gaurav Drolia, a Partner with Baker Tilly India, says there may be an appetite for deals among businesses that are emerging strongly from this difficult period.

“Market conditions have been subdued for a while, but the amount of global stimulus and strong investor sentiment indicates industry leaders are looking to strike on the right deals to consolidate their businesses and create value,” he says.

“This might actually be an incredible period for corporates with strong balance sheets and cash reserves to focus on strengthening their core by getting deals at reasonable or even bargain valuations.”

Korea also looms as an attractive investment destination. In the last 12 to 24 months, only 6.7 per cent of respondents said they invested in the country but looking ahead, 35 per cent believed it offered the best investment opportunities in the coming year.

“Tech-driven M&A has become a feature of the current market as dealmakers seek out digital assets to transform their businesses,” Mr Sonego said.

“While this has been an ongoing trend, it was solidified by the pandemic amid the necessity for businesses to become virtual as consumers were driven online.

“Korea is an example of a mature economy with strength in technology and manufacturing, which is helping to increase its appeal to dealmakers.”

But the opportunity to engage in these markets remains limited by travel restrictions and the ongoing pandemic.

Nearly 40 per cent of dealmakers say they won’t consider any cross-border deals until the pandemic abates, and another 47 per cent say they will only consider certain cross-border investments. More than half reject global cross-border deals until the health crisis lifts.

Domestic deals appear more likely to be completed, with 57 per cent saying they would only consider certain investments and other 17 per cent saying the pandemic would not change their current strategy.

“As due diligence has become tough on buyers, identifying optimum targets will also become challenging,” says one respondent, who goes on to say that rising cybersecurity risks, IP challenges and potential legal issues make it all the more important to not cut corners when completing due diligence.

Waiting game for private equity

Private equity dry powder remains at record highs of US$388bn but most funds are still focusing on improvements to existing portfolio assets rather than new investment activity.

However, more than half of respondents feel opportunities in private equity throughout Asia Pacific will be better in the coming 12 months and mid-market deals will also improve, according to 47 per cent.

Distressed sales are increasing and these are likely to be a driver for private equity to return to the fold, with one telling Global Dealmakers the appetite for M&A will increase as corporations offer carveout deals and minority stakes to raise capital for core operations.

“The economic landscape will change in a couple of years and private equity firms can look forward to accelerated returns,” the respondent said.

Adrian Cheow, a Partner with Baker Tilly Singapore, said there was cautious optimism that deals could be done but the market should not expect a sudden flood of transactions.

“Private equity funds have a high level of dry powder in the region and are actively assessing new opportunities,” he says.

“However, pricing gaps between buyers and sellers are leading to longer discussions and funds are cautiously waiting and not rushing to deploy their cash yet.

“The crisis is forcing companies to transform and adapt at speed. This is where I believe PE firms play an important role in the recovery as they have capital, skills, and experience to help create value and work through these challenging times.”

A region of growth opportunity

As businesses adapt to a new post-Covid world, the mindset of business owners is beginning to move from the survival mode seen in the early part of the year.

Dealmakers believe the Asia Pacific region presents advantages and opportunities, but the fluidity of the pandemic also bring a dose of caution.

“Asia has fared better than the rest of the world,” Mr Sonego says. 

“The uncertainty created as Covid-19 spread across the globe and governments shut down, or hibernated economies, had business owners focussing intensely on their businesses. 

“As things began returning to the ‘new normal, this deep understanding has resulted in business owners and managers look at how they can use M&A to accelerate growth within their business.” 

Read: Global dealmakers: Asia-Pacific M&A market update 2020