Europe as an investment destination

M&A activity globally is suppressed as a result of high interest rates, equity market volatility, a more febrile geopolitical environment and supply chain issues that are eroding profits and driving businesses to turn their focus inward. On the flip side, inflation is falling in Europe, and despite continued price pressure from rising wages, a weakening EU labor market provides a counterbalancing effect.

E.U. regulators play outsize role in global M&A

The European Commission remains among the toughest merger control enforcers in the world, even when considering the global trend towards greater regulatory intervention in big-ticket M&A deals. Authorities globally are increasingly aligned with politicians in their view that the merger control enforcement environment has been too lenient in recent years, resulting in industries being allowed to consolidate to the detriment of competition and consumers. 

At the same time, the U.K. Competition and Markets Authority (CMA) is carving a reputation as a fearsome and unpredictable authority post-Brexit. The U.S. Federal Trade Commission (FTC) and Department of Justice (DOJ), meanwhile, have been even more interventionist than their counterparts in Brussels in recent times. This dynamic prompted one of our interviewees to admit that “M&A in Europe feels a little easier to manage right now.”

Data and tech remained a priority for the current Commission, which has intervened in recent transactions over issues including interoperability and data access. As far as the latter is concerned, the E.U. has introduced the Digital Markets Act as another way to apply pressure on the global tech giants, alongside its use of pure competition law. 

While the E.U. maintains it is open to foreign direct investment, three years on from the introduction of the E.U. FDI Screening Regulation, the proportion of foreign investments being formally reviewed continues to rise. Elsewhere, E.U. Foreign Subsidies Regulation – which is designed to protect the level playing field within the single market by introducing a notification regime for deals involving parties that have received distortive “foreign financial contributions” – adds a further layer of complexity to the deal approval process. This is particularly so for private capital firms, which now face the challenge of putting in place measures to track the relevant data at both fund and asset level.

Analysts have speculated that the forthcoming election could result in more Eurosceptic voices in Parliament on both the far left and far right, which could lead to calls for more freedom for Member States to set their own economic, fiscal and regulatory policies. If these predictions prove correct, it could make the investment environment more fragmented in the years to come.

Public takeovers require understanding of Europe’s nuances

A deep understanding of Europe’s nuances is needed when considering public company takeovers. Europe’s listed businesses have proved attractive acquisition targets in recent years, with public takeover activity peaking in 2021. While deal values and volumes have fallen since, European equities have been trading below U.S. stocks for some years. Returns from the S&P 500 began to outstrip those of the MSCI Europe (which comprises large- and mid-cap businesses across 15 markets) in 2011 and are now 2.5 times higher.

We have seen some big-ticket public takeovers in Europe in recent years, but more often public-to-private deals involving mid and smaller-cap companies that are out of the analysts’ spotlight and struggling to access liquidity with their shares trading at a discount. Here, a de-listing via a strategic combination or private equity buyout can be a lifeline. Strategic buyers currently have an advantage over financial investors because they can use their shares to fund acquisitions rather than having to seek bank syndicated loans. Other financing sources are available but can be expensive, leaving financial sponsors struggling to achieve the sorts of returns they enjoyed in the past. 

Against this backdrop, our survey painted a fascinating picture of real and perceived deal risks. Respondents whose businesses have completed an acquisition in the past two years listed cyber security due diligence as the biggest challenge they faced (73%), with managing the risk of leaks among the top five issues (67%). Our respondents whose businesses haven’t been active in M&A over the same period had leaks way down in 10th place.

The latter point is interesting in the context of public takeovers, given the importance of maintaining confidentiality under the E.U. Market Abuse Regulation (MAR). Understanding the differences between Europe’s myriad public M&A markets is critical to successful transactions.

European public takeovers: 12 issues to consider

1. Secrecy is critical in all European markets. Buyers must limit the number of insiders and use codenames and passwords to preserve confidentiality, while NDAs and standstill agreements with the target are usually needed before non-public information can be shared. Even in the earliest stages, any leaks or even general market rumours can trigger a requirement to formally announce under market abuse regulations or specific takeover rules– and in some markets can cause the bidder to lose control of the process. In Germany, a share price rise after a leak increases the mandatory minimum price the bidder must offer if it proceeds with the bid.
2. Due diligence in public takeovers is shorter and more limited than in private M&A deals, which helps to reduce the risk of leaks. Price-sensitive information should already be in the public domain due to MAR requirements, meaning targets typically see the DD process as more an exercise in confirmation than discovery.
3. In some jurisdictions including Spain, France and Belgium, targets are required to share the same diligence information with all bidders, which can cause some to withhold information in case any of their competitors emerge among the potential buyers. In the Netherlands, Germany and Italy, asymmetric disclosure is permitted.
4. It’s common for buyers to seek early engagement with senior management (and in Germany possibly the chair of the supervisory board) before making a formal approach. Managers may – and sometimes in some jurisdictions should – brief their directors, but could initially maintain confidentiality; if PE bidders jump the gun on discussions around topics like management incentives and/or equity rollovers it can jeopardise the deal.
5. In jurisdictions such as the Netherlands, it’s standard practice to submit a non-binding offer to the target board that includes, among other things, details on price, strategic rationale, financing and high-level plans for management and employees. Here, unilateral engagement with shareholders may be viewed as hostile and may be restricted under the terms of the NDA. Spanish and German public companies typically have a controlling shareholder; in these jurisdictions it’s common for the buyer to make a direct approach to them either before, or alongside, any talks with the target board.
6. Some degree of certain funds financing is required in all European markets before launching a cash bid, but there is variance among regulations and market practice in relation to the level of certainty of funding, the timing and the evidence required. For example, bank guarantees/letters of credit are required in France, Spain, Italy and Germany (although funds can be placed in a blocked account in the latter as an alternative to a bank guarantee).
7. The most common way for a bidder to achieve control is via a tender offer recommended by the target’s board. However, depending on the jurisdiction, different levels of shareholder acceptance are required to delist the target and execute a squeeze-out to reach 100% ownership. In France and Germany, the threshold for squeezing-out minorities is 90%. In the Netherlands – where public takeovers are executed via so-called “pre-wired back-end” structures – the market practice acceptance threshold is 80% (you can read more about trends in Dutch public M&A here).
8. Directors’ fiduciary duties play a critical role in negotiations, and again vary across borders. The German and Dutch legal systems for example operate a stakeholder model whereby directors must take into account a broad range of interests, including what’s best for the business in the longer term. 
9. Takeover regulators are equally important to the process, although at what level varies from market to market. The Spanish CNMV and Italian CONSOB are heavily involved from the outset and throughout. By contrast, the Dutch AFM and Germany’s BaFin are more reactive. 
10. Interloper risk is significant, particularly in Italy where many deal protections for the bidder (including break fees, “no shop” clauses and exclusivity) are prohibited. In other jurisdictions, including the Netherlands, meaningful no-shop and break fees are seen.
11. Buyers have limited ability to walk away from a deal post-announcement. In some markets, many types of condition (for example, material adverse change (MAC) conditions) are either prohibited or not invocable except in limited circumstances. 
12. Deal timetables are similar across Europe given they are largely driven by regulatory processes (eg merger control, foreign direct investment and financial regulatory).

Managing regulatory risk in deal execution

Our interviews also revealed how businesses are managing regulatory and other risks in the context of M&A transactions. Firstly, many of the business leaders we spoke to said smaller deals involving targets that fall below the revenue thresholds for some of Europe’s more stringent regulatory regimes are more challenging than bigger acquisitions.

A general counsel at a financial services firm said: “These companies may not be capturing all the climate data we require, or might not have wholly baked compliance programmes in place in other areas.” Any key regulatory compliance issues identified through the due diligence process become conditions precedent in deals, because “if we don’t articulate these things, we could be mispricing the deal”.

Trey White, vice president of corporate development at SAP agreed. “Anything we’re buying will need to meet our highest-common-denominator regulatory requirements. When we’re doing a deal with a big enough company, say USD1 billion or above, they’re already taking this stuff into consideration. Smaller companies however may have little to nothing in place. This means our teams have more work to do, which results in higher costs for the integration process and puts more strain on the business case going to the board. Over the last couple of years our due diligence request list has grown substantially and now covers questions relating to data privacy, compliance, export control, government relations, supply chains, human rights and more.”

Regulatory risk management through the deal process is particularly important for private equity buyers given their investment horizons. Regulatory investigations in Europe can take years to resolve, and if issues are not identified and addressed prior to completion they may result in enforcement action. This, in turn, could impact the sponsor’s exit options.