Europe - Plentiful Opportunities
by HSBC
The Natural Resources and Utilities (NRU) sector in Europe is approaching a tipping point. Conditions for certain buyers appear ideal and there is no shortage of distressed assets looking for a new home. Yet a variety of factors have so far delayed what seemed to many an inevitable rush of M&A activity. It seems increasingly likely that this situation will change in the coming year and M&A levels will rise substantially [1]. This in turn will create an intense period of activity for corporate treasuries. Many of these will find that while some of the treasury consequences of European M&A activity are similar to those applying elsewhere, others are rather different.
Opportunities abounding...
From a macro economic standpoint, Europe currently looks particularly attractive to those from outside the region seeking to acquire Natural Resources and Utilities (NRU) assets. This is especially true of US buyers, who have benefited from the euro's slide against the US dollar since early 2014. At the start of that period, EUR / USD stood at ~1.40, while for much of the past two years it has oscillated around ~1.10. The recent rise in US interest rates has more recently provided additional USD support. Therefore, EUR-denominated NRU assets appear relatively cheap to US buyers.
Elsewhere, while the EUR / RMB exchange rate has been less favourable to Chinese buyers, this does not appear to be damping China's outbound M&A activity. Total Chinese outbound M&A by value in the first six months of 2016 almost exceeded total M&A for the whole of 2015. By the end of August 2016, China had completed 173 global outbound deals totalling USD128.7bn. While these figures relate to M&A across all sectors, leading Chinese oil companies CNPC, Sinopec and CNOOC have all publicly indicated that they are considering global M&A [2] and [3].
...but not yet taken
Yet despite these favourable conditions, actual European M&A activity has been far below the levels many predicted for 2014 and 2015, with several factors likely to be influencing this situation [4]. Continued weakness in commodity prices appears to have created a situation where buyers are waiting for the bottom of the market, but there is ongoing uncertainty as to whether that point has yet been reached. At the same time, sellers seem to have been basing their desired sale prices more on internal expectations rather than external realities. However, as pressure continues to mount, it seems credible that this gap between buyers and sellers will close and that perhaps just one major European acquisition will be sufficient to trigger a cascade of others.
Nevertheless, despite no shortage of private equity and other investors looking to acquire inexpensive European assets, debt financing of such assets has become more challenging. Several banks have reduced or stopped providing financing for businesses in the oil and gas sector. In addition, a major focus across the sector at present is the reduction of debt ratios. This is partly being driven by the current emphasis of rating agencies on ensuring that companies are well balanced from a debt standpoint.
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Consequences for treasury
Changing operating models
NRU company treasuries globally have had to make significant changes to their operating models as commodity prices have fallen. In a sense, these treasuries have been encountering the same cost cutting pressures that their counterparts in other sectors encountered immediately post 2008. Quite apart from the consequences of any M&A activity, there has been a more general need to streamline processes, increase automation and improve efficiency. In the case of any merger or acquisition activity, this need is even more pressing as there will be considerable duplication of processes, personnel and technology that needs to be quickly rationalised. Apart from cost reduction, this situation also creates considerable operational risks that need to be rapidly mitigated.
Dealing with this situation successfully requires careful planning and swift execution. It is also an area where the right banking partner can significantly alleviate the workload by sharing industry best practice, as well as with practical implementation support. This would apply in any circumstance, but is especially germane in the case of companies from outside Europe acquiring European assets. While European business and treasury practices may be relatively familiar to US corporate treasuries, the same may be rather less true of many Chinese NRU companies. Co-ordinated support from a banking partner at local level in both China and Europe that also leverages global expertise and network can appreciably enhance outcomes.
Visibility, liquidity and funding
One of the most time-critical tasks post-acquisition is gaining visibility and control of cash across the acquired entity. There are various ways in which this can be achieved and the strategy chosen will be driven by a mixture of corporate policy and what is actually practicable. One useful solution is to use a suitable cloud-based treasury management system (TMS). The best of these already have extensive integration built in for a wide range of ERP, accounting and treasury systems. This makes quick access to a new acquisition's bank account and financial information both possible, scalable and relatively painless. In some cases, the advantages of such a cloud-based TMS may mean it is also acceptable as a permanent solution for additional tasks such as automated cash flow forecasting and providing equity and debt instrument information.
While on the subject of debt, this is an area that is likely to require attention after any M&A activity in the context of liquidity management. The acquirer may have been strongly cash-positive pre-acquisition, but the costs of the acquisition may have significantly changed this situation and/or added external debt. This makes not just cash visibility, but also cash mobilisation and robust liquidity management an imperative - especially in view of the importance rating agencies are attach to debt/equity ratios [5].
Any review of liquidity management may also need to examine the acquirer's currency mix, which may have changed and need rebalancing. In the case of Europe, standardisation of regulation relating to cross-border flows within the region and initiatives such as SEPA may make regional liquidity management less challenging from a technical perspective than regions such as Asia. Nevertheless, the acquirer may still have to make significant structural changes in order to balance its debt position with the need to ensure that the acquired entity retains sufficient cash to fund day to day operations.
Banking relationships
Acquiring an asset may also involve acquiring (at least in the short term) new banking relationships, which given the long-term consequences of 2008 for many banks in Europe may have important treasury policy implications. Many larger acquirers are likely to have minimum credit quality criteria for banking relationships as part of their treasury policy that may not be met by newly-acquired assets' existing banks.
Transitioning all accounts to a new bank will typically take at least several weeks, which creates a need for more immediate interim measures. One tactic is to set maximum acceptable balance levels for the acquired asset's existing bank relationships and automatically sweep all cash above those levels to the acquirer's preferred partner bank until a more permanent solution can be established.
Early engagement with your existing banking partner can add significant value during this time of change. Given the commonality of event driven change your bank can be a key source of ideas on how to address other challenges, what other companies have done to address certain points and also connect you with these companies if appropriate. Your existing partner can then provide guidance on a more formal future by way of a tender. Not only will this help frame the alternatives available, it will ensure competitive fees and charges apply to your business.
Conclusion
It seems increasingly likely that a new wave of NRU M&A activity will soon arrive in Europe. The weakness of the euro versus the US dollar plus the quantity of distressed assets available make that almost inevitable. If this flurry of activity occurs, NRU corporate treasuries will become even busier and resource-pressured than usual. That will result in many such treasuries looking for banks capable of supporting them in quickly integrating assets in potentially unfamiliar locations that are using equally unfamiliar technology and processes.
