Recession: Current Trends and Future Possibilities
The Ukrainian Journal of Business Law, Vol.8 #3 March 2009
The credit crunch which has turned into financial crisis and subsequently to the global economic downturn unprecedented for 70 years, has led the mergers and acquisitions market into unchartered waters. Lots of people remain clueless about the further effects of the deepening recession and its longevity. Even high-ranking and respected economists and analysts have tended not to make far-reaching prognoses since the forecasts of investment banks' analysts and rating agencies crashed at the beginning of the credit crunch.
M&A sector plummets in 2008
Last year witnessed a sharp decrease in number and volume of deals, but it is anticipated that the mergers and acquisitions sector will grow this year as number of distressed assets increases significantly, and cash-striving businesses become ready to be sold off. Some analysts put the sharp fall in mergers and acquisitions activity by some 30% in 2008 with a lot of deals breaking down. The Financial Times says approximately 1,000 deals have been abandoned (just mentioning the record BHP Billiton - Rio Tinto merger which could be worth USD 149 billion catches one's imagination).
Recently whole sectors of the economy have almost vanished from M&A news stories (real estate is the sector hit most by the credit crunch).
Turbulence in the construction and real estate markets could continue to the end of 2009 when the condition of the credit markets may stabilize (but this is a relatively optimistic projection). Retail chains are also to face serious problems and, therefore, could become targets for acquisition as the nature of their business looks more stable than the development business. The most probable scenario is that the fastest-growing chains will be hit (and some have already reported difficulties) as their dependence on lending is quite high.
There are several factors of last year's mergers and acquisitions decrease in Ukraine:
1) Lack of financial resources. Sources of stable and cheap money from abroad have almost ceased to exist. Therefore, even successful companies can hardly find financing for their acquisition transactions.
2) Decline of business profitability due to drop of consumer demand and respective fall of sales.
3) Uncertainty about future developments. The Ukrainian economic and financial situation is especially hard to predict; that is also a consequence of inconsistent government and regulators' policies.
Possible trends in 2009
A lot of companies guided by the "buy low, sell high" rule are seeking possibilities to expand their businesses by acquiring their not-so-fortunate competitors. Therefore, the harder the crisis hits, the greater the chances for the revival of M&A.
Foreign investors are also going to become interested in the Ukrainian market. Although the prospects of emerging markets, their economies, and investments thereto will be rethought in the course of the recession, Ukraine may remain an interesting market as some analysts call it the "last untapped market in Europe"; so, possibility of purchasing attractive assets for a modest price could grab the attention of investors.
The banking sector could, in its turn, become the "M&A blockbuster" of the year, with more deals than expected. Deals are going to be swift and complicated as most distressed banks will be put up for sale.
The presence of the National Bank of Ukraine as the industry regulator will make the situation with transactions more unusual than ever. The National Bank will probably try to gain assurances that troubled banks will not go bust, so the regulator's participation will be much more significant in order to facilitate the deal.
Legal aspects of the changing market
2009 is expected to be especially tough for business and so will bring some difficulties for law firms preparing to see double-digit falls in work volume.
However, the mergers and acquisitions sector may - alongside quite a few others - fluctuate more this year as distressed assets are going to be sold to raise cash for hard hit businesses. With Ukraine being hit especially hard by the economic crisis, the number of companies and businessmen in need of cash will rise in the first half of the year.
Therefore, cash-rich clients will be looking for viable businesses to acquire in times of economic decline. Companies and individuals who sold their assets just before the crisis emerged and sovereign-wealth funds could be especially vigorous in such activity.
This year will be distinguished by much fewer transactions being highly-leveraged, with lending in a state of collapse around the entire globe.
New legal trends will also materialise and the market will adapt to new conditions.
Thus, a "buyers' market" will emerge. Purchasers of assets will be able to dictate their terms to sellers, as the latter are very short of time due to the tightening financial situation. This may lead to some specific legal particularities.
Material adverse effect clauses in sale-purchase agreements are going to be expanded. Purchasers will try to expand the scope of material adverse effect clause so that it has coverage over more general industry disruptions going beyond seller-specific issues. Buyers will also try to include additional options for them to terminate a deal.
Material adverse effect clauses may also include changes in financial markets. This is determined by lenders including similar conditions in their lending instruments as a consequence of the volatility and unpredictability of markets.
Changing the trend, investments into industries currently experiencing a downturn may become prevalent as companies in such industries will struggle to find any investor not to go bust.
As the possible collapse of a deal could have disastrous effects for both sides in the context of an economic downturn, buyers and sellers are expected to negotiate more vigorously the specifics of dispute resolution terms in their merger or acquisition agreements, including choice-of-law and choice-of-forum provisions. Both parties will also concentrate on removing any ambiguity in the remedy and walk-away provisions that could result in long-lasting litigation.
Vendors are going to be more prepared to negotiate with an exclusive purchaser rather than to organise any sort of auction, which was more frequent earlier. This trend is going to emerge due to purchasers being very alert, market conditions moving extremely rapidly and leverage being hardly accessible. Sellers will also be very cautious about possible collapse of the deal and subsequent public attention.
Therefore, the swiftness of the transaction, confidentiality, confidence in obtaining funding and certainty of a deal being completed would be more important for sellers than getting the best possible price. It would be more interesting for companies to have business with a sole potential buyer who is credible and able to complete financing and the acquisition deal itself.
In exchange for exclusivity of acquisition negotiations sellers may get a lower break fee and they will also push for a shorter exclusivity period so that they can find another purchaser if the current deal collapses.
Sovereign wealth funds may become more active in 2009 as they are rich in cash and do not have problems with financing. Sovereign wealth funds which can be defined as state-owned investment funds have not been previously active in Ukraine. However, as the price of Ukrainian assets has sharply declined funds may become more interested. Their interest may be also reinforced by their mandate to have their assets diversified internationally. Sovereign wealth funds usually make long-term investments, so they could be not so anxious about recession, which could be quite extended in Ukraine.
Ukraine may become a more attractive jurisdiction due to its lack of restrictive legislation (Ukrainian legislation is virtually silent about sovereign wealth funds). Therefore, they could also not follow the Santiago Principles published by the International Working Group of Sovereign Wealth Funds, which somewhat restrict the activities of funds.
The sale of non-core assets could rise significantly this year as companies in critical need of cash and looking for restructuring will divest those of their assets that do not belong to the main business. Thus, the biggest corporations to be hit by the crisis may become major sellers.
Successful integration of merging businesses will be crucial this year, as effective synergy is one of the core issues in times of severe downturn. Therefore, united and manageable organisational system should be formed to establish operative control over cash flow, to arrange information exchange between units which were independent before the merger, and to retain key staff.
This year will be tough but full of new possibilities for businesses, as purchase of distressed assets may bring new prospects for development. There is a chance of new projects for lawyers who are going to be engaged in new as well as challenging work.
Roman Drozhanskyi is a partner with Volkov Koziakov & Partners