Easing uncertainty boosts M&A worldwide
In the past year, the global economy turned the corner to solid growth. 2017 was the first year since the crisis that none of the 45 countries and jurisdictions monitored by the Organisation for Economic Co-operation and Development (OECD) were contracting. This tailwind of global growth has been supportive of M&A activity. The OECD’s 13 March 2018 release of its global outlook showed an upward revision of global growth to 4.1 percent in 2018 and 4.0 percent in 2019. This optimistic forecast is reflected in almost all countries and jurisdictions, with developed markets seeing the greatest upward revisions.
In addition to economic momentum, several structural changes could pave the way for further M&A activity. The implications of US tax reform are becoming clearer. An outline of terms of Britain’s exit from the European Union (EU) has been mostly resolved. Elections in countries like France, Germany and the Netherlands were won by parties that generally uphold the mainstream. The upcoming elections in Brazil is widely expected to have similarly positive outcomes for global markets.
As structural reforms and economic growth provide the backdrop, the performance of M&A markets is getting stronger across the world. Following a relatively sluggish 2016, M&As got off to a slow start in 2017 but gained momentum as the year unfolded. According to Mergermarket,1 by the end of the year:
- North America saw almost 6,000 deals valued at 1.4 trillion US dollars (US$).
- With 7,235 deals, higher volumes of lower value European transactions amounted to US$929.3 billion.
- About 3,750 deals totaling US$673.5 billion took place in the Asia-Pacific region (except Japan), while over 450 deals in Japan totaled US$40.1 billion.
- Lower but nevertheless healthy deal volumes occurred in Latin America, with almost 600 deals worth US$80.4 billion, and the Middle East and Africa, with just over 400 deals worth US$59.4 billion.
- Globally, December 2017 alone saw five deals valued at almost US$200 billion.
- The energy, mining and utilities sector led the way globally in 2017 with deals valued at US$543.7 billion, followed by industrials and chemicals (US$395 billion) and consumer markets (US$380 billion).
Despite a correction in global markets early this year, M&A activity in 2018 could surpass 2017. Debt is expected to stay relatively inexpensive in the near term globally, and high accumulations of uninvested capital, or ‘dry powder’, are ready to be spent.
With a clearer idea now emerging as to the potential future bimpacts of Brexit, US tax reform and international tax changes from the Organisation for Economic Co-operation and Development’s (OECD) base erosion and profit shifting (BEPS) project, private investors that have been taking a wait-and-see approach may begin moving in from the sidelines, emboldened by consistent growth to enter multiple large deals.
Private investors that have been taking a wait-and-see approach may begin moving in from the sidelines, emboldened by rising political stability and consistent growth to enter multiple large deals.
At the same time, strategic buyers are reviewing their mix of assets to help determine they are well positioned for the coming years. Strategic buyers are also seeing a surge of investor activism — a call to rationalize their asset mix through spin-offs and carve-outs of non-core assets outside the mainstream of the business.
With interest in disposing of assets generally rising among both private equity and strategic buyers and growing demand from retail investors, interest in exits through initial public offerings may very well continue to climb.
Region by region, some of the more significant factors influencing the world’s M&A markets are as follows.
While re-negotiation of the North American Free Trade Agreement between Canada, the United States and Mexico continues to create uncertainty over future trade conditions, US tax reform is having a bigger, more immediate impact on M&A activity. The reform’s US$1.3 trillion in tax cuts will undoubtedly free up cash that can drive domestic investment.
The reform’s fundamental changes to the taxation of multinational entities could particularly affect planning for cross-border deals.
US tax reform’s fundamental changes to the taxation of multinational entities could particularly affect planning for cross-border deals. The changes include a shift from a system of worldwide taxation with deferral to a hybrid territorial system, featuring a dividend exemption regime with current taxation of certain foreign income, a minimum tax on low-taxed foreign earnings, and new measures to deter base erosion and promote US production.
In particular, the dividend exemption regime could prompt companies with offshore cash reserves to repatriate these profits, and those companies may then look for new opportunities for investment closer to home. In addition, even though interest rates remain low, the new limit on the deductibility of interest expense to 30 percent of adjusted taxable income may cause some international companies to move debt out of the US to foreign jurisdictions.
Of course, such substantial reforms will create both winners and losers. Nevertheless, US tax reforms could drive significant M&A activity involving the US over the next few years. The longer-term impact is less certain, as many aspects of US tax reform will expire in 5 years unless further legislation is enacted to extend the time-limited changes.
Europe seems to have emerged from a period of political uncertainty in good shape, with projected economic growth of 2.4 percent in 2017,2 the fastest in a decade, the European Commission says. Growth is expected to continue at 2.3 percent in 2018 and 2 percent in 2019.3 Concerns that recent elections would produce waves of populist governments across Europe did not pan out. Markets in Europe and the UK have recovered from the initial shock of Brexit, and they seem to be proceeding with ‘business as usual’ as the Brexit negotiations continue.
Technology is propelling considerable M&A activity in Europe with consolidation in the technology sector itself and more technology buys from companies in traditional industries seeking to increase their performance.
Technology is propelling considerable M&A activity in Europe with consolidation in the technology sector itself and more technology buys from companies in traditional industries seeking to increase their performance. In some sectors, technology is increasingly entwined, as shown by recent activity in financial services (i.e. fintech) and healthcare.
The OECD’s BEPS project and the European Union’s (EU) ATAD 1 and 2 continue to alter the landscape for M&A in Europe and beyond. EU member states are required to transpose minimum rules under the ATAD into domestic law by 2019.
The BEPS changes restricting interest deductions based on a limit of 30 percent of earnings before income taxes, depreciation and amortization (EBIDTA) are among the changes having the biggest impact since these restrictions are new to many European countries and jurisdictions, including the UK, Poland and Slovakia.
Many European countries and jurisdictions were among the first 70 countries and jurisdictions to take part in the signing ceremony for the OECD’s multilateral instrument (MLI) to combat treaty abuse in June 2017.4 The MLI provides a vehicle for the swift implementation of the tax treaty-related measures for hybrid mismatches, treaty shopping, permanent establishments and mutual agreement procedures.
Attention to the new risks from BEPS-driven tax changes is especially important when completing tax due diligence reviews, defining tax indemnities, and undertaking acquisition integration planning.
These changes could significantly affect cross-border M&A planning, structuring and financing in Europe and other regions. Attention to the new risks from BEPS-driven tax changes is especially important when completing tax due diligence reviews, defining tax indemnities, and undertaking acquisition integration planning.
Following the boom years of the recent past, countries and jurisdictions in this region have been establishing a firmer foundation for businesses and investing in their longer-term success. The diversity of tax regimes in the region creates varying conditions for foreign investment:
- Brazil’s upcoming election and stabilizing currency are helping to boost investor confidence and as a result the M&A market is rebounding.
- Argentina’s new government is making progress on structural reforms that are likely to attract foreign direct investment. These reforms include opening the previously state-dominated airline industry to competition, comprehensive tax reform, curbing subsidies on gas, electricity and transportation, enacting fiscal discipline, and reforming the judiciary.
- Peru and Colombia are attracting interest from private equity, particularly in the energy sector. Colombia introduced a major tax reform in January 2017 that, among other things, eases and simplifies corporation taxation while also addressing tax evasion.
- With corporate tax hikes and increasingly complex anti-avoidance rules, Chile’s recent tax changes have to some extent bucked international trends, but the country’s strong social and political stability continues to attract investors.
- The tax-friendly countries and jurisdictions of Central America remain viable, including Costa Rica despite its rising labor costs.
In the Asia-Pacific region, the near-term outlook is generally positive with adequate surplus capital and conditions for executing transactions getting easier. Like Latin America, however, the cross-border M&A climate in the Asia Pacific is mixed:
- Ongoing tax reforms in Australia continue to dampen the M&A environment. These reforms include a diverted profits tax that took effect in July 2017, increased withholding taxes on capital gains of non-residents selling certain Australian real property, and more capital gains tax changes affecting ‘look-through’ earn-out arrangements.
- Outbound investment from China in specific sectors has slowed in the past year under a stated government policy as worries that rising amounts of capital outflows have led to tighter foreign investment controls.
- Japan’s corporate tax rate has been steadily dropping to a current effective rate of about 30 percent. The lost tax revenues are being recouped through various measures, such as new limits on loss carryovers and scheduled increases to its consumption tax rate (from 5 percent in 2014 to 8 percent currently and 10 percent in 2019). Corporate tax rates have also dropped in Malaysia and Vietnam.
- Hong Kong (SAR) proposed to extend its profits tax exemption for offshore investment funds to onshore privately offered open-ended fund companies. It has also introduced a two-tiered profits tax regime that sees the tax rate for the first 2 million Hong Kong dollars (HKD) of profits reduced to half of the standard profits tax rate.
Technology accelerates tax due diligence reviews
The far-ranging impacts of current and potential future US, international and other tax reforms are complicating efforts of sellers to demonstrate full tax compliance to potential buyers and of potential buyers to conduct thorough due diligence regarding their targets’ tax affairs. With so many tax changes coming on stream, planning the tax-related details and clauses of legal agreements in advance is crucial to mitigate tax consequences, with special attention to clauses referring to price, contingent prices, liabilities, indemnification and warranties.
Brazil is leading a trend among tax and regulatory authorities worldwide to require electronic access to taxpayers’ digital records and accounts, and Latin American dealmakers have been among the first to deploy this technology in the M&A space.
Brazil is leading a trend among tax and regulatory authorities worldwide to require electronic access to taxpayers’ digital records and accounts, and Latin American dealmakers have been among the first to deploy this technology in the M&A space. Advanced data and analytics and artificial intelligence are transforming due diligence processes. As compliancedriven automation and standardization enables richer data and more powerful analytic results, due diligence teams can take a deeper dive into the tax affairs of targets more quickly, potentially shortening the deal-making process and enabling better decisions.
However, many sellers are reluctant to offer this level of openness, with sellers in the US generally showing less
comfort than their counterparts in Europe and the Asia Pacific region. As the use of data and analytics in M&A becomes more entrenched over the next 3 to 5 years, sellers in all parts of the world could be compelled to become more transparent.
On the buy side, early adopters of data and analytics could gain a significant competitive advantage, while those who delay may risk losing out as they struggle to catch up. Technology is also changing the composition of M&A teams, as data and analytic skills become an increasingly important part of the talent mix.
While the short-term outlook for global M&A is seemingly bright, some clouds on the horizon could alter the situation in the longer term. Many US tax reform measures will expire in 5 years. With a US presidential election coming in 2020 and Congressional elections in 2018, 2020, and 2022, whether these measures will be extended is unknown. If China continues to shift its global activities, the long-term implications are unclear. International tax rules should generally remain somewhat stable for 2018, but this may very well change in 2019 and 2020 as the minimum standards agreed by countries and jurisdictions taking part in the OECD BEPS project begin to take effect.
The current period of stability has M&A tax professionals with KPMG’s members firms optimistic that M&A deal volumes will continue to increase, at least for the remainder of 2018.
In summary, M&A activity is on the rebound worldwide as synchronized global growth combined with rapid technological change spur a realigning of strategic objectives. While the outlook is hazier 3 to 5 years out, the current period of stability has M&A tax professionals with KPMG’s members firms optimistic that M&A deal volumes will continue to increase, at least for the remainder of 2018. How long the current buoyancy will continue remains to be seen. For now it seems the time to ‘wait and see’ is over, and buyers and sellers have at least a limited window to make hay while the sun shines.
For more information, please contact:
Global Head of Deal Advisory, M&A Tax
T: +31 88 909 2564
Devon M. Bodoh
Global Head of Complex Transactions Group, KPMG International,
and Principal in Charge, Latin America Markets, Tax
KPMG in the US
T: +1 202 533 5681
Asia Pacific Regional Leader for Deal Advisory, M&A Tax
KPMG in Australia
T: +61 2 9335 8288
1 Mergermarket, Monthly M&A Insider, January 18, 2018, p 3–8.
2 European Commission, Winter 2018 Economic Forecast.
3 See note 4.
4 OECD, Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS.