How Dealmakers Are Weathering Global Tension: Discord over the war in Iraq should be short-lived and have minimal impact on transatlantic dealmaking.

The drive to depose Iraqi president Saddam Hussein has taken a toll on the United States’ relationships with some of its principal allies. Diplomatic relations between the U.S. and countries that opposed the invasion of Iraq are strained, and small but very visible boycotts have hit many multinational companies. In the U.S., the protests are targeted at the French and Germans, while consumers from countries that opposed the war are boycotting American and British goods. Throughout the Iraqi crisis, the U.S. continued to do business with countries that opposed its stance, but easing the tension in their relations is proving to be difficult. The most pessimistic experts on transatlantic affairs think that the ties between some European countries and the U.S. may be irreparably damaged. More-optimistic observers believe that relations will be chilly for some time, perhaps until a new president enters the White House. Still others expect that the strong commercial and political ties between the U.S. and Europe will keep relationships from disintegrating completely. As the rift over the war lingers, questions on some business people’s minds include: Are political disagreements potent enough to sour business relationships among countries? At what point do differences of opinion on political issues become so great that they cause a rupture not just in diplomatic relationships but also in economic relations? In the dealmaking sphere, buyers and sellers wonder whether the rancor caused by the war might negatively impact multinational m&a. As long as the tension does not escalate, most experts that Mergers & Acquisitions talked to expect that the discord over the war will be short-lived and will have minimal impact on transatlantic dealmaking. A possible area of concern, however, is acquisitions of consumer products companies, especially French and German firms. Political friction could impact valuations of such deals, and buyers of consumer goods manufacturers could face short-term losses in revenues due to product boycotts, they say. Most of the experts think that the length and severity of the spat, and any resulting impact on business relations, will depend on whether the U.S. is determined to seek retribution against countries that opposed the war. The U.S. has hinted that opposers’ position would be taken into consideration when it comes to awarding some of the lucrative Iraq reconstruction contracts. However, excluding certain countries from playing a major role in the redevelopment of Iraq could intensify ill will and spur economic retaliation against the U.S. “I think that how the reconstruction of Iraq plays out will determine how long the tensions will last,” says Bob Filek, a Transaction Services Partner at PricewaterhouseCoopers. “Generally, I think that the quickness and success of the war has mitigated much of the potential concern, but I do think there will be some short-term sensitivities, because clearly the governments are playing their cards, and some of those cards do impact m&a because regulators do have deal approval authority and can influence deals, if not out-and-out restrict them. If it happens that commerce in France and Germany is negatively impacted by their being excluded from Iraq reconstruction, anyone doing a merger or acquisition in those countries would have to be aware of any potential ramifications of that.” How the reconstruction of Iraq plays out could also affect the buying and selling of the types of companies likely to participate in the rebuilding of the country, notes Thomas Sauermilch, a Partner in the corporate department of law firm McDermott, Will & Emery. For example, if the U.S. were to disallow countries that opposed the war to play a significant role in the redevelopment of Iraq, certain European companies, such as construction firms, could be passed over as acquisition targets, if it appears that they will be excluded from winning contracts, he says. Conversely, he adds, U.S. construction companies that hope to get substantial business in Iraq, and find themselves on the sale block in coming months, might not view European construction concerns as their preferred buyers. Other issues that could further injure relations include the U.S.’s possible exclusion of France, which led opposition to the Iraq war, from decisionmaking in international organizations like NATO, and disputes between the U.S. and France over a U.S.-drafted resolution to end sanctions against Iraq. France and other countries say that the resolution does not give the United Nations an important enough role in redeveloping Iraq. They also demand firm guarantees on how Iraq’s oil revenues will be used. In and of itself, the animosity is not expected to cause dealmakers any major problems. Yet if the crisis represents the beginning of a clear difference in diplomatic approaches between the U.S. and Europe, economic relations could be soured. Elliot Schrage, Adjunct Senior Fellow in Business and Foreign Policy at the Council on Foreign Relations, notes that over time, if the U.S. continues to pursue more-unilateralist foreign policies, the tensions in its political relations with Europe will be accompanied by contention in its economic relationships. “The Europeans may develop foreign policies on economic-related issues that might conflict with the approaches that the U.S. government or U.S. businesses take, for example. If the U.S. pursues trade standards that don’t focus on labor, environmental, social standards, and the Europeans support such standards, the differences in our approaches may ultimately pose challenges to m&a activity,” he says. While most people think that the bad blood between certain European countries and the U.S. will be temporary, he adds, some observers wonder whether that bitterness will resurface in new disagreements on economic relations and may over time be reflected in differing approaches toward the development of standards on issues affecting trade and investment. Among other issues, the tension between the U.S. and Europe, as demonstrated by the discord over Iraq, suggests “a basic disagreement in Europe and Washington over the value of multilateral versus unilateral approaches to global problems,” says Schrage. He lists the Land Mine Treaty, the Kyoto Protocol on global warming, and the Rome Treaty on the International Criminal Court as other issues on which the U.S. has differed in opinion from the rest of the world. Over time, he thinks that disagreements on these kinds of issues could affect the U.S.’s economic relationships. The disagreement over genetically modified organisms (GMOs) has been a sore point between the U.S. and the European Union for some time, says Schrage. In mid-May the U.S., along with Canada, Egypt, and Argentina, planned to file a World Trade Organization complaint in the hopes of getting the European Union to lift its ban on genetically modified foods and drugs. But with U.S./Europe relations still uneasy, the filing of the complaint could further provoke consumer backlash against American products, experts have stated. In the current dealmaking environment, the experts say, the strain is just a “speed bump” to experienced acquirers. Buyers with well-established acquisition strategies are marching ahead with deals. However, for companies that are relatively new to m&a or that are doing big bet-the-business deals, icy relations could have a significant impact on their multinational dealmaking, notes Peter Hirschmann, a Manager and part of the m&a practice at Bain & Co. “Big deals feel very personal. They’re done CEO to CEO, they’re emotional, and they’re infrequent. If you don’t have a track record of experience in place, uncertainty can have a huge impact on you. I think these types of buyers will have to look at their deals again, maybe slow them down, and perhaps revisit their relationships with the foreign CEOs,” he states. In the view of Andre Beaulieu, a private equity specialist at Bain & Co. in Paris, “rational business analysis will trump political analysis most of the time.” For a while, he expects that companies will be a bit more careful about approaching transatlantic transactions to ensure that “they don’t open the door to those who would bring political considerations to bear on a deal.” He thinks that prolonged tension more likely would affect trade flows than investment flows, since mechanisms for trade retaliation are easier to set in motion. And because of investors’ propensity to keep growing the global market, there is less chance for disruption in foreign investment, he adds. Agreeing with Beaulieu, Roger Kubarych, Senior Economic Adviser at HypoVereinsbank Americas Inc., notes that “the time horizons for m&a and Greenfield investment are a lot longer than any of these geopolitical tensions.” “You would have to see a major regime change, including the disbanding of NATO, the disbanding of the WTO, before there would be a major change in the incentives for doing a merger or acquisition,” he says. Considerations for a dealmaking company now could include whether the company’s board, the media, or consumers would be receptive to a U.S./French or U.S./German deal, notes one observer, who requested anonymity. Could boycotts disrupt merger plans, particularly for consumer products companies? And if an American company were looking to buy a French consumer goods company, for example, might there be pressure on the target to find a French merger partner, even if that buyer offered a less attractive deal? He believes that in the near future, there certainly might be a preference for local merger partners. Long before the Iraq crisis there had been an inclination in Europe for finding local merger partners, and that could increase temporarily, notes Beaulieu. However, there is also a great need now for U.S. buyers that are flush with capital to participate in European divestitures, he says. “There is not enough autonomous ability to keep sales within Europe in every case. It wouldn’t make economic sense. We will probably be able to point to evidence on the contrary in the next few months, but in the long run, without U.S. private equity funds and U.S. buyers, how can major European companies reform themselves and divest assets?” None of the experts has witnessed any cases of public pressure against a U.S./French or U.S./German deal but they say that is a consideration that dealmakers would have to keep in mind now. The biggest concerns, they say, involve acquisitions of consumer products companies, especially French firms. Political tension could impact valuations of such deals, and buyers of consumer goods manufacturers could face short-term losses in revenues due to product boycotts. While limited in scope and effect, boycotts of French goods have hit big companies like L’Oreal and Dannon, and have negatively impacted French tourism, wine sales, trade shows, and restaurants. James Croock, M&A Partner in the London office of Dechert, says that a U.S. buyer would not want to acquire a French consumer products firm only to find that American consumers are shifting away from buying French products. Boycotts are generally temporary, he adds, but if consumers find substitute products that they like, while they are boycotting French goods, they may continue to buy those alternate products. He points to the ban of British beef, imposed in Europe in the mid-1990s in response to mad cow disease. “The concern was that when the ban was lifted, countries already would have found alternate sources for their beef imports, so the British would have lost markets it once had. Today, it is conceivable that people could switch from French to Australian or Chilean wine, for example, and the French wine market might not bounce back for a long time, if at all.” On the other hand, the experts say, the current climate could present buying opportunities, especially if the purchase prices are attractive. And even though a target’s sales might suffer in the short term, due to boycotts, in the long run, the deal could end up being profitable. “Companies taking the long-term view that the strain between the countries will eventually ease may be attracted to such an acquisition,” says Croock. The experts add that now might be a time when companies choose to downplay their country of origin, and they could use mergers and acquisitions as a means of doing so. A U.S. company looking to “soften” its Americanness, for example, may consider bidding for a French or German company that hits the sale block. Some of the experts noted that senior executives at U.S. consumer products companies that they have spoken with have said they are accelerating efforts to accentuate their “local connections,” in light of the transatlantic difference of opinion over Iraq. But one commentator noted that as American businesses are seeking to be more diverse and more broadly representative of their customers and sourcing markets, the U.S. seems to be much more focused on advancing its more narrow, national interests. Sauermilch, who focuses his practice on cross-border transactional and commercial matters, thinks that globalization may be able to mitigate political tension to some degree. “Markets are global, companies are global, and if I were a French company, particularly a consumer goods manufacturer, I’d be concerned about being perceived as being “too French” and might do something to become more American.’ A company can ask itself what it can do to make itself more immune to political risk, and in this case I think it would be acquiring a U.S. company,” he states. Another area of concern for dealmakers is m&a regulation. While none of the experts who spoke with Mergers & Acquisitions think that the next General Electric/Honeywell type of deal will draw even more scrutiny from European regulators because of the bad blood between the U.S. and the European Union, some expect a certain degree of regulatory backlash, although they believe that it would be less potent than political backlash or consumer-driven backlash. Coincidentally, General Electric Co. appears to be heading for a similar showdown over its proposed acquisition of Instrumentarium Corp., a Finnish medical products company, although analysts doubt that retaliation is a motive. The European Commission halted its investigation of the deal in mid-April after asking the companies involved for more information on the medical products market. People looking for evidence of economic retaliation point to the news in early May that aircraft-engine manufacturer Pratt & Whitney had lost a nearly $3 billion contract with French commercial aircraft maker Airbus to a group of European competitors. The awarding of the contract to the European consortium highlights long-standing trade tensions between Americans and Europeans, especially in defense work, but the decision also comes at a time of intense political tension between the U.S. and France. A week earlier, Airbus appeared to have no problem snagging a $4.8 billion deal to supply 65 jets to New York-based JetBlue Airways Corp., a budget airline. Real or perceived retaliations aside, U.S. private equity firms are poised for opportunity in Europe, says Beaulieu, although, perhaps not in “sensitive” sectors such as defense or media. In fact, France was one of the most active m&a markets in 2002, and a number of U.S. private equity firms set up shop in Paris last year. And in the first quarter of 2003, Europe propelled the global m&a market, as uncertainty in the months preceding the war in Iraq cut into U.S. dealmaking. During the first quarter of this year, European deals accounted for 56% of the $287 billion in worldwide mergers and acquisitions, compared with 41% in the same period in 2002, according to data from Thomson Financial. In tracking private equity deals, Beaulieu adds, the share of U.S. funds participating in European deals has risen over the last few years, from 5% to about 20%, and he expects that trend to continue. European deals are getting bigger, he notes, and there are more club deals involving North American and European funds or American funds partnered with local companies. Especially given the current situation, Beaulieu expects private equity firms to increasingly use the consortium approach when dealing with divesting companies, in order to present themselves as more global,’ he notes. “The kinds of deals that we’ve seen in France in recent years, which were very large, we will see more of in France and other countries. There is actually a structural need for U.S. private equity funds to play a part in those deals. From that angle, it is even more obvious that these long-term factors will have more influence than political events. However, if the tension escalates or is not alleviated, we might have a different story,” he says. Copyright 2003 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com