Raising Barriers to Inbound Deals: Political intervention is feared in future cross-border M&A

In the wake of the political firestorm over the Dubai Ports World (DPW) acquisition of Peninsula & Oriental Steam Navigation Co. (P&O), M&A experts are scrambling to make sense of the controversy’s impact on future global dealmaking. Some early developments suggest that changes in deal structuring and execution are inevitable, although the long-range picture remains unclear. “We’re in a different era now, if only because the possibility that any given acquisition by non-U.S. parties will enter the political arena is far greater,” says Dewey Ballantine Partner Harry Clark in summarizing the new realities for inbound deals. In fact, the post-DPW environment seems to have claimed at least one inbound agreement. Check Point Software Technologies Ltd., a leading Israeli software company, pulled the plug on its acquisition of smaller U.S. software player Sourcefire Inc. after American officials raised national security concerns during the deal’s review. The transaction was being vetted by the agency that had cleared the DPW/P&O deal – the Committee on Foreign Investment in the United States (CFIUS). Clark believes that prior to the DPW flare-up, the Sourcefire acquisition would have been approved. Other signs of a new ballgame include an expected increase in protectionism as a takeover defense; projections of more challenges to inbound acquisitions by commercial rivals; an upsurge in filings with CFIUS, to a large degree for public relations purposes; new deal wrinkles to defuse national security concerns; and efforts to overhaul and strengthen the CFIUS law. In another vein, dealmakers are concerned that outbound deals may hit roadblocks if foreign regulators retaliate against American companies entering their countries. National security concerns also found their way into Alcatel SA’s $13.4 billion proposal to buy Lucent Technologies Inc. The companies finessed potential objections by agreeing to put government work done by Lucent’s Bell Labs unit into a separate subsidiary with an independent board, a move that might be replicated by other cross-border partners in similar situations (see sidebar). DPW touched some raw nerves politically because with P&O came management contracts at six major U.S. container ports. Opponents, mostly in Congress, objected to an Arab company having oversight of security-sensitive infrastructure. DPW ultimately agreed to sell the American ports business to a U.S. company. But protectionism in the legislative branch was erupting before the DPW row. The battle in the summer of 2005 for Unocal Corp. between eventual winner Chevron Corp. and Chinese state-owned CNOOC Ltd. also demonstrated the limits on the U.S. market for foreign acquirers. Fadel Gheit, Senior Vice President of oil research at Oppenheimer & Co., says Chevron management used political leverage to turn back CNOOC’s bid, adding that Chevron was desperate to acquire the Unocal assets. Chevron, based in San Ramon, Calif., was able to mobilize its state’s congressional delegation of more than 50 members to help defeat CNOOC, which withdrew before a CFIUS review. “This political environment has made it very difficult for us to accurately assess our chances of success, creating a level of uncertainty that presents an unacceptable risk to our ability to secure this transaction,” CNOOC said in a written statement. The Unocal board accepted Chevron’s offer of $17.1 billion, well under the $18.5 billion offered by CNOOC. In a pending acquisition affected by the changed dealmaking climate, Dubai International Capital LLC, owned by the Dubai government, delayed its $1.2 billion purchase of privately held military equipment maker Doncasters Group Ltd. Although Doncasters is U.K.-based, it has nine plants in the United States and the deal is subject to CFIUS review. Dubai International cited potential U.S. security concerns when it announced the delay. “The fact is that this protectionism is becoming a takeover defense,” says Clark. He notes that the original objection to the DPW transaction came from Eller & Co., a Fort Lauderdale, Fla., company that worked with P&O at the Port of Miami. Concerned about a loss of business if the deal went through, Eller hired a lobbyist to bring the matter to the attention of Congress. Eller also challenged the deal in a British court, but lost. However, the Washington, D.C., lobbying initiative set off a nearly unprecedented level of attention to the acquisition of P&O and the transfer of control at ports in the United States and Vancouver, Canada. Clark says he expects to see more foreign buyers challenged by commercial opponents of the deals. “The fallout from Dubai Ports definitely opens the door for competitors to break up deals,” he says. Clif Burns, a Partner at Powell Goldstein in Washington, says that dealmakers already are filing more CFIUS notices than they did before the DPW controversy. Although notices presently are voluntary, new legislation could make them mandatory. With a timetable of a 30-day review at the first level, followed by another 45-day examination of some deals, CFIUS complications could kill some transactions merely by delaying them. Burns says that he’s more likely than before to counsel a foreign buyer to anticipate protectionist reaction against a deal and to respond by planning public relations and legislative lobbying campaigns. But even with extensive preparation, Burns notes that foreign companies have an inherent disadvantage in conducting a legislative lobbying campaign. It’s illegal for them to make campaign contributions. As a result, it will always be an uphill struggle for foreign companies to secure congressional support. This especially would be the case in an election year or if a politician finds that the need to appear “tough” on national security would play better at home than a commitment to free trade. Some U.S. antitrust theorists have maintained that the antitrust process in the European Union provides overrepresentation of competitors voices in the dialogue on whether to approve a deal. Now, they say, the U.S. antitrust process may come to resemble the European process more closely. One of the ironies in the DPW saga is that the logistics industry, in which both DPW and P&O compete already, is largely foreign-owned. “The Dubai case showed how little Congress understands logistics and the supply chain structure of inter-modal cargo,” says Clifford Lynch, a logistics consultant based in Memphis. If people were more aware of the logistics industry, they would realize the large extent to which foreign companies already own the supply chain, he adds. “Dubai is here to stay. They own formidable logistics assets. It would have been smart not to tick them off.” In fact, the logistics industry’s ownership structure may make it hard for DPW to find an American buyer for its U.S. port operations. Commentators suggest that because most U.S.-based container port operators lack the money or expertise to buy the business, a deal may have to include a private equity partner or another foreign company. The ownership picture is similar in the domestic and international security industry. “The security industry has been in the forefront of cross-border M&A early on and with continued frequency,” says Jack Mallon, an investment banker and expert on security industry deals. He points to two of the best-known American security companies – Pinkerton Security and Burns International – which were acquired by the largest pure-play security company in the world, Sweden’s Securitas AB. He notes that the first salvo in the wave of protectionism occurred when the Transportation Security Agency (TSA) required companies that bid for U.S. passenger airline screening to be U.S.-owned. Mallon says he doesn’t think the DPW deal has had much impact on security industry consolidation yet, but adds that may be because two of the largest acquirers, Securitas and Group 4 Securicor PLC, aren’t doing much buying as they try to digest a number of recent cross-border acquisitions. One likely outcome from the DPW episode is a revamping of the legislative oversight of foreign investments. CFIUS has been a little-known body composed of representatives from the Treasury Department, Defense Department, and other executive branch agencies. Filing a notice with the committee is voluntary. In the past, CFIUS was largely guided by its lead agency, Treasury. It tended to support commercial transactions and rarely invoked national security concerns to challenge deals. Indeed, it cleared the DPW acquisition of P&O. If CFIUS ruled against a deal, it would empower the President to veto the transaction. Burns says that even before any changes to the Exon-Florio Act that created CFIUS take place, people will be filing notices on inbound deals that might have been skipped in the past. “It will be seen as insurance against the President or Congress unscrambling a deal if either party deems it as anti-security,” he says. He cites the SourcePoint deal as an example of the likely reaction in the post-DPW climate, even before any new legislative measures are passed. “People will back out rather than going all the way through the process and accepting whatever conditions might be imposed,” he says. A reinvigorated committee seems likely. The Senate Banking Committee has unanimously approved a bill to broaden its review process. Sponsored by Chairman Richard Shelby (R., Ala.), the bill calls for increased security of all “critical infrastructure.” Among the provisions that may make up the final version of the bill are: * A requirement that Treasury notify Congress of deals being reviewed; * A mandate for vetting all transactions by foreign state-owned firms; * Notification to state officials and congressional representatives in districts that would be affected by inbound transactions; * Creation of a ranking system of all countries based on their relation with the U.S. and their adherence to U.S.-backed weapons controls accords; and * A requirement that the President report to Congress why a deal was approved or rejected. The reforms could subject nearly all proposed acquisitions by a foreign government or company to a review process that could take as long as 120 days. The Shelby bill did not include a plank that would give Congress the right to veto any deals, although that was discussed in preliminary sessions. A House measure was expected in April. The Senate bill, in its current form, was modified by input from the business community, which fears the legislation will have a chilling effect on investment in the United States. A group of Wall Street representatives, composed of the American Bankers Association, the Banker’s Association for Finance and Trade, the Investment Company Institute, the Securities Industry Association, the Bond Market Association, the Financial Services Forum, and the Financial Services Roundtable, sent a letter to Shelby warning against a “retreat from open markets and from the free flow of capital.” The letter closed with the request that “Congress keep America’s markets open while it protects America’s security.” In a similar vein, executives from Morgan Stanley, Merrill Lynch, Citigroup, and J.P. Morgan Chase sent a letter to the Senate Banking Committee expressing their concerns about changes in the CFIUS law. Inside the Beltway, opinion seems to indicate that there will be some legislation passed that will stiffen the review process. “Given that it’s an election year, there’s a good chance that some of the proposals will be enacted,” Burns says. Looking forward, Andrew Lipman, a Partner at Bingham McCutchen in Washington, says that if the Shelby bill becomes law, it will lengthen the review process and increasingly politicize it. He notes that since CFIUS was set up to insulate transactions from any political wrangling, the proposed changes represent a significant policy shift. Lipman suggests that foreign acquirers take the initiative in addressing the predictable concerns of CFIUS policymakers. These could include retaining data in the United States, cooperating with U.S. law enforcement authorities with regard to wiretaps, setting up boards of sensitive subsidiaries or divisions that are manned by U.S. executives, and adherence to U.S. pension and corporate governance laws. “It will be better to present a proposal with these safeguards up front, rather than to wait for policymakers to take shots at and raise concerns about a foreign investment project,” he says. And in addressing the proposed ranking system of foreign countries, Lipman says, “Who your daddy is increasingly is going to be a relevant factor.” Indeed, some dealmakers are handicapping less trouble for Alcatel/Lucent because the buyer is European, rather than Chinese or Middle Eastern. In blocking and tackling for foreign buyers, American consultants should assume that some fairly intact version of the Shelby bill will become law, Lipman says. Dealmakers, he adds, should structure transactions so that the deal documents reflect measures that will facilitate rather than complicate CFIUS approval. Dramatic as the DPW controversy has been, it has not affected M&A at every level. Some mid-market business sellers and buyers told Mergers & Acquisitions that they haven’t yet seen any effect. Charles Ogburn, the Atlanta-based Executive Director of Arcapita, an investment company whose home office is in Bahrain, says he doesn’t expect the DPW controversy to affect many, if any, of his firm’s transactions. He says that on the margin, foreign buyers that fear an irrational regulatory regime might become less inclined to pursue a deal. While Arcapita’s deals don’t touch on industries that would raise security concerns, he says he believes that the DPW situation has injured the image of the United States abroad. “The U.S. occupies a special place in the world as the biggest economy, the most open society, and the one with the deepest and broadest capital markets,” Ogburn says. “The rest of the world looks to the U.S. as the most fair and transparent market. When we pull a stunt like this, we injure that reputation.” Hazel Mack, Managing Director of the M&A practice at Willis Group, a London-based insurance broker, has another take. “The reaction to Dubai Ports strikes us as odd here,” she says. “As a Brit, I don’t think we would have reacted the same way. It seems to us that, yes, the U.S. had 9/11, and that was tragic, but that’s not a reason to embrace protectionism.” Another European dealmaker, Dr. Harald Klien, Managing Partner of CD Invest Consult in Vienna, says he thinks that while the DPW case sends the wrong message about the United States’ commitment to free trade, he hasn’t seen any effect on the mid-market deals. Of course, for U.S. dealmakers who are pitching projects abroad, the Dubai Ports effect may have a sharper edge. Ron St. Clair, CEO of Stalcop, a Thorntown, Ind.-based maker of cold-formed metal products, cites the plight of outbound investors. “This sets us back in America. Now we’re in the same boat as the French or the Germans. It will make it hard for me to explain to potential targets why the U.S. isn’t open to some foreign investors when I want to invest in their country,” he says. Away From the Fray Eager to skirt another national security blowup on an inbound acquisition, merger partners Alcatel and Lucent Technologies devised a format to insulate U.S. government work done by Lucent’s Bell Labs from the combined company. Lucent says most of the legendarily innovative Bell’s work is commercial but the portion that involves government projects, including military and intelligence, will be channeled into a “separate, independent U.S. subsidiary under Bell Labs.” Equally telling, say observers, is that three marquee defense and intelligence names have been recruited to man the board that will oversee the new unit. The board will include former Defense Secretary William Perry, who will serve as chairman; retired Lt. Gen. Kenneth Minihan, who once headed the National Security Agency and Defense Intelligence Agency; and former CIA director R. James Woolsey. An attorney familiar with inbound acquisitions says the choices are significant because they are well-known figures are in the defense and intelligence communities and thus are likely to be easily accepted by them. Additionally, they should have clear sailing in regaining their security clearances. – Mergers & Acquisitions (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com