Strategy, Not Currency Value, Drives Acquisition Decisions

One would think that a result of the declining dollar at the end of last year and in the first quarter of this year would be an increase in cross-border M&A activity by European companies hunting for relative bargains in the United States. Yet, the trend has not occurred, and it is unclear whether it will occur if the dollar does not continue its recent rebound. For example, according to research conducted by KPMG, the first quarter of 2005 saw Europeans strike only 81 deals in the United States, compared with 88 in the first quarter of 2004 and 77 in the first quarter of 2003 – when the global M&A market was much less active. As the dollar fell against the British pound, European consumers came to view vacations to the United States as bargain-basement shopping sprees, eating fancy sushi at up-scale New York restaurants for prices 40% cheaper than at similar restaurants in London. Americans, on the other hand, have been advised to avoid Europe and instead to visit South America, where the dollar has not been hit as hard. However, it’s clear that the shopping habits of consumers do not parallel those of corporations and private equity firms. There are several explanations for the apparent anomaly. The primary reason is that acquisition decisions are usually made with an emphasis on strategy and fit, with currency values playing a far less significant role. A global Conference Board survey of CEOs and CFOs determined that less than 10% of respondents were inhibited by exchange-rate volatility when making foreign investment decisions. Economic research indicates that the effects of currency fluctuations on mergers and acquisitions tend to be muted in large companies. Indeed, the importance of currency fluctuations for large multinationals is further lessened by the fact that they are able to manage their multi-currency earnings with hedging activities. A cheaper dollar, meanwhile, may have more of an effect in the middle market. While strategic needs continue to drive U.S. companies investing in Europe, a changing global market may partially explain why there has not been a surge of interest in U.S. targets. In 2002, China for the first time exceeded the United States as the number one recipient of foreign direct investment. This shift toward Asia may be responsible for a relative lack of interest in U.S. targets. The percentage of global deal volume has been declining in the United States, which accounted for approximately half of all global deals in 2000. Last year, U.S. deal volume made up a little more than 42%, according to one report. In addition, it’s not clear that the advantage of favorable currency rates in an acquisition will be fully realized. A European company that buys an American company with the hopes of benefiting from a weak dollar has to repatriate the cash flows at the future exchange rates, which are difficult to predict. Europeans may also be wary of the significant risks in cross- border deals. These deals tend to be more complex and involve added regulatory and cultural issues. The ways in which the deal is financed and structured may lessen some of these uncertainties. Acquirers should weigh foreign exchange risk against value risk and credit risk and consider hedges against each. Several other issues could be contributing to the fact that Europeans have not increased their U.S. acquisitions. One reason that European companies are not acting like European consumers is that prices are still high. Even taking into account the currency discount, American companies cannot be described as undervalued. On average, U.S. companies continue to trade at multiples higher than their European counterparts. Since many deals are financed by stock, in that sense Europeans may find themselves with a purchasing currency that may effectively be worth less. Yet another possible factor is a response to the increased regulations imposed by Sarbanes-Oxley. In fact, last year several European companies made moves to de-list themselves from U.S. stock exchanges. Be wary. Even though currency valuations are not the primary deal motivators, at some point they do become relevant. If a target presents itself as superb strategic fit, at some point a negative turn in exchange rates could make an acquisition simply too expensive. For U.S. acquirers, there are several ways to deal with this type of currency fluctuation. Although there is some risk involved, if an acquirer is fairly certain of the date the deal will close, it can enter into a financial hedging arrangement. Second, a buyer can fund the deal with local currency debt, which effectively creates a natural hedge. Regardless of currency valuation fluctuations, however, solid strategy and proper fit carry the day when processing a cross-border deal. In this era of global transactions and emerging markets, the wise know it. Without those two components in place, the old adage “you get what you pay for” holds sway. Shaun Kelly Global Head of KPMG LLP’s Transaction Services Practice ACG New York [email protected] www.us.kpmg.com (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com