The European M&A market remained buoyant throughout 2017 against a backdrop of political uncertainty, including national elections in France, Germany, UK and the Netherlands, according to the tenth edition of the CMS European M&A Study.
The study, which analyses more than 3,650 of its private M&A transactions and compares the CMS deals of 2017 against its deals from 2010-2016, reveals that, driven by solid European economic data, overall deal value climbed in Europe to USD929.3 billion, up 14 per cent compared to 2016. Structural changes arising from President Trump’s “America First” policy and Brexit, along with strong eurozone performance, continue to attract foreign investors particularly from the US and Asia. Deal data for 2018 suggests activity levels have continued where 2017 left off, indicating another productive M&A year to come.
According to the study, there were changes in risk allocation in 2017 compared to 2016. The position of sellers in 2017 was strengthened thanks to more deals with locked boxes, W&I insurance and lower liability caps.
Stefan Brunnschweiler, Head of the CMS Corporate/M&A Group, says: “We have analysed thousands of our European deals, witnessing some of the most significant changes since 2010. In 2017, we saw sellers exploit the buoyant M&A market by reducing the residual risk on seller/buyer risk allocation to the same level as 2015, and they probably did even better than that.”
Martin Mendelssohn, Corporate partner at CMS in the UK, adds: “Investors, and especially international investors, saw the structural changes potentially caused by Brexit in the UK, as a real opportunity, not a reason for caution. The UK M&A market was very busy in 2017 with sellers doing particularly well on risk allocation issues with many deals featuring locked boxes, low liability caps and W&I insurance for the buyers. That has continued in 2018.”
The 2017 European deal landscape paved the way for warranty and indemnity insurance (W&I insurance) to boom, enjoying a ten-year high. A total of 14 per cent of all European deals used W&I insurance in 2017, compared to 9 per cent of deals in 2016. This was especially prevalent in deals valued above EUR100m.
The sector with the highest proportion of deals using W&I insurance was Real Estate and Construction where 42 per cent of deals included the structure. The incidence was lower in other sectors in 2017 including Consumer Products (9 per cent), TMC (9 per cent), Hotel and Leisure (7 per cent), Energy (7 per cent), Infrastructure (4 per cent), Industry (7 per cent) and Business (other services) (15 per cent). The study revealed that the increase in W&I insurance has historically been driven by private equity activity, with a steady increase in large buy-out deals.
The use of locked boxes continued to increase, with data showing this structure featured in 25 per cent of all deals across Europe in 2017 compared to 23 per cent in 2016. The study highlights that the larger the transaction, the more likely that locked boxes were used, where the deal did not include price purchase agreements (PPA). The highest percentage of locked boxes was seen in deals larger than EUR100m that did not include PPA (88 per cent). Comparatively, locked boxes were used in only 39 per cent of deals of up to EUR25m in value without PPA provisions.
There was also a marked increase in the use of locked boxes in UK and German-speaking countries from 2016 to 2017, from 40 per cent of deals to 51 per cent in the UK and from 38 per cent of deals to 49 per cent in German-speaking countries. The use of locked boxes in Southern Europe increased from 36 per cent of deals in 2016 to 58 per cent in 2017, while the largest decline was seen in the Benelux where 50 per cent of deals used the structure in 2017, down from 71 per cent in 2016.
Liability caps, which appeared to have stabilised in 2016, decreased, with 60 per cent of 2017 deals now having a liability cap of less than half the purchase price. The use of liability caps below 10 per cent of the purchase price in 2017 stood at 21 per cent of deals compared to 14 per cent in 2016, with these lower liability caps particularly prevalent in deals of more than EUR100m. This demonstrates an increase in sellers’ negotiation power, with the rise of W&I insurance being one of the main reasons for the lower liability caps. The buyer can top up its protection relating to warranties by purchasing cover from an insurer on top of the cap agreed to by the seller.
The study revealed core differences in mechanisms within Europe. For instance, an earn-out element applies in 21 per cent of transactions across Europe but is much higher in Benelux, Southern Europe and German-speaking countries with percentages of 30 per cent, 33 per cent and 28 per cent respectively. Meanwhile, the percentage of deals applying an earn-out is much lower in CEE (15 per cent), France (8 per cent) and the UK (15 per cent).
In France, there was an increase in transactions with a lower liability cap of up to 25 per cent of the purchase price, from 70 per cent of deals to 76 per cent, higher than the European average of 42 per cent. The UK saw higher level of sellers’ liability caps than any other region except Southern Europe.
The study also highlighted a number of stark differences between the US and Europe in relation to seller/buyer risk allocation. One example is the inclusion of Material Adverse Change (MAC) clauses in 93 per cent of US deals compared to 13 per cent of European deals. Despite the differences, the study predicts that US corporates will continue to target European M&A alongside Asian and eurozone dealmakers.
Brunnschweiler says: “We are delighted to be celebrating the tenth anniversary of the European M&A study. The insights obtained provide companies with a crucial benchmark before engaging in future deals. It showcases key risk allocation features like no other study of its kind.”
