Brexit could be good news for M&A scene in SEE

By Marin Drinov, Attorney-at-law, CMS Sofia

For more than three years Brexit has remained a hot topic not only from a political perspective, but also from a business one. The decision of the United Kingdom to leave the European Union breeds insecurity with respect to many issues, including trade flows, travel, working permits, state boarders, etc. A hard Brexit scenario fuels fears of a recession, which in the environment of a globalised economy may not only spread over the European continent but produce a ripple effect on an even bigger scale. It seems that no one can predict the exact impact Brexit will have on the business but the data accumulated since the referendum show that there could be surprisingly positive turnarounds, especially for certain regions in Europe.

The general rule is that political uncertainty is bad for the business, yet when speaking about merger and acquisition activity, this may not necessarily be the case. Actually, contrary to expectations, the widespread political tension did not deter the acquisitions in SEE countries during the past years.

Surprisingly, 2018 showed growth in M&A deals in Europe and in the SEE region in particular. Worries that Brexit vote will affect in a negative way the investors’ appetite for risk with new acquisitions proved unfounded in the 2016-2018 period, both on a local and on a global scale. The SEE market witnessed an increase in overall deal value of more than 10% in 2018 as compared to 2017 whereas the deal volume remained flat with an insignificant decrease around 1%. As regards the SEE countries, the last three years were characterised by stable market indicators with little fluctuation in deal volume. Both M&A deals and greenfield investments have continued to spur economic growth across the region.

 

But by getting closer to the ‘final exit’ date there are some signs that the continuous increase will be paused, at least for a while. First-quarter data for 2019 show a decrease by 23% in global deal value and a 33% drop in volume. The downward trend is not limited only to specific regions such as SEE, but is common for the whole of Europe. Deal values and volumes declined across most regions and sectors, where crossborder deals reached their lowest annual level since 2009. The question now is whether the beginning of this year marks a significant turning point or just a temporary dip before the next rise of activity.

Of course, Brexit is not the only reason why the M&A market is losing momentum. At a time of political turbulence, economic slowdown, global protectionist policies and trade tensions, it is normal to expect disturbance in M&A activity. As the acquisition market is governed by people, it is understandable that at some points in time it may be highly volatile. In the current situation executives in charge of acquisitions may become too cautious. However, a lot of tension has accumulated, particularly because of the leave vote and the current positions of both the UK and the EU, and with the appointment of the new PM it seems that a mutually acceptable exit deal is less probable.

If a balanced deal is reached, we could witness quick growth in M&A activity in all regions of Europe. However, following the election of Boris Johnson as prime minister, the Brexit puzzle could take an even more hazardous turn as he is without doubt the most vigorous defender of the leave vote. Considering his political profile and rather unconventional behaviour, Johnson could easily become the catalyst for a no-deal exit on October 31. The fact that he is threatening not to honour the payments due to the EU under the withdrawal agreement and that nodeal hardliners are being promoted at his office will most probably lead to further deterioration of relations between the UK and the European Union, making the no-deal leave the more likely scenario.

In a worst-case scenario, the effect on the acquisition market in the UK will be extremely negative, according to all but a handful of members of the Conservative party in London. However, that could be a golden opportunity for the SEE region. Any negative effects with respect to the British economy have the potential to shift the focus of M&A activity towards countries in the Union. British companies planning their post-Brexit strategy could start acquisitions in regions with relatively stable indicators such as SEE in order to better withstand the possible downturn.

For UK companies considering moving to continental Europe, the SEE region is a logical choice. A number of British companies have already been operating in the region and are considering expanding their presence in Southеast European countries. In case of a no-deal Brexit, SEE countries could be a reassuring option for investors with the stability and easy access to the European market that they offer. According to a recent study by the London School of Economics, British companies have already diverted more than 10 billion dollars of investment to EU countries due to Brexit (12% increase in new foreign direct investment projects in EU countries by UK companies).

In a number of regulated industries, the acquisition of strategic targets in EU member countries would facilitate business operations across the entire bloc, which would be crucial for British companies trying to preserve their footprint on the European market. Furthermore, US, Asian and Western European investments could be diverted from the UK to SEE countries. So far, foreign direct investment from EU to the UK have decreased by 11% and after Brexit the total amount of foreign direct investments to the UK is estimated to decline by 22%.

All of the incentives mentioned above, combined with additional benefits such as cheap real estate and low-cost labour market, as well as well-developed transport links offered by SEE countries make the region a promising choice for investors. During the past decade a major part of the foreign investments was distributed among Central European countries, but as living standards rose, the price of investing in that region also went up. SEE countries may now grasp this opportunity to attract some of the investments by providing similar quality, yet at a better price.

On the downside, a hard Brexit is expected to have a negative effect on the GDP of SEE countries estimated at around 1%, as this could also impact M&A activity in the region. However, cheap financing due to low interest rates, the increased presence of private equity capital and the never-lasting desire of big investors to search for new opportunities will most likely offset any drop in GDP.

Brexit should not be underestimated as a threat for the smooth economic development of the SEE region. The downturn trend in M&A transactions could continue due to accumulation of concussions following the UK exit and negative effects of other international conflicts. However, considering the substantial amounts of free capital currently available and the willingness of investors to get involved in other parts of capital structure, such negative trend will probably result only in a temporary setback. Free capital with private equity and pension funds will not remain idle for long and as problems often create opportunities for quick and adaptive investors, mergers should be getting in motion.