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M&A Buyers: Look Before You Leap

Bar & Bench

by Shubi Arora

Like Reliance, other Indian companies are undoubtedly hunting for bargains and many international opportunities exist for them to expand their operations.  Compared to US and European companies, many have been stockpiling cash for years and are well-capitalized. However, Shubi Arora feels that when it comes to diligence, documentation and integration, foreign buyers in particular must exercise caution and be wary of issues that are unique to cross-border deals.

Reliance Industries Limited has just announced that it intends to purchase a controlling stake in LyondellBasell Industries AF, the world’s third-largest chemicals company.  LyondellBasell filed for bankruptcy protection earlier this year after the economic downturn triggered a sharp decline in demand for its products.  If the deal is successful, not only will it be the second largest overseas acquisition by an Indian company (second only to Tata’s 2007 acquisition of Corus Group for approximately $13 billion), but it will catapult Reliance into the ranks of one of the largest petrochemical players in the world.  The proposed deal is a winning bet for Reliance and with approximately $4 billion in cash, $8 billion in treasury stock and a favorable debt-to-equity ratio, it has the financial clout to fund the deal and significantly boost its core business.

Like Reliance, other Indian companies are undoubtedly hunting for bargains and many international opportunities exist for them to expand their operations.  Compared to US and European companies, many have been stockpiling cash for years and are well-capitalized.  Thus, they enjoy a competitive advantage with respect to their western counterparts whose sources of traditional financing have now become severely curtailed.

Most often, distressed asset deals proceed at a rapid pace.  Buyers with the desire to grow rapidly and globally may feel the need to rush into such deals to capitalize on the bargain-basement prices.  Also, distressed targets, often under pressure from maturing debt obligations, put pressure on buyers to execute deals with the utmost and sometimes unrealistic speed.  However, despite the fact that distressed deals must generally be executed with rapidity, buyers must look beyond just the bargain price.  They must bear in mind that thorough diligence, documentation and integration are still critical in such deals, perhaps even more so than in acquisitions involving healthier targets.

While comprehensive due diligence encompasses legal, financial and other business matters, the scope of diligence in a particular transaction is driven by its timing and structure. Timing in particular may impose some practical limitations on a buyer’s ability to conduct exhaustive diligence, but it is nonetheless critical to understand the material aspects of what is being purchased.  Despite any limitations, buyers must ensure that there are no skeletons in the closet that may have material and adverse implications post-closing.  Lawyers, accountants and other advisors are all indispensible to a thorough diligence process and together can help buyers understand any issues that either add value or pose risk.

Diligence enables a buyer to identify items that must be addressed in the transaction documents.  Until the current crisis, M&A documents had become increasingly seller-friendly.  Often, the parties executed documents that allocated the bulk of the risk to the buyer.  However, the tide has now turned in favor of buyers.  Buyers need to understand their bargaining position and negotiate documents in a manner that minimizes their risk.  Since sellers of distressed assets are likely to be highly motivated to sell assets or divisions due to an urgent need for cash flow, not only can buyers negotiate for provisions such as closing conditions and termination fee provisions that are more favorable than those of yesteryear, but they can also negotiate that sellers retain certain risks that might otherwise have been previously assumed by a buyer in the context of an “arms-length” transaction.

It is also imperative that buyers implement strategies to integrate the target’s operations into their own.  To be sure, this process may prove to be particularly challenging in a distressed deal.  Problems with the target may cause its customers to look into taking their business elsewhere.  In addition, key employees, fearing uncertainty with respect to their future may think about leaving.  Cross-border deals in particular involve unique problems with respect to integration.  For instance, the differences between the corporate cultures of the buyer and the target may be pronounced.  In addition, the target’s home country may have business customs that are different than customs where the buyer is based.  Without proper planning, such differences can adversely affect both internal and external relationships and have a crippling effect on the target’s post-closing operations.  These problems are surmountable, but a well thought-out integration plan is critical.

When it comes to diligence, documentation and integration, foreign buyers in particular must exercise caution and be wary of issues that are unique to cross-border deals.  Regulatory hurdles, tax considerations and disclosure obligations all merit careful attention when engaging in a cross-border transaction.  Buyers need to fully understand how the process works in the target’s country and hire sophisticated counsel and other advisors to guide them through such aspects of a proposed transaction.  Otherwise, a poor deal foundation can  prove to be very costly.

Shubi Arora is a U.S. corporate associate at the global law firm of Squire, Sanders & Dempsey LLP.  His practice focuses on business transactions including cross border mergers and acquisitions, private equity investment and project finance.

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