Q&A: Natixis' Raghu Narain

Q: What is the current climate for China M&A?

A: There's been an overall decline in M&A volumes in the first half of 2019, and it's a decreasing trend from global to Asia to China as a subset of Asia. Deal volumes are down about 8% globally and 20% in Asia ex-Japan, and down roughly 30% in China, year-on-year. China outbound M&A used to be the topic du jour, when it reached a peak of $220 billion in 2016, but that has changed substantially. Depending on what numbers you use, when you annualize the first half, China outbound M&A comes to $60-70 billion for 2019, which is at the low end of the long-term average.

Q: How much of this is due to the trade war?

A: There is a whole host of factors that flow into what we're seeing, but the trade war and the drop in China outbound M&A are very closely linked, particularly in the volumes to the US, which I would say have dropped in the region of 20%. Now some of that focus has shifted to Europe, which for the near term continues to represent a location to acquire assets. But there's a broader effect that generally dampens confidence in doing outbound M&A. There is a base level of uncertainty globally that has increased.  

Q: How has the market changed from a macro perspective?

A: Geopolitical risk today is much higher than it was 24-36 months ago. The trade war and protectionist sentiment is one aspect of that dominating the headlines. But there is no doubt that we have reached the last innings of what I would call a very long economic expansion cycle, where we're facing a slowdown or even a recession. Valuations have been high because of the high level of liquidity that has been pumped into the market over the last decade by central banks. Whatever mega-merger activity would have led to a cost rationalization has already happened. The juice has already been taken out of the system.

Q: What are the considerations for investors?

A: You're facing a riskier environment. That is impacting confidence, and it's something people need to be mindful of, especially when they're looking at very large M&A deals. Making those happen in the post-merger environment is very tricky because there's more at stake. For investors, it comes down to the basics of M&A. It's got to follow an industrial logic. In this environment of heightened uncertainty, it's not sufficient to do a deal because it presents theoretical growth. You've got to really look at whether it relates to new customers or geographic expansion.

Q: How are higher valuations impacting strategies?

A: Proper evaluation of deals is critical. In the middle part of M&A cycles, it's a bull market, where everyone is chasing deals and there's an incentive for one company to follow another because you don't want to be left behind. Now, it's more that you want to be able to do deals that truly make sense. You've got to make sure while asset prices are high that you're not overpaying for deals because that's a sure-shot way of creating trouble for yourself.

Q: So the volume of mega-deals will decline?

A: I think that would be a logical outcome, especially cross-border. Intra-US mega deals are still happening, but that's a very domestic market. Cross-border mega deals, $10 billion-plus, as they relate to Asia Pacific, that's complicated. I think there will be less desire to pull the trigger on a big one.

Q: What other trends are you seeing?

A: China divestitures are interesting, particularly where the assets were acquired by poorer deal structures, such as those with high leverage, lacking industrial logic, or just irrational investment. Those kinds of deals are unfolding, and the sale of those assets is accelerating both domestically and abroad. You've got about $35 billion of that happening this year, predominantly overseas assets. That's particularly by corporates, less so by private equity.

Q: How is private equity participation evolving?

A: The private equity experience globally, and especially in China, has been underpinned by the liquidity that's been made available either from foreign or domestic banks. When you drill into China PE, it's been mostly about accumulating assets so far because we haven't gone through a divestiture cycle. We've seen PE pairing up with Chinese corporates that have done outbound deals because PE tends to have people with more of a financial skillset than an operating skillset. So you're seeing these consortia and it's a nice combination. We've also seen Chinese PE investors as typical participants in auctions, competing to acquire midcap and large assets.

Q: What about state-owned enterprises (SOEs)?

A: SOEs will be encouraged to do deals that benefit China because they are the transmissions for the country. And on average, it will be easier for SOEs to do good deals in a cross-border outbound context than for POEs [private-owned enterprises]. The POEs are essentially linking back to the consumer base, but the SOEs are acquiring assets to promote the national agenda. We should see SOE activity picking up in outbound M&A.

Q: How is this reflected in deal targeting patterns?

A: Five to seven years ago, there was a focus on the consumer space for things that were historically not available such as brands, apparel, and fashion. But that has shifted to a sectorial experience, which is more about key things like healthcare, food safety, and education services. Whenever you have things that better the lives of people, those sectors will see more acquisitions versus, say, a nice fashion company. Luxury deals will still happen, but that's elastic demand – the appetite is just not what it was for macro reasons.

Q: How will tech uptake impact this activity?

A: The speed at which technology is evolving in China is amazing and the whole ecosystem is designed to promote the next generation of growth. But the other dimension of tech in China is in outbound M&A, which is more complicated because it touches geopolitical nerves. The thing is that tech cuts across verticals like education and food, which will be more easily acquired than a pure tech play. Healthcare tech that makes medical processes more efficient will probably continue to be more approachable.

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• Topics
• Greater China
• Advisory
• Investments
• China
• M&A
• Natixis