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Where Are All the Europeans?

Conditions seem ripe for a transatlantic M&A invasion. There are good reasons it isn't happening.
Joseph McCafferty, CFO Magazine
May 1, 2004

From across the pond, American assets look downright cheap these days. Weakened by huge U.S. trade deficits and low interest rates, the dollar has plunged 32 percent since its October 2000 peak. And with merger-and-acquisition activity heating up on both sides of the Atlantic, one might expect a "European invasion" like the 1998-2000 spree that led to BP-Amoco-Arco, Vodafone-AirTouch, Daimler-Chrysler, and numerous other combinations.

So why did European companies strike only 97 first-quarter deals in the United States this year, down from 133 in a year-earlier period when overall global M&A activity was far weaker? "It's surprising," says Scott Adelson, senior managing director at Houlihan Lokey Howard & Zukin, a Los Angeles-based investment bank and M&A advisory firm. "Effectively, everything in the U.S. is on sale."

At the same time, the exchange rate would seem to dictate that U.S. companies will shun European acquisitions. Home Depot Inc. CEO Robert Nardelli scotched January rumors of a possible British deal earlier this year by calling the idea "dumb," and arguing that "there couldn't be a worse time to do an international acquisition, with the euro at $1.25 to $1.28."

So why do other American companies now seem to be growing hungrier for transatlantic acquisitions? They have moved to snap up 160 European businesses in the latest quarter—most of them in small or midsize deals—including Yahoo Inc.'s $574 million (475 million euro) offer for France-based Internet company Kelkoo SA. Indeed, in dollar-value terms, American buying of European assets is an emerging trend, building on last year's doubling of announced U.S. cross-border deal-making from $36.3 billion to $74.8 billion—led by General Electric Co.'s $9.5 billion plan to buy British medical-diagnostics company Amersham Plc.

The reasons for this seeming flip-flop of European and American roles start with an old M&A adage: acquisition decisions are based far more on strategy and fit than on currency values. But with the increasing earnings health of many U.S. companies marking them as prime targets for strategic buyers anywhere, another look is warranted. And that deeper explanation reflects more on the unclear economic outlook in Europe.

"While the economy is improving, continental Europe still has some concerns going forward," suggests Henri Servaes, professor of finance at London Business School. "The sentiment about economic growth is not as strong as it is in the U.S." It is unlikely, he adds, that Europeans will stage another push for American acquisitions until they get their own houses in order. Amid slow growth, many European companies, especially those in the euro-zone, are still restructuring to cut costs.

"Cross-Border Is Harder"
This counterintuitive relationship between deal flow and currency values surprises few experts in the M&A field. One problem with buying American assets to take advantage of the weak dollar, observes Servaes, is that the cash flows eventually coming from the purchase must be repatriated at the future exchange rate, which is difficult to predict, but could well be less advantageous. That point isn't lost on European companies that are now watching profits from their American subsidiaries dwindle due to the weak dollar. "If a deal makes sense only on the assumptions of future exchange rates, then you should not do the deal," the professor says. Instead, he advises, don't let decisions be governed by exchange rates, and concentrate on the value of the asset. If your company thinks the dollar will recover, buy dollars instead.

Moreover, companies enamored of the exchange-rate advantages of a transatlantic transaction may forget the risks inherent in that type of deal. "Cross-border M&A is that much harder to make work," says Servaes. "Returns are generally lower," and the transactions are often more complex, while presenting higher regulatory and cultural hurdles. J.P. Morgan Chase & Co. estimates that, taking hedging activities out of the equation, the record of value creation for European acquisitions of U.S. businesses has been even worse than the unenviable performance record of deals within the United States. Perhaps, having been burned before, the Europeans are staying home these days.

Vodafone certainly is—at least for now. The favorable exchange rate wasn't enough to save the UK-based mobile-phone giant's recent bid for AT&T Wireless, after a bidding war developed with Cingular Wireless. Vodafone bowed out in February, when Cingular upped its bid to $41 billion. Vodafone had opened the bidding at $30 billion, eventually raising it to $35 billion, which translated into £18.3 billion. (The pound closely tracks the euro against the dollar.)

Illustrating the advantage of the weak dollar for Vodafone, that same $35 billion bid would have cost £21.7 billion just a year earlier. In the end, though, the deal boiled down to strategic fit, and Vodafone's commitment not to overpay. It made more sense for Cingular and AT&T to combine, putting similar technologies together and creating greater synergies. In order for Vodafone to complete the deal, on the other hand, it would have had to sell its profitable Verizon Wireless stake. That sale would have been in dollars, so Vodafone's exchange-rate benefit would have been reduced had it used the proceeds toward the AT&T Wireless purchase price.


Over There
For American companies looking overseas for acquisitions, strategy also seems to trump any weak-dollar concerns.

When Reynolds and Reynolds Co. wanted to expand to Europe, CFO Dale Medford says exchange rates weren't a large factor for the Dayton-based provider of IT systems to automobile retailers. The company paid $7 million for Incadea AG, a privately held software company based in Raubling, Germany, assuming $4 million of debt (in euros). "Had [exchange rates] been in a range that made it overly expensive, it could have made us reconsider," says Medford. "But the acquisition was very important to us strategically."

Reynolds and Reynolds plans to build on the Incadea acquisition and roll out products throughout Europe and the rest of the world. The company will not hedge against the cost of the deal, since its business will be conducted in a number of currencies. "We'll take more of a portfolio approach," Medford says. And, he adds, since the cost basis in Europe will be in euros, it will "act as a natural hedge against our euro-based revenues." (Companies that buy distribution networks in Europe to sell products that are made in the States must worry more about exchange rates. That's because their costs will be in dollars, while revenues will be in euros or pounds.)

What concerned Medford more was the array of regulatory issues to be confronted when doing business across Europe. "You have to deal with so many authorities," he says, "that it gets expensive if you are just doing a little bit." That's why Medford believes European expansion plans need scale before they make sense. "You can't just dabble," he says.

Still, some experts say that U.S. companies do need to consider the impact of exchange rates on European acquisitions. One way to offset an unfavorable exchange rate is to raise cash by issuing debt in the target company's home currency, notes Jimmy Elliott, head of North American M&A at JPMorgan. "Acquirers need to weigh foreign-exchange risk against value risk and credit risk to determine which risks to hedge," he says.

GE's purchase of Amersham, for example, will cost nearly $350 million more due to the dollar's decline since the deal was announced last October. And since it is an all-stock deal, GE has fewer options for hedging against the falling value of the dollar.

GE is going ahead with that purchase. But what should a company do if another sharp jump in the euro creates the temptation to kill its European acquisition plans, on put them on hold? Make them part of a broad pricing review, the experts suggest.

"You have to look at all the variables," says Arthur H. Rosenbloom, managing director of CFC Capital LLC, a New York M&A advisory firm. At some point, "a negative turn in exchange rates could be enough to make an attractive target too pricey."

Joseph McCafferty is news editor of CFO.

Against the Tide
Americans are buying European assets despite unfavorable exchange rates, while Europeans, after an earlier invasion, are largely passing on U.S. deals.

(in $ billions)
Americans targeting European companies
Europeans targeting American companies
1998
66.8
165.2
1999
84.7
198.9
2000
82.1
194.8
2001
41.4
60.6
2002
36.3
35.8
2003
74.8
6.1


Sources: J.P. Morgan Chase & Co., Thomson Financial




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