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Recovery in EU activity holds promise for South Africa’s M&A activity

Mergers and acquisitions (M&A) activity in South Africa in the first quarter of this year was below the levels recorded prior to the pandemic, which demonstrates a continuation of investor nervousness from 2020, says law firm CMS South Africa M&A head of Africa Deepa Vallabh.

Activity in South Africa decreased as a result of the Covid-19 pandemic. The value of the deals also shrank.

The 2020 slowdown in South African M&A deals had indicated a trend of nervous investing during the height of the pandemic and, in particular, nervousness about investing in the global South.

However, there is cause for optimism as a number of analysts predict a rise in M&A activities this year, she says.

One of South Africa’s most important trading partners remains the European Union (EU), which accounts for at least 25% of South Africa’s trade and 75% of foreign direct investments.

“Given the importance of this relationship, and understanding that the investment dialogue between South Africa and the EU still continues, trends in M&A deals recently concluded in Europe hold lessons for South Africa,” Vallabh says.

The ‘CMS European M&A Study 2021’, based on 408 recent M&A deals in the EU, found that 45% of the deals represented a buyer entering into a new market.

Further, 31% of deals were either the acquisition of know-how or acquisition hire transactions where companies were bought out primarily for the skills and expertise of their staff, rather than for the products or services they supply, and 22% were the acquisition of a competitor.

CMS found that the pandemic led to delays, the renegotiation of key terms, including in certain cases in respect of transactions closed in prior years involving earn-outs, and, in some cases, transactions did not proceed.

“Many failures in transactions arose from parties failing to secure funding. A few deals were terminated owing to the application of material adverse changes (MAC) clauses. This demonstrates that MAC clauses may become more frequently introduced in M&A transactions in the current uncertain investment environment,” Vallabh says.

In 2020, there was also a small decline in the use of purchase price adjustment clauses in M&A agreements, at 44% compared with 45% for 2019.

“This seems to reflect a levelling off in the application of such provisions over the last three years and reflects a decrease from the high of 49% in 2015. We expect to see a decline in the use of price adjustment clauses, as parties are seeking more price certainty.”

However, the disruption to the M&A market was not as severe as anticipated in early April 2020. The CMS survey indicates a return to more buyer-friendly positions on certain deal points.

For example, liability caps increased significantly in 2020 and there were fewer deals where the liability cap was less than 50% of the purchase price, with more deals being concluded where the liability cap was equal to the purchase price.

“This indicates that more buyers are looking to do deals on the basis of the ongoing financial performance of the company, instead of locking those transactions at any particular time,” Vallabh says.

“There also seems to be a drop in using warranty and indemnity insurance in transactions, although it might still be relevant to some very large transactions,” she adds.

As a result of dramatic changes in how people work and play, M&As can be used as a tool for effecting a rapid transformation to address the shift. CMS has seen an increase in technology deals.

“However, investors still need to be very cautious of South Africa‘s increased and rising debt levels, a possible resurgence of the Covid-19 pandemic and the slow roll-out of the vaccination programme.

“Given these fundamentals, South Africa may see a muted year of M&A activity, yet I remain cautiously positive about future deal activity in the region,” she adds.

“The development and roll-out of numerous vaccines, a tentative return to international travel and life slowly returning to normal should encourage corporates and sponsors to look hopefully towards the future.

“The economy in South Africa, in particular, appears to be resilient and agile, and primed for future deal-making, with respect to lower valuations, distressed deals that may come up and government support being crucial in key sectors,” Vallabh concludes.

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Portrait of Deepa Vallabh
Deepa Vallabh
Partner
Johannesburg