HOW THE POST-PANDEMIC ERA WILL RESHAPE DEALMAKING IN SOUTH AFRICA
There will come a time when South Africa puts the ‘COVID-19 era’ behind us and coronavirus becomes an inherent part of our daily lives, much like the common flu. Even so, the aftershocks from the pandemic and decisions made during the crisis will continue to reverberate through the country’s M&A landscape.
While some of the reverberations may diminish over time, others are anticipated to become firmly entrenched features of the M&A landscape.
These repercussions range from significant shifts in some regulators’ approaches to certain M&A transactions to more subtle – but no less important – changes in the legal-technical and financial detail of deal-making.
Whilst some of the changes are likely to complicate dealmaking to an extent, others may actually facilitate it.
Foreign investment: regulators signal shifts
One of the main trends emerging in South Africa is the shift in the policies and approaches of regulators as we emerge from the pandemic, most notably the Competition Commission of South Africa (Commission) and the South African Reserve Bank, with some being favourable to foreign investors and others less so.
Following global trends dealing with the economic costs of the pandemic, the Commission is taking a stronger stance on local and worker ownership. In particular, it is focusing on black economic empowerment (BEE) considerations aimed at ensuring economic participation by those sectors of society disadvantaged under apartheid.
A case in point was the decision by the Commission to prohibit the proposed private equity acquisition of Grand Parade Investment’s shares in Burger King (a BEE success story). Had the transaction gone through as proposed, the BEE shareholding would have been reduced from 68% to 0%.
Ultimately, the proposed transaction received approval after the Commission and the parties reached agreement on acceptable conditions. These included an employee share ownership scheme and significant other commitments to compensate for the diminution in shareholding by historically disadvantaged persons.
Going forward, we anticipate that the Commission will closely scrutinise BEE and other public interest considerations in future M&A transactions. It is now an inherent part of the Commission’s policy approach that every transaction must promote BEE ownership, something which is being strongly resisted by the market.
The sphere of exchange control is another noteworthy area.
While generally investment-friendly, obtaining exchange control approval for foreign investment is a common feature of dealmaking in South Africa. A noteworthy policy shift in South Africa welcomed by foreign investors has been the relaxation of the so-called ‘loop structure’ requirements with effect from January 2021.
Another welcome shift is the current proposed reduction of the ‘red tape’ associated with legitimate financial flows. This would entail moving away from the restrictive default approach of requiring prior approval for capital flows towards the introduction of a ‘progressive’, pro-investment default position of permitting all capital flows, save for a limited list of risk-based capital flow measures.
Impact investing in the limelight
A very prominent effect of the pandemic has been strong investor interest in and the growing popularity of impact investing (i.e., investments made with the altruistic intent alongside financial return). There is also a growing focus on environmental, social and governance (ESG) considerations.
Chief among the various reasons for these trends is that target companies rating highly on key sustainability metrics are more sought after. Second, regulations dealing with ESG are increasing around the world, along with consumer pressure and investor interest in ESG – and South Africa is no exception. Evidence that the South African Government is following suit on ESG trends are the changes to electricity generation policy and the publication of a technical paper on ‘Financing a Sustainable Economy’.
It remains to be seen whether or not the hostilities in Ukraine, the economic sanctions imposed on Russia and the resultant increased prices of gas, oil and wheat, and possible food shortages, will bring a new or different reality to impact investing.
Meanwhile, on a micro-M&A level, we are seeing purchasers rather than sellers in the dealmaking driving seat.
It is a buyers’ market
In the past, unless nuances specific to individual transactions dictated otherwise, it was generally sellers who took the lead in driving transaction terms, and purchasers who carried the greatest risk exposure.
Purchasers typically had a minimal number of walk-away rights, while sellers would routinely insist on payment mechanisms that would see the full purchase price being paid out on the closing date so that they could achieve a clean exit. Sellers also routinely negotiated out of deferred payments and post-closing purchase price adjustments.
From the onset of the pandemic, as an increased number of businesses found themselves financially unstable and in need of restructuring, this risk allocation began tilting in favour of purchasers, leading to a buyers’ market. This trend may continue for some time, as global volatility – the emergence of variants of the virus, supply-chain shortages, rapidly rising inflation, the hostilities currently underway in the Ukraine – risk prolonging the climate of business uncertainty.
The shift in risk allocation will see cautious purchasers increasingly looking at mechanisms to mitigate the risks associated with uncertainty by insisting on more conditionality and walk-away rights in certain circumstances.
In the pursuit of deal certainty, on the other hand, sellers may willingly concede on their traditional leverages, for example, providing additional COVID-specific warranties and increasing liability caps, so as to close the deal as quickly as possible.
How purchaser behaviour is changing
We are noting that it is becoming more common for purchasers to negotiate a deferment of purchase price and/or earn-out provisions in purchase price mechanisms. Purchasers are also more likely to insist upon closing accounts as opposed to a more seller-friendly locked-box mechanism, which is fraught with the risk of uncertainty caused by material fluctuations in price against actual value. These approaches all indicate an effort to mitigate the phenomenon of high valuations that emanated from the ‘COVID-19 era’.
Furthermore, purchasers might refuse to agree to a higher standard of best efforts in fulfilling certain obligations. Instead, they are likely to insist on commercially reasonable endeavours at most, coupled with contractual amendments where necessary to allow for more time to fulfil certain obligations. Purchasers are also increasingly negotiating bespoke closing conditions and interim period undertakings related to the performance of the target business.
Last, but certainly not least, there are the really big issues of material adverse changes (MACs) and material adverse effect (MAE) clauses that provide purchasers with a walk-away right or the ability to renegotiate the purchase price if the specified MAC or MAE occurs between signature of the transaction agreements and closing of the transaction.
In summary, we are seeing a shift in the M&A landscape as economies emerge from the pandemic. It will take some time for many businesses to acclimatise to the changes, some of which are still unfolding. However, all indications are that those who take the trouble to understand the prevailing South African dealmaking environment, particularly from a regulatory perspective, will be better placed to navigate the complexities.