January 24, 2015
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January 22, 2015
Bridging the Cross-Border M&A Gap “Korean Style”
While global uncertainties have negatively impacted mergers and acquisitions (M&A) activity in nearly every region in recent years, the emergence of buyers from the Asia-Pacific region, in particular from China, Japan and Korea, has led the region to buck the recent downward trend. According to an Ernst & Young report citing United Nations Conference on Trade and Development, the International Monetary Fund (IMF) and Oxford Economics, Foreign direct investment (FDI) outflows from East and Southeast Asia recorded a compound annual growth rate of 22.9 percent in 2005-2011, rising from $70 billion to $242 billion in that period. While a significant portion of this activity represents “greenfield” cross-border investments in new assets, a rising portion of this activity represents acquisitions of a controlling interest in an existing, often Western, company with significant historical operations. The emergence and increasing relevance of Asian buyers has focused attention on the special characteristics, issues and challenges facing transactions that involve such buyers and how M&A professionals can anticipate and address them.
While general conclusions cannot be meaningfully made about all buyers from Asia-Pacific region, the Republic of Korea (Korea) can be seen as a bellwether for the emerging trends that are driving outbound M&A activity throughout the region. This article focuses on some of the major issues and challenges facing M&A transactions involving buyers from Korea. Namely, while the Asian business model was once—and in some Asia-Pacific countries, still is—focused on low cost manufacturing, certain large scale Korean conglomerates, like their Japanese counterparts before them, have moved up on the growth and value curve and now boast world class sophistication and quality in their product, service and technology offerings. Given these strengths and a perceived saturated domestic market, Korean companies are focused on expanding overseas for growth, diversification, access to markets and resources, and access to technologies.
Challenges Facing Korean Buyers
The hurdles that Korean buyers must navigate in a cross-border acquisition are many. With the exception of cross-border acquisitions involving resources, such as mining and metals where national security of supply concerns and synergies often override all other factors, including the metrics inherent in the deal itself, closed acquisitions of operating companies in sectors outside of this privileged space are relatively few even though the levels of mutual interest among potential Korean buyers and sellers are relatively high.
Complex issues impact the ability of Korean buyers and Western sellers to bridge the gap from initial interest to actual closing. This article will focuses on three key practical issues and considerations that deal practitioners may try to anticipate, recognize, address and hopefully resolve in order to get the deal done.
1. Process Differences
(a) M&A Auctions “Korean Style”
The domestic Korean M&A market is sophisticated, active and robust. With transaction values in excess of $52 billion in 2011, M&A is a well accepted corporate strategy in Korea. As in the rest of the developed world, most large M&A transactions are conducted through auctions involving multiple bidders. Bidders include both strategic buyers as well as a number of increasingly active Korean private equity (PE) funds. While M&A market practices and overall regime are influenced by global intermediaries (e.g., global investment banks and law firms) and resemble Western practices, there are some important differences.
One of the main differences is that M&A auctions in Korea almost always involve the selection and designation of a single “preferred bidder” after one or more rounds of bidding by interested bidders. This preferred bidder will effectively have an exclusive right to negotiate final terms of a definitive acquisition agreement with the seller parties. The designation of preferred bidder status is an important milestone in the Korean M&A process and preferred bidders will significantly increase (and often only meaningfully commence) their legal, financial and operational diligence review, fundraising activities (if outside financing is required as will be the case for many PE bidders) and other activities only after receiving this designation.
Once designated as a preferred bidder(or if the process is not an auction, some other exclusive or similar arrangement having been reached), a Korean board/officer, PE, or other relevant body or entity may properly present the target and overall deal as being ready for evaluation and confirmatory review by the relevant board/shareholders, debt and/or equity syndicate, etc. Indeed, many deal practitioners in Korea have likened the overall Korean M&A regime to a process of sourcing, preparing and presenting a “product” (i.e., target company and deal terms) for evaluation and approval by the main body or entity in control of the purse strings, whether that body or entity is a shareholder, board, lender, etc.
(b) U.S. Style Contrasted
This “product” approach to M&A evaluation can contrast sharply with the more fluid, interactive and dynamic process often seen in Western M&A transactions, particularly auctions involving U.S. targets. First and most importantly, bidders in the U.S. often have no assurance that they are exclusive, preferred or special in any way and are often pitted against one another until the very end of the selection process when a definitive acquisition agreement is executed. Bidders will accordingly attempt to distinguish their bids, first by attempting to obtain credible information about their standing vis-à-vis other bids, and then either adjusting the overall value of their proposed bids or their overall contract terms, such as improving antitrust or indemnification provisions or post-closing employment covenants.
This fluid give-and-take process may be difficult for a Korean bidder that has not been designated as a preferred or exclusive because the bidder may not have conducted sufficient degree of diligence to give it enough confidence to improve certain contract terms or if the “product” presented for the relevant decision maker’s approval has now changed and thus the prior approval must be obtained anew or is thrown into question.
2. Post-Closing Management Integration and Control
Different organizational structures, different management systems and cultural differences can lead to Korean buyers either not pursuing or abandoning otherwise promising acquisitions due to what they perceive as insurmountable issues in post-closing management integration and control. Korean companies, as is the case with many Asian companies, are very tightly and often very vertically organized and controlled with central headquarters positioned as the apex and “control tower.” As these companies cross borders, however, the need for local knowledge, autonomy and nimbleness to respond to local needs increases dramatically.
From the Korean side, however, shifting to local autonomy can stir fears that they may be unable to ensure that Western managers are meeting their standards. The Korean side’s lack of familiarity or comfort with the Western/U.S. style management culture can also impede communication.
Vastly different compensation schemes, levels and mindsets between Western, particularly U.S., management and Korean/Asian management also create potential fissures. Specifically, complicated employment benefit plans and compensation structures are difficult for Korean executives to understand and reconcile, given their well-defined organizational hierarchy, particularly if the compensation level of an overseas U.S. or Western executive who is purportedly subordinate exceeds the compensation levels of many of the Korean executives. Moreover, while stock options and other forms of equity or equity-like compensation schemes have taken greater root in Korea recently, their prevalence is not as common as in the U.S., and the concept of granting equity to salaried executives may not fit well within many Korean corporate entities.
3. Seller Perceptions – the Korean Discount
Differences in the various systems and approaches as well as differing language, contract forms, communication and other styles, can lead to a steady erosion in the confidence of various seller parties and their intermediaries in the Korean side’s seriousness, level of interest and execution abilities. These factors, coupled with a lack of sufficient knowledge about the Korean party’s business reputation and financial strength, ultimately could cause many sellers and their intermediaries to devalue or discount an otherwise healthy bid. While this is changing now that some recent acquisitions by Korean buyers have successfully closed, in the eyes of some, a bid by a Korean bidder may still be less attractive when compared to a well known and seasoned U.S. buyer. In the most competitive bidding situations, without effective understanding and communication channels, this could make a significant impact on both the seller parties’ willingness to continuing to talk to the Korean bidder and the Korean bidder’s faith and trust in the fairness of the bidding process.
Bridging the Gap
The answers and approaches to addressing the issues and challenges described above will have far-reaching and long-term implications for corporate boards, governments and dealmaking intermediaries throughout the world. No one-size-fits-all solution, however, can resolve every issue described above (and many others that will undoubtedly arise). To be successful, the deal practitioners should try to understand the expectations on both sides and attempt to bridge the gap in trust. With the stakes high, efforts on both sides to understand one another can determine the success of a deal.
Engaging a professional with knowledge of cultures and languages on both sides, and can act as an ambassador, is critical to bridge the divide, come to terms on the details of the deal and ensure that the terms and risks are understood by parties.
While bridging the gap may not be a simple task, the rewards can be great as Korea buyers and buyers from other Asian countries - armed with huge capital surpluses, expanding consumer markets, and a hunger for new markets, technologies and brands - look to move further along the development curve to fully utilize and reap the benefits of M&A.