South African M&A Deal Value Down but Improvement Expected in 2019

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By Morne van der Merwe, Head of Corporate/M&A and Wildu du Plessis, Head of Capital Markets, Baker McKenzie Johannesburg

The South African economy’s dismal performance in 2018 – and the risk-off sentiment towards emerging markets in general – resulted in poor M&A deal values in 2018, but 2019 looks set to offer an improvement in M&A activity in the country. According to the Global Transactions Forecast (Forecast) issued by global law firm Baker McKenzie and Oxford Economics (OE), just $4.3bn of M&A activity was concluded in South Africa in 2018.

However, signs of more market-oriented policies and anti-corruption efforts under President Cyril Ramaphosa’s leadership should lead to economic recovery. Further, it is expected that some of the deals that were announced last year but not finalized could now go ahead, contributing to the higher volume and value of M&A deals in 2019 compared to 2018.“South Africa is therefore expected to experience a rebound in M&A activity in 2019, with total M&A deals valued at $6.2bn.

According to the Forecast, South Africa concluded $7.5bn worth of deals in 2017, dropping to $4.3 bn in 2018. This value is forecast to rise to $6.2 bn in 2019 before dropping again to $5 bn in 2020 and US$4 bn in 2021. In terms of deal volume, 182 deals were concluded in 2017, decreasing to 136 deals in 2018. In 2019, the volume of deals is expected to climb to 199 with a small drop to 178 in 2020, dropping further to 159 M&A deals in 2021.

With the world economy cooling from 2019, the Forecast predicts global M&A values will decrease in 2020. South Africa’s slight drop in M&A activity in 2020 and 2021 is partly because it is following this global cycle. The good news is that the Forecast also predicts that a new global upcycle could begin in 2021, and South Africa could see the benefit of that in future years.

According to the Forecast, more stabilisation is expected globally in 2021 after a period of adjustments: interest rates should have reached a stable level in the US; equity markets will be in a more sustainable position and, barring further escalation in trade tensions in the meantime, companies will have more certainty about their ability to trade across borders. As such, Baker McKenzie’s analysis of key macro drivers – and the historical pattern of M&A cycles – suggests a new global upcycle could begin in 2021.

South Africa – Inbound and outbound investors

Taking a closer look at the key M&A trends in South Africa last year (2018), Baker McKenzie’s analysis of Thompson Reuters data shows investors from the United States (US) announced the most deals in South Africa in 2018 (14 deals), with Mauritius announcing 10 deals in South Africa and the United Kingdom (UK) involved in nine deals in the country in 2018.

The US has been a significant investor in South Africa, and the African continent as a whole, for some time. The country outlined its new Africa strategy in December last year by reiterating its commitment to strong partnerships with key countries in Africa and said it would also seek to promote intraregional trade and commercial ties with its African allies, shifting its focus from “indiscriminate aid” to one of trade and investment. It will be interesting to see if this new policy impacts on US investment in South Africa in future years.

In terms of outbound investment, key target countries for South Africa investors in 2018 were the UK (18 deals), Australia (11 deals) and the US (eight deals). Nigeria was the most popular target country in Africa for South African investors, with six deals concluded in 2018.

The ease of doing business with the UK and Australia, brought about by various factors, including, language, historical ties and familiarity, has meant that investment between these countries has always been good. For the UK, Brexit has impacted positively on investment between the UK and South Africa in that it has caused UK trade outreach initiatives to various of its historic trade partners, including South Africa.

Sectors

In terms of sectors that saw the most activity in South Africa, inbound investors completed the most deals in the industrials sector (15 deals), followed by consumer products (10 deals) and financials (also 10 deals). South African investors looking for deals in other jurisdictions concentrated mostly on the industrials (15 deals) and materials (11 deals) sectors. There were 10 deals each announced by South Africa outbound investors in the consumer products and services, financials and high technology sectors.

The industrials sector in South Africa is well established and thus provides many opportunities for investment. It is also a good entry point for investors looking to expand into Africa as this sector is a focal point for developing economies.

In addition, a rapidly growing middle-class, improved access to new technology and demand for accessible financial services has boosted investor interest in the consumer, technology and financial services sectors in Africa.

Initial public offerings

Initial Public Offerings (IPOs) concluded in South Africa raised $1.3 billion in 2017 (mostly attributed to the Steinhoff Africa Retail Ltd IPO, which raised $1.2 billion in Johannesburg), dropping to $674 million in 2018. In 2019, IPOs are expected to raise $966 million, before dropping to $349.5 million in 2020, rising again to $541.4 million in 2021. Most of these IPOs are domestic, with cross border listings accounting for just $22.4 million of the capital raised in 2017, and $381 million in 2018. No cross-border IPOs are forecast in 2019, 2020 or 2021.

The visible drop in South African IPO values from 2017 to 2018 was mostly because the figure was artificially high in 2017, due to the Steinhoff Africa Retail listing.

However, we don’t see any more massive capital raising transactions happening until there is more political and economic stability in South Africa. Political stability will hopefully begin to return after the country’s election in 2019, but there is still a lot of work to do to stabilise the economy. The World Bank recently downgraded South Africa’s growth rates and I think there is another year of hard work before the economy starts to recuperate.

This is also the reason for the predicted halt in cross-border IPOs by South African issuers in the coming years. South African companies wanting to raise capital in other jurisdictions in Africa are thinking twice and waiting for political and economic certainty to return before going ahead.

Nigeria – M&A increasing

Nigeria has seen a rise in M&A activity of late. Economic growth in Nigeria has recovered slowly in the last two years as a gradual increase in both oil prices and oil output have supported expansion, and dealmaking has followed suit. M&A activity showed an improvement in 2018 from 2017, led by two major inbound acquisitions from the United States. And with better macroeconomic fundamentals for 2019, total M&A value it set to reach a cyclical peak at just below $3bn in total M&A.

According to the Global Transactions Forecast, M&A deals in Nigeria in 2017 amounted to $469.8 million, rising to $2.7 billion in 2018. In 2019, it is expected that deals worth around $2.9 bn will be concluded, dropping slightly to $2.5 bn in 2020. In 2021, M&A deal value in Nigeria is forecast to rise to around $3 bn. In terms of deal volume, there were 26 M&A deals in Nigeria in 2017, dropping to 23 in 2018. In 2019, 24 M&A deals are expected to be concluded in Nigeria, rising to 27 in 2020 and increasing again to 38 in 2021.

Nigeria IPOs

The IPO forecast shows domestic IPOs valued at $340.8 million are expected in Nigeria in 2019, $139.7 million are forecast for 2020 and $216.3 million in 2021.

Political instability caused a big collapse in capital raising in Nigeria in recent years, but it’s good to see that Nigeria is recovering and that there is a return of predicted IPOs in Nigeria for 2019 and 2020. Hopefully this is the start of a long upswing in capital raising activity in the country.

Africa Outlook

In Africa as a whole, signs of financial and economic stability should help build confidence and boost dealmaking from 2019 onwards. In addition to Nigeria, countries such as Ethiopia, Ghana, Ivory Coast, Kenya and Rwanda, are improving economically and further political and economic stabilisation would provide exciting opportunities for future investment.

According to the Forecast, several major African economies had a turbulent 2017-2018, and though conditions remain difficult in the short term, there are signs that 2019 should be a better year. For Africa overall, the Forecast predicts a rebound in M&A values in 2019 to around $13 billion in total. This is broadly in line with the average over the past decade, with the exception of 2015 when the $20 billion takeover of Steinhoff Holdings of South Africa inflated deal values.

Global outlook

The report projects that 2019 is likely to be a year of two halves. Several major transactions announced in 2018 are set to complete in the first half of 2019, while underlying economic conditions should remain strong throughout this period. However, macro drivers will cool the market through the latter half of next year.

The forecast predicts M&A value at $2.9trn for 2019 – down from $3.1trn in 2018 – before falling to $2.3trn in 2020. With some major IPOs scheduled for 2019, Baker McKenzie foresee total proceeds at $232bn – up from $220bn in 2018 – before dropping to $154bn in 2020. In 2021 and beyond, with borrowing costs settling at their ‘neutral’ rates and equity markets enjoying better growth, we see the potential for the start of a new upturn in both M&A and IPOs.

Michael de Franco, Global Head of M&A, Baker McKenzie says, “We remain cautiously optimistic about the environment for M&A in the years ahead. Further consolidation remains inevitable in many markets and across many sectors that a few macro-economic bumps in the road might delay but won’t postpone. We see some softening in 2020 but again a cyclical recovery further out. Good businesses will always be on the lookout for new opportunities.”

Paul Rawlinson Global Chair of Baker McKenzie adds, “We remain cautiously optimistic about the year ahead, as we believe dealmakers will continue to take the long view in a world where sitting on your hands and waiting for the volatility to die down is not an option. However, as we identified 12 months ago there are still real threats to free trade and investment flows and there remains potential for a much more serious outbreak of protectionism and isolation that business, regulators and government must try and guard against.”