Years of ever-increasing tariffs, trade deal pullouts and renegotiations, and nationalistic, political posturing from the Trump administration has rocked the well-established, international trade regime. Markets have shuddered; growth forecasts were slashed; and companies were left scrambling to try to offset rising costs. Now, Trump’s trade wars are spilling over into cross- border M&A through greater macroeconomic uncertainty, threats to historically, low-risk supply chains, and downward pressure on valuations. This has led to deal hesitancy and market adjustment, which has fueled new opportunities in previously overlooked markets.
2. The Trump Trade War
Since his presidency began in 2017, President Trump has targeted several international commerce lines, from well-established trade allies like the EU, Mexico, and Canada to more tenuous partners like India and, most predominately, China. Utilizing nationalist rhetoric, President Trump scrapped the Trans-Pacific Partnership (TPP) with Southeast Asian nations, halted the Transatlantic Trade and Investment Partnership (TTIP) with the European Union, and renegotiated the North American Free Trade Agreement (NAFTA) with Canada and Mexico.
The Trump Administration also used more blunt tools, like tariffs, to disrupt the free flow of goods and services. These tariffs were imposed on specific markets like solar panels, washing machines, steel, and aluminum, sparking feuds and retaliatory measures from South Korea, India, Turkey, the EU, and Canada. Impacted countries, meanwhile, did not stand by idly. The EU activated tariffs on U.S. products, like steel, aluminum, bourbon whiskey, motor boats, motorcycles, blue jeans, corn, and peanut butter. Canada imposed duties on steel, aluminum, agricultural and food products, and other consumer goods. Turkey levied tariffs on cars, alcohol, and tobacco. Simultaneously, multiple countries filed suit with the World Trade Organization, claiming the United States violated numerous WTO treaty rules and standards.
Although significant, these trade disputes pale in comparison to Trump’s trade war with China. Since the spring of 2018, President Trump has targeted Chinese imports, imposing or threatening to impose a cascade of duties on virtually every product entering the United States from China or more than $550 billion worth of goods. Tariffs mean rising costs for importers, and U.S. firms have responded accordingly, shifting supply chains out of China and halting Chinese capex expenditures. Not surprisingly, imports from China into the United States have declined by more than 12 percent. In retaliation, China levied tariffs on agricultural and food products, mineral fuels, some consumption goods, and medical equipment. It also directed all Chinese state-owned enterprises to halt buying U.S. agriculture products, instantly drying up a $20 billion market. U.S. exports to China have now sunk by more than 20 percent, and for the first time since 2005, China has fallen behind Canada and Mexico on the list of top U.S. trading partners.
3. Greater Uncertainty for Cross-Border Transactions
These trade disputes breathe uncertainty into macroeconomic conditions, open markets, and international supply chains, creating new hurdles and risks for cross-border transactions. With less U.S. buyers of foreign goods due to the increased price of imports, the flow of U.S. dollars into impacted countries has declined. Countries, particularly China, have started to restrict outbound capital flows to keep U.S. dollars in the country as a way to shore up currency weaknesses and stabilize financial markets. These capital restrictions translate into a substantive decline in outbound M&A activity.
In addition, trade disputes can put cross-border investments in the crosshairs of regulatory agencies. Countries with an outsized trade imbalance with the United States cannot equally retaliate against U.S. tariffs through greater or broader duties on U.S. imports. In fact, to keep prices down and domestic markets that rely on U.S. imports happy, some countries might avoid direct retaliation through tariffs. Such actions, however, come at the expense of cross-border transactions. For example, China, which exports far more than it imports with the United States, has used regulatory approval of foreign transactions as a retaliation tool against U.S. tariffs. Market analysts widely believe China intentionally delayed its antitrust approval of Qualcomm’s $44 billion acquisition of NXP Semiconductors in retaliation of the Trump administration’s first round of tariffs against China. Such regulatory uncertainty forced Qualcomm to walk away.
The U.S. also hasn’t been shy in using regulatory agencies in its trade disputes. President Trump directly inserted risk into cross-border M&A through enhanced regulatory oversight by expanding and strengthening the Committee on Foreign Investment in the United States (CFIUS), which reviews inbound foreign investment and transactions in the United States. Under the guise of national security, CFIUS now commands authority over a wider scope of transactions with enhanced oversight and bureaucratic bite. The Trump administration now uses CFIUS as a lever to prevent foreign entities from investing in the United States.
These trade disputes have also forced acquirers to rethink valuations of cross-border targets. Trade risk in deal metrics has historically been low thanks to a well-established open market consensus. But the trade wars have thrown this calculus to the wind. Sellers particularly prone to trade risk face lower valuations. As their costs rise directly due to tariffs or indirectly as a result of finding substitute suppliers, impact to the bottom line is difficult to avoid, even with passing along costs to customers. In addition, private equity firms with portfolio companies with exposure to trade risk now experience higher costs and fewer exit opportunities, which potentially leads to lower returns for general partners and a greater hesitancy to reinvest. On the buy-side, acquirers are met with added complexities and increased risk when assessing deal opportunities with cross-border targets.
4. Cross-Border M&A Flops
Some firms attempt to circumvent trade disputes by moving investments into non-impacted countries. For example, in response to tariffs on U.S. products, Harley Davidson, a U.S. motorcycle manufacturer, announced plans to invest in production facilities outside the United States, which would sell directly to foreign countries. These attempts, however, pale in comparison to the general decline in cross-border transaction activity, which have dropped to about 31 percent of transactions globally, down from a peak of nearly 40 percent in 2016. Nowhere has such declines been felt more substantially than in Asia, particularly in China, Japan, and India. In fact, in the first half of 2019, deals with Asian targets have nosedived by more than 43 percent year-on-year. China, the focus of Trump’s trade wars, faced even greater deterioration in inbound deal activity, tumbling nearly 45 percent.
Not all metrics are negative. Average deal size is actually up, fueled in large part by megadeals, particularly those out of the U.S. Outside of these large transactions, capital is flowing to domestic transactions. In the U.S., where activity is most active, deal count is still robust despite a modest softening from the past two recordsetting years. In particular, the biopharmaceutical and financial services sector remain vigorous.
5. Alternative Investments
Protectionist measures do not always translate into depressed international deal making. In fact, the World Bank found that capital sinks into international investment when trade protectionism is robust. Firms tend to pivot from product acquisitions to joint ventures and partnerships as way to offset trade restrictions. Current trade wars, however, might be too systemic in the overall macroeconomic environment to encourage alternative cross-border deals. Instead, deal makers are wetting their appetites in alternative markets, which include small to mid-size countries, which have been flying under the radar in the trade wars, as well as certain sectors like real estate and specific manufacturing outside of security and intellectual property concerns. In addition, alternative supplier markets, like Bangladesh and Vietnam, have seen outsized attention as U.S. importers seek out cheaper suppliers.