USA: Special Report - Big and beautiful?

Opportunities abound, but overseas firms may find US targets difficult to identify and compliance issues a costly burden.

by Helen Dunne, World Business
Last Updated: 23 Jul 2013

Just as mountaineers who conquer Everest (or any other big mountain) explain their rationale for the climb with George Mallory's famous words "because it is there", overseas companies are determined to buy into the US market because it's big. Despite China's rapid expansion, America still represents the single biggest marketplace in the world and exhibits a growth rate that European governments can only dream about. It also offers opportunities for overseas companies that can be far in excess of those available in local markets.

"On a macro level, America is a very important market, a key market for many companies," says Paul Teuten, London-based managing director of RSM EquiCo Capital Markets, a US investment bank specialising in mergers and acquisitions (M&A). "But on a micro level too, there are certain sectors where the scale of the US government spending is such that overseas companies are desperate to get into the market and gain part of it."

Last year the US government had an aerospace and defence budget of $442 billion - equivalent to the GDP of the Philippines - and that is estimated to rise by 7% this year. In contrast, the UK government, which has the world's second largest defence budget, allocated just £30 billion ($60 billion) in 2006. Such is the allure of the US government budget that UK-based aerospace and defence company Meggitt recently launched a $1.8 billion bid for K&F Industries, the New York-based manufacturer of aircraft wheels and brakes.

Its move follows US acquisitions by other European defence industry companies, including Ultra Electronics, Hampson Industries and Cheming. "Buying in the US can transform the rating, profit and profile of these companies," explains Teuten. "The weakness of the dollar has also made American companies appear relatively cheap, although there is the consideration that cashflows are adversely affected when they are converted back to sterling or other currencies."

But while overseas companies may be desperate to enter the US market, suitable targets can be difficult to identify. Mega-deals dominate the headlines and listed companies are legally required to provide encyclopaedic levels of information, but there are about 600,000 privately owned companies in the US of which very little is known. Bundeep Singh Rangar, chairman of IndusView, which advises Indian companies on business opportunities, says: "In certain sectors, such as technology, it is easy to get information on companies, but data on small or medium-sized enterprises operating in manufacturing, for example, can be obscure. There are many specialist companies that do not even have an online presence. Visibility can be very difficult."

Singh Rangar searches business directories, Yellow Pages and online search engines, and contacts local trade organisations to identify potential target companies. Teuten agrees that it can be difficult to find information on companies, but adds: "It is also good to ask the people in the field, and financial advisers may bring potential deals to your attention."

Although the American heartland is often portrayed as insular, potential acquirers have found their targets remarkably welcoming. "I would say that, typically, privately owned companies in Japan and France view it as a sign of defeat if they sell out, but I think US companies are open to consolidation if the deal makes sense," says Singh Rangar.

Teuten adds: "American companies are quite attracted by foreign buyers because they may have reached a limit on what they can do in their home market. They recognise that the world is a big place."

Although the US government intervened in DP World's acquisition of UK port operator P&O in 2006, forcing it to sell P&O's American port facilities, its attitude towards foreign acquisitions of US firms is generally more positive. Eddie Lazear, chairman of George W Bush's Council of Economic Advisers, recently described America as "the most desirable place for investment right now", adding: "Foreign companies have invested in the US and they provide high-wage jobs and efficient work environments that contribute to both productivity and growth."

The US government justified its intervention in DP World's transaction on the grounds of national security, and it restricts foreign ownership in industries deemed vital to national security, such as the satellite sector. But it recently allowed Russia's Evraz Group to continue with a $2.3 billion takeover of Oregon Steel Mills, which makes armour plate for the US military, after deciding it posed no risk to national security.

However, converse problems can arise when buying abroad. The owner of a US company that RSM EquiCo sold to a listed UK counterpart was upset when he learned that London Stock Exchange rules required full disclosure of the price of the transaction and the pre-tax profits of his business. "He didn't want his staff to know the financial details of his business," recalls Teuten. "The sales process can generate a lot of emotion, particularly when it comes to due diligence. Different nationalities have different approaches to due diligence, which, after all, is a necessary part of the process."

Nuances of business practice and language difficulties can cause problems at this stage. In some countries, it is considered normal to offer a high upfront price and, following due diligence, negotiate it downwards if necessary. Other countries, such as India, prefer to start with a lower price and move it upwards. "If a French company writes a letter of intent, it is legally binding," says Teuten.

"And American companies want something written down for them to know you are serious. They are less convinced by a telephone call detailing an offer or a handshake agreement. They want a letter so that everybody knows what they are talking about." Inevitably, this part of the process requires major 'hand-holding' by the advisers.

Financing an acquisition can prove a thorny problem. Most advisers recommend that funding should be in place before any approach is made. With US interest rates currently at low levels, it can be possible to borrow money cheaply and hedge it against currency movements. However, it is hard to find any adviser that recommends listing on the US stock markets to gain an acquisition currency.

David Roper, chief executive of engineering group Melrose and a veteran dealmaker, advises companies to avoid listing in America. "It is completely over the top. Unless you are involved in a global mega-merger and are a company like BT, for example, you don't need a listing. Most institutions are quite happy to hold shares in a listed London market."

However, Singh Rangar adds: "Cash is always king. There is not a lot of respect for overseas paper, although London listed paper is more attractive."

Much of the reluctance to list on the US market is due to the myriad rules and regulations, such as Sarbanes-Oxley, which are extremely costly to comply with. A survey by accountant Ernst & Young of European companies listed on the US market in 2003 found that 55% of those with revenues of more than $20 billion spent more than 100,000 hours on corporate governance issues. Martin Higginson, founder of mobile phone content group Monstermob, estimates that the annual cost of listing for any foreign company in the US, with its quarterly accounting rule, is in excess of $2 million.

Until recently, it has also been hard for foreign companies to extricate themselves from the marketplace. Robert Ripin, partner at law firm Lovells' New York office, says: "Historically, it was fairly easy to delist [from the NYSE], but deregistering from the SEC was much harder."

The situation was dubbed the Roach Motel, after a famous advertising slogan for a cockroach trap - 'they check in, but they don't check out'. Until March 2007, companies that wanted to deregister had to prove they had fewer than 300 shareholders resident in the US. Every individual who held shares through nominees, brokers, dealers or banks had to be counted. "It was virtually impossible to meet the requirements to deregister," says Ripin.

Deregistration is now permitted if a company can show the average daily US trading volume in its shares is no more than 5% of its global trading volume. The SEC estimates that 29% of the 1,200 foreign companies with US listings fall below the 5% threshold. International companies have to comply with International Financial Reporting Standards (IFRS), but if they come under the SEC umbrella, they must also report accounts consistent with US Generally Accepted Accounting Principles (GAAP). "It is another expense for companies and takes management time away from the business."

Sarbanes-Oxley is, however, the biggest cost. Section 404 requires management to assess internal controls, which must then be verified by outside auditors. "The compliance issues under Sarbanes-Oxley are a burden on management time and costs, but also increase the risk of liability on the part of management, which could result in both civil and criminal litigation," says Ripin.

Eric Hutchinson, chief financial officer of Spirent Communications, which spends nearly $6 million a year on Sarbanes-Oxley compliance, says: "We all get up, clean our teeth and have a cup of tea. Imagine you have to document that, explain any deviation from the normal routine and get your partner to certify it. And every now and again, an auditor will come round and check you've done it. That's what it feels like complying with Sarbanes-Oxley."

Once a company is acquired, experts believe it is vital to move quickly to ensure success. Ryan Barr, senior vice-president at public relations agency Hill & Knowlton, says: "Less than half of all acquisitions succeed and that is because companies don't integrate properly, particularly when it comes to different cultures. A company should identify in advance what needs to be done."

Barr also advocates grassroots lobbying. "It depends on the deal, but lobbying the right political leader at local state or county level is important. If a factory is being acquired, there could be difficulties with unions. In the political process, unions can be very powerful so it is vital that you have some sort of relationship with local officials."

Melrose's Roper adds: "It is the same with all acquisitions, people don't like change. There will always be a degree of resistance. You have a period of only between three and six months in which to change the culture of a business. There might be a lot of tensions and difficulties and resistance, but if you don't change things then you could be buying problems. Six months later, you turn around and tell the management that 'it's been fantastic and thank you all very much'."

Monstermob's Higginson, who employed corporate psychologists to understand what was important to US staff, adds: "If you are buying a business from an entrepreneur, they will leave. They are natural salesmen and will tell you everything you want to hear during the sales process, but the fact is that within one or two years, they will have disagreed with the new management and left."

Roper agrees: "You want the management on-side, but you can't just impose a business plan on them and you can't always hold them after an acquisition."

Historically, Americans have a different attitude towards compensation than their European counterparts. If an acquisition will make them part of a bigger business, then (usually) they will require more money. US companies can also be more hierarchical than overseas competitors. "A typical concern among American staff when Indian companies are involved in M&A is whether their jobs will be outsourced," explains Singh Rangar. "You have to explain that you are buying the people and their skills, and lock in key employees if necessary."

As Barr puts it: "You don't just barge into somebody's house and take what you want. Keeping staff in the loop on decisions helps keep them on-side and makes an acquisition go far more smoothly, wherever it may be."

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