Mergers and Acquisitions can give your company a competitive advantage, but when is it the right move?

Mergers and acquisitions ("M&A") are often used as critical methods for expansion. Some companies may plan successful M&A strategies such as using good economic times to strengthen their finances (paying down debt and accumulating cash reserves), and when a recession or slowdown comes, buying at low valuations.

With current high inflationary pressures, asset values may push up and it may be advantageous to assess potential M&A targets now, in anticipation of higher market interest rates, slower economic growth and for making a move when inflationary pressures start to head down.

While M&A may provide many benefits, the processes to achieve them can be inherently complex, particularly if they are subject to the legal constraints imposed by the Commerce Act 1986 ("CA") and Overseas Investment Act 2005 ("OIA").

M&A due diligence must be carefully carried out in a timely manner, to ensure M&A are suitable in a given situation and that the available due diligence information is complete and accurate to make a fully informed assessment of the M&A proposal.

Benefits of M&A

M&A aim to improve an entity's competitive advantage by extending its reach in terms of products, markets and or geography. M&A can result in beneficial growth effects for the merged entity, some of which may include:

• Increase of market share, reduction of competition (likely enabling price increases for its customers);

• Increase of business efficiency, economies of scale and scope, and a higher level of competitiveness;

• Increase of production efficiency, enabling reduced costs due to (for example) a greater scale of combined operations or increasing bargaining power with suppliers, easy access to skilled labour);

• Increase of the entity's capabilities, diversified portfolio, better financial control and more impact (such as acquiring vertical or horizontal supply or entrepreneurial technology); and

• New opportunities.

Despite the benefits, M&A can be relatively expensive and risky, given that using existing capabilities as a platform for significant leaps in terms of innovation, diversification, or internalisation may be challenging. In reality, M&A can involve a high degree of risk of failure for various reasons, such as excessive initial valuations, an exaggerated expectation of strategic fit, underestimated problems, poor systems, practices and organisation and importantly, insufficient due diligence.

How issues are resolved once detected through a due diligence investigation can contribute to the difference between a successful or non-successful M&A. Care needs to be taken in selecting and assessing target companies/businesses and undertaking a due diligence investigation. This can involve reviewing a target's key contracts and their regulatory and other compliance and practices, their assets and liabilities, determining and assessing risks and appropriate warranties, as well as the financial viability of the proposition.

Degrees of due diligence will be required for all parties to the M&A, as it impacts on warranties required and able to be given in the related M&A agreements and the potential liability for statements made by a party and relied on by another party, should those statements transpire to be incorrect.  

Legal Constraints

Given the potential for the exercise of market power to negatively impact consumers or the public, there are legal restraints in New Zealand on M&A activity under the CA and the OIA and related regulations.

Section 27 of the CA prohibits the entry into or the giving effect to a contract or arrangement, or arriving at an understanding, containing a provision that has the purpose, or has or is likely to have, the effect of substantially lessening competition in a market.

The key components for an assessment concerning what is considered the "market" and what is likely to effectively lessen competition "substantially" can be complex, and thought should be given to this when contemplating a specific M&A. While an increase in market power and reduction of competition is clearly a M&A benefit for an entity, there is a CA general concern to balance this against the need for consumer protection.  

Market power concerns, for example, have recently been reflected in additional regulation of New Zealand's retail grocery sector, where the New Zealand market is dominated and controlled by two main competitors (Foodstuffs North Island Limited, Foodstuffs South Island Limited, and Woolworths New Zealand Limited). The recent legislative amendment has added new provisions into the CA (refer Section 28A – 28D of the CA) dealing with restrictive or positive covenants concerning land development, use, or lease in the retail grocery sector, to clarify such activity will be considered anti-competitive and prohibited (unless the Commerce Commission grants authorisation).

Proposed M&A activity does not need to actually substantially lessen competition; just having the potential to substantially lessen competition is sufficient to be caught by the CA. For example, in 2017, the Commerce Commission declined clearance for the proposed merger between Vodafone New Zealand and Sky Network. The reasoning was that the popularity of the merged entity's offers could result in competitors such as 2degrees and Vocus losing or failing to achieve scale, to the point that they would reduce investment or innovation in broadband and mobile markets in the future. Therefore, the Commerce Commission could not exclude the real chance that the merger would substantially lessen competition in that market.

Prior to entering into any M&A arrangements, the question of whether the M&A proposal or other arrangement would require a Commerce Commission clearance or authorisation should be raised and considered.

Overseas Investment

Consent to a M&A may also be required under the OIA (if it involves the acquisition of sensitive land or significant business assets). A vital issue to determine is whether an overseas person will have an ownership or control interest as a result of the M&A above a 25% threshold. In considering the relevant ownership or control interests, the ownership or control interests of any of a relevant party's associates in the M&A will also be a relevant and careful analysis of such interests should be undertaken prior to entry into the M&A arrangements.  

Conclusion

Despite the complex nature and risks embedded in M&A, they are nonetheless a robust growth strategy. Our team are specialists in the field and are ready to assist your business with legal due diligence, corporate advisory and legislative compliance.

If you have any questions about M&A, please get in touch with and direct any enquiries to:

Linda Packer (lpacker@mcveaghfleming.co.nz) Auckland Office

Andrew Knight (aknight@mcveaghfleming.co.nz) Auckland Office

Steve Graham (sgraham@mcveaghfleming.co.nz) Albany Office

John Woolley (jwoolley@mcveaghfleming.co.nz) Auckland Office

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Mergers, Sales & Acquisitions

‍Written by: Linda Packer