While tit-for-tat tariffs risk an all-out trade war between the U.S. and China (see footnote 1), trade "skirmishes" have sprung up in foreign investment. Several cross-border mergers and acquisitions (M&As) involving Chinese companies acquiring U.S. entities have been blocked or terminated, purportedly for national security reasons (the same rationale behind some recent tariff actions). Meanwhile, the slow pace of approval of U.S. chipmaker Qualcomm's proposed takeover of NXP Semiconductors N.V. by Chinese regulators is likely a result of trade tensions between the two countries.
And the potential exists for these tensions to ratchet up--discussions are ongoing within the U.S. administration and Congress to increase regulatory scrutiny of cross-border M&A, especially if related to acquisitions of U.S. critical technologies by Chinese buyers. In addition, President Trump has decided to impose investment restrictions and enhanced export controls on Chinese companies relating to the acquisition of industrially significant technology. S&P Global Ratings expects these measures to be forthcoming by June 30, 2018, and to be implemented shortly thereafter.
What It Means For Credit Risk
From a business strategy perspective, the potential risks of tightened U.S. regulation on M&A are many; for example, it would temper companies' growth prospects and limit their preferred strategies. It could also lead to a tit-for-tat whereby other countries scrutinize ever more U.S. acquisitions abroad in retaliation. And the U.S. is particularly vulnerable in this area since it is both the largest destination and source of foreign direct investment (FDI) globally. (According to the Organisation for Economic Co-operation and Development [OECD], U.S. outward FDI--worth more than $362 billion in 2017--accounted for over 25% of the global total and far exceeded foreign investments from other countries.)
But from a credit perspective, muted cross-border M&A would lessen potential risk that comes from increased debt issuance, higher leverage, and other M&A-related challenges (e.g. execution risk).
|Selected M&A Reviewed For National Security Risk|
|Broadcom's acquisition of Qualcomm was blocked in March 2018.||No rating impact. Broadcom announced a $12 billion share-repurchase authorization recently following the blocked deal. We believe Broadcom favors M&A over share repurchases. However, the buyback program is a means to provide the company the flexibility to enhance shareholder returns.|
|Ant Financial, a subsidiary of Alibaba Group, planned to acquire MoneyGram. The plan was terminated in January 2018 because of failure to receive CFIUS approval.||We affirmed our rating on Moneygram and removed it from CreditWatch positive, where we had placed it following the proposed acquisition announcement by 'A+' rated Alibaba Group.|
|Chinese investment company Canyon-Bridge's acquisition of Lattice Semiconductor was blocked in September 2017.||We affirmed our rating on Lattice Semiconductor and removed it from CreditWatch with developing implications, where we had placed it after the proposed acquisition announcement.|
|ON Semiconductor offered to acquire Fairchild Semiconductor in November 2015. CFIUS did not block the deal.||After the acquisition was completed, we lowered the rating on ON Semiconductor, and lowered the Fairchild Semiconductor rating to the same level as the rating on ON Semiconductor.|
|Source: S&P Global Ratings|
Acquisitions are a source of U.S.-China trade frictions
While news headlines mainly focus on the tariffs the U.S. and China have threatened to levy against one another, we believe this is just one aspect of the trade dispute. The primary sources of U.S.-China trade friction, in our view, are China's practices related to intellectual property transfer, in which China forces delivery of proprietary technology by the U.S. and other foreign business partners; and its limiting foreign owners to minority stakes in joint ventures to allow them to operate in China. There are also concerns in the U.S. administration that China's acquisitions of U.S. companies threatens U.S. national security.
Meanwhile, Chinese acquisitions of U.S. companies represent a small proportion of overall U.S. deals. In 2016, a watershed year for Chinese acquisitions, announced M&A with Chinese buyers were $50 billion (see chart 1), but even then represented less than 4% of the more than $1.3 trillion in U.S. M&A that year--and a number of these deals were eventually scuttled due in part to national security issues.
In 2018, even though overall M&A activity is running above last year's pace, transactions with Chinese buyers have slowed to a trickle, and their U.S. targets have become less diverse--more focused on technology, health care, consumer discretionary, and capital goods than in previous years (see chart 2). Similarly, U.S. acquisitions of Chinese companies, which had been far more active a decade ago, has fallen off sharply.
The Impact Of Increased Scrutiny
Although Chinese M&As in the U.S. are not relatively large, they have seen increased scrutiny from the Committee on Foreign Investment in the United States (CFIUS)--the interagency group that reviews foreign acquisitions of U.S. companies for national security risk (see footnote 2). From 2013-2015, the highest number of transactions under CFIUS' review have had buyers from China, followed by Canada, the U.K., and Japan (see chart 3). While some have raised national security concerns about Chinese interests in acquiring critical U.S. technologies (see footnote 3), other countries such as the U.K. and Canada are the largest foreign acquirers of U.S. critical technology companies (see chart 4).
M&A pickup will drive credit risk higher
There are a myriad of proposals for greater CFIUS scrutiny (see footnote 4), such as shifting to mandatory notification for certain transactions, introducing a "country of special concern" (a country that poses a significant national security threat), and expanding its purview to encompass U.S. technological and industry leadership. These measures, if adopted, could deter dealmaking, and not just from Chinese buyers. CFIUS reviews are often associated with a drop in stock prices and negative publicity, among other outcomes.
The dealmaking landscape in the U.S. has benefited from continued accommodative financing conditions and the elimination of uncertainties related to U.S. tax reform (which lowered effective tax rates, and increased cash flow generation and access to previously "trapped" cash in foreign subsidiaries).
U.S. M&A has picked up, sparked by the return of megadeals and increased leveraged buyouts. Announced transactions in the first half should top $600 billion, representing above 400 deals--up about 40% by deal value over last year but lower by deal count (see chart 5). Health care, technology, and energy were the most active sectors (see chart 6). The factors driving transactions continue to be low organic growth, disruptive technologies, and scale efficiencies. We expect the busy M&A landscape to continue in the second half of 2018, and we see the approval of the AT&T Inc. and Time Warner Inc. merger spurring more megadeals in the cable and telecom sectors, and possibly elsewhere.
M&A has been a key rating mover for the past few years, and we expect it to remain an important rating risk going forward.
- Global Trade At A Crossroads: The Risk Of An All-Out China-U.S. Trade War Moves Up A Notch, June 18, 2018
- Global Trade At A Crossroads: Will The U.S.-China Trade Tempest Make Landfall Or Blow Out To Sea?, May 4, 2018
- Global Trade At A Crossroads: How The U.S.-China Spat May Hurt The Tech Sector, And The Latest On Qualcomm And Broadcom, April 25, 2018
- Global Trade At A Crossroads: U.S. Doubles Down In China Tariff Dispute, Worsening Credit Conditions, April 6, 2018
1. "Is Trump in a Trade War – An Up-to-Date Guide", Peterson Institute for International Economics, https://piie.com/blogs/trade-investment-policy-watch/trump-trade-war-china-date-guide
2. CFIUS was established in 1975 amid concerns about the rapid increase in U.S. investment by OPEC nations, and shifted to focus on Japanese investments in the 1980s. Over the years, CFIUS' purview has broadened beyond assessing national security in terms of defense to also include economic security and public health or safety.
3. CFIUS defines "critical technologies" with reference to U.S. export control restrictions. The largest amount of M&A involving foreign acquisitions of U.S. critical technology companies involved targets whose primary activities are in the information technology, aerospace & defense, and electronics/semiconductor sectors.
4. The Committee on Foreign Investment in the United States Congressional Research Services, March 13, 2018.
Only a rating committee may determine a rating action and this report does not constitute a rating action.
|Primary Credit Analysts:||Jennelyn U Tanchua, New York + 1 (212) 438 4436;|
|David T Tsui, CFA, CPA, New York (1) 212-438-2138;|
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