Deal making in the Asia Pacific region is experiencing a boom in 2021. In Q1 2021, Mergers and Acquisitions (M&A) activity in APAC-ex Japan was up by 55%, the highest level since 2015.
PwC’s M&A 2020 Review and 2021 Outlook, reported a similar observation in China with M&A activities up 30% to US$733.8 billion in 2020, the highest since 2016, driven by strong state and government investment support.
Refinitiv cautioned, however, that the boom hinges on how well governments can contain the COVID-19 pandemic – which itself is experiencing a rebound as variants proliferate across parts of Asia.
For William Foo, chief financial officer at Everise, M&A is a quick and efficient way of obtaining scale. Other organizations take an M&S route to stave off competition, expand offering or enter new markets. Whatever the reason for the acquisition, there are risks involved for which M&A insurance may be a way to mitigate some of the uncertainties.
Aris Wong, managing director for BMS Group Asia, says M&A insurance traditionally insures against underlying unknown risks associated with the target company, often crystallizing only post-closing - after the buyer has taken over the company.
The need for M&A insurance
As much as possible, parties involved in M&A discussions are expected to perform their due diligence. However, Wong cautioned that about information asymmetry – where there is a limited amount of information that a buyer can uncover in performing due diligence.
Recalling the phrase “caveat emptor or buyer beware”, she added that a buyer is taking on a company with a lot of contracts, employees, unknown liabilities. “These unknown liabilities could have a black swan event-like kind of impact, which means that it's a low probability, but high severity,” she opined.
While she conceded there is a low chance of a black swan striking but when it does – it can cripple the target company and buyer. “In this case, you want the sellers to warrant or stand behind such a historical state of affairs if these state of affairs are inaccurate,” she added.
The beauty of insurance is that the buyer does not need to tell the other party that it is buying insurance.
Wong made it clear that a seller also stands to benefit from buying their insurance against the deal.
Not quite critical but still important
Is buying M&A insurance sufficient to mitigate against the risks brought about by the pandemic? Wong conceded the critical value of insurance but on its own is insufficient as a risk management strategy.
“Insurance is only one of the many risk mitigation tools available to the deal makers. And from a risk management perspective, risks associated with M&A deals are multifaceted. If you think about it, whenever you're acquiring a company, risk will pop up anywhere in the most unexpected areas,” she opined.
CFO considerations when buying insurance
In M&A discussions, buying insurance (whether on the sell or buy-side) should occur in tandem with the structuring of the transaction, noted Wong. During the due diligence investigation, the CFO should consciously think about whether they would like to buy M&A insurance.
That’s the ideal. She acknowledged being called into an M&A discussion “at the very last minute when parties are sort of in deadlock, negotiating the reps just a few days before signing, but that wouldn't be ideal,” she commented.
How much insurance is for the deal?
Wong threw out the thought: “Ultimately, insurance is all about weighing the cost-benefit analysis, which means if you pay this amount of premium and you get to hedge against this risk, is it worth that amount or should you just self-insure?”
She laid out a hypothetical deal.
In a $100 million transaction, often parties wouldn't insure up to the full amount, because that's assuming that something could happen which wipes out the entire value of the company.
In $100 million deals, parties typically insure $20 million. Assuming a one per cent premium rate (she made it clear rates vary), a $20 million insurance policy equals a premium of about $200,000. This payment is one time for a multi-year policy of up to seven years.
Amortizing it equates to about $30,000 a year of premiums for what is essentially hedging against a loss of up to a fifth of the value of a $100 million company.
Never a substitute
Wong is quick to remind us that insurance is never a replacement for due diligence work.
“It is vital to have market standard diligence being conducted because that's something that the insurers looked to as well.
“Ultimately, insurers are stepping into the sellers’ shoes. They are responding to claims made by the buyer concerning the reps that the sellers are giving.
“Because of that, they would like to ensure that the buyer has done a good job (with) diligence the company and flushing out potential known issues, they can into account in valuing the target company,” she concluded.
As stated earlier, M&A is a complex undertaking for which neither party, seller or buyer, may have the requisite skills or experience in navigating the issues and processes that are part and parcel of the process.
When bringing in a third party into the discussion, Wong suggested looking at the experience of these outside experts.
You want to be working with parties who have had a similar experience, and they can bring that to the table. It's also important to identify the individuals who will be working with you because ultimately, these individuals are the ones who bring the experience along.
“In the M&A service provider space, it's still very much driven by personal relationships. While you need to have the technical expertise, the dealmakers also need to know that they can trust you to take a very commercial approach or ensure that you do the right thing in working together with them to achieve the outcome. This often entails that there's an alignment of interest and in reaching that outcome,” she concluded.
Click on the podchat player and hear Wong’s views and recommendations around M&A insurance.
- What is M&A insurance? Is this a new trend in Asia?
- How does it work?
- Who should buy M&A insurance?
- We’ve seen a surge in M&A deals in the first half of 2021, given the prevailing conditions brought about by the pandemic, is having insurance to cover M&A deals a sufficient risk management strategy?
- Can you cite a recent example of an M&A deal that would have benefited from having insurance (for either party)?
- At what point should the CFO consider buying M&A insurance (as it relates to M&A discussions)?
- Can you suggest key points for consideration by the CFO, including how to calculate the size of the insurance cover?
- Due diligence importance
- Given the prevailing appetite for M&A, can you name 3 recommendations for CFOs and the leadership when it comes to managing their risks, particularly under the continuing cloud of the pandemic and increasing regulatory oversight?