Street fighters battle with isolationism

Euromoney Magazine, June 2006

At a time when M&A volumes are rising, a toughening up of the CFIUS could deter foreign companies looking to buy in the US. And that would take a serious chunk out of Wall Street's fees. Kathryn Tully reports.

AFTER THE UPROAR in March over the approval given to Dubai company DP World to manage terminal operations at six US ports, many hoped the perceived threat to national security when foreign companies attempted to make acquisitions in the US might fall off the agenda. DP World had capitulated to the pressure and agreed to divest those assets, so wasn't that the end of the story?

Not so - as soon as US senator Richard Shelby proposed a bill in March that would toughen the way the Committee on Foreign Investment in the US (CFIUS) reviewed foreign investments on national security grounds, US financial markets lobby groups such as the Securities Industry Association and the Bond Market Association were out in force to get the proposed legislation watered down before it was voted on by the Senate banking committee.

"Not only would these proposals seriously jeopardize the vibrancy, depth and liquidity of the capital markets, it could be a green light for trade partners to put up their own protective barriers," says a spokesman for the Securities Industry Association.

And the list of signatories of an open letter from Wall Street CEOs to Shelby at the end of March through the Financial Services Forum expressing concerns about the potential legislation read like a Who's Who of investment banking. Chuck Prince, Hank Paulson, Jamie Dimon, Dick Fuld, Stan O'Neal, John Mack and Ken Thompson were just a few of those who urged Congress "to embrace policies that protect national security without resorting to unwise and unnecessary new constraints on open markets and the free flow of capital in the global economy".

Wall Street is rattled about the potential impact of this review, and so it should be. If foreign companies are discouraged from making acquisitions in the US as a result of uncertainty over the reception they will get there, real or perceived, there will be a lot at stake in the cross-border M&A market alone. Last year, Wall Street firms made more than $1.1 billion in fee revenue from foreign companies acquiring in the US, according to data from Dealogic, and that's before taking into account the financing of these acquisitions or all of the follow-on deals that might emerge. Goldman Sachs alone made $168 million from cross-border deals where the target was a US company. And combined revenue for Wall Street from foreign companies acquiring in the US in 2006 to the end of the first quarter reached $247 million.

Up in arms

It's no wonder Goldman Sachs, Merrill Lynch, Morgan Stanley and others are up in arms about the whole issue. "Deal volumes are growing, deal sizes are getting bigger in general and cross-border deals like Alcatel and Lucent are an important part of that. If those sorts of deals are hindered, clearly we will lose out," says a US investment banker. Several market players suggest that more rigorous escape clauses for companies and kill fees for bankers might be inserted into the terms of future M&A agreements involving foreign companies in the US now that the shape of the review process is much less certain.

One Washington source said that the Treasury department was working on an alternative to Shelby's legislation that would be more palatable to Wall Street. As well it might, given the possible impact of this bill on the US economy. A spokesman from the Treasury said that he would not comment on specific pieces of legislation or their components but that the Treasury was "certainly working with both houses to make the legislation effective in meeting the principles set out by the president". What that amounts to is that the US, while protecting its national security, must be seen to be open to the outside world. In fact, Treasury secretary John Snow warned in April that the US could not send out the message that it didn't welcome foreign investment.

As one commentator puts it, the proposed legislation could still "use some more work". Shelby's draft legislation was amended, partly under pressure from lobby groups, before it was unanimously passed by the Senate banking committee at the end of March. However, remaining contentious areas include the provision that it will broaden the range of deals that must be reviewed by CFIUS, with deals by state-owned foreign companies getting much greater scrutiny, and that CFIUS should rank countries by their perceived risks, including areas such as their commitment to arms control pacts. The maximum review period under the proposed deal could also be extended from 90 days to 120 and the proposals also say that lawmakers should be notified of CFIUS reviews of pending deals.

The last proposal has raised fears that the existing review process could become much more politicized. In fact, the endorsement of the proposed merger of French telecoms equipment maker Alcatel and US company Lucent Technologies in April by senator Chuck Schumer, who had led the congressional opposition to DP World's deal, suggests this is already happening. Schumer said that he had been getting calls from business leaders about his position on the deal and had met with Lucent's chief executive, Patricia Russo. A CFIUS review of the Alcatel/Lucent transaction has been launched, partly because of concerns about the close relationship between Lucent's Bell Labs facility and the US defence and intelligence agencies. But Schumer has no part in the formal CFIUS review process.

M&A lawyers in Washington say foreign companies are already beginning to check out the political angle, testing the temperature before they embark on a deal. "Already we are seeing more pre-notification, with interested parties talking to constituencies on the Hill before they go ahead," says Ronald Lee, partner and expert in national security law and policy for law firm Arnold & Porter in Washington.

Prolonged uncertainty

Lee believes that the prolonged review period in the proposed legislation could certainly hinder foreign companies from making competitive bids for US assets. "A longer review process clearly prolongs the period of uncertainty, both about the ultimate result and how long the whole process will take, which would make foreign offers less attractive," he says. "There's also the question of whether the review process would be longer for everyone, or whether Congress or CFIUS would be able to decide in individual cases."

Lee adds that the uncertainty is intensified because the political response to foreign takeovers over the past 18 months has been so erratic. "At the moment, it's difficult for interested parties in and outside the country to assess what the external political reaction will be, as it has been different in each contentious deal," he says.

Then there is the proposed ranking of potential problem countries, although it's not yet clear whether the compilation of this list would be a congressional or executive function, whether or not it might discourage investment that could actually be beneficial to the US from countries that are on the list, and whether as a result of the vetting process there would be more or less scrutiny for deals originating from countries that are not on the list.

Several foreign companies are rumoured to have postponed acquisitions in the US as a result of the continued uncertainty. As Lee points out, though, it's difficult to assess the impact of possible changes to the CFIUS review system because it's very hard to assess the baseline. "There may be lots of foreign companies holding off now until the dust has settled," he says. "But you have to consider how many deals don't get through under the existing CFIUS regime, how many got changed or influenced through CFIUS, and you need to take into account how many companies are cancelling or postponing deals now."

Nevertheless, the uncertainty as to how strenuous the CFIUS reform is going to be will remain a fact of life for a while because Shelby's proposed legislation now has to be debated on the floor of the Senate and in the House. Then there's also the possibility that alternative bills will be tabled - from the Treasury or from other sources.

In the meantime, foreign companies investing in the US are going to have to get used to taking their chances - and gauging the prevailing mood on Capitol Hill at that time. And Wall Street's investment bankers are going to have to come up with new ways of protecting their advisory dollars.

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