Spanish dealmaking defies health and economic crisis

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White & Case LLPWhile Spain's recession is expected to be among the deepest on the continent, the nation has remained one of the most attractive deal destinations in Europe for PE and M&A.

As Europe became the epicenter of the COVID-19 pandemic in its early weeks, Spain was one of the hardest hit nations on the continent. Despite its challenges, Spain’s M&A market has defied the crisis to post a comparatively robust first half to the year.

H1 2020 saw US$14.5 billion invested across 154 deals, representing year-on-year falls of 38% and 35% by value and volume respectively. In contrast, global deal value fell far more steeply, collapsing by a full 53%.

The largest acquisition of the year to date holds two clues to where activity can be expected into 2021, as Spain works toward economic recovery: telecoms and private equity. The pending US$3.3 billion take-private of telco Masmovil Ibercom by Lorca Telecom ensured that TMT was the largest sector by value in H1, with US$6.2 billion in activity.

Masmovil, Spain's fourth-largest telco, holds potential for consolidation for a number of reasons. Consumer telecommunications has defensive qualities in recessions and in this one in particular, as restrictions of movement and the emphasis on homeworking and entertainment mean that fixed broadband services have performed well. But company closures and reduced economic activity also mean that telcos are expected to post revenue falls in 2020 amid falling B2B turnover—leading to poor share price performance. This comes as the sector already faces the long-term erosion of profit margins.

Splitting the difference

An ongoing theme in the telecoms sector is for operators to split off their infrastructure assets, either running them as a separate company or selling them outright, and this trend is driving up M&A figures. The strategy allows the customer-facing telecoms services side of the business and the infrastructure side of the business to hone their respective strategic focuses. The former can raise much-needed cash from the sale and the latter can raise cheaper debt financing as a streamlined infrastructure operator. Private equity has played a central role in this sector-wide restructuring.

Telxius, the infrastructure business of Spain's Telefónica, has been part owned by KKR since 2017, and was responsible for the largest outbound deal from the country in H1 2020. The company acquired a portfolio of tower and rooftop assets from Telefónica Deutschland for US$1.7 billion in early June, contributing to Spain's total outbound M&A value of US$9.8 billion in the first half. This represented a moderate annual fall of 13% but a more substantial 37% drop in volume, to 106 deals.

Looking ahead, Masmovil is a credible contender for divesting its own infrastructure assets to Telxius as it seeks a potential consolidation of the services market, a move made easier by recent legal developments. In May the European General Court found that the European Commission (EC) had been wrong to block a proposed merger between UK market leaders Three and O2 on the basis that national markets require at least four main players to remain competitive. The ruling paves the way for consolidation activity across Europe as the sector comes under pressure from COVID-19.

This consolidation in waiting is exemplified by the planned US$39 billion merger in the UK between Telefónica-owned O2 and Virgin Media. If that deal completes before the end of the year, it would propel Spain's outbound deal activity to its highest level in at least the last five years.

Banking on the recovery

It is not just telecoms where PE sees opportunity in Spain's struggling economy—the International Monetary Fund has projected Spain’s economy will contract by as much as 8% in 2020, a bigger retrenchment than for the Eurozone overall (7.5%). However, the country's central bank reported in June that it cannot rule out a contraction of as much as 15.1% if a second wave of coronavirus emerges.

Spain is one of Europe's most popular tourist destinations, and quarantine measures and an ongoing aversion to travel have left its hospitality sector reeling. The fall in travel has created an opportunity for financial sponsors in a country where other sources of equity financing are relatively limited.

While Spain has a high number of multinational groups, which are able to tap capital markets for debt and equity, Spain does not benefit from a high number of well-capitalized, family-owned businesses as does Italy, the Mediterranean's other major economy.

At a time when banks have become more risk averse and the worst affected sectors struggle to secure loans, PE has an opportunity to deploy capital at attractive price multiples.

In July, Madrid-based private equity real estate firm Azora raised €680 million for a new fund focused on hotel investments around the Mediterranean, with a primary focus on Spain.

FDI considerations

One potential roadblock for overseas acquirers with an eye on Spanish bargains is the country's heightened scrutiny of foreign direct investment (FDI) in strategic sectors including telecoms, energy, defense and technology. The government announced on March 17 that investors outside the European Union will temporarily require a new authorization from the government if they wish to control or increase their participation to more than 10% in a domestic company in certain industries, public or private.

Spain is by no means alone in tightening FDI controls. In March, following the spread of the pandemic to Europe, the EC issued non-binding guidelines calling on member states to make the screening of foreign investments more strict. In recent months, a number of countries, including France, Italy, Germany and the UK, have tightened their FDI review frameworks, including widening the scope of sensitive sectors and requiring more information before approving deals. Of particular concern in light of the crisis is the foreign takeover of businesses that play a critical public health or infrastructure role.

Spain’s scrutiny of FDI is not new. The pandemic has accelerated a trend that was already underway. As Spain's economy contends with one of the steepest contractions in Europe, EU investors—both PE funds and corporations seeking to re-strategize by repurposing their portfolios—are at a significant advantage compared to those outside the bloc.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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