UK tech industry – full of Western promise for Asian investors?

SUMMARY:

Experts are split over whether the balance of power is about to shift irrevocably from the US to Asia in terms of investment in European tech companies, or whether there is still a long way to go before US dominance wavers.

Asian investment into European tech companies will reach a “watershed” this year and has the potential to transform the sector for ever, according to Magister Advisors.

Last year, Asian businesses invested a huge $58 billion in the region’s tech firms, but the merger and acquisition (M&A) advisory firm expects this figure to double during fiscal 2017/18.

Victor Basta, a partner at Magister, attributes this situation to a number of factors:

  • Many Asian investors are thinking twice before committing more money to the US – they are starting to feel less welcome given President Trump’s rhetoric that Asian companies have benefitted too much from trade arrangements that now need to be rebalanced. Moreover, the fact that private equity and offshore corporate cash is moving back to the US, combined with the fact that US tech valuations are not cheap, mean that Asian investment appears less vital to the country.
  • Asian companies are likely to build on existing European investments to create long-term assets
    There are nearly 50 European tech ‘unicorns’ valued at $1 billion plus, which are more mature than their US counterparts due to a European trend away from valuations based on potential rather than performance
    There is a European funding gap for late-stage companies and the European venture capitalist market is still immature.
  • As European home markets are smaller and more multi-lingual than the US, most European technology is more internationalised from the outset, making it easier and less risky to adapt for Asian markets
    Paradoxically, despite Brexit, the UK market is proving particularly appealing due to sterling’s weakness, which is creating a 25% discount on tech company purchases compared to a year or so ago.

As a result, Basta advises European organisations to start “‘looking East’ from 2017” as to do so is likely to “accelerate the development of the tech ecosystem far faster than it could ever develop by ‘looking West’.” Three markets he sees as being in particular ascendancy in the region comprise payments, analytics software and artificial intelligence (AI).

But other experts had decidedly mixed views on the situation. One supporter was Per Lindtorp, director at technology investment bank GP Bullhound. His view was that, depending on how you measure investment, Asia actually overtook North America in terms of expenditure in 2016, although the region was still slightly behind from a volume transaction point of view.

A need to grow

For the first time that year, China also surpassed Japan as the largest investor in Europe, with India coming in third. Lindtorp says:

China has been involved in enormous investment sprees for a couple of years, especially in relation to technology, and we expect that to continue. It’s China’s plan to climb the value chain and so how do you do that? Acquire high tech and IT as one of the key elements of your industrial strategy…But it’s important to realise, Chinese companies aren’t buying European ones to move their engineers to China, but because of the unique talent and intellectual property in the region, and so the amount of investment will increase significantly.

He sees interest being particularly high in areas such as sensors and the Internet of Things, augmented and virtual reality as well as vehicle-related technology as the automotive sector is also considered vital to China’s industrial strategy.

Jean-Marie Mognetti, co-principal and head of trading and operations at investment management firm Global Advisors, meanwhile, is also convinced that China will keep on spending money in the region. This, he says, is because:

They need to grow and that’s the mentality to buy, integrate and re-export….Countries like Germany, Italy, France and the UK offer a unique selection of small and medium-sized enterprises and some of the best technologies in the world. It represents a way to transfer know-how back home and then build world-class enterprises. It’s particularly true in the domain of big data, neural networks, AI, blockchain, pattern recognition and machine learning.

Moreover, Mognetti adds, since Eurobonds took off in China in 2008, it has given Chinese investors “a feel for Europe”, although the country had already been spending money on the region’s property and infrastructure, which includes the port of Pireaus in Greece and Toulouse airport in France, for some time before that too. Other factors that have also encouraged investment include the fact that:

Relationships between China and Europe are much less competitive and confrontational than with the US. On top of that you can add the rise of Chinese bilateral relations agreements with European countries over the last 10 years.

Something else that has done no harm to China’s European tech plans is that the country does not worry about “overpaying” and is also willing to take greater risks than the average European investment fund, points out Victor Decoha, deputy director at Agence du Grand Paris & Sates Real Estate. The country is instead “governed by long-term thinking”, which includes moving away from the mass production of goods at low prices to focus on higher quality products.

Shifting power balance?

But Chris Lewis, partner at M&A advisory firm Results International, is not so convinced that Asia is on the verge of dominating any time soon. Although growing numbers of Asian companies have been spending money in the region for several years now, he sees it as more a “long-term trend rather than an immediate rocket ship increase”. There are a couple of reasons for this view, he says:

At the moment, what’s key is that Chinese exchange currency constraints greatly hinder near-term, cross-border investment and cross-border strategies. The Chinese government has put in place new Forex  exchange controls when converting yuan to foreign currency for external purchases and acquisitions. This means that anything over US$5 million needs government approval. Moreover, anything above US$50 million will not get approval because of the depreciation of the yuan. No one knows when this decision will be reversed – it could be just a few months or as long as a year or more. Yes, there are ways around these rulings, including working with a fund outside of China, but the fact remains that there are immediate obstacles to Chinese investment in Europe.

This currency tightening, which took place in November last year, resulted in large numbers of deals being signed in 2016 that are still awaiting approval – the talk is that, in fact, there are as much as US$75 billion-worth of deals currently waiting to close.

Transactions at the luxury end of the market are now apparently being vetoed as they do not fit in with China’s industrial strategy, but even technology deals are taking a long time. Europe’s ongoing battle against money-laundering is also not helping the situation. Harry Allouche, associate lawyer at law firm Alto Avocats, explains:

Because of the fight against money laundering by European banks, increasingly important controls are taking place on cash flows between Asia and Europe. For this reason, establishing a European investment holding with Asian funds can become an obstacle course. Furthermore, government agencies and private companies alike increasingly want to check the identity of investors by requesting lots of details and guarantees. These obligations repel Asian investors who become discouraged by these necessary checks and the mistrust they show.

Nonetheless, GP Bullhound’s Lindtorp believes that, over time, there will be a “shift in the balance of power towards Asia” as not only M&A activity but also venture capital funding continues to grow, making the “European tech ecosystem stronger than ever”.

But Results’ Lewis is not convinced it will happen any time soon. He points to the fact that all of the really large enterprise tech players come from the US because not only is the local market “huge”, but it is possible to secure lots of money from investors with deep pockets. Once domestic sales start to falter though, “it’s natural for them to look to acquire a pan-European market leader as a further route to growth”. Lewis concludes:

In three-to-five years, the industry is not going to look massively different. Some businesses may have sold, a few will have floated and there still won’t be enough money available at the venture level or in capital markets. And, of course, the market will still be dominated by the US….The reality is that, despite [President] Trump and all of the accompanying upheaval, it’s still the US that matters. Yes, we are going to see Asia continue to grow in the long-term, but it’s still going to be dwarfed by the amount of capital flowing out of the US. Think of this Asian activity as the cherry on the cake – not the cake itself.

My take

No matter who is right over whether the US is likely to maintain its dominance over investment in the European tech sector into the near- or even medium-term, what is certain is that the growing power and influence of Asia should never be underestimated.

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