In the uncertainty of the current climate it’s important to continue to find ways to get deals done. With borders closed and financial markets on edge, the process of conducting cross border M&A transactions has been rapidly evolving. For many businesses, cash flow has been the most pressing concern, with orders slowing down and freezes on invoices and settlement times. As such, it has become particularly difficult to rely on historical financial data or expected projections of cash flow and market multiples to determine an accurate or fair valuation. However one traditionally volatile risk you can manage, is your Foreign Exchange (FX) risk.
1. FX Risk M&A
FX risk is the risk associated with the Foreign Exchange market where currencies are traded. The most common way currency is traded is on the spot market, where currencies are bought and exchanged on current price. The spot rate between international buyers and sellers at the inception of a deal determines the value of the deal in the buyer and seller’s currency. This rate is used to value assets and liabilities as well as the long-term cash flow. Due diligence can often take months to complete, and any resulting changes in the spot price will result in the buyers and sellers valuations changing. These changes in the spot price can stop a deal in its tracks or cause a renegotiation of the price.
2. Managing FX Risk
So how can we manage this risk? Our contract requires an exchange of currency at some point in the future, but forward contracts aren’t suitable, so what is the alternative?
One alternative is to use an FX currency basket. An FX basket is composed of a ‘basket’ of long position high yielding currencies. The value of these currencies provides a weighted average rate to peg against a currency that is not technically part of the basket, which in this case, is the currency in which we wish to perform the transaction. A basket of several currencies measured against one another provides stability and diminishes the risk caused by potential currency fluctuations. This weighted average against the currency used in our transaction provides us with the stability we need to keep FX fluctuations low and our final price accurate.
3. How Do We Pick Our Basket?
Determining the basket of currencies to use is best done by machine learning, whereby statistical analysis of the currencies is performed by computers to identify the best basket. A basket which will minimize valuation change for both buyers and sellers during due diligence and keep the fluctuation low (e.g. under 1%) during the typical due diligence period would be the desired result.
FX risk is ever present when conducting international transactions and can never be completely avoided. Therefore, it is in the interests of both parties to minimise this risk as best they can. Using currency baskets ensures we are not vulnerable to the extreme rise and fall of the market, and allows us to peg the transaction currency against a group of stable currencies and reduce the risk of an outlier driving the value of our currency up or down.
Find Out More
Quinn M&A’s expert advisors can assist you to manage FX risks in cross-border transactions. Call on 1300 784 667 or submit an online enquiry today to arrange your free initial consultation with one of our Directors.