Friday Letter Protectionism spreads

Angela Merkel's government is set to block certain takeovers by foreign investors. Though touted as a response to sovereign wealth funds looking to buy sensitive assets, those investors infamously dubbed "locusts" in Germany are also at risk. This is a troubling prospect for German companies, like the bank IKB of which Lone Star will take control, given private equity's ability to provide much-needed liquidity.  

German politicians this week passed a draft law which would allow the government to block buyouts and other types of acquisitions by foreign investors up to three months after a deal has been agreed.

The law would extend the government's takeover veto power from the arms and weapons industry to others in which the purchase of stakes greater than 25 percent by non-European investors could pose potential threats to national security.

Modelled much after the policy in the US, whose Committee on Foreign Investment in the United Sates (CFIUS) in 2005 famously blocked China's National Offshore Oil Company from purchasing Unocal, the German government's bill has been presented as a safeguard against asset-hungry sovereign wealth funds.

“The majority of foreign investments won't be affected by the draft law,”' Michael Glos, Germany's economy minister, said yesterday in a statement which stressed that Germany “is and remains open to foreign investments”.

While business groups such as the Federation of German Industries and Germany's Chamber of Trade and Industry have protested, Glos insists the law simply gives Germany the same precautionary tool kit that countries like the US, UK and France already possess.

This tool kit, however, leaves foreign private equity investors vulnerable to the government's subjectivity.

In the US, at least one private equity deal to date has been blocked by CFIUS: Bain Capital's $2.2 billion buyout of data networking company 3Com. In March, Bain was forced to abandon the deal after it was unable allay the regulator's concerns over alleged national security threats posed by Bain's minority Chinese trade partner, Huawei Technologies.

Already considered a somewhat unreceptive environment for private equity investors, Germany now risks seeing some of the capital-rich investors it has dubbed “locusts” hop on to greener pastures.

While perhaps a minor annoyance for private equity firms, which can easily find more welcoming places to deploy funds, the legislation is likely to halt some of the deals Germany desperately needs done amid an economic downturn.

Lone Star's agreement this week to purchase roughly 91 percent of German bank IKB, for example, was characterised by the head of state-owned bank KfW as a transaction not only preventing IKB's collapse, but ensuring stability of the German economy.

The executive, Wolfgang Kroh, described the bank as facing “an existential crisis” at a press conference praising the deal.

Had the US private equity firm been prevented and or deterred from doing the transaction, a distinct possibility under the draft law limiting foreign investment, IKB would have indeed been left with “No Exit”.

Once ratified by the Bundestag in the fall, an unfortunate effect of the protectionist legislation may be that many liquidity-starved German companies will find doors to foreign capital firmly closed.