The Mergers & Acquisitions Review: Saudi Arabia
Overview of M&A activity
2019 was a record-setting year for Saudi Arabia in terms of deal value according to Mergermarket. The Saudi Arabian share of Middle East and North Africa M&A activities by deal count reached 21.5 per cent as of September 20192 with two remarkable transactions: Saudi Aramco's acquisition of 70 per cent of Saudi Basic Industries Corporation (SABIC),3 and the Saudi British Bank (SABB) and Alawwal Bank merger to create the third-largest lender in Saudi Arabia with assets of around US$77 billion.
There was a slight decline in the number of deals in 2019 when compared to 2018; however, there was an increase in the value of deals. Saudi Arabia recorded 14 deals worth US$72.5 billion according to Mergermarket compared to 20 deals worth US$8.5 billion in 2018.4
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General introduction to the legal framework for M&A
Saudi Arabia's command economy is petroleum-based; roughly 75 per cent of budget revenues and 90 per cent of export earnings come from the oil industry. The oil industry comprises about 45 per cent of Saudi Arabia's nominal gross domestic product; 40 per cent comes from the private sector.5 The Saudi Vision 2030 was announced in April 2016 with a strategic objective of diversifying the economy of the Kingdom to reduce the country's dependence on oil. In line with this objective, many reforms were introduced, notably in the business sector. These reforms include more flexibility to foreign investors to participate in Saudi Arabia's economy. In 2017, as part of the Vision 2030, Saudi Arabia announced a mega project called NEOM, which involves the building of a new hub in the desert bordering the Red Sea, with a pledged budget of US$500 billion. NEOM is planned to include 16 different facilities including cities, towns, ports, economic zones, sports entertainment venues and research centres. It is projected to be the home and workplace for more than a million citizens from around the world. NEOM will grant direct access to the Saudi market with potentially more flexible independent jurisdictions that will be more attractive to foreign investors.6 NEOM is projected to be completed by 2025.
The regulatory framework in Saudi Arabia is in a constant state of enhancement to accommodate local and foreign investors. The Ministry of Investment and the Economic Cities Authority are empowered to oversee the regulatory procedures relating to foreign investment into the country, which investment is governed by the Foreign Investment Law (issued by Royal Decree No. M/1 dated 05/01/1421 H (corresponding to 10/04/2000G)). In line with the Vision 2030, most business sectors are open to foreign investment. The Ministry of Investment maintains and publishes a regularly updated list of the activities excluded from foreign investment, which list as approved by the Supreme Economic Council. Additionally, the Ministry of Investment has an instant licence regime and investors can apply online for an immediate licence if they meet certain requirements. In addition, the restrictions on foreign investors are not applied to nationals of the Gulf Cooperation Council (GCC) countries.
The Incorporation and operation of legal entities in Saudi Arabia is regulated by the Companies Law (issued by Royal Decree No. M/3 dated 28/01/1437 H (corresponding to 11/11/2015G)) and the Professional Companies Law (issued by Royal Decree No. M/17 dated 26/01/1441 (corresponding to 25/09/2019G)). The most commonly used types of entities in Saudi Arabia are limited liability companies and joint-stock companies. A limited liability company can be established by one shareholder and can have up to 50 shareholders.7 If the number of shareholders excess 50, the entity must be transformed into a joint-stock company.
A Royal Decree was issued on 25 September 2019 approving the issuance of the new Professional Companies Law, replacing the previous law issued in 1991 and addressing key issues under the old law. The new law allows the establishment of professional companies in any form of company allowed under the Companies Law, which was not the case under the old regime, under which legal entities were limited to general partnership companies in which the shareholders were personally liable for all the liabilities of a company.
Moreover, Saudi Arabia regulates market domination, as any transaction resulting in economic concentration, which is roughly measured to be 40 per cent of the market share, is subject to the approval requirements and controls set forth in the Competition Law (issued by Royal Decree No. M/75 dated 29/6/1440 H (corresponding to 06/03/2019G)). An entity subject to economic concentration should notify the General Authority for Competition (GAC) at least 90 days prior to consummation of the concentration transaction, where the aggregate annual turnover exceeds 100 million riyals during the last complete fiscal year.8
Strategies to increase transparency and predictability
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Developments in corporate and takeover law and their impact
The Saudi Arabia Ministry of Commerce and the Capital Market Authority (CMA) recently published a draft companies law for public consultation. There are a number of significant changes under the new proposed law, which offers flexibility in the legal forms of companies and in the management structures thereof as well as wider pathways to manage financial difficulties. The draft law also promotes the use of modern technology.
Key changes provided by the draft companies law include:
- a more flexible regime to reflect parties' agreements in corporate constitutional documents such as articles of association and bylaws versus the more rigid approach stemming from the current companies law;
- removing the requirement of small and medium-sized businesses (SMEs) to appoint auditors unless stipulated in their articles, so long as such provisions do not contradict statutory law; and
- allowing for avenues of automatic conversion of convertible debt or financing instruments pursuant to their terms.
Additionally, new forms of companies are introduced in the new draft companies law, such as the simple joint-stock company, which can be established by one shareholder, and which provides flexibility in terms of management and governance of the company, including the ability to vest management authorities in a general manager rather than a board of directors.
The other notable form of company proposed in the draft companies law is a hybrid between a limited partnership and a joint-stock company, where a company will have two classes of stakeholders, one of which is generally liable for company liabilities but enjoys management authorities over the company, and the other, which enjoys limited liability. A minimum of two shareholders is required to form such company.
As for related joint-stock companies, the new proposed draft companies law eases the procedural framework related to said companies. It is proposed that such companies may be owned by one person. The draft law also removes the maximum limit set on the remuneration of board members and the statutory lock-up period for non-listed companies. Additionally, the draft law dominates the statutory reserve of capital, eliminates the requirement to terminate a company if losses reach half of its paid-up capital, and removes restrictions relating to the distribution of annual and interim dividends so long as the company is able to meet its debts as they fall due for the subsequent 12 months after distribution. Additionally, the draft companies law proposes the possibility of including drag-along and tag-along provisions in companies' articles of association and an automatic pre-emption right to stockholders with respect to a company's issuance of new stock.
While the law remains in draft form, it is expected that the law, which ushers in significant investment friendly updates and flexibilities, will come in effect soon, and that the Ministry of Commerce will ease its stance on non-statutory elements that are expressly against the letter of the draft law even prior its enactment.
Us antitrust enforcement: the year in review
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Foreign involvement in M&A transactions
In recent years, Saudi Arabia has taken a number of steps to boost its attractiveness to foreign investors, which has resulted in a marked impact on M&A activities in the past 12 months. Notably, the government promoted the role of the Saudi Arabian General Investment Authority to the Ministry of Investment, signalling the increased importance of foreign investment in the country. Such a move has already been well received by foreign investors and sovereign wealth funds.
As part of easing restrictions on foreign investment, in late 2017, a decision was issued by the Saudi Arabia General Investment Authority (now the Ministry of Investment) accepting applications from foreign investors for 100 per cent foreign ownership of entities carrying on trading activities, which ownership was previously capped at 75 per cent. In 2019, the government relaxed the 49 per cent limit on foreign ownership of publicly listed companies for foreign strategic investors. This change was effective for owning shares of companies listed on the primary exchange (Tadawul) and the parallel (small cap) exchange (Nomu). It is expected that this will open up the capital markets to large-scale M&A activities, particularly from large companies seeking to acquire controlling interests in Saudi businesses and private investors investing in growth businesses with the potential to list in the future.
As a result of a number of changes to the legal and regulatory framework in Saudi Arabia, 2019 witnessed a new record for Saudi cross-border M&A transactions, reaching a value equivalent to US$3.9 billion compared to US$831 million in 2018.9
Significant transactions, key trends and hot industries
As previously stated in Section I, in March 2019, Saudi Aramco announced the signing of a share purchase agreement to acquire a 70 per cent majority stake in SABIC from the Public Investment Fund of Saudi Arabia. As reported by Saudi Aramco, the Saudi Aramco–SABIC private transaction was for 259.1 billion riyals.10 Another notable transaction in Saudi Arabia took place in the banking sector. In June 2019, the SABB and Alawwal Bank merged to create Saudi Arabia's third-largest lender by assets in a US$5 billion deal. The merger required the approvals of the CMA, the Saudi Arabian Monetary Authority (SAMA) and the GAC. The merger created a lender with assets of around US$77 billion with an increased strength in retail and corporate banking.
The private equity sector has also gained more traction in the country, despite the impact of covid-19. Saudi Arabia witnessed 45 deals in venture capital, valued at around US$95 million in the first half of 2020. In the first quarter of 2020, the Saudi Public Investment Fund established Jada, a fund of funds with an allocation of US$1 billion for the development of the private equity and venture capital ecosystem in Saudi Arabia.
In terms of hot industries, the e-commerce industry remains the most targeted industry in Saudi Arabia, receiving more backing from governmental agencies such as the General Authority for Small and Medium Enterprises, Monsha'at, which launched an e-commerce programme enabling SMEs to transform their activities to e-commerce so that they can expand their activities.11 Furthermore, a new e-commerce law was issued by Royal Decree No. M/126 dated 07/11/1440H (corresponding to 10 July 2019G) regulating e-commerce stores and related matters such as consumer data protection, general consumers rights and applicable tax.
The financial technology industry also is gaining more traction in the wake of support by the Saudi Arabian Monetary Authority (SAMA). In 2019, SAMA established its regulatory sandbox, which is currently home to 30 fintech companies.12 The digitisation of the Saudi financial sector is part of the Vision 2030.
We expect to see more M&A transactions in light of the above key reforms and the country's open approach to foreign investment.
In response to the impact of covid-19, many government agencies, including Monsha'at, the Ministry of Finance, SAMA and the General Organisation for Social Insurance (GOSI), launched support measures to alleviate the burden on the country's small companies. Saudi Arabia ranked 12th in the index of venture capital availability, as well as 24th in the World Competitiveness Yearbook, in 202, an increase in both rankings from 2019.13
Financing of m&a: main sources and developments
Due to a number of reasons including bank risk appetites and business cuts, M&A activities in Saudi Arabia are rarely financed. The vast majority of transactions, both cash and equity, do not utilise target leveraged buyouts. Where there is a financing, it tends to occur on the balance sheet of the buyer, and almost always without limited recourse to the target asset.
In 2020, Saudi Arabia issued the Law on Securing Rights with Moveable Assets by Royal Decree No. M/94 dated 15/8/1441H (corresponding to 8 April 2020G) and the Commercial Pledge Law by Royal Decree No. M/94 dated 15/8/1441H (corresponding to 8 April 2020G). The new law and amendments to the Commercial Pledge Law provide a more secured source of financing for companies in Saudi Arabia, which could potentially boost M&A activity by encouraging financing for M&A transactions through the reduction of risks associated with financing.
Saudi's Labour Law (issued by Royal Decree Number M/51 of 2005) regulates employment relationships in Saudi Arabia. In an acquisition or a sale of business transaction, the law does not require informing employees of such transactions; nor does it provide for a specific protection for employees from dismissal resulting from such transactions, provided that such dismissal remains in accordance with the Labour Law and the contractual obligation between parties. That said, in certain events where a transaction (whether an acquisition, merger or sale of business) results in the survival of one entity (the purchaser), the employment contracts of the employees of the non-surviving entity will be terminated and new employment contracts with the surviving entity must be entered into. The termination of an employment contract in Saudi Arabia must be in accordance with the Labour Law, which provides for a notice requirement, payment of end of services gratuities, payment in lieu of unused annual leave days, and the settlement of other rights or entitlements agreed with the employees. In the event the surviving entity opts to keep certain employees from the non-surviving entity, a transfer of residency visa must take place (where applicable), and the surviving entity must ensure that it has all municipality approvals related to the number of employees that can be sponsored by it, which may require a consideration of the localisation levels applicable to its activities.
2020 witnessed many changes to the employment law and regulations due to the covid-19 pandemic, most of which are targeted at supporting and protecting the private sector and SMEs in Saudi Arabia from the impact of the pandemic. Notable among the changes was the enactment of a furlough programme that allowed employers to apply to GOSI to cover 60 per cent of their Saudi national employees' salaries up to a maximum of 9,000 riyals per employee per month through the SANAD programme (Saudi's unemployment benefit programme). In line with the efforts to support employers from the impact of covid-19, the government passed Ministerial Resolution 13/1441, dated to 6 April 2020, amending the Implementing Regulations to the Labour Law (issued in January 2019) by allowing:
- the termination of employees for reason of force majeure;
- a reduction in employees' salaries in parallel with a reduction in their working hours; and
- putting employees on unpaid leave as an exceptional measure due to the lockdown and the financial impact of covid-19.
Additionally, more flexibility was introduced in terms of working from home for both public and private sector employees. To curtail the spread of the virus, companies were also required to limit the number of employees allowed to attend their headquarters to 40 per cent of an office's workforce.14
Most of the above measures were exceptional and implemented to support businesses in Saudi Arabia while also protecting Saudi and non-Saudi employees.
Saudi Arabia has corporate income tax, withholding tax, zakat and value added tax (VAT).
Corporate income tax applies to the profits of non-GCC shareholders at a rate of 20 per cent of profits, and at higher rates to entities in the oil and gas sector.
Payments to non-resident entities from a Saudi resident entity are also subject to a withholding tax at a rate of between 5 and 20 per cent. This applies to payments for services, royalties, dividends and other types of payments.
Zakat, which is a religious tax, is applied at a rate of 2.5 per cent to a pool calculated to approximate a company's wealth or enterprise value, and is payable in proportion to a company's capital that is owned by Saudi or GCC nationals.
On January 2018, a 5 per cent VAT was introduced for the first time in Saudi Arabia. All commercial entities with an annual taxable turnover of 375,000 riyals are expected to register with General Authority of Zakat and Tax, while the threshold for voluntary registration is an annual turnover of 187,500 riyals. 15
With respect to tax applicability on M&A transactions, as noted, foreign sellers are subject to 20 per cent capital gains tax, and sales of assets may be subject to VAT in accordance with the Unified Agreement for VAT of the Cooperation Council for the Arab States of the Gulf, which the Kingdom adopted under Royal Decree No. M/51 dated 03/05/1438 H (corresponding to 31/01/2017 G). The disposal of property assets used in commercial activities may be exempt from capital gains tax, and foreign sellers should carefully consider the tax impact of their considered transactions prior to contracting. Reorganisation and restructuring within group companies (whether directly or indirectly owned) may also be exempted from capital gains tax, provided that the assets remain within the group for a minimum of two years following a transfer. There is no stamp duty payable on an acquisition of shares or assets.
During 2020, and in light of the economic impact of covid-19 on Saudi Arabia, the government tripled the VAT rate from 5 to 15 per cent in July 2020. While not expressly stated, it is widely believed that the measure was a result of the decline in government revenues due to the country's lockdown and the decrease in oil prices.
In response to the economic impact of covid-19, Saudi Arabia took certain measures to relieve taxpayers, including the easing of tax return filings and tax payment requirements for a limited time as well as delaying penalties for late submissions of returns.16
The Saudi Council of Ministers issued a new Competition Law in March 2019 to encourage new entrants to the market as well as overseas competitors. Through this legislation, the Council has indicated its willingness to support SMEs and focus on offering the Saudi consumer higher quality at fairer prices. The new Law is applicable to any natural or corporate person engaged in an economic activity in the country that may undertake an economic concertation. Economic concentration is defined by the Competition Law as 'any act resulting in the whole or partial transfer of the title to the assets, rights, liabilities, shares or stocks of an entity to another, or the merger of two or more departments in one joint department', or a dominant position, which is 'a situation in which an entity – or a group of entities – control a certain percentage of the market where it operates or has influence, or both'.17
Any entity in Saudi Arabia seeking to participate in an economic concentration transaction must inform the GAC at least 90 days before completion of the transaction if the total annual sales value of all firms intending to participate in the economic concentration exceeds 100 million riyals.
The law provides certain penalties for non-compliance, such as a penalty of 10 per cent (capped at US$2.6 million) of the total of the annual sales value that is the subject of a violation related to any breach of the economic concentration notice requirement and dominant position, 5 per cent (capped at US$1.3 million) for preventing investigators or officers from performing their duties, and a penalty of US$533,000 in the event of a breach of any of the provisions of the Competition Law.
A new specialised committee for the settlement of disputes has been established to hear cases against businesses that violate the Competition Law.
Saudi Arabia continues to showcase strong efforts to diversify its economy away from its heavy dependence on oil and gas, and towards investment in sectors with greater long-term economic sustainability. Buyers have followed suit, moving away from traditional government-backed sectors like oil and gas, construction and infrastructure, and are instead focusing their investments in the industrial, agri-food, healthcare, education and technology sectors, which in total accounted for 63 per cent of the M&A activities seen in 2019.
We are witnessing new government-backed funds in the venture capital space such as Jada, the Saudi Venture Capital Company and Al-Elm Information Security Company, and the formation of the Saudi Venture Capital and Private Equity Association, which was established by the Saudi Council of Ministers to develop the venture capital and private equity ecosystem.
Additionally, the past 12 months have witnessed ground-breaking levels of M&A activities in venture capital, which contrasts profoundly with the subdued levels of private equity in the post-Abraaj era.18 This increase is largely a result of the government's diversification plans, but can also be attributed to increased levels of family planning as high-net-worth individuals in Saudi Arabia share business decision-making with the next generation of investors.
1 Abdulrahman Hammad and Samy Elsheikh are partners at Hammad & Al-Mehdar.
6 This paragraph has been drafted using both public resources and private information from different sources such as newspapers and NEOM's official website.
7 Articles 151 and 154 of the Companies Law (issued by Royal Decree No. M/3 dated 28/01/1437 H (corresponding to 11/11/2015G)).
8 Article 12 of the Implementing Regulations of the Competition Law (issued by Royal Decree No. M/75 dated 29/6/1440 H (corresponding to 06/03/2019G)).
11 Magnitt H1 2020 report.
12 https://www.fintechfutures.com/2020/04/saudi-arabias-fintech-sandbox-welcomes-nine-more-start-ups/#:~:text=The%20Saudi%20Arabian%20Monetary%20Authority,fintechs%20into%20is%20 regulatory%20sandbox.&text=The%20sandbox%20is%20home%20to,2030%20Financial%20Sector %20Development%20Program.
13 Magnitt H1 2020 report.
15 Articles 2 and 5, Income Tax Law (issued by Royal Decree No. M/1 dated 15/01/1425 H (corresponding to 06/03/2004 G) and its amendments.
17 Article 1, The Implementing Regulations of the Competition Law (issued by Royal Decree No. M/75 dated 29/6/1440 H (corresponding to 06/03/2019G)).
18 The Abraaj Group (a private equity firm) had been responsible for around US$14 billion assets under management. However, in 2018 the firm became insolvent due to mismanagement and this event had a major impact on the market.