Favorable M&A environment
The pace of mergers and acquisitions activity remained high over the past year; while markets remain somewhat skittish amidst concerns about the strength of the economic recovery, multiple blockbuster deals and a steady pace of smaller transactions have demonstrated both continued appetite for acquisition and growth opportunities and the availability of financing for strategic and financial transactions with a compelling narrative.
Large companies are routinely employing aggressive techniques such as unsolicited offers and topping bids in pursuit of transactions they deem attractive, in part to seek to deploy the large reserves of cash many companies built up on their balance sheets during the financial crisis. While recent reaffirmations of takeover defense and deal protection mechanisms have confirmed that companies targeted by hostile acquirers and activists have a wide range of options available to them, wisdom dictates the implementation of a strong preparedness plan as aggressive acquisitive and activist behavior continues and indeed appears to be increasing. Friendly deals have also been on the rise, including in industries where mergers and acquisitions activity came to a virtual standstill during and in the years following the crisis. Throughout the market spectrum, transaction parties continue to demonstrate increased willingness to explore new and creative structures and other mechanisms to find a path to a deal that satisfies all participants.
Continuing a trend that began following the financial crisis, acquirers are pursuing hostile transactions at a larger scale and at a faster pace than at any time seen in decades. These unsolicited offers have come from strategic buyers, including International Paper’s bid for Temple-Inland, Air Products’ bid for Airgas, BHP Billiton’s bid for Potash, and Sanofi-Aventis SA’s bid for Genzyme. The same trend holds true for overbid situations, including the bidding wars over Dollar Thrifty between Hertz and Avis, 3Par between Dell and Hewlett Packard, Equinox Minerals Ltd. between Minmetals Resources Ltd. and Barrick Gold Corp., and the aborted offer by Nasdaq/ICE for NYSE Euronext following the announcement of the merger agreement with Deutsche Börse. This trend is set to continue as the increased prevalence of these tactics and their employment by large, well-respected companies erode any remaining stigma that may once have attached to hostile offers, and as companies seek to deploy the reserves of cash accumulated during the financial crisis. The continuing decline among U.S. companies of classified boards, shareholder rights plans and other similar arrangements will support a continued high level of unsolicited activity.
AT&T’s ability to obtain a commitment for a $20 billion unsecured bridge term facility to finance its acquisition of T-Mobile provides the most dramatic example of the increased availability of acquisition financing to certain segments of the credit spectrum. Investment-grade issuers such as AT&T and Sanofi-Aventis have been able to obtain sizable commitments from lenders in connection with acquisitions, as have certain companies at the higher end of the non-investment grade credit spectrum (for example, Phillips-Van Heusen in connection with its acquisition of Tommy Hilfiger). Active bond markets have permitted acquirers to quickly transition into more permanent financing by issuing notes in private or public offerings.
However, financing may still be difficult to come by for less highly rated companies, contributing to the relative dearth of very large leveraged buyouts, and it remains to be seen whether the credit markets will fully return to pre-crisis accessibility. Volatility in the markets has led lenders both to prefer deal structures that can be completed quickly (such as tender offers with high minimum conditions and top-up options), and to negotiate for additional protective rights such as the ability to require pre-closing bond offerings with escrow features, flexible pricing, and the right to renegotiate certain other terms as needed to complete a syndication.
Sale Process Considerations
A number of recent important legal cases have both reaffirmed key principles arising in the acquisition context and highlighted enhanced areas of concern, providing a road map of important procedural and structural considerations to monitor in a sale process. Reaffirmations of the poison pill and the ability of targets to control their destiny when faced with hostile offers, including decisions in the Airgas and Barnes and Noble situations, will significantly affect how future unsolicited bids play out. However, recent activity such as International Paper’s pursuit of Temple-Inland and Con-Agra’s bid for Ralcorp indicate that bidders continue to see strategic value in openly pursuing even well-defended targets. The refusal of the Delaware Chancery Court to enjoin the closing of Hertz’s acquisition of Dollar Thrifty and recent Maryland decisions in litigations over RockTenn’s acquisition of Smurfit-Stone and Ventas’ acquisition of Nationwide Health Properties continued a principle of respecting the exercise of reasonable business judgment by boards of directors, confirming that a well-informed board is not legally required to conduct a “market check” prior to entering into a binding merger agreement, and that stock transactions do not trigger so-called Revlon duties.
On the other side of the coin, the past year has brought a series of decisions highlighting potential pitfalls for boards of directors and management of potential acquisition targets, many of which related to perceived or potential conflicts of interest. Del Monte provides an important reminder for the board of a target company to carefully oversee the actions of its financial advisors, both to ensure that the board maintains control of the sale process and to avoid even the appearance of relying on potentially conflicted financial advice. The J. Crew litigation also makes clear the importance of careful board oversight, in that case over the target’s management, and a careful assessment of management’s reasons for recommending a preferred bidder.
These decisions, while in many cases reaffirming existing legal principles rather than creating new ones, provide important specific guidance that should be carefully considered in structuring any sale process.
Creative Deal Terms
Out of necessity, market participants explored a variety of innovative and novel transaction features during and immediately following the financial crisis in an attempt to cope with market uncertainties, the need to act quickly, and new regulatory developments. This trend has continued even as the economic situation has begun to stabilize, and shows no signs of dissipating. Notable developments in this vein include markedly increased variety in provisions relating to deal certainty and financing, both in private-equity style financial deals and, in a significant change from pre-crisis norms, strategic transactions. For now, the clear dividing line between strategic transactions, which had historically not employed any type of termination right for financing failure, and more flexible private equity structures employing reverse termination fees and other mechanisms capping liability, has blurred and in some cases disappeared. For example, the recent acquisition agreement between Ashland and International Specialty Products permits Ashland to terminate the deal and cap its obligations at a reverse termination fee in the event that its financing becomes unavailable, a structure once largely confined to private equity deals but increasingly employed by strategic buyers (including in Mars’ billion acquisition of Wrigley’s, Pfizer’s acquisition of Wyeth, and Merck’s acquisition of Schering-Plough). Potential parties to acquisition transactions have an opportunity to explore the terms which best suit their individual situations, somewhat freed from former perceived constraints due to market expectations that transactions would hew closely to precedents.
The employment of contingent value rights (CVRs) as a means to bridge valuation gaps is also alive and well, most notably in Sanofi-Aventis’s agreement to acquire Genzyme (the largest CVR in history) and Celgene’s agreement to acquire Abraxis BioScience. Both of these transactions employed the “event-driven” CVR model, where the securities would provide for additional payments if certain defined milestones were achieved. This structure may be most popular in industries such as health care and biotechnology, both due to the size of the impact that a single event may have on companies in such industries (such as the approval or failure of an anticipated blockbuster drug) and because such companies frequently use similar milestone tests in their commercial agreements. Price-protection CVRs, which pay out if the market price of the acquirer’s stock falls below certain levels, have been used as well, but have proven less popular in recent transactions.
Use of the dual-track tender offer/merger structure has skyrocketed in the past year. Large private equity transactions such as 3G’s acquisition of Burger King and Bain’s acquisition of Gymboree have employed this mechanism, presumably to take advantage of the increased timing flexibility it may offer. Other transactions, such as Verizon’s acquisition of Terremark, appear to be using the structure as a hedge against certain regulatory concerns (in that case, due to antitrust risk). The structure seems to have caught the market’s attention, and indications are that it will continue to be used with increasing frequency in the near future.
The Year Ahead
Economic conditions and market sentiment warrant qualified optimism that U.S. and global M&A activity will continue to bounce back towards pre-crisis levels; however, as recent negative economic indicators and the subsequent economic reaction have highlighted, the recovery remains fragile, and fears that economic growth may be stalled seem to be spreading. Despite questionable U.S. and global economic conditions, a large number of companies are armed with strong balance sheets, reserves of cash accumulated in response to the financial crisis, and the will to pursue attractive opportunities as they present themselves. Barring significant future deterioration in global macroeconomic conditions, M&A activity levels will likely remain at current levels and may continue to grow.