By Ariel J. Deckelbaum and Judith R. Thoyer, Partners; Didier Malaquin and Frances F. Mi, Counsel; and Daniel B. Levine, Associate
Paul Weiss Rifkind Wharton & Garrison
How Deals Are Getting Done
The boom and bust of the credit cycle has had a tremendous impact on the strategic M&A marketplace. During the cycle�s upswing, strategic acquirors competed with — and were often outbid by — financial buyers with easy access to credit and a higher tolerance for leverage. Aggregate transaction volume and average transaction size rose to unprecedented heights. In the 12 months ended July 31, 2007, the aggregate volume of U.S. public M&A activity was approximately $1.1 trillion, of which 42% consisted of private equity transactions.Much changed with the credit cycle�s downturn. In the 12 months ended July 31, 2009, the aggregate volume of U.S. public M&A fell 61% from the same period in 2007, to approximately $432.5 billion, with private equity activity declining 98%, to $10.7 billion. Pending transactions were tested by financing failures, underperformance and litigation, and negotiating parties were forced to reconsider transaction terms in the context of general economic uncertainty. (Click here to see Chart 1: M&A Activity as included in the PDF of the full article.)
In the wake of these events, we examined the 25 largest strategic transactions (excluding financial industry transactions) involving U.S. public company targets announced in each of the 12-month periods from August 1, 2007 to July 31, 2008 (Year 1) and from August 1, 2008 to July 31, 2009 (Year 2).
We refrain from concluding that the results of our survey indicate long-term trends. We believe that the economic environment during the surveyed period forced deal makers to reconsider and challenge traditional assumptions and focus on how to get transactions done in the face of other formidable challenges, such as reaching agreement on valuation and securing financing. Time will tell whether the approaches they used will become permanent features of the U.S. public M&A landscape. In this context, we make the following observations based on the results of our survey:
• Certainty was paramount. In uncertain economic times, deal makers that ventured into the M&A arena sought to ensure certainty. We refer to �certainty� not in the sense of certainty of closing but more broadly in terms of the contracting parties seeking to define their respective rights and obligations as specifically as possible in the face of various contingencies. The effort to achieve certainty can be seen in, among other things, the use of reverse termination fees to address the failure of a financing commitment, as discussed below.
• Strategic transactions borrowed pages from the private equity playbook. The private equity experience and the tightening of credit markets have left an unquestionable mark on the M&A marketplace. The financing out, previously the exclusive domain of private equity firms, has made its way into some strategic transactions. While far from universal, this trend highlights a shift in the collective mindset and demonstrates a realization by dealmakers that having a counterparty walk away from a binding agreement is no longer exclusively a �legal issue.� Instead, contracting parties now go to great lengths to carefully define and limit the remedies that apply to failed transactions. Here, an important distinction needs to be drawn between strategic and private equity transactions. While financing outs and reverse termination fees in private equity transactions were largely driven by the nature of the acquiror, parties in strategic transactions often used these methods to share the risk of unprecedented volatility in the credit markets. It remains to be seen whether this will be a lasting trend.
• In large transactions, cash remained king even as credit tightened. Despite an expectation that the credit crisis would cause acquirors to favor using stock as consideration, cash-only transactions dominated the survey. The preference for cash in the surveyed transactions suggests at least two factors at work: first, the economic crisis separated the strong (those with access to capital) from the weak (those without) and, second, as stock prices dropped well below their 52-week highs, many acquirors were reluctant to use their devalued stock as acquisition currency.
• Fixed exchange ratios continued to dominate transactions that used stock consideration. In transactions in which stock formed all or part of the consideration, the parties almost uniformly opted for fixed, rather than floating, exchange ratios. By opting for fixed exchange ratios, acquirors and targets chose to share the risk of fluctuations in their stock prices, instead of preserving for either party the benefits or burdens of their shares� performance relative to one another.
• A small number of completed transactions resulted from a hostile approach. Only two transactions in each of Year 1 and Year 2 were initially rejected by the target�s board of directors after the offers had been made public, and in each of those cases the target�s board of directors recommended the transaction following negotiations. Such a low level of successful hostile activity may have been driven by a number of factors, including i.) a desire on the part of potential acquirors to value targets based on in-depth due diligence rather than relying only on publicly available information and ii.) a concern on the part of potential acquirors that because most stocks were trading at substantial discounts to their 52-week highs (which, at least initially, many perceived to be the temporary result of the economic downturn), acquisition bids would likely fail without the support of the target�s board of directors.
• Tender offer activity increased. There was a trend towards structuring negotiated transactions as tender offers, which can be consummated more quickly than one-step mergers. Tender offers accounted for 20% of the Year 1 transactions and 44% of the Year 2 transactions. It is possible that in an uncertain economic environment merging parties approached their transactions with greater urgency. Overall, 32% of the surveyed transactions were structured as tender offers, a healthy level relative to the period prior to the implementation of changes to the SEC�s �best price� rule (Rule 14d-10 under the Securities Exchange Act of 1934) in December 2006. According to FactSet Mergers, tender offers represented only 8% of negotiated transactions in 2006. Our survey suggests that the revisions to the �best price� rule are having their desired effect.
• Broken transactions were infrequent. As of July 31, 2009, all but two of the Year 1 transactions were completed and only two of the Year 2 transactions had been withdrawn, an impressive result considering the spate of private equity transactions terminated during the survey period. This suggests that economic uncertainty and a credit contraction may have a different effect on closing risk in strategic transactions than in private equity transactions. In a weak economic environment, merging may become more desirable for parties seeking synergies or other opportunities, and fewer third parties may be willing or able to make competing offers. Competing offers led to the break-up of two of the four withdrawn transactions in the survey (MidAmerican Energy/Constellation and NetApp/Data Domain).
• Mergers-of-equals were absent. None of the surveyed transactions were labeled as �mergers-of-equals� by the transacting parties, and none contained all of the traditional attributes of such transactions (such as a �no-premium� offer price for the target�s shares). The dominance of pure acquisitions in the survey suggests that the credit crisis created ripe conditions for opportunistic transactions and reinforces the suggestion above that the economic environment separated the strong from the weak.
We selected the 25 largest strategic mergers involving U.S. public company targets announced during each of the 12-month periods from August 1, 2007 through July 31, 2008 and from August 1, 2008 through July 31, 2009. We selected this two-year period as representative of the downturn of the credit cycle. We excluded from the survey transactions involving financial industry targets and transactions in which either party owned more than 10% of the other party�s shares prior to the transaction. With the financial sector being the epicenter of the credit crisis, many financial industry transactions during the survey period involved targets in substantial distress, and their terms may not reflect broader market trends.
(Note: We used FactSet Mergers to develop our sample group. We identified the 25 largest transactions during each 12-month period based upon the equity value of the target implied by the merger consideration as of the transaction�s announcement date. To eliminate transactions with financial industry targets, we excluded transactions with targets having any of the following FactSet Mergers industry classifications: �Finance/Rental/Leasing,� �Financial Conglomerates,� �Investment Banks/Brokers,� �Investment Trusts/Mutual Funds,� �Major Banks,� �Regional Banks� or �Savings Banks.� We also excluded the Enterprise Products Partners/TEPPCO Partners transaction because it involved publicly traded limited partnerships.)
The findings reported herein are not intended to be an exhaustive review of all transaction terms in the surveyed transactions. We report only on those matters that we found most interesting. Our observations are based on a review of publicly available information for the surveyed transactions. Such transactions accounted for only a portion of M&A activity during the survey period and may not be representative of the broader M&A market. In addition, we treat the provisions of the surveyed transactions as if they were adopted deliberately and in lieu of mutually understood alternatives, and we ignore the roles that time, resources and informational limitations inevitably played.
Transaction Size and Form of Consideration
• Transaction size. From Year 1 to Year 2, as the credit crisis worsened, there was a substantial decline in the average and median transaction size of the surveyed transactions. (Click here to see Chart 2 as included in the PDF of the full article.)
• Cash versus stock. Cash was the exclusive consideration in the majority of the surveyed transactions each year and in a greater portion of the transactions as the credit crisis continued. (Click here to see Chart 3 as included in the PDF of the full article.) These results seem surprising given that reduced access to cash limited the ability of financial buyers to finance large acquisitions. However, for strategic acquirors that either had cash on hand or access to it, the decision to use cash, stock or some combination thereof as consideration in a transaction may have been driven by the relative costs of each to the acquiror, rather than the absolute cost of financing a cash purchase.
• Fixed versus floating exchange ratios. When stock formed part of the consideration in the surveyed transactions, the merging parties predominantly chose a fixed, rather than a floating, exchange ratio. (Click here to see Chart 4 as included in the PDF of the full article.)