May 18, 2009
The economic downturn has virtually frozen acquisition financing and collapsed the value of many companies, which is credited for breaking up numerous acquisitions. According to Thomson Reuters’ data, 70 U.S. deals were "withdrawn" in 2008 (including 11 that were announced in 2008 but cratered in early 2009). Of these 70 reported deals that came apart after being agreed to and announced, here is what appeared to drive the break-ups:
The largest single factor was the buyer’s inability to obtain financing. That was the clear primary problem in 21 percent of the cratered deals. In most of these deals, the buyer lacked a financing "out," was subject to a "reverse termination fee" provision and ultimately paid an amount that matched such provision. In the few cases in which a financing "out" existed, it functioned as intended, and the buyer escaped the transaction without penalty.
A number of these deals fell apart notwithstanding the buyer having a financing commitment at the outset, and disagreements arose between lenders seeking to avoid their commitments and the prospective borrowers. One such case was precipitated by the buyer and target agreeing to certain amendments to the agreement governing their $1.1 billion merger, including an extension of the debt marketing period. The lender asserted that, because the amendments were effected without its consent, it was no longer obligated under its commitment letter (and although the buyer publicly disputed this position, no claims against the lender were reported, and the target collected a termination fee from the buyer). In another case, a lender brought suit to avoid its obligation to finance a $1.5 billion merger on the basis that the combined company would be insolvent, but ultimately agreed to pay the target $136 million as part of a settlement.
Nearly as significant as buyer financing problems was a deterioration in the target’s condition (20 percent of the cratered deals). This category includes obvious cases (i.e., where the target bank was taken over by federal bank regulators), pretty clear cases (i.e., where the buyer cited some version of such factors in its announcement upon exiting the deal, and faced no dispute or fee claims from the target) and the arguable or even dubious cases (i.e., where the buyer stated such reasons but the target disputed such assertions, with the target in some cases prevailing on its claim for a termination fee). Nearly all of the deals in this category involved a public target.
Not all of these were mutually agreed exits – in several, the target denies having experienced a "material adverse change" and is suing to collect a reverse termination fee or to enforce a specific performance clause to require completion. In at least one deal, the buyer filed suit first, claiming "fraud in the inducement" over alleged misrepresentations from the outset, and counter-claims are continuing. In others, jilted targets have extracted substantial settlements, in the form of cash fees and/or non-controlling investments from buyers seeking to get out. The existence or absence of a contractual right to specific performance, and/or a "reverse termination fee" that effectively allows a buyer to get out, have also been key leverage points in determining who might have to pay how much to achieve an exit.
Another 8.5 percent of the cratered deals came apart because the buyer’s condition deteriorated. Unsurprisingly, the consideration in each of these transactions was either all stock or a combination of cash and buyer’s stock: As the buyer’s condition (or at least stock value) deteriorated, the deal became much less appetizing to the target’s shareholders.
Approximately 11 percent of the cratered deals came apart due to apparent deterioration in both buyer and target. All of these were stock deals or cash-and-stock deals, where the market value of the buyer’s shares was declining rapidly and the stock price or other metrics appeared to be declining for the target as well, resulting in mutual termination agreements with no party paying the other any fees. The buyer did not want to pay an escalating stock price for the target as the buyer’s stock value declined, and the target did not want to receive stock that it perceived as likely to produce less return than expected.
Half of these "mutual deterioration" deals involved a special-purpose acquisition company buyer, where the target shareholders’ interest was to be converted into its shares. Although there was not a true deterioration of the buyer in these cases (special-purpose acquisition companies generally do not have any active business that can deteriorate), the value of a special-purpose acquisition company as a vehicle for the target to go public decreased due to the overall market decline. Similarly, the potential upside to the special-purpose acquisition company’s sponsors and shareholders would decline as well.
Comparison of the deals in the buyer-deterioration, target-deterioration and mutual-deterioration categories provides some interesting observations. The first is that about half of the buyer-deterioration and mutual-deterioration deals involved buyers and targets that were banks. Not surprising, given the exceptional hits taken in that industry, and these situations would not be expected to arise as often in more stable industries.
Deals that cratered due to a deterioration in the target’s condition also were much more likely to result in litigation or claims for termination or reverse termination fees. In part, this is just the categorization exercise – counted in this category are claimed deterioration by the buyer, which sometimes may be a dubious claim that meets with counterclaims by the target. Part of the explanation is also that many of these deals involved all-cash consideration, which skews the objectives of the parties: target deterioration may mean the buyer wants to get out of the deal (so as not to "overpay"), but the target would continue to push to close at the original (arguably, now "inflated") price. By contrast, with stock deals (depending on whether collars exist that permit an exit and whether exchange ratios are tied to specified dollar values), a general downturn in stock values may mean that the deal has become worse for both sides.
Approximately 10 percent of the deals cratered due to an inability to obtain approval from the buyer’s shareholders. More than half of these were transactions by special-purpose acquisition company buyers, where three forces seem to be at work: difficulty getting supermajority approval (usually, 80 percent is required), special-purpose acquisition companies trying to hastily put together a deal before expiring and the trust account "refund" mechanism for special-purpose acquisition company holders (which starts to become an attractive alternative for the company’s shareholders when the overall market declines). Among the operating companies that needed their shareholders’ approval (because of the amount of stock to be issued), two failed because the shareholders appear to have preferred alternative transactions involving the buyer itself being acquired.
Another 10 percent came apart because of delay or inability to obtain regulatory approvals (i.e., the Federal Communications Commission, the Hart-Scott-Rodino Act and certain state government approvals). Most of this was not attributable to the downturn, although regulatory approval problems in the banking industry played a role, and were clearly affected by the meltdown among many banks. For example, one deal cratered when the Office of the Comptroller of the Currency sought capital back-stop guarantees from affiliates of the buyer and, without such assurances, held up approval beyond the drop dead date.
Finally, approximately 7 percent of the cratered deals came apart because competing superior offers emerged and prevailed. Despite the downturn, the market has not been left to singular buyers willing to proceed when no one else would. Although heated auctions among private equity buyers have all but evaporated, private equity firms did prevail in two acquisition contests, each involving a strategic competing bidder (and, in one three-way bidding situation, another private equity shop). Strategic acquirers won out in several other contests, most undertaken against industry competitors. These deals demonstrate that the "fiduciary outs," "go shops" and "window shops" still mattered in a down market – alternative bidders did appear, and the buyer was left with its break-up fee.
The remaining handful of cratered deals involved a variety of issues that did not arise frequently in the overall sample, and may not be directly attributable to the downturn. So what are the lessons?
First and foremost – deal protection terms certainly make a difference. This is not just lawyers wrangling about things that never will come to pass. A financing "out" is very real when the financing markets seize up.
A "fiduciary out" indeed allows competitors, even in a down market, to sweep in. A reverse termination fee puts a floor on deterioration in the perceived value of a deal to a buyer – paying up, while painful, can be the best course when the overall value of the transaction becomes a worse outcome. And nothing the parties do in a contract will prevail over deterioration that makes the outcome bad for both parties.
Despite some suggestions that the marketplace will re-write the rules of the M&A road to create more certainty, the record from the downturn shows a wide range of "protections" or relative lack of them – rather than a singular market standard – and a wide range of outcomes.
The parties’ respective leverage is perhaps the best explanation of such a wide range, and that’s not likely to change just because the market as a whole presents the challenges that it now does.
This article was prepared by Gibson Dunn partner Joe Barbeau and associates Jeff Petit, Anne Pogue and Marcie Areias, members of the corporate transactions group based in Gibson Dunn’s Palo Alto office.
This article appeared in the Daily Journal, Page 7, Focus Column, May 14, 2009. Reprinted with permission, Daily Journal Corp. © 2009.
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