DealLawyers.com Blog

– by John Jenkins, Calfee, Halter & Griswold LLP

The health care sector is one of the few areas of the deal economy where M&A activity remains fairly robust, particularly among the multi-national pharmaceutical companies known collectively as “Big Pharma.” For example, Johnson & Johnson announced a $1.1 billion deal last month to acquire Mentor Corporation, and the company recently completed a $358 million acquisition of Omrix BioPharmaceuticals. Earlier this month, GlaxoSmithKline completed its own $57 million purchase of GeneLabs Technologies, and Abbott Laboratories just this week announced a $2.8 billion deal for Advanced Medical Optics.

One of the things that these deals and other recent industry transactions have in common is that they have all been structured as cash tender offers. In a sense, that comes as no surprise – after all, Big Pharma companies have lots of cash, and are operating in an environment where acquisitions are a strategic imperative. That’s a scenario where you can expect to see a lot of competition among buyers, and one where the timing advantages associated with a tender offer would be pretty compelling. On the other hand, over the past decade, tender offers have been less popular in negotiated deals than you might expect, so their use in so many recent deals is something that’s worth noting.

As I alluded to earlier, the big advantage that a deal structured as a “two-step” transaction (an upfront tender offer followed by a back-end merger) enjoys over a traditional “one-step” statutory merger is timing. Since a tender offer only has to remain open for 20 business days, a two-step transaction allows companies an opportunity to close their deals in as little as 30 days from the date the tender is launched. In contrast, one-step transactions involving public company targets may take three months or more to complete.

The reason for this timing advantage is that while a one-step merger requires companies to file preliminary proxy materials with the SEC for review before mailing to shareholders, tender offers can be launched immediately. Companies still face SEC review of their tender offer filings, but that review happens while the offer is being made, and any comments received from the staff can frequently be addressed without the need to extend the offer.

Despite the advantages of a tender offer, it has not been an especially popular deal structure for negotiated transactions in recent years. Legal uncertainties associated with this structure that were only fairly recently addressed by the SEC are probably the biggest reason for this, but private equity’s dominance of the M&A market prior to the credit crunch was also a contributing factor. The legal uncertainties associated with two-step transactions arose from some case law interpretations of Exchange Act Rule 14d-10.

This so-called “best price rule” requires a bidder to pay to any security holder the highest consideration paid to any other security holder in a tender offer. Shareholder plaintiffs contended that severance, retention and other compensatory payments to target executives actually were part of the price those persons received for tendering their shares, and that the best price rule obligated buyers to pay the same compensation to all other shareholders. That meant that if any such payments were made in connection with a tender offer, shareholders would be entitled to a proportionate share of them. This argument received a sympathetic hearing from some courts, and raised the potential that buyers might face staggering damages due solely to the decision to structure a deal as a tender offer. See, e.g., Katt v. Titan Acquisitions, Ltd., 153 F. Supp. 2d 632 (Mid. Tenn. 2000). Given those risks, buyers tended to shy away from this structure.

Private equity firms also did not often structure their deals as tender offers, but not just because of concerns about the way courts might apply the best price rule. The banks that committed to finance private equity deals frequently wanted time to market the debt before funding. As a practical matter, that meant that private equity firms and their lenders weren’t anxious to sign up for a deal that they would be committed to close on before the debt could be placed.

The SEC took steps in late 2006 to address the legal uncertainties associated with the best price rule. Amendments to the rule excluded compensatory payments from its reach and established a safe harbor mechanism by which companies could ensure that their arrangements fit within the exemption. More recently, private equity buyers have headed to the sidelines as debt financing has dried up almost completely. In contrast, financing is not an issue for most Big Pharma companies, which have piles of cash on their balance sheets. With less uncertainty on the legal front, the potential to close weeks or even months more quickly by structuring a deal as a tender offer makes that option very attractive to a cash rich strategic buyer.

That’s especially true when those buyers know that they are likely to face stiff competition from other industry players on almost every deal. In that kind of environment, it’s no surprise that tender offers appear to be making a big comeback, and it’s likely that we’ll continue to see plenty more of these deals over the next 12 months.