This report from S&P Global Market Intelligence Quantamental Research analyzes the market performance of Russell 3000 companies following an acquisition greater than 5% of acquirer enterprise value between 2001 & 2016. It finds that post-M&A acquirer share price returns have underperformed peers in aggregate for the 1-, 2-, and 3-year periods following the acquisition. The findings include:
– Common Attributes Found in Successful Deals: Shareholders looking to identify successful acquisitions should look at acquisitions that use high levels of cash, have had lower historical growth, have repurchased shares, and make relatively small acquisitions.
– Acquirer Fundamentals Suffer Following Big Deals: In the aggregate, acquirers lag industry peers on a variety of fundamental metrics for an extended period following an acquisition. Profit margins, earnings growth, and return on capital all decline relative to peers, while interest expense rises, debt soars, and other “special charges” increase.
– Stock Deals Significantly Underperform Cash Deals: Acquirers using the highest percentage of stock underperform industry peers by 3.3% one year post-close and by 8.15 after three years. Acquirers with the highest one-year cumulative M&A spending underperform by 2.0% one year post close and by 9.3% after three years.
– Rapid Growth Pre-Acquisition is a Bad Sign: Acquirers with the highest pre-acquisition asset growth underperform by 5.8% one year post-close and by 13.3% after three years, while those with the highest pre-acquisition increase in shared outstanding also underperform significantly.
– Investors Beware Cash on Balance Sheet: Acquirers with the highest level of pre-acquisition cash & equivalents relative to assets underperform peers by 8.6% over one year and 10.1% over three years.
– Broc Romanek
Section 548 of the Bankruptcy Code gives a bankruptcy trustee the ability to avoid any transfer that was made with actual intent to hinder, delay, or defraud present or future creditors. In last year’s Lyondell decision, a federal court in the Southern District of New York held that under agency law, the acts of a corporation’s agent are imputed to it – “even when the agent acts fraudulently or causes injury to third persons through illegal conduct.’” In other words, one bad apple’s intent can be imputed to the corporation & establish actual fraud.
This Cleary memo reports that another SDNY judge has taken a different view on imputed intent. Here’s the intro:
In a recent decision in the Tribune fraudulent conveyance litigation in the Southern District of New York, the court dismissed claims of actual fraudulent conveyance, holding that an officer’s intent could not be imputed to the company where he did not control the challenged transaction. The holding creates a split among Southern District authorities over the appropriate test for determining when an individual’s intent can be imputed to a companyto prove an actual fraudulent conveyance.
Lyondell created a potentially big problem for public shareholders in bankruptcies. These shareholders are usually protected under Section 546(e) of the Bankruptcy Code, which generally provides a safe harbor for transactions – like transfers of securities in a brokerage account – that involve a financial institution.
Courts have been fairly tough on efforts by creditors to do an end run on this safe harbor in the public company context, but there’s one exception to it that looks much more daunting in the wake of the Lyondell case. You guessed it – the Section 546(e) safe harbor does not extend to cases of actual fraud. So if one bad apple can result in a finding of actual fraud, any shareholder who receives a payout in an LBO has reason for some concern about whether they’ll get to keep the money. The standard adopted by the Tribune court would lower that risk significantly – but it remains to be seen what standard for imputed intent will ultimately prevail.
– John Jenkins
Appraisal litigation in Delaware has been a wild ride in recent years, with approaches to valuation & decisions about “fair value” that often seem unpredictable. This Skadden memo reviews recent cases & tries to sort things out. It looks at decisions that used the merger price as the starting point, as well as those that used a DCF analysis – and identifies factors influencing the Chancery Court’s approach to value. Here are some of the key conclusions:
– Even a well-run sales process does not guarantee the use of the merger price as the basis for a determination of fair value.
– Certain transaction dynamics & structures, including LBO/MBO transactions such as in the Dell case, may involve particular risks in the appraisal context.
– If the court rejects the merger price in its determination of fair value, it likely will rely on a discounted cash flow and consider the projections and valuations used by the parties – including, for example, the internal rate of return calculations of an LBO sponsor or MBO group.
– A discounted cash flow valuation based on management projections may result in fair value determinations higher than the merger price.
– John Jenkins
This recent MergerMarket study reviews private equity fund lifecycles & reports that they’ve grown longer in recent years:
As a rule of thumb, PE funds aim to return all of their investors’ capital within 10 years — using approximately five years to invest and five years to harvest those deals, with two or more years of extensions written into the Limited Partner Agreement in order to realize value in underlying portfolio companies if necessary. Our findings show that fund life spans have increased beyond 10 years for the majority of GPs.
The study found that 66% of the fund GPs surveyed said that their most recent fund took between 11 and 14 years from initial investment to being completely wound up. Here are some of the study’s other key findings:
– 58% of respondents say the PE fundraising period for the current fund was longer than the preceding one, with 16% describing it as having increased significantly.
– 56% of respondents say that the timeframe from investment to disposition has increased over the past five years, with 12% saying it has increased significantly. This means that LPs’ called capital is illiquid for longer, making it unavailable for other general partners (GPs) who are in fundraising mode.
– Dry powder is at an all-time high, and yet PE firms are also setting records for additional fundraising. Two-thirds of respondents believe that the proliferation of PE firms and funds is behind this trend, meaning that managers will have to compete hard to raise new capital.
The study suggests that investors’ decisions to concentrate their capital with fewer managers for primary commitments may be a big part of the reason for the increase in time spent fundraising. Multiple factors have contributed to the lengthening of the investment period – including declines in asset values following the financial crisis and the length of time required for those values to recover, and the effects of increased competition for investments & record purchase price multiples for private companies.
– John Jenkins
This Paul Weiss memo reviews the Chancery Court’s recent decision in In re United Capital Stockholders Litigation – in which Vice Chancellor Montgomery-Reeves dismissed “quasi-appraisal” claims in connection with a short-form merger between United Capital & its controlling stockholder. The plaintiff alleged that the notice of the merger sent to stockholders omitted various items of material information, but the VIce Chancellor concluded that none of them were material to the only decision the minority stockholders had to make – whether or not to seek appraisal.
Here’s an excerpt discussing the Court’s analysis:
In considering plaintiff’s claims, the Court, relying on the Delaware Supreme Court’s opinion in Glassman v. Unocal Exploration Corp., noted that in the context of a Section 253 short-form merger, the parent corporation is not required to establish entire fairness; rather, “absent fraud or illegality, the only recourse for a minority stockholder who is dissatisfied with the merger consideration is appraisal.”
The company is only required to notify the minority of the availability of appraisal rights, provide them with a correct copy of the appraisal statute, and disclose information material to the decision of whether or not to seek appraisal. The Court noted that a disclosure violation results in irreparable injury, which the Court may remedy through “quasi-appraisal.”
Detailing the contents of the eighty-page merger notice, the Court noted that the plaintiff used the financial statements attached to the notice to decide that the merger price’s $186.6 million implied total equity value significantly undervalued the company in view of, among other measures, total assets of $342.4 million (nearly twice the implied equity value). Thus, the Court noted that plaintiff’s allegations suggest that the financial disclosures gave plaintiff “the minimum information necessary to determine whether he could ‘trust that the price offered is good enough,’ or whether the price undervalued the company ‘so significantly that appraisal is a worthwhile endeavor.'”
– John Jenkins
This Cooley M&A blog addresses 2017 antitrust trends & developments. Many observers expect that the Trump Administration will not be as aggressive in opposing mergers as its predecessor – but Cooley cautions that vigorous enforcement is likely to continue when it comes to HSR violations:
For years, the FTC has focused substantial resources on civil penalty actions against individuals and companies that fail to file for acquisitions under the HSR Act. This past year was no exception: in 2016, the agencies settled three HSR enforcement actions. Penalties imposed ranged from $480,000 for an inadvertent failure to file notification, to a record-breaking $11 million for the alleged misuse of the HSR Act’s “solely for the purpose of investment” exemption.
We are likely to see increased penalties imposed on parties that fail to comply with the premerger notification requirements of the HSR Act, as this past August the maximum civil penalty for noncompliance increased steeply – from $16,000 to $40,000 per day – a 150% increase.
The potential of significantly increased penalties will likely bring parties to the negotiating table. As a spokesperson for one defendant in a recent case said in a statement released after entering into a settlement agreement with the government, the “sudden and unanticipated 150 percent increase in the potential penalties” left it “no choice but to resolve the case as quickly as possible.”
– John Jenkins
Last month, the Delaware Supreme Court issued its decision in Sandys v. Pincus. The Court reversed an earlier Chancery Court decision and found that the close business and personal ties among certain directors of Zynga, Inc. were sufficient to render a majority of the board non-independent. As a result, the Court held that the plaintiff in a derivative action was excused from complying with the pre-suit demand requirement in connection with a suit alleging insider trading by senior corporate officials.
This Cleary blog takes a deep dive into the Court’s independence analysis for various director groups. Here’s an excerpt addressing Delaware’s nuanced approach to the impact of NYSE independence rules on its assessment of director independence:
Sandys, along with two other Delaware cases decided within the last few years, Baiera and MFW, provide some context for how to view the stock exchange rules juxtaposed against independence for Delaware law purposes. Effectively, courts seem inclined to respect the business judgment of directors who have made a determination that certain directors do not meet the independence standards of the stock exchange rules, thus creating a rebuttable presumption of non-independence for Delaware law purposes. However, in instances where the determination of non-independence is based on the bright-line stock exchange rules that prescribe a three-year bar on independence, and the facts have changed significantly within this three-year period, a court, as the Delaware Court of Chancery did in Baiera, may be willing to accept arguments rebutting this presumption.
This rebuttable presumption, however, is not symmetrical. A determination of independence under the stock exchange rules by the board does not seem to create a rebuttable presumption of independence more broadly under Delaware law for the Delaware courts. In such cases, a finding of independence is a fact for the courts to consider in an independence determination, treated and weighed like other alleged facts and circumstances.
Meanwhile, Evan Williford notes that the procedural posture of the case may have played a significant role in the court’s review of the independence issue:
The appeal concerned a motion to dismiss ruling using a somewhat plaintiff-friendly standard. Delaware courts will be more skeptical as to whether – after trial – a plaintiff has proven a director non-independent for purposes of invoking the stringent entire fairness standard.
– John Jenkins
This Perkins Coie memo highlights a potentially important shift in emphasis by the DOJ & FTC in antitrust merger challenges:
In a stark deviation from the traditional emphasis on consumer harm, as detailed in the Horizontal Merger Guidelines, both the FTC and the DOJ have pursued cases to block mergers based on potential competitive harm to large, national customers—the type of powerful, sophisticated customers that had previously been considered able to defend themselves against postmerger price increases by exerting their considerable buying power.
Increasingly, however, the federal agencies and some courts are adopting the argument that within certain narrowly drawn national markets, there are so few actual and potential competitors able to serve those large customers that the apparent countervailing power to restrain price increases is insufficient to prevent price increases.
If this trend continues, companies will need to assess the likely effects of their deal on all customer segments – and should be prepared to address the transaction’s implications for nationwide customers for whom local competitors don’t provide an alternative. However, the memo points out that depending on how the Trump Administration decides to approach antitrust merger review, this trend may prove to be short-lived.
– John Jenkins
This blog from Lowenstein’s Steve Hecht suggests that a buyer’s insistence on an appraisal condition – or a “blow provision” – might chill the exercise of appraisal rights. Here’s an excerpt discussing the potential impact of a 20% appraisal rights condition in a recent deal:
The very existence of a blow provision may cause some stockholders to hesitate in seeking appraisal, fearing that their dissenting vote might push the appraisal class over the 20% hurdle. Some casual observers find that only about 10% or less of the outstanding share population ultimately seeks appraisal.
Accordingly, a lower blow provision, on the order of 10% or 15%, could pose a very real challenge to appraisal and would test the resolve of stockholders who are unsatisfied with the deal price but concerned about blowing up the deal altogether. That may be true, for instance, where dissenters feel that the target is being sold at the right time but at the wrong price.
Buyers negotiate appraisal rights conditions to protect themselves against uncertainties associated with the appraisal rights process. If those provisions deter appraisal rights claims from being made in the first place – well, I guess they work. That’s a feature, not a bug.
– John Jenkins
Tune in tomorrow for the webcast – “Privilege Issues in M&A” – to hear Alston & Bird’s Lisa Bugni, Bass Berry’s Joe Crace & Akin Gump’s Trey Muldrow discuss how to deal with the attorney-client privilege in M&A transactions.
– John Jenkins