Monthly Archives: January 2019

January 31, 2019

Due Diligence: Don’t Overlook ESG Performance

Private equity buyers don’t often focus on ESG issues as part of the due diligence process, but this Norton Rose Fulbright blog says they probably ought to take the target’s performance on key ESG issues into account.  Here’s an excerpt:

In private equity, environmental, social and governance (ESG) factors are often overlooked and undervalued. Due diligence is usually more focused on the financial and quantitative aspects of the target. However, in recent years, ESG has proven to be a powerful underlying factor for business successes and failures.

As evidenced by the #MeToo movement, and the various human resource scandals that have made headlines in recent months, an unhealthy corporate culture can have serious consequences for even the biggest of enterprises. A study that looked at 231 mergers and acquisitions between 2001 and 2016 found that ESG compatible deals performed better than those with disparate positions on ESG, by an average of 21%.

This figure should be considered alongside the fact that in 2016, more than 15,000 deals were terminated or withdrawn. The face value of these terminated deals totals $3 trillion. One can appreciate the time, effort, and costs incurred in relation to these proposed transactions, which is why investors need to look beyond the bottom line, and see how a target is achieving its results early on in the evaluation process.

The blog acknowledges that a target’s ESG performance can be a tough thing for a buyer to get its arms around, but notes that the application of emerging “big data” tools to the assessment can provide insights into risks and opportunities in the ESG area.

John Jenkins

January 30, 2019

Liability Caps: Beware Undefined Fraud Carve-Outs

This recent blog from Weil’s Glenn West uses the Delaware Chancery Court’s recent decision in Great Hill Equity Partners v. SIG Growth Fund (Del. Ch.; 11/18) – which I blogged about last month – as a jumping-off point for a discussion of the perils of undefined fraud carve-outs to contractual liability caps.

Glenn points out that while the shareholders in Great Hill avoided liability beyond the contractual cap despite their CEO’s fraud, other selling shareholders haven’t fared as well.  In at least one case, selling shareholders have found themselves litigating their responsibility for another shareholder’s fraud for years due to uncertainties about the scope and application of an undefined fraud carve.  Even worse – as this excerpt points out – this issue may just be the tip of the iceberg:

It is important to note that the issue of whose fraud matters, in uncapping the liability-limitation regime, is literally just the tip of the iceberg of perils that undefined fraud carve-outs pose.  The number of other, just under-the-surface, hazards that can do serious damage to your carefully crafted and capped liability-limitation regime are legion.

They include issues as to what kind of fraud is actually being carved out (yes there are surprising forms of fraud that do not involve the deliberate conveyance of falsehoods), as well as whether the fraud carve-out encompasses fraud with respect to any statement made in the course of negotiation, or only with respect to those statements that the parties agreed were the bargained-for factual predicates for the deal and therefore important enough to incorporate into the written acquisition agreement.

The blog points out that it has become established market practice to define fraud carve-outs so that only intentional misrepresentations by a particular seller relating to the specific representations and warranties in the agreement are carved out from the liability cap.

John Jenkins

January 29, 2019

Activism: The “First Mover” Advantage in Proxy Fights

Proxy contests are probably more about politics and the art of persuasion than they are about law – and this recent study says that activists who get in front of investors before the incumbent board gain a significant advantage. This excerpt discusses just how big that advantage can be:

I find that the dissident’s communication strategy has an important effect on voting outcome and on proxy advisors’ recommendations, controlling for firm and dissident characteristics. Effective strategies entail the use of various communication channels, especially investor presentations, and the reflection of logical reasoning in the content.

Investor presentation is potentially a snapshot of all dissidents’ demands, so I focus on understanding how it affects voting outcome. As investors have limited attention, I investigate whether the timing of the presentation affects the voting outcome. Although the dissident is the first to bring proposals to the management, in only 49% of cases is the dissident the first to make a presentation.

Strikingly, I find that the dissident is 55 percentage points more likely to win if they are the first to make an investor presentation, after controlling for firm and dissident characteristics, ISS recommendations, the severity of issues in the firm, potential solutions provided by the dissident, and third party endorsements of the dissident.

The study says that the biggest factor behind the first mover advantage is investors’ limited attention spans. The first investor presentation simply gets a lot more investor attention than the second. Not surprisingly, that’s less true when it comes to institutional investors – and the first mover advantage is magnified when a company has a large number of retail investors.

John Jenkins

January 28, 2019

Tomorrow’s Webcast: “Controlling Shareholders – The Latest Developments”

Tune in tomorrow for the webcast – “Controlling Shareholders: The Latest Developments” – to hear Potter Anderson’s Brad Davey, Cravath’s Keith Hallam, Greenberg Traurig’s Cliff Neimeth and Sullivan & Cromwell’s Melissa Sawyer discuss the latest developments surrounding transactions involving controlling shareholders.

John Jenkins

January 25, 2019

Cross-Border M&A in a Protectionist Environment

The Trump Administration’s emphasis on an “America First” policy when it comes to trade and foreign affairs generally has had significant implications for how companies conduct business – and this PwC blog says that their M&A activities are no exception.

The blog points out that cross-border deals have typically represented about 25% of US deal volume in recent years, and that ongoing trade tensions could prompt some companies to focus more on in-country transactions.  And there’s some evidence that this is already happening – after a year of steady growth, the number of outbound US deals dipped by about 20% in the third quarter of 2018.

Despite the challenges, many companies remain interested in expanding their global footprint. This excerpt has some tips for companies pursuing cross-border deals in the current environment:

– Reconsider deal size. Many deals blocked recently by the US and Chinese governments have been at least $1 billion in value, and in some cases much more. That magnitude may have been a factor in government scrutiny. More moderate acquisitions may raise fewer concerns and still allow a company to move forward with its growth strategy.

– Smaller countries out of the tariff spotlight may yield possibilities. Some emerging markets have emerged, and economic power is dispersed. With information barriers largely gone, cities are more connected than ever. An urban hub in a less developed nation could offer similar quality investments to traditionally targeted countries.

– Some sectors don’t rise to a high level of regulatory scrutiny by the US and other countries, or they don’t involve as many atypical risks, even with expanded government reviews.

On this last point, while tech has been the hottest sector when it comes to cross-border transactions, deals in that highly-scrutinized sector still accounted for only 30% of cross-border M&A volume in 2018. As the blog notes, “that leaves 70% across a wide range of industries, including some – such as consumer products, real estate and certain manufacturing – in which the security and intellectual property concerns likely aren’t as great.”

Check out this Baker McKenzie memo for a region-by-region breakdown of expectations for global M&A and IPOs during the upcoming year.

John Jenkins

January 24, 2019

Attorney-Client: M&A Conflict Waivers

Over the past several years, we’ve blogged quite a bit about privilege issues relating to M&A. Topics have ranged from who owns the privilege post-closing to the viability of assertions of a joint defense privilege between buyers and sellers. But this SRS/Acquiom memo covers a related issue that we haven’t addressed directly – M&A conflict waivers.

Waivers are an important topic, because without them, the ability of the seller’s lawyer to represent its shareholders in post-closing disputes can be murky at best. This excerpt explains:

Regarding the conflicts waiver issue, whether the seller’s law firm can continue after closing to represent the selling shareholders or the shareholder representative is not always clear. The law firm’s client is usually the selling company, not its shareholders. At closing, the company that was acquired becomes a part of the buyer, and therefore, the attorney-client relationship arguably flows to the buyer. This means that the selling company’s counsel may be conflicted out of taking a position that is contrary to the interests of the combined company, as this combined company now includes its current or former client.

The memo recommends confronting this issue head-on by having the seller negotiate for a waiver of the conflict to be included in the merger agreement itself, and includes a sample waiver provision.

John Jenkins

January 23, 2019

Survey: Termination & Reverse Termination Fees

Here’s the latest edition of Houlihan Lokey’s annual termination fee study. The study reviewed 185 transactions involving U.S. company targets and involving at least $50 million in transaction value announced during 2017.

The study focused on termination fees both as a percentage of “transaction value” and “enterprise value.” Transaction value is the total value of consideration paid by an acquirer, and is generally equivalent to “equity value.” Enterprise value is the number of outstanding shares multiplied by the per-share offer price, plus the cost to acquire convertible securities, debt, and preferred equity, less cash and marketable securities.

Here are some of the highlights:

– Termination fees as a percentage of transaction value during 2017 ranged from 0.5% to 6.7%, with a mean of 2.8% and median of 3.0%. The mean & median fees in 2016 were 3.2% and 3.3%, respectively.

– Mean & median termination fees as a percentage of enterprise value during 2017 were 2.9% and 2.8%, respectively. In 2016, the mean was 3.1% of enterprise value while the median was 3.2%.

– Reverse termination fees as a percentage of transaction value varied depending on whether the deal involved a strategic or a financial buyer. In 2017, the median fee was 3.1% for strategic buyers and 4.7% for financial buyers. In 2016, the median fee for strategic buyers was 3.6% for strategic buyers and 5.8% for financial buyers.

– Median reverse termination fees as a percentage of enterprise value in 2017 were 2.9% for strategic buyers and 4.8% for financial buyers. In 2016, the median fee was 2.9% for strategic buyers and 4.5% for financial buyers.

John Jenkins

January 22, 2019

Antitakeover: Shark Repellants Promote Long-Term Value?

For as long as anyone can remember, there’s been a debate over whether anti-takeover protections are a useful tool to help build long-term value – or whether they just entrench management.  This recent study by three b-school profs supports the long-term value side of the debate.  Here’s the abstract:

We make use of data on anti-takeover provisions (ATPs) and top management characteristics hand-collected from IPO prospectuses to analyze the effect of the pre-IPO innovativeness and the top management quality of private firms on the number and strength of ATPs in their corporate charters (formed at IPO). We test two opposing hypotheses: the “long-term value creation” hypothesis, which predicts that more innovative private firms and those with higher top management quality will include a larger number of (and stronger) ATPs in their corporate charters; and the “management entrenchment” hypothesis, which makes the opposite prediction.

Our empirical findings are as follows. First, firms with greater pre-IPO innovativeness (as measured by the number of patents and citations per patent) and higher top management quality are each associated with a larger number of and stronger ATPs; the joint effect of pre-IPO innovativeness and top management quality on the number and strength of ATPs is also positive. Second, firms with stronger ATPs at IPO have significantly greater post-IPO innovation productivity, measured by the quantity and quality of innovation, as well as by the economic and scientific significance of the patents produced.

The joint effect of strong ATPs and higher top management quality on post-IPO innovation is also positive. Finally, the IPO market rewards firms with a combination of greater pre-IPO innovation productivity and stronger ATPs with higher IPO and immediate post-IPO secondary market valuations. Overall, our findings support the long-term value creation hypothesis and reject the management entrenchment hypothesis.

Well, I’m glad that’s settled. . .

John Jenkins

January 18, 2019

Our New Checklist: Shareholder Engagement – M&A Announcements

A well thought-out approach to shareholder engagement on an M&A transaction is essential – particularly if shareholders aren’t expected to support the deal overwhelmingly from the outset.  We’ve posted this new checklist from Innisfree’s Scott Winter addressing shareholder engagement following a deal’s announcement in our “Shareholder Approval” Practice Area. Check it out!

John Jenkins

January 17, 2019

The Latest Merger Trends

According to this Deloitte survey, despite recent headwinds, dealmakers continue to expect a robust M&A environment during 2019. As this excerpt suggests, both strategic & PE buyers are upbeat about prospects for the new year:

Survey respondents are increasingly bullish on expectations for M&A deal activity over the next 12 months. On the corporate side, 76% of respondents say they expect the number of deals to increase, up from the prior year when 69% projected a gain. On the private equity side, 87% of respondents foresee an uptick in deal flow, a considerable increase, up from 76% a year earlier.

Respondents from larger private equity funds are almost unanimous in their anticipation of more deals in 2019, as 94% of respondents at funds larger than $5 billion expect an increase compared with last year. Interestingly, there is not the same correlation among corporations; only 65% of respondents at the biggest companies ($5 billion or more in annual revenue) see accelerating deal flow in the next 12 months.

Corporate respondents from financial services, energy and resources, and telecommunications, media, and technology (TMT) industries were the most optimistic, in sequential order, on the likelihood for more deals in the year ahead.

A significant number of respondents not only think M&A activity will increase during 2019 – but that it will increase significantly. Nearly 1/3rd of corporate respondents anticipate a significant uptick in deal activity, and so do 29% of PE respondents.  Last year, only about 25% of corporate respondents said deal activity would grow significantly, and only 19% of PE respondents felt the same way.

John Jenkins