Bloomberg Law just published this analysis of pending M&A transactions, and the results indicate that there are a whole bunch of deals announced in 2021 and in 2020 that have yet to close. Here’s an excerpt:
According to Bloomberg data, more than 21,000 global deals announced since the start of 2020, valued at a total $2.5 trillion, remain pending in the period between signing and closing. Of the $4.1 trillion dollars in global M&A deals announced so far in 2021, for which definitive agreements have been entered into, $2 trillion have reached completion, $208 billion have been terminated, and $1.9 trillion remain pending and have yet to close. For the $3.7 trillion in deals announced in 2020, $2.8 trillion have reached completion, $179 billion were terminated, and $699 billion still have yet to close.
The sizable number of 2021 deals that still haven’t closed isn’t all that surprising – after all, regulatory clearances, shareholder approval and the satisfaction of closing conditions often take quite some time. But the fact that transactions representing nearly 20% of 2020’s total announced deal value hadn’t closed by the end of this year’s third quarter was a little surprising, at least to me. I can only imagine what things might look like this time next year if regulators continue to turn up the heat on M&A.
There’s a new study out that slams private equity funds’ lack of transparency and the metric typically used to measure their performance. The study says that reliance on “internal rate of return,” or IRR, as the Holy Grail of fund performance is potentially misleading and an impediment to determining whether these funds outperform the public markets. Here’s an excerpt from this Institutional Investor article:
Investors in private equity face high costs and increased risks because of structural issues in the industry that hinder transparency. For example, investors generally don’t measure returns and fees based on information on the underlying portfolio companies. Instead, investors have data, such as cash flows, to calculate what’s called the internal rate of return, or the IRR, of the fund. That means, “the true investment risk within their PE portfolios is largely unknown,” according to the paper.
Measuring performance with internal rates of return also makes it difficult for investors to compare the returns of different private equity funds and to contrast the strategy with what they would have earned in the public markets. Monk and his co-authors argue that the measure is heavily influenced by returns earned early in a fund’s life. As an example, the report cites private equity funds from the 1970s and 1980s, whose returns earned since inception are exceptional because of this property. “This is not only misleading as an indicator of their contemporary performance, but it forms a performance moat around the top private equity firms against which emerging managers and strategies struggle to appear competitive,” wrote the authors.
The authors argue for the use of what they refer to as “organic finance” to assess PE investments. The authors characterize organic finance as “an emerging investment philosophy underpinned by greater information transparency between investors and the sources of investment return (base assets).” The key to organic finance is greater transparency when it comes to providing investors with the data needed to calculate valuations, returns, risks, fees, performance attribution, and other performance categories of base assets.
Sounds great in concept, but right now investors don’t seem real interested in analyzing whether investments in PE funds really make economic sense. According to this PitchBook article, money is pouring in to private equity – particularly into “mega funds” raising more than $5 billion. What’s the attraction? PitchBook analyst Rebecca Springer says it’s their IRR:
When it comes to the question of whether mega-funds generate better returns, she said that overall, they have beaten smaller funds in recent years. “They are less likely to underperform and less likely to overperform relative to smaller funds,” she said. The resonating shockwaves of the pandemic are still being felt throughout private equity. Springer said the surge in mega-funds isn’t a COVID-19-specific trend, but that the pandemic probably did give the funds a tailwind.
“Mega-fund IRRs (internal rates of return) bounced back more quickly than smaller fund IRRs after Q2 2020. The larger portfolio assets of mega-funds may have been more resilient to pandemic effects and are more likely to be marked-to-market against public company comps, which meant these funds shared in the stock markets’ rapid recovery,” she said.
The authors contend that IRR is an illusion when it comes to appropriately assessing PE fund investments. If so, it’s one that private equity investors seem to find pretty comforting right now.
This Morris James blog reports on yet another Delaware decision involving claims of contractual fraud. The Delaware Superior Court ‘s decision in Aveanna Healthcare v. Epic/Freedom LLC (Del. Super.; 7/21) reached the usual conclusions about the usual issues – a reliance disclaimer isn’t going to absolve a party of fraudulent statements within the contract itself, and an owner that knowingly causes a misrepresentation can’t avoid liability just because it isn’t a party to the contract.
The transaction involved the sale of two companies. The purchase agreement contained representations by the companies – but not by the seller & its owner – as to the accuracy of their financial statements. Following the closing, the buyer found evidence that the seller had allegedly falsified those financial statements to inflate the purchase price for the companies. The sellers moved for a judgment on the pleadings, but the Court denied that motion. This excerpt from the blog summarizes the Court’s decision:
The Court held that, under its own terms, the anti-reliance clause at issue expressly was applicable to extra-contractual representations, not the intra-contractual representations concerning the companies’ financial statements; its plain language thus mirrored the result impliedly compelled by Delaware public policy. The Court also rejected the seller’s argument that the fraud claim was based on extra-contractual statements merely because alleged evidence of the alleged fraud came from documents (here, internal company emails discovered post-closing) outside of the purchase agreement.
The Court also held that certain owners could not avoid fraud liability simply because the company made the representations at-issue in the purchase agreement. Reviewing Delaware cases on this issue, the Court reasoned that under the Court of Chancery’s 2006 ABRY Partners decision and its progeny, sellers may be liable for fraud if they knew the representations were false when made. Here, the buyer had sufficiently pleaded the seller’s knowledge.
The decision wasn’t a complete victory for the buyers, because the Court declined to dismiss counterclaims by the sellers arising out of the buyer’s alleged failure to comply with contractual obligations to release certain tax refunds and amounts held in escrow.
FTI Consulting recently published its Q2 Activism Vulnerability Report, which provides an overview of the state of play in shareholder activism & ranks the vulnerability of various industries to activist campaigns. This excerpt says that there have been some changes at the top of the list:
For the first time since the Q3 2020 report, the Utilities sector is not the most vulnerable sector to shareholder activism, as defined by FTI’s Activism Vulnerability Screener. Both the Aviation & Airlines sector and the Media & Publishing sector have overtaken the Utilities sector in terms of total vulnerability to shareholder activism. The Aviation & Airlines sector faces continued COVID-19 challenges, as business travel remains depressed when compared to pre-pandemic levels; the near-term future for both business and personal travel remains murky due to the surging Delta variant.
The Regional Banks and Automotive sectors were the largest movers up the vulnerability rankings, each moving up eleven spots. The Real Estate sector, on the other hand, was the largest downward mover in the vulnerability rankings, moving lower by fourteen spots. The S&P Real Estate Select Sector Index is the top performing sector index year-to-date after a challenging 2020 in which it was the second worst performing sector index. The Real Estate sector was particularly stalled by COVID-19 and the ensuing stay-at-home orders but has rebounded as vaccination rates increase and both corporations and citizens return to normalcy.
This Sidley memo explores some of the issues associated with the rise of “fraud on the board” claims in Delaware, including the potential culpability of the defrauded directors. This excerpt explains:
Are the directors who have been deceived by an uncandid colleague simply victims, or have they breached their fiduciary duty for failure to anticipate and deal with a lack of candor caused by a conflict of interest? The answer “yes” is what the plaintiffs in Haley asserted explicitly. In that case, the plaintiffs argued that the uncandid CEO/director’s fellow directors “… breached their fiduciary duties by failing to oversee [the CEO’s] negotiations.” 235 A.3d at 715. Similarly, the Court of Chancery in PLX, after declaring that the uncandid director breached his fiduciary duty, added “… and induced the other directors to breach theirs.” 2018 WL 5018535, at *47.
This approach of victim-at-fault echoes the holding and language of the Rural Metro case. While that case related to a financial advisor’s undisclosed conflict of interest, the language of the opinion was broader in scope. “Another part of providing active and direct oversight [of a sales process] is acting reasonably to learn about actual and potential conflicts faced by directors, management, and their advisors.” In re Rural Metro Corp. S’holders Litig., 88 A.3d 54, 90 (Del. Ch. 2014).
The authors suggest that the board can protect itself by learning from Rural Metro and engaging in some degree of investigation and heightened oversight of potential conflicts involving fiduciaries, particularly in situations where an independent director has certain attributes that make conflict or lack of candor somewhat likely. Examples of these include when the director is a representative of a hedge fund or other evidence suggests a short-term bias, and when the director has a close relationship with another director who is clearly conflicted.
The terms of the preferred stock issued to PE & VC investors typically include a tightly drawn mandatory redemption obligation that kicks in after a period of time or upon the occurrence of certain events. In Continental Investment Fund v. Tradingscreen, (Del. Ch.; 7/21), the Chancery Court was confronted with a claim by preferred stockholders that a company that lacked sufficient funds to fully satisfy its mandatory redemption obligations violated the terms of the preferred stock.
As a result of the alleged default, the plaintiffs contended that they were entitled to interest from the date of the breach in 2013 through the date in 2020 when the company finally satisfied those obligations. Vice Chancellor Laster disagreed, holding that the company did not violate the terms of the preferred due to its inability to fully redeem the preferred. This Morris James blog summarizes the Vice Chancellor’s decision:
The Court concluded that the company met its redemption obligations in 2013 by redeeming all of the shares that it could. A special committee aided by a financial advisor evaluated the number of funds available for redemptions, including whether the company could obtain debt financing to pay more, and the amount of cash the company needed to continue to operate as a going concern and remain solvent for the foreseeable future. Ultimately, the committee determined that the company could use $7.2 million for redemptions and that the company should keep $20 million cash, an amount the committee thought was needed to retain and attract business in the company’s industry (i.e., providing electronic trading solutions to institutional investors around the world).
In reaching its conclusion, the Court observed that the Committee’s determination was “a judgment-laden exercise entitled to deference” absent a showing of bad faith, unreliable methods or data, or fraud. The defendants did not have the burden to show that paying more would have rendered the company insolvent. Rather, the preferred stockholder had the burden to prove the existence of additional funds legally available to redeem its shares. The Court also rejected the argument that the committee erred by reserving funds for two years of operation, rather than one, reasoning that directors have the discretion to evaluate the appropriate time horizon and resources required for their particular corporation to continue as a going concern.
Paul Weiss put together this presentation on M&A transactions during the month of August. It covers a lot of ground, including information about domestic and global deal volume, strategic v. sponsor activity, SPAC deals, and inbound & outbound cross-border transactions. This excerpt reviews public company deal terms for transactions announced last month:
U.S. public merger highlights in August include the following:
– Cash only consideration was up compared to the LTM average, while stock only consideration was low at 15% of the deals in August compared to 27% LTM.
– Unaffected premium percentages saw a significant increase in August to 47% as compared to 31% in July and 37% LTM.
– The percent of deals relying on tender offers increased to 15% in August which is slightly above the 14% LTM average.
– Reverse break fees increased to 7% compared to 6% LTM.
– Go-shops were used in 8% of deals compared to 8% LTM.
This Fried Frank memo discusses the FTC’s rapidly evolving approach to merger review and enforcement, and makes it clear that there’s a new normal when it comes to the FTC’s priorities. Here’s the intro:
In a memorandum issued to the Federal Trade Commission (FTC) staff last week, Lina Khan, the new Chair of the FTC, indicated that the agency’s priorities and approaches in reviewing proposed M&A deals will differ from those in the past. Kahn stated that the FTC, rather than viewing its work in two “silos” relating to antitrust and consumer protection, will be reviewing deals “holistically” and taking an “integrated approach” to the harms that “Americans are facing in their daily lives.”
She explained, for example, that the agency will focus on whether there are “power asymmetries” leading to “harms across markets, including those directed at marginalized communities,” and whether the business models and structures used will “incentivize or enable” unlawful conduct. Further, she stated that, given “the growing role of private equity and other investment vehicles,” the agency will “examine how these business models may distort ordinary incentives in ways that strip productive capacity and may facilitate unfair methods of competition and consumer protection violations,” particularly when “these abuses target marginalized communities ….”
The memo goes on to point out that the FTC’s merger review won’t be based solely on conventional market-based analysis, but will also involve an assessment of the broader societal impacts of a transaction. That appears to be already happening, as the memo notes that “in some deals the FTC has been seeking information during the second request stage of its investigations about topics such as unions, wages, the environment, corporate governance, franchising, diversity, and noncompete agreements.”
As further evidence of the changing environment, the FTC’s Bureau of Competition announced in a blog post yesterday that it was implementing a number of changes to the second request process that were designed to make it more streamlined and more rigorous. While several changes are being made, the expanded approach to merger review outlined in Chair Khan’s memorandum is front and center:
First, we are seeking to ensure our merger reviews are more comprehensive and analytically rigorous. Cognizant of how an unduly narrow approach to merger review may have created blind spots and enabled unlawful consolidation, we are examining a set of factors that may help us determine whether a proposed transaction would violate the antitrust laws.
Providing heightened scrutiny to a broader range of relevant market realities is core to fulfilling our statutory obligations under the law. To better identify and challenge the deals that will illegally harm competition, our second requests may factor in additional facets of market competition that may be impacted. These factors may include, for example, how a proposed merger will affect labor markets, the cross-market effects of a transaction, and how the involvement of investment firms may affect market incentives to compete.
A few years ago, I blogged about Intralinks’ list of top deal code names and concluded that, overall, dealmakers’ efforts were severely lacking in creativity. This recent Intralinks blog setting forth the most unusual deal code names this year suggests that people are getting better at coming up with these. That being said, I think that Intralinks probably overlooked the “elephant in the room” when it discussed the likely reasons behind one deal team’s choice of a particular code word:
Sir Laurence Olivier first uttered the line, “Release the Kraken,” in the 1981 cult classic, Clash of the Titans. Nearly 30 years later, Time magazine included the phrase as one of its Top 10 Buzzwords of the Year after Liam Neeson’s more exuberant delivery of the phrase in the 2010 remake. Today, it’s become a sort of cultural shorthand for “all hell’s about to break loose.” Maybe a dealmaker had this in mind when project “Kraken” was named, calling to memory the Nordic (not Greek) mythical sea monster known for gobbling everything in sight. Maybe this deal was part of a multi-acquisitional strategy?
Yeah, I doubt it. I’m pretty sure that in 2021, this decision to use this particular code word had a lot more to do with Rudy & Sidney than with Larry & Liam.
Last year, I blogged about Vice Chancellor Glasscock’s decision in In re TerraForm Power, Inc. Stockholder Litigation, (Del. Ch.; 10/20), in which he held that dilution claims associated with an allegedly underpriced issuance of shares to a controlling stockholder were direct, not derivative, and therefore survived a motion to dismiss premised on the minority stockholders’ loss of standing due to a merger. Last week, the Delaware Supreme Court reversed his decision, and overturned the precedent upon which it was based in the process.
Vice Chancellor Glasscock’s opinion noted that while such claims would ordinarily be viewed as derivative under Tooley v. Donaldson, Lufkin & Jenrette, (Del.; 4/04), he was compelled to hold that the claim was direct by virtue of the Delaware Supreme Court’s decision in Gentile v. Rossette, (Del.; 8/06). In Gentile, the Court held that fiduciary duty claims for an allegedly underpriced issuance of stock to a controller could be maintained by former stockholders as direct claims even though they no longer had standing to assert derivative claims.
The Vice Chancellor observed that the Gentile decision had been widely criticized, but felt that he was bound by existing precedent. However, he certified an interlocutory appeal to the Delaware Supreme Court, and in Brookfield Asset v. Rosson, (Del.; 9/21), the Supreme Court reversed his ruling & overruled Gentile. In her 50-page opinion for the Court, Justice Valihura reviewed the doctrinal issues with the Gentile decision, and then pointed out that the exception to Tooley that it created was superfluous:
Aside from the doctrinal difficulties discussed above, we see no practical need for the “Gentile carve-out.” Other legal theories, e.g., Revlon, provide a basis for a direct claim for stockholders to address fiduciary duty violations in a change of control context. And as we observed in El Paso, “equity holders confronted by a merger in which derivative claims will pass to the buyer have the right to challenge the merger itself as a breach of the duties they are owed.” Such stockholders might claim that the seller’s board failed to obtain sufficient value for the derivative claims.
Justice Valihura’s opinion also noted that Gentile created the potential practical problem of allowing two separate claimants to pursue the same recovery, which could create double recovery issues. The plaintiffs argued that the Court should of Chancery devise a mechanism to “proportion” any recovery between the plaintiffs if both derivative and direct shareholders claim it, but the Court concluded that permitting such dual claims would unnecessarily complicate their resolution.