According to this recent Bloomberg Law analysis, the Covid-10 pandemic may be depressing the M&A market, but PE funds aren’t wasting the crisis. Instead, they’re growing their market share in U.S. small & middle-market M&A. Here’s an excerpt:
In the second quarter, we saw historically low M&A deal volume across the board. The same held true for the small and middle market, which had the lowest volume for any quarter in at least five years. Roughly $75 billion dollars in deals involving U.S. targets valued up to $1 billion dollars were announced in the second quarter, compared to $115 billion in the first quarter and $156 billion in the fourth quarter of last year.
If we look at the private equity subset of these small and middle market deals, we see a slightly different story. For PE deals, the second quarter was definitely slow, with lower volume than in prior quarters, but the negative impact on deal volume was not as drastic compared to the rest of the market.
What’s striking is the increase in private equity’s share in this segment: Over recent years, private equity deals have represented about half of all deals. In the second quarter, this percentage market share rose to 62%.
So, while the entire small and middle market pie did shrink last quarter, private equity came away with one of the largest slices of the market it’s had in recent years.
Bloomberg Law says that PE funds grabbed the lion’s share of deals in each the three hottest M&A sectors during the second quarter: consumer non-cyclical (66%), technology (81%), and financial (54%).
Tune in tomorrow for the webcast – “Distressed M&A: Dealmaking in the New Normal” – to hear Woodruff Sawyer’s Yelena Dunaevsky, Fredrikson & Byron’s Mercedes Jackson, and Seyfarth’s Paul Pryant & James Sowka discuss the unique challenges and opportunities presented by acquisitions of distressed targets.
When I taught law school, I absolutely hated grading exams. It was a frustrating and humbling (am I really this bad a teacher?) process, and an extremely time consuming one to boot. I was sometimes tempted to use the grading approach that many law students suspect their profs use – just throw the exams down the stairs and sort out the grades based on where they land. While I managed to resist that temptation, when I read Vice Chancellor Slights’ opinion in Kruse v. Synapse Wireless, (Del. Ch.; 7/20), I wondered how he resisted what must have been a similar temptation in reaching his decision in this appraisal proceeding.
In many respects, the case presented a worst case scenario – it involved a minority squeeze-out of a private company at a price of approximately $0.43 per share with no market check or competitive sales process. Both parties pointed to valuation analyses prepared by their competing experts, which resulted in wildly divergent valuations. The petitioner’s expert opined that each Synapse share was worth $4.1876 at the time of transaction, while Synapse’s expert provided a valuation range of $0.06 to $0.11 per share. Vice Chancellor Slights acknowledged that this left him in a bind:
When dueling experts proffer wildly divergent valuations, the resulting trial dynamic presents difficult and, frankly, frustrating challenges for the judicial appraiser. This case presents another, more fundamental challenge; after carefully reviewing the evidence, it is difficult to discern any wholly reliable indicators of Synapse’s fair value. There is no reliable market evidence, the comparable transactions analyses both experts utilized—a dicey valuation method in the best of circumstances—have significant flaws and the management projections relied upon by both experts in their DCF valuations are difficult to reconcile with Synapse’s operative reality.
In the typical litigation context, the lack of fully reliable evidence might lead the factfinder to conclude that neither party carried their burden of proof and neither party, therefore, is entitled to a verdict. But “no” is not an answer in the unique world of statutory appraisal litigation. If the parties fall short in their respective burdens, the court must still reach an answer—a fair value appraisal must still be provided.
This is the point at which I’d likely have opted to throw the two valuations down the stairs. Admirably, the Vice Chancellor didn’t do that. Instead, he dutifully slogged through the competing DCF valuations, and concluded that Synapse’s expert “credibly made the best of less than perfect data to reach a proportionately reliable conclusion,” while the petitioner’s expert did not.
As a result, with the exception of relatively minor adjustments to Synapse’s expert’s conclusions about the amount of its debt and available cash, the Vice Chancellor adopted that expert’s approach to the DCF analysis and concluded that the fair market value of the company’s shares was approximately $0.23 per share – nearly 50% below the purchase price.
According to this McDermott Will blog, the FTC has its nose out of joint about the pace of implementation of required post-closing divestitures – and that may result in a harder line on divestiture remedies in the future. Here’s the intro:
The US Federal Trade Commission (FTC) recently extracted a $3.5 million civil penalty from two companies involved in a gas station merger. The FTC asserts the companies violated their settlement agreement with the government, which required the divestment of 10 gas stations within 120 days from the date of the settlement agreement. The parties overshot the divestiture deadline by more than three months. The Commission stated its deadlines are not a suggestion and it will not permit parties to profit from order violations of any kind, including late divestitures.
FTC commissioner Rohit Chopra’s dissenting statement, made in an unrelated case just two weeks prior to this fine, emphasized that divestitures should be completed promptly and raised concerns with settlements involving divestitures that are made “after a prolonged period of time.” Taken together, if there is a change in administrations in November, we may see even more focus on requiring buyers up front or buyers in hand for mergers that require divestitures to gain clearance.
The blog provides additional details on the case and its potential implications. Even without a change in regimes in DC, these may include the FTC & DOJ pushing for additional terms in settlement agreements to add more bite to parties’ violations of those terms, including the divestiture timeline.
Last month, in Jaroslawicz v. M&T Bank Corp., (3rd Cir; 6/20), the 3rd Circuit vacated the dismissal of a Section 14(a) claim premised on allegedly inadequate risk factor disclosure in a merger proxy statement. The plaintiff challenged the adequacy of disclosures of risks relating to M&T’s anti-money-laundering deficiencies and consumer checking practices contained in its proxy statement for the acquisition of Hudson City Bancorp.
M&T’s compliance shortcomings in these areas resulted in an extended regulatory approval process & a CFPB enforcement action, and ultimately delayed the deal’s closing by more than two years. Shortly before closing, the plaintiff filed a class action lawsuit alleging that, because the proxy didn’t address M&T’s compliance issues, it failed to disclose material risk factors facing the merger, as required by Item 105 of Reg S-K. In turn, that failure allegedly resulted in violations of Section 14(a) of the Exchange Act and Rule 14a-9.
As this excerpt from Cahill’s recent memo on the decision points out, the Court focused its analysis on the line-item requirements of Item 105 of Reg S-K:
The Third Circuit found that plaintiffs’ complaint plausibly alleged that the anti-money-laundering deficiencies and consumer checking practices were known to M&T, and posed significant risks to the merger, before issuance of the proxy. The Court commented, “[i]n short, while Item 105 seeks a ‘concise’ discussion, free of generic and generally applicable risks, it requires more than a short and cursory overview and instead asks for a full discussion of the relevant factors. That, as we will see, is where the Joint Proxy fell, in a word, short.”
The Third Circuit began its discussion of Item 105 by highlighting guidance from the SEC and other circuits that it found illuminating. In the SEC’s Legal Bulletin on the subject, under the section titled “Risk Factor Guidance,” the SEC explains that “issuers should not present risks that could apply to any issuer or any offering.” The SEC guidance continues that Item 105 risk factors fall into three broad categories: (i) industry risks, which companies face by virtue of the industry in which they operate; (ii) company risks, which are specific to the company; and (iii) investment risks, which are specifically tied to the security that is the subject of the disclosure document. SEC Legal Bulletin No. 7, 1999 WL 34984247, at *5-6. “When drafting risk factors, [companies must] be sure to specifically link each risk to [the] industry, company, or investment, as applicable.”
After reviewing precedent from other circuits, the Court concluded that the plaintiffs had adequately pled the existence of shortcomings in the proxy disclosures. In particular, the Court emphasized M&T’s awareness that its compliance program would be subject to close scrutiny and that failure to satisfy regulators could end its merger plans. It concluded that this knowledge was enough to impose a duty to provide more specific disclosures about the impending regulatory scrutiny. The Court reached a similar conclusion about M&T’s consumer checking issues.
Despite its finding on the risk factors, the Court rejected plaintiffs’ claims that M&T’s failure to discuss these allegedly non-compliant practices rendered M&T’s opinion statements about regulatory compliance and the prospects for prompt regulatory approval misleading under the Omnicare standard.
The Jaroslawicz case provides an example of something that most M&A and capital markets lawyers already know – when it comes to “risk factor” disclosure, boilerplate won’t cut the mustard. But those lawyers also know that it is often a lot easier to identify the most significant threats to a deal with the benefit of hindsight than it is to call them out in advance.
It’s easy to see why a controlling shareholder contemplating a take-private transaction would want to reach out to obtain support from large minority shareholders before moving forward with a deal. The trouble is that – as Dell recently discovered – those contacts can create a big problem if the parties want to obtain business judgment review for the transaction under the MFW standard.
That point was brought home again by the Chancery Court’s decision last week in In re HomeFed Stockholder Litigation, (Del. Ch.; 7/20), which arose out of Jefferies Financial Group’s July 2019 acquisition of the 30% interest in HomeFed Corporation that it didn’t already own. A HomeFed director originally proposed a take-private deal to Jeffries in 2017, and the company put in place a special committee to negotiate with Jeffries in December of that year. The process was paused in March 2018, when Jeffries told the committee that it wasn’t interested in pursuing a deal.
Over the next 11 months, Jefferies discussed the potential deal with BMO, HomeFed’s largest minority stockholder. BMO’s support was essential to get a deal done with the approval of the minority stockholders, and in February 2019, it told Jeffries that it would support a 2-for-1 share exchange. After it received the “thumbs up” from BMO, Jefferies formally proposed acquiring the rest of HomeFed’s shares on those terms, conditioned on the approval of a special committee & a majority of the minority shareholders.
The plaintiffs sued the HomeFed board & Jeffries for breach of fiduciary duty, and the defendants responded that MFW should apply and that the transaction should be evaluated under the business judgment standard of review. Chancellor Bouchard disagreed, and declined to dismiss the plaintiffs’ claims. This excerpt from Steve Quinlivan’s recent blog on the case summarizes his reasoning:
Central to the case was whether Jefferies committed itself to the dual protections of MFW before engaging in substantive economic discussions concerning the transaction that anchored later negotiations and undermined the ability of the special committee to bargain effectively on behalf of the minority stockholders.
The court first considered whether the pause in negotiations in March 2018 put enough time and distance between subsequent negotiations around February 2019 so that the MFW protections were implemented in a timely manner. The court agreed with plaintiffs that the break in negotiations was not meaningful. The board never dissolved the special committee, negotiations were only paused, negotiations continued with BMO and BMO ultimately supported the exchange ratio.
The timing of the two sets of negotiations was not the fatal flaw however, but how the final negotiations progressed. Jefferies engaged in a series of discussions with BMO until Jefferies received an indication of support for a 2:1 share exchange from BMO—whose support was essential to get a deal done with minority stockholder approval—as well as from a financial advisor and key stockholder before Jefferies agreed to the dual MFW protections. To be more specific, Jefferies received these indications of support in early February 2019 but did not agree to the MFW protections until, at the earliest, February 20, 2019, when it amended its Schedule 13D.
The Court rejected defendants’ argument that Jefferies’ discussions with BMO before the February 2019 offer did not pass the point of no return for invoking MFW’s protections because those discussions were “preliminary” and only involved “an unaffiliated minority stockholder with no ability or authority to bind the corporation or any other stockholder.”
The Chancellor cited the recent Dell decision for the proposition that “MFW’s dual protections contemplate that the Special Committee will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work.” He said that a special committee was “uniquely qualified to perform this task,” due to directors’ superior access to internal information, their ability to “deploy the board’s statutory authority” and to act as an “expert bargaining agent.”
Chancellor Bouchard also noted that directors also owe fiduciary duties & don’t suffer from the collective action problem of disaggregated stockholders. In contrast, minority stockholders are unencumbered by fiduciary duties and their individual interests may diverge from those of other shareholders – which makes negotiations with a large minority holder in a situation like this potentially problematic.
This Sidley memo (p. 6) provides insights into the antitrust merger review process during the Covid-19 crisis. We’ve touched on some of the memo’s key takeaways before – including regulatory skepticism toward the “failing firm” defense, heightened concerns about gun jumping & the fact that complex merger reviews are taking more time. However, the memo address several other topic that we haven’t covered. Here’s an excerpt on the potential increased risk of regulatory scrutiny of non-reportable deals:
– Transactions That Are Not Reportable Can Be Subject to Antitrust Scrutiny. A number of major jurisdictions including the U.S., UK and Canada have the ability to investigate and challenge transactions that are not reportable, either before or after they close. In ordinary circumstances the U.S. agencies on average challenge two transactions a year that were not reportable.
During past economic crises, that number has increased, in part because the agencies have greater resource availability due to the decline in filings. Parties to non-reportable strategic transactions that raise antitrust issues should consider the risk of antitrust scrutiny before signing. Buyers should also consider the risk of a post-closing investigation that could result in a divestiture order.
The memo cautions that regulatory authorities are applying the same standards as before, and are on the lookout for companies that may try to exploit the current crisis to complete an anticompetitive transaction.
With valuations taking a big hit and the turmoil that the pandemic has created for many portfolio companies, many sponsors that might otherwise have sought an exit this year are biding their time until more favorable conditions return. This recent McKinsey report says that sponsors are using this additional time to prepare for an exit. Here’s an excerpt on some of the “hard pivots” that portfolio companies are taking to enhance their value:
As we mentioned, the recession has revealed material weaknesses in some business models, such as those of specialty retailers that mistakenly saw themselves as essential to consumers and of retailers that lack bargaining power with suppliers. After solving their immediate liquidity issues, forward-thinking sponsors are making the hard choices now to pivot to a stronger and more resilient business model.
One technology company preparing for exit sold predominantly into the real-estate and hospitality sectors. It had generally priced on a pay-per-use model, which was attractive to many customers. It had previously resisted attempts to move to a fixed-fee software-as-a-service (SaaS) model, as many similar companies have done. Although it has sufficient cash on hand to withstand a protracted downturn, it is now taking the plunge, moving many of its customers to fixed-price or take-or-pay contracts that will provide an even greater cushion in the next downturn (and will probably support better financing).
Some portfolio companies are also diversifying revenues to reduce cyclicality and improve resilience. For an infrastructure-services company focused on logistics and installation of capital equipment, this means a shift toward recurring revenues tied to services in operations and maintenance. Similarly, an industrial-equipment company shifted its mix to include more digitally enabled services.
This July-August Issue of the Deal Lawyers print newsletter was just posted – & also sent to the printer (try a no-risk trial). It includes articles on:
– M&A Transactions & PPP Eligibility and Forgiveness Considerations
– Strategic Acquisitions of Distressed Companies in the COVID-19 Environment
– Due Diligence: “That Deal Sounds Too Good to Be True”
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There hasn’t been much for dealmakers to cheer about in recent months, but this Deloitte report suggests that there may be some reason for optimism about what lies ahead in M&A:
When the COVID-19 pandemic swept into the US, it curbed deal-making significantly. Between February and March, the number of announced deals dropped from 2,349 to 1,984, with deal value decreasing from just over $151 billion to about $130 billion. Instead of launching new deals, the urgent priority for many finance leaders was to resolve any in-progress transactions, re-evaluating their strategic assumptions and taking appropriate actions to safeguard their financial positions.
Now, as finance leaders move past the recovery phase of the pandemic and conceive plans for thriving in a changed economic landscape, M&A is poised to play a central role. In April, Deloitte conducted a snap poll of 2,800 US companies, and 70% of the respondents indicated they will continue with M&A and, in some cases, accelerate their deal activities over the next 12 months. In addition, 31% of the 156 CFOs who responded to Deloitte’s Q2 2020 North American CFO Signals™ survey said they expect to acquire distressed assets or businesses over the next year.
The report addresses offensives & defensive rationales for M&A activity, and notes that plenty of buyers are well positioned to move on attractive opportunities. The S&P 1200 companies have a record $3.8 trillion in cash reserves & the wherewithal to service debt in a “dovish” monetary environment. That’s in addition to the $2.4 trillion war chest that PE firms have ready to be deployed.