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.
Remember when the Delaware Supreme Court issued a sharply worded opinion reversing Vice Chancellor Laster’s decision to adopt an “unaffected market price” approach to fair value in his Aruba Networks appraisal decision? Well, last Thursday, in Fir Tree Value Master Fund v. Jarden, (Del.; 7/20), the Court unanimously upheld Vice Chancellor Slights’ decision to use that same valuation standard in an appraisal proceeding involving Jarden Corporation.
Chief Justice Seitz’s 43-page opinion rejected the petitioners’ argument that the Court’s decision in Aruba Networks “foreclosed as a matter of law the court’s use of unaffected market price to support fair value.” Instead, he said that the neither Aruba nor the Supreme Court’s other recent appraisal decisions ruled out using any recognized valuation methods to support fair value:
In DFC, Dell, and Aruba we did not, as a matter of law, rule out any recognized financial measurement of fair value. Instead, we remained true to the appraisal statute’s command that the court consider “all relevant factors” in its fair value determination. Although subject to academic debate, we have also recognized the efficient capital markets hypothesis in appraisal cases. The Vice Chancellor got the “takeaway” exactly right from our recent appraisal decisions: “[w]hat is necessary in any particular [appraisal] case [] is for the Court of Chancery to explain its [fair value calculus] in a manner that is grounded in the record before it.”
So, it appears that the Court’s hostility toward the Chancery’s use of the target’s unaffected market price to determine fair value in Aruba Networks had more to do with Vice Chancellor Laster’s approach to the valuation process in that case than it did with any fundamental concerns about the use of that standard to determine fair value.
We’ll be posting memos in our “Appraisal Rights” Practice Area. But for now, check out Prof. Ann Lipton’s analysis of the decision over on “Business Law Prof. Blog.”
I don’t think it will come as a surprise to many public companies to learn that their investors are becoming more open to listening to pitches from activist shareholders, but IR Magazine’s report may still raise some eyebrows with its conclusions about just how willing they are to hear activists out:
Almost two thirds of investors say they are open to talking to activist investors about a company they have a position in, according to recent research from IR Magazine. While many companies continue to experience volatile share prices and balance sheet concerns – with a significant increase in the number of companies adopting poison pills this year – investors are more likely to support an activist campaign now than they were three years ago.
This is according to IR Magazine’s Shareholder Activism research report, which was released last month. Almost two fifths (39 percent) of investor respondents say they are more likely to support an activist campaign than they were three years ago, with almost half of European and Asian respondents agreeing with this statement.
The silver lining for company boards & management is that the number of investors siding with activist investors remains relatively low. The report says that only 22% of buy-side respondents have been involved in an activist campaign since 2017, with 5% leading the campaign and 17% supporting or partnering with an activist investor.
Public companies acquiring divisions or product lines have often had to seek Corp Fin’s sign-off on the use of abbreviated acquired company financial statements in connection with those acquisitions. That process introduces an additional element of potential delay & uncertainty to these “carve-outs,” but this Cooley blog says that the SEC’s new rules on acquired company financial statements provide some real help. This excerpt from the intro summarizes the implications of these changes for buyers:
The new rules permit buyers to file abbreviated financial statements in these types of carve-out transactions without prior SEC consent, as long as certain criteria are met. Eliminating the need to obtain this relief from the SEC will save buyers time and legal and accounting expense. More importantly, the new rules may better position a buyer in an auction process where the buyer needs to know that it will be able to satisfy its SEC filing obligations if its bid prevails.
Under the current rules, a potential buyer is often forced to choose among several less than ideal options in an auction process, whether it be (i) seeking permission from the seller to request the SEC exemption on a contingent basis during the process, (ii) including a contingency in its bid for obtaining this SEC relief or (iii) accepting the risk that it might not be able to satisfy the financial statement requirements and become non-compliant with SEC filing requirements (therefore losing S-3 eligibility).
While buyers will still need to make arrangements with sellers to prepare & audit the abbreviated financial statements, the blog notes that the new rules eliminate much of the uncertainty for many carve-outs. That’s because they provide that abbreviated financial statements may be used without prior SEC approval if certain conditions are met, including the absence of separate historical financials for the acquired business. The acquired business also must represent 20% or less of the seller’s total assets & total revenues on a consolidated basis for its most recently completed fiscal year.
This Sidley memo (pg. 2) discusses how the implications of the Covid-19 crisis may require buyers & sellers to scrutinize earnout provisions with a “new lens,” whether they are negotiating new deals or potentially renegotiating existing ones. This excerpt addresses some of the considerations associated with using a “sliding scale” earnout instead of the more customary all or nothing arrangement:
Earnouts are often structured with all-or-nothing payment terms such that seller receives nothing if the earnout threshold is not met. It is difficult to forecast appropriate earnout benchmarks, and, when a company is performing well or creating value but these all-or-nothing terms are still unattainable, a seller (or former equity holders of seller who are current key employees of the target) may lose motivation to drive company performance.
Further, key employees of seller may terminate their employment with buyer in the absence of other significant retention mechanisms. Thus, when a company is performing well, but below an earnout threshold, value is lost when both parties would have continued to perform if a lower payout than was previously negotiated were available. In these scenarios, making a reduced earnout payment may be less costly to buyer than the loss of aligned incentives to drive future company performance or the loss of key employees. Similarly, if a threshold for performance is set too low, for example, because the longer-term impacts of COVID-19 are overestimated, seller may take its foot off the gas when it is clear that an earnout will be achieved, even if better performance is achievable.
Given the unexpected downturn in the economy caused by the COVID-19 pandemic, earnouts that were negotiated in 2018 and 2019 assuming in-line 2020 performance may be unachievable now and, without renegotiation, can result in value loss to both buyers and sellers. In some of these situations, buyer may still want seller’s ongoing assistance to navigate the current conditions and may be willing to pay an earnout, albeit in a lesser amount than originally negotiated, or amend the earnout metrics to incentivize continued assistance driving future value.
When earnouts are structured with a sliding scale payout (i.e., setting a floor for minimum performance and a ceiling for a maximum payment, with the payment based on a performance formula) or multiple payment thresholds (i.e., setting multiple payout levels in steps based on performance), this can help preserve some of the value that would have been lost in all-or-nothing payout structures.
The memo notes that if the buyer selects an appropriate floor and ceiling for its earnout obligations, a sliding scale or multiple payment structure may increase the likelihood that the parties’ objectives remain aligned.
The “common interest” privilege protects privileged information that is exchanged by two parties represented by counsel concerning a legal matter in which they share a common interest. The privilege has often been asserted to protect communications between buyers & sellers during the course of a acquisition. This Morris James blog discusses the Delaware Superior Court’s recent decision in American Bottling Co. v. Repole, (Del. Super.; 5/20), in which the Court declined to apply the privilege to communications that it determined were predominantly commercial, not legal, in nature.
The case involved a dispute over whether a merger involving the plaintiff had terminated a distribution contract. The plaintiff inadvertently produced materials relating to the contract that it had shared with a third party that subsequently merged with the plaintiff’s parent, and sought to claw them back based on a claim that the common interest privilege applied. This excerpt reviews the Court’s analysis of the privilege claim:
The documents were a series of charts and other work product that described the nature of the distribution agreement between Plaintiff and Defendant and described how best to “capitalize on” it in the context of the merger. The documents were drafted and shared by the Third Party Entity’s counsel with Plaintiff’s parent after the merger agreement was executed but before the merger closed. For the documents to remain privileged, Plaintiff needed to show that a common interest applied to protect the shared documents.
The Court found that the Plaintiff and the Third Party Entity did not share a common legal interest sufficient to protect the documents from production on the basis of privilege. Following an in camera review, the Court found that the documents were shared with the Plaintiff for predominantly commercial purposes rather than to facilitate rendering legal advice.
Applicable Delaware precedent established that if the primary focus of the interest was commercial, “[i]t is of no moment that the parties may have been developing a business deal that included as a component the desire to avoid litigation,” regardless of whether legal counsel provided input on the documents. Accordingly, the Court concluded that the common interest privilege did not apply.
– Global M&A value for the first half of the year is down 41% from 2019, while the number of deals is down 16%. In the U.S., value is down 68.8% but deal volume is up 10.6%.
– Global deal value fell 25% between Q1 2020 and Q2 2020, while U.S. deal value fell 57%.
– There were over 3,100 global private equity deals valued at around $200 billion in the first half of 2020, representing a deal number decline of 7.9% and a deal value drop of 23.6% over the same period in 2019.
The FTC & DOJ just issued the final version of their Vertical Merger Guidelines. As I mentioned when I blogged about the draft guidelines issued last January, this represents the first update to these guidelines in nearly 40 years. Here’s an excerpt from Wachtell’s memo on the final version:
The new Guidelines clarify the agencies’ analytical practices and en-forcement policies, and provide illustrative examples of transactions that may raise competitive concerns. The Guidelines primarily focus on unilateral theories of harm that the agencies commonly investigate in their review of vertical mergers, including the ability and incentive of a combined firm to raise its rivals’ costs or foreclose their access to essential inputs, distribution channels, or complementary products.
Vertical mergers may also raise unilateral concerns when they provide the combined firm with access to competitively sensitive information about its upstream or downstream rivals, or make entry by a potential competitor more difficult by requiring entry at different levels of the supply chain or by foreclosing access to a necessary asset. Similarly, non-horizontal mergers may eliminate nascent competition by combining complementary products or an established firm with an emerging player in an adjacent market.
The inclusion of these theories of harm in the Guidelines signals a convergence with other jurisdictions, such as the EU, where they are often considered by antitrust regulators. In addition, the Guidelines discuss the ways in which a vertical merger may make coordinated interaction among firms more likely.
Although the guidelines say that “vertical mergers are not invariably innocuous,” they acknowledge that these transactions create efficiencies that are beneficial to consumer, and indicate that efficiencies are an important part of the merger review process.
One potentially important change from the draft guidelines is that the final guidelines eliminate a proposed “quasi-safe harbor” for vertical mergers in which the parties have less than a 20% share of upstream and downstream markets. The memo says that this aspect of the draft guidelines had apparently drawn criticism from the FTC’s Democratic commissioners, but in any event, it’s elimination wasn’t sufficient to sway them – both voted against the final guidelines.
Yesterday, in Fort Myers Gen. Emp. Pension Fund v. Haley, (Del. 6/20), the Delaware Supreme Court overruled an earlier Chancery Court decision and held that a seller CEO’s failure to disclose discussions with the buyer about his post-closing comp during the negotiation process was sufficient to rebut the business judgment presumption and subject the transaction to review under the entire fairness standard.
In her opinion, Justice Valihura acknowledged that since the allegations focused on the conduct of a single officer & director, in order to rebut the presumption of the business judgment rule, the plaintiffs must adequately allege that (i) the director was “materially self-interested” in the transaction, (ii) the director failed to disclose his “interest in the transaction to the board,” and (iii) “a reasonable board member would have regarded the existence of [the director’s] material interest as a significant fact in the evaluation of the proposed transaction.”
The Supreme Court, with Justice Vaughn dissenting, concluded that the plaintiffs’ allegations met this threshold, despite the fact that the Chancery Court had determined otherwise. In that earlier decision, Vice Chancellor McCormick held that the business judgment rule applied for three reasons. First, she concluded that the board knew the CEO would likely receive a larger salary when running the combined entity, and therefore was fully informed of the conflict when it appointed him as lead negotiator. Second, the board was generally kept apprised of the negotiations. Finally, the compensation discussion in question only concerned a proposal, and the CEO’s actual compensation was not negotiated until after the merger closed.
The Supreme Court’s decision focused on the meaning of the term “materiality” in this context, and concluded that none of the factors cited by the Chancery Court was sufficient to undermine a conclusion that information about the compensation discussions was material:
The issue here is whether the alleged omissions meet the legal definition of materiality. We hold that the Plaintiffs have adequately alleged that the Proposal altered the nature of the potential conflict that the Towers Board knew of in a material way. “Material,” in this context, means that the information is “relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decisionmaking.”
It is elementary that under Delaware law the duty of candor imposes an unremitting duty on fiduciaries, including directors and officers, to “not use superior information or knowledge to mislead others in the performance of their own fiduciary obligations.” Further, “[c]orporate officers and directors are not permitted to use their position of trust and confidence to further their private interests.”
This doesn’t appear to be a case in which there were significant differences between the Supreme Court and the Chancery Court about what the law required. Instead, it seems that the two courts simply reached different conclusions about the implications of the CEO’s conduct. That point is underscored by the first sentence of Justice Vaughn’s dissenting opinion, in which he noted his agreement with the legal principles underlying the decision, but dissented “simply because when I apply those principles to the facts as pled in the complaint, I come to a different conclusion.”