Monday, September 3, 2007
Here it is folks, the Fall M&A Preview. This is my take on the big (and not so big) M&A and other market legal issues and expected events for the Fall of 2007. It is going to be a fascinating time to be watching the markets.
The Big Picture
Expect strategic transactions to be driving M&A activity in the Fall as the private equity firms focus on clearing out some of the big deals on their plates. Regardless, also expect market innovation and adjustment to occur as these private equity firms attempt to close these deals and reallocate the liabilities and costs among the parties (ala Home Depot) as they, their targets and financing banks desperately avoid one of these big deals breaking. NB. This is a much harder task in the public company context than in the Home Depot paradigm.
There are now four potential material adverse change (MAC) cases by my count (Lone Star/Accredited; SML/PE Consortium; Genesco/Finish Line; Radian/MGIC). If markets further deteriorate, expect more of these cases as acquirers attempt to escape or renegotiate deals and use the MAC as a bargaining tool. The big MAC case right now is the Lone Star/Accredited one which is in litigation and has scheduled hearings before VC Lamb in Delaware Chancery on Sept. 26. An opinion would resolve significant questions over what constitutes disproportionality under a MAC clause and have much wider market ramifications for other, pending deals. So, as a law professor I am rooting against settlement and for an opinion, though, given that Lone Star is a financial buyer (unlike Tyson) resolution through litigation seems unlikely.
Private Equity (And SPACs and BDCs)
It is going to be a busy Fall for private equity as they attempt to close their pending deals. Here, I expect the private equity shops who can to use reverse termination fees as a bargaining tool to renegotiate deals. These fees provide them a clean way to walk away from a deal without further liability provided they pay a termination fee of approximately 3-4% of deal value (see my post on these here which was quoted in the N.Y. Times: thanks Andrew R. Sorkin!). This maneuver was used in the Home Depot deal where it was reported by the WSJ that the lending banks offered to pay the reverse termination fee if the private equity firms walked. Showing perhaps that this story was planted by the private equity firms themselves, the story also reported that the private equity firms balked at this stance due to the reputational effect of such a maneuver. Aren't they swell? Nonetheless, private equity firms are not charities, if the market does further deteriorate expect the private equity firms to strongly reassess this position, and in any event to use this provision to non-publicly attempt to renegotiate troubled deals.
One other thing to look for is how the many, pending initial public offerings of SPACs (special purpose acquisition companies) and BDCs (business development companies) fare. These are private equity derivative investments that have been all the rage of late (e.g., SPACs constituted twenty-eight percent or thirty seven of the 133 initial public offerings through July 20, 2007). I look at these offerings as the "canary in the mine-shaft" so to speak; they will be a good indicator through the Fall of the current state of private equity and the prospects for the takeover market generally. And BDCs will take a particular hit though no matter what given the implosion of KKR Financial, LLC, KKR's BDC. Nonetheless, I expect fund adviser ipos to continue to pop-up and for KKR's ipo to go through in the Fall. Their historical record right now is unlikely to get any better, and so it is a good time for them to sell even if they won't get Fortress's or Blackstone's pricing.
The M&A action in Europe these days is incredible; it is a much more vibrant and innovative takeover market than the U.S.-one as the actors struggle and adjust with the 25 differing takeover regimes. Here, the Takeover Directive has now been fully implemented; in its final form everyone knew it was weak medicine for harmonization. But the required implementing legislation has led to a reexamination by many countries of their takeover codes which has pushed the countries even farther apart. France has used this process as an excuse to adopt legislation permitting targets to issue stock warrants in the face of a hostile offer – a modified form of poison pill. Meanwhile, Britain has stayed in the opposite camp. It has maintained its prohibitions on takeover and transaction defenses in all circumstances (which the English call frustrating action). The result is grist for a worthy academic study on federalism and regulatory competition as the effects of these differing laws on their domestic/cross-border M&A markets take effect (one that I hope to pursue). Ultimately, despite any inhibiting effects of these laws the European takeover market is now as robust as the U.S.-one; expect it to stay that way through the Fall, as shareholders and institutional investors become increasingly active in the takeover process (e.g., ABN Amro/Barcalays/RBS; Arcelor/Mittal).
M&A Specific Issues
The Return of the Tender Offer? In the first five months of 2007, 15.5 percent of negotiated transactions were accomplished through tender offers (see my prior post outlining the reasons for this here). While that is a low figure, it is more than three times higher than in the same period last year. As strategic transactions return to the fore, expect more acquirers in negotiated transactions to continue to use this acquisition structure.
The Top-Up. Expect top-ups to become standard in tender offers, to the extent they are not already.
The Rise of the Exchange Offer? I'm rooting for it. In the M&A Release, the SEC attempted to put cash and stock offers on parity by providing for early commencement of equity exchange offers in Rules 162 and 430 of the Securities Act. Now, with reform of the all-holders/best price rule, the main problem with tender offers has disappeared. So, with the return of the cash tender offer, I would expect to see the exchange offer begin to emerge. Exchange offers permit stock-for-stock acquisitions to be consummated on a tender offer time table instead of the 2-3 months for a merger. M&A lawyers would do well to inform their acquiring clients of this despite the significant extra lawyer time it involves.
Whither the Go-Shop? These provisions have been criticized here and elsewhere for their illusory nature, providing cover to private equity firms and management who attempt to take over a company. Go-shops have also been subject to increasing judicial scrutiny in Delaware in the NetSmart and Topps cases. Hopefully, this scrutiny and criticism will bring innovation among M&A practitioners to revise the terms of these provisions to provide them with more significance. But otherwise, they will continue to persist in some form in private equity deals.
Shareholder/Board Action. Expect shareholder activism to diminish to the extent we remain in a down market and shareholders take what they can get. Still, the Topps transaction is likely to be defeated. Also, to the extent shareholders do protest takeovers, expect boards to avail themselves of Strine's recent decision in Mercier to attempt to further influence the shareholder approval process in takeovers (more on this here).
The Global Competition for Listings. The comment period for the SEC's concept release on IFRS accounting for U.S. issuers expires November 13, 2007. While this is not a great idea (there are different considerations for U.S. issuers than foreign ones which make it more appropriate to compare apples with apples), the SEC is starting to "get" the fact that there is a global listings and offerings market and to actually compete in it. I believe that this is the most exciting regulatory development this year. Put this on top of the SEC's push for IFRS for non-U.S. issuers by 2009 and the effectiveness of the foreign issuer deregistration rules this Spring, and I am positively giddy. Also, expect an article by a news reporter this Fall headlined -- foreign issuers flee the United States -- reporting the high number of non-U.S. issuers who have now deregistered in recent months. It will likely quote an academic who says this points to Sarbanes-Oxley and the anti-competitive position today of the United States. Don't believe it. The deregistration/delisting wave is a product of the the pent-up demand for delistings and a restoration of market equilibrium in light of the new SEC rules permitting such deregistration. The more important indicator here is the number of new cross-listings -- and all signs through today point to this number as being a good one. [NB. if any law professor out there is interested in putting together a comment on the concept release please contact me -- I'm working on one right now and would welcome a co-signer or two]
Hedge Funds. The SEC will consider this Fall raising the Regulation D Rule 506 investing requirements for investment in hedge funds and private equity to $2.5 million for individual investors. Showing what it thinks of the benefits of economic cost/benefit analysis, the SEC did not cite a single financial or academic study to support raising this standard. Instead, the SEC continues to rely on the proposition that hedge funds are too "risky" for public investment, and issues of systematic risk to place these investments off limits to public investors. Here, I am reminded of the Massachusetts Securities Division which refused to permit residents of that state to invest in the initial public offering of Apple Computer because it was “too risky”. The SEC would do better to undertake real cost/benefit analysis of public investment in these funds, a study which would have to recognize their benefits for diversification and excess returns (i.e., alpha). For those who want more on these issues see Troy Paredes recent, terrific article on this.
Fairness Opinions. After four amendments and eight extensions, the time period for SEC action on Rule 2290, the FINRA rule on fairness opinions, will expire on October 31 (see the rule filings here). At this point, everyone would be better off if FINRA acknowledged reality and withdrew the rule. Instead, the SEC should sit down and take a hard look at fairness opinion practice. These opinions are subjective and not prepared using best practices or to any definitive standards; problems which are exacerbated by the conflicted nature of the investment bank in rendering these opinions. Moreover, SEC rules need to be updated in this area (e.g., fairness opinion disclosure is required in proxies but not for Schedule TOs). For more on this, see my article Fairness Opinions published in the American Law Review.
My New Years' Wish List. Since I get three wishes as blog editor here they are:
- Merger/Tender Offer Parity. The poison pill has sterilized the use of the tender offer as a takeover device. Consequently, there is no significant difference between the tender offer and merger structure any more. The SEC should undertake a comprehensive review to end the disclosure, timing and other regulatory differences between tender offers and mergers to put them on parity. (e.g., a company who is not current in its financial reporting can be the subject of a tender offer but, because of an SEC staff proxy rule interpretation, may not be able to issue a merger proxy, a particular problem in options back-dating cases. There is no reason for this. For more on these inappropriate differences, see here).
- Updating the Cross-Border Rules. The Cross-Border Rules were a significant step by the SEC to attempt to accommodate cross-border acquisitions. Yet, because of a number of technical problems with the rules (detailed here), they have not been fully utilized and instead issuers have increasingly relied on the exclusionary offer to avoid wholesale application of the U.S. securities laws. The SEC should take the easy steps to fix these problems and again encourage these transactions to include U.S.-based holders. It would also help if the SEC looked at the scheme of arrangement exemption under Section 3(a)(10); most U.K. acquirers now use it as the preferred method to largely avoid the U.S. securities laws in acquisitions, and I am not so sure that it functions the way the SEC thinks intended it should when it first permitted this exemption (I'll post more on this later this week).
- Abolish Rule 14e-5 as it applies to tender offers. My pet-peeve. Rule 14e-5 was promulgated in 1969 as Rule 10b-13 to prohibit bidder purchases outside of a tender offer from the time of announcement until completion. The primary reason put forth by the SEC for barring these purchases in 1969 was that they “operate to the disadvantage of the security holders who have already deposited their securities and who are unable to withdraw them in order to obtain the advantage of possible resulting higher market prices.” This is no longer correct; bidders are now obligated to offer unlimited withdrawal rights throughout the offer period. Moreover, Rule 10b-13 was issued at a time when targets had no ability to defend against these bidder purchases. Not true anymore either -- the poison pill and other regulatory bars limit or inhibit bidder purchases outside an offer. And Rule 14e-5 applies to tender offers but not mergers (the parity issue again). But the Market Reg. division of the SEC has assiduously protected this rule despite its obsolescence. The SEC would do better to deregulate and leave the possibility or actuality of bidder toeholds and post-announcement purchases to be regulated by targets through a low-threshold poison pill or other takeover defenses as well as through bargaining with potential bidders (For more on this see here).