"US M&A: Looking Back at 2013 and Forward to a Brighter 2014"
U.S. deal activity was the bright spot in an otherwise relatively muted global M&A market in 2013. Several large U.S. transactions were announced in the first two months of the year, and although deal volume for transactions (involving U.S. targets) grew at a slower rate over the remainder of the year, large transactions continued to drive improved U.S. deal volume for 2013 generally. In addition, a modest uptick of deals in the fourth quarter may be a harbinger of increased confidence and heightened M&A activity in 2014.
Improving U.S. economic conditions could boost boardroom confidence levels and advance M&A activity that boards previously may have put on hold. In addition, shareholders are playing a more active role as drivers of M&A activity, prompting boards to consider divestitures, spin-offs and company sales. Corporate cash balances remain at historically high levels, and acquisition financing continues to be available on attractive terms. Equity markets have been stable, and stock prices are at near-record highs, creating attractive acquisition capital for potential corporate acquirers; however, this may often be offset by increased acquisition costs and a decreased number of targets perceived to be undervalued. Financial sponsors continue to sit on large reserves of capital to be deployed for acquisition-related investment (approximately $395 billion worldwide and $207 billion in North American-focused buyout funds as of January 2014, according to Preqin estimates), and private equity portfolio company exits should continue apace in 2014. All that said, favorable indicators have existed in recent years, including in 2013, without igniting robust levels of deal activity. As such, the outlook for 2014 remains encouraging.
U.S. Activity Drives Global M&A Market. In light of continuing economic uncertainty and volatility in other markets, U.S. targets were attractive to buyers seeking to deploy cash and take advantage of low interest rates as well as the perceived safety of investing in the United States. The dollar value of announced M&A transactions for U.S. targets was $1.04 trillion in 2013, representing approximately 43 percent of total global deal activity, according to Thomson Reuters data. Ten of the 15 largest transactions announced worldwide in 2013 involved a U.S. target.
Similar to last year, we expect the telecommunications and media and technology industries to remain among the most active in 2014. The telecommunications and media sector was the greatest contributor to deal volume (in dollar value) in 2013, largely because of the $130.1 billion Verizon Wireless transaction. Meanwhile, the technology sector, despite a slight decline from the previous year, had the largest number of transactions last year. While several observers expect U.S. M&A activity in the health care sector to heat up due to consolidation fueled in part by the implementation of the Affordable Health Care Act, issues surrounding the act’s initial implementation and other factors may contain deal activity in the near term (see Regulatory/“Health Care and Life Sciences: Affordable Care Act Rollout to Impact M&A and Enforcement Activity”).
Megadeals Return. After a notable lack of high-value deals in 2012, the “megadeal” returned in 2013, with 11 announced transactions in excess of $5 billion involving U.S. public company targets. Several large deals were announced early in the year, including the acquisitions of H.J. Heinz Co. by Berkshire Hathaway Inc. and 3G Capital ($27.4 billion) and Dell Inc. by Michael Dell and Silver Lake Partners ($24.9 billion), fueling short-lived speculation of a rebound in 2013 M&A activity to prefinancial crisis levels. In September, Verizon Communications Inc. announced the acquisition of Vodafone Group’s 45 percent interest in Verizon Wireless for $130.1 billion, the largest transaction of the year and the third-largest in history.
One-Step Mergers Remain Preferred Deal Structure … for Now. The majority of acquisitions involving U.S. public company targets have been one-step mergers, which enable a buyer to gain 100 percent control of a target through a simple statutory process, requiring target shareholder approval. Buyers seeking speed often utilize a two-step structure — a first-step tender offer followed by a second-step short-form merger — because it does not require shareholder approval and can be completed more quickly than a one-step merger, often in as little as one month. However, if the number of shares tendered into the offer is not sufficient to permit a short-form merger, the parties are required to follow the long-form merger process.
Amendments to the Delaware General Corporation Law became effective in August 2013, which permit the use of a short-form second-step merger if, following the completion of a first-step tender offer, the buyer owns a sufficient number of shares to approve the second-step merger (typically a majority of the outstanding shares, compared to 90 percent of the outstanding shares prior to the amendments). After the amendments went into effect, the number of transactions structured as first-step tender offers followed by second-step short-form mergers increased (see "Delaware Continues to Influence US M&A"). Transactions implementing this structure in 2013 included Paulson & Co.’s acquisition of Steinway, Valeant Pharmaceuticals' pending acquisition of Solta Medical and Endo Health Solutions’ pending acquisition of NuPathe. The amendments are particularly noteworthy in leveraged acquisitions, where the increased certainty of closing on the tender offer and second-step merger in the same day gives buyers and their debt financing sources greater comfort in their ability to use the target's assets as collateral for financing the tender offer.
While we expect to see an increase in the number of deals structured as first-step tender offers, it is too early to tell whether the two-step merger will become the M&A acquisition structure of choice. Transaction parties will need to evaluate the various considerations of their particular deal — will the regulatory review process be lengthy, is the committed support of the target's large shareholders desirable for deal certainty — as well as the fiduciary duties of the target board in determining the appropriate structure.
Psychology of Strategic Buyers and Sellers
Strategic buyers and sellers exhibited discipline in their dealmaking activities in 2013, adopting a risk-averse approach. With stock prices nearing historic highs, boards and management carefully evaluated buy-side opportunities to avoid overpaying, including deciding whether to participate in competitive auctions. Strategic buyers continued to look for “add-on” acquisitions to expand their existing product and service offerings, customer base and/or geographic footprint in an environment of low organic growth. Although prevailing economic and market conditions were favorable, few big-ticket transformational transactions were announced during the year. It remains to be seen whether the completion of those transactions and the continuation of stable market conditions will give boards the confidence to undertake industry-changing transactions in 2014.
Strategic sellers continued to focus on their core businesses, divesting noncore businesses to an eager audience of buyers hungry for attractive acquisition candidates. Buyers took advantage of available credit, low interest rates and historically high levels of cash to pursue these candidates, while strategic sellers continued to use spin-offs to focus on their core competencies, unlock the value of high-growth business segments and boost stock prices.
Exits Drive Private Equity Deal Activity
Private equity sellers were ideally situated to realize sizeable returns on the sale of portfolio companies in 2013, as buyers actively sought attractive targets and stock market valuations were at historically high levels. In one of the largest private equity exit transactions of the year, Warburg Pincus sold its portfolio company, Bausch & Lomb Inc., to Valeant Pharmaceuticals for $8.7 billion. IPOs also continued to be a popular exit strategy, as private equity firms looked to monetize the value of their investments while the IPO market remained open (see Capital Markets/“The JOBS Act: The Resurgent IPO Market and What We Learned in Year Two”).
However, despite record levels of callable capital reserves (or “dry powder”) and the availability of acquisition financing at historically low interest rates, private equity buyers have been struggling to find quality assets at attractive prices. In the absence of platform acquisition opportunities, private equity buyers are engaging in more add-on acquisitions, with a focus on enhancing the revenue and value of their existing portfolio companies. The low interest rate environment and accessible debt markets in 2013 also facilitated portfolio recapitalizations, a trend that carried over from 2012. Information technology, particularly software, was a popular industry for private equity buyers in 2013, with more traditional industries for private equity investment such as retail, media, and business products and services attracting lower levels of interest.
Contractual terms around deal certainty remain an important element in private equity acquisition activity. While variants on the theme exist, some form of specific performance, together with a reverse break-up fee typically in excess of levels of seller terminations fees (and concomitant caps on damages against the buyer/sponsor), continue to be the prevailing contractual mechanics to address certainty and redress for nonperformance by a private equity buyer. While transaction parties and deal practitioners will continue to find creative variations on existing contractual technology surrounding deal certainty (and related remedies), we do not expect to see any major structural changes to the private equity contractual terms in this area in the immediate future.
Shareholder Activists Influence M&A Activity
Increasingly, activist shareholders have been seeking to influence the strategic direction of companies; and in many instances, they have garnered support for their ideas from mainstream institutional investors. While activists historically have focused their efforts on smaller, underperforming companies, in 2013 they turned their attention to large-cap and diversified businesses with multiple operating segments, including companies performing consistently with their peers. Boards and management are reassessing the strategic fit of noncore businesses, and activists are reinforcing this boardroom trend, often resulting in divestitures or spin-offs. Activists played prominent roles in several large M&A transactions last year — most notably Carl Icahn in his rival bid for Dell Inc. All indications, including the activist community’s fundraising efforts and commentary, point to a continuation of activism in 2014 and beyond (see Governance/“US Corporate Governance: Boards of Directors Face Increased Scrutiny”).
Another trend capturing attention in boardrooms and the deal community in 2013 was shareholder activism in the context of opposing announced transactions, such as Soft Bank/Sprint/Clearwire, Plains Exploration/Freeport-McMoRan and Dell. Activist funds and arbitrageurs made their presence known in the public company M&A arena and, in several instances, led campaigns to improve deal economics. Transaction parties should be prepared in advance to address shareholder concerns and should not assume that an arm's length, heavily negotiated, carefully analyzed, good-faith determination to enter into a transaction will lead to shareholder approval without controversy.
Hostile and unsolicited activity was subdued for much of 2013, with only four hostile transactions announced during the first three quarters; however, activity picked up somewhat in the fourth quarter, with the announcement of seven unsolicited transactions.1 Hostile activity often is perceived to correlate with higher levels of board and management confidence, and the fourth quarter may be an indicator for increased dealmaking activity in 2014.
Of particular note is the unsolicited $2.3 billion acquisition proposal by Jos. A. Bank for Men’s Wearhouse, a rival men’s clothing company, announced in October 2013. After its proposal was rejected by Men’s Wearhouse, Jos. A. Bank withdrew its offer. In a maneuver referred to as a “Pac-Man” defense transaction, Men’s Wearhouse turned the tables and announced an offer to acquire Jos. A. Bank, the smaller of the two companies, for $1.5 billion. This offer was rejected in late December by Jos. A. Bank. Men’s Wearhouse formally launched an unsolicited tender offer for Jos. A. Bank on January 6.
Political, fiscal and monetary uncertainties persist in the U.S., and levels of M&A activity remain muted when compared to the historic highs of the pre-2008 market. However, some of the factors that contributed to an encouraging finish in 2013 could play a role in a brighter U.S. M&A market in 2014. While the pace of activity in the new year may be modest, the factors are in place to stimulate increased dealmaking.
1 For this discussion, we count Jos. A. Bank/Men’s Wearhouse twice.
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* This article appeared in the firm's sixth annual edition of Insights on January 16, 2014.