Merger and acquisition activity is confidence-driven, and most of the financial indicators appear to be moving in the right direction. However, figures detailing merger and acquisition (M&A) activity demonstrate that confidence is tentative at best. It is worth examining the current macroeconomic conditions shaping M&A deals and how they are structured during the economic recession and post-Lehman.
Bank borrowing has gone from the most attractive to the least attractive form of finance in the space of two years. In the boom of 2007, strategic purchasers were often outbid by financial buyers, such as private equity (PE) houses, due to their easy access to credit and a higher tolerance of leverage. Now it is strategic buyers that are best-placed to lead on M&A deals.
Minority investments are becoming increasingly popular as financing outright acquisitions can be difficult in the current climate. Much of the private M&A activity has been distressed. However, there is an inevitable conflict between distressed acquisitions and the increased hunger for greater due diligence as part of increased risk management by companies.
The lack of interest paid on companies’ cash reserves means that companies with cash are tempted to improve their returns on capital via targeted acquisitions. There is also a temptation for boards of directors to bolster growth in a weak financial year by acquiring rival companies.
Potential purchasers face little competition from the PE sector, as the crisis has deprived PE investors of the debt needed to finance deals. Moreover, those investors took a hit at the height of the financial downturn last year and are struggling to meet their financial commitments.
With banks under pressure from regulators to retain some more capital, some observers opine that M&A activity will remain subdued. Uncertainties over the extent of any economic recovery and fears of a double-dip recession mitigate M&A activity.
The airline, financial services, pharmaceutical, health care and media sectors are all repeatedly cited as being ripe for consolidation. Any non-cyclical industries (such as energy) and cash-generative industries (such as gaming outside of Russia) should also be fairly active where market conditions permit a degree of M&A activity.
There has been an increase in reverse termination fees, which aim to address the potential failure of a bidder to find a financing commitment from a lender. Where stock has formed part of the consideration on an acquisition, parties are using fixed exchange ratios for the shares. The effect is that both target and purchaser have a risk of fluctuations in their stock prices.
At present there appears to be a blanket prohibition on a target soliciting competing offers from third parties, with a target only able to enter into negotiations with a rival bidder where it receives a “superior bid.” In such a situation, if a superior bid is accepted, termination fees will typically be triggered.
In the context of material adverse change clauses in M&A deals, there appears to be a major increase in carve-outs by a target for any failure to meet analysts’ projections. It should be noted that earn-outs are being used in a broader range of M&A deals, not just for high growth businesses or as a management incentive tool.
Finally, transitional service agreements appear to be viewed as increasingly important and are thought about far earlier in M&A deals post-Lehman, in light of broad fears over sellers’ financial strength.
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