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— Judgment Call —
Despite the market meltdown, strategic buyers continue to pursue the next deal. Several transactions have been announced since the beginning of the year, including a controversial all-stock merger between Ticketmaster Entertainment Inc. and Live Nation Inc. If the deal closes, the new company, Live Nation Entertainment Inc., will be the nation's largest ticket provider, artist management group and concert promoter.
To a large extent, continued M&A activity in 2009 will likely be driven by such "stock-for-stock" transactions, which allow an acquirer to enter into a deal without depleting much-needed cash or securing debt financing. Assuming that a potential acquirer could secure financing at all in the current market, it would probably be on terms that challenge the economics of the proposed deal.
Potential acquirers must exercise caution: The popularity of all-stock deals emerges in a business climate that exacerbates the risk inherent to such transactions by creating uncertainty with respect to the value to be delivered to the target's shareholders at closing. While the transaction value remains more or less constant between the signing of the definitive agreement and the closing of the deal when payment is in cash, the value of stock fluctuates daily. Anyone watching the current market has witnessed dramatic stock value fluctuations with some historic single-day point drops. Additionally, since all-stock deals could potentially take longer to complete than their all-cash counterparts, the parties remain at the mercy of fluctuating stock prices even longer. Such particulars should make any potential acquirer skittish. However, appropriate pricing and protection mechanisms can help protect an acquirer's interests. The simpler of the two basic pricing mechanisms in all-stock transactions is the fixed exchange ratio, where each share of the target is exchanged for a fixed amount of shares of the acquirer. This ratio does not change with fluctuations in share prices during the period between the signing of the definitive agreement and the closing of the deal. The alternate pricing mechanism is the floating exchange ratio or the fixed value ratio. In a floating exchange deal, the acquirer agrees to pay a number of shares the value of which must equal a predetermined dollar amount. If the value of the acquirer's shares decreases after the definitive agreement is signed, more shares must be issued when the deal closes in order to equal the predetermined dollar amount. Conversely, if the value of the acquirer's shares increases, fewer shares must be issued. The fixed exchange ratio is not only simpler to execute but is the better choice for the acquirer. The target's shareholders likely would bear the risk of receiving less value at closing, especially in a market where the risk of decreasing share prices is significant. It is no surprise then that the Live Nation-Ticketmaster merger will use the fixed exchange mechanism, with Ticketmaster shareholders receiving 1.384 shares of Live Nation common stock for each Ticketmaster share they own. Compare this to an all-stock transaction with a floating exchange ratio. As noted above, in such a deal, if the value of the acquirer's shares decreases, more shares must be issued in order to equal the predetermined exchange amount. Thus, the acquirer's shareholders bear the risk of dilution, since more stock would be issued to the target's shareholders. However, if the value of the acquirer's shares increases, fewer shares must be issued in order to equal the predetermined amount. In this scenario, the target's shareholders forfeit the opportunity to benefit from any rise in the share price. At first glance, this may seem equitable. However, given the current economic climate, where the risk on the downside likely is greater, the cost of engaging in such a transaction would likely fall on the acquirer and its shareholders. Depending on the bargaining power between the parties, even within the fixed exchange paradigm, additional protections may be afforded to the buyer's shareholders. For instance, an acquirer could negotiate a cap that would impose a maximum reference price with respect to the acquirer's shares, up to which price a deal would be consummated at the fixed exchange rate. If the actual share price were to rise beyond the cap, one could either negotiate walk-rights (i.e. the acquirer would have the power to terminate the deal without penalty) or a downward adjustment to the exchange ratio, which would limit the value to be delivered to the target's shareholders and protect the acquirer's shareholders. Of course, the target would also attempt to negotiate protections that would mirror the ones in favor of the acquirer. However, the current crisis will likely shift bargaining power in favor of the acquirer. Until the crisis hit, the "standard" form of a merger agreement had become more and more seller-friendly over time. More frequently than not, acquirers committed to transactions that allocated the bulk of the risk to the acquirer by omitting or limiting the conditions upon which the acquirer could terminate its obligation to close (e.g. the occurrence of a material adverse change affecting the target, the lack of available financing, or the failure of the target to meet specified closing conditions). But given the erosion of factors that justified these seller-friendly terms, such as a shrinking pool of potential acquirers and the lack of financing sources, the tide is bound to turn in favor of acquirers. In addition to an increase in all-stock transactions with fixed exchange ratios and further price protection mechanisms benefiting acquirers, one should expect to see a general shift toward a model that is more balanced and even acquirer-friendly in the coming year. Scott M. Coffey is a partner and Shubham V. Arora an associate with the international law firm of Squire, Sanders & Dempsey LLP. The authors are based in West Palm Beach, Fla., and focus their practice on mergers and acquisitions, corporate finance, and project finance matters. |
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