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— Analysis —
The conventional wisdom was wrong. Deal terms that give buyers the option of walking, at a fraction of the deal value, have spread, even in investment-grade strategic acquisitions, the most common theme in recent M&A markets. "Buyers are foisting risk on sellers," says a Wall Street M&A lawyer. "It's almost like a bad virus."
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Consider several recent strategic acquisitions. Buried deep in their merger agreements lurk reverse breakup fees that allow buyers, if they can't finance the cash portion of their deals, to walk away after paying a nominal penalty. Those deals include Macrovision Corp.'s $2.8 billion acquisition of Gemstar-TV Guide International Inc.; Ashland Inc.'s $3.3 billion deal for Hercules Inc.; and Brocade Communications Systems Inc.'s $3 billion purchase of Foundry Networks Inc. The usual penalty fee for walking: 3% of the total deal value. In other deals, caps on damages limit the amount sellers can receive in compensation if a deal falls apart, the most prominent being Mars Inc.'s $23 billion acquisition of Wm. Wrigley Jr. Co., which includes a $1 billion damage cap. That cap serves as a reverse termination fee; Mars won't be on the hook for any more than that amount if the deal falls apart. Reverse breakup fees in strategic deals have been used in the past to protect buyers against antitrust, or regulatory risk, says James Woolery, a partner in Cravath, Swaine & Moore LLP's M&A practice. Such was the case in the proposed merger of EchoStar Communications Corp. and Hughes Electronics Corp. in 2001. In that deal, EchoStar agreed to pay $600 million to Hughes if regulators rejected the deal. In fact, that's exactly what happened. EchoStar paid Hughes the fee after they agreed to end the $18 billion transaction late in 2002. Until recently, however, reverse-breakup fees have been virtually unheard of as structures designed to protect buyers against financing risk. Most strategic deals were stock transactions, and most buyers' credit was investment-grade, which limited the risk that financing markets would reject a deal. But as stock markets tumbled, many big strategic deals had to put up cash. This depressed valuations of companies and reduced the value of equity as acquisition currency. And now that buyers, even big strategics, must fund deals with cash, they must confront the reality of the credit crunch, which has prompted buyers and sellers to question whether banks will actually meet their commitments. In several LBOs, notably Thomas H. Lee Partners LP and Bain Capital LLC's $23 billion acquisition of Clear Channel Communications Inc., lenders who made commitments forced a reworking of terms. This precedent has interjected a palpable sense of risk into strategic buyers' calculations. "There's still a genuine fear of completion risk as far as financing goes," says Jimmy Neissa, chairman of UBS' mergers and acquisitions group. In fact, evidence is that even investment-grade bond and loan issuance has been affected, particularly in the U.S. According to Dealogic, global investment-grade bond issuance fell 1% between January and the end of July 2008 and the same period last year. In the U.S., however, volume declined 10%. Investment-grade loan volume fell 30% globally for the January to July period, and 38% from a year ago in the U.S. Wary investors, says Neissa, account for some of this drop. "A lot of investors are not only taking a harder look at credits, but quite a few are staying on the sidelines," he says. And because buyers don't want the risk that financing won't be completed, they are passing it to sellers, whose boards seem willing to accept it. "Sellers are acknowledging the difficulty of the credit markets," says John Finley, a partner at Simpson Thacher & Bartlett LLP. "There is a worry that funding may not be provided." Not every strategic deal of recent vintage has included reverse breakup fees. In the $52 billion merger between InBev SA and Anheuser-Busch Cos., which is being financed with $45 billion in debt, there is no option for InBev to terminate because of an inability to get the debt, sources say. One source says antitrust risk is not an issue for geographically separate brewers. And according to InBev's filings with the Securities and Exchange Commission, the company received fully committed financing from foreign banks, including Banco Santander Central Hispano SA, Bank of Tokyo-Mitsubishi UFJ Ltd., Barclays Capital, BNP Paribas SA, Deutsche Bank AG, Fortis Bank, ING Groep NV, J.P. Morgan Chase & Co., Mizuho Corporate Bank Ltd. and Royal Bank of Scotland Group plc, all of which would be bound to provide certain funds under U.K. financing laws. According to Woolery, reverse breakup fees are easier to get when sellers feel there are few other options -- more prevalent with buyout shops often sidelined. "It's a function of deals happening where there are few other logical buyers," he says. In the Mars deal for Wrigley, there were few other buyers large enough to acquire the candy maker, and no other confectioners counterbid. One source says this made it easier for Mars to ask for looser terms once the board became convinced a deal might be in its best interests, given the 28.1% premium to Wrigley's market capitalization. It obviously didn't hurt to have Warren Buffett helping finance the deal. One lawyer says there is a sense among selling boards that because it is generally easier to get investment-grade financing for highly rated companies, the risk of deals blowing up for financing reasons is relatively low, which makes giving up the conditional option to terminate less of a concern. Indeed, several dealmakers say boards do not even generally look at reverse breakup fees as the conditional put options that they are and have not quantified their value. Of course, neither did buyout shops for years -- until those options to bolt became suddenly critical in a crumbling market. As several sellers, such as Harman International Industries Inc., Reddy Ice Holdings Inc. and Finish Line Inc. -- all of which saw pending LBOs fall apart amid the credit collapse -- realized in the past year, low risk when a deal is agreed upon may not be so low when it comes time to close. "Boards can get into trouble if they spend too much time focused on valuation, and not enough time on the key terms," Woolery says. Given the past year, it's a little surprising that needs to be said. |
Last year, when the first financial sponsor-backed deals began to implode, conventional wisdom argued that boards of selling corporations would react by demanding more certainty in deals. Gone would be the reverse breakup fees that allowed buyers to walk from transactions by paying a nominal amount of the total deal value. Gone would be caps on damages in lawsuits, replaced, many believed, by more onerous claim rights, making it riskier for buyers to back out and giving sellers more certainty that deals would close.
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