May 2019 Issue
Done properly, a merger of rivals can be hugely rewarding. The $107bn deal between Anheuser-Busch InBev and SABMiller in 2015, for example, created a powerhouse in the drink and brewing industry. Today, Anheuser-Busch InBev is the world’s largest brewer with revenues in excess of $56bn.
However, not all mergers between rivals are successful. The so-called ‘merger of equals’ between advertising giant Omnicom Group and French rival Publicis Groupe, for example, ultimately failed to meet expectations “The most important principle to remember is that there is no such thing as a ‘merger of equals’,” notes Mark Herndon, president of M&A Partners. “It is an acquisition – a big one, to be sure – but legally, financially, operationally and from a governance control standpoint – there is going to be a ‘buyer’ and a ‘seller’.”
Antitrust anxiety
Selling a business will always create challenges and pressures for individuals, from the C-suite down to the post-room. And it puts an enormous strain on the business itself. These pressures are magnified when the deal involves selling a company to a competitor, be it a direct or indirect rival. Direct competitors have the same target market and customers as the seller and are usually the most obvious buyers. Indirect competitors share some of the market, while near competitors target a different section of the market.
Merging with a competitor can also create significant antitrust concerns. The ongoing investigation into the proposed £7.3bn merger between Sainsbury’s and ASDA has prompted the UK’s Competition and Markets Authority (CMA) to launch an investigation which may ultimately see the deal rejected. The CMA has warned that the transaction may require the combined company to sell a “significant” number of stores in order for it to be approved. Bodies such as the CMA, the Department of Justice (DOJ) and the Federal Trade Commission (FTC) in the US, among others, will analyse these types of mergers and may set forth remedies before allowing parties to merge, such as divesting assets or business entities, however they may also reject deals out of hand. In the US, the proposed $26bn merger between T-Mobile and Sprint has received opposition from rivals, unions and consumer groups claiming the deal would harm competition, cost jobs and raise prices. In light of antitrust concerns, companies and their counsel should identify early in the transaction planning process any areas of concern which should be addressed in the merger agreement. For deals of a certain size, notification may be required in the home country, as well as in jurisdictions abroad where the two participants may have sales or business locations.
Antitrust concerns aside, companies selling to a rival may face other challenges. Arguably, the biggest issue to consider is determining whether the competitor is honourable in its dealings with people and in the market, and is serious about pursuing such a merger. “There are companies that would enter into discussions with a competitor just to learn confidential information about the business without any real interest in completing a transaction,” says James E. Abbott, a partner at Seward & Kissel LLP. “Often in an auction to sell a business, the decision is made not to allow direct competitors to become bidders in the process, even though they might be in a position to offer the highest price. If competitors are invited to participate, it is prudent not to provide them with selected sensitive business information until late in the process when terms of a deal are largely agreed and there is a good sense of momentum toward completing the deal.”
Identifying the right potential buyer is one of the most important steps companies can take when considering a sale to a competitor. Parties must also identify and protect the key value drivers in the business, namely the people, customers, technology and supply chain, according to Frank Chaiken, a partner and practice group leader of the corporate transactions & securities team at Thompson Hine. “Before even beginning any discussions, sellers must formulate a view of how, or whether, those key value drivers will be preserved, and valued, in the transaction, and a strategy for doing so. Sellers must also identify and value the synergies on the revenue and cost side that may benefit the combined businesses and formulate a strategy for factoring those into the valuation. They must find and engage a banker with deep knowledge of the industry and market, who can assist with the foregoing. Finally, sellers must get the house in order prior to the transaction. Contracts, corporate governance, licensing and compliance should be in good order going into due diligence.”
Compliance and legal teams should be involved in the merger process as early as possible in order to ensure that the necessary resources are put in place prior to the announcement of a takeover. Any merger contains risks and it is imperative that those risks are assessed and mitigated. Acquirers must assess the target’s compliance programme and legal status.
Due diligence and cultural clashes
Due diligence has an important role to play on both sides of the transaction. “Effective diligence is obviously essential, but many public-to-public mega mergers announce on definitive agreement with only public records, such as annual reports, analysis and trade knowledge as diligence,” says Mr Herndon. Due diligence is a not a one-time event but an ongoing process. After the definitive agreement, the best thing the parties, their respective lawyers and investment bankers can agree to do is ‘post-definitive agreement discovery’ and carefully managed pre-close joint planning.
Due diligence can also help both sides of the transaction to identify cultural and historical differences between the organisations. Deep, competitive rivalries cultivated by years of intense competition are not easily resolved and must be managed at the highest levels. Otherwise, the entire integration strategy could be adversely affected, and poor decision making and execution processes may result in unanticipated value erosion.
“Economic uncertainty, increasingly competitive markets and shareholder demand for value generation will likely create more instances of rivals merging. For those companies, there are undoubtedly lessons to be learned from previous successes – and failures.”
Cultural challenges have the potential to derail any transaction, however they can be particularly damaging for deals involving rival organisations with little to nothing in common, despite occupying the same market. When rivals merge, though one may expect the integration process to be more natural than when an acquirer moves into a new market, this is not always the case. Merging parties must manage personalities and expectations, and overcome different operating styles if the transaction is to be successful.
Navigating such problems can yield a number of advantages. “Selling to a competitor creates the potential for synergies, ensures that the buyer has knowledge of the market and increases the likelihood of continuing solid business execution post-closing,” explains Mr Chaiken. “However, there are cons. There will likely be a loss of executive positions due to redundancy; there will also be customer and regulatory concerns due to consolidation of suppliers.”
Sell-side due diligence is an important part of the process. Companies must ensure that they are selling to a competitor for the right reasons, and so must ask relevant questions. Is the acquirer serious about the deal? Has it offered to pay much more than what the company is worth? If so, this may be an indication that the buyer has not done its due diligence on the company or is perhaps not serious about the transaction. Equally, sellers must understand the buyer’s deal history, and should determine how the proposed buyer will finance the deal, as well the buyer’s intention and ideas for the company post-close. The acquirer may wish to replace key employees or significantly alter the structure or vision of the company, for example. Knowing whether a buyer will implement wholesale changes or maintain the company’s existing direction and strategy may be crucial to deciding whether to accept any potential offer.
Necessity of NDAs
The question of how much information should be shared with a potential acquirer is complex. Sellers should consider contracting a third-party, such as a financial adviser, consultant or business adviser, to share some key financial/metric data with a potential acquirer, on a no-name basis, to gauge initial interest. Data such as key accounts and customers should be prioritised and kept away from would-be acquirers, however.
Non-disclosure and confidentiality agreements (NDAs) are a key way of ensuring the secrecy of confidential information given to another party. NDAs are a crucial best practice in any M&A discussions. “The risks of disclosing sensitive business information to a competitor are acute,” says Mr Chaiken. “In order to minimise antitrust and competition concerns, there is a need to segregate who on the buyer’s and seller’s sides even has access to information, in the form of a ‘clean team’ agreement that would limit dissemination only to certain non-operational advisers of the parties prior to the closing of the transaction.”
NDAs are very important when a competitor is involved. The acquiring party will likely gain access to the seller’s trade secrets and confidential information. If no NDA has been agreed, the rival may use the target’s trade secrets to grow its competing business. For this reason, parties must ensure that an NDA is in place. The language of the NDA should broadly protect confidential information of the selling business and prohibit not just disclosure of the information by the potential buyer but also any use of the information for any purpose other than consideration of a transaction. “An important additional provision will prohibit the potential buyer from hiring the employees of the selling business,” suggests Mr Abbott. “Depending on the nature of the business, there is a real risk that the competitor could gain much of the value it saw in the acquisition by simply hiring one or a couple of key employees of the target business, so this needs to be restricted for as long a period as possible. Negotiations on the length of these no-poaching restrictions and also on the expiration date for the confidentiality covenants generally can be important and difficult to agree, and this document is the first to be signed in a transaction process and will give the seller an indication of the difficulty of dealing with the potential buyer and potentially of its intentions if it is unwilling to sign a strong NDA.”
There is no silver bullet, however. An NDA is only as good as the person signing it, and if the other side breaches the contract, expensive and time-consuming legal action may be required. NDAs can also be difficult to enforce. “While the agreement is binding and enforceable as a strict legal matter, litigating to enforce the agreement is expensive, so the smaller party in the potential transaction is at a disadvantage in bearing the cost of a dispute, and there is also the problem of proving that the potential buyer is improperly using confidential information it obtained in the process,” explains Mr Abbott. “While an NDA normally requires the return or destruction of all confidential information if transaction talks fail, there is no way to erase the knowledge in the brains of the potential buyer’s people who were exposed to the information, and it can be very difficult to prove that the business decisions they thereafter make are or are not based on the protected confidential information. Successful litigation to enforce this type of NDA is in my experience rare.”
Economic uncertainty, increasingly competitive markets and shareholder demand for value generation will likely create more instances of rivals merging. For those companies, there are undoubtedly lessons to be learned from previous successes – and failures.
Pursuing a merger is a difficult and expensive proposition which can easily backfire. “One plus one cannot necessarily be expected to equal three,” notes Mr Abbott. “‘Synergies’ that buyers model into their justification for the purchase price of acquiring a business are difficult to actually realise and should always be discounted. It is prudent for a buyer not to pay for the added value to be gained from synergies, but instead to view them as the gravy to be enjoyed if the integration is a success but not the reason to pay a steep price for a target. Structuring the purchase price to include an earnout that will give the seller more consideration if the business does well post-transaction is one good way to avoid overpaying based on expected synergies – although earnouts have their own drawbacks and risks, including the risk of disputes down the road.”
In the globalised economy, any merger of rivals is going to have an arduous and lengthy regulatory approval process. “During extended regulatory reviews, companies should proactively prepare for closing in advance, but carefully manage compliance with antitrust, anti-competitive and gun-jumping statutes in the interim,” explains Mr Herndon. “By definition, this requires adhering to an extremely rigorous legal chain of approval for meetings, agendas, participants, content to be discussed and data to be shared.”
For companies pursuing a horizontal merger, there are many roadblocks to dodge. This complex process requires careful due diligence and precautionary measures to protect the organisations in the event that the transaction falls through.
© Financier Worldwide
BY
Richard Summerfield