Why deals are becoming harder to close – and what to do about it

January 2020 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

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On the heels of an extraordinarily busy year for M&A activity in 2018, 2019 offered both opportunities for celebration, as well as some causes for concern for market participants. Complex forces are currently converging to create an economic environment that remains difficult to navigate. Many commentators have expressed concerns about an impending downturn in the global economy, and some are forecasting a dry spell for accretive M&A in the year ahead. With that said, chief executive and board appetites for major, transformative deals do not appear to be slowing any time soon, and stock markets remain buoyant. Whether 2020 will be another great year for M&A dealmaking or whether it will usher in the recession that some believe to be overdue, we are confident only that M&A transactions will become harder to close in the year ahead.

Several major M&A transactions incurred meaningful obstacles to closing in 2019. Recent data from Gartner, Inc. has suggested that the number of days elapsed between the signing and closing of M&A deals has increased over 30 percent since 2010. We do not expect this trend to abate in 2020. M&A deals are taking longer to proceed from announcement to completion, and dealmakers and their clients should seek to understand why. This article will review some of the major reasons why we believe that closing M&A deals will continue to be a much more difficult exercise than in years prior. We will conclude with a few thoughts on how dealmakers should react to this phenomenon and steps that can be taken to prepare accordingly.

Regulatory environments have made transaction approvals more difficult to obtain

First, the regulatory environment for obtaining transaction approvals has become more complex. Acquirers are being forced to work harder than ever to fulfil approval-related closing conditions on a timely basis, and regulators are not afraid to withhold their approvals of deals for as long as it takes until they are satisfied as to the merits of the transactions at hand. Five years ago, a chief concern among advisers in strategic M&A deals was how long it might take to clear a Hart-Scott-Rodino Act ‘second request’, but it was still generally expected that almost all of these deals would still make it to the closing table. Today, transformative horizontal and vertical combinations are increasingly being litigated and aggressively investigated by regulators, and a higher number of parties are walking away from the table with only unsuccessful deals to show for their efforts. This is one of the reasons why the average reverse break fee in an M&A deal has ticked up to 7.3 percent of transaction equity value in October 2019, up from 5 percent over the previous 12 months, according to Deal Point Data.

Perhaps echoing sentiments that may underlie the larger global debate about rising global economic inequality, antitrust regulators appear to have become increasingly sceptical of large market leaders that are consolidating their dominant positions and growing revenues through M&A. US antitrust oversight of M&A transactions is approaching a local zenith, where we continue to witness a clampdown on business combinations and a muscular approach to M&A oversight that was not anticipated from the ‘pro-business’ Trump administration. Overtures from the campaign trail aside, the Trump administration’s Department of Justice (DOJ) has been unexpectedly active in reviewing, scrutinising and now even aggressively litigating against various transactions. On the heels of a regulation-laden Obama administration that pushed heavy regulatory overlays upon American corporations, many hoped that president Trump would bring a welcome respite from governmental scrutiny. There is no doubt that the president places significant emphasis on the performance of the US stock market, but he has hardly been the rubber stamp for M&A dealmaking that many anticipated. The president exhibited immediate scepticism of big deals after taking office, starting with a string of tweets against the AT&T/Time Warner merger, which could only be closed over two years later. Most recently, a post-closing action by the DOJ unwound a consummated $5bn aviation fuel M&A deal between Parker-Hannifin and CLARCOR that had already been closed over six months previously, and that had complied with the mandatory waiting period imposed by the Hart-Scott-Rodino Act. Dealmakers must not only be concerned with federal regulatory approvals of their deals, as individual state attorneys general are also voicing public concern about the potential negative effects of deals on consumers, as is currently being witnessed in the Sprint/T-Mobile transaction.

European regulators have been similarly aggressive in the policing of deals and the enforcement of European Commission (EC) merger control rules. In February 2019, the EC blocked Siemens’ proposed takeover of Alston, citing pricing concerns and reduction in innovation. ThyssenKrupp’s tie-up with Tata Steel was also rejected, which would have created a joint venture between the second and third largest producers of flat carbon steel in the European economic area. In an expansion of its authority, the EC has announced a proposal to introduce ‘interim measures’ to apply remedies to harmful business combination activity in situations where its full investigation has not been completed. European deal regulators argue that these types of new tools, which are largely injunctive in nature and can be deployed quickly to require companies to either act or refrain from acting in specified manners, are necessary to confront acceleration in industries like technology and software.

And antitrust is not the only regulatory framework that threatens to hamstring the closing process in 2020. President Trump’s administration has long been deeply protective of US industrial competitiveness, and the latest measure taken in this regard has been the expansion of authority granted to the Committee on Foreign Investment in the United States (CFIUS). In August 2018, the president signed into law the Foreign Investment Risk Review Modernisation Act of 2018, which expanded the types of investments and transactions subject to review by CFIUS on national security grounds. Just a few months ago, CFIUS published new proposed rules that can bring ‘non-controlling’ minority investments, as well as certain transactions involving US real estate, under the jurisdiction of CFIUS.

The types of deals that are likely to draw CFIUS’s focus are expanding in scope. In its early stages, CFIUS was adopted to police foreign investment in the military and aerospace and defence sectors, but CFIUS has recently adopted ‘critical technology’ and ‘critical infrastructure’ into its lexicon for determining where it will focus. Those terms have yet to be conclusively fleshed out into exhaustive lists of the types of investments they cover. As part of the Foreign Investment Risk Review Modernization Act’s FIRRMA’s pilot programme, as many as 27 key industries were identified as comprising ‘critical technology’ and ‘critical infrastructure’, but, as currently styled, CFIUS’s investigative authority is not strictly limited to those 27 key industries and can include other applications that have not yet been enumerated.

Institutional investors are increasingly demanding to be heard

Beyond just regulation, other market forces pose challenges to completing M&A transactions. Major shareholders have become keenly aware of the power they wield in shaping and approving M&A deals. These shareholders have exhibited a willingness to participate and be included in the dealmaking process and to understand the thesis for a given deal before announcement. Shareholder activism has remained a key driver of M&A activity over the last few years, and other types of investors, including active managers, are resorting to activist-like tactics, including public campaigns and statements for or against certain deals, to make their voice heard.

As has been well documented, index investing and the capital flowing out of actively managed mutual funds and into the hands of low-fee index fund managers has empowered passive investors like Vanguard, BlackRock and State Street to place a renewed and sharper focus on corporate governance and purpose. The popularity and performance of these types of exchange-traded investment products has, in turn, placed pressure on more expensive fund products offered by active managers such as T. Rowe Price, Neuberger Berman and Wellington to demonstrate greater value and to show customer-investors who have a choice why they should select an investment with a higher fee. Being openly vocal about their beliefs on whether a given deal will create shareholder value, or whether current corporate leadership is optimal for the company, is a departure from these active managers’ previous trend of watching idly by and remaining largely silent as deals were announced.

Where active fund managers question the motivation or the thesis underlying a given deal, they are becoming more apt at speaking up in protest. Actively managed funds, once they articulate a distaste for a deal, can find friends in shareholder activists and other persuasive equity investors that have been described as hunting in ‘wolf packs’. This powerful constituency, comprised of many disparate individual actors, that sways the fate of M&A transactions has been nicknamed the ‘shareholder electoral college’. While the goals of actively managed funds are not necessarily to agitate for a higher price, or better terms, as would a traditional greenmailer of yore, active managers today generally yearn for increased engagement with the board and to understand how a given deal supports the larger strategy of the company that has been previously communicated to them. The $74bn Bristol-Meyers-Squibb acquisition of Celgene was a highlight among 2019 deals, but not only because it was a mammoth merger in size or scale. Wellington Management, an active manager, that owned about 8 percent of Bristol-Meyers-Squibb prior to the deal’s announcement, wasted little time in publicly expressing its disfavour of the transaction in a one-paragraph press release issued six weeks prior to the Bristol-Meyers-Squibb shareholder meeting. This moment was said to mark an unprecedented intervention in the M&A evaluation process by an institutional equity holder. Hedge fund Starboard Value later also expressed similar concerns at that deal’s prospects for value creation. After further engagement by Bristol-Meyers-Squibb with Institutional Shareholder Services and proxy adviser Glass Lewis, both of those proxy firms eventually expressed support for the deal, which closed on 20 November 2019 after finally receiving US Federal Trade Commission (FTC) approval.

In March 2019, shareholder Paulson & Co. sent a public letter to Newmont Mining Corporation expressing that Paulson did not support its planned acquisition of Goldcorp as initially structured. Newmont Mining subdued Paulson’s concerns by promising a special dividend to its investors if the Goldcorp deal received shareholder approval. We expect to continue to see fund managers like Neuberger Berman, Fidelity and T. Rowe Price, names that never would have been thought to intervene or initiate in proxy battles just five years ago, continue to vie for enhanced engagement and to exert considerable influence over the strategy and direction of any company in which they are invested.

These situations reveal a complicated dynamic where important stakeholders must be identified and thoughtfully and strategically engaged by companies and their advisers on the road to deal creation. These types of holders are another key constituency whose opinion and influence can no longer be overlooked. It requires meaningful time and effort that must be devoted to yet another workstream on a parallel timeline to negotiations with the counterparty. It requires special expertise, beyond the investment bank or average law firm to navigate these waters and ensure that an impending transaction is not met with an unwelcome surprise from an important constituent after announcement. Where those surprises happen, the path to closing becomes even more unpredictable and difficult to tread, and even when a deal does close, it is becoming apparent that enduring peril for incumbent corporate leadership does not end there.

What to do about it?

Recognising today’s headline regulatory considerations and other potential event-driven impediments that can hang up a proposed deal is a sound first step in adequately preparing. With respect to mitigating the obstacles to closing deals in today’s M&A market, we recommend that buyers and sellers, in addition to equipping themselves with top-flight advisers, place enhanced emphasis on communication and deal strategy.

With threats to deal completion consistently evolving around new regulations and potentially aggravating market forces, the experience of an advisory team that understands and is at the forefront of these issues can turn into an enduring competitive advantage. Sharp bankers and M&A drafters are, of course, a must-have for any transaction to stay on course, but it is equally important to employ a deep bench of subject matter experts with demonstrated first-hand experience with the entities who may decide the fate of a transaction. The supply of advisers who have boots-on-the-ground experience, working with governance professionals at fund managers, the DOJ or the FTC for example, that can predict the inquiries that may arise and chart a course for navigation that can save valuable time and expense, is not ubiquitous in the market. It is, however, worth seeking out.

Communication and articulation of a deal and its narrative, why it makes sense over other strategic alternatives, including remaining an independent standalone company, is going to be paramount to successful dealmaking in 2020 and beyond. Well-rounded advisory teams, and deep discussion among them, can assist in developing that narrative. From a regulatory perspective, early engagement with economists and market consultants empowers corporate leaders to develop a story, and data, around the deal that can be expressed, and defended, as and when it becomes subject to scrutiny. Understanding concerns around novel antitrust situations, such as data sharing, ‘informational’ monopolies and horizontal combinations involving technology giants, is critical to developing a cohesive and defensible story underpinning the decision to do a deal. With respect to mitigating the impact of an adverse intervention by a well-known shareholder, it is no longer enough for boards and executives to look only at the legal risks in a traditional manner. Best-in-class advisers are using cutting-edge monitoring tools and techniques to track shareholder ownership and to triangulate it against emergent shareholders’ past practices and tendencies. They deploy deep relationships with personnel from related institutions, who know the personalities of those who are making voting decisions at important funds and governance institutions, and they draw on backgrounds in governance, investor relations, crisis management and strategic communications. This process is iterative and bespoke, it must be continuously conducted in real time and it leverages diverse professional skillsets beyond those provided only in law schools. The strategies needed to successfully and persuasively interface with the ‘shareholder electoral college’, comprised of significant equity institutions and their portfolio managers and research analysts who may be studying a proposed deal, is in equal parts an exercise in financial analysis and investor relations as it is in clearly understanding fiduciary duties and the legal regimes applicable to directors and managers. This process requires great foresight and often must look several moves ahead to develop the record needed to justify why a given deal is appropriate at a given time.

Availing oneself of uncommon advisory expertise and establishing these channels of communication to deliver purposeful messaging to the market can make or break a deal in today’s resilient, but increasingly fragile, M&A environment for big players. Deals will still be able to be found in the year ahead, although we expect they will become even tougher to wrangle across the finish line. While they may seem daunting, the heightened stakes present opportunities for those companies that are prepared to continue to leverage M&A to build sustainable lasting organisations and deliver value to stakeholders.

Mark Davies is a partner and Sawyer Duncan is an associate at King & Spalding LLP. Mr Davies can be contacted on +813 4510 5604 or by email: mdavies@kslaw.com. Mr Duncan can be contacted on +813 4510 5608 or by email: sdduncan@kslaw.com.

Mark Davies and Sawyer Duncan

King & Spalding LLP