U.S. M&A: the land of opportunity meets challenges

U.S. market hits the brakes

The Covid-19 pandemic has had a multitude of impacts on the U.S. M&A market, presenting challenges for parties at every stage of the deal process, including:

• valuation
• access to and the terms of financing
• conducting due diligence
• obtaining regulatory approvals and third party consents
• complying with pre-completion covenants

We have seen buyers seek to avoid completing high-profile transactions while sellers have filed suit trying to force them to do so.

High-profile deals fall through

Few industries have been immune, with both strategic and private equity players affected.

• In the technology sector, Xerox terminated its USD34 billion hostile bid for HP at the end of March, having previously raised its bid.
• In cybersecurity, Advent International tried to terminate its agreement to take Forescout Technologies private.

Elsewhere the effect has been even more pronounced:

• In travel and leisure, Mirae, the Korean asset manager, is attempting to pull out of buying a portfolio of luxury hotels for USD5.8bn.
• In the fitness industry, Level 4 alleges that CorePower is using the enforced closure of its facilities as a reason to avoid purchasing a number of yoga studios.
• In retail, where lockdowns became widespread and consumer confidence dried up virtually overnight, Sycamore Partners cited numerous breaches of the purchase agreement due to store closures and employee furloughs to claim it no longer had to buy Victoria’s Secret. L Brands has since let the buyer walk away.

It will take time for court cases to play out. The threshold in U.S. courts for establishing material adverse effect and the exceptions related to general economic impacts (including some specific references to pandemics) is high. So many of these cases may hinge on “ordinary course of business” covenants, which require:

• target companies to operate in the ordinary course of business between signing and closing
• that certain actions may not be taken without the buyer’s consent

In addition, there are complexities. Target companies forced to shutter or significantly cut back their businesses may, arguably, not be operating in the ordinary course of business. However, they can counter claim that they are complying with other pre-completion covenants, including abiding by any laws or government directives, which drove many of their actions.

The outcome of these cases will likely depend on how courts seek to compare the conduct of each business. They may, for instance:

• use the way other businesses in the sector have acted during the pandemic as a measure
• look at how the specific business has operated historically
• take into account the length of the pandemic
• assess how quickly the business can recover
• consider whether the parties have acted and communicated in good faith

Other deals stay the course

While numerous potential deals have been shelved, we have seen agreements signed before the crisis took hold continue to completion. For example:

• Greif, Inc., a global leader in industrial packaging, completed the sale of its Consumer Packaging Group business in April
• Xperi completed its merger with TiVo
• State Grid International Development is on track to acquire Sempra Energy’s Chilean business by the end of June

Notably, many of the completed transactions have involved strategic acquisitions between companies in the same sector, facing similar economic prospects.

A golden opportunity for some

Despite the widespread disruption, new opportunities are emerging for those who can deploy resources and capitalise on reduced company valuations.

For private equity firms, many armed with record amounts of cash, Private Investment in Public Equity (PIPE) transactions are on the rise. Competition here is so fierce that processes are often being run like M&A auctions, with multiple firms vying for a piece of the most desirable companies.

PIPE transactions often increase when uncertainty plagues traditional financial markets. It happened during the 2008 financial crisis, as well.

Dramatically decreased stock prices in travel, retail and entertainment companies are also providing opportunities for investors.

These deals are often in the form of an investment rather than a takeover, allowing the buyer to acquire a large stake at a discount and the target to raise cash quickly. Recent deals include Wayfair’s private equity-led raising of USD535 million, and preferred stock issuances by Cheesecake Factory (USD200m) and Expedia (USD1.1bn).

Post-pandemic landscape

Despite ongoing public health concerns, high rates of unemployment and decreased consumer confidence, equity markets have stabilised in recent weeks, largely due to massive federal government stimulus programmes.

However, M&A activity has been slower to rebound due to continued concerns about underlying economic and social conditions.

Though anecdotal evidence suggests certain players, particularly private equity, are quietly gearing up for a spurt of deal activity, a sustained and distributed recovery depends on a variety of factors. These include the stabilisation of valuations (at levels where buyers and sellers can agree), financial market conditions and, most importantly, evidence that the market is returning to growth.