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December 2010

M&A analysis of global trends in mergers and acquisitions

Mergers and acquisitions (M&A) activity has risen significantly in the first three quarters of 2010 compared to the same period last year. We have seen a marked increase in hostile public M&A, crossborder M&A and the return of private equity-backed transactions. Although the fundamental drivers of M&A activity remain consistent, changes in the market have brought about new challenges in areas such as valuation, financing, deliverability and risk management which, in the context of a rapidly-evolving regulatory environment, continue to have an impact on the market. Buyers and sellers are having to recalibrate their sensibilities to deal with these challenges, with an increased focus on flexibility and innovation. There is currently more than $1 trillion of cash balances on corporate Americas balance sheet, with more than $350 billion held by the 20 companies with the highest cash balances. Access to financing for investment grade borrowers is available at extremely attractive interest rates. By most estimations, private equity sponsors have more than $0.5 trillion in dry powder. With this level of cash ready to be deployed, the rise in M&A activity can be expected to continue through 2011. But uncertainty in the macro-economic environment means that buyers remain cautious particularly in some sectors and geographies. Confidence in Asia and emerging economies is robust, and the importance of these markets as drivers of global M&A is well established. attractive and significantly more secure alternative to the plan by CSR to demerge its sugar assets, CSR identified the speed and flexibility with which Wilmar moved as an important factor in sealing the deal.


Changing features of the auction process: market adaptations

Buyers with strong balance sheets and access to the capital markets have shown an appetite for strategic acquisitions and willingness to pursue their targets. Krafts acquisition of Cadbury, for example, demonstrates an opportunistic bidder identifying and methodically pursuing a target viewed as an ideal strategic fit. French pharmaceutical giant Sanofi-Aventiss quest to buy biotech company Genzyme represents another such example. Indeed, in contrast to the markets in 2006 and 2007, in private M&A, a strong strategic buyer is now often seen as the favourite to win an auction process over financial investors. As a result of this shift in market dynamics, the auction process is, in many cases, less rigorously executed. There is greater opportunity for pre-emptive bids as well as late entrants to a sale process. Bidders that are able to act quickly and deliver certainty gain a clear advantage. For example, Bright Foods (China) was in deal negotiations for six months with CSR (Australia) for the sale of its sugar unit. But Wilmar International (Singapore) was able to swoop in and close the deal in six weeks. Although a potential acquisition of CSR by Bright Foods appeared to be an Matthew Layton Partner, Global Head of Corporate T : +44 (0) 20 7006 1229 E :

Roger Denny Partner T : +852 2826 3443 E :

Brian Hoffmann Partner T : +1 212 878 8490 E :

Arndt Stengel Partner T : +49 697 199 1486 E :

M&A analysis of global trends in mergers and acquisitions

Deal certainty, material adverse effect (MAE) and break fees

After the downturn, many commentators anticipated a return of the material adverse effect (MAE) and other transaction conditions in sale and purchase agreements. The prediction has not been borne out in practice. In Germany, for example, our experience is that many sellers continue to reject an MAE provision in favour of deal certainty. In addition, regulation limits the scope of market and business MAE clauses in German public deals. This means that in such situations the MAE must be unambiguous and must not allow for bidder discretion. Similar requirements apply to conditions for public bids in other European Union (EU) member states. Although MAE clauses are almost universal in sale and purchase agreements in the United States, the practical protection afforded by a negotiated MAE clause is often limited, as demonstrated in numerous cases that were litigated before and during the credit crisis. In the absence of language to the contrary, the burden to prove that an MAE has occurred rests with the party seeking to invoke the MAE clause to excuse its performance. Courts have often remarked that the burden is a heavy one. Most recently, the Delaware Chancery Court in Hexion v. Huntsman observed that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement.1 Coming out of the crisis, commentators predicted that lawyers would draft more precise, quantitative MAE and MAE1 2

related clauses, using objective criteria, such as an adverse change in the revenues, EBITDA or liabilities of such businesses or assets in excess of a specified amount, but the inclusion of such objective criteria with respect to MAE is still rare.2 The flip side of MAE and deal certainty is break fees. In the US, break fees continue to be commonplace and currently vary between 2.5 per cent to 4 per cent of the deal value. In a recent Delaware case, 3 the Delaware Chancery Court rejected the plaintiffs argument that, notwithstanding the fact that approximately 40 per cent of the market capitalisation of the target was attributable to cash, the cash on its balance sheet should be excluded (which would increase the percentage of the fee in relation to the transaction value) for purposes of evaluating the reasonableness of the termination fee, as dictated by the Unocal standard. 4 In this case, the deal was valued at $943 million, with the target holding $518 million in cash. Excluding the cash on the balance sheet, the enterprise value of the deal is worth about $425m. The $28.3 million break fee is over 6.5 per cent of the deals enterprise value, but the court instead analyzed it as a 3 per cent break fee. In the US market, we also see the continued use of reverse break fees that are triggered by a failure to secure financing or merger/antitrust clearances, as well as reciprocal breaks for willful breach. The DynCorp Cerberus agreement provides for a particularly high break fee in the event of willful breach. In that transaction, if either party to the agreement willfully breaches the agreement prior to its termination date,

that party shall pay the other $300 million, which equals 20 per cent of the $1.5 billion transaction valuation. In our experience, break fees are used less frequently in other jurisdictions. However, there are exceptions. For example, in Germany, a notable exception is Techem AGs promise of a break fee to a white knight, after Macquarie had made an unsolicited offer. In Asia, we have seen break fees payable by the buyer when it has needed approval for the deal from its own shareholders. For example, in the Prudential AIA Group deal, when the shareholders of Prudential indicated that they did not want to proceed, Prudential was on the hook for 152.3 million in break fees. Similarly, shareholder dissatisfaction with price derailed a $1.6 billion takeover of WuXi Pharma Tech by Charles River Laboratories, triggering a $30 million break fee. In the UK, we see the use of reciprocal break fees in cases in which transaction completion has been subject to shareholder approval or other substantive conditions.

Bridging the gap in valuation

With continuing uncertainty in macroeconomic conditions and a relatively high level of market volatility, valuation remains a significant challenge in M&A deals. There has been an increase in share-forshare transactions in the last year where the issue of valuation multiples can be less material, but, in other scenarios, buyers and sellers have deployed several techniques to bridge the valuation gap. In Germany, as in other markets, parties have looked for innovative ways to bridge the differentials with asset swaps, vendor

3 4

Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 738 C.A. No. 3841-VCL (Del. Ch. Sept. 29, 2008). For some examples of quantitative MAEs, see, e.g., Midamerican Energy Holdings and Constellation Energy (Oct 2008); Allied Waste Industries and Republic Services, Inc. (Dec 2008); Heller & Friedman and Getty Images (Jul 2008); Apollo Global Management and Cedar Fair, L.P. (Dec 2009). In re Cogent, Inc. Shareholder Litigation, Cons. C.A. No. 5780-VCP (Del. Ch. Oct. 5, 2010) Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985) (requiring that the board justify the reasonableness of actions taken in response to a takeover threat).

Clifford Chance LLP, December 2010

M&A analysis of global trends in mergers and acquisitions

loans and contingent value rights. Where possible, buyers in private acquisitions are seeking to be more selective, cherry picking assets and leaving behind difficult-to-value or onerous assets, thereby eliminating the valuation challenges on those assets altogether. The asset carve-out light approach provides one such example. In this case, the buyer acquires, for example, specific intellectual property, R&D, distribution and customers, leaving behind other assets, such as the production site. The seller engages in interim toll manufacturing until the buyers production is fully operational. Of course, such an approach is not always acceptable to a seller! Overall, in U.S. public M&A deals, we still consider share-for-share transactions to be the exception, although they are expected to increase. In the U.S., the use of equity as consideration in public deals of companies in the same industry helps to eliminate disputes over the appropriate multiple. In private transactions, share consideration and vendor financing are used to bridge the valuation gap when outside financers are not prepared to finance a price that the seller will find attractive. In this scenario, the seller provides a portion of the financing by taking stock or debt as partial consideration. Earn-outs are also used as a mechanism to bridge the valuation gap when the seller predicts an increase in profitability but the buyer is wary of economic uncertainty. However, many buyers and sellers alike remain wary of the challenges of earn-outs achieving the desired economic outcome in practice. Milestone payments, or contingent payment rights that enhance consideration if certain milestones are met, or upon the occurrence of certain events, are also used in the U.S and

other markets. The terms of the Celgene Corporation Abraxis BioScience merger agreement, for example, contemplate that each share of Abraxis BioScience common stock will be converted into the right to receive an upfront payment of $58.00 in cash and 0.2617 shares of Celgene common stock. The upfront payment values Abraxis at approximately $2.9 billion. Each share also receives a contingent value right (CVR), entitling its holder to receive payments upon future regulatory milestones. The CVR holders will receive a pro rata share of $250 million cash payment if Abraxane is approved as a treatment for non-small cell lung cancer and $300 million in cash if it is approved to treat pancreatic cancer. If the pancreatic cancer approval comes by 1 April 2013, Celgene will pay another $100 million cash payment. In recent days, CVRs have been suggested by commentators as a way to bridge the valuation gap in Sanofi Aventiss hostile bid for Genzyme.

Minority stakes are also attractive for private equity companies in Asia. Examples of such transactions include CVC Asia Pacifics 35 per cent stake in Chinese printer and packager Hung Hing, and Permiras 20 per cent stake in Macaubased gaming group Galaxy Entertainment. This arrangement is particularly attractive to family-controlled companies that want to take on private equity support without relinquishing control. In Germany, we also see an increased interest in taking a minority stake in German companies. As with familycontrolled companies in Asia, German family-controlled companies are willing to take on minority investors from India and Japan, which, in turn, gain access to resources, technology and know-how from the German companies. KKRs acquisition of a 35 per cent stake in food ingredients business Rudolf Wild GmbH & Co KG provides one such example. We have also seen an increase in private investment in public equity (PIPE) transactions in Germany and other markets, of which Qatar Investment Authoritys stake in Volkswagen and Aabar Investments (Abu Dhabi) stake in Daimler are prominent examples in the automotive industry.

Joint ventures and minority stakes

A joint Clifford Chance/Economic Intelligence Unit survey published earlier this year found that, among Chinese multinational corporations (MNCs) seeking to make acquisitions in the coming years, 47 per cent prefer a joint venture (JV) structure or similar alliance, 18 per cent prefer taking a minority interest, and 27 per cent prefer a majority stake. This finding should not come as a surprise, because MNCs generally choose to enter new markets through JVs. However, in the past, Chinese MNCs have focused on gaining controlling interests. Now it appears that the Chinese are keen on the advantages afforded by a JV, such as attracting less political ire and regulatory attention, and taking advantage of the knowledge of local co-investors. We see the same preference by Japanese and Korean MNCs and MNCs of other Asian countries.

Regulatory challenges
Regulatory risk is high on the agenda for most buyers and sellers. M&A deals are increasingly facing regulatory challenges across jurisdictions from new merger control regimes that have been created in recent years. And more merger control regimes are on the way (e.g., India). Government regulators rejected American International Groups (AIG) proposed $2.2 billion sale of its Taiwan insurance arm, Nan Shan Life, to a Hong Kong consortium comprising Primus Financial Holdings and China Strategic, questioning

Clifford Chance LLP, December 2010

M&A analysis of global trends in mergers and acquisitions

the consortiums ability to raise funds and run the insurer. National Australia Banks proposed $13.3 billion acquisition of AXA Asia Pacific was blocked by regulators on anti-monopoly grounds, and BHPs proposed takeover of Potash Inc. recently failed to secure approval in Canada. Sellers have become so wary of execution risk that, in many cases, we have seen strategic buyers volunteer antitrust analysis and offer to provide undertakings to make necessary divestitures early in the process to address the sellers concerns upfront. Sellers, as a corollary, may discard bidders that they believe will bring material antitrust risk to the transaction. Regulatory changes in other areas are also having an impact on the M&A markets. In the U.S., new legislation, in the form of the so-called Volcker Rule of the Dodd-Frank Act, prohibits bank holding companies and their affiliates from owning interest in or sponsoring hedge or private equity funds by 2012. The application of this provision, in specific instances, could be delayed, but this regulatory development, along with other regulatory changes in the financial institutions group (FIG) sector, are likely to drive M&A activity over the next few years. Financial institutions are therefore reassessing their strategic focus. In a joint Clifford Chance/Finance Asia survey published in October 2010, 77 per

cent of respondents cited protectionism as the most significant concern for buyers in the market. This marks a sizeable leap from 56 per cent of respondents who indicated the same in the prior year. The economic situation and increased protectionist rhetoric in, for example, the U.S., probably contributes to this perception. In the latest round of regulatory action under the Exon-Florio Act, a politicized process has become more politicized with amendments giving Congress a formal oversight role in the approval process. However, government intervention in Germany appears to have waned, highlighting the difference between the European approach and the U.S./Asian approach. Even in cases in which government intervention would be arguably palatable (i.e.,where a national champion, such as Hochtief, finds itself in a hostile situation), the German government continues to adopt a laissezfaire approach. Parties should proactively manage issues which are likely to be raised by politicians and other stakeholders early in the process, even ahead of any public announcement. If this is done, they often achieve their objectives.

continue to do so, and buyers who introduce mechanisms safeguarding transactions to increase the likelihood of deal certainty are more likely to steal a march on other bidders. However, transactions that we have discussed have demonstrated noteworthy variations on this theme, and reveal some of the emerging trends. We anticipate that public M&A in the U.S. will continue to look more like it does in the rest of the world, with a clear shift from a board-dominated playing field to a jump-ball between the board and shareholders. In Europe and elsewhere, M&A parties that show flexibility in the processes that they employ and embrace innovative deal structures are likely to be more successful than those expecting the precrisis standard M&A transaction. Companies in Asia have demonstrated their ability to adapt rapidly to the changing environment. We expect that they will continue to succeed and gain ground globally as M&A activity continues to increase. This article is based on a webinar, Global M&A Trends in M&A transactions, presented by Matthew Layton, Brian Hoffmann, Arndt Stengel and Roger Denny. The webinar can be viewed at newsandevents/webinars.html

The Road Ahead

In many ways, buyers and sellers across the world have responded similarly to pressures brought about by changes in their market and regulatory environments. Sellers have sought deal certainty and will

Clifford Chance LLP, December 2010. Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC323571. Registered office: 10 Upper Bank Street, London, E14 5JJ. We use the word partner to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications.

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