Retail M&A Deals Unravel in the Face of Coronavirus

By: Amarins Laanstra-Corn, Winston Shum, Roshni Padhi (Stanford) and Kritika Venkateswaran, Sreeja Mamillapalli, Aman Singla (NYU)


I. Background

A. M&A Process

The traditional mergers and acquisition process usually follows a standard but intense regimen that, after proper due diligence, aims to leave both parties satisfied. After target lists are compiled and initial contact has been established, both sides will then typically agree to terms of a confidentiality agreement in order to preserve each company's respective financial reputation. After a confidentiality clause has been ratified, the seller will begin to send over its confidential information memorandum (CIM), a composition of documents that outline the company’s history, structure, financial dealings, product description, etc. If the CIM adheres to the buyers’ expectations, an indication of intent (IOI) is sent expressing a range valuation for the selling company and negotiations can begin. More due diligence is conducted in order to assess a proper fit between both companies and to ensure that the seller’s original financial holdings are what they are claimed to be. Once an appropriate price is agreed to by both buyer and seller, a letter of intent (LOI) is put forth expressing the exact terms and conditions for the sale, and a purchase agreement is signed. When the deal is finally closed, the official merging process begins. This can happen one of three ways. The first is a stock purchase; this starts with the buyer purchasing a large or the entire amount of stock from stockholders, effectively assuming ownership while leaving the company whole. The second is through asset acquisition which is when the buyer then acquires the majority or entirety of the seller’s assets, usually purchased through cash or stock. The final potential process is a merger, where the two companies fully integrate with each other in order to form an entirely new entity.

B. MAC Clause

The Material Adverse Change (MAC) clause stipulates that any significant change in circumstance, qualified as one accompanied by a substantial decline in business value, may be used as grounds to avoid previously enforceable obligations. These obligations include closure on any pre-signed merger or acquisition agreement, funding loan conditions, or valuations of parties involved. The MAC clause, if present in a contract and viable, serves to offer the buyer a cushion against risk, as it can effectively be used to back out of any prior transaction under the umbrella of adverse change. Since the onset of COVID-19 in March 2020, MAC clauses have become ever-present in the legal language of mergers and acquisitions. This, however, comes far from surprising given the current volatility of markets and company valuations. As has been seen across sectors, even massive and previously stable corporations have been noted to hemorrhage money since the beginning of this crisis, leaving investors and buyers worried globally. And due to this crisis, the once widely accepted MAC clause has been drumming up controversy as sellers become increasingly more nervous of potential instability and pullouts and buyers view a MAC clause as non-negotiable. This is because the MAC clause offers little protection nor compensation for sellers if invoked and can often serve as a catalyst against the seller’s attractability to other potential buyers.

II. Case Studies

A. LVMH / Tiffany & Co.

The planned $16.2 billion acquisition of American jeweller Tiffany by Parisian conglomerate LVMH Moët Hennessy Louis Vuitton had appeared to be on the rocks because of the economic downturn caused by COVID. The companies had touted their deal when they announced it in November as beneficial to both, strengthening LVMH's luxury jewellery portfolio and providing Tiffany with much-needed resources to achieve its aims for long-term growth.

Many of the trends that made Tiffany an attractive target late last year have turned for now. LVMH planned to grow the jeweller’s footprint in Europe, where it has fewer than 50 boutiques. The French group’s clout with landlords could help Tiffany land prime locations in cities like Paris and Milan, thereby capturing more spending by Chinese tourists. But overseas visitors, who typically generate half of all luxury sales in Europe, are now gone. Aversion to long-haul travel could depress revenue in the region’s upscale stores for years. LVMH also wanted higher exposure to the U.S. luxury market and was confident that it could increase the jeweller’s relatively low sales densities there. This still makes sense, but the Tiffany turnaround is likely to need longer now that the IMF expects the U.S. economy to shrink by 5.9% this year. Even before the pandemic, LVMH’s big U.S. deal wasn’t expected to make a return on investment above its weighted average cost of capital until 2025, according to estimates by RBC analysts at the time of the announcement.

Due to these reasons, Bernard Arnault was reviewing the $16.2 billion offer he made for Tiffany late last year. However, Tiffany was able to stay ahead and persuaded its lenders to increase the leverage ratio at which it would be in breach of its borrowing terms. It can do this under the merger agreement, according to finance chief Mark Erceg. That will make it harder for the French company to cut its current $135-a-share offer; a covenant breach could have helped LVMH to force Tiffany back to the negotiating table. The new terms will be in place until next year—long after the deal must close. Tiffany’s lawyers have left LVMH with little flexibility in the merger agreement. Although there is a $575 million break fee if the jeweller itself decides to walk away, the buyer doesn’t have the same option. There is no specific clause that would allow LVMH to walk away in a pandemic, nor can it use a deterioration in the relationship between the U.S. and China, or any event that affects the luxury industry as a whole, as a reason to break the contract. LVMH did not want to risk litigation issues in the future, which is why it first agreed to continue with the deal although there was a 3-month delay in the proceedings.

However, on Wednesday, September 9th, LVMH announced that it is backing out of the deal because of how the transaction has been dragged into the middle of trade disputes between the United States and France. Specifically, the French government requested LVMH to delay the acquisition until January 6, 2021, which falls more than a month after the stipulated closing date. While LVMH considers this letter from the French foreign ministry to be legally binding, Tiffany disagrees, claiming that “LVMH will seek to use any available means in an attempt to avoid closing the transaction on the agreed terms” and that “there is no basis under French law for the Foreign Affairs Minister to order a company to breach a valid and binding agreement.” This dispute has not been resolved yet and will likely be impacted by the outcome of the Trump administration’s threat to impose French tariffs, but in the meantime, Tiffany’s s