By: Amarins Laanstra-Corn, Winston Shum, Roshni Padhi (Stanford) and Kritika Venkateswaran, Sreeja Mamillapalli, Aman Singla (NYU)
Photo: Arturo Rey (Unsplash)
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 share price has fallen 9.9% as a reaction to the news.
B. Simon Property / Taubman Centers
On February 10th, a month before the coronavirus was declared a pandemic, Simon Property Group, the biggest U.S. mall owner, declared to merge with Taubman for a total of $3.6 billion USD by buying Taubman shares at $52.50, a premium of 51% compared to the previous trading day. The deal was supposed to close on June 30, 2020. Taubman Centers is the owner of 26 high-end malls scattered throughout the US and Asia. Initially, the purpose of buying Taubman was to increase funds from operations for at least 3% through creating new innovative retail environments that compete against online shopping in local communities.
However, the pandemic has created immense stress for mall owners such as Simon Property Group; Simon has recently sued Gap, one of its biggest tenants, for not paying rent at their malls. As such, Simon Property Group has decided to terminate the merger deal with Taubman, stating that Taubman has not cut operating expenses and capital expenditures while relying on Simon to pick up what’s left after the deal closes. In addition, Simon Property Group claimed that the deal specifically outlined the right to terminate the transaction if the pandemic disproportionately affected Taubman. Being a mall owner in densely populated metropolitan areas, Taubman depends on domestic and international travel to survive. The lack of travel along with the trend to move towards online shopping has made the retail real estate industry lose investors, and for Taubman, that means Simon Property Group’s decision to terminate the contract.
On the other hand, Taubman believes that Simon’s decision is invalid and without merit, expecting Simon to be bound to the contract in all aspects. Taubman also stated that they will pursue Simon for legal remedies and monetary damages. In response to this, Simon has filed a legal suit against Taubman for terminating the contract in the Circuit Court of Oakland County, Michigan. The final decision can make a huge impact on Taubman’s financial status. If the court decides that Taubman has experienced a MAC, Taubman shareholders will be out of luck and the company may end up in a lot of debt. On the other hand, if the court decides that Taubman has not experienced a MAC, then Taubman has a choice to either continue pursuing the deal or monetary damages. Analysts expect that this back-and-forth argument will continue, and uncertainty will follow until the court makes a decision. In the meantime, both Simon and Taubman shares have dropped significantly in value, which doesn’t help during a time of crisis.
C. L Brands / Victoria’s Secret / Sycamore Partners
Victoria's Secret has barely been able to keep afloat during the pandemic but has faced struggling sales and brand value even prior to COVID. The popular lingerie and clothing store is under L Brands, an American fashion retailer that also owns Bath & Body Works. In 2019, L Brands saw a loss per share of $1.33 which was primarily attributed to 7% decline in comparable sales at Victoria’s Secret which offset Bath & Body Works’ increase in comparable sales of 10%. In recognizing that such performance could cause a liquidity squeeze, L Brands struck a deal with Sycamore Partners in February where the Private Equity firm would acquire 55% of Victoria's Secret at $525 million. Whilst there were hopes that the Sycamore deal can improve the company's balance sheet, the shutdown of several Victoria's Secret retail stores was counted as a breach of contract by Sycamore resulting in a cancellation of the deal.
Sycamore did not pay a cancellation fee as they stated that the termination of the acquisition was due to L Brands' improper operations of the retail company and that the pandemic is "no defense to (their) breaches of the Transaction Agreement". Although L Brands attempted to countersue to try and close the deal, eventually both sides agreed to simply cancel the acquisition.
The termination of this transaction can result in liquidity risks to shares of L Brands as Victoria's Secret struggles to meet their debt obligations on time. Former CEO of L Brands, Leslie Wexner's remarks of the transaction “bringing a fresh perspective and greater focus to Victoria’s Secret” was to no avail as L Brands continues to take a hit from the worsening pandemic. However, in efforts to keep business running at Victoria's Secret, L Brands plans to cut 15% of its corporate workforce as part of cost-cutting measures.
D. SoftBank / WeWork
In August of 2019, WeWork filed for an IPO; after facing scrutiny from investors and the public regarding profitability and leadership concerns, its valuation fell from $47 billion to as low as $10 billion. In October, its biggest investor SoftBank launched a $3 billion tender offer to hold 80% of the company’s fully diluted shares. WeWork desperately needed the money and agreed to the terms of the proposal.
However, in early April of 2020, SoftBank pulled the offer, citing concerns regarding WeWork’s failure to assume full ownership of a joint venture in China, the impact of COVID-19, and ongoing criminal and civil investigations. After the announcement, SoftBank’s shares closed up 2.5%, indicating positive public sentiment. WeWork did not respond as favorably and instead chose to sue SoftBank on the grounds that SoftBank breached its fiduciary duty to WeWork’s minority shareholders. They argued that “SoftBank has already received most of the benefits provided to it under the [Master Transaction Agreement], including broad control of WeWork and additional economic benefits” and that “SoftBank’s wrongful conduct in failing to consummate the tender offer deprives WeWork’s minority stockholders of the liquidity that they were promised.” The lawsuit also contended that SoftBank secretly undermined WeWork’s planned takeover of a joint venture in China, which was a precondition for the deal. SoftBank countered with the claim that “Nothing in the Special Committee’s filing today credibly refutes SoftBank’s decision to terminate the tender offer” and that “several of the conditions the Special Committee, WeWork, Adam Neumann, SoftBank and SoftBank Vision Fund agreed to last October as requirements for completing the tender were not met as of April 1, 2020.”
The pandemic not only negatively impacted WeWork’s financial health but also played a role in SoftBank’s decision to pull the tender offer. Before the markets were struck, SoftBank expected dozens of its portfolio companies to exit via IPO in the next 18 to 24 months. However, most of those companies are projected to put those plans on hold and turn to SoftBank itself for cash during trying times.
III. Future Outlook
A. Financial Perspectives
Traditionally, a significant percentage of M&A deals are financed through debt, particularly in the private equity space, as it is usually cheaper for the business to issue in comparison with equity. However, recent financial-market volatility resulting from the pandemic induced economic slowdown has generated difficulties for transactions that rely on third-party debt financing as there is uncertainty about the availability and terms. Companies will have to figure out whether the debt financing will actually be available when the time comes to close the acquisition and whether the lenders will increase pricing and insist on stricter financial covenants, increasing the risk of future default. As a result, companies will likely face downward pressures on deal values and turn to a greater focus on equity financing like stock issuance and altering pricing structures.
Buyers likely also have concerns about their ability to properly value another company in this economic landscape. Previous valuations made using comparable transactions will likely be no longer applicable. Given the uncertainty with respect to the duration and severity of COVID-19, companies will need to employ even more careful considerations and judgment as they work through impairment assessments pertaining to assets such as goodwill, PP&E, and equity method investments.
Additionally, there will be an increase in the percentage of transactions involving rescue deals, restructurings, and distressed sellers as opportunistic investors move to targets that have been adversely affected by the pandemic. While the equity and debt markets are likely to begin to stabilize in 2021 and many transactions have been put on hold rather than canceled, some companies might not directly finish those deals. Companies have been forced to redirect the focus and energy of their teams toward the immediate health of their own companies and away from longer-term goals that include pursuing growth through acquisition strategies.
B. Legal Perspectives
There will be significant delays in the deal timelines as there have been several alterations made to the typical M&A procedures. Each stage of a typical transaction, including preliminary negotiations from both parties, the formulation of the letter of intent, an agreement of a definitive acquisition, and the pre-closing period, will likely take longer to accomplish.
To begin with, all negotiations will take a longer period of time as the major players of the deal will be working remotely, resulting in less efficiency than companies are used to. Next, there will be delayed approvals from external sources such as obtaining any necessary antitrust or other regulatory approvals. Specifically, the Department of Justice has asked firms involved in M&A to add at least 30 days to their deal timing agreements.
One of the most dramatically altered portions of the deal agreement is due diligence. Due diligence in connection with ongoing and future M&A transactions will increase in importance, due to substantial disruptions to businesses that may not have previously been accounted for in a target’s financial statements. Companies must re-evaluate material contracts, financial solvency, supply chain, risk management, insurance policies, and employment.
Furthermore, buyers and sellers will likely refrain from sending a traditional letter of intent until the buyer has performed due diligence in relation to the coronavirus. Once the letter of intent negotiation begins, buyers should expect sellers to attempt to include provisions that concern closing conditions, pre-closing covenants, and drop-dead dates. These are unusual provisions for most letters of intent, but during the pandemic, sellers will want to take advantage of any bargaining leverage they have to address risk uncertainty.