The Impact of The Covid-19 Crisis on U.S. M&A Deals

By Dylan Litt, Kyle Amelio, and Michael Lipsky (New York University), Charlie Solnik (CalPoly), Mihir Gupta (University College of London)

 

The rapid spread of COVID-19 has roiled capital markets and clouded the global economic outlook. In order to prepare for an uncertain future, many companies have cut capital spending and furloughed non-essential employees in an effort to preserve liquidity. As a result, potential and agreed upon M&A deals have been called into question as companies prepare for extended closures and significant reductions in revenues. Here’s our take on some of the most important M&A activity that has been impacted.



1. Xerox's Hostile Takeover of Hewlett Packard


At the beginning of November 2019, Xerox began pursuing a hostile takeover of Hewlett-Packard (HP) with the backing of activist investor Carl Icahn, a shareholder of both companies. Even prior to the recent selloff, it seemed like a case of the minnow swallowing the whale due to HP’s much larger size. HP’s market cap is currently more than five times the size of Xerox’s. To overcome the difference in size Xerox was planning on executing a leveraged buyout. They were going to fund their purchase by borrowing heavily against HP and taking advantage of the low long-term debt levels HP had maintained.

After several rejections by HP’s board, the value of the tender offer rose to a peak of $35 billion. The deal was set to be funded by both debt and the issuance of Xerox’s own stock. However, the recent stock market turmoil reduced Xerox’s market cap by over 50%, reducing the overall value of  the deal by about $4 billion. While Xerox believed the merger would be beneficial to both companies (estimating a cost savings of over $2 billion), HP leadership disagreed with those estimations. They felt they were overly optimistic and announced a plan to return $15 billion to shareholders through stock buybacks to dissuade them from supporting the merger.

Carl Icahn disagreed and voiced support for the deal several times throughout the process. He even went as far as to say that “the combination of HP and Xerox is one of the most obvious no-brainers I have ever encountered in my career.” It was a powerful rebuke to the statements that had been coming out of the HP board room as they repeatedly tried to fend off the takeover. However, his support for the deal was instead used as ammunition by HP. Icahn owns a far larger percentage of Xerox as compared to HP, causing the latter’s board to point out that he would benefit far more if HP were purchased at a price below it’s actual worth. That was just one of many criticisms that kept Icahn from getting his “no-brainer” deal completed.

HP also disagreed that the combined company would be able to operate as well as they were able to separately. While the deal would have brought together two of the largest players in the printer and copier industry, HP doubted Xerox’s ability to properly manage the PC, 3D printing, and digital manufacturing businesses. The HP board also criticized the “irresponsible capital structure” which would result from Xerox’s need to borrow so heavily to complete the deal.

Any hope for a deal fell away earlier this week when Xerox announced that in light of the “macroeconomic and market turmoil caused by COVID-19,” they would be pulling their bid to acquire the much larger company. Reflecting the contentious nature of the acquisition attempt, Xerox did not miss the opportunity to take a swipe at HP’s board in their statement, saying they did “a great disservice to HP stockholders” by refusing to engage. Despite those remarks, the failure of the merger more likely stemmed from questions as to whether Xerox would be able to secure the $24 billion in financing at favorable rates as investment grade corporate bond yields have risen nearly 50% since the beginning of March. Those higher interest rates would have eaten into the value generated by the synergies and made the deal less beneficial for both companies. Despite deteriorating conditions, it wasn’t until last week that the merger was officially taken off the table.



2. Simon Property Group's acquisition of Taubman Centers

Simon Property Group’s (SPG) long sought acquisition of Taubman Centers (TCO) looks likely to go through as planned, despite the street discounting Taubman to 20% below the takeout price. On February 10th 2020 American Mall REIT giant Simon announced they would be acquiring an 80% stake in Taubman, their much smaller rival. Simon had been pursuing Taubman’s portfolio of high end malls since they fought off a hostile takeover bid from Simon and Westfield in 2003. For decades industry experts have said that a combination of the two REITs would create long term value for investors. Numerous attempts have been made by shareholders to get Taubman to sell itself, but the Taubman family has been able to keep control of their business. 

The terms of the acquisition make it highly unlikely that Simon would be able to exit through the deal’s “Material adverse effects” clause. The clause, intended to protect from adverse shocks, can only be triggered if Simon can prove in court that the Covid-19 pandemic had a “disproportionate impact” on the target company relative to its peers. A higher bar than a “force majeure” clause, which was not included in the terms, that would allow an exit for any unforeseeable circumstances. In response to the pandemic Taubman and Simon closed their malls within a day of each other as well the other mall REITs across the nation. Not only has Taubman been impacted to a similar degree as the rest of America’s mall REITs, with their malls in China already reopened, they seem set to slightly outperform their peers in the crisis. 

The deal will put disproportionate pressure on Simon property during this difficult time for retailers and the malls they occupy. Mizuho managing director St. Juste said “I think a lot of investors wish they would [pull out]... not only the fact that [the market’s] down, but retailers have an additional challenge here, and they’re adding the weight of acquiring a portfolio in the middle of all this.” Earlier in February Simon joined a consortium of investors in a bailout acquisition of the retailer Forever 21, looking to protect themselves from the loss of a major tenant, which under the current circumstances serves as an additional liability. 

Industry professionals are confident that the deal will go through and Taubman’s prime portfolio will create long-term value for Simon shareholders, as long as the mall industry recovers from the Covid-19 pandemic. With debt capital already secured, the path for Simon to exit seems impossible. Alexander Goldfarb, managing director and senior research analyst at Piper Sandler, said “It is a deal that gets [Simon] 10 of the best malls in the country… there’s no out mechanism for Simon, so that would be some pretty intense litigation.” Given Taubman and Simon's history of aggressive litigation, a prolonged court battle is the only risk to a deal. Mizuho’s St. Juste said “The merger agreement seems fairly iron-clad.” Projecting a similar level of confidence as SunTrust analysts. Who said in a note that the decline in Taubman’s stock was “suggesting some concern” about the deal closure, but ultimately they said it was highly likely to go through.

Taubman’s 20% decline in share price represents the indiscriminate selloff in industries with the most exposure to the pandemic. With incredible speed and vigor investors dumped shares in mall REITs sending the index down 65% from its peak. Many investors sold shares to reduce mall exposure, but Taubman’s relatively small decline shows that investors view the stock as a safer place to hold their capital than the overall mall sector with a deal set to