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$Page 1: Thomson Reuters & the Florida Bar Business Law Section ... · prototype template (5428278) \screen library_new_final.ppt 2/11/2013 8 …And U.S. Volumes Declined (1) (2) Source: Thomson$
February 14, 2013

Thomson Reuters & the Florida Bar Business Law Section – 31st Annual Federal Securities Institute

Mergers & Acquisitions: Current Issues in Negotiating Public Company Deals

Panelists

Moderator: • Andrew R. Brownstein – Wachtell, Lipton, Rosen & Katz

Panelists: • Audra D. Cohen – Sullivan & Cromwell • Nathaniel L. Doliner – Carlton Fields • Vice Chancellor Sam Glasscock, III – Delaware Court of Chancery • James Head – Morgan Stanley • Robert E. Spatt – Simpson Thacher & Bartlett LLP

2

Overview

• Banker Update on M&A Environment • Negotiating Public Company Deals

– Omnipresent Litigation – Confidentiality Agreements and Standstills after Vulcan – El Paso and Managing Potential Conflicts of Interest – Deal Protections Update – Addressing and Allocating Regulatory and Financing Risks

3

Banker Update on M&A Environment

4

M&A Market Environment

February 2013

Thomson Reuters & the Florida Bar Business Law Section – 31st Annual Federal Securities Institute

prototype template (5428278)\screen library_new_final.ppt 2/11/2013

6

2012 Set Up: All of the Ingredients Were in Place

Record Low Funding Costs

Flush Corporate Balance Sheets

Volatility Dampened

Stocks at Record Highs

Europe On the Mend

Financial System Functioning


7

2,533

3,385

3,987

1,764

2,281 2,301 2,190

2,481

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2005 2006 2007 2008 2009 2010 2011 20120

150

300

450

600

750

900

1,050

1,200

1,350

1,500

…Yet 2012 Global M&A Volumes Were Flat (1) (2)

Worldwide M&A Dollar Volume ($Bn)

Source: Thomson Reuters as of January 7, 2013 (1) Includes announced transactions, each with an aggregate value of $100MM or more. Includes transactions with estimated values.

Excludes terminated transactions. Future terminations of pending transactions will reduce totals shown (2) Includes transactions announced as of December 31, 2012

Average Worldwide Dollar Volume 2005 – 2012: $2,615

S&P 500 Average

S&P 500 Average


8

…And U.S. Volumes Declined (1) (2)

Source: Thomson Reuters as of January 7, 2013 (1) Includes announced transactions, each with an aggregate value of $100MM or more. Includes transactions with estimated values.

Excludes terminated transactions. Future terminations of pending transactions will reduce totals shown (2) Includes transactions announced as of December 31 2012

1,010 7447697208731,4521,443

1,095

0

1,000

2,000

2005 2006 2007 2008 2009 2010 2011 2012

U.S. M&A Dollar Volume ($Bn)

2005 – 2012 Average: $1,013Bn

599931 1,240 1,654

932 502 616723

0700

1,4002,100

2005 2006 2007 2008 2009 2010 2011 2012

Europe M&A Dollar Volume ($Bn)

2005 – 2012 Average: $900Bn

692 723897542675

882702507

0

600

1,200

2005 2006 2007 2008 2009 2010 2011 2012

Rest of the World M&A Dollar Volume ($Bn) 2005 – 2012 Average: $703Bn


9

What Is Impeding Growth in the M&A Market?

• Slow economic recovery

• Valuation gap exists for the most attractive assets

• Investors have a seat at the table….

• …and so do regulators

• Mega deals were on the sidelines


10

Consumer Confidence (1)

Macro Indicators

Unemployment Rate (1)

(%)

U.S. Real GDP Growth

(%)

1.81.52.02.4

(0.1)(1.0)0.01.02.03.04.0

2009 2010 2011 2012 2013E

CEO Confidence (1)

Sources: Morgan Stanley Research, Bloomberg (1) Average of beginning and end of year

8.08.39.19.7

8.4

0.0

3.0

6.0

9.0

12.0

2009 2010 2011 2012 2013E

71.472.273.566.3

0.020.040.060.080.0

100.0

2009 2010 2011 2012

5.15.75.3

3.2

0.0

2.0

4.0

6.0

8.0

2009 2010 2011 2012


11

Market Valuations: Is There a Value Gap? S&P 500 P/E Multiples

Market Valuations Seem Reasonable on the Surface S&P FY+1 P/E Multiple

Source: CapIQ

…But the Top Quartiles Are Still Expensive S&P FY+1 P/E Multiple

8.0

12.0

16.0

20.0

24.0

Jan-05 Oct-06 Aug-08 Jun-10 Dec-12

(x)

S&P 500 Index

(x)

21.3

15.4

13.1

9.5

0.0

5.0

10.0

15.0

20.0

25.0

Middle of4th Quartile

Middle of3rd Quartile

Middle of2nd Quartile

Middle of1st Quartile

Median: 16.6x

2005 – 2012 Average: 14.9x

14.1x


12

What to Do With All of the Cash?

Corporates Have Been Accumulating Excess Cash December 2005 – December 2012

$1.1$1.2 $1.2 $1.2

$1.3

$1.6$1.5

$1.0

0.8

1.1

1.4

1.7

2005 2006 2007 2008 2009 2010 2011 201210.0

12.0

14.0

16.0($Tn)

Cash / Revenue (%)

Cash / Revenue Aggregate Cash Balance S&P 500

Source: FactSet

Buybacks Regular Dividends

Special Dividends Tactical / Financial Strategic /

Transformational

Investor Lens: Framework for Capital Deployment

Return of Capital Mergers and Acquisitions


13

Lackluster Mega Deal Activity in 2012 (1)(2)

328 348 371

155

351

87

0100200300400

2007 2008 2009 2010 2011 2012

U.S. M&A Dollar Volume - $10Bn + Transactions ($Bn)

Total

Sponsors

14 13 13 7 15 6

5 – – – – –

Source: Thomson Reuters as of January 7, 2013 (1) Includes announced transactions, each with an aggregate value of $10 billion or more. Includes transactions with estimated

values. Excludes terminated transactions. Future terminations of pending transactions will reduce totals shown. Seven largest transactions are detailed for most recent years

(2) Includes transactions announced as of December 31, 2012

Target / Acquiror (2011) ($Bn)

AbbVie / Shareholders 66

El Paso / Kinder Morgan 36

Medco Health / Express Scripts 34

Kraft Foods-NA / Shareholders 32

Progress Energy / Duke Energy 26

ConocoPhillips / Shareholder 22

Synthes / Johnson & Johnson 21

Target / Acquiror (2012) ($Bn)

Sprint Nextel / Softbank 20

Plains Exploration / Freeport-McMoRan 17

Archstone Enterprise / Investor Group 16

Pfizer Nutrition / Nestle 12

Archstone-Smith [26.5%] / Barclays 12

NYSE Euronext / ICE 10


14

Who Has a Seat at the M&A Table?

Regulators / Government Entities Investors


15

4th Quarter 2012 Showed Signs of Life

494

583541

0

100

200

300

400

500

600

700

800

2010 2011 2012

Quarterly Average Global M&A Volumes 1st - 3rd Quarters

4th Quarter Global M&A Volumes

Source: Thomson Reuters as of January 7, 2013

707

550

657

0

100

200

300

400

500

600

700

800

2010 2011 2012


16

M&A Environment: Key Themes for 2013

Continued Strategic Activity in the Context of Economic Uncertainty

Cross-Border Transactions Driving Volume

High Expectations for Financial Sponsor Activity

Shareholder Activism a Growth Market

Corporate Restructurings Continue (Spin offs, Split offs)


17

Continued Strategic Activity Despite Economic Uncertainty

Strategic Expansion Despite Economic Uncertainty

Consolidation Moves

Bets on Europe

• Markets remain focused on outcome of European debt crisis • Some taking the view that Europe is currently inexpensive, oversold

• Consolidation “required” given lower growth environment • Investors capitalizing announced synergies in logical transactions

Examples Market Themes

• Strategic deals continue, despite economic uncertainty • Relatively inexpensive capital available, in size • Shareholders rewarding acquirors for strategic activity that has sound,

industrial logic


18

Cross-Border Transactions Driving Volume

• Cross-border transactions accounted for 25% of 2012 global volume,

40% of Morgan Stanley 2012 volume (1)

− Most active sectors: Industrials, Healthcare, Energy

• Emerging markets a key growth area

• Currency differentials creating opportunities

• Return of Japanese buyers

• Use of foreign earnings encourages U.S. companies’ cross-border

acquisitions

Examples Themes

(1) Thomson Reuters as of December 31, 2012


19

Corporate Restructurings Continue (Spin offs, Split offs)

(1) Tyco split into three independent companies

• A number of large corporate separation transactions were announced and executed in 2011 and 2012 − Separation

announcements have generally been well received by the capital markets

• Separation activity driven by: − Industrial logic − Low return environment

and correlation of investment returns

− Activism / external stimuli to separate

Parent Announce Date SpinCo

SpinCo Revenue

% of Total

2 Week Relative Price Reaction

(%) Dec-12 Security Technologies ~14 –

Aug-12 Government Technical Services / IT Business ~36 2

Aug-12 Starz ~53 1

Aug-12 Dairy / Organics ~16 28

Jun-12 Publishing ~26 (2)

Jan-12 Coffee and Tea ~41 (1)

Oct-11 Diversified Pharmaceuticals ~44 (3)

Sep-11 ADT N.A. Residential / Flow Control / Comm. Fire & Security (1)

~19 ~21 ~60

2

Sep-11 McGraw-Hill Education ~38 11

Aug-11 N.A. Grocery ~33 8

Jul-11 Refining and Marketing ~73 (1)

Jan-11 Marathon Petroleum ~83 9


20

High Expectations for Financial Sponsor Activity

Examples Market Themes • Leveraged loan / HY bond market wide open, in size • Sponsors have significant equity capital to deploy • Sponsors paying full value for high quality assets

− Selective engagement not willing to stretch for marginal assets

• Enormous portfolio of sale candidates creating a significant M&A pipeline

Sponsor Deal Volume # of Deals

574

333

193

317359 383

24

0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013 YTD

Source: Thomson Reuters as of February 6, 2013


21

Shareholder Activism A Growth Market

Examples Market Themes • Low return environment ideal for activists

• Majority of activity in the U.S., but expected to increase worldwide

• No target immune / too big for activist campaign

Activist Campaigns (1)

# of Campaigns

607080

90100110120

130140150

Dec-10

Jan-1

1

Feb-11

Mar-11

Apr-11

May-11

Jun-1

1Ju

l-11

Aug-11

Sep-11

Oct-11

Nov-11

Dec-11

Jan-1

2

Feb-12

Mar-12

Apr-12

May-12

Jun-1

2Ju

l-12

Aug-12

Sep-12

Oct-12

Nov-12

Dec-12

Source: SharkRepellent (1) Defined as all publicly disclosed activism excluding 13D filers with no publicly disclosed activism and targets with a

market capitalization less than $1Bn


22

Takeaways

• “Green shoots” in M&A market

• Corporates can’t sit still in a low return environment

• Sponsors testing new limits

• Activism here to stay

• M&A practitioners must evolve

Negotiating Public Company Deals

23

Omnipresent Litigation

• In 2011, there were shareholder lawsuits filed in response to 96% of U.S. public company deals valued over $500 million, with an average of 6.2 filed per deal, compared to 53% of deals and 2.8 lawsuits per deal in 2007*

• Delaware courts encouraging post-closing damages (Southern Peru; Tokio Marine; El Paso)

• Exculpation applies generally for independent directors, but reputational concerns matter

• Delaware courts articulate high expectations of process • Are target directors becoming skittish? • Impact on buyer activities?

24

*Source: Robert M. Daines and Olga Koumrian (Cornerstone Research), Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions, March 2012 Update

Martin Marietta v. Vulcan: Key Provisions of CAs • Use Restriction: Under the NDA, “[e]ach party … shall use the other party’s Evaluation

Material solely for the purpose of evaluating a Transaction.” A “Transaction” is defined as “a possible business combination transaction [] between [Martin Marietta] and [Vulcan] or one of their respective subsidiaries”

• Use Restriction: The JDA required that “Confidential Materials” be used “solely for purposes of pursuing and completing the Transaction.” The “Transaction” was defined as “a potential transaction being discussed by Vulcan and Martin Marietta…”

• Neither the NDA or the JDA included an explicit “standstill” provision • “Notice and Vetting” Provision: NDA and JDA contained similar provisions requiring a

party legally compelled to disclose confidential information through oral questions, interrogatories, requests for information or documents in legal proceedings, subpoena, civil investigative demand or other similar process to (1) provide prompt notice of disclosure demand to the other party, (2) limit disclosure only to information which the disclosing party’s counsel determined was legally necessary to satisfy the external demand, and (3) use best efforts to obtain confidential treatment of disclosed information

25

Martin Marietta v. Vulcan: Key Court Determinations

• Neither the exchange offer nor the proxy contest falls under the “Transaction” definitions in the CAs, so Martin Marietta breached the CAs by using confidential material in furtherance of them

• Martin Marietta’s S-4, “which spilled ten single-spaced pages worth of the parties’

negotiating history that was” Transaction Information, was not filed in response to a legal proceeding as contemplated under the NDA, so Martin Marietta breached its non-disclosure obligations under the NDA; it also violated the Notice and Vetting Process

• Martin Marietta breached its non-disclosure obligations through communications with investors and the press

• Chancellor Strine enjoined Martin Marietta from participating in any proxy contest or exchange offer for a period of four months, effectively terminating its hostile bid for Vulcan

26

Martin Marietta v. Vulcan: Implications • Delaware will enforce contracts, even if it means blocking a deal from being taken

to shareholders – A hostile bid is not a license to breach agreements – RAA Management v. Savage Sports- Delaware Supreme Court applies non-

reliance and waiver provisions in NDA even where potential seller made misrepresentations during the due diligence process

• A CA is not a standstill, even if it can halt a hostile bid – Relying on disclosure/use provisions requires target to prove breach – Scope of the judicial remedy is also an issue

• What if Martin Marietta v. Vulcan were a fiduciary duty case? • Practice tips:

– Diligence should be thoughtful and tailored – Control access to confidential data? – Definition of Transaction – “Legally required” exception – Interaction of bargained standstill provisions and confidentiality terms

27

El Paso: Managing Potential Financial Advisor Conflicts Background:

• In May 2011 El Paso announced the spin-off of its E&P business. • After non-public approach and negotiations, El Paso and Kinder Morgan reached an agreement in principle for a

sale of El Paso in September 2011 • Board appointed CEO to negotiate deal, but Court found CEO to be conflicted because of his interest in participating

in a PE-backed MBO of the E&P business following the transaction • Kinder Morgan backed off from the initially agreed price based on new financial projections for El Paso. El Paso

agrees to price reduction • Agreement for acquisition of company by Kinder Morgan for $21.1 billion signed in October 2011 (48% premium at

time of opinion) Factual Focus of Court regarding Financial Advisors:

28

Goldman Sachs: Morgan Stanley:

• Owned 19% of Kinder Morgan ($4 billion) • Brought in to deal with Goldman Sachs conflict

• Controlled 2 Kinder Morgan board seats • Goldman Sachs had exclusivity on spin-off, so Morgan Stanley fee was either:

• Lead banker did not disclose $340,000 ownership of Kinder Morgan stock

− Approve deal with Kinder Morgan and receive $35 million; or

• Goldman Sachs continued to advise on spin-off transaction

− Counsel Board to do spin-off or other option and receive “zilch, nada, zero”

Outcome: • Stockholders sued for preliminary injunction which would allow El Paso to continue shopping any

and all of itself, terminate transaction without breakup fee, or accept deal until injunction expired • Chancellor Strine found “plaintiffs have a probability of showing that more faithful, unconflicted

parties could have secured a better price from Kinder Morgan,” but denied injunction because no other bid on table and El Paso stockholders would have opportunity to vote on merger

• Case allowed to proceed to trial against the directors, management, Goldman Sachs and Kinder Morgan, but the Court noted:

– It would be difficult to establish liability for Goldman Sachs and Kinder Morgan on the basis that they “knowingly” aided and abetted breach of fiduciary duties by El Paso directors

– Independent directors would likely be exculpated under Delaware law • No overbid appears • Shareholders overwhelmingly approve the deal (75% of outstanding shares) • Settlement terms

– $110 million from Kinder Morgan • $26 million in legal fees to plaintiffs’ attorneys

– Goldman Sachs waived requested $20 million merger fee

29

El Paso: Managing Potential Financial Advisor Conflicts (cont’d)

• What information should a board seek in selecting and engaging its financial advisor to identify conflicts?

– Other client relationships? How determined? – Firm investment positions? – Individuals?

• Does the El Paso decision impact a board’s ability to agree to – Exclusive engagements? – Contingency fees? – Tie-in arrangements for additional work?

• What steps should a board take if a potential conflict exists or arises? – Engage a second financial advisor

• When? What should the role be of the second financial advisor? What, if anything, changes in the role of the original financial advisor?

– How should the second advisor’s compensation be structured? – Should the original financial advisor still deliver a fairness opinion?

• Transatlantic Holdings: Chancellor Strine criticized the decision not to have the banker running the sales process also deliver a fairness opinion for the deal

30

El Paso: Managing Potential Financial Advisor Conflicts (cont’d)

Deal Protection Update: Fiduciary Exception to Target Board Recommendation Covenant

31

Source: 2012 Strategic Buyer/Public Target Mergers & Acquisitions Deal Points Study (For Transactions Announced in 2011), Mergers & Acquisitions Market Trends Subcommittee, Mergers & Acquisitions Committee of the American Bar Association Business Law Section

“. . . withdrawal or modification of . . . recommendation is required in order for the board to comply with fiduciary duties . . . .”

“[N]othing . . . will prohibit the board from taking any action necessary to comply with fiduciary duties . . . .”

Intervening Event: “Unforeseen material development or change in circumstances . . . and board determines in good faith that, in light of such event, the withdrawal or modification of . . . recommendation is required to comply with fiduciary duties . . . .”

Superior Offer: “Unsolicited, bona fide written offer . . . For more than [x]% of shares. . . that board determines in good faith (based upon a written opinion of an independent financial advisor of nationally recognized reputation) . . . constitutes a superior offer . . . and is reasonably capable of being completed on the terms proposed.”

* Substantially all of the deals in which the fiduciary exception was limited to a Superior Offer and/or an Intervening Event also included an additional provision generally requiring the target board to also determine that, in light of such Superior Proposal or Intervening Event, change of its recommendation was triggered by a fiduciary obligation.

Deal Protection Update: OPENLANE continues erosion of Omnicare Background

• Thinly-traded company; management owned 68.5% of stock • Limited auction for company- three strategic buyers contacted for sale; no financial buyers

– Board-run auction: No financial advisor/No fairness opinion • After extensive negotiations with two of the three bidders, board accepted highest offer

– No express voting agreement, but a majority of shareholders executed written consents approving merger the next day

Holdings • Rejecting shareholder challenges, Vice Chancellor Noble reaffirmed Delaware’s

longstanding refusal to impose a mandatory checklist of merger features – Although the auction process was not a “model to be followed,” Vice Chancellor Noble

emphasized company’s small size and board’s “impeccable knowledge” of the business as justification for not running an extensive auction or seeking fairness opinion

– Substantial share ownership by management aligned incentives in favor of seeking best value

• Although management owned a majority of the company, making approval of deal a “virtual certainty,” Vice Chancellor Noble distinguished Omnicare on grounds that there was no express lock-up agreement between buyer and management

32

Deal Protection Update: Situation-Specific Approaches to Deal Protections • Compellent: In December 2011, Vice Chancellor Laster issued critique of what he classified as

especially “buyer-friendly” deal protections: – 3.95% termination fee and expense reimbursement with broad triggers – Adoption of poison pill exempting acquirer – No-shop with broad scope/narrow fiduciary outs – Notice terms that potentially prevented board from immediately fulfilling known fiduciary duties

• Micromet: In February 2012, Vice Chancellor Parsons refused to enjoin negotiated tender offer

with provisions similar to Compellent, emphasizing importance of majority-independent board, robust pre-signing market check, and deal consideration at significant premium over the pre-announcement value

– Deal protections found to be “relatively standard,” including: • 3.4% termination fee • Exemption of acquirer from existing poison pill • No shop

– Adverse recommendation provision with last-step fiduciary determination

• Comverge: Vice Chancellor Parsons refused to enjoin distressed acquisition even though variable termination fee could be as high as 6.8% of equity value

33

Deal Protection Update: “Don’t Ask, Don’t Waive” Standstills- The “Emerging Issue of December 2012”

• Two earlier cases, In re RehabCare (Vice Chancellor Laster, Sept. 2011) and In re Celera (Vice Chancellor Parsons, Mar. 2012), questioned the validity of DADW provisions because they might prevent board from fulfilling duty to be adequately informed

• In re Complete Genomics (Nov. 2012): Vice Chancellor Laster suggests that such

agreements are impermissible because they could create an informational vacuum and result in the Board being willfully ignorant of a potential high bid

– DADW provisions have “the same disabling effect as [a] no-talk clause, although on a bidder-specific basis.” (Phelps Dodge/Capital Re)

• In re Ancestry.com (Dec. 2012): Chancellor Strine cautions that DADW provisions

are not per se invalid and may have a proper and beneficial use as “auction gavel” – Suggestion that “potent” nature of DADW provisions may require additional

disclosures

34

Deal Protection Planning Guides • Deal protections should be viewed

– as an entirety, rather than individually – in the context of the transaction history – in the context of the negotiation history

• The most sensitive issues arise – where there is a conflict or appearance of conflict – where that record does not reflect an engaged, well-informed board – where there is a disgruntled competitor

• Omnicare continues to impede transactions with controlled companies and more workarounds can be expected

• Although the market for corporate control is robust, courts articulate high

standards for fiduciaries and transaction professionals – Process deficiencies will not be absolved by shareholder approval or

absence of an overbid

35

• Provisions dealing with regulatory risk can be viewed as a spectrum from buyer-favorable to seller-favorable:

• no obligations to make any divestitures, etc. • take “reasonable best efforts,” but no obligation to make any divestitures, etc. if result in any material

adverse impact on seller or buyer or on benefits of deal to buyer • … if would require divestiture in excess of [negotiated numeric $ impact / lost revenue, etc.]

AT&T/Deutsche Telekom • … if result in MAE on seller [or buyer]

Express Scripts/Medco Health Google/Motorola Mobility

• … if result in MAE on combined pro forma entity NYSE Euronext/Deutsche Börse

• reverse break fee paid by buyer to seller if deal fails due to antitrust conditions not satisfied (antitrust injunction or drop-dead date due to failure of antitrust clearance), and other conditions satisfied; covenant usually relatively light; size of fee negotiated NYSE/ICE (9%) Google/Motorola Mobility (20%) AT&T/Deutsche Telekom (7.7% including cash and ~15% in assets) Grupo Modelo/Anheuser-Busch InBev (3.2%) Review of 41 public deal antitrust break fees since 1/1/08 shows approx. 5-6% of equity value

mean fee • “hell or high water” covenant

Kinder Morgan/El Paso • The above covenants need to be viewed in connection with the covenants relating to

the nature of cooperation and, increasingly, reverse termination fees

Buyer favorable

Seller favorable

Dealing with Regulatory Risk

36

Addressing Financing Risk

37

Pre-Crisis Current Environment Strategic Deals

Typically no financing condition “Pure option” uncommon (Mars/Wrigley)

Typically no financing condition (Phillips-Van Heusen/Warnaco)

Financing condition in some (but rare) (Reynolds/Graham Packaging)

Specific performance sometimes limited to non-financing failure to close (“financing failure” structure) (El Paso/Kinder Morgan, Alpha Natural Resources/Massey Energy)

Some PE-style break fees for financing failures in strategic deals (CB&I/Shaw; Rail America/Genesee)

Private Equity Deals

Significant optionality for buyers; right to abandon upon payment of reverse break fee (Bain, THL/Clear Channel, URI/Cerberus, ADS/Blackstone, KKR, GS Capital Partners/Harman)

Most common is “financing failure” structure, fees increasing (Carlyle, Hellman & Friedman/PPDI; KCI/Apax)

“Pure option” less common (Tianfu Yang, Abax/Harbin Electric)

“Full equity financing” limited to smaller deals (ResCare/Onex)

Documents

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