Speed is a Key Component of Successfully Executing a Stock-for-Stock Merger

The general notion among M&A practitioners is that time kills deals. That is even more the case in public deals and even more so in a stock-for-stock deal. To be sure, for each day the deal is not signed, the risk grows that some event occurs that swings the buyer’s or the target’s stock, throwing off valuations and making the deal now impossible to reach a signing.

The most effective antidote to this risk: speed. The faster you get to signing and announcement, the less opportunity for uncontrollable and unpredictable events to throw a wrench into the deal. That said, speed for the sake of speed should not be the goal. The benefits of speed must be balanced with those of allowing sufficient time to conduct a full due diligence process, negotiate key deal terms, and prepare the all-important announcement roll-out. Striking the right balance can be difficult. But there are – as discussed further below – certain avenues you can take to best position yourself to do so, including conducting significant work before engaging with the other side, being fully prepared and structuring your teams appropriately.

Unpredictable Stock Price

Although there are many unknowns and things outside your control in a public deal, the biggest (and most material) is that you will never be able to predict how the stock price of the target and the buyer will trade at any given time. Indeed, there may be an agreement in principle on the price per share to acquire the target (or on the range within which a final price will be agreed) and the number of shares to be issued by the buyer as consideration in the deal (i.e., the exchange ratio), but changes in the stock price of either company can undermine that agreement.

If the target’s stock trades higher, that increase could make the price offered by the buyer no longer attractive, and even if not, could incentivize the target to try to renegotiate for a higher price. On the flip side, if the target’s stock trades lower, the buyer could view itself as now overpaying, and could seek to lower its offer price or terminate discussions. The same can be said for movement in the buyer’s stock. If the buyer’s stock trades up, the shares it is offering to the target’s shareholders are now more valuable. As a result, the buyer may seek to adjust the exchange ratio to lower the number of shares it is issuing for each target share. Similarly, if the buyer’s stock price goes down, what it is offering the target’s shareholders is now less valuable. This could lead to the target seeking to adjust the exchange ratio to increase the number of shares being issued by the buyer.

Stock price movements can be particularly fatal if the buyer’s and target’s stock diverge. Indeed, many a stock-for-stock deal has gone off track when the target’s stock price goes up at the same time the buyer’s stock price decreases, as the prior agreed economics no longer make sense, even if the fundamentals of the deal still do. The same is true for the inverse, where the buyer’s stock goes up and the target’s stock goes down.

During the course of negotiations prior to deal signing, there are a few events to be on the lookout for that can create movement in stock prices and problems for the deal, including:

• Quarterly Earnings Reports. Shortly after the end of each fiscal quarter, public companies release their quarterly earnings report detailing their financial performance for the prior quarter. These releases can result in significant trading in company shares, as traders, hedge funds and other market participants react to the new data, many times resulting in significant price swings. Trading can be particularly significant if prior company guidance is missed or surpassed.

• Industry Sector Swings / Macroeconomic Factors. Industry sector volatility can create issues for deals, particularly where the buyer and the target are in different sectors. One company’s stock can move significantly, while the stock of the other company either stays flat or goes in another direction. Certain sectors – e.g., energy, commodities and financial – experience much more volatility than others, and so deals in these sectors are at a greater risk of this divergence. In addition, macroeconomic conditions and geopolitical events can cause sectors to move in unpredictable ways. For example, oil and gas stocks increased dramatically shortly after the Russian invasion of Ukraine, as economic sanctions issued by Western countries limited the supply of oil from Russia.

• Leaks. Leaks are particularly problematic for a stock-for-stock deal. For the buyer, if its stock price goes down in response to a leak, not only does this create a value issue (i.e., the consideration offered is now less valuable), but it could also be seen as a vote of no confidence in the deal by the buyer’s stockholders. Where the buyer requires stockholder approval for the deal, a decline such as this also adds further closing risk.
  
  
  On the target side, if its stock price decreases after a leak occurs, that is likely an indication that the market does not like the deal and that obtaining stockholder approval may prove more difficult than expected. It also creates a value issue, as the buyer may now view itself as overpaying at the prior agreed economics. If, however, the market reaction is positive, then the target’s stock could pop after a leak, which again can throw prior valuations off, particularly if the stock trades above the intended deal price.
  
  
  Another problem created by a leak is that the buyer and target lose control of the narrative. Successful execution of the “story of the deal” is one of the most important things to get right in a stock-for-stock deal. When signing occurs without a leak, the parties get to tell the story on their own terms and create the narrative they believe best to lead to a successful transaction. But when a leak occurs, the parties’ ability to control the story is undermined and the market is generally left on its own – at least in the first instance – to interpret the deal.
  
  
  A leak may also draw attention from activist investors, who could then take a position in the buyer’s or target’s stock and attempt to influence the transaction. Additionally, a leak may lead to a competing bidder. Not only do these dynamics typically create substantial movement in the stock of one of the parties (if not both), they also increase the difficulty in executing a successful transaction.

• Competition Risk. If the market views the target as a company that ultimately needs to be acquired to survive in the long run or if the target is a smaller company in a sector that is experiencing consolidation, there’s a good chance more than one buyer is contemplating an acquisition of the target. Indeed, in each of these cases, buyers (and their bankers) will typically see it as an opportunity to pursue the target. Additionally, larger companies in a consolidating sector at times feel pressured to grow larger through acquisitions to ensure that they will have sufficient scale, once consolidation ends, to stay competitive with their rivals who have been growing through acquisitions during the consolidation (e.g., to avoid the predicament Anheuser-Busch found itself in after it stayed on the sidelines during the beer industry consolidation of the 2000s). In general, these market dynamics can make it more expensive for a buyer to acquire the target because it increases the risk that another potential buyer emerges, resulting in competition.

Striking the Right Balance

Reaching a signing on an accelerated basis allows you to minimize the opportunity for these unpredictable and uncontrollable events to arise and thereby create issues for your deal. But speed must be balanced with other important aspects of the transaction, many of which require sufficient time to be completed successfully. Below are a few ways to best position yourself to strike the right balance between speed and a thoughtful process.

• Do everything you possibly can before you engage with the other side. For a buyer, it should do all the analysis and due diligence it can before it approaches the target. As the target is publicly listed, it is required to file extensive amounts of information under securities laws. All of this information should be reviewed and understood by the buyer and its advisors. By completing a significant amount of the due diligence work before engaging, a buyer decreases the amount that needs to be done post-engagement and its now significant knowledge of the target will allow it to conduct more focused due diligence after engagement. This allows for a much quicker due diligence process while the parties negotiate the deal, without undermining the effectiveness of the buyer’s due diligence.
  
  
  For a target, it should be prepared to address the due diligence inquiries of the buyer(s). The data room should be set up and fully populated. The target should understand the key areas that buyer(s) will focus on and have responses and documents ready in response. A target’s ability to respond to buyer(s) due diligence requests and questions quickly and thoroughly will go far in accelerating due diligence.

• Both the internal and external deal teams should be ready to engage from day one and with a sense of urgency. Slowly bringing on various team members and taking time to get people up to speed once the process has begun will create delays.

• The internal and external deal teams should be staffed appropriately. This could entail increasing the number of people on the deal or ensuring that those staffed do not have other competing priorities.

• Avoid bottlenecks. Not every item needs to be answered or reviewed by the deal team leader. Having differing levels of decision-making authority based on materiality allows for a more streamlined process.

• The Buyer should engage, and the target should encourage the buyer to engage, in directed due diligence focused on the issues that could impact the transaction valuation, structure and deal timing, as well as areas of meaningful risk. Engaging in a “no stone unturned” due diligence process will create significant delays and likely for minimal benefit. To be sure, absent foul play, and considering the target’s disclosure obligations under securities laws, this type of due diligence rarely results in additional information that has a material effect on the deal which would not otherwise have been uncovered through directed due diligence. That said, conducting directed due diligence runs the risk that something will be missed. The buyer needs to weigh this risk versus the benefits of speed.

• If the circumstance presents itself, the buyer and target should consider first engaging shortly after quarterly earnings reports are released. This provides the parties with the benefit of the most recent information and a three-month period to reach a signing before the next earnings release.

• Consider avoiding a “testing the waters” or “small, slow concessions” approach to negotiations. These approaches will likely increase the timeline and run an increased risk of a leak.