Lauren C. Bellerjeau, Mike Krigbaum, Michael G. O'Bryan, Tyler J. Sewell, and Graeme Sloan
Mergers + Acquisitions
From sweeping changes to the U.S. tax code, to big ticket M&A transactions making headline news – 2017 proved to be an eventful year for M&A dealmakers. As we settle into 2018, we wanted to take a moment to reflect on some of the past year’s key M&A developments, and consider how these trends might evolve in 2018.
For more information on Morrison & Foerster’s Global M&A Practice, please visit our page on mofo.com.
1) Big Ticket M&A Continues…
There seems to be no end in sight for consolidation activity through 2018. Even with the ever-changing political, regulatory and tax environment of 2017, we witnessed a flurry of splashy deal announcements, including Broadcom’s over $100 billion proposed takeover of Qualcomm, CVS Health’s proposed $69 billion acquisition of Aetna, and Disney’s proposed $52.4 billion offer for 21st Century Fox assets. As some of the dust starts to settle (at least with respect to tax reform), we expect that both acquirers and targets will be ready to jump into discussions with potential combination partners in 2018.
Why are we seeing this public company merger activity? One major factor is ever-increasing competition, which has resulted in sweeping industry consolidation as both serial and opportunistic acquirers have focused on larger strategic transactions with both industry rivals and complementary businesses to strengthen their market positions. The technology industry exemplifies this trend. In the world of semiconductors, we have recently seen a number of tie-ups, including Broadcom’s proposed takeover of Qualcomm, exhibiting the desire of acquirers to take advantage of strategic synergies through big ticket combinations with other industry players.
However, we also continue to see large acquirers diversifying into new complementary business lines, with deals such as AT&T’s proposed merger with Time Warner. Entering into a new business line via acquisition is particularly attractive at a time when industry lines are grayer than ever, with technologies converging and becoming more industry agnostic, infusing new competition into traditional markets – like, for instance, the rise of online streaming and its impact on the media sector. According to a recent Deloitte survey of approximately 1,000 corporate and private equity dealmakers, the top driver for M&A activity in 2017 was the acquisition of technology assets, highlighting the pressure that companies are facing to embrace new technologies into their businesses. And as traditional companies race to acquire technology assets, technology giants are conversely acquiring in traditional markets as a means of expanding their own business lines, resulting in a further blending of industries.
Lastly, despite ongoing CFIUS issues (which are explored in another section) and the uncertainty in the regulatory environment, many view the current climate as favorable for deal activity, particularly now that the tax reform bill – which lowers the corporate tax rate and encourages the repatriation of overseas cash – was signed into law and companies are currently holding more cash than ever. This optimistic outlook will only strengthen if some of the mega-mergers announced in late 2017 receive regulatory approvals to complete their transactions.
2) …But So Does the Spike in Abandoned Deals
As the mega-merger spree continues, so has a spike in abandoned deals. A number of high-profile blockbuster transactions, including Aetna’s $37 billion tie-up with Humana and Anthem’s $54 billion deal with Cigna, were canceled in 2017, following a 2016 spike that saw 1,009 cancelled deals worth $797.2 billion and a failure rate of 7.2 percent, the highest rate since 2008.
The reasons behind the rise in failed tie-ups can vary. One major factor for deal cancellations in 2017 was the regulatory environment. U.S. national security review by CFIUS, which is explored in the next section, had an increasing impact on cross-border deal activity in 2017, particularly as it relates to Chinese investment in U.S. technology companies. CFIUS could have an even greater impact on 2018, should lawmakers pass legislation to expand CFIUS’ authority.
Antitrust regulations also continue to be in the spotlight, with deals such as Aetna/Humana falling to antitrust concerns. As 2018 opens, much attention is being given to the DOJ and the Trump Administration, as the DOJ challenges the proposed $85 billion merger between AT&T and Time Warner. Dealmakers will follow the case closely, as it is expected to have major implications for the future of mega-merger deal activity.
The type of transaction can also determine its chances of success, with high-stakes deals involving larger companies simply failing at higher rates, according to a study by IntraLinks. Logic says that as companies increasingly consider mega-mergers, the result will be a correlating increase in the number of abandoned deals.
3) CFIUS Impacts Chinese Investment into the U.S.
The Committee on Foreign Investment in the United States (CFIUS), an inter-agency committee responsible for reviewing the national security implications of foreign investment in U.S. companies, had an increasing impact on cross-border deal activity in 2017, particularly as it related to Chinese investment in U.S. technology companies. At the end of the year, legislation was proposed that would expand CFIUS’ authority, including both the factors it considers and the kinds of transactions it might review, and reflecting CFIUS’ concern with cybersecurity and personal data. National security appears poised to play a significant role in 2018 as well, necessitating careful planning and execution of deal strategies and potentially changing the competitive dynamic of some company sales.
2016 saw Chinese investment into the U.S. surge to over $56 billion. Some U.S. lawmakers reacted by pushing for additional oversight of this increasing deal flow. In its November 2016 annual report to Congress, the U.S.-China Economic Security Review Commission recommended, among other things, banning Chinese state-owned businesses from buying U.S. companies. At the end of 2016, President Obama, following a CFIUS recommendation, blocked the proposed acquisition of Aixtron SE, a German company with U.S. operations, by Grand Chip Investment, a company owned by Chinese nationals; in September 2017, President Trump followed suit by blocking Chinese-backed Canyon Bridge Capital Partners’ proposed acquisition of U.S. semiconductor company Lattice Semiconductor. More recently, MoneyGram announced that it had terminated its agreement to be acquired by Ant Financial, citing inability to obtain CFIUS clearance. At the same time, potential Chinese investors worked to respond to changes in China’s rules on overseas investments. Congress continues to review CFIUS’ mandate and powers, and may approve a version of the proposed legislation noted above and potentially other changes.
Despite CFIUS concerns, the U.S. market remains attractive to overseas investors. Chinese and other investment continues to flow into the U.S., and deals from around the world are regularly clearing CFIUS review. But, for Chinese acquirers, engaging in a U.S. transaction in sensitive industries requires the careful selection of targets to avoid those most likely to present CFIUS concerns, or the preparation of specific actions to respond to potential CFIUS concerns even before engaging with CFIUS. It also might ultimately require submitting a higher-priced offer than that of U.S. bidders to make up for perceived incremental risks. U.S. sellers, on the other hand, might now need to consider whether higher bids from Chinese investors are worth the potential regulatory hurdles the deal could present.
It is clear that CFIUS will remain an issue for dealmakers in 2018, requiring careful planning and approach. This will be even more the case if U.S. legislators further strengthen the committee’s powers and expand its role into new industries and types of transactions.
Read our article in Directors & Boards for more information on how technology company boards can navigate CFIUS and related considerations.
4) UK M&A and Brexit
The United Kingdom’s 2016 “Brexit” vote, which resulted in a decision for the country to leave the European Union, led to an immediate drop in the pound sterling and a cloud of uncertainty in global M&A markets. But after the initial shock, the UK enjoyed a strong 2017 that saw a 14.6 percent increase in M&A deal value over 2016, according to MergerMarket. We anticipate this positive trend to continue through 2018 as a clearer Brexit timeline slowly emerges and the UK’s lower currency value continues to attract foreign investment in British real estate and corporate assets.
In terms of the Brexit timeline, news broke in December 2017 that European Union (EU) leaders had approved of moving to Phase 2 of Brexit negotiations and agreed to a transition period after the UK leaves the EU in March 2019. While the March 2019 deadline is still over a year away and there is plenty left to be negotiated, clearing this first hurdle is a strong step forward that could create momentum for UK M&A activity in 2018.
The rise in foreign investment into the United Kingdom, which began immediately after the Brexit vote with SoftBank’s £24 billion ($31.4 billion) acquisition of UK-based semiconductor and software design company ARM Holdings plc (for which MoFo was lead counsel to SoftBank), has been a key characteristic of the UK’s changing M&A landscape in the wake of Brexit. Inbound activity reached $127.8 billion across 687 deals in 2017, representing the highest inbound deal count on MergerMarket record.
China’s investors, in particular, have maintained a continued interest in the UK market notwithstanding Brexit. Since 2015, China has represented 33.5 percent of total global investment into the UK, investing some $14 billion since the beginning of 2016 alone. UK real estate is seen to be potentially even more attractive to Singaporean and other Southeast Asian investors post-Brexit.
Much is still to be determined as the UK chugs ever-closer to its Brexit destiny but, in the meantime, the UK M&A market has proven its resilience and the outlook is positive for UK deal activity in 2018.
For an in-depth look at international investor sentiment toward Brexit, please see our recent client alert, which was authored by 15 of our leading attorneys across the global MoFo network.
5) Wide-Ranging Tax Changes Impact M&A
Tax has always been a key value driver in M&A transactions, with substantial cash flows and various potential risks turning on tax considerations. In December 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act (the “Act”), considered to be the most significant overhaul of the U.S. tax code in more than 30 years. Although the economic impact of the Act remains to be seen, there is no question that it dramatically alters the federal government’s historical approach to both domestic and international taxation in a variety of highly meaningful ways that will impact global M&A activity. Indeed, dealmakers are already scrambling to incorporate the new rules into their strategies.
At a very high level, the Act makes a wide variety of changes affecting M&A, ranging from dramatic changes in tax rates, to new approaches to tax preference items and attributes, as well as a comprehensive overhaul of the international tax system. A few of these key changes include:
For more information on tax reform and potential implications for M&A, private equity and venture capital transactions, please read our January 2018 client alert or email TaxReform@mofo.com to request access to the MoFo U.S. Tax Reform Tracker.
6) Private Equity Activity Continues at High Level
With a substantial amount of dry powder available for use and favorable debt markets, 2017 was an active year for private equity firms. According to Preqin, buyout deal values in 2017 increased over 2016’s strong totals, with record activity in Asia including Toshiba’s $18 billion sale of its memory business to a consortium led by Bain Capital. This momentum is likely to continue, with 76 percent of private equity respondents in a recent Deloitte survey indicating that they expect to see an uptick in transactions in 2018, though private equity firms will need to adapt to the new tax paradigm (highlighted in the previous section and discussed in more detail in our January 2018 client alert), as well as to a potential increase in interest rates and continued competition from corporate acquirors.
The technology space has proven to be particularly ripe for private equity deal-making in recent years, with private equity firms in 2017 announcing more than double the amount of tech deals announced five years ago, according to 451 Research’s M&A Knowledgebase. In fact, in 2017, private equity firms for the first time matched U.S. public companies in the total number of tech deals announced, according to a report by 451 Research. This trend is expected to continue, with 59 percent of technology industry dealmakers in our September 2017 Tech M&A Leaders’ Survey forecasting an increase in private equity activity in the tech space.
This deal activity is concentrated to a small number of fast-growing technology sectors, including software and SaaS (software-as-a-service). Software-related targets accounted for over 40 percent of private equity’s tech deal flow in 2017, according to 451 Research’s M&A Knowledgebase. And SaaS continues to attract private equity investment, in part due to the use of the subscription-based model and its recurring revenue stream.
One trend that could impact private equity deal activity in 2018 is the rise in private company valuations, with rising multiples that are likely to remain high as competition heats up between private equity firms and corporate acquirers, according to PitchBook’s 2018 Private Equity Outlook. But private equity weathered a similarly high valuation market in 2017 and showed no signs of faltering in their deal activity.
Additionally, while both private equity and corporate buyers will be affected by the recent tax reforms, private equity buyers in particular are likely to be significantly affected by the new limits on deductibility of interest, which cap those deductions at 30 percent of an amount similar to the company’s EBITDA (tightening up to the company’s EBIT in 2022). Not all companies were able before the reforms to quickly utilize all interest deductions (because, for example, they did not have the income), but in general this will make leveraged acquisitions more expensive. The overall lowering of tax rates also affects the relative value of all deductions, including interest deductions. Other aspects of the tax reforms may be beneficial to buyers, such as the increased future cash flows that may result from lowered tax rates, but private equity buyers will need to assess the impact of these changes on their deal models, as well as on the structures of the private equity firms themselves, while facing competition from corporate acquirers who will likely be affected differently by the tax reforms.
7) Increased Focus on Privacy and Cybersecurity Due Diligence
With data breaches and cyberattacks regularly splashed across front-page news, there is little doubt that privacy and cybersecurity will remain top of mind in 2018. As these breaches rise in frequency and magnitude, accounting for cyber risk is also becoming an increasingly pivotal aspect of the M&A due diligence process.
In our most recent Tech M&A Leaders’ Survey conducted in September 2017 with 451 Research, 82 percent of dealmakers in the technology space reported that acquirers are putting an increased emphasis on the cybersecurity standards and practices of target companies during their due diligence processes.
How has this translated to the negotiation table? As the industry adjusts to cyber vulnerability as an ever-present threat, these risks are not always deal-breakers. However, they often affect the terms of a deal, as acquirers may elect to negotiate special indemnities or other remedies or adjust the purchase price. In more extreme cases, such as where a target’s core business proposition requires the improper or questionable use of data in ways in which the target is not expressly permitted to use such data, acquirers could find the risks of the deal to be too great to complete the acquisition.
For potential sellers, it has never been more important to assess and address cybersecurity and privacy risks prior to engaging in an M&A transaction. This includes understanding the compliance landscape in every jurisdiction in which the seller operates, reviewing privacy policies and existing information security program documentation, and asking counsel to assist with a gap analysis. Understanding and strategizing fixes for your company’s security shortcomings can help avoid issues once a transaction is underway.
As we enter 2018 and our world continues to move toward data-driven solutions, we can expect that companies will increasingly emphasize privacy and cybersecurity due diligence as part of their strategic plans. To learn more about how Morrison & Foerster can help, please visit our Cybersecurity Resource Center.
8) M&A Litigation Moves from Delaware
What a difference a year makes. As of October 2017, only 9 percent of the 108 lawsuits that had been brought to challenge public-company mergers had been filed in Delaware. That represents a considerable drop from 2016, when 34 percent of the nation’s merger-objection suits were filed in Delaware, and 2015, when 60 percent of the nation’s merger-objection suits were filed in the Diamond State. The trend is clear: M&A litigation is moving away from Delaware.
The drop in the portion of M&A lawsuits being filed in Delaware can be attributed largely to judicial trends reflected in two opinions:
(1) the Delaware Chancery Court’s 2016 holding in In re Trulia, which virtually rejected the disclosure-based settlement — in which the plaintiffs in a lawsuit contesting a merger released the defendants from liability in exchange for attorneys’ fees and additional disclosures in the proxy statement; and
(2) the Delaware Supreme Court’s 2015 holding in Corwin v. KKR Financial Holdings, applying the business judgment rule and making it more difficult, at least in the context of post-closing litigation, to find public-company directors liable for approving a merger that was approved by an uncoerced, fully-informed vote of disinterested stockholders.
In the wake of Corwin and Trulia, overall deal litigation has dropped off slightly from its all-time high in 2013, when 96 percent of deals were the subject of lawsuits filed in some state or federal court, be it in Delaware or elsewhere. Of the 127 deals inked in the first ten months of 2017, 85 percent were the subject of a lawsuit filed in some state or in federal court. In 2016, that number was even lower: 73 percent.
The opinions also seem to have increased the federal courts’ popularity with merger-objection lawsuit plaintiffs. In the first ten months of 2017, 87 percent of the lawsuits that had been filed over mergers were filed in federal court. That’s a significant increase over years past. To avoid forum selection bylaws that require internal corporate state law claims to be filed in Delaware, these suits typically state federal claims that the proxy statement and other acquisition-related disclosure by the company violates Sections 14(a) and 20(a) under the federal securities laws instead of alleging breaches of fiduciary duty.
Nonetheless, claims and litigation continue, in Delaware and elsewhere, as parties and courts apply and test the limits of Trulia and Corwin. Claims and litigation also continue, in Delaware and elsewhere, over other issues, including with respect to appraisal, with plaintiffs, companies and courts wrestling with questions of how to value a company in an acquisition.
For a review of the latest Delaware Supreme Court decisions addressing appraisal issues, see our December 2017 client alert.
Read Our 2017 M+A Annual Review
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