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Research Spotlight

Collar & Walkaway Provisions

New York - November 3, 2009 Jim Mallea

The percentage of deals involving full acquisitions US public targets where stock was all or part of the consideration offered is at its highest level since 2004. In 2004, the percentage of deals where cash was the only form of consideration offered versus those where some or all stock was offered was nearly equal, with cash deals accounting for 51.41% of announced deals and stock swap deals accounting for 48.24% of deals. By 2006, when the M&A market was being spurred by easily secured credit, this difference had widened considerably with all cash deals representing slightly more than 70% of all deals announced and stock swaps accounting for just under 30%. So far this year, stock swaps are up almost 11% and all cash deals are down correspondingly as compared to last year, with cash and stock swap deals now representing 56.89% and 42.51%, respectively, as the chart below indicates.

Many potential buyers have seen their stock price rise over the last several months as the stock market has improved. In addition, many potential buyers still cannot get access to deal financing, so using their increasingly valuable stock as consideration offered is an obvious alternative if they want to get a deal done now. Given these factors and the trend of increasing stock swaps we have already discussed, we used MergerMetrics to analyze the prevalence of both collar and walkaway provisions in definitive agreements. These are two key deal protection mechanisms that buyers and sellers can negotiate into a merger agreement to protect themselves from changes in the acquirer's stock price once a transaction is announced. Interestingly, collar and walkaway provisions are rarely used in conjunction with each other in the same agreement. For deals announced between 2004 and today, the average percentage of deals with both a collar and walkaway provision is only 5.84%. In 2004, only 2.29% of announced deals with definitive agreements included both provisions.

A collar provision is designed to mitigate the risk to the target and acquirer in stock swap transactions due to potentially dramatic changes in the acquirer's stock price between the time a deal is announced and the time it completes.One of the biggest risks the target board has when negotiating a stock swap transaction is that the acquirer's stock price will fall between the deal's announcement and completion and that the acquirer will therefore significantly under pay for the target company. The acquirer, on the other hand, is concerned that its stock price will increase dramatically while the deal is pending and that they may end up over paying for the target. A collar provision ensures that target shareholders receive either a minimum or maximum value in acquirer stock if the deal has a fixed exchange ratio or a minimum or maximum level of ownership in the acquirer if the deal has a floating exchange ratio (see our previous research spotlight on Fixed vs. Floating Exchange Ratios). The collar accomplishes this by setting up different ranges, or bands, based on the acquirer's closing stock price.For example, imagine a hypothetical deal where the acquirer offers .6 shares of its stock for each target share and its stock price is trading at $41 when the deal is announced. If the acquirer's average closing stock price is between $50 and $35, then the target shareholders will continue to receive the .6 shares offered for each share held as originally negotiated. However, if the acquirer's average closing stock price is $50 or greater, then the target shareholders will receive a maximum dollar amount of the acquirer's stock. If the acquirer's average closing stock price is less than $35, then the target shareholders will receive a minimum dollar amount of the acquirer's stock. This way, no matter what the acquirer's stock price does between announcement and completion, the target's board has guaranteed a minimum and maximum dollar amount of value for their shareholders and the acquirer has guaranteed the minimum and maximum amount of equity it will issue in the transaction.

As an alternative to, or in conjunction with a collar, a walkaway provision can also be negotiated into a definitive agreement. A walkaway provision, which is sometimes referred to as a 'market out' provision, allows one or both of the parties to terminate the merger agreement based on a significant change in the acquirer's stock price. It protects the target by limiting the amount the acquirer's stock price can decrease between announcement of the deal and closing by giving the target the right to get out of the deal if the acquirer's price falls below the negotiated walkaway price. It protects the acquirer by limiting the amount their stock price can increase between announcement and completion, thereby ensuring that the acquirer does not overpay for the target if their stock price rises above the negotiated walkaway price.

Interestingly, the percentage of stock swap transactions where a definitive agreement was reached that included a collar or a walkaway provision has fallen steadily since 2006, when both provisions were most prevalent as measured in the period between 2004 and today (as shown in the graph below).

As mentioned previously, 2006 was also the year in which there was the widest gap between all cash deals and deals involving all or some stock.This decline in the use of both collar and walkaway provisions can be explained by a couple of different factors. First, 2006 was a seller's market as there were multiple buyers chasing a limited number of targets, so sellers had negotiating leverage. In those deals where the target chose to accept stock when 70% of other targets were accepting cash, targets wanted to ensure the value that their shareholders would receive in the acquirer's stock and they did so by including collars and walkaway provisions. Second, as the M&A market has cooled off over the last couple of years and the credit markets have tightened up, thereby reducing the number of potential buyers in the market, sellers have lost negotiating leverage and are less likely to push for certain deal protection mechanisms. Target boards that have chosen to accept stock are more willing to accept the risk of changes in the acquirer's stock price while the deal is pending instead of pushing in negotiations to include collar and walkaway provisions.

We also examined the distribution of collar and walkaway provisions by the type of consideration offered. As the charts below indicate, since 2004 collars are most frequently negotiated into definitive agreements when the consideration offered is cash and stock. Walkaway provisions are most frequently used when the target shareholders are offered a choice of receiving stock or cash, which is sometimes referred to as a 'cash election' since the target shareholders can elect to receive cash instead of stock

Lastly, we examined the frequency of use based on the different types of walkaway provision; those where the right to terminate is based on a change in the acquirer's stock price only applies to the target, only to the acquirer or where both parties had the right to terminate. As expected, target side only walkaway provisions were employed most frequently, appearing almost 80% of the time, followed by those deals where both sides had the right to terminate. Deals where the acquirer was the only party that had the right to terminate is based on changes in their stock price were very rare, occurring in less than 2% of the definitive agreements announced since 2004, as the chart below indicates.

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