Research Spotlight

M&A Year End Review
New York - January 23, 2009 Jim Mallea

The turbulence in the M&A market that began in the second half of 2007 continued through all of 2008. Globally, deal volume was down nearly 49% between 2007 and 2008 and the number of announced deals was down over 29% according to FactSet Mergerstat. In the US, the number of announced transactions involving full acquisitions of US public companies fell almost 35% between 2007 and 2008. Even in a down market, there were still several important trends worth noting.

Unfriendly Deals

Unfriendly transactions, those involving deals that started with unsolicited offers and may have become hostile, represented 23% of all announced deals involving full acquisitions of US public companies in 2008, according to FactSet MergerMetrics. In addition to the unfriendly M&A activity, corporate boards faced a record number of proxy fights in 2008. A total of 123 proxy fights were waged in 2008, an increase of 14% over the previous years total of 108, according to FactSet SharkRepellent's 2008 Year End Review. This is well above the percentage of unfriendly deals we have seen in the past 5 years, where 2006 saw the next highest percentage of just 14%. Healthy corporate buyers, spurred on by the declining stock prices of potential targets, took advantage and made offers in an attempt to secure strategic partners at discount prices. Not only was there a significant increase in the number of unfriendly deals, but there were many high profile companies that were targeted this year, including Anheuser-Busch, Yahoo, Calpine Corp., SanDisk Corp. and ImClone Systems.

Whether the increase in hostile M&A and the current market conditions will ultimately reverse the six year trend of companies reducing takeover defenses remains to be seen, but the level of defense protection continued to decline in 2008, albeit at a slower pace than previous years. The average Bullet Proof Rating of the S&P 1500 declined from 4.57 at end of 2007 to 4.23 in 2008. The Bullet Proof Rating is a relative measurement of a company's takeover defense protection. One surprising development in 2008 was the late year surge in poison pill adoptions. The 28 pill adoptions in December was the most in any month since October 2001 and 2008's full year total of 127 adoptions was the most in any year since 2002. The 76 first time pill adoptions in 2008 was the most in three years, a dramatic reversal from 2007's total of 42 which was the lowest total since the early 1980s, according to FactSet SharkRepellent. The increase in poison pill adoptions is likely related to the precipitous drop in valuations and not a sea change in the current thinking on poison pills which has been waiting until a raider actually appears before adopting one. In the press release announcing the poison pill adoption, several of the companies pointed to current market conditions as the impetus for the adoption.

Going Private Deals

Going private deals accounted for more than 31% of all agreed deals involving US public targets in 2007, with private equity buyers involved in 65% of those deals. By comparison, going private deals accounted for just 22% of agreed deals in 2008 with private equity buyers involved in just 52% of those deals. The largest announced agreed going private deals in 2008 were strategic acquisitions, led by Mars, Inc.s $22 bil acquisition of Wm. Wrigley Jr. Company and Liberty Mutual Group Inc.s $6.1 bil acquisition of Safeco Corp. The average deal size for going private deals between 2007 and 2008 fell 69% to just $785 mil from $2.5 bil.

Negotiated Deal Provisions

As the M&A market heated up between 2004 and the first half of 2007, we identified noticeable shifts in how merger agreements were negotiated. The availability of cheap credit and the increased leverage sellers had in negotiations led to a steady decline in the inclusion of financing conditions. In 2005, over 13% of agreed deals involving full acquisitions of US public targets included a financing condition. By 2007, that percentage was down to 2.29%. In 2008, with cheap credit no longer available due to the credit crunch, the percentage of deals with financing conditions has started to tick back up to 4.55%, although this is still well below the levels we have recorded between 2004 and 2006.

Reverse breakup fees is another merger provision for which we have seen a significant change over the last several years. The percentage of agreed deals involving full acquisitions of US public targets held fairly steady at slightly below 30% between 2004 and 2006 , but increased dramatically in 2007 to more than 42%. In 2008, that percentage fell almost 10% to 32.73%, which is much closer to the historical levels we have seen.

Go shops are another negotiated provision that have received lots of attention over the last few years. A go shop provision allows a target company to actively seek a competing bid for a specified period of time after it has entered into a definitive acquisition agreement, which is prohibited in agreements that do not include go shop provisions. In 2007, when the M&A market was being driven by private equity buyers, almost 11% of all agreed deals involving full acquisitions of US public targets included a go shop provision. Between 2004 and 2006, go shops were negotiated into the definitive agreement much less frequently. There was a noticeable increase to 4.36% in 2006, but this was still 50% lower than the percentage in 2007. In 2008, the percentage of deals with go shops fell slightly to 7.73%, but continue to be negotiated into agreements. The average number of days that the target can seek a competing bid during the go shop period fell in 2008 to just under 37 days from a high of 40 days in 2007. The percentage of deals with a separate go shop termination fee also fell in 2008 to 71% from 84% in 2007. While go shop provisions allow targets to actively seek a competing bid, they are not very effective as they have lead to a competing offer less than 10% of the time since 2004.

One Step versus Two Step

As acquirers prepare to enter into a definitive agreement, they are faced with the decision of whether to use a one step or a two step merger and acquirers are increasingly choosing to use a tender offer instead of a straight merger in their acquisitions. Tender offers give acquirers several advantages over traditional one step transactions, particularly the speed at which the transaction can be completed and the option to use a short form merger once more than 90% of the shares have been tendered in the offer. Prior to December 2006, when the Securities and Exchange Commission clarified the rules governing tender offers, tender offers were used between 7% and 10% in agreed deals between 2004 and 2006. In 2007, the percentage of agreed deals involving tender offers doubled to more than 16% and in 2008, tender offers were used more than 24% of the time.

Another significant development we have seen related to tender offers is the use of top-up options. A top-up option gives the acquirer the option to purchase that number of newly issued shares of the target company necessary to give them one more share than the 90% threshold they need in order to close out the deal with a short form merger. There is generally a minimum threshold that must be reached as far as the number of shares tendered in the agreement before the top-up option can be exercised. Some deals set the threshold at 70% or 80%, meaning that the acquirer cannot exercise the top-up option until 70% or 80% of the shares have been tendered. Some transactions set the threshold as low as 50%. In a case like this, once more than 50% of target shareholders have tendered their shares, the acquirer can exercise the top-up option to get over the normal 90% threshold, which enables them to close out the deal with a short form merger. The lower the threshold on a top-up option, the greater the likelihood that the acquirer can close out the transaction with a short form merger, effectively removing any concern that the target will need to hold a shareholder meeting to approve the transaction. In 2004, 35% of agreed tender offers included a top-up option. By 2006, that number had increased to 64%, and in 2007 they had become nearly ubiquitous, with 94% of all agreed tender offers including a top-up option. In 2008, the inclusion of a top-up option had become standard as 100% of all agreed tender offers included one.

Consideration Offered

Cash remains the currency of choice for transactions involving full acquisitions of US public targets. More than 66% of all announced deals in 2008 were cash only deals, which equals the percentage in 2007. Deals where the acquirer offered only its stock increased almost 4% in 2008 to 17% from just over 12% in 2007. The percentage of deals where a combination of cash and stock were offered accounted for 10% of announced deals in 2008, which equaled the percentage in the previous year. Choice deals, those where the acquirer allows the targets shareholders to elect to receive either cash or stock, fell almost 7% between 2007 and 2008.