Research Trends and Conclusions: Mergers & Acquisitions 2010
Jessica Harvey -
With the first quarter of 2010 complete, the economy is still puzzling lawyers in the aftermath of the financial crisis. And though pricing and the market sentiment are now somewhat lifted, any optimism is tinged with caution.
At the global recession’s deepest, the merger and acquisition market was one of the hardest hit. The mood was bleak, the future uncertain and deal prices were falling or deals were simply not being done. Very few could raise the cash or the courage to spend, reluctant to weaken their balance sheets in an unstable marketplace.
An Altered Landscape
The collapse of the global financial services industry is well documented. Since the summer of 2007, when there was an abundance of cheap finance and a surplus of big-ticket deals, the fall in M&A activity has been sharp and widespread. Between the first and second halves of 2008, figures released by PKF estimate that M&A activity fell in the UK by 47 per cent. By the first quarter of 2009, the volume of M&A deals fell to a mere £9.7 billion. In the US, the situation was equally dire. According to figures released by Thomson Reuters, activity for the 2008 calendar year declined by 37 per cent. What marks this recession out from its predecessors is not only its scale, but the unprecedented levels of government-backed investments that account for much of the activity during this period. In the UK, 41 per cent of the deal value in the second half of 2008 was attributable to HM Treasury’s investments to save floundering banks. The government’s final acquisition of a 70 per cent equity interest in RBS, the largest deal of 2008, estimated at £15 billion, is a graphic depiction of the troubles that beset the deal market. The US government resorted to similar measures with a Troubled Asset Relief Program distributing over $199 billion among 600 financial institutions. Figures estimate the level of government commitments to be as high as $12 trillion. As the banks faced unprecedented difficulties and counterparty risk, they stopped lending, signalling the end of what had been termed the “free money era”.
The shift in the market this brought is significant, directly impacting on lawyers and clients alike. With financing remaining difficult, a lull in activity at the private equity houses has provided the opportunity for strategic investors to regain a foothold in the market. Many of the lawyers we spoke to identified the advantageous position that blue-chip companies with large war-chests and strong balance sheets benefited from. But the fallout from the financial crisis runs deeper than this. With financing harder to come by, several lawyers noted an increasing number of corporations requesting advice on strategic mergers as a means of raising cash. Seizing the pendulum’s swing, the strategic buyer’s occupation of the market has been felt widely throughout the deal economy. In the US, Charles “Casey” Cogut of Simpson Thacher & Bartlett LLP notes the marked shift in the playing field: “If strategic companies want to compete, they will have an advantage they did not have in the free money era of 2006 and 2007.” His observations are echoed throughout the legal community. The vast majority of lawyers we spoke to describe a dearth of private equity activity – a sharp contrast with recent years. As Charles Szalkowski of Baker Botts LLP explains, “A lot of current mergers are between two healthy companies – one that has cash and the other that has some growth. They’re not strategic in the sense of developing expanded product lines or vertically integrating, but rather are being forced by one company’s need for cash.” The impact this has had on law firms, however, is far from clear. Arguably, firms with a greater proportion of private equity clients have suffered as a result. Certainly firms with a strong financial institution client base have seen a decline in this area from the leveraged deal heyday; the redundancies in the legal sector are a testament to this. Logic dictates that firms with a stronger client base of strategic movers have fared a little better, but this is only part of the picture. Many firms have shifted their focus to secure further work opportunities.
Retool and Restructure
As bankruptcy-related M&A transactions have increased, practices that specialise in insolvency and restructuring have naturally seen more openings to participate in this sub-market. Many lawyers have attempted to make up for the private equity shortfall by taking advantage of the M&A/bankruptcy crossover and note an increase in transactions that involve a distressed element. Corporate, financing and insolvency lawyers have seen some growth caused by increased restructuring. Some have benefited from longer-standing client relationships, acting in financings that they secured before the decline, but many say that the true breadth of restructuring activity is yet to be seen. As one prominent source describes, one of the reasons for this may be that “financing put in place in 06/07 was so favourable that it is almost impossible to default under it”. Those that have witnessed previous recessions predict that restructuring will continue to feature over the forthcoming years as the slow ascent from recession continues.
Areas of Activity
Some areas have, however, witnessed a more steady deal flow, the mid-market being a prime example. In our research, several lawyers identified a large number of mid-cap transactions in the energy, chemicals and utilities, and the industrial products sectors with an overall lower financial deal value. Those jurisdictions that didn’t participate so fully in the boom have been somewhat shielded from the decline. In Denmark, Klaus Søgaard of Gorrissen Federspiel notes that the only moderate increase in the level of deals of 2007 and 2008 has paid dividends in 2009 with work remaining at a favourable constant. “We did not have the extremely large deals that London and New York did, [or] the massive teams working on them, and hence we are not missing them now. We have experienced a steady growth since the middle of 2009 and this continues in 2010 where we are presently extremely busy,” he says. Nevertheless, while the financial value of deals may be smaller, in tough times their repercussions can be more widely felt, calling on a range of legal expertise within insolvency and employment law, and for the industrial sector, environmental law too.
Many of the lawyers that our research team spoke to noted a continued interest in energy-related transactions. Observing an “an uptick in the energy space M&A” David Kirkland of Baker Botts LLP highlights growing interest in deal issues such as creative securities, company performance and earn-outs that often herald increased deal flow. Here too, strategic buyers find themselves with the upper hand. Sources of financing have changed across the board. As Fulbright & Jaworski LLP’s James Griffin says, some strategic buyers view this financing disruption as an opportunity, using cash to finance transactions while the debt market remains problematic: “Those companies with available cash on the balance sheet can now engage targets at lower valuations, providing the target financing certainty and paying a significant premium based on the current, albeit lower, trading price” thus allowing the strategic buyer to “acquire the asset at a time when the competitive bidding from an M&A standpoint may not be as prevalent, due in part to the unavailability of attractive financing”. Here, there is further opportunity for law firms with corporate governance expertise. With the popular message being that shareholders need more voice and increased concern over governance matters, boards have become more cautious about saying no to a significant premium, resulting in an increasing number of directors willing to entertain discussions with strategic buyers who are willing to put the pressure on.
The global financial crisis is not all-encompassing, however, with continuing activity in the Asian market being notable. The lawyers that our researchers spoke to reported a “pronounced pick-up in the level of transactional activity in the second half of 2009”, fuelled by Chinese activity that is driving further growth in surrounding areas. In Vietnam, lawyers observed an encouraging change in banking finance with rising government pressure on commercial banks to increase their equity capital. Further opportunity lies in an increased interest in infrastructure and setting up provincial sovereign wealth funds. In Singapore, the liberalisation of the legal market, with six firms granted licences to practise, has seen an increased international presence in the area, with four international firms, including Allen & Overy LLP and Latham & Watkins LLP moving in to the region to take advantage of the local rise in cross-border transactions and overall increase in corporate work. Dillhan Pillay Sandrasegara of WongPartnership LLP observes that the field is a little more even between the private equity and strategic players, with “private equity becoming more active in the Asian market”. Further activity can be found in India where interest in private equity and investments overall has increased, the demand for infrastructure driving “extraordinary growth”. In Europe, taking a long-term view, it is anticipated that further M&A activity will result from divestments made by the banking industry to reduce their balance sheets, as required by the European Commission. Many of the lawyers we spoke to identified that the FIG sector has been more “bullish”, as a result.
A Cautious Optimism
Many of the lawyers our researchers canvassed spoke of a puzzling marketplace. One prominent source noted that the market ought to be poised for a significant pick-up, but that curiously, fewer mergers had taken place than was anticipated. Many mentioned that while there had been an increase in bankruptcy work, this too, was less significant than expected. A lack of stability in the market and a widespread crisis of confidence have been held responsible for the activity shortfall, as Charles “Casey” Cogut says: “[We] need a more genuine recovery on Main Street […] a higher degree of economic confidence and a willingness of the banks to be more aggressive in lending.”
Across all the jurisdictions that we surveyed a “cautious optimism” prevailed. While still bearing the scars of 2008-2009, the vast majority of our sources saw positive signs for the year ahead. With an upturn in M&A and IPO activity, and the sale of asset management portfolios another eagerly anticipated trend, the outlook is certainly brighter. As effects of the crisis continue to be widely felt and with nervousness about banking finance continuing, the Cadbury/Kraft deal shows that financing can be obtained at the right price, particularly for those that are able to use stock to fund deals. As Stephen Cooke at Slaughter and May says: “Developments in the business environment often drive M&A. Whenever the architecture changes, people see opportunities.” For the legal marketplace, the challenge lies in being able to respond and meet ever-increasing client demands. As the nature of deals changes, one source notes that “a lot of legal teams will be gearing up, but there will be only one buyer”. With competition and cost pressure mounting, efficiency and industry knowledge continue to be of fundamental importance to maintaining key client relationships and securing new work. For many, adopting a more diverse practice will ensure a busier time sheet in what is anticipated to be a long and protracted period of economic recovery.