[co-author: Annie Tonken - Articling Student]
The disruption caused by the COVID-19 pandemic will be far-reaching and profound. With global financial markets plagued by turmoil and uncertainty, the number of companies re-evaluating, re-negotiating or terminating M&A transactions grows daily as the long-term effects of the economic lockdown remain unclear. According to data compiled by Bloomberg, at least 17 major transactions are in jeopardy and more than US$10 billion worth of mergers, acquisitions and investments were terminated globally over the first week of May. Unsurprisingly, many deals under threat are in travel, hospitality and other sectors hit particularly hard by the pandemic.
Canada has not been spared from the global rout of economic and deal-making activity. Canadian M&A transaction activity in the first quarter of 2020 dropped approximately 56% compared to the same quarter of 2019 and 69% from the final quarter of 2019 to $27.8 billion, its lowest level since 2015. The second quarter of 2020 will reflect the first whole fiscal quarter impacted by the pandemic-induced lockdown and M&A transaction levels are likely to weaken further.
While the reasons for deal cancellation may be contextual or confidential, the following trends appear to arise in respect of a number of publicly disclosed transactions in turmoil:
1. Material Adverse Change/Effect (MAC)
Transaction agreements typically have a MAC clause that permits the purchaser to terminate the transaction when an event has materially and adversely affected the target company. Depending on the construction and context of the clause, purchasers may look to argue that the COVID-19 pandemic qualifies as such an event and attempt to terminate the transaction on that basis. There is very little Canadian case law governing the interpretation and treatment of such clauses (see COVID-19: Material Adverse Change in a Canadian M&A Context),
2. Share Price Volatility
The volatility in financial markets has severely complicated the valuation of many M&A transactions, specifically in two circumstances: (i) when shares of the purchaser are used as consideration, or (ii) when the purchase price is calculated as a premium to the average trading price of the target company during a pre-COVID-19 period. The COVID-19 pandemic has contributed to a substantial drop in the market value of many listed issuers, and it is difficult to ascertain when a recovery in share prices may occur. In such instances, either party may attempt to renegotiate or terminate the deal under the perceived notion that consideration is no longer considered "fair" for the value exchanged.
3. Leveraged Buyouts
Deals that are highly leveraged will likely come under greater scrutiny for a variety of reasons. The economic lockdown has resulted in a significant strain on cash reserves, forcing many companies to incur sizeable and unforeseen operating debt loads. Accumulating additional debt to finance an acquisition may be highly unpalatable in the current climate. In addition, acquisition financing typically contains rigorous financial covenants (e.g., EBITDA-to-debt ratios), adherence to which may be difficult given the economic shutdown. Lenders may look to use such non-compliance as justification to withdraw from deals with substantially increased risk profiles.
4. Increased Use of Earn-outs
Pervasive economic uncertainty has increased the use of earn-out provisions in deals penned and renegotiated during the COVID-19 pandemic. By tying a portion of the purchase price to the performance of the target company after closing, earn-out provisions give purchasers a degree of security and certainty. Earn-outs have increased in number and have been subject to increased scrutiny as parties search for a tailored solution to the particular target business and the impact of COVID-19. An agreement on the allocation of risk on earn-outs may be a suitable compromise to save certain deals in jeopardy.
Recently Announced Deals
The following transactions represent just a few of the publicly announced M&A transactions as reported through various media outlets:
Proposed Acquisition of PartnerRe by Covéa from EXOR
On May 12, 2020, French insurer Covéa called off the proposed acquisition of the global insurer, PartnerRe, from EXOR. A memorandum of understanding was signed between the parties on March 3, which entailed a total cash consideration of US$9 billion, plus a cash dividend of US$50 million. The pandemic is believed to have sweeping effects on the insurance and re-insurance industries. Lloyd's of London predicts an industry-wide underwriting loss of approximately US$107 billion, compounded by a fall in investment portfolios of an additional estimated US$96 billion.
Purchase of Stake in American Express Global Business Travel
On May 9, 2020, private equity firm Carlyle Group Inc. and Singapore sovereign-wealth fund GIC Pte. Ltd. announced they were pulling out of a deal to purchase a 20% stake in American Express Global Business Travel. The investment was previously announced in December for approximately US$1.5 billion, based on a target valuation of US$5 billion including debt. By early April, Carlyle had raised concerns that the economic shutdown may constitute a "material adverse effect" and the travel-booking business may be facing insolvency. Lawsuits have been traded between the parties in the Delaware Chancery Court over whether the transaction should be closed. On May 14, Judge Joseph Slights III ruled that the court will not expedite the trial to meet the transaction financing deadline of June 30, which may raise questions regarding the efficacy of suing to force unwilling parties to close a transaction in a timely manner.
Acquisition of Victoria's Secret by Sycamore Partners from L Brands Inc.
On February 20, 2020, private equity firm Sycamore Partners and L Brands Inc. came to an agreement for the sale of L Brands' controlling stake in the lingerie retailer, Victoria's Secret, for a purchase price of approximately US$525 million. By late April, Sycamore Partners requested to terminate the acquisition, citing the fallout from the COVID-19 pandemic and its effect on the retail industry. L Brands sued to force Sycamore Partners to complete the purchase, stating that a global pandemic was explicitly carved out from the "material adverse effect" clause in the acquisition agreement. On May 4, 2020, the parties mutually agreed to terminate the acquisition with no termination fee or further consideration, each expressing a desire to focus on dealing with the pandemic and a hesitation to participate in a costly, drawn-out litigation.
Acquisition of Rifco Inc. by CanCap Group Inc.
On February 3, 2020, a deal was announced for the sale of Rifco Inc. to CanCap Group Inc. for $25.5 million. By April, CanCap sought to terminate the purchase of the auto financing company, arguing that recent COVD-19-related events amounted to a "material adverse effect" (MAC) and entitled CanCap to pull out of the acquisition. The case is now before the Alberta Court of Queen's Bench to determine whether a MAC had occurred and if the deal can be terminated. We will continue to follow this case closely as it could have significant implications for the Canadian interpretation of a MAC clause.
Merger of Woodward, Inc. and Hexcel Corporation
The two large aircraft part suppliers first entered into an agreement to merge in January 2020. The proposed deal was an all-stock merger of equals valued at US$6.4 billion. Since the announcement of the deal in January, both Woodward's and Hexcel's share values have been halved in response to the impact of the pandemic on the aerospace and industrial sectors, as well as the global financial markets broadly. On April 6, 2020, both companies agreed to terminate the merger. The combined company would have created one of the largest aerospace and defense suppliers.
Hostile Takeover of HP Inc. by Xerox Holdings Corporation
On March 31, 2020, Xerox Holdings Corp. walked away from its five-month, US$35-billion hostile cash-and-share bid to acquire its larger rival, HP Inc. The initial bid secured commitments for up to US$24 billion from a syndicate of lenders including Citigroup Inc., Mizuho Financial Group Inc. and Bank of America Corp. Since the beginning of March, Xerox’s market value was roughly halved, reducing the value of its bid by approximately US$4 billion. In a statement issued by Xerox, the "current global health crisis and resulting macroeconomic and market turmoil caused by COVID-19 have created an environment that is not conducive to Xerox continuing to pursue an acquisition of HP Inc."
Not all M&A transactions have been under pressure as some deals have shown resilience during the pandemic. Various dealmakers have found solutions to the COVID-19 upset: Devon Energy Corp and Banpu Pcl. agreed to amend the terms of a pending deal for Devon's Barnett Shale assets by incorporating contingency payments tied to future commodity prices; Delphi Technologies Inc. and BorgWarner Inc. also renegotiated to save their deal after a dispute surrounding Delphi's use of their line of credit and reduced the proposed share ratio by 5%; and in late April, Vancouver-based Silvercorp Metals Inc. announced the signing of a definitive agreement for the acquisition of Guyana Goldfields Inc., having conducted its due diligence online and remotely through a variety of technological workarounds.
The M&A dealscape may also shift as companies look to divest distressed assets or parts of their business to opportunistic buyers in the new pandemic environment. Most recently, Uber recently announced a takeover bid for Grubhub, an offer that could value Grubhub up to US$6.9 billion, and give Uber Eats 55% of the U.S. food delivery market with an addition of 24 million active users. The consolidation of two third-party food-delivery giants will be closely followed as, according to industry experts, the field has lacked profitability for years and has come under increased scrutiny during the surge of food delivery during the pandemic.