WHAT’S MARKET 2013 YEAR IN REVIEW LOOKING BACK AND … · middle market deals, with $10.6 billion of covenant-lite loans being issued by middle market borrowers. While middle market

February 2014 | practicallaw.com32

LOOKING BACK AND THE ROAD AHEAD

W H A T ’ S M A R K E T 2 0 1 3 Y E A R I N R E V I E W

©iS

tock

phot

o.co

m/S

ashk

inw

© 2014 Thomson Reuters. All rights reserved.

33Practical Law The Journal | Transactions & Business | February 2014

An overview of recent trends in loan terms and key highlights from public M&A activity in 2013, along with projections for the coming year.



The US loan market had a solid year in 2013. Total US syndicated lending reached $2.14 trillion, a 36% increase from 2012.

This article looks behind the headline numbers and examines trends seen in loan transactions in the large corporate (large cap) and middle market segments of the US loan markets in 2013, including:

�� The continued convergence between terms in high-yield bonds and the term B loan market.

�� The migration of some deal terms from large cap deals to middle market deals.

�� The evolution of loan terms that emerged in recent years.

OVERVIEW: COVENANT-LITE LOANS AND REFINANCINGSCollateralized loan obligations (CLOs) continued to pump liquidity into the loan market, as CLO issuances totaled $81.3 billion in 2013, a 50% increase from 2012. The return of CLOs, coupled with a flood of liquidity from other loan market investors searching for yield, continues to help create a borrower-friendly environment for both large cap and middle market borrowers.

Market conditions fueled an acceleration in covenant-lite loan issuances with $238.2 billion coming to market in 2013, a 185% increase from 2012. Demand has become so strong that, in some deals, arrangers no longer have flex rights to add financial maintenance covenants to the terms of the deal in order to achieve a successful syndication. Until recently, these flex rights had been typical in syndicated loans.

Covenant-lite terms have also begun appearing in certain larger middle market deals, with $10.6 billion of covenant-lite loans being issued by middle market borrowers. While middle market covenant-lite deals may bear a higher credit risk than large cap covenant-lite deals, in the current lending environment lenders are attracted to the increased pricing of middle market covenant-lite deals.

Search Great Wolf Resorts, Inc. and Polymer Group, Inc. in What’s Market for summaries of recent middle market covenant-lite loan agreements.

Continuing a key theme from the past couple of years, deal flow from M&A activity and other new money issuances continued to

be far outweighed by refinancings, driven by repricings of existing loans and dividend recapitalizations (dividend recaps). Fully 72% of the $2.14 trillion of loan issuances in the large cap and middle markets were for refinancings of existing facilities.

Despite a slowdown at the beginning of 2013, dividend recap issu-ances surged in the second half of the year, totaling $49.8 billion in 2013, compared with what had previously been a record volume of $47 billion in 2012. While fears over the fiscal cliff and uncertainty about tax rates contributed to the high volume of dividend recaps in 2012, the increased activity in 2013 reflects the availability of funds at attractive rates. This gives sponsors an alternative to a sale or public offering of a portfolio company by allowing them to return cash to their investors without overburdening the company with unmanageable levels of debt and interest expense.

Search Generac Power Systems, Inc. and TriNet HR Corporation in What’s Market for summaries of recent dividend recaps.

The large cap loan market remained very active in 2013, with $1.93 trillion of issuances coming to market in 2013, representing a 39% increase from 2012. In contrast, deal activity in the middle market did not see similar gains, despite lenders looking to put money to work. Market participants point to a number of factors that may have led to middle market loan issuances totaling $203.5 billion in 2013, a relatively small 12% increase from 2012. These include:

�� A lack of meaningful M&A activity.

�� Fewer opportunities to lend to quality credits.

�� Concerns about excessive leverage for some borrowers.

Second lien loans performed well in 2013. Through the third quarter of 2013, second lien loan issuances reached $21.2 billion, an increase of more than 100% from the same period in 2012.

With interest rates remaining near historic lows and demand from investors high, the loan market has become tolerant of increased leverage levels and lower equity contributions that are approaching levels last seen before the financial crisis. Some large cap deals have included first lien leverage ratios of between 4.0x and 4.5x and total leverage ratios of between 6.5x and 7.0x, while in sponsored deals, larger sponsors have successfully negotiated equity contributions of 25% or less. A similar trend can be seen in middle market deals where total leverage ratios of between 5.0x and 5.5x are common, with required equity contributions commonly in the range of 25% to 30%.

2013 Year-end Trends in Large Cap and Middle Market Loan Terms

Practical Law Finance



MARKETS CONVERGEWith so much liquidity from investors flooding the US loan market in 2013 and the changing nature of the investor base, loan documentation in both the large cap and middle markets increasingly allowed for limited restrictions on borrowers and the erosion of other lender protections, creating a more borrower-friendly lending environment.

HIGH-YIELD BOND AND TERM B LOAN MARKET CONVERGENCE

The increasing influence of institutional investors in the syndicated loan market, coupled with an emphasis on trading over holding loans, has resulted in more term B loans coming to market with bond-like features.

Bond-like features that now regularly appear in loan documentation relate to:

�� Uncapped investments in non-loan parties.

�� Builder basket calculations.

�� Uncapped restricted payments.

�� Permitted acquisition debt.

�� Event of default cure periods.

�� Changes in loan buybacks.

�� Restricted and unrestricted subsidiaries.

Uncapped Investments in Non-loan Parties

Loan agreements often include a provision restricting the borrower’s and other loan parties’ ability to make investments in non-guarantor subsidiaries, including by requiring a cap on these investments. The rationale for this restriction is to limit the amount of funds that are allowed to leave the credit group and preserve the assets available to the lenders. In some recent large cap deals, loan parties have been permitted to invest uncapped amounts in any of their subsidiaries, including foreign subsidiaries, even if those subsidiaries are not guarantors of the borrower’s loan.

Builder Basket Calculations

Often, large cap and some sponsored borrowers have been permitted to make restricted payments and permitted investments or prepay subordinated debt using a basket (builder basket) based on the borrower’s retained excess cash flow (ECF).

In some recent large cap and sponsored middle market deals, the builder basket is instead based on the borrower’s cumulative consolidated net income and also includes the proceeds of equity issuances and equity contributions, a formulation common in covenants in bond indentures. In other deals, borrowers have been permitted to increase the size of the builder basket by the amount of any declined proceeds from ECF mandatory prepayments. Sponsors have also successfully negotiated for the ability to switch between builder basket formulations to provide them with added flexibility.

Search Travelport LLC and Revlon Consumer Products Corporation in What’s Market for summaries of loan agreements with builder baskets based on consolidated net income.

Uncapped Restricted Payments

Typically, large cap and middle market borrowers have been permitted to make restricted payments subject to a cap. In many recent large cap and middle market deals, borrowers have been permitted to make restricted payments subject only to being in pro forma compliance with a specified leverage ratio, rather than a cap or basket. This provides the borrower with even more flexibility than is customary in high-yield bond indentures.

Search Scientific Games International, Inc. and Hilton Worldwide Finance LLC in What’s Market for summaries of loan agreements permitting uncapped restricted payments.

Permitted Acquisition Debt

In most large cap deals, the borrower can incur permitted acquisition debt if its pro forma leverage ratio does not exceed a specified level. In some recent top-tier sponsor deals, the borrower has been permitted to incur this additional debt as long as its pro forma leverage ratio is no worse than before the debt incurrence.

Search Scientific Games International, Inc. and Hilton Worldwide Finance LLC in What’s Market for summaries of loan agreements with this flexibility for permitted acquisition debt.

Event of Default Cure Periods

In some recent large cap deals, borrowers have been given more latitude to cure certain events of default by including more flexible cure rights. In certain sponsor deals where the borrower’s capital structure includes high-yield notes, if the borrower defaults under its indenture, which would typically trigger the loan agreement’s cross-default, the cross-default event of default under the loan agreement is deemed to have been cured if the borrower cures the default under the indenture.

Changes in Loan Buybacks

In some recent sponsored deals, borrowers have been permitted to buy back loans on a non-pro rata basis, in some cases without a cap, with a corresponding dollar-for-dollar reduction in the borrower’s ECF sweep. Non-pro rata purchases allow the borrower to buy back loans from individual lenders.

However, reducing the ECF sweep dollar-for-dollar by the amount used to buy back loans undermines the pro rata application of prepayment proceeds that is customary in loan agreements. Because borrowers are not currently doing buybacks in significant volumes, these provisions may have limited practical impact. In addition, the strain on relations between the borrower and its bank group that could arise if the borrower negotiated a repurchase of its debt with an individual lender that deprived the remaining lenders of prepayment proceeds may act as a disincentive to conducting a buyback on these terms.

Search Mariposa Merger Sub LLC and H.J. Heinz Company in What’s Market for summaries of loan agreements permitting buybacks with a corresponding dollar-for-dollar reduction in ECF.



Market participants also continue to consider appropriate mechanisms to provide large cap and middle market borrowers (and sponsors) with increased flexibility to conduct loan buybacks while, at the same time, trying to standardize buyback procedures. Issues commonly considered include:

�� Whether buyback procedures should be specified in the loan agreement.

�� Whether borrowers should be permitted to make open market purchases (as opposed to purchases through Dutch auctions), and whether or not there should be a cap on those buybacks.

�� Whether sponsors need to give a non-public information representation for open market purchases or whether an affiliated lender must identify itself.

�� Additional procedures and safeguards for assignments to affiliated lenders, including caps on the buyback amounts and limitations on voting rights.

Restricted and Unrestricted Subsidiaries

In many recent large cap and larger middle market deals, borrowers may designate unrestricted subsidiaries that are not subject to the loan agreement’s covenants or events of default and are not required to guarantee the loans or grant a security interest over their assets.

Search Scientific Games International, Inc. and Hilton Worldwide Finance LLC in What’s Market for summaries of loan agreements allowing the borrower to designate unrestricted subsidiaries.

Search Term Loans and High Yield Bonds: Tracking the Convergence for more on high-yield bond and term B loan market convergence.

CONVERGENCE BETWEEN MIDDLE MARKET AND LARGE CAP DEAL TERMS

With high levels of demand for investments in loans and middle market borrowers increasingly backed by top-tier sponsors, many large cap deal terms continued to find their way into middle market loan transactions.

Large cap terms that are now appearing in middle market commitment letters include:

�� Limitations on expense reimbursement.

�� The specification that sponsor’s counsel will be responsible for drafting the loan documentation.

�� Looser “SunGard conditionality.”

Additionally, large cap terms that are now appearing in middle market loan agreements include:

�� Financial performance measurements that are being negotiated.

Meyer discusses deal activity in the large cap market and key issues the Loan Syndications and Trading Association (LSTA) is considering addressing in its Model Credit Agreement Provisions (MCAPs):

What factors do you see potentially affecting the level of deal activity in the large cap market in 2014?

2013 was another record year for the leveraged loan market, with volume exceeding $600 billion. As we begin 2014, with continued low benchmark rates and investor appetite for higher-margin leveraged loans, there are good reasons for optimism. However, there are strong headwinds that could adversely impact leveraged loan volume in 2014 and shift capital structures towards more asset-based loans and bonds.

First, in March 2013, regulatory agencies issued final Interagency Guidance on Leveraged Lending, which

provided financial institutions with “high-level principles related to safe-and-sound leveraged lending activities.” In the guidance, the agencies articulated that total leverage ratios in excess of 6x raise concerns and advised financial institutions to risk rate loans considering borrowers’ ability to delever (explicitly referring to the ability to repay all senior secured debt and at least 50% of total debt within five to seven years).

Because the guidance did not become effective until May 2013, many transactions completed in 2013 were underwritten in accordance with pre-guidance standards and it is not yet clear what additional procedures financial institutions will implement in 2014 in response to the guidance. However, anecdotal evidence suggests that some financial institutions have reacted to the uncertainty surrounding the guidance by declining to participate in certain highly leveraged transactions.

MEYER C. DWORKINPARTNERDAVIS POLK & WARDWELL LLP

Meyer is a partner in the firm’s Corporate Department, practicing in the Credit Group. He advises financial institutions and borrowers on a variety of credit transactions, including acquisition financings, asset-based financings, debtor-in-possession financings and bankruptcy exit financings.

An Expert’s View



�� Amend & extend provisions.

�� Incremental and refinancing facilities.

Limitations on Expense Reimbursement

Smaller middle market and public company borrowers typically must reimburse the arrangers for expenses regardless of whether the deal closes. Similarly, borrowers looking to add incremental capacity to their existing loan facilities must also reimburse arrangers for their expenses even if the incremental financing does not close. By contrast, many large cap and sponsor acquisi-tion deals require expense reimbursement only if the transaction closes. Some recent middle market commitment letters are making expense reimbursement contingent on closing.

Search ACP Tower Holdings, LLC in What’s Market for a summary of a middle market commitment letter with contingent expense reimbursement.

In other deals, mostly in the middle market, the expense reimbursement obligation can vary based on the creditworthiness of the borrower and may:

�� Require the borrower to make a deposit against its expenses despite being required to reimburse the arranger’s expenses regardless of whether the transaction closes.

�� Require the arranger to provide a fee estimate when the commitment letter is signed.

�� Cap the arranger’s fees that must be reimbursed.

Sponsor’s Counsel to Draft Loan Documentation

In many recent larger middle market sponsor deals, sponsor’s counsel has drafting responsibility for the loan documentation, rather than lender’s counsel which is the traditional approach. In other recent cases, where lender’s counsel drafts the loan documentation, sponsors are often permitted to specify a precedent or form on which the loan documentation will be based. In certain deals, where the borrower has a pre-existing relationship with its lenders, the borrower can be permitted to designate counsel for the lending group.

Search ACP Tower Holdings, LLC in What’s Market for a summary of a middle market commitment letter permitting the borrower to specify a precedent.

Looser SunGard Conditionality

Many commitment letters for acquisition financings contain SunGard clauses that limit the representations and warranties made by the borrower and the delivery of certain types of

Second, in August 2013, regulatory agencies re-proposed rules for implementing the credit risk retention requirements of the Dodd-Frank Act. Under the rules, the manager of a CLO is required to keep at least 5% of the “fair value” of securities issued by the CLO. While the rules outline various ways of establishing compliance, any of the mechanisms will adversely affect the economics of the CLO manager and potentially chill new CLO issuances.

The rules do provide an exception for CLOs that hold only loans in which lead arrangers keep at least 5% of the principal amount. However, the commercial viability of this exception is not clear, as loans are not commonly issued on this basis today and some market participants are skeptical that they ever will be. As CLOs are major investors in leveraged loans, any decrease in the issuances of new CLOs will have a material effect on market demand.

In sum, while conditions are generally conducive to another strong year, the increased regulatory scrutiny of underwriting standards, combined with a potential reduction in demand from new CLOs, may have a negative effect on 2014 leveraged loan volume.

What are some of the key issues the LSTA is considering addressing in its MCAPs?

Many of the issues that the LSTA is considering in the update to its MCAPs, including provisions addressing amend & extend transactions, borrower buybacks/affiliate lender assignments and cashless roll mechanics, are

generally accepted or administrative in nature. However, one subject that will likely generate much focus, and have the greatest potential impact on loan transactions, is the inclusion and implementation of a “disqualified lender” exception for assignments.

To prevent competitors and other disfavored institutions from obtaining sensitive information and participating in decisions affecting its capital structure, borrowers increasingly insist that assignments of loans to specified disqualified lenders be prohibited. Certain borrowers have further requested:

�� Broad descriptions of disqualified lenders (for instance, including “all affiliates”).

�� The ability to update the disqualified lenders list at any time without lender consent.

�� That the disqualified lenders list be maintained and administered by administrative agents.

While prohibiting assignments to specific institutions identified to the syndicate before the closing date has gained acceptance, to avoid materially impacting the liquidity of the underlying loans, lenders have strongly resisted each of the additional requests (other than a limited ability to update the disqualified lender list). In addition, administrative agents have similarly rejected any obligation to monitor lenders’ compliance with these lists. Given the broad inclusion of buy-side participants in the MCAPs update process, the scope and mechanics of disqualified lender lists are likely to be vigorously debated.



collateral required by the lenders on the loan closing date. In many recent middle market deals, the types of collateral required to be delivered at closing are becoming more limited.

Most middle market lenders now only require at closing a perfected security interest in collateral that can be perfected by filing Uniform Commercial Code financing statements, as well as the delivery of stock certificates. However, in a refinancing where the exiting lender has possession of the stock certificates, the new lender typically does not require their delivery at closing. Unless intellectual property assets are an important part of the borrower’s overall worth, lenders typically do not require borrowers to execute intellectual property security agreements on the closing date.

Negotiation of Financial Performance Measurements

The negotiation of net leverage ratios and EBITDA add-backs (typically a list of deal specific charges and expenses incurred by the borrower) in financial performance measurements is now common in middle market deals, aside from the smallest deals.

However, in some cases these add-backs are subject to caps. In addition, in some deals, the percentages of ECF required to prepay loans and the related step-downs based on financial ratio tests are also being negotiated.

Amend & Extend Provisions

Many recent middle market deals include provisions permitting the borrower to amend and extend its loans. These provisions are being included despite the argument by lenders that this ability is not necessary because these provisions do not constitute a commitment by any lender to extend their portion of the loan at a later time.

Search Radiation Therapy Services, Inc. and Vince, LLC for summaries of middle market loan agreements with amend & extend provisions.

Search What’s Market: Amend & Extends for more on amend & extend provisions and recent precedents.

Incremental and Refinancing Facilities

Incremental facilities have become common in many middle market deals. In some of these deals, however, lenders are hesitant to allow additional lenders into the deal and have required that they be given the right of first offer before a borrower accepts commitments from new lenders.

Search Tropicana Entertainment Inc. and RE/MAX, LLC in What’s Market for summaries of middle market loan agreements with incremental facilities.

Search What’s Market: Incremental Facilities for more on incremental facilities and recent precedents.

Refinancing facilities are now permitted in certain larger middle market deals, though typically only when the loans are syndicated. In smaller middle market deals, refinancing facilities



Cassandra reviews developments in middle market deals:

What factors do you see potentially affecting the level of deal activity in the middle market in 2014?

The factors that may affect 2014 deal activity are not markedly different from past years. Not surprisingly, M&A activity will have a major impact on middle market deal volume. Hopes are high that 2014 will be a better year than 2013 was for M&A, but a lot will depend on both buyers’ and sellers’ expectations for purchase price multiples.

Continued regulation or “guidance” of the bank lending market could also have a major impact on deal activity in the middle market. Specifically, it will be interesting to see how bank lenders implement internal policies and procedures with respect to the Interagency Guidance on Leveraged Lending, and whether these policies and procedures affect overall middle market deal activity.

The general stability of both the US and global economies may also affect deal activity. Interest rates also have the potential to have an impact, although I would not expect to see big changes in early 2014.

Is middle market loan documentation affected by the closer relationship between the borrower and its lenders and, if so, in what ways?

In many cases, especially for private equity-backed deals where the sponsor may work with the same lender or group of lenders on many deals, documentation certainly is affected by the closer relationship in several ways.

First, documentation tends to be completed at a faster pace for multiple reasons, including:

�� The parties’ familiarity with “hot button” issues for both the lender and the borrower and how these issues have been satisfactorily addressed in prior transactions.

�� The use of previously negotiated loan documentation (including many of the boilerplate provisions and materiality thresholds for covenants and representations and warranties that often take a protracted time to negotiate).

�� An overall comfort level with each party’s policies and procedures.

Second, a long-term relationship helps build confidence in, and trust between, the borrower and its lenders. This confidence and trust often leads to more straightforward communication and quicker resolution of disputed deal points. Lenders may also be more willing to “stretch” on terms somewhat more for a borrower with whom it has a long-standing relationship, for example, justifiable EBITDA add-backs, net leverage, basket levels for negative covenants, grace periods and cure rights. Ultimately, however, the deal needs to make sense in terms of the lender’s risk return analysis or it is not going to get done no matter the length of time a lender and a borrower have been doing business together.

Third, in a default scenario, a resolution, whether documented pursuant to a waiver or a forbearance, may be achieved more quickly in deals where the borrower and the lender have a close relationship. This is especially the case where the parties have worked amicably through a default situation and reached a resolution satisfactory to both in other deals. Confidence and trust are particularly important in this situation.

CASSANDRA G. MOTTPARTNERTHOMPSON & KNIGHT LLP

Cassandra represents lenders and borrowers in middle market finance transactions. She has structured, negotiated and documented senior, subordinated and mezzanine financing facilities of various types, including single, “club” and multi-bank, syndicated, general working capital, investment-grade credit, asset-based, cash flow, first lien and second lien, and multijurisdictional and multicurrency facilities.

An Expert’s View

are not as common because of the smaller size of the deals and the closer relationship between the borrower and lender.

Search Norcraft Companies, L.P. and PGT, Inc. in What’s Market for summaries of middle market loan agreements with refinancing facilities.

Other Notable Terms

There are several additional large cap terms that had previously appeared in some middle market deals and continued to be seen in 2013, including:

�� No financial ratio closing condition.

�� Fully negotiated covenant levels.



�� Bifurcated governing law provisions.

�� Affected lender standard for amendments.

ONGOING TRENDSThe following loan market trends emerged or evolved in recent years and continued through 2013:

�� Second lien loans. In the current lending environment, investors are drawn to the higher pricing of second lien loans. For the most part, these investors are content for the non-economic terms of second lien loans to mirror the terms of the related first lien deals with additional cushions around covenant levels in the second lien loans. As between first and second lien lenders, there is often little pushback on intercreditor agreement terms, with many second lien lenders accepting limited rights over shared collateral as the price for the higher interest rates. For summaries of second lien loan agreements, search Eastman Kodak Company and Black Ridge Oil & Gas, Inc. in What’s Market.

�� Unitranche financing. Still a uniquely middle market financing option, unitranche loans are structured as single debt instruments (one tranche of loans) that combine senior and subordinated tranches of debt into one facility with a blended interest rate (which is often less than the combined rate the borrower would pay for two separate facilities). Outside the loan agreement, the unitranche loan is divided into first and second lien tranches, with lenders entering into an agreement among lenders (AAL) that provides for the treatment of priority issues. AALs are rarely disclosed and not standardized between different lenders.

�� Cashless rolls. Because many pre-financial crisis CLOs are now outside their reinvestment periods, they are restricted from making new investments with the proceeds of loan repayments. To be able to maintain its investment in any portfolio loan that is to be refinanced by its borrower, an older CLO must roll exposure of its loan into the refinancing facility without first being repaid for the original loan. A cashless roll is a mechanism to allow a refinanced loan not to be categorized as a new loan and therefore permit an older CLO to keep its investments. Cashless rolls also allow offshore lenders who prefer not to participate in primary syndications of loans to US companies to keep their investments in the refinanced loans. Concerns among practitioners continue around:�z whether a transaction should be characterized as a continuation of an existing loan or as a new loan facility (with normal syndication procedures to follow);�z whether a cashless roll should be accomplished using an amendment to the existing loan documents or a separate letter agreement;�z the level of involvement by the administrative agent in the process, such as whether the administrative agent should be required to sign off on the characterization of the transaction and whether the loan agreement’s exculpatory provisions apply to any role the administrative agent plays in a cashless roll transaction; and�z whether language should be added to loan agreements explicitly permitting cashless rolls, regardless of the form they take.

�� Call periods. One of the factors that has helped to encourage the refinancing boom has been the expiration of call protection in borrowers’ loan agreements at a time when interest rates are at historic lows. While the borrower can refinance its existing loans without paying a penalty once its call period terminates, it must still consider other costs associated with the refinancing. These include:�z legal fees and expenses;�z transaction expenses; and�z time and energy of the borrower’s management spent away from running the borrower’s business.

�� Disqualified lender lists. Large cap borrowers continue to push for more expansive lists of disqualified lenders and for the ability to add to the list post-closing. However, lenders are still resistant to these points. Discussions among market participants concerning disqualified lender lists include the following issues:�z whether affiliates of the borrower’s competitors should be included;�z whether the list should be attached to the loan agreement as a schedule; and�z the consequences of assignments to a disqualified lender.

�� Precap provisions. Precap provisions (which allow the sale of a borrower’s equity interests without triggering a change of control event of default) continue to be available for top-tier sponsors in large cap deals. However, in practice, transactions using precap provisions remain rare.

LOOKING AHEADAlthough 2013 was a year of readily available credit on favorable terms for many borrowers in the US loan markets, many market participants continue to be concerned about the potential impact of the Interagency Guidance on Leveraged Lending. These guidelines were issued by federal regulators in March of 2013 in response to concerns that lenders’ underwriting practices do not adequately address risks in leveraged lending. The guidelines may significantly reduce the extent to which lenders can offer loans on today’s borrower-favorable terms and may weigh on loan market activity as lenders implement them.

Despite the 36% increase in syndicated lending in 2013, M&A activity and other new money issuances were not primary drivers of loan market volume, as market participants had hoped they would be. While market watchers were hopeful that the announcement of a handful of large, high profile transactions (such as Verizon Communications, Thermo Fisher Scientific Inc. and Amgen Inc.) had signaled a broader return of M&A activity, this turned out not to be the case. However, in the second half of 2013, new money deals made up nearly 60% of all institutional issuances, with M&A activity accounting for 50% of those issuances, according to Fitch Ratings Ltd. This shift could be a promising sign for the loan market in the coming year.

The market statistics cited in this article were provided by Thomson Reuters LPC, except where otherwise noted.



Public M&A deal volume has been steadily declining for years, with 2013 having the lowest level of activity since 2009. Despite a rebound in the third quarter, slow activity

throughout the rest of the year kept overall deal volume low.

Against this backdrop, 2013 saw:

�� High levels of activity in the large cap market, with weakening middle and small markets accounting for the overall decline in deal volume.

�� Continued consolidation in the banking and financial services and the computer and electronics industry sectors.

�� Increased use of the tender offer structure, due largely to the adoption and effectiveness of Section 251(h) of the Delaware General Corporation Law (DGCL).

In spite of the low deal volume, many noteworthy developments in deal-making took place in 2013, including:

�� A willingness of an increasing portion of strategic buyers to agree to go-shop provisions.

�� The emergence of novel deal-protection devices, including creative no-shop exceptions.

�� A significant number of deals using contingent value rights to bridge valuation gaps.

�� Innovation in material adverse effect definitions and carve-outs.

�� The use of reverse break-up and other fees to allocate antitrust risk.

�� Hostile deal activity in the form of unsolicited offers and transactions prompted by shareholder activism.

OVERVIEW: LOW DEAL VOLUMEIn 2013, What’s Market tracked 140 signed agreements for acquisitions of publicly traded US companies valued at $100 million or more. This continues the steady decrease in deal volume in the US since a post-financial crisis high of 181 deals in 2010, which fell to 157 deals in 2011, 143 deals in 2012 and 140 deals in 2013. Deal flow in the first two quarters of 2013 was fairly even, with a spike in activity in the third quarter, followed by a drop-off over the last three months of the year (see Figure A). The fourth quarter of 2013 saw the fewest deals since the first quarter of 2012.

DECREASE IN DEBT-FINANCED DEALS

The overall decline in public M&A volume was also reflected in the year’s leveraged public M&A activity, with 2013 being the weakest year since 2010. Despite a small uptick in the second quarter, in which a majority of public M&A deals were

debt-financed, 2013 continued the trend observed for the last three years of declines in debt-financed deals in both volume and as a share of public deals overall (see Figure B).

The primary method of allocating the risk of financing failure is through a reverse break-up fee payable for the buyer’s material breach or failure to close the transaction, including for a financing failure. Just under two-thirds of all leveraged deals in 2013 (37 out of 57) were structured to have this type of fee (excluding reverse break-up fees payable for antitrust failure or other triggers similar to a target company break-up fee). Of these deals, 19 (51.4%) contained a fee valued at more than 6% of the total deal value.

Although this fee structure is typically associated with debt-financed deals, the largest reverse break-up fee of the year, by percentage, was in an equity-financed deal, TPG Capital’s acquisition of Assisted Living Concepts, Inc. The fee payable in that deal represented over 14% of the deal value and would be triggered in the event of TPG Capital’s failure to close the merger when required.

Only one deal in 2013 featured a “pure option” structure, under which the sole and exclusive remedy of the target company for the buyer’s breach is the reverse break-up fee, but no right to

50

40

30

20

10

0

60

Q1 09

Q2 09Q3 09

Q4 09Q1 1

0Q2 10

Q3 10Q4 10

Q1 11

Q2 11Q3 11

Q4 11Q1 1

2Q2 12

Q3 12Q4 12

Q1 13

Q2 13Q3 13

Q4 130

10

20

30

40

50

60

13

22

30 30

48 48 49

4044

28

3633

42

353032

23

35

5053

Num

ber o

f dea

ls

Quarter

FIGURE A: PUBLIC M&A ACTIVITY BY QUARTER

2013 Year-end Public M&A Wrap-upPractical Law Corporate & Securities



seek specific performance of the buyer’s obligations under the merger agreement. This deal, the management buyout (MBO) of AsiaInfo-Linkage, Inc., was also one of only two debt-financed deals in 2013 to include a two-tier reverse break-up fee, where the larger fee is payable if the breach or financing failure is committed willfully. The other deal was the leveraged buyout of Arden Group, Inc. by TPG Capital.

Search Reverse Break-up Fees and Specific Performance for more on reverse break-up fee provisions.

STRATEGIC VS. FINANCIAL BUYERS

With overall and leveraged M&A activity both down, the split in deals among strategic and financial buyers remained at roughly 75% to 25%, which is consistent with the past several years (see Figure C). Of the 34 financial deals in 2013, 25 were reached with single private equity firms. Of the remaining nine:

�� Six were MBOs (including the Michael Dell/Silver Lake Partners and Dell Inc., and David H. Murdock and Dole Food Company, Inc. deals).

�� One was a “club” deal with multiple buyers (the buyout of BMC Software by a consortium comprised of Bain Capital, Golden Gate Capital, GIC Special Investments and Insight Venture Partners).

�� Two were entered into with other types of financial buyers.

INCREASE IN LARGE CAP DEALS

Following a memorable burst of activity in the first two weeks of February, 14 acquisitions of US public companies valued at $5 billion or more were agreed to in 2013 (see Figure D). This is more than double the six deals valued at $5 billion or more for all of 2012, though still less than the 20 large cap deals signed

in 2011. On a percentage basis, large cap deals made up exactly 10% of overall deal activity in 2013, up significantly from 4.2% in 2012. For further comparison, large cap deals made up 12.7% of deals in 2011, 6.1% in 2010 and 12.0% in 2009.

The largest domestic deal of 2013 was Publicis Groupe SA and Omnicom Group Inc.‘s July 2013 agreement to combine in an all-stock merger, with a resulting $35.1 billion combined market capitalization. This deal was also one of several cross-border “inversion” deals in 2013 structured as a merger of equals in which the US party to the deal (usually the buyer) merges into a new entity in a European jurisdiction with lower corporate tax rates.

The next four largest deals of 2013 in the US were signed in the first four months of the year, with deal values ranging from $13.6 billion to $28 billion. These include:

�� The Berkshire Hathaway Inc./3G Capital and H.J. Heinz Company leveraged buyout.

�� The Dell MBO.

�� The Liberty Global, Inc. and Virgin Media Inc. merger.

�� The Thermo Fisher Scientific Inc. and Life Technologies Corporation merger.

While the market for large cap deals was relatively active in 2013, the small and middle markets lagged. A total of 79 public mergers of US target companies valued between $100 million and $1 billion were agreed to in 2013, down from 83 deals in 2012 and 91 deals in 2011. The volume of deals valued at $1 billion to $5 billion also fell off, with 47 deals in that range in 2013, compared to 54 in 2012, 46 in 2011 and 64 in 2010.

CONSISTENT LEVELS OF STOCK DEALS

With US stock markets showing prolonged strength, a significant portion of buyers accessed their stock as currency for their deals.

90%

80%

70%

60%

50%

0%

10%

20%

30%

40%

100%

Q1 10

Q2 10Q3 10

Q4 10 Q1 11

Q2 11Q3 11

Q4 11Q1 1

12Q2 12

Q3 12Q4 12

Q1 13

Q2 13Q3 13

Q4 130

10

20

30

40

50

60

70

80

90

100

1218

10

21

24

31

15 18

11

23

1719

11

18

16 11

18 32 38 32 24 18 13 14 12 17 19 25 22 17 26 19

Perc

enta

ge o

f all

deal

s

Quarter

FIGURE B: DEBT-FINANCED DEALS BY QUARTER

Debt-financed Not debt-financed

50

40

30

20

10

0

60

Q1 11

Q2 11Q3 11

Q4 11Q1 1

2Q2 12

Q3 12Q4 12

Q1 13

Q2 13Q3 13

Q4 130

10

20

30

40

50

60

36 36

2125

18

29 29

34

24 25

33

24

12 13

77

5

117

10

910

9

6

Num

ber o

f dea

ls

Quarter

FIGURE C: STRATEGIC VS. FINANCIAL BUYER ACTIVITY BY QUARTER

Strategic Financial



Particularly over the last 18 months, the percentage of deals in which buyers have used stock as a component of consideration (including in all-stock/equity exchanges, cash and stock deals and cash-or-stock election transactions) has remained stable at around 30%.

In the second half of 2013, buyers in 27.8% (20 of 72) of deals relied on stock for at least a portion of the consideration, down slightly from 29.4% (20 of 68) of deals in the first half of 2013 and from the second half of 2012, when buyers in 31.3% (25 of 80) of deals paid at least partially with stock. Although these percentages have been in a small decline, they still represent a significant turnaround from the 12 months comprising the first half of 2012 and second half of 2011, when less than 20% of buyers paid with stock consideration (see Figure E).

MOST ACTIVE INDUSTRIESThe banking and financial services industry was the most active industry sector in 2013 for public M&A, with 23 agreements for acquisitions valued at $100 million or more signed. This is the first year since 2009 that the software and electronics industry was not the most active sector.

The most active industry sectors in 2013 were:

�� Banking and financial services (23 deals, up from 19 in 2012).

�� Software and electronics (20 deals, down from 26).

�� Pharmaceuticals and biotechnology (12 deals, down from 13).

�� Oil, gas and utilities (11 deals, up from ten).

�� Medical devices and healthcare (nine deals, down from 15).

�� Consumer goods (eight deals, up from five).

�� Manufacturing and machinery (seven deals, down from eight).

The banking and financial services sector was dominated by smaller deals, often involving regional consolidations. Only four deals in the sector were larger than $1 billion, none larger than the $2.3 billion acquisition of CapitalSource Inc. by PacWest Bancorp. By contrast, the software and electronics sector featured some of the largest deals of the year, including the Dell and BMC Software deals, and the acquisition of Molex Incorporated by Koch Industries. Half the deals in this sector were valued at $1 billion or more.

The typical form of consideration was also a point of distinction between these two sectors. In the software and electronics sector, all but one of the buyers paid entirely with cash, and half borrowed funds to finance the deal. The banking and financial services sector, on the other hand, featured only three all-cash deals, with the rest of buyers paying entirely with stock or a mix of cash and stock.

INCREASE IN TENDER OFFERS AND IMPACT OF DGCL SECTION 251(h)The most significant legal development of 2013 affecting M&A activity was the amendment to the DGCL to ease the tender offer process. The new Section 251(h) of the DGCL eliminates, for qualifying transactions, the shareholder-approval requirement on back-end mergers following front-end tender offers. The amendment became effective on August 1, 2013 and, as anticipated, triggered a significant increase in the use of the front-end tender offer structure.

While only 17.6% (12 of 68) of deals in the first half of 2013 were structured as tender offers, one-third (24 of 72) of deals in the second half of the year were structured that way, including 37.9% (22 of 58) of deals signed after August 1 (see Figure F ). Of the 20

90

80

70

60

50

0

10

20

30

40

100

110

1st H

alf 09

1st H

alf 10

1st H

alf 11

1st H

alf 12

1st H

alf 13

2nd Half 0

9

2nd Half 1

0

2nd Half 1

1

2nd Half 1

2

2nd Half 1

30

10

20

30

40

50

60

70

80

90

100

110

15

3135

42 44

18

2924

30 276

710

19 16

13

10 20 7 15

9

20

29

3526

2022

32

2324

5

7

6

511

9

2

4

86

Num

ber o

f dea

ls

Six-month period

FIGURE D: PUBLIC M&A BY DEAL VALUE

Deals valued at $100 million to $500 million

Deals valued at $1 billion to $5 billion

Deals valued at $500 million to $1 billion

Deals valued at $5 billion or more

1st H

alf 10

1st H

alf 11

1st H

alf 12

1st H

alf 13

2nd Half 1

0

2nd Half 1

1

2nd Half 1

2

2nd Half 1

3

30%

25%

20%

15%

10%

5%

0

35%

0

5

10

15

20

25

30

35

32.5%

26.7%

33%

21.7%

15.9%

31.3%29.4%

27.8%

Perc

enta

ge o

f all

deal

s

Six-month period

FIGURE E: PERCENTAGE OF DEALS WITH STOCK AS A COMPONENT OF CONSIDERATION



Delaware-governed tender offers tracked by What’s Market since August 1, 2013, only one did not “opt in” to Section 251(h).

Because Section 251(h) eliminates the need for a shareholder vote in qualifying tender offer transactions, top-up options to reach the short-form merger threshold, which had been the previous method for avoiding a shareholder vote, are similarly no longer necessary in qualifying transactions. This not only streamlines the path to closing, but also allows willing parties to draft simpler merger agreements by omitting the old mechanical language for top-ups. Notably, of the 19 tender offers that opted in to Section 251(h), 13 agreements did not include language for a top-up option even as a fallback if the transaction were to fail to meet the requirements of Section 251(h).

Search Merger Agreement (Tender Offer, Pro-buyer) for more on DGCL Section 251(h) and sample language for opting in to Section 251(h).

GO-SHOPS AND NO-SHOPS IN PUBLIC M&A DEALSGo-shop provisions allow the target company to actively solicit and negotiate competing bids from third parties and provide confidential information to those parties for a specified period of time following execution of the merger agreement. They are most often included in a merger agreement if the target company had not conducted a meaningful pre-signing auction, so that the target company’s board can satisfy its fiduciary duties to the shareholders.

In 2013, 12.1% (17 of 140) of deals contained a go-shop, down from 13.3% (19 of 143) of deals in 2012. The most common length of time for a go-shop period in 2013 was 30 days, agreed to in six of 17 deals (35.3%) with a go-shop. Thirty days was also the most common length of time for a go-shop period in each of the last two years (42.1% of deals in 2012 and 35.3% of deals in 2011). The next most common go-shop periods in 2013 were 40

days (five deals) and 45 days (four deals). The other two deals with go-shops had lengths of only 22 days and 18 days.

Despite the small decline in the use of go-shops from 2012 to 2013, the year saw some significant innovation around the terms of go-shops and their interplay with other deal-protection measures.

INCREASE IN GO-SHOPS AMONG STRATEGIC BUYERS

Go-shops have traditionally been less common in deals with strategic buyers, who are not as opposed as private equity buyers to pre-signing auctions. However, go-shops were agreed to with greater frequency in strategic deals over the last 12 months. In 2013, eight of 106 strategic buyers (7.5%) agreed to a go-shop. This was an increase from 2012 and 2011, where only 5.4% and 5.0%, respectively, of strategic deals included a go-shop.

Strategic buyers in 2013 also took up a larger proportion of the total number of deals with go-shops than they have in the past. Of the 17 deals with a go-shop in 2013, eight (47.1%) were with strategic buyers and nine (52.9%) with financial buyers. In 2012, however, 31.6% (six of 19) of deals with a go-shop were negotiated with strategic buyers, similar to the 35.3% (six of 17) in 2011.

DECREASE IN GO-SHOPS IN FINANCIAL DEALS

By contrast with the trend seen in strategic deals, the second half of the year saw a severe decline in the occurrence of go-shops in financial deals, with only two of 15 financial deals (13.3%) containing a go-shop, compared to seven of 19 financial deals (36.8%) in the first half of 2013 (see Figure G). While statistics from the first six months of 2013 were in line with those from 2012 (13 of 33 financial deals, or 39.4%), the overall usage in 2013 (nine of 34 financial deals, or 26.5%) returned to a pace more consistent with 2011 numbers (11 of 39 financial deals, or 28.2%). The leveraged buyouts of Dole Food Company, Inc. and

1st H

alf 09

1st H

alf 10

1st H

alf 11

1st H

alf 12

1st H

alf 13

2nd Half 0

9

2nd Half 1

0

2nd Half 1

1

2nd Half 1

2

2nd Half 1

3

30%

25%

20%

15%

10%

5%

0

35%

0

5

10

15

20

25

30

35

28.6%

32.3%

27.5% 26.7% 26.8%

30%28.6%

26.3%

17.6%

33.3%

Perc

enta

ge o

f pub

lic c

ompa

ny a

cqui

sitio

ns

stru

ctur

ed a

s fr

ont-

end

tend

er o

ffers

Six-month period

FIGURE F: TENDER OFFERS BY HALF-YEAR PERIOD

90

80

70

60

50

0

10

20

30

40

100

0

10

20

30

40

50

60

70

80

90

100

7(41.2%)

13(56.5%)

6(24%)

5(35.7%)

8(50%)

5(29.4%)

7(36.8%)

2(13.3%)

10 10 19 9 8 12 12 13

Perc

enta

ge o

f fina

ncia

l dea

ls w

ith a

go-

shop

Six-month period

FIGURE G: OCCURRENCE OF GO-SHOPS IN FINANCIAL DEALS

Go-shop No go-shop

1st H

alf 10

1st H

alf 11

1st H

alf 12

1st H

alf 13

2nd Half 1

0

2nd Half 1

1

2nd Half 1

2

2nd Half 1

3



Yongye International, Inc. were the only financial deals with a go-shop in the second half of 2013.

MODIFIED GO-SHOPS

Over the last 12 to 18 months, What’s Market has observed an increase of “modified go-shops” in public M&A deals. These provisions create a similar bid-encouraging environment as go-shops, but do not explicitly carve out an exception to the no-shop to actively solicit third-party bids. Rather, modified go-shops offer a two-tiered break-up fee structure under which the target company can pay a lower fee if it terminates the merger agreement to enter into an unsolicited superior proposal within a certain number of days of the signing of the merger agreement.

The modified go-shop structure was somewhat common in the first half of 2013, appearing in five deals:

�� MidAmerican Energy Holdings Company and NV Energy, Inc.’s merger.

�� Shuanghui International Holdings Ltd. and Smithfield Foods, Inc.’s merger.

�� Vista Equity Partners’ tender offer for Websense, Inc.

�� Madison Dearborn Partners and National Financial Partners Corporation’s merger.

�� General Electric Company and Lufkin Industries, Inc.’s merger.

The second half of the year contained only one instance of this deal structure, in Vista Equity Partners’ tender offer for The Active Network, Inc. These six deals in 2013 represent an increase from 2012, which saw only two such deals, both appearing in the second half of the year.

GRANDFATHER CLAUSES

“Grandfather clauses” permit the target company to continue negotiations after expiration of the go-shop with qualifying competing bidders who submitted a proposal during the go-shop period. The qualification for this exception usually comes in one of two forms:

�� A requirement that the competing bid, as made, is or is likely to lead to, a superior proposal.

�� A cap on the length of time for the target company to continue negotiations with qualifying competing bidders.

In the first half of the year, eight of the 11 deals (72.7%) with a go-shop included a grandfather clause. Grandfather clauses became even more common in the second half of the year, as five of the six deals with a go-shop contained a grandfather clause. Of the 13 total deals with go-shop grandfather clauses, five contained both types of qualifications and eight contained only the superior-proposal qualification. None were drafted with only the negotiation period cap.

The use of grandfather clauses has been increasing over the last couple of years. Of deals containing a go-shop, 76.5% (13 of 17) of deals in 2013 and 73.7% (14 of 19) of deals in 2012 included a grandfather clause, up from 62.5% (ten of 16) of deals in 2011.

CONTINGENT VALUE RIGHTSA contingent value right (CVR) is a right given to stockholders of a public target company in a merger transaction that entitles them

to additional consideration after the closing once certain payment triggers are met. The What’s Market database indicates that CVRs are typically agreed to in only a few deals each year, almost all in the pharmaceutical or healthcare industries, where they generally are driven by drug-approval and drug-sale metrics.

Despite generally being quite rare due to their complexity and one-sided risk, 2013 saw six deals in which the parties opted to use CVRs to bridge valuation gaps relating to uncertain future events that could impact the target company’s value. These deals included five in the pharmaceutical and healthcare industries and one in telecommunications:

�� Endo Health Solutions Inc.’s tender offer for NuPathe Inc. ($105 million deal value at signing, plus CVRs of up to $166 million).

�� Cubist Pharmaceuticals, Inc. and Optimer Pharmaceuticals, Inc.’s merger ($535 million deal value, plus CVRs of up to $233 million).

�� Cubist Pharmaceuticals, Inc.’s tender offer for Trius Therapeutics, Inc. ($707 million deal value, plus CVRs of up to $111 million).

�� Community Health Systems, Inc. and Health Management Associates, Inc.’s merger ($7.6 billion deal value, plus CVRs of up to $1 per share).

�� AT&T Inc. and Leap Wireless International, Inc.’s merger ($1.2 billion deal value, plus CVRs for a pro rata share of sale proceeds).

�� AstraZeneca and Omthera Pharmaceuticals, Inc.’s merger ($323 million, plus CVRs of up to $120 million).

By their terms, the six CVRs of 2013 are activated by different types of triggers. The NuPathe, Optimer Pharmaceuticals, Trius Therapeutics and Omthera Pharmaceuticals deals all have CVRs triggered by the achievement of sales milestones, with the Omthera Pharmaceuticals CVR also having milestones for regulatory approvals. The Leap Wireless CVR pays out a share of the proceeds of a sale of a spectrum license, while the Health Management Associates CVR is tied to the resolution of litigation involving the target company.

What’s Market tracked only two deals with CVRs in 2012, four in 2011, two in 2010 and one in 2009.

Search Contingent Value Rights for information on the most common CVR structures, key features of a CVR and the advantages and disadvantages of using a CVR in a merger agreement.

MATERIAL ADVERSE EFFECTOver the last several years, material adverse effect (MAE) provisions in public merger agreements have remained relatively stable in terms of both their definition and the events that are carved out from triggering an MAE. But in 2013, a significant number of agreements featured uncommon MAE definitions, thresholds or carve-outs that are worth highlighting. For example:

�� Four deals reacted to the political environment by specifically carving out any government shutdown or the effects of the “sequester” or “debt ceiling” from an MAE:�z the Engility Holdings, Inc. and Dynamics Research Corporation merger agreement;



Richard examines recent developments in public M&A and offers projections for 2014:

What trends in deal structure and other negotiated provisions in public M&A did you observe during 2013?

The most significant trend in deal structuring in US public company M&A in 2013 was the effectiveness in August 2013 of new Section 251(h) of the DGCL. Section 251(h) was enacted to facilitate two-step transaction structures consisting of a first-step tender offer followed by a second-step merger.

For transactions in which it is available, Section 251(h) will eliminate the need for approval of the stockholders of the target for the second-step merger (provided that the tender offeror owns at least the number of shares of target common stock that would be necessary to approve the second-step merger). As a result, it will:

�� Shorten the time period between consummation of a first-step tender offer and completion of the second-step merger.

�� Reduce the costs associated with two-step transactions.

�� Reduce the risk that an acquirer will not be able to complete the second-step merger after having consummated the first-step tender offer.

A number of market commentators predict that Section 251(h) will lead to an increase in two-step transactions relative to acquisitions structured as single-step mergers, particularly for highly leveraged acquirers. I do not expect a significant increase in two-step transaction structures. I do anticipate, however, and we have already seen, a reduction in the use of other deal technologies that have been developed to manage the risks with two-step transaction structures. These other technologies include:

�� Top-up options, which permit a tender offeror to purchase additional shares following successful completion of a tender offer so as to commit the offeror to cross the 90% threshold necessary for a short-form merger under Delaware law.

�� The so-called “Burger King” or “dual-track” structure, in which an acquirer proceeds simultaneously down the path of a cash tender offer as well as a single-step merger.

�� Subsequent offering periods.

Negotiated provisions in US public company M&A in 2013 have continued to show the normal range of terms regarding deal-protection provisions, material adverse change clauses and antitrust commitments.

One feature that has become much more common is the concept of the “Intervening Event.” Most US public company

RICHARD HALL PARTNERCRAVATH, SWAINE & MOORE LLP

Richard is a partner in the firm’s Corporate Department and Head of the Mergers and Acquisitions practice for EMEA. His practice focuses on mergers and acquisitions and corporate governance advice.

An Expert’s View

�z the Sycamore Partners and The Jones Group Inc. merger agreement;�z the Essilor International SA and Costa Inc. merger agreement; and�z the Integrated Mission Solutions LLC and Michael Baker Corporation merger agreement.

�� Two merger agreements included in the MAE definition carve-outs for specified labor disruptions, even if the disruptions are not specifically related to the announcement of the merger agreement (the Georgia-Pacific LLC and Buckeye Technologies Inc., and Packaging Corporation of America and Boise Inc. merger agreements).

�� Two merger agreements included explicit monetary thresholds that trigger an MAE:�z the MB Financial, Inc. and Taylor Capital Group, Inc. merger agreement, where any claim or penalty assessed or

threatened against Taylor Capital that “would warrant” a reserve of $20 million under GAAP triggers an MAE; and�z the ProAssurance Corporation and Eastern Insurance Holdings, Inc. merger agreement, where an MAE is “conclusively presumed” if the target company’s shareholders’ equity as of any month end before closing is 90% or less than its shareholders’ equity as of June 30, 2013.

�� Three merger agreements included MAE carve-outs to confirm that seasonal fluctuations in the target company’s business will not count as an MAE (the StrykerCorporation and MAKO Surgical Corp., Koch Industries, Inc. and Molex Incorporated, and Hudson’s BayCompany and Sak Incorporated merger agreements).

Search Material Adverse Change Provisions: Mergers and Acquisitions for more on material adverse effect provisions and relevant case law.



M&A agreements include a covenant on the part of the board of directors of the target company to recommend the transaction to target stockholders. This covenant is usually subject to a negotiated fiduciary exception. Increasingly, the scope of this fiduciary exception is being limited to circumstances in which there is a superior proposal or an Intervening Event. An Intervening Event is basically a change in circumstances not involving a superior proposal or other event contemplated by the agreement. The concept of the Intervening Event is being developed to alleviate concerns on the part of the buyer that the target board might simply change its mind.

Apart from acquisition activity, have you noticed any other significant developments impacting M&A practice recently?

There have been two significant factors affecting US public company M&A practice in 2013. The first is the increased level of shareholder activism, which is influencing M&A practice through a variety of channels. Many boards of directors and management teams have become more proactive in considering M&A transactions (particularly divestitures and spin-offs) as preemptive measures to keep activists at bay. Business rationalization is a frequent declared objective of shareholder activists, so boards of directors and management are seeking to get ahead of the activists.

In addition, for those companies that have actually been targeted by activists, significant M&A (again, primarily divestitures or sale of the company) may be a response to the activism. Both of these are somewhat conducive to increased M&A activity. A countering effect of shareholder activism, however, is greater concern on the part of buyers regarding whether a particular acquisition will be well-received by its stockholders and greater concern on the part of the target board of directors about the possibility of activists opposing a proposed sale of the company.

The second significant development is the continuing improvement in the US market for acquisition financing. While the US M&A market in 2013 is well below the boom years of 2006 to 2007 for leveraged activity, it is clear that bank and debt capital markets capacity has increased and firmed up for significant leveraged acquisitions by strategic acquirers and private equity funds. There is heightened confidence across the acquirer universe, ranging from blue-chip corporate borrowers to private equity acquirers, that debt is available at signing and at closing to execute highly leveraged acquisitions.

2013 did not see the hoped-for rebound in US public M&A activity. What drives the public M&A market and what do you think are the prospects for increased deal activity in 2014?

In the medium to long term, US public M&A activity is driven by real economic activity and by rising stock market values, partly offset by regulatory constraints. Over the short term, however, M&A activity can be enhanced by irrational exuberance or retarded by excessive pessimism or stock market volatility. For these reasons, I am generally optimistic about the prognosis for US public M&A, particularly if the US stock market does not quickly surrender a significant portion of its gains from 2013.

M&A activity in a number of sectors, including financial institutions and the energy sector, remains subject to significant regulatory headwinds, and I expect those sectors to continue to underperform from an M&A perspective relative to their contribution to the US macro economy. I see the most significant risks to US public M&A in 2014 as coming from external factors, such as renewed political uncertainty in Washington, further negative news regarding economic recovery in Europe and negative news relating to political developments in the Middle East.

ALLOCATING ANTITRUST RISKFifteen deals in 2013, as in 2012, included a reverse break-up fee payable by the buyer for failure to obtain antitrust approval. The largest of the antitrust-related reverse break-up fees in 2013 was in the merger agreement between The Kroger Co. and Harris Teeter Supermarkets, Inc., valued at 8.0% of the total deal value.

2013 was notable for a new development in how buyers and target companies allocate the risk of failure to obtain antitrust approval. In two deals, the parties negotiated for the rare, antitrust-related “ticking fee.” A ticking fee increases the merger consideration by a certain amount per day for each day that the merger does not close after a deadline for obtaining the required antitrust approvals. Ticking fees may be used instead of, or in conjunction with, reverse break-up fees for antitrust failure.

The two deals with an antitrust-related ticking fee, both reached in the first half of the year, were:

�� The Service Corporation International and Stewart Enterprises, Inc. merger agreement, which provided for both an antitrust-related ticking fee and a reverse break-up fee for antitrust failure.

�� The Thermo Fisher Scientific and Life Technologies Corporation merger agreement, which contained only a ticking fee as an antitrust risk-shifting mechanism.

Search What’s Market: Antitrust-related Ticking Fees for more on ticking fees for antitrust failure.

HOSTILE DEAL ACTIVITY AND SHAREHOLDER ACTIVISMOne of the most important trends in public M&A in 2013 was the role of shareholder activists as drivers of M&A activity. While



shareholder activists traditionally (and still do) pursue smaller changes such as appointing a dissident slate of nominees to the board, shareholder activists in 2013 broadened their scope by influencing, prompting or disrupting several prominent M&A deals. This occurred in several ways, including by encouraging unsolicited bids, advocating for spin-offs or other sales, or opposing a board-approved merger.

The most prominent example of this phenomenon was the Dell MBO, which involved a highly public back-and-forth between the parties to the buyout and activist investor Carl Icahn. The merger agreement, originally signed in February 2013, went through substantial revision, with an amendment that increased the consideration, lowered the break-up fee and modified the voting-approval threshold for the merger.

Other examples of shareholder activists influencing or triggering M&A activity in 2013 were:

�� The Community Health Systems, Inc. and Health Management Associates, Inc. merger. Facing a proxy contest launched by its shareholder Glenview Capital Management, Health Management Associates entered into a merger agreement with Community Health Systems for a deal valued at $7.6 billion. Although a merger usually is the sort of event that placates shareholder activists, Glenview Capital continued its proxy contest for a time until it eventually announced its support for the deal.

�� The Office Depot, Inc. and OfficeMax Incorporated merger. Under pressure from shareholder Starboard Value in the fall of 2012, Office Depot entered into a $1.17 billion merger agreement with OfficeMax in February 2013. As in the Health Management Associates deal, the announcement of the merger agreement did not prompt Starboard to drop its opposition to Office Depot’s board. Office Depot and Starboard eventually reached a settlement that provided for some of Starboard’s nominees to be appointed to the post-merger board.

�� The Men’s Wearhouse, Inc. and Jos. A. Bank Clothiers, Inc. merger. The takeover battle between Men’s Wearhouse and its smaller rival, Jos. A. Bank Clothiers has gone through several iterations of offers and rejections from both sides. The counteroffer made by Men’s Wearhouse, a spin on the old “Pac-Man” takeover defense in which the target of a hostile bid attempts to acquire its own bidder, may have been prompted in part by the public advocacy of Eminence Capital, a hedge fund with significant holdings in both Men’s Wearhouse and Jos. A. Bank.

Several other hostile situations triggered by shareholder activists, including Barington Capital/Darden Restaurants, Inc., Crescendo Partners/Aéropostale Inc. and Biglari Capital/Cracker Barrel Old Country Store, Inc., are still ongoing.

Along more traditional lines, there were three successful “deal jumps” in 2013, two of which resulted from unsolicited bids for the target company and one that resulted from a superior proposal received during a go-shop period. The deals were:

�� Cascade Bancorp’s agreement to acquire Home Federal Bancorp. Cascade topped Banner Corporation’s agreement to acquire Home Federal for $197 million in cash and stock,

with a bid amounting to $265.7 million in cash and stock. The Cascade merger agreement was signed during the go-shop period of the Banner merger agreement, triggering payment of a break-up fee of nearly $3 million (1.50% of the deal value) to Banner.

�� Paulson & Co. Inc.’s agreement to acquire Steinway Musical Instruments, Inc. Paulson’s $512 million all-cash proposal trumped Kohlberg & Company’s agreement to acquire Steinway for $438 million in cash, triggering payment by Steinway of a $6.68 million (2.65% of the deal value) break-up fee to Kohlberg.

�� Kroenke Sports & Entertainment, LLC’s agreement to acquire Outdoor Channel Holdings, Inc. Kroenke bested InterMedia Outdoors Holdings, LLC’s agreement to acquire Outdoor Channel for $176.6 million in cash and stock, triggering payment of a $6.5 million break-up fee under that merger agreement. Initially challenged in early March 2013 by Kroenke, the InterMedia agreement went through several rounds of amendments and increases in consideration before Kroenke and Outdoor Channel eventually reached a deal that closed in May for $258.54 million in cash.

For summaries of the deals mentioned in this article, visit What’s Market at us.practicallaw.com/about/WhatsMarketUS and search by party name.

© 2014 Thomson Reuters. All rights reserved. Use of Practical Law websites and services is subject to the Terms of Use (http://us.practicallaw.com/2-383-6690)

and Privacy Policy (http://us.practicallaw.com/8-383-6692).

WHAT’S MARKET 2013 YEAR IN REVIEW LOOKING BACK AND … · middle market deals, with $10.6 billion of covenant-lite loans being issued by middle market borrowers. While middle market

Documents