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January 26, 2015
M&A AND CAPITAL STRUCTURE STRATEGY OUTLOOK 2015, PART II

Strategic Activity In The Technology & Telecoms Sector

Mirroring a trend seen in the US mergers and acquisitions market, global technology and telecoms M&A market finally regained volume levels last seen during the pre-crisis peak year of 2007.

26 January (1) 26 January (2)

Sources: S&P CapitalIQ, Reuters, 451 Group

The surge in technology deals is in part related to the eye-popping prices large capitalisation, publicly traded firms are willing to pay for bolt-on technologies or products that can be easily (at least in the eyes of the acquirer) monetised by their sales and distribution forces.  Facebook’s $19 billion purchase of WhatsApp stands as perhaps the most prominent example of this type of transaction.

Many of these technology giants are serial acquirers. Google, for example, announced in excess of three dozen transactions over the course of 2014 with an outlay of approaching $30 billion.

The downside of this trend is that it truly does become a winner-take-all world. The market is offering massive rewards to the one or two winners of the large, public company acquisition-sweepstakes; conversely,  a much less appealing future awaits the others that may have crowded into the sub-sector in question.

Another interesting trend not reflected in the statistics above is technology M&A in Brazil, Russia, India and China (the so-called BRICs). Dealogic reports that 2014 saw $55 billion of technology M&A in the BRICs, with China accounting for over half of that.  2013 saw approximately $33 billion of technology-sector M&A in the BRIC economies. One can presume that the sanctions regime enacted in the wake of the hostilities in the Ukraine will impinge on M&A in Russia.

Private Equity And M&A

Having raised (on a worldwide basis and in all types of fund) $495 billion in 2014, private equity firms ended the year with almost $4 trillion of assets under management. Capital raised was actually below 2013 levels (a year that saw $528 billion of capital inflows into private equity). The industry returned almost $450 billion of capital to LPs during the year, so inflows exceeded outflows for yet another year.

Yet a positive balance of funds flowing into the industry is not necessarily all being invested. The buyout market is the largest segment of private equity industry. Buyout transactions totaled $334 billion during 2014 – a little over $100 billion less than the $428 billion of exits during the year. This $428 billion was spread over ~1600 deals. Canada was the venue for the largest buyout-backed deal: 3G Capital’s portfolio company Burger King buying the donut and coffee chain Tim Hortons.

Venture capital also lagged. Over 1000 venture capital exits produced total proceeds of $120 billion – substantially more than the $86 billion of venture investments made during the year. The largest consumer of venture capital during the year was Uber, which bagged $2.4 billion over tow rounds (June and December).

Canada has played a particularly important role in driving change in the private equity industry. The co-investment model pioneered by the giant Canadian pension funds is increasingly popular on a global basis. This reduces fees for LP. Separate accounts are also growingly popular.

Technical Trends In M&A And Restructuring

We are noting the increase use of insurance policies focused on M&A representations & warranties . Private equity firms looking for a clean sale wherein there will be no holdbacks and trailing indemnity commitments are increasingly looking at such mechanisms to enhance the likelihood of transactions closing.

Another interesting development – and a case of hedge funds versus private equity funds – has been the growing use in the United States of litigation under the Trust Indenture Act of 1939. This Federal law – an outgrowth of Depression-era corporate restructurings – was originally designed to forestall secret deals that could damage or restrict the rights of the owners of a company’s bonds. Such secret deals – or out-of-bankruptcy deals – during restructurings of firms with excessive debt loads have often succeeded because of the implicit (or indeed explicit) threat of a bankruptcy filing.  The law states that rights of a bond-owner to interest or principal payments may not “be impaired of affected without the consent of such holder[s]”.

The potentially changing landscape was precipitated by two cases brought by hedge funds against two private-equity owned firms:  Caesars Entertainment Operating Company and Education Management. These cases were argued before the Federal District Court in Manhattan (rather than in Delaware Chancery Court). In the Education Management case the judge seemed to imply that the Trust indenture Act could reasonably be argued to be a “broad protection against nonconsensual debt restructurings” as opposed to a “narrow protection against majority amendment of certain ‘core terms’”. In the Caesar’s case, which allowed a lawsuit to move ahead, termed the removal of a guarantee by the parent of Caesar’s Entertainment Operating Company as an “impermissible out-of-court debt restructuring”. It is perhaps important to note that what is being attacked is not the ability to restructure; rather what seems to be viewed as problematic is secret deals amongst a handful of participants to a restructuring.

Whilst Canada is increasingly accommodating M&A tactics designed to delay, or impede, unwanted bids, there are limits to how far such a trend can run. Spurred by takeover fears surrounding a well-known hardware chain, 2013 saw Quebec’s former PQ government float proposals enshrining a board’s ability to say “no” and block an unsolicited and unwanted bid. There was talk of giving Quebec companies a form of defensive wall. The new Liberal government seems to have taken a more collaborative approach. It has signed on national initiatives to balance the rights of bidders and boards of target companies.  Bids, under the new proposals, must remain in force for 120 days. The proposals also set the minimum tender condition at 50% (this allows boards more time to seek an alternate bidder and or articulate an alternate value creation strategy to investors.

Another trend is increasing focus on process. Delaware Chancery Court underscored this in its rulings regarding the 2011 sale of an ambulance company (Rural/Metro Corporation) to a private-equity group. Rural/Metro’s adviser was lambasted for conflicts of interest between internal departments as well as for lax internal procedures regarding management of such conflicts. In Cheverny’s view this is inevitable in a bank that has departments trying to advise, lend to, trade in the debt- and equity- securities and manage the personal money of one (or even both) sides. Rural/Metro’s board also came in for criticism: it was deemed to have been equally procedurally lax.

The management and board of directors of Tibco Software received even more by way of condemnation from the Delaware Court of Chancery. Amidst a deal process Tibco based analyses on an inaccurate share count and presented a proposed transaction as representing an equity value $100 million higher than it actually di.

One trend that looks set to vanish in 2015 is the U.S. tax inversion: the basis for 3G’s bid for Tim Hortons. A tax inversion allows a U.S. firm to change tax domicile via an M&A transaction. In late September the U.S. Treasury Department moved to ban such transactions. This will leave late movers gazing enviously at those that had the will and capacity to seize this opportunity early.

Foreign Firms & Cross-Border Deals Dominate M&A In Canada In 2014

Canada also saw the highest level of M&A since 2007, with just shy of $230 billion of announced transactions. This was an over 40% increase from 2014 and was driven mainly by oil and gas transactions: a confluence of events unlikely to be repeated in 2015. The sector may witness a flurry of activity driven by a requirement to deal with stressed balance sheets and over-leverage, but the growth- and reserve- driven deals of 2014 are unlikely to reappear until the declining price of crude oil becomes less of a factor

Four of the top five advisers by deal volume were global bulge bracket banks. Foreign firms dominated M&A through a coverage model of local bankers paired with global teams and a focus on large transactions. Foreign firms have an accordion-like history of expanding and contracting their ranks in Canada, something that does not augur well for long-term relationships.