In a period of economic, political and regulatory change, how can companies plot the right course for M&A success?
Merger control in a changing world
Global economic growth is back on the agenda and companies are once again looking to position themselves for success by pursuing mergers and acquisitions. But what are the prerequisites for success in an increasingly disrupted world?
Welcome to the second White & Case merger control publication, the first edition of which was warmly received. Earlier this year, it became apparent that an update was required, not so much driven by regulatory change, but rather to take into account policy shifts.
For example, we have seen the US catch up with Europe in relation to vertical mergers, the AT&T/Time Warner review being the most prominent recent example. At the same time, the European Commission has forged ahead again with a focus on conglomerate mergers and innovation markets. Perhaps the Dow/DuPont merger has attracted the most attention, as authorities now get out their telescopes and look far into the horizon to identify anti-competitive harm. There is a sense among the Commission’s hard-liners that in the past too many mergers wriggled through without proper analysis. Our own view is that it may be legitimate to look ahead to try and identify harm (after all, that is what merger control is all about), but this long lens should not be forgotten when it comes to reviewing the synergies that a merger may create. However, Europe has set the tone, and we expect other authorities to follow.
Europe also seems to be taking the lead (and others will follow due to the prospect of publicity-garnering fines) in relation to procedural infringements. The argument for pursuing companies for inaccurate filings, for example, is that such violations call into question the very system of merger control. Be that as it may, due process needs to be followed in such cases, and this may divert valuable resources to past cases as opposed to dealing with the current case load. In other words, pursuing a few flagrant cases may be necessary to set a precedent, but they should not become regular items on the authorities’ agendas (bringing with them attendant increases in filing times, and costs). Our view is that the authorities should confine their focus to statements that would have yielded a very different outcome, not mere technical infringements.
This leads us to the subject of gun-jumping. Again, viewed from afar, this should not be a problem in no-issues filings, and authorities typically have the tools to unwind a completed merger. The maxim ‘no harm, no foul’ ought to be applied to these cases to ensure that valuable resources are not frittered away on them.
In sum, our assessment is that the global system of merger control continues to limp along. However, the costs associated with a system containing myriad controls are increasingly high. Looking ahead, we wonder whether a fundamental overhaul is needed to ensure that transactions that pose no problems are not saddled with the costs imposed by the global system. (Yes, this will mean some authorities will have to relinquish jurisdiction in certain instances, safe in the knowledge that a transaction will be reviewed elsewhere.)
But more importantly, we continue to believe that the system of mandatory pre-merger review is fundamentally flawed and that instead we should shift to a system of voluntary merger control in which only mergers that present genuine issues need to be notified. Ironically, when commentators question whether the UK system of merger control needs to change in light of Brexit, one of the things that we would not change is the voluntary nature of the system.
The European Commission is increasingly concerned that market consolidation will harm innovation and has changed dramatically the way it examines the impact of mergers on innovation. Merging parties should be prepared for it.
When it comes to mergers within the digital landscape, the greatest challenge for regulation is to strike the right balance as regards enforcement. How are EU authorities taking action and what does this mean for the innovation economy?
The European Commission is paying greater attention to investors who hold stakes in multiple companies in the same industry and considering how this concentration of influence might have an anti-competitive effect.
Delays or derailment of a deal by merger control considerations can significantly impact the commercial returns for both parties. But there are a number of steps that businesses can take to mitigate the risk.
Avoid unnecessary 'triggering events'
In the majority of jurisdictions, a filing is triggered only if there is a 'change in control', meaning that a party acquires de jure or de facto joint or sole control over the target. Typically, the acquirer obtains sole control if it alone can decide on strategic matters, such as the budget, business plan, major investments and appointment/removal of senior management. The acquirer would obtain joint control if it can block such decisions ('veto rights').
There would be no change in control if the acquirer obtains a non-controlling minority stake in the target company or if the transaction results in 'shifting alliances', where each strategic decision is approved by a different combination of shareholders.
Some jurisdictions, however, have chosen to create additional 'triggering events' that may cover situations in which an acquirer is not seeking control. For example, the acquisition of a certain percentage of shares or votes in a company constitutes a notifiable transaction in a number of jurisdictions, such as Austria, Germany and Brazil.
In a minority of jurisdictions, a transaction constitutes a notifiable transaction where the acquirer obtains some form of 'material influence', but less than control. In Germany, for instance, the acquisition of the 'ability to exercise competitively significant influence' constitutes a notifiable transaction. This provision is triggered when the acquisition of less than a 25 per cent stake is accompanied by so-called 'plus factors', such as information rights, the right to appoint board members or certain blocking rights. Although not very commonly used, this provision is relevant where the investor is a strategic acquirer with stakes in competing businesses.
Delays caused by notifiable transactions can significantly impact the commercial returns for both parties. Therefore, it may be more commercially attractive to structure the deal to ensure that there is no triggering event. However, it's important to ensure that the structure and deal documentation reflects the parties' true intentions, as competition authorities will assess the economic reality of the transaction and consider whether a situation may give rise to de facto control.
Make use of a put and call option agreement
Entering into a put and call option agreement allows the parties to postpone a filing obligation up to the moment in time when the option is exercised, and where a filing obligation may no longer interfere with deal imperatives or competitive conditions may have changed.
There are two scenarios in which such a move could delay timings of aspects of the transaction that may lead to trigger events: where an acquirer is attempting to purchase multiple businesses; and where an acquirer is looking at a large business that can be carved up to be acquired in stages. In the first of these scenarios, acquirers may wish to combine two similar or complementary targets to create synergies, which can give rise to antitrust scrutiny.
Even if the transactions are undertaken separately (i.e., no mutual conditionality) such that separate filings are triggered, both sets of competition authorities (which may or may not be the same) will review the combination if the transactions run in parallel (i.e., simultaneous closing). Even if they are sequential but overlap to some extent, such that the competition authorities reviewing the second of the two transactions would review the combination, the combination would in practice impact the review by the first set of authorities (in particular if the same authorities review both transactions). This could delay closing of both deals, which can put an acquirer at a disadvantage notably in a competitive bidding context. The acquirer would therefore have to balance two potentially conflicting priorities: ensuring that it signs both deals to realise the envisaged synergies, while not jeopardising its chances of signing each one of them because of the implications the combination may have on the process.
One way to manage this balancing act is to proceed with the more pressing deal first and agree on a put and call option on the second deal. Provided that the second seller is willing to wait, the potentially problematic combination is not reviewed until the acquirer exercises the option, which allows the acquirer to put forward a competitive offer for the first deal while securing both deals.
Where the acquirer is looking at one target which alone gives rise to competition issues, it may be possible to acquire part of the business (for example, one manufacturing plant) or a minority stake initially, alongside a put and call option for the remainder of the business. At the point that the acquirer decides to exercise the option, competitive conditions may have changed or the parties could have used the longer lead time to develop remedies to tackle the authorities' scrutiny.
When exercising staggered acquisitions of several parts of a business involving the same acquirer and seller in the EU, even for acquisitions which are not mutually conditional, extra caution needs to be taken. Even if each individual acquisition would not trigger any filing obligations because the revenue of each part does not hit the filing thresholds, all the staggered transactions involving the same acquirer and seller over a period of two years' time would become notifiable with the most recent acquisition, if one or several of the transactions taken alone or together triggers the revenue filing thresholds.
Offer an up-front carve-out or remedies
If a merger filing is required and it is expected to give rise to in-depth scrutiny, the acquirer can ensure that competition concerns are addressed up-front to avoid slowing down the overall process.
The parties can carve out assets likely to be causes of concern to the authorities before launching the transaction. However, it must be made clear to the authorities reviewing the transaction that the carved out assets will not fall within the scope of the main transaction nor their review. The authorities will also want to satisfy themselves that the problematic assets have indeed been carved out before the main transaction closes.
An alternative to an up-front carve out is up-front remedies, where the parties offer a comprehensive and clear-cut remedy package in Phase 1 to avoid going through the lengthy and in-depth review of a Phase 2 investigation.