Partner, Co-Chair, Mergers & Acquisitions
Fenwick & West
Doug Cogen shared his views with Global M&A Network on the impact of stock market volatility on deal activity, the nuances of selling venture-backed companies, the multifaceted issues involving European deals, the "what if scenarios" for avoiding earn-out related litigation as well his thoughts on executing Reverse Morris Trust transactions such as the pending 2.35 billion dollar merger between Diamond Foods and Pringles.
Q.: In your observation, what are the prominent themes in the American mergers and acquisitions deal volumes in a slow growth economy?
Mr. Cogen: In a slow growth economy, generally the strong get stronger, and M&A plays a certain role in this. But, given the current extreme volatility in company valuations, it seems likely that M&A volumes will remain depressed for the foreseeable future. Deals are largely driven by CEO and boardroom confidence and optimism, which is a commodity in short supply these days. It is also a skittish environment from a process point of view - there is a truly an intense level of due diligence being performed and many deals are being aborted as too risky. All of that said, there is significant cash on balance sheets across corporate America and for the solid companies, ample ability to borrow, so the means are there, but the will is shaky.
Q.: How will the current level of volatility in the stock markets impact the deal activity for the buyer and seller?
Mr. Cogen: Obviously, volatility is generally the enemy of deal-making. It is the rare and truly disciplined acquirer that can advance a deal through the board approval despite 3 - 5% swings in its market capitalization on a daily basis. While many fundamental value metrics have actually been strong over the past year, a steep drop in stock price makes the same economic deal look like an unusually high premium. And, this makes many acquirers uncomfortable out of concern to Wall Street's reaction on the deal announce or that it will make their subsequent deals more expensive.
In the target's board room, being confident that you are selling at the right time and are satisfying duties to achieve best value become that much more pressured when stock prices are on a roller coaster. And adding to the difficulty is the widely held sense that the drivers of the current volatility-government debt levels and a confused policy response, anemic consumer demand, tightened capital spending-are not likely to quickly dissipate.
Q.: In light of economic uncertainties, what global sectors do you see most active, and why?
Mr. Cogen: Health care will continue to be strong, particularly medical devices and pharmaceuticals. The major health care companies have tremendous amounts of cash on hand and their need to replenish drugs coming off patent continues unabated. The materials and commodities-based industries continue to see heavy consolidation. In Tech, while overall deal volume is down, mobile computing, social gaming, storage, software-as-a-service business models, online payments, security, and virtualization all continue to be sub-sectors with substantial activity. Also the renewable energy sector is undergoing a wave of consolidation as this industry matures and its cash flows increase and stabilize.
Q.: Do you anticipate hedge fund activism to drive deals in this sluggish economy?
Mr. Cogen: Activism is certainly playing a role, but I don't think it's a primary driver. While Carl Icahn's sustained pressure on Motorola was no doubt being felt in that boardroom, it seems it was the valuation in the Nortel patent purchase that really accelerated the Motorola acquisition. Many companies are learning to live in a world with a certain level of activism and the relationship between companies and their shareholders is no doubt evolving. But you still have to find that counter-party and a deal value that makes sense, and in this environment, that can be difficult regardless of how much your shareholders, or a particularly vocal subset of them, might like to see an exit event.
Q.: Corporations are increasingly acquiring venture-backed companies. Do you foresee a continuation of this trend in light of stock market uncertainties?
Mr. Cogen: The same pressures on deal-doing such as agreeing on valuation in a volatile environment, getting comfortable with additional business risk or diligence issues--that we have been discussing all apply to VC-backed companies as well, of course.
Q.: What are the nuances of selling a venture-backed company involving many rounds of financing?
Mr. Cogen: The main issues that are particularly acute in a VC-backed sale usually center on valuation and indemnification. In a company that has had multiple financing rounds, the valuation inflection points at which different VC's who invested in different rounds will have a successful exit can vary wildly, and getting the requisite alignment of stockholders to gain approval of a deal can be very tricky.
Q.: Can you elaborate on the indemnification terms for the venture capital backed sale?
Mr. Cogen: Indemnification terms are always controversial, and many VC's are concerned that indemnity obligations that "go beyond the escrow" jeopardize their ability to distribute deal proceeds to their limited partners. Also merging two venture-backed companies can require the reconciliation of two sets of multiple preferred stock series, and in that process, many investors can be unhappy with where they stand in the liquidation "waterfall" when the dust settles.
Q.: There has been a noticeable rise in unsolicited bids lately. How have the tactics of unsolicited takeovers evolved?
Mr. Cogen: While there have been a number of unsolicited bids recently, I wouldn't say an overwhelming number of these have been successful. Target company boards have been fairly disciplined in rejecting bids and holding the line until the valuation has substantially increased or the bidder walks away.
Q.: In an unsolicited bid situation, how is the target company's board exercising their duties?
Mr. Cogen: The target's board, if it determines following due deliberation and analysis, that an offer, even at a substantial premium, does not adequately reflect the long-term value inherent in the company's strategic business plan, is able to reject the bid and use all reasonable and proportionate means to resist it. The board may do this even if a majority of shareholders support the offer and would accept it but for a poison pill or other takeover defense, as the Delaware Chancery Court definitively held earlier this year in the Airgas-Air Products battle.
Q.: What are the best practices in reducing litigation related to M&A such as earn-out disputes?
Mr. Cogen: The best saying about earnouts is "rarely earned, sometimes paid, often litigated!" You really need to spend a lot time with clients on both sides of the deal to ensure the underlying tensions that exist in all earnouts such as alignment of interests between the acquirer's and target's management team, how to deal with natural evolutions in a business (potentially allocating resources away from the products or business metrics that are being measured), departures and additions to the affected team - are truly understood and then documented in a way that at least avoids the foreseeable disputes. The key to this is working through lots of "what if" scenarios and then level-setting all parties expectations.
Q.: What are the top legal concerns in executing cross-border deals?
Mr. Cogen: At a basic level, many of the deal structures that we take for granted in the US, such as the simple statutory merger, are much harder to execute in foreign jurisdictions due to required court approvals or super-majority voting requirements. It is also well understood that the European antitrust regulators are accustomed to taking a more aggressive stance on deals, and it's generally a more open-ended, less defined process in the EU for gaining regulatory approval. And the employee-facing elements of a deal are inevitably more complex abroad, and you are far more likely to encounter true defined benefit pension schemes in foreign companies than in the States, which require careful structuring to assume and maintain.
Q.: Can you further clarify how employee-related issues play out in deals involving Europe?
Mr. Cogen: Sure. The Acquired Rights Directive and related laws can substantially change the economics of a contemplated deal as the buyer may not have modeled the scope and scale of employee-related liabilities that will mandatorily transfer with a desired business. In most European jurisdictions, works councils and trade unions play a far more significant role and need to be considered throughout the deal process.
Q.: Congratulations on representing Diamond Foods on its pending $2.35 billion merger with Pringles. What are the complexities of a "split-off" transaction including tax ramifications?
Mr. Cogen: The Diamond-Pringles deal is a Reverse Morris Trust transaction, which permits a parent company to split off a subsidiary in a dividend to, or share exchange with, its shareholders, and then this subsidiary merges with a target company with the subsidiary's shareholders owning more than 50% of the merged company.
This type of transaction is extremely tax-efficient for both companies and their shareholders, and permits the target company to operate the spun business that is larger than it itself. The merged company needs to comply with a range of requirements post-closing to ensure the tax benefits are preserved. Pringles is also a truly global brand and business, with operations in over a dozen countries, so there are myriad compliance issues that need to be managed.
Q.: What differentiates Fenwick & West's mergers and acquisitions practice team?
Mr. Cogen: One key differentiator is that because we are so deep in the Tech and Life Science industries, our team has a real, organic understanding of our client's business and value drivers. When we see a commercial agreement or a patent portfolio in diligence, we aren't just providing a summary but a full assessment integration and remediation plan as we know what's a problematic business term or an IP landscape that's rife with litigation risk.
We also have one of the strongest tax practices in the country which gives us the benefit of providing very sophisticated structuring, such as in the Diamond-Pringles deal. Moreover, given our deal volume (among the top ten in the United States), the fact that we do it with a group substantially smaller than the other league-leading firms, means that all of our attorneys see a lot more action pound-for pound compared to their counterparts at other firms.
Q.: In closing, what book are you currently enjoying?
Mr. Cogen: I'm a bit embarrassed to admit it, but I'm reading the Game of Thrones series by George Martin. I was a never a big fan of the fantasy genre, but it's very well-written with a brilliantly complex plot. A nice departure from merger agreements!
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