July 29, 2020 – The term “horse-trading” describes the act of driving a hard bargain in a negotiation. It traces its roots back two-hundred years to describe the fabled shrewdness of the traders who specialized in the buying and selling of horses.
In certain environments, horse-trading can occur in corporate mergers and acquisitions, especially when a specific event occurs that grants one party leverage over the other.
COVID-19 Effects on M&A
The COVID-19 pandemic has produced an interesting number of case studies with respect to corporate stick-handling in the context of a definitive merger agreement.
The global pandemic was an unprecedented shock to the economic system, and many acquirors were completely unprepared for it. By the second quarter of 2020, some M&A targets that buyers had previously negotiated deals with had seen a significant portion of their revenue disappear as the recession sapped demand. Suddenly, buyers were stuck with deals for corporate acquisitions that were likely worth less than they initially bargained for. However, these days merger agreements are notoriously difficult to wriggle out of, as lawyers sharpened their pencils after watching acquirors try to walk from deals struck during the great financial crisis of 2008-2009. Nonetheless, some acquirors have recently engaged in some interesting corporate horse-trading in the coronavirus era.
Once the pandemic hit, some less than reputable acquirors, or those primarily focused on financial returns, tried their best to terminate previously agreed-to acquisitions that all of a sudden looked far less financially compelling.
Opportunity for Hijinks
One pure financial buyer that engaged in some M&A hijinks is private equity firm Advent International. On February 6, 2020, right before the pandemic commenced, Advent struck a friendly deal to acquire publicly-traded tech company Forescout Technologies for $33.00 per share, a $1.9 billion deal at a 30% premium.
Soon after the ink on the merger agreement dried, the coronavirus pandemic hit and a global recession ensued, leading to rapid declines in the prices of risk assets and the widening of arbitrage spreads. The Forescout merger arbitrage spread widened dramatically during March 2020, however, quickly rebounded as confidence returned to the market.
By mid-May, all conditions were satisfied for Advent’s takeover of Forescout and the deal was set to close. Unfortunately, on closing day, acquiror Advent refused to close, spooked after seeing poor first quarter results from Forescout. Unfortunately for Advent, merger agreements are definitive contracts that do not just allow one party to walk away with no repercussions. In an attempt to wriggle out of the deal, Advent purported that a material adverse effect had occurred.
What’s a MAE?
A material adverse effect (“MAE”) is a legal term defined as a change in circumstances that significantly reduces the value of a company. Historically, MAEs have been extremely difficult to prove in order to exit deals without paying financial damages. In fact, a MAE has been demonstrated successfully in court just once, in the case of Akorn v. Fresenius. The landmark case established what is and what is not a MAE:
The Court reaffirmed that “short-term hiccups in earnings” do not suffice; rather, the adverse change must be “consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.”
– A Watershed Development for “Material Adverse Effect” Clauses, Harvard Law School Forum on Corporate Governance
A few days after refusing to close the deal, Forescout rightfully sued Advent, seeking specific performance of the merger agreement, meaning that it would ask the court to force Advent to complete the deal.
Under the one MAE precedent, Advent would face a slim chance of success in court given that Forescout’s poor financial performance was only a temporary hiccup. This thesis was further buoyed by its positive Q2 earnings results, posted after Forescout sued and before it went to trial, which showed a bounce back and normalization in revenue.
Nonetheless, litigation is notoriously unpredictable, and therefore both sides have incentives to settle. Despite having a presumably rock-solid case, Forescout’s stock was in the low $20’s, representing a 35%+ discount to the deal terms. Forescout’s board of directors were keenly aware that shareholders would prefer a price cut instead of the risk of deal collapse, which would result in a further price decline.
Advent knew its case was flimsy and stood a low probability of success. Nonetheless, it was able to utilize the litigation uncertainty, combined with Forescout’s struggling share price, to engage in some horse-trading and come to terms with Forescout on a repriced deal.
Unsurprisingly, days before litigation was to commence, Advent and Forescout met seemingly on the steps of the courthouse and agreed to an amended deal at $29.00 per share, a -12.1% decrease. While not as lucrative for investors as a transaction at the original terms of $33.00, a modest reduction in the deal consideration in-line with precedents should be considered a win for arbitrageurs (and the Accelerate Arbitrage Fund, which holds Forescout shares), given a reprice is always better than a potential deal break.
Source: Accelerate, Bloomberg
How were we able to be confident in the result of this complex turn of events?
In these complex situations, the Accelerate AlphaRank Merger Monitor database pays off. This proprietary alternative data set, featuring detailed analytics on thousands of public M&A transactions over the past decade, provides valuable precedent insights and analysis to investors.
From the extensive alternative merger arbitrage data set, we can glean M&A precedents in which deals have been re-cut to guide expectations on potential resolutions in the Advent / Forescout drama.
Historically, approximately 1% of U.S. mergers have been repriced downward. We analyzed the following historical negative deal repricings from the database:
Precedent M&A repricings have been in the range of -5.0% to -14.6%, with an average reduction of -9.5%.
The Answer is Always in the Data
As many things in finance, Advent’s repricing of the Forescout deal fits nicely with the data, with the -12.1% repricing result in the range of precedent data. The issue is, the vast majority of market participants don’t have access to proprietary alternative datasets such as the Accelerate AlphaRank Merger Monitor database. However, with the democratization of data and information, that is expected to change in the near future.
Whenever an investor is unclear regarding a potential scenario analysis, it always helps to look at the data. In the case of the horse-trading on Forescout Technologies, the historical data set paid off for investors handsomely.
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