B Cover title, initial cap only, goes here Cover: Stand first. Omnihill oribusapis erum ad mo dolore de expere pro od quidign ihilicit moditatur? Cabore nissint ibustiis ma natur, nias anis et latium quo omnis a quunturibus aut auditis US M&A 2014–15: Full steam ahead B US M&A H1 2015: Riding High US M&A is booming—continuing the record-breaking trends from last year © Getty Images/Marvin E. Newman US M&A H1 2015: Riding High In the first six months of the year, the US market delivered US$753.3 billion worth of deals, up from US$598 billion in H1 2014. US M&A is on pace to post its best performance since 2007. Activity has been supported by an incredibly friendly deal environment. The US economy is stable and has grown for each of the last five years. Interest rates remain low, which has allowed for cheap and plentiful financing. Corporates and private equity firms have accumulated substantial cash piles, and shareholders and investors are eager for boards to use this capital to deliver growth and make large strategic acquisitions. It is estimated that US corporates have US$1.4 trillion of unused cash at their disposal, and private equity firms are sitting on US$1.3 trillion. Megadeals in the technology, media and telecommunications (TMT), healthcare and pharmaceutical sectors, such as the US$55 billion deal between Charter and Time Warner Cable, Anthem’s US$54.2 billion acquisition of Cigna and Mylan’s US$27 billion move for Perrigo, have been a feature of the market for more than 18 months now. There has seldom been a better set of circumstances to support dealmaking. As robust as US deal activity is, however, the big question is whether this bull run can be sustained. Valuations have soared alarmingly, with average prices now sitting at 16x EBITDA. Also worrying is the fact that the rise in deal valuations is not matched by a similar increase in the number of deals initiated. Deal values have been skewed by a handful of megadeals in a small number of sectors. If the surge in megadeals does ease, overall deal values could fall sharply in H2. Recent stock market volatility, uncertainty in the financing markets and anticipated interest rate increases in the fall could put a break on M&A too. If stock prices fall for a sustained period of time, enthusiasm for deals among buyers is likely to decline, particularly because it may take a while for sellers’ expectations to adjust to new price realities. A mismatch between buyers’ and sellers’ expectations would negatively affect M&A activity. New investments from private equity firms will also need to increase if current momentum is to be sustained. Private equity buyouts are down from 2014—many firms feel that deals are too expensive and that it is very difficult to compete with cash-rich corporates. After a record run of exits in 2014, both the number and the value of private equity deals are down. US M&A markets are strong, but challenges remain for dealmakers and advisors. The number of mid-market deals needs to increase before it can be said that the market has made a full recovery. The high multiples paid for assets is also a concern, and stock market volatility could create a meaningful difference in price expectations between buyers and sellers. John Reiss Partner, White & Case Gregory Pryor Partner, White & Case The boom continues Contents The boom continues Page 3 US M&A market proves a record 2014 was no one-off Page 5 Sector watch: The usual suspects lead the way in M&A Page 8 CFIUS reality check: Seven insights for Chinese investors Page 10 US M&A in figures Page 12 Private equity pulls back in 2015 Page 13 Looking ahead: All eyes on H2 and beyond Page 16 US M&A H1 2015: Riding High 5 I n 2014, US dealmakers celebrated a long-overdue comeback, and the positive momentum continued into 2015. In the first six months of the year, the US M&A market posted its strongest first-half performance since the downturn. There were US$753.3 billion worth of deals secured in H1 2015, up from US$598 billion in H1 2014, putting the market on track to deliver its best year since its last peak in 2007. Strong macroeconomic fundamentals have supported this surge. According to the World Bank, the US economy grew by 2.4 percent in 2014 and has grown for the last five years. Stock markets are up too, with the S&P 500 rising by more than 12.5 percent over the last 18 months. HEADLINES n US deal values at record half-year high n Deal values were up by more than a quarter compared with H1 2014 n Growing economy, low-interest environment, record cash balances and high stock market valuations continue to foster thriving M&A environment n Inbound investment is rising n India ranks as a top 10 inbound bidder for the first time since 2012 n Japanese inbound investment value already higher than whole of 2013 n Megadeal mania continues with 32 deals in H1 2015 US M&A market proves a record 2014 was no one-off Unemployment fell to 5.3 percent, according to the US Department of Labor, the lowest since 2009. And at the beginning of 2015, the University of Michigan’s consumer confidence index was at an 11-year high. Sustained low interest rates have ensured that financing is readily available; US loan issuance came in at US$1.1 trillion in H1 2015, representing 52 percent of global issuance according to Thomson Reuters. Meanwhile, corporates and PE firms are sitting on record amounts of cash. According to consultancy Factset, non-financial US corporates have US$1.4 trillion at their disposal—a record high— while Preqin estimates that buyout firms have US$1.3 trillion. Boards and investors are eager to deploy this capital. A survey of more than 100 US CEOs by PricewaterhouseCoopers showed that more than half expect to complete a domestic acquisition in 2015. Research by Bank of America Merrill Lynch, which included a survey of 234 fund managers with US$653 billion in assets under management, found that more than two-thirds believed companies should be using profits to grow, rather than just paying out dividends and conducting share buybacks. The surge in megadeals has added fuel to market confidence. And, in some cases, megadeals change the competitive landscape, causing players across an industry to respond with their own transactions, as has happened in the healthcare sector. Boards are using cash to do deals that will further their strategic aims, protect market positions and pursue growth. The Charter/Time Warner transaction, for example, will enable the two companies to provide an expanded service offering, reach more customers, reduce costs and create a business at the forefront of technological developments. “The stock market has rewarded acquirers much more than in the past. It appears to have taken a view that strong acquirers can improve their business by getting bigger and taking advantage of the things that come with scale like synergies, access to other markets and strength with suppliers,” says White & Case partner John Reiss. “It’s a booming M&A market because we have booming valuations. Valuations are high because there is a strong stock Total US M&A 2010 – 2015 H1 Number of deals Deal value (US$ billion) Volume Value 0 200 400 600 800 1,000 1,200 1,400 1,600 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2010 2011 2012 2013 2014 2015 0 50 100 150 200 250 300 350 400 450 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 $753 billion The value of US M&A in H1 2015 6 White & Case largest pharmaceutical company, of US group Gavis Pharmaceuticals and affiliate Novel Laboratories for US$800 million. This was the largest outbound investment by an Indian pharmaceutical firm on record. Ongoing concerns around Greece’s future within the EU and instability in the Middle East and Ukraine have made the United States the most attractive and stable jurisdiction for foreign investors. The deal values generated in H1 2015 reflected the outsized influence of megadeals. Transactions such as Anthem’s US$54.2 billion agreement to acquire Cigna, Charter and Time Warner’s US$55 billion deal, and the US$50 billion Heinz/ Kraft merger, have ensured that deal values continue to push to nearrecord levels. If these megadeals are stripped out, overall deal figures are less impressive, and the M&A recovery looks more fragile. White & Case partner Mort Pierce says that while pharmaceutical companies may pause for breath after a run of megadeals, the strategic challenges facing the industry mean that M&A is likely to be sustained. “Pharmaceutical companies are always pushing to become larger so they conduct their business more efficiently. Consolidation brings down costs and makes it easier to conduct research.” In TMT, meanwhile, the increasing use of tablets and smartphones to consume content means that companies will still want to consolidate, although there are fewer targets, and regulators are watching tie-ups closely. “So many people are using wireless devices to watch content, and companies need spectrum and scale to deliver that. M&A will still be more important, but there are not too many more deals out there,” says White & Case partner Dan Dufner. Deal volumes dropped to 2,215 in H1 2015 from 2,602 in H1 2014. Flat volumes suggest that while corporates have cash to deploy, there is still a degree of caution, with acquirers analyzing deal rationales carefully and investing large sums, but on high-quality targets. Valuations heading north High deal values suggest that prices are at risk of becoming frothy. In the first half of 2015, median EBITDA multiples for US deals stood at 11.2, up from a median of 10.4 during 2014. This could explain why deal volumes have remained flat. 226% The percentage increase in value from Canadian investors in H1 2015 market, which gives people who pay in stock more currency and rewards acquisitions.” US M&A markets are still strong, but the question now is how long can the current level of activity be sustained. Inbound rebound Against the favorable backdrop in the United States, H1 2015 inbound value rose by 15 percent to US$163 billion. Interest from the United Kingdom was particularly strong in H1 2015, with 60 deals worth US$17.7 billion, making it the second highest inbound bidder by volume. Another key investor is Japan. By value, the country is second only to Canada in H1 and Japan’s total spend of US$18.7 billion is higher than its entire 2013 total. Japanese deal volumes are also higher in H1, with 41 deals, compared to 29 in H1 2014. Japanese corporates have cash to deploy and are eager to buy technology from abroad that supports their strategic objectives. In February, Japan’s Asahi Kasei paid US$2.2 billion for the energy storage business of US group Polypore. The deal was driven by Asahi Kasei’s strategy of strengthening its business globally and expanding its technology in the area of batteries and energy storage materials. Despite China’s stock market difficulties, it still ranked as the fourth most active acquirer into the United States in H1 2015. China has relaxed foreign exchange controls, encouraging cross-border investment, and investors have been eager to acquire successful western brands that can be rolled out in their home market. (See “CFIUS reality check” for insights for Chinese investors about navigating US national security reviews.) India too has forced its way onto the top 10 buyers table (with ten deals) for the first time since 2012. One standout deal was the acquisition by Lupin, India’s fourthMillennium Bridge, London © istockphoto/_ultraforma_ US M&A H1 2015: Riding High 7 Top 10 inbound bidders, by volume Top 10 inbound bidders, by value (US$ billion) Number of deals 0 10 20 30 40 50 60 70 80 90 India Netherlands Switzerland Ireland (Republic) Germany France China Japan United Kingdom Canada Deal value (US$ billion) 0 10 20 30 40 50 60 Spain Australia France China Luxembourg Netherlands United Kingdom Ireland (Republic) Japan Canada It’s a booming M&A market because we have booming valuations. Valuations are high because there is a strong stock market. John Reiss, Global Head of M&A, White & Case A new hope? Although the wider macroeconomic environment is relatively stable, given recent stock market instability the possibility of headwinds in 2016 could put a brake on deal activity. US interest rates are expected to climb in 2016, which will cause the cost of financing to increase and could cool appetites for transactions. Political instability in places such as Ukraine and the Middle East could also affect confidence, even though it has not so far. China’s difficulties and the impact of these on markets around the world have also introduced a degree of uncertainty in valuations. “With recent volatility we could see buyers get nervous, especially those buyers whose acquisition currency is tied to the stock market. We could see a scenario where there is a hiccup in public company activity,” Reiss says. “Volatility could put a significant damper on activity, as could falling stock prices.” Despite these risks and climbing valuations, at present the US M&A market remains strong and on track for a record year. $19 billion Investment into the United States from Japan, the second-highest inbound investor by value 8 White & Case As was the case in 2014, the TMT and pharma, medical and biotech sectors accounted for the lion’s share of overall deal value. TMT deals led the way, with US$233.6 billion worth of transactions in the first half of 2015, a US$90 billion year-on-year increase. Pharma, medical and biotech saw deal value increase from US$104 billion in H1 2014 to US$144 billion in H1 2015. The number of deals in these sectors, however, was lower in 2015 compared to 2014. TMT deal volumes fell 20 percent to 449 transactions in the first half of 2015. Pharma, medical and biotech deals dropped slightly to 244 deals from 246 deals in H1 2014. Industrials and chemicals delivered 358 deals, the second-most productive sector behind TMT, but this was down by 21 percent compared to H1 2014. The strong deal value but lower number of deals in the TMT sector reflect a market where a handful of strategic megadeals by large players have dominated activity. The rapid growth of wireless devices and the increase in consumption of content on these devices has pushed up demand for broadband capacity, which in turn has driven convergence between telephony, broadband and television. Corporates are making large strategic deals so that they can bundle these services together, consolidate customer bases and provide so-called over-the-top content (OTT), which involves the delivery of audio, video and other media via the Internet free of multiple-system operators that would control the flow of content. Verizon’s US$4.4 billion takeover of AOL, for example, was driven by this trend. HEADLINES n TMT was the most active sector in H1 2015 with 449 deals n TMT was the most valuable sector with US$234 billion worth of deals—a US$90 billion year-on-year increase n TMT deals driven by convergence and innovation n Pharma, medical and biotech sector saw deal value increase from US$104 billion in H1 2014 to US$144 billion in H1 2015 n Megadeals dominate in the TMT and pharmaceutical sectors n Volatile oil prices are creating uncertainty in the oil and gas sector Sector watch: The usual suspects lead the way in M&A Top sectors H1 2015, by deal volume Top sectors H1 2015, by deal value Number of deals 0 50 100 150 200 250 300 350 400 450 500 Transportation Construction Leisure Energy, mining, utilities Financial services Consumer Pharma, medical, biotech Business services Industrials & chemicals TMT Deal value (US$ billion) 0 50 100 150 200 250 Transportation Leisure Real estate Financial services Business services Industrials & chemicals Consumer Energy, mining, utilities Pharma, medical, biotech TMT US M&A H1 2015: Riding High 9 But although telephone, broadband and TV providers still need to acquire the spectrum and scale to capitalize on the convergence between mobile, content, broadband and telephony, a shrinking pool of potential targets and antitrust concerns could see activity cool. “The strategic reasons for doing a deal are still valid, but there are fewer targets. There are also competitive concerns, as seen with the unsuccessful attempts from AT&T to buy T-Mobile and Comcast to buy Time Warner Cable,” says White & Case partner Dan Dufner. Dufner adds, however, that nontraditional players like Amazon and Facebook could make moves in the TMT space, while foreign players like France’s Iliad and the UK’s Liberty Global could invest without the level of antitrust and FCC restrictions faced by domestic players. The demand for broadband has also stimulated activity in the semiconductor sector, where corporates have moved to find cost synergies in order to remain competitive, as demonstrated by the US$40 billion merger between NXP and Freescale. In the pharma, medical and biotech sector, large deals like Pfizer’s US$17 billion acquisition of Hospira, Mylan’s US$27 billion bid for Perrigo, and CVS’s US$12.9 billion purchase of Omnicare continue to drive activity. In 2014, tax inversions stimulated M&A, as US players looked to acquire foreign rivals in order to shift their headquarters to lower tax jurisdictions. The US Treasury tightened up the rules for tax inversions last year. Tax inversions are still an option for pharmaceutical companies, but most pharmaceutical deals in 2015 so far have been driven primarily by more strategic considerations. “Tax inversions are still an option, but if you look at the landscape there are not as many tax inversions around as last year,” says White & Case partner Mort Pierce. “Even when a tax inversion has been one of the reasons for doing a deal, delivering synergies and replenishing pipelines have always been the main drivers.” Pierce adds that even if there are fewer megadeals between large pharmaceutical companies, the dynamism of the sector means that there will always be attractive M&A targets available. “There are large numbers of new companies researching and developing new drugs. A company can go from a start-up to a multibillion-dollar business overnight, and as long as these companies are still emerging, then M&A activity will remain strong,” Pierce says. Dufner, who advised health insurance company Anthem on its US$54.2 billion pending acquisition of Cigna, says M&A across the wider healthcare market is likely to be buoyant. “For healthcare insurers, doctors’ groups and hospital groups, the bigger you are, the more customers you have and the more leverage you can gain in negotiations with suppliers. I think we are going to continue to see a lot of M&A across the whole healthcare sector,” Dufner says. The energy sector could also deliver interesting opportunities. There were only 154 deals in the sector in the first half of 2015, worth US$79.1 billion. A volatile oil price, which fell from more than US$100 a barrel to about US$50 in the last year, was the main reason for the slowdown. “When there is uncertainty around the oil price, it is very difficult for buyers and sellers in the oil & gas sector to agree on valuations. Sellers do not want to sell at the bottom of the market and that impacts negatively on deal flow,” says White & Case’s Gregory Pryor. “When the market levels off and companies have more clarity on longer-term commodity pricing, we could see valuation expectations start to match up and a recovery in dealmaking. For now, I think the focus is on pinching the pennies and saving money wherever possible.” Anticipated restructuring deals did not materialize either, as companies were able to raise equity from investors and were protected by hedges. But now that hedges have unwound and investors have been tapped, companies no longer have a buffer and may have to open the door to an acquisition in order to survive. “For those companies with debt on the balance sheet, as hedges unwind and the cash impact of the pricing declines are felt, something will have to be done to fund debt repayment, which could lead to more distressed dealmaking,” Pryor says. “The electric power sector could also see an increase in activity in the second half of 2015. Indeed, a number of power assets went to auction over the summer,” says White & Case partner Michael Shenberg. 449 TMT deals in H1 2015—the most active sector in the United States Transmission towers in Fontana, California © Getty Images/Irfan Khan to help Chinese investors better understand—and successfully navigate—this important facet of the US M&A market. Most deals are not reviewed The Rhodium Group reported that Chinese entities acquired 139 US companies from 2011 to 2013; CFIUS reviewed 54 Chinese deals during this period. Dividing reviewed deals by the total number of deals completed over a set timeframe yields an imprecise but serviceable proxy estimate of the CFIUS review rate. By this calculation, the review rate for Chinese deals from 2011 to 2013 was about 39 percent. This suggests that more than 60 percent of Chinese acquisitions were not reviewed by CFIUS. Most reviewed deals proceed In 2013, CFIUS reviewed 97 deals overall, 21 of which were by Chinese acquirers. We know that eight acquirers withdrew from the process, and no deals were formally blocked. CFIUS does not report details about withdrawals by nationality, so we China’s appetite for US M&A has increased dramatically since the turn of the century, with the annual number of Chineseled US acquisitions increasing from zero in 2000 to 100 in 2014, figures from the Rhodium Group show. Yet in the minds of many Chinese investors, the Committee on Foreign Investment in the United States (CFIUS) remains a formidable barrier to getting deals done, says White & Case partner Farhad Jalinous. CFIUS reviews the national security implications of foreign investments in US companies, and it has the power to limit or scuttle deals that it deems threatening. Although CFIUS reviewed more Chinese deals than deals from any other country in each of the last two years for which the committee provided data (23 in 2012 and 21 in 2013), many of the concerns that Chinese entities have about CFIUS may be exaggerated or even false, notes Jalinous. Drawing on our experience representing investors in CFIUS reviews, along with publicly available information, we identified some CFIUS insights and rules of thumb CFIUS reality check: Seven insights for Chinese investors don’t know how many withdrawn deals were Chinese. But even if all eight were Chinese, China’s pass rate would have been at least 62 percent in 2013. Given that CFIUS reviewed deals from 26 countries in 2013, it is unlikely that all eight withdrawals were Chinese deals. China’s pass rate is probably closer to the overall pass rate of 92 percent. (It’s also important to remember that transactions may be withdrawn for reasons unrelated to CFIUS, such as when a deal falls through for business reasons.) Don’t avoid CFIUS CFIUS can review any deal that might have national security implications, even if that means conducting the review after a deal has closed. Companies that wait to submit deals for review or attempt to evade review altogether expose themselves to the risk of having to change their deal terms late in the process—or live with CFIUS conditions after the deal has closed. CFIUS-imposed mitigation measures can be significant, including asset divesture and access restrictions, and they can render deals impracticable for participants. 39% of Chinese deals were reviewed by CFIUS between 2011 to 2013 21 The number of Chinese deals reviewed by CFIUS in 2013 © Michele Falzone / Alamy Stock Photo Source: US Department of the Treasury In the worst-case scenario, CFIUS can recommend that the president order the buyer to sell the US business (often at a substantial loss) after the deal has already closed. Just the threat of this possibility is usually sufficient to compel buyers to divest, particularly because presidential decisions are publicly announced. Don’t count on US political ties CFIUS, which is composed of representatives from various departments and agencies of the executive branch of the US government, is not required to notify Congress about the deals it reviews until it has made its final decision about them. Details about deals sometimes get out by other channels before CFIUS renders a decision, and in some cases political figures and competitors attempt to influence CFIUS. It is important to note that CFIUS has approved many controversial deals, even when politicians have made concerted 2012 2013 2012 2013 China 22% 20% Japan 19% 8% Canada 13% 11% UK 7% 15% France 7% 7% Other 32% 39% Deals reviewed by CFIUS, split by country, 2012 & 2013 efforts to stop them. Shuanghui International’s 2013 acquisition of pork producer Smithfield Foods is a case in point. The deal faced bipartisan opposition from US lawmakers expressing food safety concerns, but CFIUS let it proceed. Having ties to the Chinese government isn’t a deal breaker Government ownership—regardless of the country involved—triggers additional scrutiny under the CFIUS statute; CFIUS also gives weight to indirect ties, as when the management team is associated with the Chinese government. Although government ties are a factor in the national security analysis, this is not in itself a reason to block a deal, as the record clearly shows. According to the Rhodium Group, government-owned Chinese entities acquired 76 US companies from 2000 to 2014, which accounts for 21 percent of the total number of Chinese acquisitions in the United States during that period. Many tech-related acquisitions proceed CFIUS gives special attention to deals that involve the acquisition of cutting-edge or strongly controlled technology, but many deals involving technology proceed without complication. To raise concerns, the technology in question must be relevant to national security. Technology that is already mainstream, particularly if not subject to substantial export controls or available widely on the international market, is usually fair game, as is suggested by an example from 2011. That year, a unit of China Aviation Industry Corp, the state-run aerospace and defense company, made a bid for Cirrus Industries, a Minnesotabased aircraft manufacturer. Lawmakers raised defense concerns, but CFIUS did not object to the deal, presumably because Cirrus’s technology was not considered sensitive. Portions of US companies with special security or defense status may be fair game Due to US export-control and industrial security laws and policies, a Chinese investor cannot normally own a US company that has facility security clearance or is registered under the International Traffic in Arms Regulations (ITAR). But if such a company can segregate a portion of its business from the parts that require security clearances or ITAR registration, that unrestricted, commercial portion of the company could be made available for acquisition by a Chinese buyer. 12 White & Case US M&A in figures * The Intelligence Forecaster is based on ‘companies for sale’ tracked by Mergermarket in the United States between 1 August 2014 and 31 January 2015. Mergermarket’s Intelligence Forecaster of predicted deal flow is based on intelligence relating to companies rumored to be for sale, or officially up for sale. It is therefore indicative of sectors that are likely to be most active during 2015. Total US M&A 2009 – H1 2015 Volume 0 500 1,000 1,500 2,000 2,500 3,000 H1 2009 H2 2009 H1 2010 H2 2010 H1 2011 H2 2011 H1 2012 H2 2012 H1 2013 H2 2013 H1 2014 H2 2014 H1 2015 Value† Proportion of US M&A accounted for by private equity 0 5 10 15 20 25 30 35 2009 2010 2011 2012 2013 2014 H1 2015 Buyout Exit Secondary buyout 7% 7% 14% 13% 14% 18% 11% 13% 6% 13% 14% 4% 5% 14% 12% 6% 14% 3% 16% 4% Inbound M&A by country, H1 2015 47% Percentage of inbound deals with European buyer Canada 78 deals US$49 billion UK 60 deals US$17.7 billion Japan 41 deals US$18.7 billion China 28 deals US$6.9 billion France 22 deals US$6.4 billion Germany 18 deals US$0.8 billion Ireland 16 deals US$18.5 billion Switzerland 13 deals US$1.4 billion † Indicated by size, where the smallest is US$303 billion, and the largest is US$747 billion. TMT, pharmaceuticals and industrials poised to be most active in 2015 Lowest deal flow Highest deal flow 366 Pharma 431 TMT 165 Consumer 225 Business services 191 Financial services 43 Construction 66 Leisure 36 Transportation 13 Agriculture 2 Other 276 Industrials and chemicals 9 Defense 33 Real estate 223 Energy, mining and utilities The M&A Forecaster* predicts sector deal flow by volume in the US M&A market for 2015. US M&A H1 2015: Riding High 13 The challenge of cash-rich corporates and vaulting valuations has led buyout firms to exercise restraint in the first half of the year. The number of private equity buyouts was down to 398 in H1 2015 from 456 H1 2014. Buyout deal value was also down, falling 25 percent year-on-year to US$58 billion. The figures suggest that financial sponsors are holding back. Investors are still cautious as they emerge from the financial crisis and have balked at high valuations unless they are investing in an asset of exceptional quality. Competition for good companies has also increased, making it tougher for firms to make investments. “Stock markets have been strong for the better part of 2015, and a number of potential private equity targets have opted for an IPO instead,” says White & Case partner Oliver Brahmst. “We have also seen corporates return to M&A and when a strategic buyer is hell bent on doing a deal, private equity generally has a difficult time being competitive.” The competition at large-cap PE firms are facing from strategics has had an impact on the activity of midmarket players too. Large-cap buyout houses are increasingly looking to do smaller deals, which has meant that mid-market players are facing tougher and more competitive auctions. In order to compete, firms are focusing more on the operations of potential targets and portfolio companies in order to deliver strong returns when buying companies for high prices. They are also working harder on due diligence in order to identify steps they can take to improve company performance and grow revenues. Buyout firm Clayton, Dubilier and Rice, for HEADLINES n Private equity exits down after stellar 2014 n Buyout volumes also down n High valuations and cash-rich strategic buyers challenge the private equity sector Private equity pulls back in 2015 Number of deals Deal value (US$ billion) 2010 2011 2012 2013 2014 2015 Volume Value 0 50 100 150 200 250 300 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 0 10 20 30 40 50 60 70 US private equity buyouts 2010 – H1 201 example, runs a team of operating partners who all have direct industry experience and focus exclusively on improving company performance. These operating partners, which include former senior Unilever executive Vindi Banga and former General Electric CEO Jack Welch, will work on transactions predeal to identify what operational improvements a buyout firm can make if it invests. As Tate Pursell, managing director of US private equity firm Unlimited Horizons, said in a recent interview: “Private equity groups had to change from financial engineering to building value. They had to sharpen their game.” (See the sidebar “Management compensation in a hot M&A market” for details about how these dynamics affect how portfolio company managers are compensated.) Brahmst adds: “Private equity firms cannot simply rely on financial engineering. They need to focus on operations to increase returns. We see firms acting like quasistrategic investors by investing in companies, then supporting their addon acquisitions. It is also still the case that investors will favor a private equity buyer if it reduces the antitrust risk.” The private equity industry is, however, at the beginning of a new fund cycle, so firms can afford to maintain discipline and refrain from investing for a while. US private equity exit figures are also down, falling from record highs in 2014. On a year-on-year basis, 14 White & Case Number of deals Deal value (US$ billion) 2010 2011 2012 2013 2014 2015 Volume Value 0 50 100 150 200 250 300 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 0 20 40 60 80 100 Value 0 20 40 60 80 100 Financial Transportation services Energy, Leisure Construction mining, utilities Pharma, medical, biotech Business TMT Consumer services Industrials & chemicals Volume Number of deals US private equity exits 2010 – H1 2015 Buyouts by sector, H1 2015 Management compensation in a hot M&A market Alignment of interests is the cornerstone of the PE model—not just between firms and their investors, but also between buyout houses and portfolio company management teams. White & Case’s Henrik Patel notes that PE firms have always been willing to offer management teams attractive financial incentives in order to drive returns. “Firms do worry about whether they are compensating management too generously, but if a deal delivers returns, PE sponsors are happy for management teams to share returns,” he says. Experience suggests that management teams are typically in line to receive a relatively healthy return of between 10 and 20 percent of deal proceeds, assuming that the PE sponsor makes a return of two to three times the money on the investment. In the current market, however, where the contribution of leverage and multiple arbitrage to overall returns is shrinking and operations have become more important for generating alpha, buyout firms have moved to sweeten deals for management teams even further. “Salaries and bonuses are in line with the past, but something we have seen more of this year is a focus on incentivizing homerun deals,” Patel says. “If a management team knocks it out of the park, with returns of above 3.5x, they may get another incremental piece of the pie. Management may earn another 5 percent of the deal returns above an agreed multiple.” Patel adds that in order to differentiate themselves from management teams, PE sponsors may offer to structure deals as partnerships rather than corporations, so any management returns receive the more favorable capital gains tax rates. PE sponsors are also paying more attention to non-compete terms in contracts, to protect them from managers leaving to work for rivals. Firms are also insisting on terms that prevent managers from voluntarily departing and being eligible for severance and special treatment of their equity. In addition, financial investors are insisting the management teams reinvest in deals, in order to maintain alignment between the firm and management. “Buyout firms will typically expect management to roll over between 25 and 50 percent of the after-tax value of what management would receive in a deal,” says Patel. exit numbers fell 21 percent in H1 2015, with exit value down 42 percent. For many firms, the pressure to realize value for investors has eased after the strong run of exits in 2014. Private equity has made record distributions to investors at good multiples. According to Preqin, PE firms returned US$444 billion to investors globally in H1 2014. These distributions have been made at good returns. A Bain & Company analysis of public pension fund median returns over a ten-year investment horizon shows PE outperforming all other asset classes. Private equity firms also sold many of their very best assets in 2013 and 2014 to support fundraising efforts. Now that new private equity funds have been raised and portfolios exited, there is a smaller number of companies that private equity firms need to sell. “Private equity had a very successful run selling companies in 2013 and 2014, with these exits fetching high valuations. After selling so many companies, there has been a pause of breath,” says White & Case partner Oliver Brahmst. US M&A H1 2015: Riding High 15 Private equity had a very successful run selling companies in 2013 and 2014, with these exits fetching high valuations. After selling so many companies, there has been a pause of breath. Oliver Brahmst, Partner, White & Case Commuters in Grand Central Terminal, New York City © Kevin Foy / Alamy Stock Photo 16 White & Case Looking ahead: All eyes on H2 and beyond © istockphoto/P_Wei US M&A H1 2015: Riding High 17 The US M&A market is in its strongest position in years. Deal values are up compared to 2014 and on track to match or surpass figures recorded at the peak of the market in 2007. The outlook is positive. The US economy is steady, financing is cheap, balance sheets are strong and shareholder confidence is high. This is a good time to be doing deals. As healthy as the market appears, however, there are some clouds on the horizon. Valuations are high and positive deal figures have been underpinned by megadeals in a few sectors, rather than a broader recovery across the whole market. Dealmakers pursuing transactions should keep the following in mind: Maintain discipline: Valuations are at new record highs, and there is a large amount of capital chasing a limited number of transactions. There are opportunities to do deals, but it is important to keep an eye on prices and avoid overpaying in a hot M&A market. Be clear on strategy: Shareholders are supportive of companies doing deals, but in a market where valuations are high, investors want to see a clear rationale for doing a transaction and a detailed plan for what an acquirer is going to do with a target post-deal. Monitor world events: To date, the US deal market has remained broadly insulated from issues abroad, such as the Chinese stock market crash and the risk of Greece leaving the EU. But events abroad have had some impact on US deal activity. European investment in US M&A, for example, is down on 2014 levels as Europeans step back from M&A due to uncertainty in domestic markets. Dealmakers should be aware of potential headwinds from outside the United States. Los Angeles, California As healthy as the market appears, however, there are some clouds on the horizon. 18 White & Case Global John M. Reiss Partner, New York T +1 212 819 8247 E firstname.lastname@example.org Americas Gregory Pryor Partner, New York T +1 212 819 8389 E email@example.com EMEA Dr. Jörg Kraffel Partner, Berlin T +49 30 880911 400 E firstname.lastname@example.org Jan Matejcek Partner, London T +44 20 7532 1333 E email@example.com Asia Barrye L. Wall Partner, Singapore T +65 6347 1388 E firstname.lastname@example.org NY/0915//TL/148070_v7 © Getty Images/Marvin E. Newman whitecase.com In this publication, White & Case means the international legal practice comprising White & Case llp, a New York State registered limited liability partnership, White & Case llp, a limited liability partnership incorporated under English law and all other affiliated partnerships, companies and entities. This publication is prepared for the general information of our clients and other interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice. Disclaimer This publication contains general information and is not intended to be comprehensive nor to provide financial, investment, legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any investment or other decision or action that may affect you or your business. Before taking any such decision, you should consult a suitably qualified professional advisor. While reasonable effort has been made to ensure the accuracy of the information contained in this publication, this cannot be guaranteed and neither Mergermarket nor any of its subsidiaries or any affiliate thereof or other related entity shall have any liability to any person or entity which relies on the information contained in this publication, including incidental or consequential damages arising from errors or omissions. Any such reliance is solely at the user’s risk. Published in association with Mergermarket Part of the Mergermarket Group www.mergermarketgroup.com For more information, please contact: Robert Imonikhe Publisher, Remark, part of the Mergermarket Group Tel: +44 20 3741 1076
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US M&A is booming—continuing the record-breaking trends from last year
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