The M&A mega deal, valued at $10 billion or more, helped make 2015 a record year. But data from Bloomberg Law suggest mega deals come with an increased risk of not closing. Market participants are comparing that finding with their on-the-ground experience of why deals fail.
The data show mega deals failed at a rate above 28% percent from January 1 2012 to June 30 2015. The data set relates only to deals with US targets and US and overseas acquirers, and defines a failed deal as one that was terminated or withdrawn. According to the data, the failure rate for mega deals contrasted with a less than five percent failure rate for M&A transactions valued between $100 million and $10 billion over the same period.
One suggestion is that on top of any data, the failure of mega deals can be prone to exaggerated perceptions.
“Mega deals certainly get a lot more publicity,” said David Gibbons, partner at Hogan Lovells. Accordingly, the media are more like to pick up on those that fail, and so make those deals appear more frequent than in reality.
“Deals fail for many different reasons, and I think some of the smaller deals that fail simply don’t get the publicity and don’t show up as even having been considered,” Gibbons said.
So headlines on the success rate or otherwise of mega deals should be handled with care.
But whether they do indeed carry increased risk of failure is also worth considering.
One widespread perception is that the larger the transaction, the more likely it is to attract regulatory attention. Some recent failures certainly give the impression of regulators intervening based at least in part on size.
In April, the US Treasury unveiled new temporary and proposed regulations governing inversions. Two days after that announcement, pharmaceutical giant Pfizer gave up on its attempt to buy Irish-based company Allergan for a record $160 billion. In this case, the practice of inversions was under fire. But its size also appeared to ring regulatory alarm bells. Earlier this year, Halliburton and Baker Hughes also terminated their $28 billion merger deal after opposition from European and US antitrust regulators.
According to Neil Torpey, partner at Paul Hastings, the biggest risk factor is the regulatory environment: "If you look over 20, 30 or 40 years in the US, the relative robustness of enforcement has waxed and waned depending on, among other things, which party has been in the driving seat."
But making deals work isn't easy. "Don't do a deal that looks like a tax inversion, and do your homework very carefully to avoid the most common reason for failures on the big deal side: antitrust," he added.
Lawyers are keen, however, to stress that regulators don’t necessarily use size as the deciding factor when questioning a deal.
“Regulators naturally take a careful look at impactful transactions, and impact can be – but isn’t always – tied to size. Impact is also related to market concentration,” said Bill Curtin, partner at Hogan Lovells and global head of the firm’s global M&A practice. US regulators use the concentration ratio, a measure of the degree to which a market is monopolistic and not a measure of individual company size.
- Data suggest mega deals come with an increased risk of not closing;
- US counsel suggest media perception exaggerates the failure rate, with failed smaller deals often ignored;
- Regulators also focus on market concentration, not size – although size is a signal of potential impact;
- There’s been a sharp uptick in the mid-market, defined as deals valued below $1 billion;
- 2016’s first half saw overall M&A deal volume for US targets decrease at a rate of 4.3 percent when compared to the same period last year.
“If the huge deal doesn’t result in market concentration, then it may not get scrutinised. But if a small deal does, it will,” added Gibbons.
That’s certainly not to say that 2016 is seeing the same level of mega deal activity as 2015. The research shows that the pace set for mega deals in 2016 is behind that in 2015. However, there are almost as many mega deals in the first half of 2016, at 19, as there were in full year 2014, during which there were 24. So while volume this year is down on 2015, market participants don’t foresee the demise of the $10 billion-plus transaction.
“Of course, everybody’s pointed this out: the mega deals we saw in 2015 are fewer and further between. But I don’t expect it to be their end,” Gibbons said. “There’s a lot more activity in middle markets in 2016, and even at the lower end we’re seeing a lot of activity."
Market participants are taking protections against failed deals, often in the form of break fees. "Our experience is that the break fees have been going down a bit over the last few years. We were seeing between six and seven percent, and sometimes eight percent or higher a few years ago," said Torpey.
He explained that they fell in 2014 from the previous year, and have gone up again slightly in the past two years. "A lot of deals cluster around the six percent range, that could be a little bit higher or lower depending on the size of the deal," he said. And there's also been a marked increase in the use of warranty and indemnity (W&I) insurance.
"We've seen insurance providers become increasingly sophisticated over the last two to three years," he added.
That's because insurers have a lot more data to help gauge their exposures, which makes them more sure-footed in the product they're offering, how they price it and how they analyse risks. "We've seen, in our deals, a very significant increase in W&I and it seems a trend that's likely to continue," said Torpey.
In interpreting the success rate of deals, however, there’s another insight beyond the data. According to Curtin, the real measure of a deal’s success is not whether it closes, but the life and times of the subsequent business entity.
“Just because a deal completes doesn’t make it successful. A deal can consummate but not integrate, or consummate and integrate, but not produce – those are all types of failure,” he said. “People in the business sector understand there are a lot of failed deals of all sizes that did consummate,” Curtin said.
That relates to the worlds of economics and business, rather than to the law alone. But it does mean that the size of a deal, and its likelihood of failure, are not necessarily linked.
“I don’t believe that there is a correlation between failing deals and deal size,” Curtin said.
There are of course failures resulting from regulatory blockages or parties simply getting cold feet. But post-close failure is most often due to a lack of rigour at the stage at which business people are asked to consider a transaction. In short, many become enthralled at what a big deal might do for both their footprint and their bottom line. “That kind of momentum, if not carefully checked, can lead people to be somewhat less than rational,” said Curtin.
“The risk factors around mega deals mean, as an M&A lawyer, you really have to maintain your rigour,” he said.
According to data from Bloomberg Law, the first half of this year saw overall M&A deal volume for US targets decrease at a rate of 4.3 percent when compared to the same period in 2015, although deal volume in the first half of 2016 significantly outpaced the same periods in 2014 (by 15.2 per cent), 2013 (120.3 per cent) and 2012 (221.4 per cent).
This year’s M&A appetite also saw a 20% rise in the number of deals announced in the first half of 2016 than in the same period in 2015.
"The risk factors around mega deals mean you really have to maintain your rigor"
This is a reminder that if a board is dead set on what seems like a great deal, but later finds unappealing issues at the stage of due diligence or in the contract, it requires a lot of restraint to stop.
“If I’m driving down a sunny Park Avenue and I’ve had seven green lights in a row, but then there’s a yellow light, you have to remember it’s yellow for a reason,” Curtin said. “Failure is often due to a lack of rigour in a transaction."
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