Cooley M&A Team News - March 2014

MARKET DEVELOPMENTS
Recent Trends in Antitrust and Regulatory Risk-Shifting in M&A Agreements

The recent drumbeat of aggressive antitrust and regulatory merger enforcement has put a spotlight on the importance of understanding the antitrust and regulatory risks raised by a potential deal, and efficiently allocating that risk in the transaction agreement. While transactions in dynamic technology, healthcare/life sciences, new media and telecom industries remain at the very top of the antitrust and regulatory enforcement agenda, the agencies will not hesitate to investigate matters in mature industries—for example, the FTC's recent 9 month investigation of Tesoro Corporation's $1.1 billion acquisition of petroleum assets from BP, which ultimately closed without a challenge in 2013. Several recent transactions also underscore the substantial antitrust risk that parties may face even in smaller, non-reportable matters.

There is no "one size fits all" approach, but there is often a premium on structuring the transaction to achieve the benefits of clear risk allocation and certainty that are commensurate with the amount of risk that the transaction presents, rather than relying on a broadly and generically worded "efforts" provision. In some instances where the target is being sold in a competitive process, a buyer may be compelled to take more antitrust/regulatory risk in order to win the bid, making it critical for the buyer to have confidence in its underlying antitrust/regulatory analysis. Market dynamics and regulatory landscapes also can change from deal-to-deal or even between signing and closing of a pending transaction; raising questions of how the parties should allocate the regulatory risks that are, in a contractual sense, unknowable at the time of signing. Whatever the facts may be, in transactions that present potential antitrust and regulatory risk, it is essential to establish close coordination between transaction counsel and antitrust and regulatory counsel to effectively negotiate the contractual risk shifting provisions.

The recently announced Comcast/Time Warner transaction, which is pending DOJ and FCC review, is illustrative of a trend towards efficient allocation of antitrust/regulatory risk in the negotiated transaction agreement. Industry observers generally expect this transaction will get intense DOJ and FCC review but is likely to be approved with conditions. The parties did not negotiate a reverse break-up fee or even an obligation to litigate with the agencies. Rather, the parties negotiated a customized and limited "divestiture" covenant—a sort of anticipatory "fix-it-first" approach. Specifically, Comcast agreed to (1) divest up to three million of the company's combined subscribers, (2) accept other conditions that are consistent in scope and size to those imposed on other U.S. domestic cable system deals valued at $500 million or more within the past twelve years, and (3) implement undertakings set out on a schedule to the merger agreement (not publicly disclosed). If the DOJ and FCC do not clear the deal by the upset date or impose "burdensome conditions" (defined as divestitures or other undertakings beyond those Comcast has expressly agreed to make or take), Comcast may terminate the merger agreement without liability.

Comcast's covenant to divest three million subscribers would hold Comcast's total national market share under 30% of video subscribers (based on an FCC cable ownership cap that applied in previous cable deals but has since been vacated by the courts). The second commitment would encompass conditions imposed in Comcast's acquisitions of AT&T in 2002 and Adelphia in 2006 (the 1st and 5th largest cable operators at the time) (e.g, anti-discrimination protections for rival multi-channel video distributors and independent network owners, especially regional sports networks). Finally, Comcast has already publicly announced its intention to abide by certain behavioral conditions imposed on Comcast when it acquired NBC in 2011 across the Time Warner Cable systems (e.g., this could include net neutrality conditions from the NBC deal even though the FCC needs to rewrite the rules based on a recent court ruling).

What about concerns that these types of provisions may raise, rather than mitigate regulatory risks, because such provisions provide a "roadmap" to the agencies, or even worse, provide the agencies with negotiating leverage to demand overbroad divestitures/remedies? The outcomes in numerous recent merger investigations reveal that these types of provisions do not necessarily create a path to a self-fulfilling prophecy, particularly when the contractual terms are well-crafted and the process is managed effectively. For example, in the Tesoro/BP matter, despite the fact that the acquisition agreement expressly provided for the divestiture of a specific refinery by Tesoro (as well as a reverse break-up fee and a ticking fee), the FTC closed its investigation after nine months without taking action, concluding that the transaction would not "lessen competition substantially" in the relevant market in California.

Of course, antitrust and regulatory risk allocation is not negotiated in isolation—parties bargain over many price and non-price terms. For instance, just as Comcast is not required to pay a reverse break-up fee if the parties are not able to obtain regulatory clearance, Time Warner Cable is not required to pay a break-up fee if its stockholders vote against the deal.

All M&A lawyers involved in industries or transactions with competitive, FCC or other regulatory issues should become familiar with market approaches to contractual risk-shifting and have knowledgeable and experienced antitrust and regulatory counsel on their deal teams.

MARKET DEVELOPMENTS
Appraisal Arbitrage—A Rising Star in the Activist Playbook

Shareholder activism gains momentum and publicity with each passing proxy season. Activist-focused funds increase capital and investor expectations, proxy contest tactics become more practiced and skillful, nominees for board positions are industry tailored and more sophisticated and social media increases the reach (and entertainment value) of activist communications. What comes next? Appraisal rights as arbitrage.

Appraisal rights are a state statutory remedy available to dissenting shareholders in extraordinary corporate transactions. The rules vary from state to state, but the most common scenario in which appraisal rights are used is a cash merger where objecting shareholders seek a court's separate assessment of "fair value" for their shares. Under Delaware law, appraisal awards accrue statutory interest at the federal discount rate plus 5%, compounding quarterly from the transaction closing date until the award is paid. And, absent bad faith, the interest rate is paid regardless of the ultimate appraisal decision. In evaluating appraisal claims, Delaware courts also have wide latitude; they may consider "all relevant factors" in determining value, often relying on expert opinions and factoring in complex variables such as future projections, expected tax rates, equity risk premiums, control share premiums, and discount rates.

Historically, appraisal actions in connection with M&A transactions were uncommon, typically only filed by disgruntled shareholders. But, increasingly, activist funds are exercising statutory appraisal rights in public company transactions in order to maximize return—either by obtaining a court ruling that dissenting shareholders are entitled to additional consideration in excess of the deal price, by settling the claim, or by collecting the simple return generated by the statutory interest rate applicable to these claims.

Here is how the "arbitrage" works. Beginning in 2007, the Delaware Chancery Court's Transkaryotic decision made it clear that any beneficial holder with shares held through Cede & Co. (also known as DTC, the clearing house for US stock) could seek appraisal rights regardless of when the shares were acquired, provided that the total number of dissenting shares was less than the total "street name" shares not voted or voted against the deal. Accordingly, investors can now determine, based on market reaction to a deal and applicable disclosure in proxy or similar materials, whether or not to "buy into" appraisal claims. In addition, the interest rate applicable to such claims, particularly in our current low interest rate environment, is a reliable offset to the risk and cost of an appraisal action. Notably, it also serves as an additional point of leverage in settlement discussions with target companies.

Going forward, appraisal rights will be a considerable factor in deal risk and related litigation. Data from Delaware's Chancery Court reveals a clear trend—i.e. a significant increase in the number of appraisal actions filed. From 2009 to 2012, the number of filed claims was 16, 18, 20, and 21, respectively. That number jumped up to 35 in 2013. And so far in 2014, 20 appraisal claims have already been filed. Not only is the rate of claims on the rise, but so too is the use of their strategic force. For those who followed the recent Dell or Dole Foods management buyouts, the use of appraisal litigation (or at least its threat) was a major force in public resistance to the transactions and, potentially, a major windfall to the investors who exercised their right to have a court independently determine the value of their shares.

Appraisal rights are not an easy, quick or affordable remedy for all shareholders. Claims often take years to resolve and dissenting shareholders must pay their own fees while taking the risk of a court determined value (note that in some states, a court may actually determine fair value to be less than the deal price). Appraisal rights also ensure a level playing field for minority shareholders that may be harmed in an "insider" deal negotiated at a lower than "market" price. The market must now consider, however, if the advantage afforded to large (and possibly opportunistic) activist funds is fair or appropriate as compared to smaller holders with fewer resources.

All M&A practitioners are well advised to consider the impact of appraisal claims on public company transactions, particularly those, like management buyouts, that may be subject to heightened scrutiny regarding valuation. Both buyers and sellers are likely to focus on closing conditions tied to the number of shares subject to appraisal, a feature not common in today's public deal agreements, as weighed against the potential hold-up value provided to activist funds looking to capitalize on arbitrage opportunities. It is also worth noting that many practitioners view this appraisal arbitrage as pure rent-seeking and, therefore, have initiated a call for legislation to limit the available statutory interest (particularly in cases where the appraisal value is set at or lower than the deal price) and/or to eliminate the ability to "buy into" an appraisal claim following announcement of the transaction.