Virus creating M&A jitters, lawyers say

The coronavirus pandemic and turbulent public markets threaten to disrupt M&A activity, at least in the short term, corporate lawyers said.

That was illustrated Tuesday when Xerox Holdings Corp. confirmed it was no longer pursuing a hostile takeover bid of HP Inc., citiing "macroeconomic and market turmoil" caused by the global pandemic.

"As you might expect, we're getting inquiries from parties to pending M&A deals as to whether there's a way out for the buyer," said Richard E. Climan, a Menlo Park partner at Hogan Lovells, who was speaking generally, not about HP. "In situations where the buyer feels that the pandemic has had an adverse impact on the fundamental value of the target company, the buyer may be disinclined to pay the purchase price it originally agreed to pay."

Whether or not the buyer has the right to walk away from a pending M&A transaction requires nuanced analysis that turns in part on the wording of the "material adverse effect" clause in the acquisition agreement, according to Climan.

"As a threshold matter, a buyer seeking to walk away because of the current pandemic needs to establish that the coronavirus will have a very serious negative effect on the target company's long-term earnings potential," he said. "But that's not necessarily the end of the analysis because catastrophic occurrences such as epidemics are sometimes carved out of the definition of 'material adverse effect,' and this could preclude a buyer from terminating a deal even where the adverse impact is significant."

John H. Olson, co-leader of the merger and acquisition practice at Gunderson Dettmer Stough Villeneuve Franklin & Hachigian LLP, said his clients are asking similar questions regarding COVID-19 and its impact on their deals, especially transactions already in negotiations.

The virus pandemic has heightened the focus on material adverse effect clauses, he said.

"Those clauses have historically been very heavily negotiated but have also tended to be negotiated in the abstract, where people had to stretch to think about all the various potential problems that might happen in the world and the world economy. Here with COVID-19, suddenly everyone is asking and thinking about how the material adverse effect clause should be negotiated with this very specific risk in mind. So, it's taking a very abstract discussion and made it very, very concrete," Olson said.

Olson said he has not seen buyers use the clauses to walk away from a deal because of the pandemic, but he expects to see litigation in the next few months over the material adverse effect clauses.

Approval delays from regulators could result in deals timing out, which gives the parties the right to terminate the deal.

COVID-19 has additionally created operational issues for companies, which has caused delays on getting deals done, Olson said.

"One of the challenges to making and getting a deal done is to understand that the people who are getting the deals done are people. The dealmakers are themselves being impacted by all the measures put in place to protect the public from the COVID-19 outbreak," he said.

On top of these operational issues, quarantine and working from home have caused many business to shift focus to their core business.

"I think that those operational concerns can be solved," Olson said. "I think that those are contributing to delays in getting a deal done but not necessarily posing existential threats to deals. Whereas I think that the overall impact of the COVID-19 pandemic on the economy has a greater chance of posing an existential threat to a particular deal."

From Jan. 1 through March 31, there were 723 M&A transactions where at least one party was based in California. That's 45 fewer transactions than the same period in 2019, according to data from Refinitiv Deals Intelligence, which tracks M&A globally.

Since Jan. 2020, 3,316 mergers and acquisitions have been announced, roughly a 7.6% decrease from the same time in 2019, when 3,568 deals were announced. The 2020 numbers mark a four year low, according to Refinitiv.

Globally, M&A deals have declined 28%, according to the Refinitiv report. Worldwide M&A activity totaled $697.6 billion during year-to-date 2020, down 28% from the same period last year. This year's tally marks the lowest year-to-date period for global deal making since 2016's $664 billion. By number of deals, worldwide deal making has fallen 14% so far this year, a six-year low.

Mehdi Khodadad, a partner in the private equity, M&A and capital markets practices at Sidley Austin LLP, said the current situation might not be negative for all companies and could present opportunities.

"I think there's going be tremendous opportunities, at least on the front lines for a lot of the buyers, if these conditions persistent and asset valuations are really discounted the way they have been. I think that it presents an opportunity for buyers with a lot of capital to deploy. For buyers that are strategic M&A buyers, they tend to be lot more conservative. So, you know, some of those clients pause transactions just because they just want to wait and see, especially when there's concern around being able to integrate a transaction within time and meeting their own plans."

Although the M&A sector is seeing pauses and delays, how COVID-19 impacts future deals depends on how long the crisis lasts, Khodadad said.

Climan said he expects a near-term decline in M&A deal flow but not necessarily a dramatic long-term decline.

"If history is any indication, M&A activity is going to fall off in the short run, and we would expect to see a decline in aggregate deal value perhaps coupled with a somewhat less significant decline in the total number of M&A deals," he said.

"In the longer run, M&A is going to go on, but it may be going forward in a recessionary environment with changed valuation expectations on the part of sellers and buyers. It generally takes sellers some time to come to terms with the fact that they're not going to be able to command the same valuations they might have obtained before the crisis, and that's one of the things that can lead to a near-term slowdown in M&A activity," Climan said. "But after the coronavirus risk subsides and the stock markets stabilize, things will sort themselves out and M&A deals will get done."

Attorneys quoted in this article did not speak about specific clients or business matters.