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Pandemic Unravels Post-TCJA Mergers and Acquisitions Predictions

Posted on May 11, 2020

The United States was a popular market for European outbound deals in 2019, thanks to the lasting attractiveness of corporate tax cuts, but the COVID-19 crisis has changed the global mergers and acquisitions landscape dramatically.

While 2019 wasn’t a great year for European M&A activity overall, the proportion of outbound deals targeting the United States increased, according to Mergermarket’s "Global & Regional M&A Report 2019." “Taking advantage of corporate tax cuts and steadier growth prospects across the Atlantic, European firms struck 66.4 percent of their outbound deals by value in the U.S.,” which was a 6 percentage point increase over 2018, the report said.

This wasn’t just a European phenomenon. “Inbound deals from international bidders saw an over 12.9 percent increase by value” compared with 2018, Mergermarket said. The largest U.S. inbound deal to be announced in 2019 was the $27 billion acquisition of Refinitiv by the London Stock Exchange Group, slated to close in the second half of 2020. Also notable was the $16.2 billion bid for Tiffany & Co. by France’s LVMH, announced November 25, 2019, and expected to close sometime in 2020. “The U.S. market was home to 47.2 percent of global M&A activity in 2019, the highest share since 2001,” Mergermarket said.

Coming data showing that more cross-border deals are landing in the United States since the enactment of the Tax Cuts and Jobs Act were hinted at in February by a Johnson & Johnson executive, who said deals like the intra-U.S. $74 billion merger of Bristol Myers Squibb and Celgene, which closed in November 2019, would have been hard to envision before U.S. tax reform.

Another deal that might fall into that category is the $63 billion acquisition of Ireland’s Allergan PLC by AbbVie Inc. Allergan moved its tax home to Ireland in 2015 through its acquisition by inverted pharmaceutical Actavis PLC, and AbbVie made an unsuccessful attempt to invert to the United Kingdom through a merger with Shire PLC that cratered in 2014. AbbVie announced the completion of its acquisition of Allergan May 8.

Dutch-registered inverter Mylan NV announced in July 2019 that it would combine with Pfizer division Upjohn, thereby “returning the company back to the United States,” according to Mylan Chair Robert J. Coury. That deal is on track to close in the second half of 2020, according to an April 22 Mylan release.

The U.S. corporate tax environment before the TCJA was a challenge for parties that otherwise may have opted for a U.S. parent for business reasons, like maximizing access to U.S. capital and markets, said Ryan Gaglio of Stradling Yocca Carlson & Rauth PC. Removing the impediment “allowed these deals to happen in a way that comported with business goals,” Gaglio said. The U.S. parent in many ways became the default for a lot of smaller inbound deals, he added.

Companies in countries that Gaglio hadn’t dealt with much in the past “all of a sudden now saw advantages to U.S. parent entities,” he said. Entities in places like Argentina, Brazil, and Uruguay suddenly considered U.S.-parented structures suitable for their global activities, Gaglio said.

Before the TCJA, U.S. pharmaceutical companies often thought of themselves as potential targets for foreign acquisitions; “because they were perceived as being worth more in foreign hands, that was a regular expectation,” according to an industry source. “With the rates flattening, the once-ubiquitous discussions around unlocking value through foreign ownership of companies and assets has really calmed,” the source said. “You always want to be careful about causation, but this seems pretty clear: The tax rate changed, access to cash changed, and there was a change in M&A.”

Despite the continued positive effects of the TCJA on U.S. M&A, there has actually been a decline in cross-border deals targeting the United States since 2017, according to Ken Bisconti, co-head of financial technology company SS&C Intralinks. There was a 20 percent increase in cross-border M&A deals with U.S. targets in 2017, but that level fell by 3 percent in 2018 and another 10 percent in 2019, Bisconti said.

Still, the future of the global M&A market looked promising at the beginning of 2020. “After stalling for the past two years, 2020 could herald the beginning of a new cycle of growth in worldwide M&A activity,” according to an SS&C Intralinks deal flow predictor report released February 18. Healthcare was among the sectors in which growth was expected to be strongest, according to the report, which didn’t mention the then-emerging health crisis. At the time, a 5 percent increase in deal announcements was expected for the first half of 2020 compared with the same period in 2019.

The first quarter of 2020 was relatively strong until mid-March, Bisconti said. “Worldwide M&A deal announcements grew by just under 2 percent in [the first quarter], and there was a particularly strong February,” he said. January brought an increase of about 13 percent in worldwide early-stage deals driven primarily by Europe, the Middle East, Africa, and North America, “but then that ultimately turned into about a 10 percent decline for the month of March,” Bisconti said.

The largest deal announced in the first quarter of 2020 was Aon PLC's agreement to acquire Willis Towers Watson in a $30 billion intra-European transaction expected to close in the first half of 2021. Of the five largest deals announced in the first quarter, two targeted the United States, two targeted Germany, and the last was the Aon-Willis Towers Watson combination, which will be headquartered in London but with an Irish parent. North America boasted a 40.6 percent share of global M&A during the quarter, according to Mergermarket.

What happened at the tail end of the quarter “threw a wrench in a lot of our traditional predictions,” Bisconti said, adding that SS&C Intralinks isn’t officially sticking to its projection of 5 percent growth for the first half of the year. “All regions except Japan registered year-on-year declines in terms of deal announcements” for the quarter, primarily because of sharp declines in March that followed February growth, he said.

By March, the coronavirus had begun to disrupt activity. Gaglio said he saw a slowdown as early as January and February as supply chains were being disrupted. The value of global deals in the first quarter ended up almost 40 percent lower than it was during the same quarter last year, according to Mergermarket. The value of cross-border deals globally was down 27.6 percent, it said.

Financial markets platform Dealogic reported in April that in the first quarter of 2020, “Americas-targeted M&A volume saw the deepest year-on-year decline of 50.2 percent.”

“We saw activity just really sort of halt by mid-March,” said Philip Segal of Mergermarket, who added that some of his colleagues marked March 9 as one of the last days the market was considered open. March 9 is the day Aon and Willis Towers Watson announced their merger agreement. “We saw a major drop-off, both in deal value and deal count, in mid-March; it definitely hit the U.S. and European markets then,” Segal said. Activity in Latin America was down overall but didn’t seem directly affected by the coronavirus yet, he said.

It was becoming evident that some deal processes couldn’t proceed or needed to be put on hold, Segal said, citing the deterioration of Xerox’s bid to acquire HP Inc. through a tender offer launched March 2. Xerox released a statement March 13, saying that while it would postpone deal-related presentations and meetings in light of the COVID-19 pandemic, it didn’t consider the recent decline in the market or suspended trading to be fatal to the acquisition. Eighteen days later, the company announced that the pandemic and related market disruptions had “created an environment that is not conducive to Xerox continuing to pursue an acquisition of HP Inc.

Aircraft parts manufacturer Woodward Inc. and industrial materials company Hexcel Corp., which agreed to a $6.4 billion merger of equals in January, announced the termination of the transaction April 6. The mutual decision came as a result of “the increasing impact on both the aerospace and industrial sectors, and global markets broadly, resulting from the health crisis,” according to the announcement. Neither company was on the hook for a termination fee.

Deals have also slowed in the pharmaceutical industry, with uncertainty and financing issues for buyers and price depression an issue for sellers, according to the industry source. “That doesn’t mean it’s over; that means this is not the right moment,” the source said.

“Clearly, net new M&A is a bit on hold,” Bisconti said. “Uncertainty stalls decision-making for sure.” And there is uncertainty not only about things like pricing and financing, but also about how to conduct M&A when you can’t meet with people. “It’s kind of akin to buying a house online,” he added.

But there is life left in the market, Bisconti pointed out. While new M&A deal starts gradually weakened over the course of the first quarter, there were over 10,000 M&A deals announced during that period, with over 3,000 announced in March alone, he said. “The vast majority of deals [that were] in motion are still in motion,” he added.

At the end of March, dealmakers reported that many transactions at the due diligence stage were being paused or slowed “due to extreme business and valuation uncertainties,” Bisconti said. As a result, deals that started in the first quarter are likely to have extended timetables, he said. Deals are dying off, but “out of the thousands of deals that we’re managing, it’s handfuls a day,” he added.

Unsurprisingly, market disruption has somewhat tracked the virus’s path. “We saw the impact on activity happen first in China and North Asia, and actually some of those areas are starting to pick back up as some of the other areas are slowing,” Bisconti said. “What we’re seeing is just the geographic flow of the virus,” as regions stall and then people return to work, although there are constraints in some countries that didn’t exist six months ago, he said.

“I’ve historically not done a lot of work with South American companies, but right now, those are my active deals,” Gaglio said. “It’s still 2019 in South America.”

Latin America did face uncertainty in the first quarter of 2020 as a result of political unrest and protests in several countries, which contributed to a 50 percent decline for the quarter in deal activity in the region, compared with the same period in 2019, according to Mergermarket. “As the coronavirus spreads, the region could see further declines in M&A activity in the months ahead,” it said.

Both strategic and private equity investors are probably focusing more on their existing businesses, which means less emphasis on new deals, Gaglio said. He said new deals in his practice had largely stopped as of early April, which he attributed to buyers' and sellers' inability to price deals. One area in which there is increased interest — but still a lot of uncertainty — is essential services, like hospitals, consumer goods, and food manufacturers, Gaglio said. “There’s a lot of renewed interest in those spaces, but . . . buyers and sellers are struggling to appropriately price in today’s market,” he added.

Gaglio said he expects some sectors to rebound faster than others. “There’s going to be a lot of cash on the balance sheet for a lot of businesses; I think there’s going to be a lot of pent-up demand,” he said. Businesses in which that demand can ramp up quickly will recover quickly — manufacturing, possibly — but “certain sectors are going to be a much longer-term recovery,” he said.

“In a lot of crises you can look at the winners and losers, but I think at this point, it might be a little too early to start looking at that,” Segal said.

There are bull and bear case possibilities, Bisconti said. In the bull cases, the fundamental forces that support M&A activity — fear of missing out, low inflation, low interest rates, lots of private equity dry powder, and shareholder activism — would reassert themselves soon, he said, adding, “The things that concern us would be anything that resembles economic nationalism or M&A protectionism.”

Bisconti said he expects to see traditional M&A activity being replaced in the near term by things like restructuring activity “and potentially, unfortunately, bankruptcies as well.” Once confidence came back and uncertainty abated following the financial crisis in 2008 and 2009, there was a big resurgence in M&A activity, he added.

Gaglio said he expected tax attributes to be more of a focus in M&A than they have been in the last couple of years. “We saw that in 2008 and 2009: As deals were getting re-priced, all of the sudden those tax attributes became, relative to the value of the company, more important,” he said.

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