Mergers: When Will Action Replace Talk?

Due diligence that usually would be three or four months now takes eight or nine months, an M&A lawyer says.
Kate O'SullivanNovember 6, 2009

Will the growing buzz about M&A turn into some real deals? Each week the market appears to be gaining momentum. CFO.com recently spoke with David Grinberg, a partner in the mergers and acquisitions practice at Manatt, Phelps & Phillips in Los Angeles, about the latest trends in M&A.

What are you seeing in terms of M&A volume?

The way I would describe M&A right now is that things are percolating, which is a lot more than I could have said six months ago, or back in the first quarter of 2009. People are talking about deals. People are getting excited about deals. There hasn’t been a ton of execution, but at least people are talking. But will it sustain itself; will it turn into a ton of transactions? Or will something happen to quiet it? It’s tough to say.

Are there certain industries that seem particularly active?

There have been a lot of big pharma mergers. The financial-institutions sector has been active, but only on one particular front, which is banks buying other banks that have been seized by the FDIC. There have been very few healthy bank M&A deals. If you buy from the FDIC, you get a loss-sharing agreement. Why go in and buy a bank directly if you can just wait until it’s taken over and buy it from the FDIC? So there’s action there, but a different type of action.

Other than that, I wouldn’t say there’s any particular industry that’s outpacing any of the other industries at the moment.

What are you seeing in terms of the mix of strategic vs. financial buyers? Are private-equity buyers getting back into the mix?

It’s mostly strategic buyers right now. If financial buyers are doing anything, they’re taking minority positions, whereby they can just use equity but don’t have to count on any leverage. When’s the last time you’ve seen a $10 billion deal done by a private-equity fund? It’s been a while. It will probably be a while.

What do you think are the most important things for CFOs to be thinking about in this environment, as either a potential buyer or a potential seller?

The CFO needs to worry about how the deal’s going to get financed. If you’re the buyer, you’ve got to figure out how you’re going to pay for the acquisition. And if you’re the CFO of the seller, you’ve got to think about whether a deal is something you should be pursuing with a particular seller. How likely is this buyer to be able to close the transaction? You don’t want to waste time negotiating an agreement only to find that the buyer doesn’t have the money or can’t finance it. It’s really all about, “Is this a deal that can get done from a financial point of view?”

What else should CFOs be thinking about in terms of due diligence?

I think that due diligence generally has gotten much, much more intensive. Buyers are going to a level they’ve never gone before, both in terms of detail as well as how long it’s taking to conduct due diligence. And of course, as the CFO, you want to make sure that the day after you buy the company you don’t find a lot of skeletons in the closet that makes the price you paid look like too much. But to be perfectly blunt, due diligence is painfully long.

It’s a lot about financing the deals. People are getting creative to finance the deals these days. People are using seller’s notes, earn-outs. There are a number of different ways to help bridge the gap between buyer and seller both in terms of valuation as well as making sure there’s enough money to get the deal done. Lenders, who traditionally have supplied a lot of that money, are holding back fairly tightly, although it’s starting to loosen up maybe a touch, but you can’t get as much leverage as you once did, and you can’t get it for all types of businesses. It’s really about how you finance the deal, and can you make a case that it’s going to be accretive to your shareholders.

Previously, I think shareholders were willing to withstand a dilutive deal and wait for it to be accretive later on. Nowadays people are interested in it being accretive right off the bat because of the nature of the environment and the thought that things aren’t going to get better quick; it’s going to take a lot more time.

So figuring that out plays into the length of the due-diligence process?

Right. You’ve got to uncover everything. What most people are afraid of is closing a deal and then shortly thereafter discovering problems that cause the deal to be more expensive than they originally thought. Some can be covered by indemnification of the seller. The official legal term for that is what we call “schmuck insurance.” You don’t want to have to go back to the board of directors and look like a schmuck, or like a clown.

Everyone is so worried, it causes the diligence to take forever, and just when you think that the buyer’s done, there’s more that they want. They’re asking for revised projections, revised this, revised that, multiple times. For a CFO who still has to run his business, both on the buy side and on the sell side, it’s really a second job, having to go through an acquisition process on either side. That’s become very taxing on senior management certainly, but also the level under senior management who are also involved in the deal. Diligence that usually would be three or four months now probably takes eight or nine months. And a lot of deals are not getting done, either because the buyer finds something they don’t like or because people get deal fatigue, and they just can’t do it any longer.

It must be disheartening to put in all that time and then at the last minute find out you can’t get the deal financed.

Absolutely. You have to try to get comfort as close to the beginning of the process as possible that the buyer can do the deal. But both sides can spend a lot of time and resources to get the deal done, only to have something crater at the end. That’s somewhat common these days.

What do you think the market for M&A will look like going forward?

There’s a lot of pent-up money waiting to be utilized. The question is when will people feel like the ground has stopped shaking under them enough to go on a buying spree? I think at some point M&A will come back strong, but when that is remains to be seen. If you had asked me at the beginning of ’09, I would have probably said the third or fourth quarter of ’09, and I would have been wrong.

Now I would say maybe beginning of 2010. It’s hard to know. Perhaps all the chatter and percolation is setting us up for a good 2010, but we’re still in an environment where if one big, bad thing happens again, it could crush that chatter quickly. I think I would say I am cautiously optimistic. For 2010. I don’t think there’s going to be a big uptick in 2009.

There’s a lot of uncertainty with health care, a lot of uncertainty with regulation of financial institutions. There’s a lot of uncertainty about the economy. People are less likely to do deals in an uncertain environment because they’re unsure of whatever they’re buying is going to look like tomorrow.

For example, a private-equity firm with a ton of money may want to buy a financial institution. But until the regulators give them some kind of guidance, it’s going to be very difficult to do a financial-institution deal, if only because you’re not sure what the landscape is going to look like tomorrow.

We have a financial-institution practice and we know a lot of banks that want to be bought by private-equity firms, and we know a lot of private-equity investors wanting to make an investment in banks, but there are very few deals that have been consummated. People are OK doing deals in a bad environment or OK doing deals in a good environment. The one environment that makes it hard for deals to happen is an uncertain environment, and that’s where we are right now.