Contributing Editor

Joseph B. Frumkin Sullivan & Cromwell LLP

INTRODUCTION

CHAMBERSGlobal Practice Guides

Contributed by Joseph B. Frumkin

Sullivan & Cromwell LLP

Corporate M&A

2017

Contributing Editor

Joseph B. Frumkin Sullivan & Cromwell LLP

INTRODUCTION

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JOSEPH B. FRUMKIN INTRODUCTION

IntroductionSullivan & Cromwell LLP Sullivan & Cromwell LLP pro-vides the highest quality legal advice and representation to clients around the world. The results the Firm achieves have set it apart for more than 130 years and have become a model for the modern practice of law. Today, S&C is a leader in each of its core practice areas and in each of its geographic mar-kets. S&C’s success is the result of the quality of its lawyers, the most broadly and deeply trained collection of attorneys in the world. The Firm’s lawyers work as a single partnership without geographic division. S&C hires the very best law school graduates and trains them to be generalists within broad practice areas. The Firm promotes lawyers to partner almost entirely from among its own associates. The result is a partnership with a unique diversity of experience, excep-

tional professional judgment and a demonstrated history of innovation.

Clients of the Firm are nearly evenly divided between U.S. and non-U.S. entities. They include industrial and commer-cial companies; financial institutions; private funds; govern-ments; educational, charitable and cultural institutions; and individuals, estates and trusts. S&C’s client base is excep-tionally diverse, a result of the Firm’s extraordinary capac-ity to tailor work to specific client needs. S&C comprises more than 875 lawyers who serve clients around the world through a network of 12 offices, located in leading financial centers in Asia, Australia, Europe and the United States. The Firm is headquartered in New York.

Contributing Editor

Joseph B. Frumkin, managing partner of Sullivan & Cromwell’s M&A group, has pro-vided legal counsel on many of the largest mergers and acquisitions transactions in history, representing buyers, sellers and special committees of independent direc-

tors. His practice focuses on US and cross-border acquisi-tions, leveraged buyouts, corporate preparedness and proxy contests as well as corporate governance and general corpo-rate representation.

M&A activity in 2016 has remained robust in the face of eco-nomic, political and regulatory headwinds. These headwinds have slowed activity when compared to 2015’s historic levels, but with USD1.6 trillion in announced transactions up to June 30th, the decline is only 11.5% versus the same period in 2015. The business confidence of 2014-15 is tempered by uncertainty regarding continuing economic weakness in Eu-rope, exacerbated by the United Kingdom’s decision to exit the EU, the significant transactions that have been blocked on competition or other regulatory grounds and efforts by global banking regulators to limit leverage levels in com-mitted financing for acquisition transactions. High public company valuations are also a challenge for reaching agree-ment on the terms of M&A transactions.

Global M&A volumes for the first half of 2016, of USD1.6 trillion, declined by 11.5% compared to the first half of 2015. The decline was led by European targets, which were down 26.5%. 2015 M&A volumes were reduced by the termina-tion of USD400 billion of previously announced transac-

tions, including some of 2015’s largest deals. These M&A trends illustrate some important points about the dynamics shaping M&A activity:

• As M&A transactions again routinely take on a scale meas-ured in the tens of billions of dollars, the regulatory risks to completion of these transactions grow. Not only do combi-nations of size attract more attention from competition and other regulators around the world, but scale draws more attention to matters of tax policy, national security review and bank lending credit exposures.

• Asia’s importance in global M&A activity continues to increase. This is true for both inbound and outbound investments. Whilst the M&A sophistication of Chinese companies varies greatly, the trend towards greater sophis-tication and M&A appetites is unmistakable. In the first half of 2016 M&A activity involving Asia-Pacific-based parties decreased only slightly compared to 2015 and to-

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INTRODUCTION JOSEPH B. FRUMKIN

talled USD612 billion, substantially more than the Western European total of USD483 billion.

• Brexit-related uncertainties dampened M&A activity in the UK and Europe in the first half of 2016 and it is likely that they will continue to do so at least until the terms for Brit-ain’s exit become clear. The negative impacts of uncertainty are offset to some extent by the continuing low interest rates resulting from monetary easing by UK and EU central banking authorities and the decline in the pound sterling.

• In a low-growth world, M&A transactions become one of the few ready avenues to achieve significant revenue and earnings growth, which creates the incentives necessary to encourage companies to pursue transactions even in an uncertain economic and regulatory environment.

• M&A execution is threatened by tightening global compe-tition law enforcement, and the need for transactions to of-ten satisfy competition authorities in multiple jurisdictions, increasing both the time period required for completion and the risk of an adverse determination in one significant jurisdiction.

• Large-scale M&A also is threatened by the seemingly strengthening popular sentiment in jurisdictions around the world against globalisation and its effects. There is a risk that this popular sentiment over time will make it more dif-ficult to achieve cross-border mergers that create globally competitive business enterprises.

How much longer this M&A wave can continue is uncertain. It has already lasted longer than the average “up” cycle in global M&A activity. Dollar volumes tend to be driven by a few handfuls of large transactions and large transactions may continue to be challenged by regulatory hurdles. But the world continues to shrink and there are large companies in more countries participating in large-scale M&A as both buyers and sellers. This bodes well for the future.

US M&A Market: Good Times With a Catch2016 has seen substantial levels of M&A activity. North American deal activity in the first six months totalled USD964 million, down 10.2% from the same period in 2015, but with a much stronger second quarter than first. Mon-santo is the target of a bid by Bayer AG, Baxalta agreed to be acquired by Shire, Johnson Controls agreed to be acquired by Tyco and Spectra agreed to be acquired by Enbridge. All are acquisitions of US companies by non-US acquirers. The US saw over USD700 billion in M&A activity in the first half of 2016, spanning many industry sectors and types of transac-tions. Appetites remain strong for M&A in general and there continues to be a willingness for global corporate buyers to pursue USD10 billion+ M&A transactions.

This M&A activity has many sources. These include the al-ways-present desire for revenue and earnings growth, con-tinuing low borrowing costs, strong equity valuations, mar-

ket receptivity to M&A activity and continuing challenges in achieving organic increases in revenues and profits.

This M&A activity is also fighting against strong regulatory currents pushing back against merger transactions. These regulatory currents include the US’ adoption of tax regula-tions making inversion transactions both harder to execute and less tax efficient (see termination of Pfizer-Allergan merger), tightening competition regulation (see Baker Hughes-Halliburton merger termination), increased nation-al security scrutiny (see Philips’ termination of the sale of its lighting business to a Chinese-led investor consortium) and industrial policy/competition concerns (see Canadian Pa-cific’s withdrawal of a proposal to acquire Norfolk Southern).

The success of competition regulators in blocking major transactions may embolden them to object to even more transactions, making it more difficult to predict which trans-actions will be strongly challenged by regulators. US antitrust enforcement trends show a markedly increased reluctance to accept efficiency arguments to offset possible negative effects of increased market power; without a willingness to consider benefits, it becomes more difficult to persuade enforcers that transactions will not harm the competitive landscape. In ad-dition, although never articulated as such, there is a sense that antitrust enforcers find some of the largest transactions objectionable on the basis that they create business enter-prises of a size and complexity that is an independent source of concern.

Banking regulators have contributed to the M&A head-winds by strictly enforcing leverage limits for traditional bank lenders. This has limited the debt available for private equity transactions, requiring a higher proportion of equity investment, with the resultant decline in returns on invested equity. It has also led to the entry of non-traditional lenders into the leveraged loan market, providing leverage at greater levels than is permitted by the regulators of the traditional lending institutions. These non-traditional lenders have be-come an important capital source in the smaller and mid-market sector of the private equity M&A world, but they do not yet have the capital to fund the larger-scale private equity transactions. As a result, private equity M&A levels have remained active but muted, with a focus on mid-market transactions.

Political trends around the world may also negatively im-pact M&A activity. The success of Donald Trump in the US, the Brexit vote in the UK and the strengthening of nationalist parties in continental Europe all reflect a deep, broadly sourced unease with the status quo, which includes the economic status quo. Globalisation of business activi-ties, including through mergers, gives rise to efficiencies, innovation and other benefits, but the broad acceptance of free-market principles over the last 30-40 years has left many

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JOSEPH B. FRUMKIN INTRODUCTION

voters feeling marginalised and susceptible to arguments for political and economic nationalism. If these trends continue and strengthen, they seem likely to affect adversely, perhaps severely, cross-border M&A activity.

European M&A: Waiting for a ReboundThe UK referendum on withdrawal from the EU, which was held on 23 June 2016, has given rise to significant uncertain-ty which widely affected European M&A activity in the first half of 2016. Combined with the US government’s clamp-down on tax inversion deals, this led to European activity during the first six months of 2016 dropping to USD342.8 billion, reaching the lowest level since 2013.

Whilst during the first quarter of 2016 European M&A ac-tivity slightly improved, the second quarter saw a significant decrease (coming down 46% compared to 2015) as the EU referendum drew closer.

During the first half of 2016, Asian groups sustained their investment in Europe as a result of their continued strong interest in acquiring European technologies. However, US investors were particularly cautious as a result of the possi-ble impact of Brexit on the economy and the exchange rates (as evidenced by a 67% decrease in the first half of 2016 in the volume of European M&A transactions involving US acquirers).

French M&A was negatively impacted by the tensions around the labour environment, which continued to keep investors away from French targets. The pharmaceutical sector was the most active, in particular with the Sanofi – Medivation megadeal. Forecasts remain uncertain but the French government is try-ing to take advantage of Brexit to favour foreign investments and repatriation of employees through the implementation of an at-tractive tax regime. If such a new tax regime were to be adopted, it could have a very positive effect on French M&A.

The UK, naturally, was more affected by the Brexit referen-dum than any other European country and suffered a sig-nificant decrease of M&A activity during the second quarter of 2016. During the period ahead of the referendum vote on June 23rd, the majority of companies and investors adopted a “wait and see” approach. Generally speaking, this approach has continued during the period since the “leave” vote was announced on June 24th. This was to be expected, given the uncertainty about both the timing and manner of the UK’s withdrawal from the EU, and the associated economic con-sequences for both the UK and Europe. Those transactions which have been announced since the referendum vote are largely ones where the parties were already in negotiations before the vote (including significant transactions such as Softbank’s offer for ARM Holdings, which was announced on July 18th).

The longer-term impact of the “leave” vote on UK M&A will depend to a large extent on the timing, form and substance of the political settlement that is reached between the UK and the EU in relation to the UK’s withdrawal from, and future relationship with, the EU (and, in particular, whether the UK remains part of the EU single market and whether the UK’s withdrawal from the EU results in a second ref-erendum on Scottish independence). In addition, the new industrial policy announced by UK Prime Minister, Theresa May, on July 11th could restrict the ability of acquirers to consummate acquisitions of UK companies in certain sec-tors (although it should be noted that the UK government has issued a public statement supporting Softbank’s offer for ARM Holdings in the light of binding commitments made by Softbank in relation to UK employees).

M&A activity in Germany resisted the negative European trends, with a slight increase compared to the first half of 2015. The industrial and chemical sectors were particularly attractive, especially for Asian investors. Prospects remain positive in spite of Brexit, given the stability and solidity of the German economy and the German market’s liquidity.

In the light of the uncertainties in Europe, pan-European transactions have also decreased, despite the announcement of significant transactions such as the USD27 billion merger between the London Stock Exchange (LSE) and Deutsche Boerse. European groups are now looking to broaden their exposure outside Europe by investing abroad and in particu-lar in the US. For the first half of 2016, the value of trans-actions from European investors directed to a US target increased by 278% compared to 2015, with ten announced deals exceeding USD10 billion (including Bayer – Monsanto, Tyco International – Johnson Control, Air Liquide – Air-gas, Sanofi – Medivation). Investments in Asia during the first half of 2016 by European groups have also increased by 154% compared to 2015 but remained rather low in terms of value.

As the European market continues to lack visibility, signifi-cant investments from European groups in the US should continue in the coming months, as demonstrated by the re-cent announcement of the Danone USD12.5 billion acquisi-tion of WhiteWave.

Latin American M&AAs has been the case in prior periods, deal activity in coun-tries across Latin America in the first half of 2016 contin-ued to be a study in contrasts – disparately affected by both global trends with direct impact on economies increasingly integrated into world trade and diverse developments in domestic economies affecting prospects for deals going for-ward. Whilst aggregate deal values were marginally up from the first half of 2015 as a result of a few deals that were ex-ceptionally large for the region, overall deal volumes in this

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INTRODUCTION JOSEPH B. FRUMKIN

period were reportedly down from the first half of 2015. In several countries, however, there are some signs for opti-mism that the relatively muted activity could be poised for return to greater growth in the near to medium term.

First, whilst 2016 ushered in a period of enhanced political un-certainty in several of the world’s key economies (most notably from Brexit’s potential impact on the EU bloc and a contentious election season in the US), there is hope that recent political developments in many Latin American countries may be more conducive to deal-making. For example, administrations widely considered supportive of foreign investment have been elected in Peru and Argentina following elections that bred significant un-certainty. Perhaps most significantly, the installation of interim President Michel Temer’s administration in Brazil may help to restore some investor confidence that the ongoing political and economic crisis in the region’s largest economy may be one step closer to turning around.

In addition, the diversity of sectors of deals during this pe-riod is an encouraging sign that diverse opportunities in the region are being driven by various trends. For example, continued low commodity prices worldwide and related di-vestiture programmes have helped spur significant activity in energy and mining, including Petrobras’ dispositions of its stakes in Petrobras Argentina S.A. to Pampa Energia and distribution assets in Chile to Southern Cross Group. Di-vestment initiatives have also been driven by other factors: companies affected by the far-reaching corruption investi-gations in Brazil, such as Oderbrecht S.A., have announced significant divestments in the region and the process of cer-tain global financial firms’ exiting from the region appears to continue with Citigroup Inc.’s announced plans to exit retail operations in Brazil, Argentina and Colombia.

Acquirers’ interest in the region has also been sustained by other trends that have been at play for several years and continue to be a factor. Outbound M&A interest from Chi-nese acquirers, which has recently been a significant factor in deal-making worldwide, has led to transactions such as China Molybdenum Co Ltd’s USD1.5 billion acquisition of Anglo American Plc’s Brazilian niobium and phosphate

businesses. Long-term GDP growth expectations have driv-en the interest of pension funds and other investors in utility and infrastructure assets throughout the region, particularly in markets like Peru (Brookfield’s acquisition of a stake Rutas de Lima toll road), Colombia (Brookfield’s potential USD4.7 billion acquisition of Isagen S.A.) and Mexico (OTTP/CP-PIB’s acquisitions of a USD1.1 billion stake in the Arco Norte toll roads) with a relatively stable outlook compared to econ-omies like Brazil. Finally, expectations for the strength of the middle class in many markets remain robust, which, com-bined with relative currency devaluations, have continued to sustain interest from both fund and strategic investors in sectors such as healthcare, education, and retail (such as with the recently announced USD1.2 billion acquisition of Chile’s Ripley by Mexico’s department store chain Liverpool).

Korean M&AThe first half of 2016 saw a significant cool-down in M&A activities involving Korea. Aggregate deal value decreased by over 50% compared to the corresponding year-on-year period, and deal value was at its lowest level since 2013. The decrease was due in part to a much higher base in the last few years when a number of mega deals were completed (eg Oriental Brewery, ADT and Homeplus), but political un-certainty and increased market concerns globally, regionally and domestically all contributed to a decrease in deals.

Many Korean conglomerates are increasingly considering sig-nificant restructurings to focus on core business competency. However, divestitures of non-core assets to entities other than other Korean conglomerates still face significant internal resist-ance in Korea, primarily from employees and labour unions who fear losing long-term employment stability at name-brand con-glomerates. This significant hurdle has not deterred the inflow of, or re-opening of offices by, private equity funds looking to take advantage of these divestitures when they occur. In the long run, the increased interest of global private equity funds and the need of the conglomerates to restructure will eventually lead to strong deal-flow in this area. The question is just when.

Despite the factors dampening domestic Korean M&A activ-ities, as discussed above, fundamentals favouring outbound investment by Korean companies are strong. Low domestic GDP growth, saturated or maturing domestic markets and large corporate cash reserves will fuel the demand for acqui-sitions outside Korea by Korean companies. Cross-border deal experience of Korean companies varies substantially across industry, but the needs for diversification (mostly focused on established US and European markets) and for growth (through presence in developing markets) are be-coming more important and are likely to be the main drivers for the M&A activities involving Korean companies in the coming years.

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