Category: Mergers & Acquistions

Cybersecurity Due Diligence Is Crucial in All M&A—Including Energy M&A Transactions

Can a single data breach kill or sideline a deal? Perhaps so. Last month Verizon signaled that Yahoo!’s disclosure of a 2014 cyberattack might be a “material” change to its July $4.83 billion takeover bid—which could lead Verizon to renegotiate or even drop the deal entirely. Concern over cybersecurity issues is not unique to technology or telecommunications combinations. In a 2016 NYSE Governance Services survey of public company directors and officers, only 26% of respondents would consider acquiring a company that recently suffered a high-profile data breach—while 85% of respondents claimed that it was “very” or “somewhat” likely that a major security vulnerability would affect a merger or acquisition under their watch (e.g., 52% said it would significantly lower valuation).

Bottom Line: Cybersecurity should play a more meaningful role in the due diligence portion of any potential M&A deal. Certainly this is so when a material portion of the value in the acquisition comes from intangible assets that might be most vulnerable to hackers. Financial information comes to mind. Personal information of employees does as well. But companies also need to be concerned about their trade secrets, know-how and other confidential business information whose value inheres in its secrecy. Therefore, a merely perfunctory approach to cybersecurity can become very costly. The union of companies today is a union of information, malware and all.

Energy M&A Is Not Immune

To weather the plunge in prices, many oil companies have sought out new innovations to reduce the cost of extraction and exploration. Investments in digital technologies will likely only increase—a 2015 Microsoft and Accenture survey of oil and gas industry professionals found that “Big Data” and the “Industrial Internet of Things” (IIoT) are targets for greater spend in the next three to five years. Cybersecurity threats were perceived in the survey as one of the top two barriers to realizing value from these technologies.

These developments in energy industry—bigger data and bigger vulnerabilities—are here to stay. The proposed merger of General Electric and Baker Hughes also speaks to the growing importance of analytics to oil production. Commentators note that the acquisition would allow GE more fully to implement its Predix platform, an application of IIoT to connect everything from wellhead sensors to spreadsheets. However, as last month’s massive cyberattack on DNS provider Dyn, Inc. demonstrated, the IIoT holds unique challenges as well as great promise for operational efficiency. (In this attack, reportedly 400,000 internet-linked gadgets were hacked and used to reroute web traffic to overload servers.)

Bottom Line: Robust cybersecurity diligence should be de rigueur for energy M&A.

What Can Companies Do to Protect Deal Value?

For starters, energy companies should treat cybersecurity as a separate and more involved category for due diligence.

Liability for or damages from legacy data breaches or malware can become expensive—damages to systems, theft of information and liability from the release of personal or reputation-damaging information, to name a few. Therefore, anticipating problems post-merger, cataloguing past vulnerabilities and most importantly, discovering actual breaches before closing is crucial to avoid deals blowing hot and cold.

Companies should retain IT specialists who can do an objective assessment of the cybersecurity posture of a proposed merger or acquisition. This can help prospective acquirers better determine the adequacy of a target’s cybersecurity programs, such as its policies over incident response, how access to data is distributed, the extent of a company’s online presence and vulnerabilities, and how remediation of any potential cyberthreats or actual breaches may best proceed.

A cybersecurity questionnaire should also be developed, covering such topics as:

  • How and where has company data been stored?

  • Who has had access?

  • Have there been any actual or attempted intrusions into (or leaks) of company data?

An acquirer could further insist on specific representations and warranties from a target company regarding their cybersecurity compliance, as well as bargain towards indemnity for prior data breaches.

On the target side, energy companies should prepare (in turn) for more scrutiny over their data security and privacy practices. Among other benefits to “knowing thyself,” getting ahead of this process should offer targeted companies a better negotiating position. It would also allow them to take a more proactive role in defining the policies of the combined company post-merger. At the very least, these efforts could help avoid the kind of hiccups and uncertainties that lead to undervaluation. In any event, poor cybersecurity practices can give an impression that a target lacks risk management in other areas—not an ideal pose to strike in any bargain.

Parting Thoughts

It is a trope in cybersecurity writing to invoke figures like Sun Tzu and shoehorn in quotes about war stratagem. Well, these habits are in some ways unavoidable: For all intents and purposes, fighting anonymous hackers resembles battle prep—a method of self-awareness and readiness that defies box-checking.

Energy companies could take these words to heart from the inestimable Miyamoto Musashi, a samurai who won 60 duels: “If you consciously try to thwart opponents, you are already late.” (A sentiment echoed more recently by Mike Tyson’s truistic “Everyone has a plan until they get punched in the mouth.”)

And This Key Takeaway: Any cybersecurity program must go hand-in-hand with a corporate culture that respects data as among its most valued assets. Efforts in detection, reporting and remediation are challenges that fall throughout the ranks and, if reflexive to the unknown, stand the best chance of being fully realized.

Bottom Line: Mind Your Data!

ARTICLE BY Jeff C. Dodd, Douglas W. Rommelmann & Ross Campbell of Andrews Kurth Kenyon
© 2016 Andrews Kurth Kenyon LLP

Microsoft Acquiring LinkedIn as Move into Enterprise Social Media

Linkedin MicrosoftMicrosoft has announced that it is buying LinkedIn for $26.2 billion, one of the largest tech acquisitions in history, and that it intends to use the business social media giant to put Microsoft at the center of our work lives.

Currently, LinkedIn has 433 million members in 200 countries. Microsoft has 1.28 billion Office users worldwide. Microsoft CEO Satya Nadella said in an interview with Bloomberg:

“This is about the coming together of the leading professional cloud and the leading professional network. This is the logical next step to take. We believe we can accelerate that by making LinkedIn the social fabric for all of Office.”

Nadella said that Microsoft’s vision is to place your LinkedIn profile at the center of your online work life, connecting it with Windows, Outlook, Skype, PowerPoint and other Microsoft products.

For example, Cortana (Microsoft’s digital assistant) could provide users with information on other participants in an upcoming meeting by pulling data from LinkedIn profiles. Members working on a project could pull up LinkedIn articles concerning their project or use LinkedIn profiles to search for an “expert” to help with the project.

Microsoft also sees LinkedIn playing a major role in developing a new customer relationship management (CRM) tool for sales organizations. LinkedIn analytics could be integrated with Microsoft’s Dynamics tool, which competes with Salesforce.com, to assist companies with managing their customers.

Here’s a CNBC interview with Nadella and LinkedIn CEO Jeff Weiner explaining the opportunities.

ARTICLE BY Stephen Fairley of The Rainmaker Institute

© The Rainmaker Institute, All Rights Reserved

U.S. Sentencing Commission Weighing Recommendation to Increase Criminal Antitrust Penalties

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In June, the United States Sentencing Commission, which is appointed by the President to make recommendations to Congress on the criminal penalties for the violation of federal law, issued a request for comments regarding whether the guidelines for calculating antitrust fines should be modified. Currently, corporate fines for cartel price fixing are calculated on a sliding scale, tied to the amount of the “overcharge” imposed by the violators, with the standard maximum fine under the Guidelines for a corporation capped at $100 million and, for an individual, capped at $1 million. The deadline for such comments was July 29, and the views expressed on the issue varied considerably.

Contending that the current Guidelines do not provide an adequate deterrent to antitrust violations, the American Antitrust Institute urged the Commission to recommend an increase in the fines for cartel behavior. The AAI stated that the presumption in the Guidelines that antitrust cartels, on average, “overcharge” consumers for goods by 10% is greatly understated, and thus should be corrected to reflect more accurate levels. Pointing to economic studies and cartel verdicts, the AAI suggests that the median cartel “overcharge” is actually in excess of 20%, and therefore the presumption should be modified in the Guidelines. If adopted, the AAI’s proposal would double the recommended fines under the Guidelines for antitrust violations.

Perhaps surprisingly, the DOJ responded to the Commission’s Notice by stating that it believes that the current fines are sufficient, and that no increase in antitrust fines is warranted at this time. The DOJ indicated that the 10% overcharge presumption provides a “predictable, uniform methodology” for the calculation of fines in most cases, and noted that the Guidelines already permit the DOJ to exceed the fine levels calculated using the 10% overcharge presumption in some circumstances. Specifically, the DOJ noted that the alternative sentencing provisions of 18 USC 3571 already permit it to sidestep the standard guidelines and seek double the gain or loss from the violation where appropriate. Notably, the DOJ utilized this provision in seeking a $1 billion fine from AU Optronics in a 2012 action, although the court declined the request, characterizing it as “excessive”. The court did, however, impose a $500 million fine, an amount well in excess of the cap under the standard antitrust fine guidelines.

Finally, D.C. Circuit Court of Appeals Judge Douglas Ginsburg and FTC Commissioner Joshua Wright offered a completely different view on the issue in comments that they submitted to the Sentencing Commission. Suggesting that fines imposed on corporations seem to have little deterrent effect, regardless of amount, they encouraged the Commission to instead recommend an increase in the individual criminal penalty provisions for antitrust violations. Notably, they encouraged the Commission not only to consider recommending an increase in the fines to which an individual might be subjected (currently capped at $1 million), but also to recommend an increase in the prescribed range of jail sentences for such conduct (which currently permit for imprisonment of up to 10 years).

The Commission will now weigh these comments and ultimately submit its recommendations to Congress by next May. If any changes are adopted by Congress, they would likely go into effect later next year. Stay tuned.

ARTICLE BY

James M. Burns
 
OF 
Dickinson Wright PLLC

The Real Tax Benefits of Inverting to Canada

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On August 26, Burger King announced that it entered into an agreement to acquire Tim Hortons, Inc., the Canadian coffee-and-doughnut chain, in a transaction that will be structured as an “inversion” (i.e., Burger King will become a subsidiary of a Canadian parent corporation).  The deal is expected to close in 2014 or 2015. The agreement values Tim Hortons at approximately $11 billion, which represents a 30 percent premium over Tim Hortons’ August 22 closing stock price.

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Under the terms of the deal, Tim Hortons shareholders will receive a combination of cash and common shares in the new company. Each common share of Burger King will be converted into 0.99 of a share of the new parent company and 0.01 of a unit of a newly formed, Ontario-based limited partnership controlled by the new parent company. Holders of shares of Burger King common stock, however, will be given the right to elect to receive only partnership units in lieu of common shares of the new parent company, subject to a limit on the maximum number of partnership units issued.  Burger King shareholders who make this election will be able to defer paying tax on the built-in gain in their Burger King shares until the partnership units are sold. 3G Capital, Burger King’s principal shareholder, has elected to receive only partnership units. 3G will own approximately 51 percent of the new Burger King-Tim Hortons company, with current public shareholders of Burger King and Tim Hortons receiving 27 percent and 22 percent, respectively.

Inversions have gotten plenty of negative publicity during the past few years.  Most of the reported deals involve U.S. companies that have acquired smaller foreign companies in low tax jurisdictions such as Ireland, Switzerland, and the U.K.  As with any inversion transaction, the U.S. company will continue to be subject to U.S. federal income tax on its worldwide income.  The U.S. company will benefit, however, from the ability to: (i) reorganize its controlled foreign subsidiaries under a new foreign parent corporation (thereby removing those subsidiaries from the U.S. “controlled foreign corporation” regime and also allowing for the future repatriation of non-U.S. source profits to the foreign parent corporation and avoid U.S. corporate income tax); and (ii) “base erode” the U.S. company with intercompany debt and/or license arrangements with the new foreign parent or its non-U.S. subsidiaries.

It has been reported that Burger King’s effective tax rate was 27.5 percent in 2013 and Tim Hortons was 26.8 percent (15 percent federal rate plus 11.8 percent provincial rate), so “base eroding” Burger King with deductible interest and/or royalty payments to Canada will not provide a significant tax benefit to Burger King.  Where the use of a Canadian parent corporation, however, will benefit Burger King (and other U.S. companies that have inverted into Canada) from a tax perspective is the ability to take advantage of Canada’s (i) “exempt surplus” regime, which allows for the repatriation of dividends from foreign subsidiaries into Canada on a tax-free basis; and (ii) income tax treaties that contain tax sparing provisions, granting foreign tax credits at rates higher than the actual foreign taxes paid.  The United States does not provide either of these tax benefits under its corporate income tax system or treaty network. 

Canadian Exempt Surplus Regime

In general, under Canadian law, dividends received by a Canadian corporation out of the “exempt surplus” of a foreign subsidiary are not subject to corporate income tax in Canada.  Exempt surplus includes earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a country with which Canada has concluded an income tax treaty or, more recently, a tax information exchange agreement (TIEA).  A TIEA is an agreement between two jurisdictions pursuant to which the jurisdictions may request and share certain information that is relevant to the determination, assessment and collection of taxes, the recovery and enforcement of tax claims, and the investigation or prosecution of tax matters.  The extension of the exempt surplus regime to jurisdictions that have signed TIEAs (but not income tax treaties) with Canada is significant because Canada has signed such agreements with low-tax jurisdictions, such as the Cayman Islands, Bermuda, and the Bahamas. Historically, the use of a Barbados IBC, which has a maximum corporate income tax rate of 2.5 percent, was the preferred jurisdiction for a Canadian parent company operating in a low-tax jurisdiction because of the long standing Canada-Barbados income tax treaty.

On the other hand, dividends received by a Canadian corporation out of the “taxable surplus” of a foreign subsidiary will be taxable in Canada (subject to a grossed-up deduction for foreign taxes) at regular corporate income tax rates. Taxable surplus includes most types of passive income, such as royalties, interest, etc., and active business income of a foreign subsidiary that is resident in, or carrying on business in, a country with which Canada has neither an income tax treaty nor a TIEA.  Special rules may deem certain passive income (such as interest or royalties) to be included in exempt surplus if received by a foreign subsidiary resident in a tax treaty or TIEA jurisdiction, if those amounts are deductible in computing the exempt earnings of another foreign subsidiary.  For example, interest and royalties paid from an active business of a U.K. subsidiary of a Canadian parent corporation to a Cayman Islands subsidiary of such Canadian parent will be eligible to be repatriated to Canada from the Cayman Islands under the exempt surplus regime on a tax-free basis.

It is interesting to note, however, that Burger King will not be able to repatriate most of its foreign-source income to Canada on a tax-free basis under the exempt surplus rules.  The majority of Burger King’s foreign-source income consists of royalties and franchise fees, which will be considered passive income for Canadian income tax purposes.  (Burger King, which operates in about 14,000 locations in nearly 100 countries, has become a franchiser that collects royalty fees from its franchisees, not an operator of restaurants).

Canada’s Tax Sparing Provisions

Another tax benefit offered by a Canadian parent corporation is the ability to utilize the “tax sparing” provisions contained in many Canadian income tax treaties. Canada currently has income tax treaties that contain tax sparing provisions with more than 30 countries, including Argentina, Brazil, China, Israel, Singapore, and Spain. In general, the purpose of a tax spari
ng provision is to preserve certain tax incentives granted by a developing jurisdiction by requiring the other jurisdiction to give a foreign tax credit for the taxes that would have been paid to the developing country had the tax incentive not been granted.  For example, under Article 22 of the Canada-Brazil income tax treaty, dividends paid by a Brazilian company to a Canadian parent corporation are deemed to have been subject to a 25 percent withholding tax in Brazil and therefore, eligible for a 25 percent foreign tax credit in Canada, even though the treaty limits the withholding tax to 15 percent (and in actuality, Brazil does not even impose withholding taxes on dividends under its local law).  A similar benefit is available for interest and royalties paid from Brazil to Canada (e.g., a deemed withholding tax, and therefore foreign tax credit, of 20 percent, even though the treaty caps the withholding tax at 15 percent).  As noted above, the United States does not currently have any income tax treaties that contain tax sparing provisions.

Conclusion

With Burger King’s effective corporate tax rate of 27.5 percent in the United States in 2013 and Tim Hortons 26.8 percent in Canada, the tax benefits of Burger King inverting to Canada are not readily apparent.  Notwithstanding the lack of a significant disparity in these tax rates, Canada does offer the ability to exclude from its corporate income tax dividends received from the earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a jurisdiction that has concluded an income tax treaty or TIEA with Canada.  This key benefit, along with the Canadian income tax treaties that contain tax sparing provisions, provides one more example of why U.S. multinationals are operating at a competitive disadvantage when compared to other OECD countries around the world. 

ARTICLE BY

Jeffrey L. Rubinger
 
OF 
Bilzin Sumberg Baena Price & Axelrod LLP

Sizing Up the Competition: Antitrust Enforcement and the Bazaarvoice Ruling

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High-profile or highly profitable firms are no longer the sole targets of post-merger divestitures by antitrust enforcers. Today, firms that have little or no revenues, including some that operate in emergent industries with little or negative profits, also find themselves subject to merger inquiries, as demonstrated by the recent merger review of Bazaarvoice’s 2012 non-reportable $160 million acquisition of PowerReviews. 

Bazaarvoice merger antitrust

These competing firms were both operating at a loss in the relatively small Ratings and Review (R&R) market. Yet, the nature of competition in the industry and the industry’s potential importance to adjacent industries – combined with statements by the acquirer’s executives prior to the transaction – attracted the scrutiny of antitrust enforcers. Ultimately, Bazaarvoice agreed to divest all of its PowerReviews assets, including employees and client base, to a small competitor, Viewpoints – which had initially entered R&R space by building a solution for Sears – for $30 million.  

This article considers the economic arguments and evidence used by the court to reach its decision in United States v. Bazaarvoice.

Background

R&R platforms offer an online interface for customer reviews of different products, which can help to drive sales, increase product visibility, and offer valuable information on customers to brands and retailers, allowing brands to respond to customer concerns in real time. Leading platforms offer clients the following services: confirmation of the authenticity of customer reviews; moderation of reviews (e.g., removing offensive language); syndication that combines reviews from multiple retailers to increase the visibility of a product; data on retailers and social media analytics to support marketing; and search engine optimization to drive traffic. Bazaarvoice and PowerReviews offered clients all of these services, but Bazaarvoice generally provided more customizable features at higher price points to larger clients. Bazaarvoice offered human moderation of customer reviews, for example, while PowerReviews offered only automated monitoring.

The Department of Justice (DOJ) applied competitive analysis that ignored more traditional focuses on supracompetitive pricing, high margins, and immediate harm to consumers.

In 2012, Bazaarvoice had 800 employees and revenue of $106.1 million; in 2011, the privately held PowerReviews employed just 80 people and reportedly had revenue of $11.5 million. Although PowerReviews did not publicly report its profitability, according to Bazaarvoice executives, the smaller firm was operating at a loss. Similarly, Bazaarvoice itself reported consistently negative operating margins in 2011–2013 that were no higher than -23%.

At the time of the court ruling (January 2014), actual competition from other platforms in the R&R market was marginal, composed primarily of a handful of start-ups with inferior products or of larger firms that offered complementary products. Direct competitors like Pluck, Gigya, Practical Data, Rating-system.com, and European Reevoo were tiny, with few customers and weak services. More established firms that might have acted as potential competitors, such as Google, Facebook, Oracle, and Salesforce, were more interested in partnering with Bazaarvoice than in competing in the R&R market. Meanwhile, Amazon accounted for 28% of e-commerce revenue and maintained (and still does, as of August 2014) its own R&R platform, which was not available to competing retailers. 

Competitive arguments and evidence 

In its review of the transaction, the U.S. Department of Justice (DOJ) applied competitive analysis that ignored more traditional focuses on supracompetitive pricing, high margins, and immediate harm to consumers. The analysis focused instead on the nature of competition in the R&R industry, including barriers to entry and the anticompetitive potential for long-run harm to consumers as detailed in the assessments of Bazaarvoice senior staff.

Low margins: The parties were losing money. Their profits were a far cry from the supracompetitive profits often associated with companies targeted by antitrust litigation. In previous antitrust cases against Microsoft, for example, the company’s margins on Windows and MS Office had played a significant role at trial. Similarly, the potential for enhanced market power and exceptional margins contributed to the DOJ decision to prevent Microsoft from acquiring Intuit in 1994–1995.

Barriers to entry: Bazaarvoice’s extensive syndication network, in particular, became a major component of the case. The DOJ argued that it would be extremely difficult for competitors to develop a comparable syndication network of retailers and brands, allowing Bazaarvoice to leverage anticompetitive economies of scale across many important clients. These advantages, combined with the difficulty of switching from one R&R platform to another – as demonstrated by the reluctance of PowerReviews customers to switch to the Bazaarvoice platform – would effectively block new entrants from the market. While the DOJ’s argument was much less convincing with respect to other barriers to entry, such as the company’s technology and reputation, clearly antitrust enforcers had seized on important elements of the relationship between Bazaarvoice’s value proposition and the growth of the R&R market.

Bad documents: These potential anticompetitive implications were explicitly referenced in Bazaarvoice’s own internal documents, which became instrumental in court. The firm’s current CEO remarked that there were “literally, no other competitors” beyond PowerReviews, and the former CEO wrote that after the proposed acquisition of PowerReviews, Bazaarvoice would have “[n]o meaningful direct competitor.” Bazaarvoice senior executives openly acknowledged that syndication networks created high barriers to entry in the R&R industry and clearly described that the elimination of Bazaarvoice’s “primary competitor” would provide “relief from price erosion.” The DOJ seized on these documents, arguing that the merger would increase prices and eliminate the “substantial price discounts” that retailers and manufacturers received as a result of competition between Bazaarvoice and PowerReviews.

Court’s opinion 

In this case, the court noted these apparent competitive weaknesses and remained on the lookout for changes in the R&R market. In fact, in the 18 months from the time of the acquisition on June 12, 2012, until the case’s ultimate outcome on January 8, 2014, the only post-merger evidence that was considered dispositive by the court was
the absence of serious entry to the market. The court explicitly rejected the use of pricing data, suggesting that it could be manipulated. The same pricing data that regulators might have expected to rise above competitive levels – and that therefore could have created space for new entrants in the R&R market at lower price points – was viewed as suspect. The DOJ case was structured instead around the absence of a credible entry threat in the R&R space, despite Bazaarvoice’s annual margins of around -30%. 

For Bazaarvoice, the challenge was less about responding to customer concerns or even to actual prices than it was about addressing the incendiary internal paper trail left by the company’s senior executives.

Discussion 

The court’s focus on the entry threat and its dismissal of pricing policies is curious, because the two issues are highly related. In an industry characterized by prices so low that the market leader is highly unprofitable, new firms have no incentive to enter. To become profitable, Bazaarvoice would have had to double its prices, and yet no evidence presented in the case demonstrated that entry would be impossible at that much higher price level. Surprisingly, the court did not connect these two issues in a meaningful way.

For Bazaarvoice, the challenge was less about responding to customer concerns or even to actual prices than it was about addressing the incendiary internal paper trail left by the company’s senior executives. In fact, as the testifying expert for Bazaarvoice/PowerReviews, Dr. Ramsey Shehadeh, pointed out, customers expressed no reservations about the merger, and Bazaarvoice had not raised prices. Ultimately, the court discounted Bazaarvoice’s arguments related to the absence of actual anticompetitive effects, noting that the firms could moderate their behavior while under antitrust scrutiny and focused instead on the firm’s own internal documents, which had detailed a plan to block competitive pressure. Bazaarvoice found itself fighting its own internal assessment of the competitive effects of the proposed merger, in addition to the DOJ’s economic arguments. The internal documents and emails were far more difficult to explain away than the economic circumstances, resulting in a full divestiture.

ARTICLE BY

Rebecca Kirk Fair
 
OF 
Analysis Group, Inc.

Federal Trade Commission (FTC) Wins Appeal: ProMedica Merger with St. Luke’s Not Allowed

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On April 22, 2014, the U.S. Court of Appeals for the Sixth Circuit (Sixth Circuit) upheld the Federal Trade Commission’s (FTC) finding that the merger between Ohio-basedProMedica Health System, Inc. (ProMedica) and St. Luke’s Hospital (St. Luke’s), an independent community hospital that operates in the one of the same counties as ProMedica, would adversely affect competition in violation of federal antitrust law. Prior to the merger, ProMedica and St. Luke’s comprised two of the four hospital systems in Lucas County, Ohio. After the two systems merged, ProMedica held more than 50% of the applicable market share.

Accordingly, in 2011 the FTC ordered ProMedica to divest itself of St. Luke’s. ProMedica appealed the FTC’s order to the Sixth Circuit. In a unanimous opinion, the Sixth Circuit denied ProMedica’s petition to overturn the FTC order, citing concerns about anti-competitive behavior and the ability of ProMedica to unduly influence reimbursement rates with healthcare insurance companies.

The full 22-page court opinion may be accessed here.

Article By:

Patrick J. Cannon
Of: 
von Briesen & Roper, S.C.

Tips for Success in the Current Mergers and Acquisitions Environment

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If you have been waiting for a recovery in the Merger & Acquisition environment in the defense and government services industries, we have bad news: you will most likely have to wait until well into 2014. By almost all accounts, the M&A market has yet to snap out of the doldrums.

Back in 2008 and 2009, we could blame the problem on a dearth of available financing; however, today there is plenty of cash on corporate balance sheets. Lenders are more than willing to finance good deals. So, what gives? The reasons are diverse, including concerns over declining federal budgets, uncertain government programs, questions about the sustainability of global growth, and the increasing cost of business resulting from the vast array and complexity of government regulations, to name just a few.

With M&A volume meandering sideways, the fact that valuations are stagnant should also come as no surprise. Middle market M&A multiples continue to remain in the 4X to 6X EBITDA range, and sometimes higher in the case of acquisitions by strategic buyers.

While this all might sound depressing, it should not be. For companies with an interest in growing through M&A, conditions could not be much better. Between cash balances and available credit, there is plenty of financing available to fund good deals. Next, the Federal Reserve and other central banks have indicated a commitment to maintain low interest rate environments. Additionally, Baby Boomer retirements and generational transitions in family-owned businesses should continue to result in buying opportunities. Finally, the absence of frothy valuations typically present at this stage of a recovery have not yet materialized, increasing the likelihood of M&A success (when measured in terms of return on investment). This last point is particularly important, because M&A failure rates tend to increase dramatically as asset prices increase.  Additionally, many larger companies are opting to divest non-core business units.

Despite the favorable environment, it is important to remember that M&A is fraught with risk. To maximize your probability of success, keep the following points in mind:

  1. Make sure you have an M&A strategy. Clearly defining business objectives you intend to accomplish through M&A can help identify a broad pool of targets, sift through those targets to identify the best fit, and minimize merger premiums.
  2. Start small. Successful acquirers tend to grow through a large number of small acquisitions, rather than “betting the farm” on a single transaction.
  3. Set a walk-away price. The best acquirers set a maximum price early on and stick to it.
  4. No stone unturned.  Make sure you and your advisors do as much due diligence as possible before an acquisition, so you can make an informed investment decision and arrive at a proper valuation.  In addition to thoroughly understanding the business and the financial aspects of the transaction (the target’s assets, revenue streams, liabilities, cost analyses and projections), also make sure you have a firm grasp on the risks involved in the transaction, and mitigate them to the best of your ability.
  5. Do not fall in love with the deal. Negotiating a deal is exciting, but walking away is not. Call it what you want—pride, hubris, delirium—but the sheer desire to close the deal often leads incredibly brilliant people to do incredibly stupid things. Hit the pause button from time to time and ask the advice of those you trust.
Article By:

Michelle DiCintio
Of: 
Odin, Feldman & Pittleman, P.C.

Call Waiting: Department of Justice (DOJ) to Maintain Scrutiny of Wireless Industry Consolidation

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The wireless industry has seen steady consolidation since the late 1980s.  Recently, in late 2013, reports began circulating about a potential merger between Sprint and T-Mobile, the nation’s third and fourth-largest wireless carriers, respectively.  Last week, however, in an interview with the Wall Street Journal, William Baer, the assistant attorney general for the antitrust division at the Department of Justice (DOJ), cautioned that it would be difficult for the Agency to approve a merger between any of the nation’s top four wireless providers.

T-Mobile’s CEO, John Legere, stated that a merger between his company and Sprint “would provide significant scale and capability.”  Baer, on the other hand, warned that “It’s going to be hard for someone to make a persuasive case that reducing four firms to three is actually going to improve competition for the benefit of American consumers,”  As a result, any future consolidation in the wireless industry is likely to face a huge hurdle in the form of DOJ’s careful scrutiny of any proposed transaction.

Much of the DOJ’s interest in the wireless industry stems from the Agency’s successful challenge of a proposed merger between T-Mobile and AT&T in 2011.  Since then, Baer believes consumers have benefitted from “much more favorable competitive conditions.”  In fact, T-Mobile gained 4.4 million customers in 2013, bringing optimism to the company’s financial outlook after years of losses.  In the final two quarters of 2013, T-Mobile’s growth bested that of both Sprint and AT&T.  The low-cost carrier attracted customers and shook up the competition by upending many of the terms consumers had come to expect from wireless carriers, as well as investing in network modernization and spectrum acquisition.  This flurry of activity has pushed the competition to respond with its own deals, resulting in “tangible consumer benefits of antitrust enforcement,” according to Baer.

The DOJ’s antitrust division has kept careful watch over the wireless industry the past few years. That scrutiny will remain, as the Agency persists to advocate that four wireless carriers are required for healthy market competition.  The cards are beginning to play out from the Agency’s decision, and as Baer stated, “competition today is driving enormous benefits in the direction of the American consumer.”

Article by:

Lisa A. Peterson

Of:

McDermott Will & Emery

Judge Rules in Favor of DOJ Finding Bazaarvoice / PowerReviews Merger Anticompetitive (Department of Justice)

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On January 8, 2014, Judge Orrick of the Northern District of California ruled that Bazaarvoice’s acquisition of competitor PowerReviews violated Section 7 of the Clayton Act.  The ruling was in favor of the U.S. Department of Justice (DOJ).  The public version of the opinion was made available on January 10.  In its self-described “necessarily lengthy opinion,” which spans 141 pages, the court ultimately found that the facts overwhelmingly showed the acquisition will have anticompetitive effects and that Bazaarvoice did not overcome the government’s prima facie case.  The case included 40 witnesses at trial, more than 100 depositions and 980 exhibits.  Dr. Carl Shapiro testified as DOJ’s economist and Dr. Ramsey Shehadeh testified on behalf of Bazaarvoice/PowerReviews.  The court noted that the case presented some difficult issues, including that there were no generally accepted “market share statistics covering the sales of R&R solutions or social commerce solutions and no perfect way to measure market shares.”  And while neither side presented flawless analyses, the court found Dr. Shapiro’s approaches more persuasive than those of Dr. Shehadeh.

Bazaarvoice and PowerReviews each offered sophisticated “R&R platforms.”  R&R platforms provide a user interface and review form for the collection and display of user-generated content (i.e., user reviews) on the product page of a commercial website where the product can be purchased.  Often these are in the form of star ratings and open-ended reviews in a text box.  R&R platforms increase sales for the retailer and have a variety of different features.  The court noted that many on-ine retailers view an R&R platform as “necessary.”  Before the merger, Bazaarvoice and PowerReviews offered similar products and features and targeted similar customers.

The court found that the relevant product market was the narrow “R&R platforms,” rather than the broader “social commerce tools” or “eCommerce platforms.”  The court went through many popular social media platforms such as Facebook, Google+, Twitter, Instagram, and Pinterest, explaining why each was not a substitute for these R&R platforms.  In this relevant market, the court found that PowerReviews was Bazaarvoice’s only real competitor, and thus the merger “would eliminate Bazaarvoice’s only meaningful commercial competitor.”

At the end of the opinion, the court commented on the role of antitrust “in rapidly changing high-tech markets.”  It noted that there is a debate as to whether antitrust is properly suited to assess competitive effects in these markets.  The court declined to take sides and stated that its “mission is to assess the alleged antitrust violations presented, irrespective of the dynamism of the market at issue.”

The case now moves to the remedy phase.  In its complaint, the DOJ requested that the court order Bazaarvoice to divest assets originally possessed by either Bazaarvoice and/or PowerReviews to create a viable, competing business.   However, as Judge Orrick noted, 18 months after the merger, it may not be so simple to divest assets.  The judge scheduled a conference for January 22 with the parties to discuss a possible remedy.

There are several lessons to be gathered from this case.  First, the Bazaarvoice litigation is further evidence that the antitrust agencies are not shy about litigating mergers they feel are anticompetitive.  The DOJ invested significant resources and time – including three full weeks at trial in California – into litigating the case, beginning with its investigation that it launched two days after the firms closed their transaction on June 12, 2012.  It has established a significant record of bringing, and winning, merger cases.

Second, this is a significant event, having a federal district court evaluate a consummated merger transaction.  While the agencies have challenged many non-reportable transactions, almost all have been resolved by consent order, or litigated through the Federal Trade Commission’s (FTC’s) in-house administrative hearing process (where, not surprisingly, the FTC essentially always wins).  Accordingly, parties to a non-reportable transaction that raises significant antitrust risks should expect the agencies to investigate and, if warranted, litigate.

Third, the Court heavily discounted Bazaarvoice’s arguments regarding lack of any actual anticompetitive effect, because the companies knew the DOJ was reviewing the deal and could moderate their behavior.  The court discounted Bazaarvoice’s arguments that none of the 104 customers who were deposed complained that the merger has hurt them.  The court stated “it would be a mistake to rely on customer testimony about effects of the merger for several reasons.”  Among the reasons the court included was “Bazaarvoice’s business conduct after the merger was likely tempered by the government’s immediate investigation; the customers were not privy to most of the evidence presented to the Court, including that of the economic experts; many of the customers had paid little or no attention to the merger; and each had an idiosyncratic understanding of R&R based on the priorities of their company and their different levels of knowledge, sophistication, and experience.”  Thus, while raising prices after a transaction provides strong evidence to support the government’s case, the lack of a price increase does not necessarily support the merging parties’ defense.

Finally, and perhaps most importantly, the case shows the need to be circumspect in preparing ordinary course documents.  Aside from the fact that in reportable transactions, the DOJ and FTC are entitled to “4(c)” and “4(d)” documents about the transaction, once a second request is issued or discovery begins, documents created in the ordinary course of business are discoverable.  This includes Strengths, Weaknesses, Opportunities and Threats (SWOT) analyses, board meeting minutes, business and strategic plans, market and market share analyses, and competitive assessments.  In this case, the court found the ordinary course documents, and particularly those made by the companies’ executives, some of the most persuasive evidence.  The court quoted extensively from the documents and cited numerous documents from Bazaarvoice and PowerReviews that showed that the parties viewed each other as their primary competitor, that there were no other strong competitors in this market, that the two companies operated in essentially a duopoly, and that the intent of the merger was to eliminate a primary competitor.  Despite the parties’ efforts to explain away these documents, the court was not persuaded.  Thus, it is important that companies carefully consider what to include in documents and e-mails, and assume that any non-privileged material may be discovered.

The agencies’ aggressive pursuit of perceived anticompetitive, non-reportable transactions places a premium on parties’ evaluating the antitrust risk.

The public version of the court’s opinion can be found here:http://www.justice.gov/atr/cases/f302900/302948.pdf

Article by:

Carrie G. Amezcua

Of:

McDermott Will & Emery

International Group Structures Are Subject to An Ongoing Review for Optimizing Their Tax Position

GT Law

The recent trends show that offshore jurisdictions are off the corporate agenda in view of the increased scrutiny and decreased levels of acceptance from both fiscal and corporate social responsibility perspectives. Client feedback confirms the following rationale for moving corporate tax planning solutions onshore:

  • Increased scrutiny on tax havens and statutory requirements regarding tax substance, potential issues concerning withholding tax and taxation of foreign profits; and
  • Avoiding overtly complicated tax systems with strict CFC (controlled foreign company) regulations, thin capitalization rules and prohibitive transfer tax applicability.

It is a well-known fact that the Netherlands is not a tax haven but a safe haven and a logical choice as an alternative with an extensive double taxation treaty network. In addition, the Netherlands has an extensive bilateral investment protection treaty network that is regarded to provide premium coverage in view of the broad definition of “investor” and “investment” and providing access to dispute resolution through arbitration against independent states and awards that are enforceable against states, often referred to as “the Dutch Gold Standard.” Dutch structures are increasingly a recurring feature in international corporate structures for the purpose of protecting key corporate and personal assets. In this GT Alert, we briefly set out the options for migrating a corporate structure to the Netherlands to benefit from the all of the features that the Netherlands has to offer.

How to Achieve a Corporate Migration

Migrating a corporate entity within the EU into the Netherlands is a straightforward process from a Dutch law perspective. The following options are available:

Registration of an EU member state entity with the Dutch Trade Registry

The tax residence of an existing holding company can often be changed by moving its place of effective management and control outside of its existing jurisdiction for tax purposes. This may trigger a tax charge on exit.

Cross border merger

EU parent companies can migrate to the Netherlands by effecting a statutory merger with a Dutch entity under the cross-border merger regulations. It is also possible for non-EU parent companies to merge with a Dutch company by initially entering into the EU through a conduit EU jurisdiction that permits cross-border mergers with non-EU entities.

Share swap

It is possible to incorporate a holding company in the Netherlands whereby the existing shareholders exchange their existing shares for shares in the newly created Dutch holding company.

Re-registration as Societas Europaea 

An EU parent company can re-register as a European Company (Societas Europaea) and transfer its statutory seat to the Netherlands followed by a re-registration in the Netherlands as a Dutch parent company.

Why migrate to the Netherlands?

Key drivers for migrating the top holding company of an international group structure to the Netherlands are:

  • Low corporate income tax rate of 25% on trading profits (20% up to EUR 200K first band);
  • The Netherlands has an extensive double taxation treaty network with well over 90 jurisdictions;
  • The Netherlands has entered into a vast number of bilateral investment protection treaties (BITS) that offer comprehensive protection against unfair treatment of investments by sovereign states through access to world class dispute arbitration;
  • International and well-recognized jurisdiction with one-tier corporate governance system similar to that of common law countries;
  • Straightforward, cost-efficient and fast incorporation process for Dutch entities;
  • Public company N.V. entities are widely recognized as listing vehicles;
  • The Netherlands is the premier port of entry to mainland Europe with excellent facilities in terms of corporate and financial services;
  • English language optional for proceedings before the Amsterdam courts; and
  • Limited and straightforward corporate reporting requirements.

Taxation

The Netherlands is a gateway to Europe and the rest of the world. For many years, the Netherlands has been a preferred location for foreign companies to establish a business. The location, the political stability and, especially, the beneficial tax regime have turned the Netherlands into one of the go-to countries in this respect. The following tax points are of particular relevance:

  • The general Dutch corporate income tax rate is 25% (20% up to EUR 200K first band). This rate is more than competitive in the region, as all countries surrounding the Netherlands have higher corporate income tax rates.
  • Traditionally, the Dutch participation exemption has been a major attractor of companies to the Netherlands. This facility allows the receipt of dividends and capital gains from subsidiaries free of tax in the Netherlands. The Dutch facility is still one of the most flexible and easy accessible compared to other jurisdictions, especially, with regard to the following conditions: no holding period is required, an interest of 5% is already sufficient to apply, interest in subsidiaries located in tax havens are allowed to benefit from the facility and certain other specific benefits are available.
  • No withholding tax on royalties and no withholding tax on interest.
  • Dividends are taxed at a statutory rate of 15%. However, this rate may be reduced by virtue of tax treaties to 0-10%. In principle, no dividend withholding tax applies to distributions made by a Dutch cooperative pursuant to the domestic rules.
  • No controlled foreign company/Subpart F rules
  • No thin capitalization rules.
  • There is no stamp duty or capital tax.
  • One of the most extensive international tax treaty networks (the Netherlands has concluded over 90 tax treaties, more than most other countries) and the membership of the EU (and corresponding access to EU treaties) ascertain minimal taxation on payments to any group company.
  • Another traditional benefit of the Netherlands is the open attitude of the Dutch tax authorities. The Netherlands offers the possibility to discuss and reach agreement on tax positions in advance with the Dutch tax authorities that can be formalized in agreements (or advance tax rulings) to offer optimum certainty in advance.
  • Currently, the Dutch government´s main focus is on innovation. In 2007, the government was one of the first countries to introduce a special tax regime aimed at innovation (Innovation box). Based on the Innovation box, income earned out of R&D activities can benefit from an 80% exemption, resulting in an effective tax rate of 5%;
  • The Netherlands has extensive experience in the use of hybrid structures (i.e. hybrid entities and hybrid loans). These structures can be used to further optimize the group tax rate.
  • The Netherlands has traditionally not only been very welcoming to foreign companies, but also to expatriates. In the Dutch Personal Income Tax Act, expatriates (with certain skills) can receive 30% of their income as a tax free allowance under the so-called “30%-ruling.” A benefit that also benefits the employer in negotiating (net) salaries.
  • Customs authorities in the Netherlands have a reputation for being cooperative, innovative and exceptionally efficient; all to facilitate the free flow of goods. Customs duties or import charges are charged at a later date, if the goods are stored in accordance with customs procedures in the Netherlands. This leads to considerable cash-flow advantages to foreign shippers.
  • The Netherlands’ position on Value Added Tax (VAT) is also advantageous. In contrast to other EU member states, the Netherlands has instituted a system that provides for the deferment of VAT at the time of import. Instead of paying VAT when the goods are imported into free circulations within the EU, the payment can be deferred to a periodic VAT return. The Dutch VAT system offers companies significant cash-flow and interest benefits.
  • Even though the Netherlands provides several unparalleled tax facilities, it is not blacklisted as a tax haven, but can be considered as a safe haven.
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