Flexibility is the new black in M&A and everyone is looking to don it.  Ensuring maximum wiggle room, even after reaching “firm” agreement to terms, companies of different stripes have reached major M&A deals in recent days. Concluding that the M&A market is firmed up may be premature, as “outs” of different sorts, financing and fiduciary among others, are at the core of recently announced agreements. With the lessons of the now-settled Dow-Rohm acquisition/litigation/acquisition, companies are looking to structure deals to account for the burdensome conditions of the current economy.

Three major M&A transactions have been announced over the past few days, each following soap operas of varying plots.  In common: each has had to go to great lengths to successfully structure around the risks introduced by the current economy and emphasized by the now-resolved Dow-Rohm litigation (described below). Suffice it to say that fees and “outs”, both actual and attempted, are a tool of choice. Merck agreed to merge with Schering-Plough, with a financing out and weighty break-up fees at the core. Roche finally closed in on its desired acquisition of the remainder of Genentech, yet made it subject to a fiduciary out to be available to Genentech’s board.  In the background to all of this is the on-again, off-again affair between Dow Chemical and Rohm & Haas, riddled with attempted “outs”.  As a result, Dow and Rohm are now positively rushing toward the M&A altar by April 1, following negotiations in both the boardroom and the court room.

The first deal we examine was announced on March 9 between Merck and Schering-Plough. The transaction was complicated by a third-party agreement as well as structures to accommodate financing requirements. Schering-Plough has a distribution agreement with Johnson & Johnson subsidiary Centocor regarding the anti-inflammatory drugs Remicade and Golimumab. The agreement included a change of control provision which required Merck and Schering to come up with a complicated structure to avoid triggering this provision. In essence the transaction will have Schering-Plough remain as the surviving entity, though it will change its name to Merck, avoiding any change of control. Another aspect of the transaction includes a two-tiered termination fee structure. The first is for $1.25 billion if either party is unable to complete the merger. The second tier is a reverse termination fee, a concept taken from private equity transactions, that allows the target company a remedy for a specific breach of the agreement. In the Merck-Schering case it would apply if all of the closing conditions are met except that the financing proceeds are not available in full and Merck refuses to complete the transaction. Merck would then be required to pay Schering a $2.5 billion termination fee along with expenses. This allows Merck a way out of the deal if catastrophic circumstances lead to the financing drying up.

The second transaction involves Roche's acquisition of Genentech which has been an ongoing story in its own right. Roche already held over 50% of Genentech when it made an offer for the remaining shares in July of 2008. Roche subsequently made a second offer at a lower price in January of 2009, both of which were rejected by a special committee of Genentech’s board. Roche finally reached an agreement on March 12 after offering $95 per share. The Genentech special committee still has the ability to change their recommendation, an “adverse recommendation change”, if the committee determines that it would be inconsistent with its fiduciary duty to continue to recommend the transaction. Roche would have 48 hours to modify the proposal, but this gives the Genentech special committee significant power to terminate the transaction if it believes the shareholders would be harmed.

The final transaction we examine, the Dow Chemical-Rohm & Haas saga began in July 2008 with the merger announcement by Dow giving $78 per share for Rohm & Haas. Later in 2008 Dow announced a joint venture agreement with the Government of Kuwait which would have provided $9 billion which Dow intended to use to finance the Rohm & Haas acquisition. Kuwait pulled out of the agreement at the end of December which led Dow to claim that it was unable to complete the transaction with Rohm & Haas due to the joint venture failure with Kuwait as well as the overall global financial crisis which it considered material developments. Rohm & Haas sued Dow to complete the merger and Dow answered that it was unable to at the time due to economic conditions that would cause irreparable harm to both companies and their shareholders. On March 9 the two companies announced a settlement that still provides for the $78 per share price but now includes financing provided by some of Rohm & Haas’ largest shareholders. The Haas Family Trust and hedge fund Paulson & Co. will provide $2.5 billion in exchange for preferred stock. Another $4 billion is being provided by Berkshire Hathaway and the Kuwaiti Investment Authority, the same government that pulled out of the joint venture.

The economic crisis has not only affected the amount of M&A activity we have seen recently but also is forcing changes to the deal structures as well. Current circumstances require new deal terms that were not part of normal agreements in the past. The terms are now being fashioned to either create flexibility for instances such as financing falling through, a much more common occurrence at this time, or to account for agreements with third parties that would restrict the merger from being completed. The financial limitations brought on by the economic crisis are forcing flexibility within the agreement provisions to allow the M&A deals to get done.

Published:  March 12, 2009