Not at Any Price – Contested M&A, The New Normal

What Changed?

Friendly, board-supported M&A transactions, are routinely being challenged by shareholders. While this is not a new phenomenon, the frequency and organized public nature of shareholder opposition to announced transactions has caught many public companies by surprise.

In the past, institutional shareholders unhappy with a deal might have just sold their shares or privately communicated their displeasure with a transaction, they have become increasingly comfortable in publicly voicing their opposition – with some initiating full-blown proxy contests to defeat a transaction.

Another critical difference is investor opposition does not hinge on an incremental improvement in economics, a practice we call “bumpitrage”, but rather outright opposition to the transaction proceeding.

Why are Investors Challenging Transactions?

The post-Covid dislocation across the capital markets has produced a divergence in investor views over the standalone prospects of public companies. This applies to companies attempting to grow through transformative M&A and companies engaging in private equity sponsored, ‘go-private’ deals.

While stock-for-stock deals give rise to debates over the relative value of the merging entities, the all-cash go-private transaction offers a certainty of value, but also caps and ends shareholder participation in the potential future upside of the target company. Take-private transactions can be especially fraught when companies are acquired at prices significantly below historical highs.

During our representation of companies defending transactions and shareholders opposing transactions, we have observed some familiar themes across several situations over the past 12 months:

1. Value-Transfer Away from Shareholders: The idea that the risk-adjusted potential future upside due to shareholders, is being captured by the merger partner or acquiring entity. The divergence in views over standalone prospects is a critical component of this theme, and results in competing valuation and risk narratives. The company’s prior public statements and projections about the business (often optimistic) will be contrasted against the rationale in a go-private which tends to emphasize risks, diminished prospects, and the need for significant additional investment as a private company.
2. The Conflict Between ‘Rolling’ and ‘Non-Rolling’ Shareholders: Take private transactions typically involve a private equity sponsor and a requirement that current management, directors and/or founding shareholders, “roll” their equity into the new private entity. Shareholders opposing transactions argue that the ability of some, but not all shareholders, to roll their equity into the private entity injects significant potential conflicts of interest into the deal process. While a requirement to roll is a customary condition for private equity acquirers, it is frequently viewed as a perk by non-rolling shareholders.
3. Questions About the Process: The proxy disclosures may contain significant fodder for a dissenting shareholder. The length of the process and rounds of negotiations; perceived independence; alternatives considered and size of that universe; presence or absence of competitive tension; go-shop period; and, an overall perception of the fairness of the process, can all be called into question by shareholders. Some shareholders have offered a near point-by-point commentary or rebuttal to the background process detail provided in the proxy in making their case.
4. Change in Control Payments and Management Compensation: Change in control payments typically function as a form of mitigation against management entrenchment in the context of M&A. However, in a contested M&A transaction, management and the board’s realization of gains under long term incentive plans or change in control payments, can attract shareholder attention.

Shareholders are Vocal and Public with their Views

While companies are accustomed to the public wrath of activist investors, contested M&A in 2023 featured sometimes multiple shareholders releasing public statements and letters – both in favor and against transactions. Institutional shareholders are increasingly comfortable in taking a public stance on their investment.

Over the past year, we have seen a substantially increased willingness of public mutual funds to engage directly with companies and other shareholders, including issuing public statements outlining their views.

Some shareholders took their opposition a step further and engaged in full-fledged proxy solicitations, including presentations to ISS and Glass Lewis, to attempt to defeat a transaction.

What Should Boards and Companies Do?

• Be open about the risks and opportunities the company faces post-merger. Continuing private company shareholders often have no secondary market for their shares, and participate in the ongoing liquidity, operating and competitive risks faced by the company.
• Boards rightly focus on the governance process that governs an M&A transaction and must balance the need to maximize value with the certainty of getting a deal done. However, boards cannot lose sight of the need to actively convince shareholders that approving a deal is in their best interests.
• We believe that at the outset of a strategic process, boards should carefully consider whether the process followed will be fair – not just from a legal perspective, but in the retrospective perception of public shareholders. If the outcome of the sale process appears predetermined, even if it was a logical conclusion arrived at in good faith, it can fuel shareholder objections to a deal.
• Transaction communications should be led by the independent directors of the board, particularly in situations where management’s interests may diverge from those of other shareholders. An active or leading voice for management gives rise to the perception that they and not the independent board members, drove the transaction.
• Given the propensity for even relatively well-received transactions to feature some shareholder opposition, it is imperative to approach M&A with the same lens as boards would approach other significant governance matters such as a reconstitution of the board or C-suite succession.