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| Jonathan Levitsky |
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| Kevin Rinker |
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| Ted Hassi |
Whatever the final pieces of the puzzle, the country's politics are closely divided and a Senate majority for major legislative changes will be difficult to build. Nonetheless, the president has broad powers and elections have consequences.
What will this election mean for the mergers and acquisitions market?
We will leave it to others more expert to comment on the broader economic impacts of the election, including the potential for additional fiscal stimulus, and expectations for an accommodative monetary policy from the Federal Reserve, weighed against the pandemic's continuing drag on employment and consumer confidence and recent hopes to see a more effective vaccine sooner than was initially anticipated.
All of these factors will surely influence the M&A market in 2021 and beyond. Here are the issues we are tracking.
Pandemic Problems
M&A activity collapsed in the second quarter of this year, with global deal volume declining by 49% and deal value by 69% compared to the same period in 2019, according to the research provider Mergermarket. Strategic investors and private equity firms were focused on shoring up their businesses, determining the impact of the pandemic and addressing related issues, so sales processes were put on hold.
The M&A market has since meaningfully bounced back, with a 33% increase in deal volume and a 140% increase in deal value in the third quarter compared to the second quarter of this year, along with a stabilization of the debt markets making funds available for leveraged deals. But worldwide M&A activity by volume and value for the first nine months of 2020 is still 27% and 28%, respectively — below the same period in 2019.
While discussions with market participants and our own experience indicate that the pipeline of unannounced deals in process is solid, the pandemic continues to weigh on deal activity, particularly in the hardest hit sectors such as travel and hospitality. Indeed, it seems that a handful of sectors, such as technology and healthcare, are driving a substantial portion of the volume with other industries lagging significantly behind the comparable period in 2019.
Uncertainty about the trajectory of the pandemic and potential long-lasting impacts makes it challenging for buyers and sellers to reach agreement on valuation — particularly in directly affected industries. While earn-outs and similar techniques are useful, they only go so far and are difficult to structure outside of private deals.
On-site due diligence also remains difficult, and can be a real barrier for transactions that are dependent upon a buyer's assessment of hard assets such as manufacturing facilities. Deal professionals have long been accustomed to negotiating via email and conference call, a trend that began in the wake of 9/11.
But the mutual confidence and relationship building that comes from personal connection is important, particularly among business principals. For example, most of our sponsor clients have a strong preference for in-person meetings with senior management teams before entering into transactions. And while these meetings are resuming to a limited extent, it seems clear that the difficulty of normal in-person interaction is a continuing, low-level drag on deals.
Biden ran his campaign on a commitment to get the virus under control. That is a tall order, but a return to normalcy would of course be a very positive development for the M&A market as with so much else.
We are hopeful that national leadership on these issues, combined with additional data to support the expected availability of safe and effective vaccines and treatments, will provide greater certainty on the path forward that gives dealmakers the confidence to proceed and the ability to project future business performance.
Will Tax Changes Drive Deal Activity?
If the Democrats ultimately take control of the Senate, taxes are likely to go up for corporations and higher income individuals. Anecdotally, we saw evidence in the run-up to the election that the potential for increased taxes on sale proceeds had resulted in the acceleration of M&A activity to beat a perceived year-end deadline.
That pressure may be somewhat alleviated by the expectation of divided government and stability in the tax laws, but many transaction timelines have already been set and, as discussed, there is still at least the possibility of a Democratic sweep. That said, even if the Democrats are able to reach fifty votes in the Senate, it seems unlikely that there will be enough support for radical — or retroactive — changes to the tax code.
Of particular interest to our private equity sponsor clients, the taxation of carried interest at capital gains rates seems unlikely to change under divided government — but could be back in play if the Democrats control the Senate. Further limits on the deductibility of interest on portfolio company borrowing, and other potential regulatory changes targeting the private equity industry, also seem less likely.
Antitrust Outlook
Tighter antitrust scrutiny over M&A transactions seems likely under a Biden presidency. Strategic buyers and sponsors acquiring assets through existing portfolio companies will need to think more carefully about the antitrust agencies' response to potential acquisitions. That may favor private equity buyers doing standalone deals that do not present competitive issues, while also potentially depressing valuations as sponsors consider reduced prospects for an exit by sale to a strategic buyer.
Personnel is to some extent policy in this area, so the nature of any change remains to be seen and is highly dependent upon the individuals chosen as Federal Trade Commission commissioners and the new assistant attorney general for antitrust, as well as their staff.
The U.S. Department of Justice leadership serves at the pleasure of the president, but FTC commissioners are appointed to seven-year terms and technically cannot be removed by the president. The first Republican commissioner's term does not expire until September 2023. So it is theoretically possible that the three Republican commissioners stay and retain the current 3-2 majority.
More likely, one or more will step down. And in any event, the president can appoint one of the two Democratic commissioners, or a replacement, to be the agency's chair. The chair has considerable power, including the power to appoint new bureau directors who set the tone and direct the agency's day-to-day efforts.
Possible policy outcomes range from a return to Obama-era practices, to a substantially more aggressive enforcement posture — backed by beefed-up agency staffing — resulting in more frequent second requests and a greater willingness to challenge and litigate over proposed transactions. Transactions in the health care/pharmaceutical, financial services and technology sectors seem particularly likely to receive close scrutiny.
Counterbalancing these considerations, we anticipate a return to more predictability and transparent communication about areas of concern that will allow dealmakers to plan accordingly. As with most markets, the M&A market does not like uncertainty.
Biden has not made antitrust a priority in the past. But the Democrats in Congress have, and if they eventually obtain control of the Senate, more substantial changes are possible and that could impede certain deals.
Sen. Amy Klobuchar of Minnesota, the top Democrat on the Senate Judiciary Subcommittee on Antitrust, has led the Democrats' efforts to heighten antitrust enforcement. Although the antitrust agencies already win a significant majority of the merger challenges they bring, Klobuchar supports changes that would further strengthen their hand.
She has introduced bills that would shift the burden of proving that a merger will not reduce competition to the parties — as opposed to the current standard where the government must prove that a merger is substantially likely to lessen competition; that lower the Clayton Act's well-established standard from mergers that would substantially lessen competition to mergers that are materially likely to lessen competition; and to increase funding and personnel for the antitrust agencies.
Shifting the burden to require the buyers to show that the deal's procompetitive benefits outweigh its anticompetitive effects would make it significantly easier for beefed-up antitrust agencies to challenge mergers, and would likely have a deterrent effect on merging parties. Other, even more far-reaching proposals have also been made.
Our expectation is that it will be difficult to obtain votes for dramatic changes to the underlying antitrust laws in a closely divided Senate, even if there is effective Democratic control, but greater funding to provide the agencies the resources to pursue more frequent challenges is realistic in the near term.
In addition to heightened scrutiny of potential transactions, we also expect the antitrust agencies to pursue standalone cases involving alleged anticompetitive practices such as monopolization with greater frequency. Blockbuster cases like the DOJ's Google Inc. action and the FTC's anticipated case against Facebook Inc. are not going away. We expect there will also be others — particularly in the technology sector. It is not inconceivable that we could see forced changes to the business models of major players driving their own form of deal activity.
CFIUS — Steady Course, Less Politics
In a Biden administration, we do not anticipate any meaningful change in the application of the Committee on Foreign Investment in the United States, or CFIUS, statute and regulations. This regime, which regulates investment in the U.S. by foreign persons from a national security perspective, was updated in 2018 on an overwhelming, bipartisan basis by the Foreign Investment Risk Review Modernization Act, or FIRRMA.
FIRRMA expanded CFIUS' jurisdiction and provided more resources and authority to CFIUS. The legislation was driven in part by a deeply embedded distrust of China, which is reflected in the statement Congress endorsed as part of FIRRMA.
Both during the Obama administration and today, regulators' concerns have gone well beyond the historic interest in a relatively narrow range of national security concerns to include a broader focus on sensitive — export-controlled — technologies, access of foreign persons to personal data about U.S. citizens and cybersecurity.
It seems likely these considerations will continue to dampen foreign enthusiasm — particularly on the part of certain countries such as China that are viewed as strategic competitors — for acquiring or taking an active role in investing in U.S. businesses that might be regarded as sensitive.
Although the legislative and regulatory framework, and the national security concerns, will remain unchanged, we do expect a change in tone. We anticipate CFIUS will return to a more circumspect, less public vetting of potential transactions, and a more predictable approach.
Summing Up
Yogi Berra is famously alleged to have said, "It's tough to make predictions, especially about the future." So many factors impact the M&A market beyond the regulatory environment that we all need to heed Berra's adage. That said, sitting where we are today, the M&A market appears to be well positioned for continued recovery and growth under a Biden administration, particularly as we get to the latter innings of the pandemic.
Jonathan Levitsky, Kevin Rinker and Ted Hassi are partners at Debevoise & Plimpton LLP.
Debevoise partners Peter Furci and Peter Schuur contributed to this article.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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