United States: Looking Ahead: The State Of M&A In 2015

Introduction

Companies are often spurred to engage in mergers and acquisitions (M&A) in the hopes of creating growth, unlocking shareholder value, revising business strategies, and/or better coordinating resources. These efforts are affected by ever-changing political and economic factors. In the sections below, we highlight some of the factors we believe will impact M&A in 2015.

Market Outlook

Though the global economy is not as robust as it was in 2006, generally the world economy has found an equilibrium and may be considered stable. According to the International Monetary Fund, the global economy is forecasted to grow 3.3 percent in 2014 and 3.8 percent in 2015.1 It should be noted that economic growth is not evenly distributed throughout the globe. The numbers reflect that the global economy is recovering from the Great Recession but hitting a few speed bumps in certain regions.

The United States

The economy of the United States, for one, has picked up steam and is showing progress. In the first half of 2014, 70 percent of companies in the S&P 500 beat earnings estimates. As of the third quarter of 2014, the Nasdaq Composite and the S&P 500 were up 7.59 percent and 8.34 percent, respectively. 2 Furthermore, in the first eight months of 2014, the US economy, on average, added 215,000 jobs. This number represents an increase of more than 20,000 jobs per month over the average monthly employment gains posted by the US economy in 2013. As of August 2014, the unemployment rate hovered at 6.1 percent, down from the recession high of 10 percent in October of 2009. It is anticipated that the job growth occurring in 2014 will also reduce the number of underemployed workers and the number of individuals who exit the workforce prior than they planned due to the unavailability of suitable employment opportunities after the Great Recession. 3

Other Economies

On the other hand, China's economy is expected to grow at a rate of about 7.3 percent this year, representing the slowest growth rate in five years. 4 Also, perhaps as a result of the uncertainty and tension between the Ukraine and Russia, Europe is stagnating. France, Spain, and Italy endure unemployment rates in excess of 10 percent. 5 Germany, the largest economy in the Eurozone, is predicting meager growth of 1.2 percent for the year and its economy contracted in the second quarter of 2014. 6

M&A Activity

Despite the uneven global recovery, according to Bloomberg, the third quarter of 2014 enjoyed the highest third quarter M&A deal volume results in the past seven years, with deal volume on a global basis reaching $888.9 billion. The Western Hemisphere accounted for more than half of that deal volume. 7 In addition, the number of deals valued at over $10 billion reached twelve. That represents a 300 percent increase in such transactions over the prior year. 8 As one New York Times article noted earlier this year, "Shareholder beware: M.&A. mania is back." 9

The calendar year 2014 has been characterized by less overall number of transactions but an increase in large cap deals with huge deal values. 10 In fact, global M&A reached seven-year transaction value highs in the second quarter of 2014, with the United States accounting for half of the global volume based on deal value. 11 For example, Comcast's acquisition of Time Warner Cable, a deal announced on February 13, 2014, was valued at $69.8 billion. Also, AT&T Inc.'s acquisition of DirectTV Group Inc., announced on May 18, 2014, was valued at $67.1 billion. 12 These types of mega deals increase market confidence and should result in additional M&A activity. 13

2015

For 2015 we expect a continued increase in global M&A activity. At least in the United States, such M&A activity will not be spurred by tax considerations (which are discussed below), but will instead be led by a surge of middle market deals (with deal values below $1 billion) focused on synergistic acquisitions. 14 According to a recent survey conducted by EY, "the number of executives that view the global economy as stable has almost doubled in the past 12 months." Despite conflicts in the Middle East, tensions between Russia and the Ukraine, and Ebola scares in Africa as well as the United States, a full 40 percent of these executives were interested in pursuing an M&A transaction within the next twelve months. More than 80 percent of the transactions these executives contemplated in the next twelve months were expected to have a deal value of $250 million or less. The majority of these deals are meant to enhance the core business of the acquiring company or to increase the products and services provided by the acquiring company pursuant to the acquisition of a complementary business. 15

Tempering the Surge in Tax-Driven Deals

Given the relative stability of the global and US economies, for 2015 we are more focused on the impact of legislative and regulatory action on M&A activity.

One recent regulatory action which we expect to have a chilling effect on M&A activity is a recent notice published by the United States Department of the Treasury (US Treasury) and the Internal Revenue Service (IRS). That notice points to the possibility that the US government may enact legislation or regulations reducing the tax benefits of tax inversions, a type of M&A transaction. In a tax inversion, concurrently with a merger or acquisition of a non-US company, a US-based purchaser redomiciles to the jurisdiction of the non-US target company where, typically, a lower corporate tax rate applies. After a tax inversion, only profits earned in the United States are subject to the US corporate income tax rate. Generally, the United States imposes a 35 percent corporate federal tax rate on income earned by US companies within the United States and abroad, though, with respect to non-US income, a US company can delay paying taxes on such income until such income is paid or repatriated into the United States as a dividend or distribution to the US company. Until recently, tax inversions were a popular part of global M&A activity because such transactions usually translated into substantial and ongoing tax savings for the purchaser.

Since the first tax inversion was consummated in the early 1980s, the IRS has introduced various rounds of regulation to discourage US-based companies from re-incorporating in a different jurisdiction. Beginning in 2004, companies desiring to invert and reincorporate in a non-US jurisdiction were required to have "substantial business activity" in the country of reincorporation. Thereafter, the IRS:

1. Determined that "substantial business activity" generally required a company to have at least 25 percent of its assets, income and employees in the new non-US jurisdiction and

2. Required that the former owners of the US entity own less than 80 percent of the new non-US entity. 16

The latest salvo against tax inversions came in the form of a notice published by the US Treasury and the IRS, which aims to, among other things, prevent

1. Inverted companies from using "creative" loans to access cash earned by a foreign subsidiary without paying taxes on such cash,

2. The sale of shares in a foreign subsidiary with substantial earnings from a US entity to a non-US entity to avoid paying taxes on such cash, and

3. The transfer of assets located in the US to a foreign company to avoid paying taxes on such assets.

In addition, the notice makes it harder for US entities to consummate a tax inversion by strengthening the requirement that the former shareholders of the US company own less than 80 percent of the non-US surviving entity. 17 If the former shareholders of the US company own at least 60 percent but less than 80 percent of the non-US surviving entity, then, although the United States will acknowledge that the surviving entity is not a US entity, such entity may be subject to other unfavorable tax consequences. 18 In each case, the new stricter guidelines apply to tax inversions closing on or after September 22, 2014.

The chilling effect of the notice on M&A activity was felt immediately. For one, the merger of AbbVie Inc., a US company, and Shire PLC, a company based in the United Kingdom, was terminated in October of 2014 after the board of directors of AbbVie determined that the US Treasury's notice and new interpretation of US tax rules eliminated tax savings related to the proposed tax inversion. 19 AbbVie's chief executive officer stated: "The Company's decision was based upon its assessment of the September 22, 2014 notice issued by the U.S. Department of Treasury, which reinterpreted longstanding tax principles in a uniquely selective manner designed specifically to destroy the financial benefits of these types of transactions. The notice introduced an unacceptable level of risk and uncertainty given the magnitude of the proposed changes and the stated intention of the Department of Treasury to continue to revise tax principles to further impact such transactions." AbbVie agreed to pay Shire a $1.64 billion breakup fee. Other deals have also stalled. 20

The US Treasury's press release also indicated that additional regulatory action may be forthcoming. Specifically, the notice also included a quote from the Secretary of the Treasury that highlighted the fact that M&A transactions aimed at reducing the tax burden on US-based companies will be facing much tougher agency scrutiny: "Treasury will continue to review a broad range of authorities for further anti-inversion measures as part of our continued work to close loopholes that allow some taxpayers to avoid paying their fair share." 21

Delaware Amendments to the Delaware General Corporation Law

Not all legislative developments are expected to dampen M&A activity. Recently, Delaware enacted several changes to the Delaware General Corporation Law (DGCL) and the Delaware Code. These amendments are generally expected to be positive developments for M&A activity in the United States. In addition, the amendments have the cumulative effect of ensuring that Delaware stays at the vanguard of corporate innovation and remains the venue of choice for companies formed or incorporated in the United States. 22

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Footnotes

1 INT'L MONETARY FUND. WORLD ECONOMIC OUTLOOK OCTOBER 2014 - LEGACIES, CLOUDS AND UNCERTAINTIES (2014), available at http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/text.pdf .

2 T. Rowe Price, Third Quarter 2014 Market Wrap-Up, T.ROWEPRICE, http://individual.troweprice.com/public/Retail/Planning-&-Research/T.-Rowe-Price-Insights/MarketAnalysis/Quarterly-Wrap-Ups (last visited Dec. 10, 2014).

3 Dr. Patricia Bukley, United States Back on Track after First-quarter Detour , DELOITTE UNIVERSITY PRESS (Oct. 21, 2014), http://dupress.com/articles/global-economic-outlookq4-2014-united-states/.

4 See China's economic growth falls to lowest in 5 years, ASSOCIATED PRESS. (Oct. 21, 2014), http://www.theguardian.com/business/2014/oct/21/chinas-economic-growth-falls-to-lowest-in-5-years.

5 Catherine Bosley, Europe's Glacial Growth Lowers Prospects for Job Seekers, BLOOMBERG (Oct. 28, 2014), http://www.bloomberg.com/news/2014-10-28/europe-s-glacial-growthlowers-prospects-for-doubting-jobseekers.html.

6 Barbara Miller, German economy could lead Europe back into recession, ABC (Oct. 28, 2014), http://www.abc.net.au/news/2014-10-28/german-economy-could-lead-europe-backinto-recession/5847416 . See also Dr. Alexander Borsch, Eurozone Recovery stalled, DELOITTE UNIVERSITY PRESS (Oct. 21, 2014), http://dupress.com/articles/global-economic-outlook-q4-2014-eurozone/.

7 BLOOMBERG, GLOBAL M&AMARKET REVIEW FINANCIAL RANKINGS 1ST 3Q 2014, available at http://www.bloomberg.com/professional/content/uploads/sites/2/2014/10/Bloomberg-3Q-2014-MA-Financial-Rankings.pdf.

8 Id.

9 Jeff Sommer, Merger Fever Can be a Menace for Shareholders, N.Y. TIMES (Jun. 21, 2014), http://www.nytimes.com/2014/06/22/your-money/merger-fever-can-be-a-menace-forshareholders.html?_r=0 .

10 See Alexa Davis, No Slowdown in Sight for 2014's M&A Frenzy, FORBES (Jun. 24, 2014), http://www.forbes.com/sites/alexadavis/2014/06/24/no-slowdown-in-sight-for-2014s-mafrenzy/.

11 Bloomberg Global M&A Market Review Financial Rankings 1H 2014.

12 2014's Biggest Announced Mergers and Acquisitions,: FORBES, http://www.forbes.com/pictures/gfhd45fkk/comcast-time-warner-cable/ (last visited Nov. 23, 2014).

13 Global Capital Confidence Barometer, October 2014, 11th Edition, EY http://www.ey.com/GL/en/Services/Transactions/EY-capital-confidence-barometer-m-a-outlook?gclid=CJDE8-fBxcECFQMT7Aoda2gAQw  (last visited Nov. 20, 2014).

14 Id.

15 See Id.

16 David Gelles, New Corporate Tax Shelter: A Merger Abroad, N.Y. TIMES (Oct. 8, 2013), http://dealbook.nytimes.com/2013/10/08/to-cut-corporate-taxes-a-merger-abroad-and-a-newhome/?_php=true&_type=blogs&_r=0.

17 Fact Sheet: Treasury Actions to Rein in Corporate Tax Inversions, U.S. DEP'T TREAS. (Sept. 22, 2014), http://www.treasury.gov/press-center/press-releases/Pages/jl2645.aspx.

18 See Gelles, supra note 16.

19 See Announcement of Termination of Proposed AbbVie and Shire Transaction, ABBVIE (Oct. 20, 2014), http://abbvie.mediaroom.com/index.php?s=20295&item=122549.

20 Factbox: Another U.S. tax 'inversion' implodes, pending deals dwindle, REUTERS (Oct. 24, 2014), http://www.reuters.com/article/2014/10/24/us-usa-tax-pending-inversions-idUSKCN0ID1VR20141024.

21 Treasury Announces First Steps to Reduce Tax Benefits of Corporate Inversions, U.S.DEP'T TREAS. (Sept. 22, 2014), http://www.treasury.gov/press-center/press-releases/Pages/jl2647.aspx .

22 According to the Division of Corporations of the Secretary of State of the State of Delaware, over 50 percent of US publicly traded companies and 64 percent of Fortune 500 companies are incorporated in Delaware.

Previously published by Thomson Reuters/Aspatore

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