-- This article was written by Ronald Orol of The Deal
Investment banker advisers carry a lot of the blame for the mega-merger wave that ended with government lawsuits and other regulatory efforts to block big deals.
However, not to be forgotten are the activist hedge fund managers and in some cases, analysts, who also contributed a lot to the damage and billions of dollars in scrapped or contested mergers.
"Many antitrust-sensitive mergers were driven by activist hedge funds," contends Kai Liekefett, a partner and head of the shareholder activism response team at Vinson & Elkins. "Activists have the luxury that they can take their profits and run following the announcement of a proposed merger. By the time the merger experience pushback from the antitrust authorities many months later, the activists may have already divested some or all of their position, leaving the merger parties holding the bag."
Probably the most explicit example of an activist fund that drove a deal gone wrong involves activist Starboard Value's Jeff Smith's 2015 campaign at both Staples (SPLS) and Office Depot (ODP) to push for the two companies to consider a merger. Starboard accumulated large stakes in both office supply companies and had been eyeing a March 2015 Staples board deadline to nominate director candidates, according to people familiar with the situation, as part of an effort press the two companies into a combination. The two office supply chain companies agreed in February, 2015 to combine in a blockbuster $6.3 billion deal that was subsequently challenged in December by the Federal Trade Commission, which said the deal would violate antitrust laws by reducing competition. The deal was called off on May 10 after a judge officially blocked the combination, charging that it would create anti-competitive forces.
The Starboard push, in retrospect, may have been motivated partly by a much-publicized September 2014 Credit Suisse analyst report, which said a combination between the two box-store office supply giants "makes significant and operational sense." The note suggested that a possible combination was "synergistic" and had been "essentially blessed" by the Federal Trade Commission's wording of an Office Depot-Office Max approval documents from 2013. The deal may still go through, most likely with concessions, but Starboard has since liquidated its Staples stake and appears on the road to doing so with Office Depot.
The more problematic deals are being driven by the activist push, said Deborah Feinstein, director of the Federal Trade Commission's Bureau of Competition, "You wonder who is counseling that these [deal proposals] are going to be OK or whether there is such activist pressure that [deal ideas] got out of boardroom when they shouldn't have," Feinstein said. "In a lot of these cases we're talking about the number one and two players in industries merging. Most people would take a deep breath and ask, 'Is this a good idea and is this one worth the risk?'"
Separately, after Halliburton (HAL) announced in late 2014 that it was seeking to acquire Baker Hughes (BHI) in a blockbuster $35 billion acquisition, activist investor ValueAct Capital Partners' Jeff Ubben acquired significant stakes in both energy companies and agitated for the deal to be consummated. According to the Justice Department, ValueAct sent a memorandum to its investors outlining a strategy of being a "strong advocate for the deal to close." It added that if the deal encountered "regulatory issues" ValueAct "would be well positioned" to "help develop new terms." However, the blockbuster merger was called off earlier this month after the Justice Department in April filed a civil antitrust lawsuit in the U.S. District Court in Delaware seeking to block the merger. In addition, ValueAct also became the subject of a related DOJ lawsuit, with the U.S. arguing that the fund couldn't qualify for a passive investor exemption from regulatory disclosure rules since it purchased substantial stakes in both Halliburton and Baker Hughes "with the intent to influence the companies' business decisions as the merger unfolded."
According to the Justice Department, ValueAct sent a memorandum to its investors suggesting that if the deal encountered "regulatory issues" ValueAct "would be well positioned" to "help develop new terms." Now that the deal is off, ValueAct may be contemplating a plan B for share value generation at Baker Hughes - seeking to break it up. The agency's lawsuit filing also revealed that the activists "discussed internally" a back-up plan in the even the deal was blocked or abandoned - they would push Baker-Hughes into selling at least some of its pieces. The fund's recently reported a move to nearly double its shares, from 5% to 9% suggesting that ValueAct may have a second act to play at Baker-Hughes.
In addition, embattled activist investor Bill Ackman and his Pershing Square Capital Management was a key contributor to Canadian Pacific Railway (CP) lengthy but ultimately cancelled hostile effort to buy Norfolk Southern (NSC). Ackman, a major CP shareholder and a director on the railroad company's board since 2012, had called Norfolk "an deal activist situation." CP on April 11 cancelled its efforts after Bill Baer, head of the Antitrust Division at the Justice Department, in March raised concerns about pre-merger coordination between the two companies. Four days before the bid was called off, the chief lawmaker on the House Transportation Committee piled on by also publicly taking issue with the transaction, suggesting it is not in the best interest of the U.S. freight industry.
Ackman has long been an advocate of railroad industry consolidation and CP's unsuccessful 2014 run at CSX (CSX) In addition, the Justice Department last month announced it was extending its antitrust investigation of the proposed $130 billion merger and later break up of Dow Chemical (DOW) and DuPont (DD) The deal would create the world's largest chemical company--at least until the companies carry out their plan to break the merged firm into three separate ones focusing on agriculture, material science and specialty products. Opponents of that highly complicated multi-faceted deal can look to activists Third Point and Trian Fund Management LP as at least partly to blame there.
Trian's Nelson Peltz waged an unsuccessful proxy campaign against DuPont last year. But he threatened to come back in 2016 and in the months following his defeat DuPont stock price dropped and it subsequently replaced CEO, Ellen Kullman. The companies said that merger discussions began soon after that CEO switch. And separately, Third Point's Dan Loeb, another frequent deal agitator, in 2014 settled with Dow to install two dissident nominees on the chemical giant's board. Upon the Dow-DuPont deal's announcement, Loeb said in a letter he supported it but questioned the timing and called for Dow CEO Andrew Liveris to be removed.
In addition, last year, activist Elliott Management's Paul Singer criticized the management of Family Dollar Stores (FDO) for agreeing to be purchased by Dollar Tree (DLTR) rather than be acquired by Dollar General (DG). Pushed on by Singer, Dollar General launched a $9 billion bid to acquire Family Dollar Stores, a move that was ultimately rejected by the discount retailer's shareholders over antitrust risks.
Shareholders and regulators should watch this development closely. The costs of failure to obtain approval for a deal can be huge. Halliburton, for example, agreed to pay a $3.5 billion reverse termination fee to Baker Hughes as part of its merger agreement, after opposition from U.S. regulators. Baker Hughes plans to buy back $1.5 billion in shares and cut its debt by $1 billion with the proceeds. Separately, Staples agreed to pay Office Depot a $250 million break up free now that their deal was rejected.
And activists appear to be able to make money on deals even if the merging companies end up being sued by the government. Starboard accumulated shares to reach a 5.1% stake in Staples at prices ranging from $12.00 to $13.92 a share in October and November of 2014, according to a December 2014 securities filing. The fund in February reported that it had began liquidating its Staples stake-- shortly after the FTC filed its complaint to block the deal -- by selling shares to bring it to below a 5% stake at prices between $16.75 and $17.15 a share. Shortly after the office supply company mega-merger was called off, Staples shares fell to trade Wednesday at around $9.30 a share while Office Depot dropped to $4.50 a share. Staples shares traded Friday at $$8.31 a share.
With all the blockbuster deal challenges, DOJ threats and cancelled deal efforts, one wonders whether activist fund managers will still be pushing for mega mergers in the months to come. And if they do, whether corporate executives will push back harder.
-- This article was originally published by The Deal, a sister publication of TheStreet that offers sophisticated insight and analysis on all types of deals, from inception to integration. Click here for a free trial.