Green: M&S bid

Just as mergers and acquisitions were starting to recover from the post 11 September 2001 doldrums, along came the M&S case to warn firms of the potential problems with conflicts of interest, writes Lucy Trevelyan

For merger and acquisition (M&A) lawyers, the new millennium heralded a halcyon era of spectacularly high-value deals. Then came 11 September 2001, a stock market downturn, the Iraq crisis and a series of high-profile corporate scandals. The M&A market underwent a radical change from which few believe there will be a full recovery.


Interestingly, although M&A partners universally report an upturn on last year’s doldrums - which most agree was one of the worst M&A periods for years - according to a recent report from accountancy firm KPMG, the value of UK-completed transactions for the first half of 2004 was down $3 billion (£1.65 billion), from $80 billion to $77 billion, on the same period of 2003.


The number of completed deals was also down a hefty 25% from 1,343 in the first half of 2003 to 1,001 so far this year. This compares with a global drop of only 10% in completed deals to 8,073 deals so far in 2004. The UK pipeline is also slow compared to the global picture: seeing only a 5% rise in the value of announced deals compared with a 54% increase in the global value of announced activity on the first half of 2003.


The worrying figures keep coming. There has also been an 18% drop in announced bid numbers in the UK to 1,117 compared to the first half of 2003. Of these, 177 deals valued at $37 billion are still awaiting completion. One of the largest pending UK transactions is currently the Royal Bank of Scotland (RBS) bid for Charter One Financial in the US for $10 billion, announced on 4 May 2004. Linklaters acts for RBS on the UK elements, while US firm Wachtell Lipton Rosen & Katz represents Charter One.


And then, of course, there is Philip Green’s bid for Marks & Spencer (M&S), which catapulted his legal advisers, City firm Ashurst, to the top of the table of M&A advisers for the first half of this year (see [2004] Gazette, 1 July, 7). Ironically, Ashurst toppled Freshfields Bruckhaus Deringer, which had been Mr Green’s lawyers until the now famous High Court challenge which led to them withdrawing due to a potential conflict of interest.


Allen & Overy partner Richard Cranfield says there has been a marked decline in M&A since the 2000/1 boom, but the levels now are a return to normality.


However, Linklaters partner Mark Stamp disagrees. He says: ‘I think this is low. I hope it isn’t normalised. We are definitely busier than last year but it is always difficult to tell at this time of year. Just before the holidays, the markets go a bit dead.


‘The stock market has been under-performing and there has been a lot of pressure on company performances and profitability. Everyone is concentrating on their core areas.’


Wragge & Co corporate partner Edward Dawes says levels of activity have broadly aligned with how smoothly operations have gone in Iraq. ‘When things seemed to have gone well, activity picked up; now things have not turned out as easy as first thought, activity has declined. In an unsafe and uncertain world, people are less inclined to undertake major M&A activity.’


Herbert Smith partner Henry Raine says: ‘In the public sector, there are concerns about accounts and the extent people can rely on them. Public companies are wary of committing to large deals when people are saying: "How comfortable are you with the figures?" It’s a matter of investor confidence.


‘There’s also a lot of concern about the relationship between chief executives and chairmen. Companies are concentrating on their own business rather than buying other people’s.’


He adds that there has been a back-to-basics approach, with many companies selling off surplus businesses and restructuring because they grew too quickly in the boom time.


Mr Stamp says the Financial Services and Markets Act 2000 has led to a stricter approach to corporate governance - with institutions more willing to show their teeth - while Mr Cranfield says the US market has suffered the double whammy of 11 September and the post-Enron and WorldCom fallout. Telecommunications company WorldCom declared profits for 2001 and the first quarter of 2002 owing to accounting irregularities, when it should have reported net losses.


‘The Enron and WorldCom scandals have made everything in the US more corporate-governance driven, which has made the market tougher in New York. The slowing-down there was particularly noticeable post-11 September - it knocked the stuffing out of the New York market.’


All the lawyers agree that there has been an increased concentration on due diligence in recent times.


Mr Dawes says: ‘Gone is the bullishness that abounded in the run-up to the millennium. The pricking of the dot-com bubble was a salutary lesson for all those involved in M&A, not just those who got their fingers burnt. We are now seeing clients being more exacting and demanding in their due diligence requirements; this is one of the reasons we have formed a dedicated due diligence team.’


Ashurst partner Chris Ashworth says the changing and more cautious market has led to a change in the approach to deals.


He says: ‘There is a lot of reluctance and uncertainty. Transactions take longer, financing is more complicated. There is a caution in doing deals which was absent before.’


He says also that the shape of M&A teams has changed of late. ‘Partners and senior assistants play a much bigger role, rather than being able to use more juniors in due diligence. Teams are also smaller and deals take longer and require a higher level of input - not that clients will often allow changes in the reasonable or sometimes unreasonable time periods we operate in.’


The unfortunate fall-out of the downturn in the market for non-partners in M&A departments, Mr Raine and Mr Stamp agree, is that promotion prospects are not as rosy.


Mr Stamp says: ‘We have had to be more realistic in our appraisal process. We have tried to make sure our lawyers are realistic about their prospects. New partners are made up much less than in a boom market.’


Mr Raine says that with many people wary of accepting payment in shares, the approach to the market has changed as venture capitalists are now the major buyers, with five or six funds involved in most of the deals.


With such an emphasis on due diligence, he says, firms are having to be more flexible in their approach to fees, with some firms agreeing to enter into contingency fee arrangements whereby they accept a lower fee unless the deal is completed.


‘One has to give flexibility to clients, but we have to protect our business as well. You have more auctions nowadays too, with sellers agreeing to pay the due diligence costs of buyers.’


Mr Stamp says: ‘You have seen the emergence of private equity houses in the last couple of years - they have money to spend whereas other people haven’t. They think they can get good deals because there is less demand for companies. Trade buyers generally will pay a higher price because they are buying for a strategic purpose whereas private equity houses buy something to make as much money in as short a time as possible.’


He says this sea-change has led to a reduction in hostile take-over bids and an increase in potential buyers using the press as a sounding board before a bid has even been made.


‘Private equity houses can’t make hostile bids because their funds don’t want them to. The press are being used earlier in the process as a sounding board to see if the deal should go ahead before an offer has even been made. This was true of the Philip Green situation with Marks & Spencer.


‘The Takeover Panel should be strict on this sort of thing, although it has to be careful not to make people "put up or shut up" too early, otherwise potential buyers may walk away from the deal because they do not have enough time or organise the bid.’


Mr Dawes says there is concern over the Takeover Directive, adopted by the European Union’s (EU) Council of Ministers on 30 March 2004 and giving the Takeover Panel a statutory basis as the UK competent authority regulating takeovers.


‘The opt-out arrangements under the directive give little prospect of any significant opening-up of corporate control in EU markets, whereas the directive risks impairing the UK’s current non-statutory regime and the flexibility, speed and certainty of the panel’s decision making.’


He would also like to see the UK Listing Authority’s review of the listing rules to address the inequities that can arise as a result of the class tests, particularly where price is compared with a company’s market capitalisation.


‘This can lead to a profitable company being unable to undertake an acquisition which it can otherwise well afford simply because it is an unloved listed company whose market capitalisation is consequently depressed. Combine this with competing bidders who may not be so constrained - and the desirability of moving fast in certain circumstances - and you have the listing rules, which are there to protect investors, potentially operating to their detriment.’


But at the moment, for M&A lawyers, it all comes back to M&S. Mr Raine says Slaughter and May’s injunction preventing Freshfields Bruckhaus Deringer from acting for Philip Green also fired a warning shot at law firms generally.


Mr Justice Lawrence Collins ruled there was a real prospect that there would be a conflict of interest in Freshfields acting since the law firm was still retained by M&S on ongoing contractual transactions. Because of the firm’s past work for M&S, he ruled that confidential information was put in jeopardy by Freshfields’ acting for Mr Green.


Mr Raine says: ‘It was a bit of a wake-up call in terms of lawyers thinking about who they act for. It’s another factor to bear in mind.’


Lucy Trevelyan is a freelance journalist