Walking Away with the Money: The Impact of Break-Up Fees on M&A Deals

Weekly Corporate Growth Report, Jul 24, 2006 by Dolbeck, Andrew

Many merger and acquisition deals include termination fees. These fees help cover the expenses of planning, negotiating, and investigating the merger deal in the event that the transaction is not completed. They also help protect the buyer if the seller receives a competitive offer. Sometimes, however, breakup fees can make it difficult for the seller to accept a better offer, even if the offer on the table may not be in the best interest of company shareholders.

Termination fees provide valuable benefits to a deal. A buyer can invest a lot of money in preparing a transaction, performing due diligence, negotiating a definitive agreement, meeting disclosure regulations, and so on. The break-up fee provides a measure of financial insurance for these expenses. It also shows a commitment to the transaction, reassuring both parties that the deal is being seriously considered.

Ideally, the termination fee is not high enough to be a deterrent to considering other offers that might come along while the deal is in motion. Aztar Corporation paid a $78 million break-up fee to Pinnacle Entertainment when it broke their deal in favor of a takeover offer from Columbia Sussex Corporation. Columbia's buying price was $110 million higher than Pinnacle's, so Aztar could switch deals and still profit.

Sometimes, however, termination fees can make it difficult to consider competitive offers. On May 2, Marsh Supermarkets entered into a merger agreement with MSH Supermarkets Holding for $11.125 per share. On May 30, Marsh announced that it had received an offer of $13.625 per share from Cardinal Paragon and Drawbridge Special Opportunities Advisors LLC. Although the second bid is clearly higher, Marsh opposed it and held to its first agreement, citing the break-up fee it would have to pay to MSH as grounds for not switching deals. Under its agreement, MSH has the right to end the merger and claim a $10 million termination fee if Marsh does not oppose a competing bid within ten business days.

The structure of the termination fee agreement also has an impact. Sometimes the fee is paid only if the deal is broken, sometimes it is paid if the seller does not actively oppose other offers, or when another offer is approved. The presence or absence of break-up fee agreements in competing bids can also make a difference. English land development company McCarthy & Stone accepted a £1 billion offer from an investment consortium led by Primera. Another investment consortium, led by HBOS PLC made a higher offer, subject to due diligence. The deal with Primera includes a break-up fee worth one percent of the bid's value, payable if the board changes its recommendation in favor of another bid. Under UK law, a company cannot pay more than one percent of its value in termination fees in any bidding situation. As a result, McCarthy & Stone could not offer a termination fee in any agreement with HBOS.

This arrangement puts both the HBOS consortium and McCarthy & Stone at a considerable disadvantage. If it pursues its McCarthy & Stone, HBOS has to offer enough to offset the break-up fee. If the board of McCarthy & Stone approves the HBOS bid, the fee would be immediately payable to Primera, regardless of whether or not the HBOS transaction ultimately succeeds. If the HBOS deal falls through, Primera could still win, with McCarthy & Stone losing the break-up money and HBOS unable to get a termination fee to cover any costs it incurred in pursuing the offer.

A high termination fee can also discourage other companies from attempting competitive bids. Analysts spoke against the proposed $33 billion merger between Lucent Technologies and Alcatel SA because it was designed as a merger of equals with no premium paid to Lucent shareholders. A more profitable scenario for Lucent would have been to accept a takeover offer from another industry buyer. According to Frank Dybeck, an analyst at Network Communications Architects, the $500 million termination fee written into the deal discouraged competitors from making bids.

As the above examples illustrate, the presence, size, and structure of termination fees can all impact the competitive dealmaking process. Break-up fees can discourage sellers from seeking or accepting alternative buyers and can also discourage potential bidders from making offers. Although termination fees provide certain financial benefits to deals, they need to be considered carefully and weighed against the potential harm they may have on competitive negotiations.

Sources: Breaking Views, Drug Store News, Mergers & Acquisitions: The Dealmaker's Journal, New York Times

By Andrew Dolbeck

Editor