Picking Up the Pieces

When Deals Fall Apart

The health insurance sector’s M&A market has been dealt some large blows as of late, as two enormous deals fell through – the proposed merger between Anthem and Cigna and the one between Aetna and Humana have both come to grinding halts. Valued at $48 billion and $37 billion respectively in a recent New York Times article[1], these deals represent months of work and considerable expenditures for all sides of the negotiation table.

What, then, caused this failure to launch? The answer comes down to regulatory hurdles, most notably antitrust concerns. The United States Government sued in both cases to prevent the mergers from happening, citing competition concerns and the judges for each case both came to the same conclusion – the potential cost savings and efficiencies (ostensibly to be passed on to customers) would not be large enough to make up for decreased competition in the industry. As these deals would shrink the number of major players in the market from 5 down to 3, it’s not difficult to see where the judges were coming from, regardless of whether or not you agree with their decisions.  But what does this mean for the companies involved in terms of the consequences of this deal falling through? And how are deals best immunized against these legal actions?

The Bad

For all parties involved, be they the ones to be merged or the advising M&A teams, these decisions are very disheartening – an enormous amount of work ended up being for naught. Practically any deal is difficult to put together, and huge deals between mega-cap companies like these crank the complexity up to eleven. Both mergers required immense amounts of man-hours and expenses. While the deal-makers are compensated for their services, they lose out on the chunkiest part of their revenues attached to the work: the success fees. Beyond this, they also effectively pay a hefty opportunity cost in lost success of another deal they could have worked on that would have gone through.

For the companies to be merged, they obviously have to pay their advisors the general retainer fees associated with the deal, but must also cough up considerable amounts of cash for the legal defenses mounted to argue in favor of the deal in court. Beyond this, mergers often have breakup or “termination” fees. Structured as part of the deal contract, these fees are triggered by any number of circumstances, from the seller backing out to newly discovered liabilities that cause the buyer to rethink their decision. These clauses are written into the contracts to protect both parties involved. Since the valuation process of M&A transactions require companies to reveal to each other often very sensitive information regarding their inner workings, there needs to be some recourse if one party later decides to back out. In general, they exist to ensure deals go through without much hemming and hawing. In the case of Aetna and Humana, because the deal didn’t close, Aetna is on the hook to pay Humana $1 billion, no small sum, though considerably less than the deal would have cost.

Lastly, everyone involved suffers some kind of reputational damage when these things fall through. For the advising teams involved, they lose prestige and perceived reliability, as it is seen as their job to do the leg work required to ensure the deal is successful. For companies attempting to merge, having the courts say, in a very public way, that they are deliberately attempting to enrich themselves at the expense of their customers in an anti-competitive manner can be damaging as well. Given the contention attached to the health insurance sector in the US as of late, this rings particularly true in these cases.

The Silver Linings

Believe it or not, it’s not all bad news when deals fall apart. From a holistic point of view of the markets, competition breeds excellence, and maintaining a competitive arena for companies encourages innovation in the industry, both by way of cost savings and product development. It’s also good for consumers, helping to keep prices both lower and fairer.

From a financial point of view, credit risk is also reduced for the acquirers. Buying out a major competitor is a pricey action, and bond markets punish large expenditures by applying wider credit spreads, making capital more expensive for a firm. If a deal collapses, the buyer’s spreads move inwards, reflecting the higher probability that a company will be able to pay back its debts.

Lessons Learned

Despite the aforementioned upsides, it’s fairly obvious that the downsides to a deal falling apart outweigh them, at least from the points of view of the companies involved. There are certain techniques to help ensure these pitfalls are avoided, like the calculation of concentration ratios to see if the deal stands a chance of standing up in court. Another popular method is to spin off parts of an acquired company’s operations to dilute the consolidation occurring as a result of the merger. Any legal precedent set in industries with similar levels of concentration also makes it easier for a judge to rule in a deal’s favor, as it’s been shown to be acceptable in the past.

At the End of the Day…

Preparation is incredibly important and can’t be stressed enough but, in the end, it all comes down to a judge’s decision in cases like these. Nobody likes to see all their hard work swept away with little to show for it, especially when it hits their bottom line in a bad way. It’s important to remember not to be disheartened, and that antitrust rules are in place for an important reason, even if they mean things don’t always go your way.


Kevan Hartford

Kevan Hartford is a Toronto-based finance professional working in asset management.