Editor: Please tell our readers about your background.
Watkins: As a corporate and transactional lawyer, I have done M&A deals and financing transactions, including investments from pools of capital such as private equity firms, venture capital firms, hedge funds, family offices, and wealthy individuals, for over 30 years. I have handled transactions for parties on each side of the transactions.
Editor: Have you done public deals as well as private?
Watkins: I have done something like eight to ten acquisitions of public companies in the course of my career, and probably hundreds of private company deals. The mix is not surprising given that there are many more deals done involving private company targets. I read recently that 90 percent of U.S. companies have revenues between $10 million and $100 million, so there are many more private company targets. In addition, the legal and compliance costs of Sarbanes-Oxley have outweighed the benefits for small companies to go public in the last 10 years.
Editor: How do you view the current M&A climate including LBOs and MBOs?
Watkins: Based upon the latest data, it appears that the number of M&A deals will be flat or even somewhat down in 2013 from 2012. There was a bubble of activity in the last quarter of 2012 because everyone correctly believed there would be tax law changes that would take effect in 2013. Despite lower interest rates and attractive financing, there has not been the upturn in M&A activity that one would expect.
That said, there are some very active pockets of M&A, and one that we have seen is in the cybersecurity space. For example, one of our private equity clients has a portfolio company called Prolexic Technologies, which helps companies deal with distributed denial of service (DDoS) attacks, in which hackers use a huge number of computers to knock a retailer’s website out of commission. In early December, Akamai announced that it had agreed to acquire Prolexic for $370 million.
While this is not a huge deal, it nevertheless illustrates that there are areas that are hot as ever, such as cybersecurity. My perception may be somewhat influenced by our office location here in the DC area – close to Fort Meade, Maryland, where NSA is headquartered and many large defense companies have offices. Smaller companies have begun locating near Fort Meade as well, in order to be close to the most important hub of cybersecurity activity in the country.
Editor: In what industry sectors have you done most of your work?
Watkins: I’ve worked in a broad variety of sectors, with five or six in particular. I’ve worked in the technology area with software companies and information technology (IT), primarily IT services companies, and in the communications area, doing radio, TV and telephone local exchange carrier acquisitions. I have worked on deals with defense companies and government contract companies – which are a large part of the business community here in the Washington area. I’ve worked with education companies, too. Finally, I’ve represented a broad array of manufacturing companies ranging from the maker of large industrial compressors to a manufacturer of customized doors and windows for office buildings to a company that produces soils and mulch for use in gardens and for landscaping. So, basically I go from high-tech companies to those that sell dirt. The range of work has made this a lot of fun for me over the years.
Editor: Please describe your experience regarding M&A in the context of regulated industries. How difficult is it to work with companies operating in two regulated industries?
Watkins: It’s true that my practice at Wiley Rein has involved representing companies in regulated industries. In the government contract area, where you’re frequently dealing with classified contracts, programs and facilities, you must ensure that people on the due diligence team have the security clearances required to review certain documents. You must also be very concerned about the potential liability that the target may have to the government if there has been a failure to comply with the requirements under the government contract, so you must conduct a performance review of the target. Further, you may have issues with regard to novation of government contracts, export control issues and foreign ownership, control or influence issues.
Then, if an equity owner of the buyer is a foreign person, you may have CFIUS concerns that need to be addressed. This can be particularly difficult because the process is very fact-dependent and can be confusing. A firm with a great deal of experience, such as Wiley Rein, can be very helpful in this area.
Additional complexity is presented with clients that are not only government contract companies but that are also subject to the complicated U.S. healthcare regulatory regime, which of course will only become more complex as the Affordable Care Act becomes fully effective. So, in these cases, the due diligence would involve identifying for the buyer the material financial risks, as you would in any deal. But then you also have compliance risks, including assessing whether the target has complied with all of the healthcare laws and regulations that are applicable, such as the fraud and abuse laws as well as the privacy rules of HIPAA. In terms of executing on the transaction, there are a host of required federal, state and local licenses and accreditations. We have also seen an increased government interest in the antitrust scrutiny of healthcare transactions. The third layer of complexity is that some of these companies are not-for-profit, and so there may be characteristics of the transaction that need to be responsive to the maintenance of their tax status.
In short, when you handle M&A or financing transactions with companies in regulated industries, there are many opportunities to stub your toe – especially when you have multiple regulatory schemes to deal with – so it’s critical to engage lawyers with the appropriate experience and knowledge.
Editor: How important are antitrust considerations in the due diligence process?
Watkins: We go through a checklist at the outset to determine whether there are significant antitrust issues. Do the buyer and seller compete with one another, and, if they do compete, do the companies have a significant market share in the market where they compete? We try to determine whether the deal would reduce the number of competitors and whether customers are likely to complain about the deal. If the answer is yes to some or all of the questions, the parties are actual or potential competitors, and, in that context, sharing competitively sensitive information, even with a confidentiality agreement in place, can raise anti-competitive concerns. Antitrust issues are presented even if there never is a closing because competitively sensitive information – for example, pricing information, strategic plans, R&D plans and customer-specific information – may have been shared between competitors.
We then guide our clients through the best way to deal with the issues. First, it’s crucial for many reasons, including these antitrust concerns, that a confidentiality agreement be entered into. This is usually done as a matter of course. Then, we may consider phasing in the due diligence process and providing more detailed information only after we feel there’s a high likelihood that the transaction is going to occur.
We’ve also worked with clients to establish a “clean team” to conduct the due diligence. The clean team consists of buyer employees who are not involved in the daily operations of the buyer, making it less likely that the sensitive information would be shared with operations or sales people. This may help alleviate anti-competitive concerns a regulator may have. We’ve also had situations where the buyer has engaged a third-party consultant to perform the due diligence review and issue a report to the buyer, thereby providing a level of insulation between the sensitive information and operating personnel at the buyer.
Editor: At what point do you go for Hart-Scott-Rodino approval in this process?
Watkins: First you must determine whether the purchase price triggers a Hart-Scott filing. If it does, then you look for an available exemption or exception. If you do have to file, my experience is that you work with the buyer and the seller, and that when you file depends on the desires of the party. A Hart-Scott filing can be made on the basis of a letter of intent, so if there are no other regulatory approvals to slow down the process, the parties can move quickly. I’ve had such instances, and we were able to greatly accelerate the time to the closing. On the other hand, if there are other regulatory issues or if a stockholder vote of the target company is required, then Hart-Scott approval is not driving the timing of the closing. In those instances the Hart-Scott filing will likely not be made until the definitive agreement is executed.
Editor: How does the presence of intellectual property affect M&A deals, particularly technology deals?
Watkins: It is extremely important to have robust and effective IP reps and warranties in the purchase or merger agreement. However, most clients recognize that having recourse under the contract is not sufficient. We encourage clients to undertake very methodical and thorough due diligence with regard to IP matters, first because the legal claim (and potential lawsuit) under the agreement is often a major headache for the buyer. Second, careful due diligence may enable the buyer to identify issues that can be addressed in the definitive agreement. Remember, IP is critical to most deals, especially in the technology sector. In fact, many deals are done in which the primary reason for the transaction is the technology. Take Google’s acquisition of Motorola Mobility, for example.
As for issues to look for, we advise our clients to focus on matters such as whether the target owns all of the intellectual property that it believes it does; frequently, there are issues with regard to IP filings, or failures to have all employees enter into assignment of IP rights agreements. Second, the target may have entered into contracts that restrict the use of the intellectual property. Third, the target may be subject to pending or threatened claims of IP infringement from third parties. Finally, other persons may have “blocking rights” such that the buyer should consider undertaking a freedom to operate analysis with respect to the target’s intellectual property.
Editor: Do you expect to see more mergers in the healthcare industry as the Affordable Care Act kicks in?
Watkins: I hear anecdotally from my healthcare partners that there are more and more deals being done, and there are predictions of substantial additional activity in the sector. But at this point it’s difficult to know how the rules and regulations are going to settle and thus determine who the winners and the losers will be. I imagine that as that becomes more clear, there will be an uptick in transactions.
Editor: What is your view as to why there has been an increase in litigation around public M&A deals?
Watkins: I believe the driver for the increase is the potential for plaintiff-side law firms to make money from the litigation. Virtually every public deal these days results in a lawsuit based upon either a failure to comply with the securities laws and/or that the directors have breached their fiduciary duties to shareholders. Having been through a number of these, I know that while the lawyers strive for perfection, every deal can be criticized for some flaw or imperfection in terms of the procedure or the disclosures. In every transaction in which I’ve ever been involved, both the buyer and the seller are focused on closing the deal, and therefore there’s a willingness to spend a relatively small amount of money to settle the litigation. It’s typical for these lawsuits to be settled for some additional disclosure to shareholders and a payment of an amount that is small relative to the transaction size. Generally, little consideration is received by the plaintiff stockholders, but there is a significant payday for the law firm that has brought the litigation.
Editor: Has this increase in litigation changed the way in which deals are done?
Watkins: Yes, because everyone is aware that litigation is going to happen. My experience is that the deal lawyers do their utmost to follow the prescribed process and to provide perfect disclosure to comply with the securities laws. Despite these best efforts, it seems that there’s always something the plaintiff law firm can find on which to base a claim. When a deal is announced, within a day or two a law firm issues a press release stating that it is investigating XYZ transaction for concerns about breach of fiduciary duty and securities laws violations. Prospective plaintiffs see those press releases, lawsuits are brought; additional disclosures are made; the lawsuit is settled. It’s a very common occurrence. In addition, on the public deals I’ve worked on, the lawyers are careful to advise the directors that it is highly likely that a lawsuit will be brought relating to the transaction. We give directors a heads-up that they are likely to be named in the suit and sued individually. We let them know that this is a common practice and that if it doesn’t happen, they’re lucky.