Regulators have drafted new M&A rules, and leveraged buyout artists aren’t happy.
M&A professionals—the bankers, lawyers and private equity investors who earn their living by the buying and selling of US companies—worry that antitrust authorities are trying to fix what isn’t broken.
For more than 46 years, the merger review process under the Hart-Scott-Rodino (HSR) Act—which specifies how regulators evaluate the broader market ramifications of a pending transaction—hasn’t changed much. Then, in June, the Federal Trade Commission (FTC) and the Department of Justice (DOJ) unveiled a massive 126-page document with a preliminary set of new rules. Prepare for greater scrutiny, the regulators were more than hinting.
Dealmakers swiftly clapped back. The desired changes would make the process more time consuming and expensive, they argue, and possibly hurt corporate financing. Plus, the HSR process is already a lengthy one, depending on the size and scope of the transaction.
Supermarket giant Kroger, to take one example, is coming up on a year since it offered to buy the Boise, Idaho-based Albertsons chain for $25 billion. The pending review is complicated by the fact that seven state-level secretaries of state want the deal quashed. A Kroger-Albertsons combination would allow one company to control nearly a quarter of the entire US food retail business: “a significant consolidation of the already limited competition within the market,” the officials wrote in a joint letter to the FTC.
A complex process like the one facing Kroger is typical for a big-name acquirer, according to Karin Kovacic, president of the Association for Corporate Growth, a private equity network.
“Larger mergers involving major companies are more likely to raise concerns about market concentration, potential monopolistic behavior, or adverse effects on consumer welfare,” she says. As a result, these transactions may undergo more extensive review by regulators and face a longer approval process.
Smaller mergers in the lower to middle market, where the price tag is less than $1 billion, “may not face the same level of scrutiny or red tape,” Kovacic adds. “These transactions may be considered less likely to have a substantial impact on competition, and therefore, the approval processes may be relatively smoother and quicker.”
Publicly traded companies have largely kept quiet on the rules revisions. Leveraged buyout firms are howling. It’s the larger private equity firms that will be most impacted, argues Dileep Saksena, managing partner at lower middle-market firm 40|73 Capital. “They are the ones that have the capability to acquire large platform companies that are most susceptible to DOJ enforcement action,” he says.
Per S&P Global, private equity firms presently have about $2.5 trillion at their disposal. And their modus operandi—leveraging buyouts with debt and stripping value to exit with a profit—has drawn the ire of M&A critics for years. A 2019 study showed that private equity-owned portfolio assets are 10 times more likely to go bankrupt and cause thousands of job and service losses.
The updated guidelines, says US Attorney General Merrick Garland, are a response to modern market realities. They will enable the Justice Department to “transparently and effectively protect the American people from the damage that anticompetitive mergers cause.”
“I hope it’s not the first step toward a US market covered in red tape,” say Rami Cassis, CEO of London-based Parabellum Investments, a firm with more than $100 million in assets.
“I believe there is a direct link between private equity’s long-standing image problem and this fresh regulatory clampdown,” he adds. “If the industry is to break the trend of increasing regulation, it needs to make a concerted effort to improve its image, increasing transparency and rooting out bad practice.”
Foreign Players Take Note
Among the new questions and requirements regulators unveiled in the June document: Does the deal involve an overseas buyer or seller? Verbatim translations of all foreign language documents must be provided. Did the buyer conduct any acquisitions within the past decade? Companies must include a detailed summary on each of those deals, including any safety violations that might have occurred. Will foreign jurisdictions need to review the deal? All information regarding subsidies or financial support must be described in full. New filings would also mandate more detailed financing disclosures by certain foreign governments: namely, North Korea, China, Russia, and Iran.
“I think it will delay all cross-border deals,” Acharya Capital Partners’ David Acharya says of the new rulebook. “If those listed governments are involved, you bet that it will get higher scrutiny.”
Currently, HSR paperwork isn’t particularly complicated, but it isn’t free either. If a transaction exceeds a certain price threshold (this year, $111.4 million) both the buy and sell sides of the deal must file forms with the FTC and DOJ, along with various documents and information about the merger or acquisition. The fee to file these forms can be anywhere from $30,000 to $2.25 million.
The new rules will require commencement of HSR filing preparation “well before a definitive deal is agreed to by the parties,” Acharya believes. A late start runs the risk of additional upfront costs that may be significant but also wasteful, he adds, “because deal negotiations end up being derailed.” Cassis anticipates that the filings will require administrative outsourcing and legal consultation. The surge in demand for these services “will, of course, see costs rise,” he says, “which will weigh on portfolio management.”
Making A Dry Spell Drier
None of the new burdens are for sure—yet. The FTC is currently in a public-comment phase. Although the new rules are not likely to go into effect until next year, they were unveiled during an especially dry season. Global M&A declined 29% in the first eight months of 2023, Refinitiv data shows. Worldwide announced M&A totaled $1.8 trillion during that time frame, down 29% compared to the same period in 2022 and the lowest January to August total in a decade.
Global private equity-backed deal volume also was down 51% from a year ago, with US activity declining 49% and EU activity plummeting 70%. Challenging macroeconomic conditions, including sticky inflation and the Federal Reserve’s ongoing rate hikes, bear part of the blame.
The new FTC rules will certainly have a further “cooling effect,” Cassis warns. Then again, where else will the money go? “We won’t see funds turning away from the US en masse in favor of other markets,” he adds. Parabellum, which Cassis founded in 2012, recently acquired Vantage Consulting Group, a New Jersey-based manufacturing automation firm.
“The US remains the most attractive market for private equity investment, and the proposed changes don’t change that,” he argues. “In the current environment of economic uncertainty, investors are looking for security, and the US has a reputation for being a very secure market supported by a healthy private equity sector.”
Until the FTC and DOJ make the new rules official, private equity firms like Acharya’s are anticipating pain points. One of the updates, he notes, requires acquirers to provide considerable detail on minority investors and other “entities or individuals that may have material influence on the management or operations.” This, he expects, will prohibit the practice of filing an HSR form early in a deal process.
“Given the fact that deal structures are typically revised during the negotiation process, this requirement may make the deal negotiation process more constrained,” he predicts.
Another side effect of HSR’s next evolution is that it might inspire the biggest funds to ink cheaper deals and avoid regulatory oversight altogether. “I recently lost two deals for companies with $1.5 million to $2 million of EBITDA,” Saksena says. His hope was to have those smaller companies serve as platforms for growth. Not anymore.
“You see larger private equity firms and middle-market-focused private equity firms coming down market when conditions get tougher in their respective markets in terms of quality deals for the size companies they typically focus on,” he says. “It could make the situation worse if the DOJ has enforcement action success and it have sufficient internal resources to go after large private equity firms, which will hasten their speed to smaller company acquisitions.”