Sector Watch

The US M&A revival has been in some part driven by a series of game-changing megadeals in the technology, media and telecommunications (TMT) sector and the pharma, medical and biotech sector.

Deals in these two sectors accounted for six of the ten largest deals in H1 2014. In TMT, the largest deal of the period was Comcast’s proposed US$68.5 billion takeover of Time Warner Cable, while Canada- based Valeant’s pending US$44.4 billion acquisition of Allergan was the largest in the pharma, medical and biotech sector. TMT accounted for 34 percent of total deal value in H1 2014, and pharma, medical and biotech represented 22 percent of combined deal values.
Deal volumes, however, indicate that other sectors have also benefitted from the deal recovery. While TMT still topped the list, accounting for 21 percent of deal volume, industrials and chemicals (18 percent), business services (13 percent) and pharma, medical and biotech (10 percent) also accounted for a significant share of deal volumes in the first half of 2014.
TMT in focus By a distance, TMT was the most active sector for M&A in the first half of 2014. Deal values of US$233.7 billion and deal volumes of 497 in the first half of 2014 represented the highest level of activity in the last five years. Values for H1 2014 are up 177 percent from the US$84.2 billion recorded in H1 2013, and deal volumes have climbed by 33.7 percent from 371 transactions. Of the four largest transactions recorded in the United States in the first half of 2014, three have been in the TMT sector.
Consolidation in telecoms has been the main driver of TMT deal activity, including megadeals such as Verizon’s US$124 billion acquisition of Verizon Wireless from UK’s Vodafone, AT&T’s US$65.5 billion pending bid for satellite TV provider DIRECTV and Comcast’s US$68.5 billion pending takeover of Time Warner Cable.
AT& T, T-Mobile, Verizon and Sprint all need to acquire more spectrum. There is a spectrum auction scheduled for mid- November, but the capacity required by these companies will be greater than what is on offer.
Dan Dufner, partner, White & Case
Wild for wireless Another major driver of this consolidation has been the growth of wireless. According to wireless industry group CTIA, there are now more connected devices in the United States than people. CTIA estimates that penetration rates in the United States now stand at 104 percent. Revenues of wireless service providers in the United States increased by 17 percent from the beginning of 2009 through the middle of 2013, according to research house MoffettNathanson.
This rapid increase in the use of wireless devices and the rising demand for broadband have sparked a scramble to acquire the capacity to serve demand. This has pushed the convergence of telephony, wireless and wired broadband and television.“

Demand is likely to continue to grow as more devices, such as cars, and home automation technologies, such as thermostats and other appliances, all start requiring a way to connect to the Internet,” says White & Case partner Dan Dufner. “You can now adjust the pool temperature or set the home security alarm from a smartphone, and the market is just beginning to see the increase that these new technologies have on finite spectrum resources.”
Merging interests In order to build scale, protect existing customer bases and grow without raising antitrust concerns, telephone, Internet and satellite cable companies have encroached upon each other’s turf. For example, the rise in use of wireless devices has seen the lines between broadband and television blur. Cable companies have watched as customers are increasingly streaming content on wireless devices and are expressing great interest in subscribing to “over the top” packages where they can buy specific content rather than being required to subscribe to the full range of channels. Telephone and broadband providers have needed to broaden their range of activity to gain customers and remain competitive. “People between the ages of 20 and 25 are unlikely to buy a full cable package. They are watching TV on Netflix and, in many cases, would prefer buying a package of a few channels,” Dufner says. In AT&T’s pending acquisition of DIRECTV, for example, AT&T opted to expand its historically small market share in television. “This is a unique opportunity that will redefine the video entertainment industry and create a company able to offer new bundles and deliver content to consumers across multiple screens—mobile devices, TVs, laptops, cars and even airplanes,” said AT&T Chairman and CEO Randall Stephenson after the announcement of the proposed transaction.
According to White & Case partner Morton Pierce, this grouping together of services to reduce costs is helped by M&A. “The same line into the home provides video, Internet and telephone services, and companies attempt to win more customers by offering these services as a bundle,” he says. “Size is very important for these companies. It requires a large amount of capital to build these systems and infrastructure, and if you try and do that on your own, you risk taking on too much debt.”
Although the market has already absorbed a flurry of large deals and regulators are concerned about antitrust issues, there is still potential for more transactions in the sector.
“Demand for wireless is going to continue growing. AT&T, T-Mobile, Verizon and Sprint all need to acquire more spectrum. There is a spectrum auction scheduled for mid-November, but the capacity required by these companies will be greater than what is on offer, so companies are likely to turn to more M&A in order to combat their spectrum shortages,” Dufner says.
Demand is likely to continue to grow as more devices, such as cars, and home automation technologies, such as thermostats and other appliances, all start requiring a way to connect to the Internet.
Dan Dufner, partner, White & Case

Foreign buyers could also have a role to play in future dealmaking. France’s Iliad and Japan’s SoftBank, which acquired Sprint in 2013, are both eager to gain exposure to the growing wireless market. Iliad has made public offers to acquire T-Mobile (although Iliad recently dropped its plans), while SoftBank recently struck a deal with fellow Japanese technology company Sharp to develop smartphones specifically to target the US cellphone market.

On the domestic front, other companies that may be looking to do deals include DISH Network Corporation—which has amassed a great deal of wireless spectrum and has publicly shown interest in T-Mobile—Chicago wireless provider US Cellular, and Internet, landline and television provider CenturyLink. Amazon, Apple and Google, which have their own suite of wireless devices and services, could also be players in future deals. As an example of this, in August 2014 Amazon paid US$970 million for video-game streaming service Twitch.
Outside of the deal flurry in telecoms and cable, another hot sub-sector within TMT has been social media. Microblogging site Twitter achieved a US$25 billion valuation when it listed in New York, and Facebook paid US$19 billion for messaging service Whatsapp in its largest deal yet.
“Social media groups have achieved huge valuations, but the growth in these companies and the success of the technology all comes back down to wireless and the long-term growth in this area,” Dufner says.
Pharma in focus Deal activity within the US pharma, medical and biotech sector increased significantly in the first six months of the year as US businesses pursued deals domestically and were also targeted by acquirers from abroad. In H1 2014, the sector saw 246 deals worth US$150.2 billon. This compares with 175 deals worth US$50.3 billion in H1 2013 and 223 deals worth US$46.8 billion in H2 2013.
In terms of deal value, the sector hit its highest level in five years in H1 2014. This can be attributed, in part, to a wave of megadeals, with five of the ten biggest deals by value in the sector over the last five years being announced in the first half of 2014. These include Ireland-based Actavis’ US$23.1 billion takeover of Forest Laboratories, and German firm Bayer’s acquisition of Merck & Co.’s consumer care arm for US$14.2 billion.
Patent problems Pharma, medical and biotech businesses are using M&A to position themselves for the long term. The diseases for which companies are now seeking cures are more difficult to treat, and discovering new medicines is taking more time and investment. Companies are therefore pursuing deals that will replenish and diversify their portfolios and focus their businesses on core markets where they can be market leaders.
“Bigger is better in the pharma sector,” says White & Case partner Morton Pierce. “As drugs move off patent, companies are searching for the next blockbuster drug. R&D is expensive and requires large- scale investment, so companies need to find efficiencies and work economies of scale.”
Building pipelines In addition to seeking improved profitability through synergies and reduced R&D costs, companies are buying smaller biotech businesses to replenish pipelines. Larger acquirers will then use their in-house expertise to take new drugs through clinical trials and marketing. For instance, in August Swiss drug giant Roche purchased California-based biotech firm InterMune for US$7.5 billion, helping it gain control of a pipeline of respiratory and fibrotic disease therapies.
For any deal, the companies involved are looking at what the mix of drugs will be when the two businesses are put together. This increasingly includes a detailed look at the lifespan of the merged portfolio. “Everybody wants to buy the next blockbuster drug at the beginning of its lifespan. However, that is unlikely to happen, so what companies are looking to do is build a portfolio in a chosen area that has a range of drugs at different phases in their life spans,” says Pierce.

Corner your markets Big pharma groups are also structuring themselves so that their businesses are focused on specific industry niches. In the past six months Valeant, for example, which has a strong portfolio of skin and eye care products, has chosen to pursue Allergan, which is strong in dermatology and cosmetics, in order to strengthen its position in its chosen industry. Companies will look to take leading positions in a specific treatment area and also increasingly choose to focus on either prescription or over-the-counter medicines. In addition to factors specific to the pharma sector, the recent pickup in pharma sector M&A can be attributed to the stabilization in the US economy and returning confidence in financial markets.This leads to less expensive debt that is more widely available, and greater use of high-valued stock as consideration currency. “When you are operating in a difficult economic environment, you are not worried about expansion. You are focused on your core business and preparing for the next earnings call to explain how you have been protecting your business,” Pierce explains. “Now that the economic climate is improving, the confidence is there for the pharma sector to do deals again.”
When you are operating in a difficult economic environment, you are not worried about expansion. You are focused on your core business and preparing for the next earnings call.
Morton Pierce, partner, White & Case
THE INVERSE RELATIONSHIP
White & Case’s William Dantzler explains why government action on inversions has not swept them off the table as a viable strategy
Tax inversion deals, where US businesses acquire foreign companies and transfer their tax domicile to secure lower tax rates, have been one of the key deal rationales behind large outbound M&A deals in 2014. AbbVie’s proposed US$54 billion acquisition of Shire (which has now been abandoned in light of the regulatory changes highlighted below), Medtronic’s US$45.95 billion purchase of Ireland’s Covidien and Actavis’s takeover of Warner-Chilcott for US$8.4 billion are all tax inversion deals. These deals have the potential to unlock substantial savings for US acquirers.
This momentum was curtailed, however, when a US Treasury notice issued in September 2014 introduced regulations that will restrict some of the advantages associated with tax inversions.
The changes have affected a key reason for inversions, namely, the acquirer’s ability to access trapped cash without incurring US tax. Many US companies have cash offshore that they cannot bring back to the United States without being taxed, even though foreign-based companies are allowed to earn cash offshore and bring it back to their parent company tax free.
Tax inversions were a way for US companies to use this trapped cash, but most of the provisions in the Treasury notice are aimed at strategies that an inverted company would use to access that trapped cash. In short, the Treasury has shut this avenue down.
Yet while some commentators saw the notice as signaling the end to these types of deals, the reality is that inversions still provide an attractive proposition for US companies in two different ways neither of which has been affected by the rule change.
Building abroad. A tax inversion allows a company to grow future businesses offshore and out from underneath a US parent. The Treasury notice has had no impact on this potential benefit. And while this has not been a key driver during this round of inversions, this recent action could mean it becomes an attractive motive for future deals.
Leverage. The main attraction of an inversion is the ability to leverage up the US operations and deduct interest against the US taxable income. Foreign-based multinationals have always been able to do this up to certain limits. Inversions allow US business to enjoy the same tax benefits.
The new regulations will have no impact on this rationale for pursuing an inversion. The Treasury notice does not touch tax deductibility of interest. The deduction for interest is in the Internal Revenue Code. Only Congress can change that. And while this remains the case, the size of this advantage means there will still be plenty of deals out there that make sense, even when the trapped cash advantages are taken away.
The regulations issued by the Treasury will have some impact on the appetite for inversions. However, the fact that interest deductibility and building businesses offshore remain untouched means that inversions still offer companies some significant advantages.
The big question about the future for companies is what Congress will do on the back of this. The Treasury only took action because Congress wouldn’t and is unlikely to do so this session but there is a prevailing fear that the new Congress, which starts next year, will do something effective January 2015.
This is a major concern. For instance, an inversion deal involving two public companies can be, at least, a four or five month process. If they are facing the risk throughout that period that Congress may take action and rescind the advantages, it can put the whole transaction in jeopardy. The future for inversions will only be resolved when the uncertainty in Washington is resolved. And that will only come with time.
Consolidation in telecoms has been the main driver of deal activity
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HEADLINES

■ TMT most active sector in H1 2014, accounting for 34 percent of M&A activity by value ■ M&A driven by consolidation of broadband,TV and mobile services as well as growing demand for spectrum due to explosion in wireless use ■ Pharma, medical and biotech second most active sector, accounting for 22 percent of activity by value ■ Activity driven by replenishing of product pipelines and desire for R&D synergies and tax savings ■ Pharma, medical and biotech also at forefront of rising use of M&A for tax inversions

THE INVERSE RELATIONSHIP
White & Case’s William Dantzler explains why government action on inversions has not swept them off the table as a viable strategy
Tax inversion deals, where US businesses acquire foreign companies and transfer their tax domicile to secure lower tax rates, have been one of the key deal rationales behind large outbound M&A deals in 2014. AbbVie’s proposed US$54 billion acquisition of Shire (which has now been abandoned in light of the regulatory changes highlighted below), Medtronic’s US$45.95 billion purchase of Ireland’s Covidien and Actavis’s takeover of Warner-Chilcott for US$8.4 billion are all tax inversion deals. These deals have the potential to unlock substantial savings for US acquirers.
This momentum was curtailed, however, when a US Treasury notice issued in September 2014 introduced regulations that will restrict some of the advantages associated with tax inversions.
The changes have affected a key reason for inversions, namely, the acquirer’s ability to access trapped cash without incurring US tax. Many US companies have cash offshore that they cannot bring back to the United States without being taxed, even though foreign-based companies are allowed to earn cash offshore and bring it back to their parent company tax free.
Tax inversions were a way for US companies to use this trapped cash, but most of the provisions in the Treasury notice are aimed at strategies that an inverted company would use to access that trapped cash. In short, the Treasury has shut this avenue down.
Yet while some commentators saw the notice as signaling the end to these types of deals, the reality is that inversions still provide an attractive proposition for US companies in two different ways neither of which has been affected by the rule change.
Building abroad. A tax inversion allows a company to grow future businesses offshore and out from underneath a US parent. The Treasury notice has had no impact on this potential benefit. And while this has not been a key driver during this round of inversions, this recent action could mean it becomes an attractive motive for future deals.
Leverage. The main attraction of an inversion is the ability to leverage up the US operations and deduct interest against the US taxable income. Foreign-based multinationals have always been able to do this up to certain limits. Inversions allow US business to enjoy the same tax benefits.
The new regulations will have no impact on this rationale for pursuing an inversion. The Treasury notice does not touch tax deductibility of interest. The deduction for interest is in the Internal Revenue Code. Only Congress can change that. And while this remains the case, the size of this advantage means there will still be plenty of deals out there that make sense, even when the trapped cash advantages are taken away.
The regulations issued by the Treasury will have some impact on the appetite for inversions. However, the fact that interest deductibility and building businesses offshore remain untouched means that inversions still offer companies some significant advantages.
The big question about the future for companies is what Congress will do on the back of this. The Treasury only took action because Congress wouldn’t and is unlikely to do so this session but there is a prevailing fear that the new Congress, which starts next year, will do something effective January 2015.
This is a major concern. For instance, an inversion deal involving two public companies can be, at least, a four or five month process. If they are facing the risk throughout that period that Congress may take action and rescind the advantages, it can put the whole transaction in jeopardy. The future for inversions will only be resolved when the uncertainty in Washington is resolved. And that will only come with time.