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The Impact of The Covid-19 Crisis on U.S. M&A Deals

By Dylan Litt, Kyle Amelio, and Michael Lipsky (New York University), Charlie Solnik (CalPoly), Mihir Gupta (University College of London)

​The rapid spread of COVID-19 has roiled capital markets and clouded the global economic outlook. In order to prepare for an uncertain future, many companies have cut capital spending and furloughed non-essential employees in an effort to preserve liquidity. As a result, potential and agreed upon M&A deals have been called into question as companies prepare for extended closures and significant reductions in revenues. Here’s our take on some of the most important M&A activity that has been impacted.

1. Xerox's Hostile Takeover of Hewlett Packard

At the beginning of November 2019, Xerox began pursuing a hostile takeover of Hewlett-Packard (HP) with the backing of activist investor Carl Icahn, a shareholder of both companies. Even prior to the recent selloff, it seemed like a case of the minnow swallowing the whale due to HP’s much larger size. HP’s market cap is currently more than five times the size of Xerox’s. To overcome the difference in size Xerox was planning on executing a leveraged buyout. They were going to fund their purchase by borrowing heavily against HP and taking advantage of the low long-term debt levels HP had maintained.

After several rejections by HP’s board, the value of the tender offer rose to a peak of $35 billion. The deal was set to be funded by both debt and the issuance of Xerox’s own stock. However, the recent stock market turmoil reduced Xerox’s market cap by over 50%, reducing the overall value of the deal by about $4 billion. While Xerox believed the merger would be beneficial to both companies (estimating a cost savings of over $2 billion), HP leadership disagreed with those estimations. They felt they were overly optimistic and announced a plan to return $15 billion to shareholders through stock buybacks to dissuade them from supporting the merger.

Carl Icahn disagreed and voiced support for the deal several times throughout the process. He even went as far as to say that “the combination of HP and Xerox is one of the most obvious no-brainers I have ever encountered in my career.” It was a powerful rebuke to the statements that had been coming out of the HP board room as they repeatedly tried to fend off the takeover. However, his support for the deal was instead used as ammunition by HP. Icahn owns a far larger percentage of Xerox as compared to HP, causing the latter’s board to point out that he would benefit far more if HP were purchased at a price below it’s actual worth. That was just one of many criticisms that kept Icahn from getting his “no-brainer” deal completed.

HP also disagreed that the combined company would be able to operate as well as they were able to separately. While the deal would have brought together two of the largest players in the printer and copier industry, HP doubted Xerox’s ability to properly manage the PC, 3D printing, and digital manufacturing businesses. The HP board also criticized the “irresponsible capital structure” which would result from Xerox’s need to borrow so heavily to complete the deal.

Any hope for a deal fell away earlier this week when Xerox announced that in light of the “macroeconomic and market turmoil caused by COVID-19,” they would be pulling their bid to acquire the much larger company. Reflecting the contentious nature of the acquisition attempt, Xerox did not miss the opportunity to take a swipe at HP’s board in their statement, saying they did “a great disservice to HP stockholders” by refusing to engage. Despite those remarks, the failure of the merger more likely stemmed from questions as to whether Xerox would be able to secure the $24 billion in financing at favorable rates as investment grade corporate bond yields have risen nearly 50% since the beginning of March. Those higher interest rates would have eaten into the value generated by the synergies and made the deal less beneficial for both companies. Despite deteriorating conditions, it wasn’t until last week that the merger was officially taken off the table.

2. Simon Property Group's acquisition of Taubman Centers

Simon Property Group’s (SPG) long sought acquisition of Taubman Centers (TCO) looks likely to go through as planned, despite the street discounting Taubman to 20% below the takeout price. On February 10th 2020 American Mall REIT giant Simon announced they would be acquiring an 80% stake in Taubman, their much smaller rival. Simon had been pursuing Taubman’s portfolio of high end malls since they fought off a hostile takeover bid from Simon and Westfield in 2003. For decades industry experts have said that a combination of the two REITs would create long term value for investors. Numerous attempts have been made by shareholders to get Taubman to sell itself, but the Taubman family has been able to keep control of their business.

The terms of the acquisition make it highly unlikely that Simon would be able to exit through the deal’s “Material adverse effects” clause. The clause, intended to protect from adverse shocks, can only be triggered if Simon can prove in court that the Covid-19 pandemic had a “disproportionate impact” on the target company relative to its peers. A higher bar than a “force majeure” clause, which was not included in the terms, that would allow an exit for any unforeseeable circumstances. In response to the pandemic Taubman and Simon closed their malls within a day of each other as well the other mall REITs across the nation. Not only has Taubman been impacted to a similar degree as the rest of America’s mall REITs, with their malls in China already reopened, they seem set to slightly outperform their peers in the crisis.

The deal will put disproportionate pressure on Simon property during this difficult time for retailers and the malls they occupy. Mizuho managing director St. Juste said “I think a lot of investors wish they would [pull out]... not only the fact that [the market’s] down, but retailers have an additional challenge here, and they’re adding the weight of acquiring a portfolio in the middle of all this.” Earlier in February Simon joined a consortium of investors in a bailout acquisition of the retailer Forever 21, looking to protect themselves from the loss of a major tenant, which under the current circumstances serves as an additional liability.

Industry professionals are confident that the deal will go through and Taubman’s prime portfolio will create long-term value for Simon shareholders, as long as the mall industry recovers from the Covid-19 pandemic. With debt capital already secured, the path for Simon to exit seems impossible. Alexander Goldfarb, managing director and senior research analyst at Piper Sandler, said “It is a deal that gets [Simon] 10 of the best malls in the country… there’s no out mechanism for Simon, so that would be some pretty intense litigation.” Given Taubman and Simon's history of aggressive litigation, a prolonged court battle is the only risk to a deal. Mizuho’s St. Juste said “The merger agreement seems fairly iron-clad.” Projecting a similar level of confidence as SunTrust analysts. Who said in a note that the decline in Taubman’s stock was “suggesting some concern” about the deal closure, but ultimately they said it was highly likely to go through.

Taubman’s 20% decline in share price represents the indiscriminate selloff in industries with the most exposure to the pandemic. With incredible speed and vigor investors dumped shares in mall REITs sending the index down 65% from its peak. Many investors sold shares to reduce mall exposure, but Taubman’s relatively small decline shows that investors view the stock as a safer place to hold their capital than the overall mall sector with a deal set to close at $52.50 per share later this year. With the stock trading at $42.16 as of Friday, April 3, the biggest risk for investors looking to buy the stock is that Simon comes back to litigate the deal seeking better terms, a fight Simon could win if they face major liquidity issues and default on the debt capital they raised for the deal.

3. Eldorado's acquisition of Caesars cleared by the FTC

Concerns over regulatory issues regarding Eldorado’s (ERI) acquisition of Caesars(CZR) have abated as it now appears the deal will close. However, the recent outbreak of Covid-19, has left the gaming industry with an estimated decline in revenues of up to 20%, calling into question the future solvency of numerous gaming companies such as Eldorado.

Before the threat of Covid-19, the FTC’s primary concern with Eldorado’s acquisition of Caesars was about Eldorado’s increased market share. This is due to the fact that the merger will create a regional gaming giant which would control 60 gaming properties in 18 states. In Atlantic City alone, Eldorado would employ 40% of the industry’s workers and generate nearly 37% of total gaming revenue for the city. To address anti-trust issues raised by this merger, Eldorado originally announced they would sell casinos in June and July, seemingly alleviating any FTC concerns.

However, because of the Covid-19 outbreak, the responsibilities of those reviewing the deal pivoted from anti-trust concerns, to ensuring the survival of one of biggest players in the industry. The rapidly spreading virus left regulators and Eldorado with quite a predicament. In the deal, Eldorado encounters the “material adverse effects” clause, something that has become common in previously agreed upon but incomplete deals in the face of this crisis. Unless Eldorado can prove through litigation that Caesars was adversely affected by the crisis to a “disproportionate degree” when compared to the U.S. gaming industry, they will not be allowed to back out of the deal. As a result of this clause, Eldorado is facing possible bankruptcy no matter what they chose to do.

They could either buy Caesars for $17.3 billion, assuming $7 billion of debt from JP Morgan Chase and Credit Suisse, bringing the total debt of the combined company up to $21 billion, or be forced into paying an agreed-upon $837 million breakup fee, most likely forcing them into large-scale layoffs. Both options could potentially bankrupt the company when taking into account declining revenues from Covid-19. Despite the risks of the deal, the FTC decided that the lesser of the two evils would be to allow the merger to transpire, with the hopes that Eldorado will survive Covid-19.

Eldorado's acquisition of Caesars carries similar risks to a past deal involving Caesars from 2008, when the private equity firms Apollo and TPG Capital teamed up to acquire Caesars in a deal that left the company with $25 billion in debt, eventually forcing them into bankruptcy. After the deal closed, Caesars’ revenue had dropped 20 percent in 2009 from its 2007 peak, paving the way for losses that forced the company into Chapter 11 in 2015 despite several refinancings. In fact, for the past three quarters Caesars has failed to generate EBITDA sufficient enough to outpace their interest payments. Additionally, the 20 percent drop in revenue from 2009 almost exactly matches gaming analyst estimates for the drop in revenues resulting from the Covid-19 outbreak, signalling a possible repeat of history when it comes to the solvency of the company.

Overall market sentiment seems to reflect a general sense of pessimism pertaining to the future of the combined company given macro industry headwinds. Before the virus, the large assumption of debt that Eldorado would undertake seemed ambitious yet not unrealistic with high revenues. However, now faced with a 20% decrease in revenues their ability to pay off their new debt is called into question, as is the case for many others who were in the middle of a leveraged acquisition. The possibility of future liquidity issues for Eldorado resulting from the deal has been reflected in a steady decline in price for Eldorado shares since the announcement on March 31st that the deal will close in June. Shares have already fallen from $15.05, their peak on March 31st, down to $10.14, as of closing on April 3rd.

4. Marathon splitting up, or selling its Speedway unit

In a letter sent in September of 2019 Elliot Management believes that to maximize shareholder value Marathon’s (MPC) board should move to split into three companies that will be leaders in their different sectors: Retail, Midstream, and Refining. The letter came as a response to Marathon’s poor stock performance after their acquisition of competitor Andeavor to become the largest oil refiner in the US. Since the acquisition of Andeavor in April of 2018 up until market close of September 22nd, when the letter was sent, Marathon’s stock declined 32% compared to other refiners such as Valero and Phillips 66, which in the same time frame declined 24% and 7%, respectively. Elliot believes that splitting the company will lead to an increase in shareholder value, which Berkshire Hathaway estimates to be $22B, a 61% increase from its 39.6B market cap at the time. The company is now trading at $26.73 a share price which represents a market cap of $17.4B, a decrease of 55% since the letter was sent. Upon splitting, the three entities would become Speedway, MPLX CO., and New Marathon.

  • Speedway upon separation would be the largest convenience store operator in the US with approximately 3,900 locations.

  • MPLX would establish itself as a top-five midstream operator through its processing, storing, transporting and marketing of oil, natural gas, and natural gas liquids.

  • New Marathon would be the largest independent merchant refiner in the US.

Concerns arising from Covid- 19 involving valuations cause Japanese Seven & I Holdings Co. to scrap what would have been a $22B acquisition of Speedway. Besides concerns regarding valuations, the acquisition of Speedway would have been credit negative for Seven & I Holdings Co., which would result in the deterioration of its financial standing at a time where all companies need to preserve liquidity. Marathon itself is facing similar challenges as a lack of demand for oil and increased production has driven down prices. Seven & I Holdings Co backing out of their purchase of Speedway would have expended liquidity that they would need to turn MPLX into a corporation. COVID-19’s effect on Marathon’s ability to sell off parts of the company have increased the pressure that Elliot Management and activist investors have put on Marathon to separate the company.

The U.S. oil-and-gas industry is being challenged by the decrease in oil demand and the effects of the Russia and Saudi Arabia price war. In response to increased Saudi Arabian on April 1st the production of oil the US is pumping almost 13 million barrels a day, while demand for gasoline fell to 6.7 million barrels a day from 8.8 million a week earlier. This time last year, drivers were using about 9.2 million barrels a day of gasoline. U.S. gasoline consumption translates to the equivalent of 10% of global oil demand.” This influx of oil with a lack of demand in the global market for crude oil caused the lowest price for oil in two decades at $20 a barrel on March 18th. This ongoing issue is unprecedented as US oil companies can't determine when to stop production with such little demand and stockpiles filling up. At the same time, they need to continue producing in order to not lose market share to foreign companies and countries. The decrease in demand for oil in the US along with the effects of the price war has further depressed valuations of oil companies, which contributed to the Seven & I Holding Co. acquisition of Speedway to fall through.

5. Apollo and other bidders competing for Tegna

Apollo Global Management’s acquisition of broadcasting company, Tegna (TGNA), has been affected by the traumatic share price decline because of the upheaval in the marketplace due to the economic impacts of Covid-19. The acquisition offer put forth by private equity firm Apollo Global Management for Tegna is an all cash offer valuing the share price of the company at approximately $20. The value of the shares declined as the US equities market entered a period of entrenched losses. Tegna specifically witnessed its share price fall to approximately $13, surfacing in the $16-17 range.

Tegana is undergoing a major shift in its short term priorities due to the impact in terms of scale that COVID-19 can have on their business. The pandemic has acted as a major cause of concern for Tegna to shift its focus from dealing with potential acquirers to stabilizing its business and cash flows which have faced a major setback due to the aggressive social distancing measures that were imposed on by federal and state governments. However, on the positive side Tegna continues to earn significant contractual subscription revenues and maintains a strong balance sheet with minimal short-term debt maturities.

Demands on behalf of third party investors are putting the company in a difficult spot. With offers from Gray's Television and Apollo Global Management falling away and an offer from entrepreneur Byron Allen and the religious broadcast group, Trinity, in partnership with Najafi companies emerging in the background. Tegna management is under great pressure from a major shareholder, Standard General, to be more active in courting sellers at a time of continued consolidation of local TV stations. Standard General has proposed an alternative slate of five directors to join the Tegna board as part of its effort to push the company to act on the M&A front which Tegna has refused.


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