Are Activist Hedge Fund Managers to Blame for Mega-Deal Failures?

By Ronald Orol  | 04/26/16 - 03:50 PM EDT

Over the past several years, a wave of huge mergers have been challenged and, ultimately, blocked by the federal government. 

Using data from the Federal Trade Commission and The Deal, a subsidiary of TheStreet.com, TheStreet has discovered a pattern of increased regulatory actions challenging mergers that dates back to the Reagan administration. Under President Obama, the FTC, DOJ and other regulatory bodies have challenged and blocked a higher proportion of U.S. deals than ever before. At the same time, deals are getting bigger and more complicated. Call it "Big Business vs. Big Government."

Each administration since Ronald Reagan has challenged a larger proportion of mergers, TheStreet has discovered. Source: Hart-Scott-Rodino Act filings with the FTC.

While the government has certainly been more active in affecting deal activity than in years past, is an overaggressive Uncle Sam the only culprit for this new era of deal-busting?

Activist hedge fund managers and, in some cases, analysts, are to blame, too. 

"Many antitrust-sensitive mergers were driven by activist hedge funds," contends Kai Liekefett, a partner and head of the shareholder activism response team at law firm Vinson & Elkins. "Activists have the luxury that they can take their profits and run following the announcement of a proposed merger. By the time the merger experiences pushback from the antitrust authorities many months later, the activists may have already divested some or all of their position, leaving the merger parties holding the bag."

Probably the most explicit example of an activist fund that drove a deal gone wrong involves activist Starboard Value's Jeff Smith (pictured) 2015 campaign at both Staples (SPLS) and Office Depot (ODP) to push for the two companies to consider a merger.

Starboard accumulated large stakes in both office supply companies and had been eyeing a March 2015 Staples board deadline to nominate director candidates, according to people familiar with the situation, as part of an effort press the two companies into a combination. The two office supply chain companies agreed in February, 2015 to combine in a blockbuster $6.3 billion deal that was subsequently challenged in December by the Federal Trade Commission, which said the deal would violate antitrust laws by reducing competition.

The Starboard push, in retrospect, may have been motivated partly by a much-publicized September 2014 Credit Suisse analyst report, which said a combination between the two box-store office supply giants "makes significant and operational sense." The note suggested that a possible combination was "synergistic" and had been "essentially blessed" by the Federal Trade Commission's wording of an Office Depot-Office Max approval documents from 2013.

The deal may still go through, most likely with concessions, but Starboard has since liquidated its Staples stake and appears on the road to doing so with Office Depot.

The more problematic deals are being driven by the activist push, said Deborah Feinstein, director of the Federal Trade Commission's Bureau of Competition.

"You wonder who is counseling that these [deal proposals] are going to be OK or whether there is such activist pressure that [deal ideas] got out of boardroom when they shouldn't have," Feinstein said. "In a lot of these cases we're talking about the number one and two players in industries merging. Most people would take a deep breath and ask, 'Is this a good idea and is this one worth the risk?'"

The now-rickety Halliburton (HAL) -Baker-Hughes (BHI) is another good example. Activist investors Jeff Ubben from ValueAct and his team had been key agitators seeking to drive the $35 billion acquisition by Halliburton of Baker Hughes, a combination that earlier this month was hit with a Justice Department lawsuit seeking to have combination stopped. In fact, the fund might have gone to improper lengths to push the deal. Deep Dive: Will the Halliburton-Baker Hughes Deal Survive Government Opposition?

A couple days before filing suit against the deal, the DOJ filed a related lawsuit against ValueAct itself, arguing that it improperly purchased substantial stakes in both Halliburton and Baker Hughes "with the intent to influence the companies' business decisions as the merger unfolded." According to the Justice Department, ValueAct sent a memorandum to its investors outlining a strategy of being a "strong advocate for the deal to close." It added that if the deal encountered "regulatory issues" ValueAct "would be well positioned" to "help develop new terms."

Embattled activist investor Bill Ackman and his Pershing Square Capital Management are also part of this costly trend. Ackman was a key contributor to Canadian Pacific Railway (CP) lengthy but ultimately cancelled hostile effort to buy Norfolk Southern (NSC). Ackman, a major Canadian Pacific shareholder and a director on the railroad company's board since 2012, had called Norfolk "an ideal activist situation."

Canadian Pacific on April 11 cancelled its efforts after Bill Baer, head of the Antitrust Division at the Justice Department, in March raised concerns about pre-merger coordination between the two companies. Four days before the bid was called off, the chief lawmaker on the House Transportation Committee piled on by also publicly taking issue with the transaction, suggesting it is not in the best interest of the U.S. freight industry. Ackman has long been an advocate of railroad industry consolidation and was also behind Canadian Pacific's unsuccessful 2014 run at CSX Corp.

The Justice Department last month announced it was extending its antitrust investigation of the proposed $130 billion merger and later break up of Dow Chemical (DOW) and DuPont (DD). The deal would create the world's largest chemical company--at least until the companies carry out their plan to break the merged firm into three separate ones focusing on agriculture, material science and specialty products. Opponents of that highly complicated multi-faceted deal can look to activists Third Point and Trian Fund Management as at least partly to blame there. Deep Dive: Top Antitrust Regulator Debbie Feinstein Q&A

Trian's Nelson Peltz waged an unsuccessful proxy campaign against DuPont last year. But he threatened to come back in 2016 and in the months following his defeat DuPont stock price dropped and it subsequently replaced CEO, Ellen Kullman. The companies said that merger discussions began soon after that CEO switch. And separately, Third Point's Dan Loeb, another frequent deal agitator, in 2014 settled with Dow to install two dissident nominees on the chemical giant's board. Upon the Dow-DuPont deal's announcement, Loeb said in a letter he supported it but questioned the timing and called for Dow CEO Andrew Liveris to be removed.

Shareholders and regulators should watch this development closely. The costs of failure to obtain approval for a deal can be huge. Halliburton, for example, agreed to pay a $3.5 billion reverse termination fee to Baker Hughes if antitrust approval could not be obtained.

And activists appear to be able to make money on deals even if the merging companies end up being sued by the government. Starboard accumulated shares to reach a 5.1% stake in Staples at prices ranging from $12.00 to $13.92 a share in October and November of 2014, according to a December 2014 securities filing. The fund in February reported that it had began liquidating its Staples stake -- shortly after the FTC filed its complaint to block the deal -- by selling shares to bring it to below a 5% stake at prices between $16.75 and $17.15 a share. Staples shares traded late Monday at $10.39 a share.

With all the blockbuster deal challenges, DOJ threats and cancelled deal efforts, one wonders whether activist fund managers will still be pushing for mega mergers in the months to come. And if they do, whether corporate executives will push back harder. 

-- Bill McConnell contributed to this report

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