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The new rules governing M&A

Financial writer Tom Taulli expects tech mergers to surge next year. But in the aftermath of Sept. 11, buyers and sellers will face a decidedly different calculus of considerations.

Even before the terrorist attacks of Sept. 11, the merger and acquisitions market was drying up. With equity markets continuing to fall and the economy worsening, buyers were simply waiting for a better day.

Of course, in the wake Sept. 11, there will be some significant changes in the M&A marketplace--some of which will be long-lasting.

Here's a look at what we might see:

Deal slowdown
It is no surprise that M&A activity has slowed considerably since the terrorist attacks. After all, much of the M&A infrastructure is based in New York. And it will take months for the industry to regroup.

True, some M&A firms are using videoconferencing technologies to facilitate deals. However, this will have limited use. To do an effective M&A deal, a buyer should visit the company. Relying solely on financials is a recipe for disaster.

But by next year, expect the M&A market to surge. Many high-tech companies are selling at historically low valuations. And with a tough IPO market, companies will have no choice but to look for potential suitors.

Back to basics
Sellers will want to see more cash as consideration for buyouts. On the other hand, buyers will be targeting those companies that have a strong fit and are not dilutive.

Then again, in the slow-growth environment of the past few years, companies have been aggressively streamlining operations, making themselves more attractive buyout targets.

Corporate profiling
Buyers will be much more vigilant when buying a foreign-based company. Does the seller have ties to terrorism? Where did the financing come from? Who are the shareholders? Who are the suppliers and customers? A variety of companies, such as Kroll, help companies with this type of due diligence.

Material adverse change (MAC for short)
Most merger agreements have material adverse change clauses. Essentially, if some type of catastrophic event occurs, the buyer or seller can back out of the deal. What events? Usually, it will cover severe problems in the financial system or a war. But does the Sept. 11 attack fall within the parameters of a typical MAC provision? Well, a variety of companies are certainly using the provision to unwind deals.

Look at Warren Buffet. He backed out of his deal to buy the bonds of Finova Group. He considered the terrorist attack to be an "act of war." He also relied on another clause in the deal document, which applies to "any general suspension of trading in securities of any national securities exchange."

In fact, M&A lawyers are already crafting new MAC clauses to deal with the new world order. For example, on Sept. 27, Reliant Resources agreed to purchase Orion Power Holdings for about $2.9 billion. In the merger agreement, there is a clause that mentions terrorism:

For purposes of this Agreement, the term "MATERIAL ADVERSE EFFECT" shall mean any change or event or effect that, individually or together with other changes, events or effects, is materially adverse to the business, assets or financial condition of the Company and its subsidiaries, taken as a whole, except for any such change, event or effect resulting from or arising out of: (1) changes or developments in international, national, regional, state or local wholesale or retail markets for electric power or fuel or related products including those due to actions by competitors, (2) changes or developments in national, regional, state or local electric transmission or distribution systems except to the extent caused by a material worsening of current conditions caused by acts of terrorism or war (whether or not declared) occurring after the date of this Agreement which materially impair the Company's ability to conduct its operations except on a temporary basis, (3) changes or developments in financial or securities markets or the economy in general except to the extent caused by a material worsening of current conditions caused by acts of terrorism or war (whether or not declared) occurring after the date of this Agreement, (4) effects of weather or meteorological events, except to the extent causing damage to the physical facilities of the Company and its subsidiaries, or (5) any Change of Law.

Interestingly, the above clause is fairly vague. After all, there is no definition of "acts of terrorism." In addition, the phrase "material worsening" is not clear. In fact, such vague phraseology may make it difficult for the clause to be enforced.

How is a court to use a standard to make consistent decisions? An important case to watch is USA Networks' lawsuit to end its merger with National Leisure. USA Networks is arguing that the Sept. 11 attack "could reasonably be expected to have a hugely negative impact on NLG's business, assets, condition, financial performance and result of operations."

Moreover, after the attack, one of National Leisure's top customers, Costco Wholesale, decided to terminate its relationship.

The Delaware Chancery Court will hear the case. Keep in mind that in June, the court handed down a major decision regarding a MAC provision. The court ruled that Tyson Foods could not terminate its acquisition of IBP because of a deterioration of finances.