TheChek News Flow

The Flash is an analytical summary of key corporate events concerning M&A activity that provides advisers and corporations with business development leads, investment ideas and competitive intelligence.

* Not another 2015

* Bright spot in oil patch

* Angles struggle to remain aloft

* Banks keep merging

* Same with hotels

* Activists lose the easy plays

* January AGM forecast

A few of our thoughts on how the year ahead may play out in the event driven arena:

2016 will not be another record breaking year for US M&A – Uncertainty ahead of the US Presidential election in November 2016 will cause dealmakers to err on the side of caution. While Democrat Hillary Clinton leads the pack of presidential hopefuls, her election is anything but a slam dunk. The populist ground swell has been deafening with many willing to at least tell pollsters they support the movement despite a polarizing candidate (Republican Donald Trump). Then there is the small, but non-zero chance Clinton will be indicted for mishandling classified information or the obstruction of justice related to her private email cache. Clinton, who is not known for backing down from a fight, could lead a counter offensive during the campaign that could prove detrimental to healthcare deals. Tax inversions, predatory drug pricing, and soaring healthcare premiums will continue to be front and center in the lead up to the election. We would expect healthcare companies to lay off on the mega deals into 2016, while focusing on more discreet bolt-ons and asset swaps. Overall, we see companies pushing some deals into 2017 to avoid being in the cross-hairs during a nasty political battle and the possibility for change in antitrust enforcement with a Republican administration.

Energy will lead the next wave of consolidation – The one area we don’t expect to wait it out would be energy. Many companies just won’t have the luxury given their dire straits. The Saudi’s just slashed their 2016 budget and it looks like they are serious about flushing out the weak hands. Meanwhile, on the demand side, China tries to shift to a consumer economy while it digests years of overbuilding. We don’t see either of these situations changing until at least the second half of 2016, putting the commodities risk squarely on the downside. Weak companies will enter into survival mode, which will mean asset sales to shore up capital concerns or big mergers to create scale and improve operational efficiencies.

Debt ratings will play more of a role in strategic corporate decisions – With the Fed off the zero bound and the blow out in prices of the most speculative junk due to the commodities collapse, funding is no longer (relatively) free. We expect companies to work much harder at keeping their current credit ratings. This means using more stock for M&A (why not at these inflated levels?) and the curtailment of issuing debt strictly for repurchase shares. Post announcement downgrades (especially in high yield) that lead to much higher funding costs could eat up a much larger chunk of deal synergies, pushing companies to rethink risky deals. Lenders could crack down as well, helped by regulators’ increased scrutiny, and the days of covenant-lite for all could be drawing to a close. The gap between investment grade and high yield could widen even more if banks pull or not renew revolvers and other short-term financing on a downgrade to junk, severely limiting companies’ flexibility.

More regional banks explore options – Meanwhile, a continued rise in rates can’t come fast enough for many midsized lenders. This year First Niagara Financial (NASDAQ:FNFG) decided to pursue a sale in part because the Fed didn’t raise rates in September, a development that increased the prospects of continued underperformance. Comerica (NYSE:CMA), Zions Bancorporation (NASDAQ:ZION) and Citizens Financial Group (NYSE:CFG) are among the institutions with elevated asset sensitivity. All three have indicated in the past that they aren’t interested in selling, but FNFG long maintained that position until its board realized it had few other options. With regulators now regularly clearing big deals, regional banks no longer have an easy excuse for avoiding BB&T’s (NYSE:BBT) Kelly King’s call. On the flipside to FNFG, the fall’s other major bank sale, Astoria Financial (NYSE:AF), came amid worries that a rate increase would lead to losses as the former savings bank’s liabilities repriced before its assets. A few other New York City metro area thrifts like Dime Community Bancshares (NASDAQ:DCOM) are in a similar position. The AF proxy suggests it attracted interest from two other suitors in addition to buyer New York Community Bancorp (NYSE:NYCB): Investors Bancorp (NASDAQ:ISBC) and People’s United Financial (NASDAQ:PBCT). Along with the NY area, perhaps PBCT could revisit a bid for Massachusetts-based Brookline Bancorp (NASDAQ:BRKL), whose stock has hardly moved since a merger a few years ago. Another area in banking to watch is lenders that still have private equity investments from the financial crisis such as United Community Banks (NASDAQ:UCBI). If these banks prove unable to continue making acquisitions of their own, financial sponsors will likely pressure boards to put up for sale signs.

Consolidation in the hotel sector continues - Marriott International’s (NASDAQ:MAR) proposed acquisition of Starwood Hotels & Resorts Worldwide (NYSE:HOT) created the first hotel chain with over 1m rooms. We think the smaller players will now be pressed to act to create scale and take back margin from the Online Travel Agencies (OTAs). Our best guesses:

Accor (EPA:AC) merges with Hilton Worldwide Holdings (NYSE:HLT) giving Blackstone Group (NYSE:BX) an exit on its remaining shares

Shanghai Jin Jiang International Hotels Development (SHA:600754) acquires InterContinental Hotels Group (LSE:IHG) for instant access to the US market

Wyndham Worldwide (NYSE:WYN) acquires Choice Hotels International (NYSE:CHH) with plans to dominate the budget category

Hyatt Hotels (NYSE:H) does no strategic deals due to Pritzker involvement and instead is taken private

Out of left field: One of the OTAs acquires a hotel company. Priceline Group (NASDAQ:PCLN) and Expedia’s (NASDAQ:EXPE) combined market cap is around USD 82bn. The entire combined market cap of all the publicly traded hotels around the world is only a bit above USD 100bn. One of these OTAs could easily take out any of the major players, combine the loyalty programs and offer exclusive deals in an attempt at synergies.

Activists will have more impact than ever – With more and more investment flowing into passively managed index strategies, the average shareholder will continue to lose influence. Activist shareholders will be called upon to keep executives in check by pushing for more operational and strategic efficiencies. Given the success at the board level of activists in implementing changes in 2015, next year will see an increase in the number and the size of company targets.

At the same time, the best activists will need to adapt to changing conditions for continued success. After a number of wins on pushing tech companies to go private, activists struggled in 2015 to secure buyouts for bigger USD 10bn+ EV targets - see Citrix Systems (NASDAQ:CTXS), NCR (NYSE:NCR), and CDK Global (NASDAQ:CDK). With valuations still high and a much tougher financing environment, this strategy doesn’t look workable in 2016. Instead of quick cash sales, activists need to become an alternative to private equity firms by increasing their due diligence and coming up with (real) detailed operational turn around plans of their own. We saw that work in the consumer goods sector in 2015 to the point where many companies are now making proactive changes before investors get involved. With that group picked over, activists might do well to move on to the next sector in need of a revamp, energy (see above), where hard times could mean outsized influence for activists who can push firms on the hard CAPEX decisions. The REIT spin game may be shut down by the IRS, but activists could turn to pushing existing REITs trading well below NAV to unlock value via asset or wholeco sales.

Looking ahead to this spring’s AGM season, there are a few situations that could develop in 2016. Here are a few upcoming board nomination window openings to keep an eye on:

We’ve discussed the seemingly never-ending rumors of an activist targeting Twitter (NYSE:TWTR), though with shares down roughly 40% over the last year, and the director nomination window approaching, we may find out if this is indeed the year. TWTR has some fairly unfriendly corporate governance, such as a staggered board and ability to adopt a poison pill. However, unlike some of its larger tech peers, the company doesn’t have a dual-class share structure. The company’s nomination window runs from 5 February to 6 March.

Back in August, when Teradata (NYSE:TDC) was trading around USD 36 per share, this news service reported that the data warehousing company’s valuation could keep suitors away, but a drop down to USD 30 per share could attract suitors or an activist. And after reporting poor 2Q15 results shortly after, shares dropped below USD 30, and have yet to trade strongly back above that level. The window opens 30 December, and runs through 29 January. We wonder if an activist will try for some board representation.

Carlson Capital went active at Vitamin Shoppe (NYSE:VSI) back in April, but has been relatively quiet. There has been ongoing speculation that the company could look to merge with peer GNC Holdings (NYSE:GNC). Shares of the two companies had a rough 2015, with GNC down 34% YTD and VSI not far behind with a 31% decline. And with the companies having overlapping nomination windows (GNC’s runs from 23 January to 20 February, while VSI’s runs from 3 February to 5 March) could Carlson, or another activist, target the nutrition retailers for a board shakeup or merger deal?

Xerox (NYSE:XRX) has already pushed back its director nomination deadline for its 2016 AGM from 8 December to 29 January and is working with Goldman Sachs on a strategic review after Carl Icahn went active with a 7.1% stake on 23 November. With Icahn now finally finished with the Pep Boys – Manny Moe & Jack (NYSE:PBY) bidding war, he may turn his attention to XRX next, although we would expect a settlement before the deadline as opposed to a proxy fight given XRX’s actions thus far and Icahn’s relative silence on the tech name.

Activist fund performance will be subdued – Overall market valuations are quite lofty by most historical standards and will limit stock appreciation in 2016. We see an upside scenario of mid-single digit appreciation with a downside scenario in the negative 20% range. Even as activists become more influential, overall performance could be even worse than 2015 considering the current risk/reward imbalance and given that most funds are still bullish and relatively unhedged, running 80%+ net long.