Cadbury Schweppes plc's (Cadbury) recent acquisition by auction of the Adams confectionery division of US Pfizer Inc. was its biggest ever and has catapulted it to a leadership position in the global confectionery market. This article looks behind the scenes at the US$4.2 billion cross-border deal.
Acquisition structure. Adams is not a stand-alone business and it operates in 40 jurisdictions. A single asset and stock sale and purchase agreement transferred relevant US assets and stock and contained overarching terms such as sale conditions, representations and warranties, covenants and indemnification (the master agreement).
The master agreement also required relevant Pfizer or Adams companies to enter into separate local implementation agreements to transfer either Adams assets in non-US jurisdictions or shares in non-US Adams subsidiaries to local Cadbury subsidiaries. About 20 separate agreements were entered into, all of which were based on an agreed template.
Due diligence. In a departure from normal practice, a team of about five in-house lawyers and about 40 to 50 Shearman & Sterling lawyers tested Cadbury's business case for Adams against the information in Pfizer's New York data room.
For example, where Cadbury's acquisition model contemplated scope for rationalisation of the two businesses, the lawyers would be asked to ascertain whether the proposed course of action was possible from a legal perspective. Cadbury's internal strategy group had prepared a very detailed and sophisticated acquisition model. A traditional legal review was also carried out at the same time.
Overview. Other aspects of the deal analysed include: negotiation of the master agreement; obtaining competition clearance in the US, Canada, Mexico and individual European countries; obtaining the approval of Cadbury's shareholders; arranging acquisition finance in the form of a new US$6.1 billion facility; transferring nearly 13,000 employees from Adams to Cadbury; and dealing with a raft of pre-closing issues.Close speedread
The secret ingredient in Cadbury Schweppes plc's (Cadbury) acquisition of Adams from Pfizer Inc. was advance preparation. "The Cadbury people were incredibly well organised," says Creighton Condon, Shearman & Sterling, US counsel to Cadbury. "It was obvious to Pfizer early on that Cadbury was very well prepared and could do the deal efficiently and quickly." Cadbury, a UK company, competed in an auction against other global confectionery businesses thought to include Wrigley, Nestlé, Mars and Hershey.
Why was Cadbury so well prepared? "We anticipated that Adams would be coming up for sale," says Mike Clark, Cadbury's chief legal officer, "and planned appropriately." Cadbury spent well over a year preparing for the purchase. US pharmaceutical giant Pfizer acquired Adams as part of its acquisition of Warner Lambert in 2000.
And of course there were compelling commercial reasons why Cadbury should pull out all the stops. Adams's main brands (Halls cough lozenges, the "Bubbas" range of bubblegum and Trident and Dentyne "functional" chewing gum, that is, confectionery with health benefits) are in growth sectors. The market in functional confectionery, for example, is said to be growing at double the overall market rate. The purchase would complement Cadbury's existing chocolate business and catapult it to a leadership position in the global confectionery market.
To understand the importance of Cadbury's advance preparations, and how they gave it a competitive edge, it is worth considering the key elements of the transaction. These were:
Making a successful bid.
Agreeing a suitable acquisition structure.
Carrying out extensive due diligence on the subsidiaries and assets that make up the Adams business.
Negotiating the terms of the sale and purchase agreement.
Obtaining competition clearance in the US, Canada and Mexico and individual European countries.
Obtaining the approval of Cadbury's shareholders.
Arranging acquisition finance in the form of a new facility.
Transferring employees from Adams to Cadbury.
Dealing with a raft of pre-closing issues.
The auction for Adams was run on traditional lines, with the issue of an information memorandum, auction instructions and a draft contract by Pfizer. Bruce Futterer, in-house counsel with responsibility for Cadbury's Americas region and lead in-house counsel on the acquisition, sums up the difficulties facing a potential bidder as regards negotiating the draft agreement (which in a non-auction sale will normally be drafted by the buyer, not the seller): "It's important in an auction process to remember that there are other potential bidders who are looking at the same draft contract and that the extent to which you mark up the seller's draft may affect your competitive position in the auction. We took a moderate, sensible approach to the mark-up."
"Cadbury wanted a practical contract," says Condon. "It made a concerted effort to focus on things that were meaningful." Condon also says that the negotiations took time but Pfizer was "very constructive" in how it dealt with the agreement. It needed a flexible attitude because the contract would need tailoring to suit the individual needs of the successful bidder and because the structure of the deal was complex.
The working relationship between Pfizer and Cadbury was extremely good from the start. Futterer says this was due to a number of factors: "Cadbury's mark-up of the draft agreement was not unreasonable; there was good personal chemistry among the negotiators; and both Pfizer and Cadbury were experienced in M&A." Condon adds that: "the nature of the personal relationship that Todd Stitzer [Cadbury's Deputy Chief Executive Officer from 30 December 2002 and Chief Executive Officer from 9 May 2003] and Pfizer's Peter Garambone [Vice President, Corporate Strategic Planning] established at a senior level was pushed downstream."
Although Cadbury was buying 100% of the business and assets of the Adams division of Pfizer, it is not a stand-alone business and it operates in 40 jurisdictions. Structuring the sale and purchase agreement therefore presented a challenge. A single asset and stock sale and purchase agreement was decided on, which transferred relevant US assets and stock and contained overarching terms such as sale conditions, representations and warranties, covenants and indemnification (the master agreement) (see Negotiating the agreement below).
The master agreement also required relevant Pfizer or Adams companies to enter into separate local implementation agreements to transfer either Adams assets in non-US jurisdictions or shares in non-US Adams subsidiaries to local Cadbury subsidiaries. About 20 separate agreements were entered into, all of which were based on an agreed template. The decision whether to transfer assets or stock depended on which gave Cadbury and Pfizer optimum tax advantages (see Looking forward below).
The implementation agreements were written in English, were governed by New York law (except where there was a requirement that the agreement be governed by local law to be effective) and were executed at closing. Local lawyers advised where necessary.
It was in the due diligence exercise that Cadbury was able to put much of its extensive preparatory work to excellent use. In a departure from normal practice, a team of about five in-house lawyers and about 40 to 50 Shearman & Sterling lawyers tested Cadbury's business case for Adams against the information in Pfizer's New York data room (the validation exercise) (see box: Shearman & Sterling's role). A traditional legal review was also carried out at the same time.
"That we were able to adopt this type of due diligence exercise is a credit to Cadbury's internal strategy group," says Futterer. "They had prepared a very detailed and sophisticated acquisition model. The task of the lawyers was to validate the assumptions in the model and confirm that the value we had ascribed to the business was there."
For example, where the acquisition model contemplated scope for rationalisation of the two businesses, the lawyers would be asked to ascertain whether the proposed course of action was possible from a legal perspective. Futterer says that what was asked of the lawyers was within their skills.
"The due diligence review was very unusual", says Condon. "Diligencing against Cadbury's own business case made it harder but more relevant and more interesting. It is the exercise the client would ordinarily do alone." Futterer agrees: "It brought a tremendous focus to the diligence process. I would definitely use this approach again."
The validation exercise could be used in any M&A transaction, not just an auction, thinks Futterer. It enables the buyer to ascertain at a much earlier stage than usual whether it can achieve its aims with regard to the target, which in turn can influence the size of its bid or any price negotiations. More traditionally, this type of legal analysis would be carried out post-purchase.
Futterer does not consider that additional costs were incurred in the validation exercise: "It created a more focused and cost-effective process. That is largely a function of the amount of work that went into producing an informed acquisition model beforehand. It was also a very effective way of directing the due diligence team."
Cadbury's staff carried out a separate environmental due diligence exercise because Adams had long-standing assets in the form of plant and machinery (it has 22 factories in 18 countries). Cadbury wanted to be comfortable with the risks it was taking on. The environmental review involved local site visits. "In view of the size of the transaction," says Futterer, "the environmental issues were not particularly significant."
The master agreement was governed by New York law, in line with Pfizer's original draft. Cadbury had no objections to this. The mutual representations and warranties were, however, negotiated (subject to the approach of the parties described in Making a bid, above). "A lot of time was spent on environmental issues," says Condon. "The standard was pretty unique. It is not tied into compliance with law, but standards applied by both Pfizer and Cadbury, which are higher." The remainder of the representations and warranties are fairly typical of a transaction of this type.
The indemnification clause is also fairly standard. It contains a mutual agreement by Pfizer and Cadbury to indemnify the other for all losses arising from any breach by the other of its covenants, representations and warranties. The obligation to indemnify lasts for 18 months from closing. Pfizer also agreed to a two-year period in respect of its indemnification obligations relating to its environmental representations generally and a three-year period in respect of specific environmental liabilities that were retained by Pfizer.
As is typical, Pfizer limits its liability to claims under the indemnification. The limit is set at US$1 billion, which, Condon says is: "A meaningful dollar number. It is a reasonable cap considering the size of the business. There was not an enormous amount of exposure because of the nature of the business and the extent of the due diligence exercise."
In addition, the following covenants were given:
Pfizer and Cadbury agreed to use their best efforts to effect the acquisition, which for Cadbury included, where necessary, disposing of Adams assets or properties to obtain competition clearances (see Competition clearance below).
Pfizer agreed to conduct the Adams business in the ordinary course of business, consistent with past practice.
Pfizer agreed that for five years after the acquisition it would not compete with Adams.
The master agreement was conditional on competition clearance in the US, Canada and Mexico. These were obtained before closing and no divestments were needed. Nor was there any need for an EU competition filing because the turnover of the combined businesses did not reach the relevant thresholds.
Cadbury made filings with antitrust regulators in a number of European and non-European countries, including Germany, the Czech Republic, Turkey, Greece, Italy, Portugal, Spain, the UK, South Africa and Brazil. The requirements varied in each jurisdiction: in most of the countries where pre-notification was required it was necessary to obtain regulatory clearance before closing. In one jurisdiction, Brazil, the merger notification rules permitted the parties to close pending regulatory review.
Commenting generally on competition, Futterer says: "It was time consuming, but there were no insurmountable problems. The competition issues were handled very well." Shearman & Sterling, Slaughter and May, the Toronto firm Bennett Jones, Cadbury's in-house lawyers and local counsel shared the competition work (see box: Legal advisers).
When it came to collecting information for competition filings, "Cadbury had already done a lot in the planning stage," says Condon. At a more advanced stage of proceedings, Pfizer provided further relevant information, under cover of confidentiality agreements.
The master agreement was also conditional on the approval of Cadbury's shareholders. As a company whose securities are listed on the UK Official List (and traded on the London Stock Exchange) Cadbury is subject to the "class tests" in the UK Listing Authority's Listing Rules. For the purpose of those rules the acquisition was classified as a Class 1 transaction, meaning that the size of Adams, measured by certain tests, was 25% or more of the size of Cadbury. Class 1 transactions must always be approved by shareholders.
Cadbury's shareholders were therefore sent a circular incorporating a notice of an extraordinary general meeting (EGM). "It was a fairly typical circular," says Boxell, "in accordance with relevant English law and regulation." Because of the commercial imperative to close the deal, the EGM was convened for as early a date as possible. It was held on 5 March 2003, at which the resolution was passed with overwhelming support by shareholders: over 95% of votes cast were in favour of the acquisition.
Cadbury financed the acquisition by bank debt rather than by raising fresh capital in the markets because its cash generative business (think of all those millions of bars of chocolate bought everyday) would result in a payback over a reasonably short period of time, without a dilution of investors' interests. Bank debt is also currently cheaper than equity.
The financing was by way of a syndicated loan facility for US$6.1 billion, an amount which also covered the replacement of US$1.5 billion of existing standby facilities. A syndicated loan is the usual structure for loans of this size. Cadbury Schweppes Finance plc, rather than Cadbury, was the contracting party. "This is normal where the company has a dedicated treasury company," says Boxell. Cadbury guaranteed the facility.
Cadbury wanted the contracts of employment of Adams's employees (it had 12,900 employees across 40 countries) to transfer to it with the business. However, because not all of them were dedicated Adams employees (some had both Adams and Pfizer functions), it was necessary to determine on a site by site basis which employees should remain with Pfizer and which should transfer to Cadbury.
Much that might ordinarily be left to sweep up post-closing was, in fact, achieved before or at closing. "If matters do not get done at closing," says Condon, "they could drag on. It is better to focus attention." The following was achieved:
All the competition approvals were given before closing (see Competition clearance above).
Real estate was transferred before closing.
The allocation of employees with both Pfizer and Adams functions to one or the other was made before closing (see Transfer of employees above).
The local implementation agreements were entered into at closing.
All the trade marks (and there were thousands of them) were assigned at closing.
A transition services agreement, initially entered into before exchange, was completed before closing. It covers the provision of services by Pfizer to Cadbury and vice versa in the areas of: information technology, human resources, finance, sales, distribution, warehousing and logistics. It survives closing.
The consent of third parties to the transfer of key contracts was obtained before closing.
Closing itself was a considerable achievement. The pre-closing and closing meetings, held at Shearman & Sterling's offices in New York, together lasted three full days and two nights, with issues still being negotiated on the last day. The closing checklist was 129 pages long.
To create order, someone with a practical mind at Shearman & Sterling thought of dividing up the huge meeting room into the various jurisdictions of the deal, each marked with a small flag. "It looked like the UN," says Futterer.
Cadbury is expecting that the acquisition will give rise to US$450 million in tax cashflow benefits over 15 years. The tax benefit arises in respect of the Adams intangible assets, for example intellectual property, which are tax deductible in certain jurisdictions. This principally occurs in the US, Canada, the UK and Japan.
It is also hoping for cost synergies in areas such as manufacturing, supply chain, procurement and central administration now that Adams is part of a confectionery business rather than a non-core division of a pharmaceutical company.
Shearman & Sterling advised Cadbury Schweppes on the US law aspects of the acquisition of Adams. Cadbury has been a client of Shearman & Sterling's for about 20 years.
Creighton Condon of Shearman & Sterling's New York office led a team of about 50 lawyers. Even though Cadbury is a UK company, New York was the driving seat for several reasons: the seller was a US company; the majority of the assets being bought were in the Americas; and the sale and purchase contract was governed by New York law. The other main Shearman & Sterling offices used were London, Beijing and Tokyo.
A vast amount of local (non-US) legal advice was also needed to get the deal done. Shearman & Sterling used its own overseas offices or, where it had none, local counsel, preferably ones that had previous experience of working for Cadbury.
Shearman & Sterling lawyers with foreign languages were used to carry out preliminary due diligence on data room documents in languages other than English. Where a further, more detailed, review was necessary by lawyers qualified in non-US jurisdictions, this was carried out by local lawyers post-exchange.