Getting your MAC on

I’m sorry to disappoint you, but this article isn’t full of advice for your Tinder game. I can’t help you with that. All I can do is help you understand more of what you read about in the markets.

MAC stands for Material Adverse Change, a concept in dealmaking that gives the buyer of an asset a lifeboat in case the asset starts sinking before the deal is implemented.

Why do parties negotiate a MAC clause?

Whenever a new deal is announced, the assumption is always that it will go ahead unless there’s a nasty surprise from a regulator like the Competition Commission. Regulatory approvals are always a risk as they are outside of the control of the parties agreeing to the deal.

A MAC issue is different, as the buyer has the right to walk away from the deal if something goes badly wrong during the implementation phase. It can take many months to implement a deal due to the numerous regulatory approvals that may be required along the way. During that period, anything can happen.

The lawyers will have long and lively debates about the MAC clause while the deal is being negotiated, billing their respective clients along the way (often in 10-minute intervals, so don’t spend too much time chatting to them over a spring roll during the tea break).

It all seems pompous and unnecessary until something goes wrong and the MAC clause is needed. Nobody gets married with a plan to get divorced, yet it makes a lot of sense to put some agreements in place to regulate that unwanted outcome.

The Barloworld – Tongaat Hulett example

An excellent example of a MAC drama was found in our local market during the pandemic.

At the end of February 2020, just before the world went mad, Tongaat Hulett announced that it would sell its starch division to Barloworld for R5.35 billion.

The cash was desperately needed, as Tongaat was in a tough place even before news of an accounting scandal broke. As usual, thousands of employees lost their jobs during the financial disaster and the executives continued to enjoy their money while the wheels of justice turned slowly. The case against them is currently in the courts.

The Tongaat share price went on a rollercoaster ride in 2020, not least of all because the deal with Barloworld wasn’t as cemented as people thought. Although Tongaat shareholders were in support of the deal, it takes two to tango.

In May 2020, Barloworld tried to invoke the MAC clause based on an expectation of the EBITDA (a proxy for operating profit) for the year ended February 2021 being 82.5% or less of the prior year’s result. Barloworld was desperately trying to manage its own risks in a period of immense uncertainty, so doing such a large deal obviously felt scary for Barloworld’s board.

It took a few months to sort out, with independent expert Rothschild & Co eventually confirming that EBITDA had not fallen sufficiently to trigger the MAC. Of course, Barloworld was quick to issue an announcement gushing over the business and how great it is, even though they tried to wriggle out of buying it.

It’s just as well that the deal went ahead, as the business has been a great performer for Barloworld. In the 11 months that Barloworld owned the asset during the 2021 financial year, Ingrain generated an operating profit of R534 million vs. R452 million in the comparative period (before Barloworld owned it). It unleashed R768 million in cash flow as working capital efficiencies were realised.

Looking back, I can understand why Barloworld gave itself the option to walk away by invoking the MAC clause. Hindsight is perfect and there was no certainty at the time that things would work out so well.

This is the point of the MAC clause: optionality for the buyer. It’s a good reminder to deal executives to listen carefully to the lawyers, as the MAC clause in an agreement can end up being the most important section of all.