Studying the Dark Art of Leaking Deal Talks

Psst.

That’s how you might imagine a “leak” of a big merger or acquisition would start. A well-placed phone call. An off-handed comment over lunch. A confidential document accidentally left on an airplane.

It seems as if news of most big deals is invariably leaked ahead of the official announcement. Of the biggest deals of the year so far — the buyout of Dell, Warren Buffett’s acquisition of Heinz, American Airlines–US Airways, Liberty Global-Virgin Media — none made it to the finish line without the news media finding out about it first, sometimes with weeks of advance notice, some with just hours to go.

An intriguing academic study casts new light on the dark arts of the leak — or what used to be affectionately known in London as “the Friday night drop.” (It’s a bit of lore, but deal leaks used to be delivered by envelope on Friday night on Fleet Street to the gossipy Sunday broadsheets where the news could be placed as a trial balloon ahead of the markets’ reopening on Monday.)

According to the study, conducted by the Cass Business School in London — and commissioned by Intralinks, a provider of electronic data rooms for deal makers — sellers are often perversely rewarded by leaks in the marketplace: buyers of companies involved in deals that leaked before the announcement paid a premium averaging 18 percentage points more than in deals that did not leak.

The study examined 4,000 deals between 2004 and 2012. On average, the study suggests, despite anecdotal evidence to the contrary, that leaks have actually been reduced in recent years. According to the study, 11 percent of all deals were leaked between 2008 and 2009. Between 2010 and 2012, it fell to 7 percent.

Remarkably, there is a huge divergence based on region. During the period examined, 19 percent of all deals in Britain were leaked, while only 7 percent of deals in the United States were leaked; 10 percent of deals were leaked in Asia.

To the casual observer, those numbers may seem to understate the situation, especially because it is usually the big, complex transactions with brand names that receive the headlines.

In Britain, the Financial Services Authority published a report in 2010 suggesting that word of a whopping 30 percent of all deals was leaked before they were officially announced. At the time, the agency said, “Strategic leaks, designed to be advantageous to a party to a transaction, are particularly damaging to market confidence and do not serve shareholders’ or investors’ wider interests.” It went on to push for “a much stricter culture that firmly and actively discourages leaks.”

The Cass study also reflected a distinct downside to deal-leaking: a deal’s chances of completion drop significantly. Leaked deals were 9 percent less likely to close than those kept under wraps and took, on average, a week longer to complete, perhaps given the added commotion and complexity created by the leak. (The study did not look at what happened to deals that were leaked but never reached the point of being announced.)

So how did the study explain the reduction of leaks in recent years?

The authors attributed it to “a stricter regulatory environment with more active enforcement and, perhaps most significantly, the subdued deal-making environment and fewer buyers in the market, which has encouraged firms to play it safe and not complicate a deal by leaking.”

How true. With so few deals these days, everyone involved in a transaction — management, boards, bankers, lawyers, accountants, public relations professionals, consultants and other fixers — are reluctant to leak and risk their fees, many of which are typically contingent on a deal’s completion.

Still, of course, the art of leaking news of a deal has long been part of the mergers and acquisition machine.

Bryan Burrough, the author of “Barbarians at the Gate,” described how Henry Kravis reacted in 1986 when news that he was planning to bid for RJR Nabisco leaked, and he made a phone call to a banker he was convinced was responsible.

“I can’t believe you did this to me,” Mr. Kravis reportedly told Jeff Beck of Drexel Burnham Lambert.

“I didn’t do it! I didn’t do it! You’ve got to believe me! It was Wasserstein! It had to be Wasserstein!” Beck shot back, referring to Bruce Wasserstein. Years before Mr. Wasserstein died, he insisted to me that he wasn’t behind that leak, but he did say that leaking was part of every deal maker’s arsenal in the 1980s. I can confirm that Mr. Wasserstein never leaked to me.

Of course, the topic of this column hits a little too close to home. I will share a bit more, but not too much. A magician, as they say, never reveals his secrets.

First, leaks become exponentially more likely as more people are added to a transaction, whether it be people inside the acquirer or target, or perhaps, as additional advisers are included in the process. If a big deal needs financing — as in debt from banks — the risk of leaks jumps. Every bank contacted then knows about the deal, as does the bank’s law firm. And it is not just one or two bankers and lawyers who were first contacted — it’s often dozens of them. Every banker or lawyer who brings on a new client must clear the new assignment with a “conflicts committee.” That committee can have half a dozen or more people on it — and those people may have to check with others at the firm who are working on competitive projects. This is true not just of banks and law firms but of consulting firms, accounting firms and public relations firms.

The private equity world poses its own problem. Those firms often have large investment committees and also employ armies of outside consultants and law firms that typically do much of the heavy lifting when it comes to going through the books and records of prospective targets.

By the time deal talks begin in earnest, it is almost impossible that fewer than 100 people know about it; more likely it’s many more. If there is a “bake-off” — a competition among advisers for the assignment — the number is even higher. And if there is an auction, well, forget about it.

The Cass study suggests all sorts of motivations for deal leaks. “Leaks from the seller are seen primarily as a way to improve the target’s bargaining power,” for example. The authors added that “leaks from a buyer are seen as a tool to scupper a deal which has not progressed as originally hoped.” The authors also said that third parties, not involved in a deal but aware of it, are “seen as a source of leaks designed to sabotage a deal.” Yet, the authors also said that “some M.&A. practitioners also feel that leaks can be used to help drive a deal through when one side is delaying.”

Those explanations make sense. Over the years, I’ve heard it all: a chief executive who wanted to get a deal done despite opposition from his board and was convinced that if the market knew, investors would cheer and bolster his position; a board member who wanted to block a deal but didn’t have the votes and was convinced that if the market knew there would be an outcry; a banker who lost the business to a rival firm and wanted to make his competitor appear to be a leaker.

But the one problem with the Cass study is this: It assumes the leaks are rational and based on a considered strategy. As a reporter who has covered the world of deal-making for more than a decade, I can attest that most “leaks” are actually not that organized. More often than not, they start out as accidents — a tip from a competitor about a transaction they heard about that then gets passed on.

The rate of deal leaks may be down. But if the economy begins chugging along — and a merger boom, a good gauge of market sentiment, returns — keep your eyes peeled. The “Friday night drop” might stage a comeback.