Business Law Prof Blog

Will Ronald McDonald Put on His Smiley Face for the Hedge Funds...

In a move that sent the stock price up over $35 for the first time in four and a half years, Bloomberg has reported that Pershing Square Capital Management LP, the hedge fund that urged Wendy's International Inc. (NYSE: WEN) to sell assets, acquired 4.9% of McDonald's. (NYSE: MCD).

McDonald's stated that it did not know whether Pershing has bought a stake in the company.  "Based on McDonald's business performance, shareholders have demonstrated continued confidence in McDonald's management and strategic direction," said spokeswoman Anna Rozenich. "Beyond that, we have no specific information on the extent or form of Pershing Square Capital's position in McDonald's."

Last summer, Pershing went into Wendy's and urged the board to sell off its Tim Horton's chain, which Wendy's is currently doing. (I discussed this matter here).   Analysts and others believe that Pershing might be doing the same with McDonald's.  In fact, within the past couple weeks, Jim Cramer in his Mad Money show did a spotlight on McDonald's and the value of its assets.  Specifically, McDonald's has a majority stake in restaurant chain Chipolte and owns restaurant chain Boston Market.  Analysts believe that selling these two chains could bring in approximately $2B.  Others have pointed to unlocking the value of McDonald's real estate assets, by selling the real estate McDonald's owns to its franchisees.  The value of real estate has been seen in the sell-off of KMart's (NASDAQ: SHLD) real estate to companies like Home Depot (NYSE: HD).  Analysts believe this could bring in another $2B.  To follow through this line of thought, McDonald's could then take these revenues and pay down its debt, and announce a major stock repurchase or dividend increase.  Following the Wendy's example, McDonald's executives will then exercise their compensatory options and sell some McDonalds's stock, cashing in on the stock's price rise.

Ellison Settlement Questions

Lawrence J. Ellison, the CEO of Oracle Corporation, is full of surprises.  The latest one, his offer to settle a California derivative action for $122 million, is a doosey.

Last week Ellison announced that he would pay $100 million to charity and $22.5 million to the plaintiffs’ lawyers to settle a California derivative action based on claims of insider trading in January of 2001.  The settlement must be approved by the Superior Court Judge in San Mateo. 

Near the end of January in 2001, on the eve of the collapse of the high-tech stock market in March, Ellison sold a whopping 29 million shares of Oracle stock for $900 million, over 2 percent of his total Oracle holdings.  He still owns twenty four percent of the company, valued at over $13.7 billion.  He had not sold any Oracle stock for five years.  He had paid 23 cents a share and sold for $30 to 32 a share   

One month later his company announced that it might not meet the company’s forecasts of earnings for the third quarter and the stock dropped like a rock in value, bottoming at $16.88 a share.  We now know that some of the earnings decline was due to the correction of accounting improprieties.   Ellison’s $900 million sale would have garnered him around $500 million had he sold after the negative announcement, a cool $400 million cash savings.

Ellison’s remaining 24 percent lost $18.9 billion in value, however, in the high-tech share price swoon.

Plaintiffs’ lawyers sued Ellison and a colleague for insider trading in Delaware state court, Oracle is incorporated in Delaware, and in state and federal court in California, the location of Oracle’s headquarters.

The case in Delaware progressed quickly and Ellison won a summary judgment motion in the trial court in November of 2004.  Vice Chancellor Strine, in a lengthy opinion, found that no evidence that Ellison knew, at the time of the sale, that Oracle would not meet the market estimates.  Strine was resolute, calling the plaintiffs’ arguments the “ravings of conspiracy theorists.”  Last month the Delaware Supreme Court affirmed the decision.

In California, Ellison was also holding his own.  A federal district court in California dismissed the securities class action on the pleadings but the Ninth Circuit reinstated and remanded the action for trial.  The Ninth Circuit’s decision is curiously at odds with the decision in the Delaware Chancery Court, which did not refer to the accounting problems at all (except for a brief footnote implying that the plaintiffs had dropped the claims).  The Ninth Circuit held that the plaintiffs’ claim that Ellison knew of the accounting gimmickry was sufficient to justify a trial.  But the case would be tried in a district court that was obviously very skeptical about its merits.

Then came the surprise settlement.  In the pending California state court action, a derivative action, Ellison would settle the case for a staggering $122 million, one of the largest derivative action settlements of its kind.  Why?   Ellison had strong arguments that the California derivative action was decided in his favor by the Delaware decision, Oracle was a Delaware company.  The plaintiffs were suing under a California statute, creating a special derivative action, but whose law applies to define the open ended terms in the California statute (board of director "good faith" for example)?  If California law does apply is there a violation of the Commerce Clause for inconsistent results (a violation of the internal affairs doctrine)?  Is he negotiating a release of the federal action as well?  There are many, many legal questions here.

There is also the nature of the payment.  $100 million will go to charity and $22 million to lawyers, depriving the firm of the of settlement money (75 percent of which would benefit shareholders other than Ellison).  Ellison will, no doubt, claim a charitable deduction on his taxes, hoping to recoup potentially $30 million or so back from federal and state governments.

The settlement is an embarrassment for the Delaware courts.  Dismiss on summary motions an action against Ellison and he settles the same action elsewhere for $122 million – the Delaware judges have to wonder whether they were hoodwinked. 

  Strine bought the following story:  Financial advisors told Ellison he had to "diversify" by selling some stock.  He had too much of his wealth tied up in Oracle stock.  Furthermore he had a tax bill coming up on the exercise of some expiring compensatory options and would need substantial cash. Coming back from vacation he realized that he had to sell in the "window" around quarterly reports and only a few windows a year were available.  His advisors told him that the forecasts for the 3Q of 2001 were still accurate even though there could be some problems; but similar problems with earlier forecasts for past quarters had always worked out and those forecasts had been met.  He sold only 2% of his stock, even though the numbers were huge, and lost $18.7Billion on the 24% stack in Oracle that he still held.  His loss shows his belief in his company. 

   Here is an alternative plausible story, one that a $100 million settlement could support:  Ellison is smart and likes to make money.  He also knows the high-tech business better than all but a few people on the planet; indeed he is at the epicenter of the business.  He comes back from vacation and gets negative vibrations about the health of the country's high tech business (probably oral communications from trusted buddies in the business).  The written internal forecast reports hint at problems but the staff knows better than to tell the boss in writing bad news;  Ellison likes good news.  Ellison has a problem:  he is sitting on $35 billion in stock, valued at $30 that he bought, in essence, for $.25.  The securities acts limit his resales;  his resales are capped by the 33 Act that requires a full registered offering for his sales unless he can meet the limit imposed by Rule 144.  He does not have time to do the registered offering so he calls his lawyer and says sell as much as you can under Rule 144 in each of the windows that will follow.  His lawyer and broker comply with the Jan. 2001 sale, the market collapses, surprising even Ellison (his broker dumps $900 million, a pittance to Ellison but a staggering amount to mortals), and subsequent sales must wait as inside information outpaces public information for a year or two.  Ellison also knows that lawsuits are now inevitable.  He waits out the bottom, still very wealth at $13.7 billion in value in stock, but $400 million in cash better off having sold in January.  Strine, on summary judgment motions, dismisses the case based on the internal written forecasts by loyal staff.  Now Ellison, facing a real trial, throws $22 million at some very happy plaintiffs' attorneys and offers $100 m to charity (what a great guy).  He still comes out $300 ahead, more if the government gives him a tax deduction for a charitable contribution.  Is this a great country or what?   

Crash Landing: Delta Airlines and Nortwest Airlines file for Chapter 11 Protection

As predicted, Delta Airlines (NYSE: DAL), the number 3 air carrier, today filed for Chapter 11 protection.  (Delta's website about the process can be found here; the press release can be found here).  Chapter 11 will allow Delta to continue operations while it develops a plan to reorganize its business.

According to its website, Delta filed for Chapter 11 protection because: "During the last year we have developed and implemented a transformation plan focused on making Delta a simpler, more efficient and cost-effective airline. The considerable benefits we are realizing under this plan, however, are being outpaced and masked by historically-high aircraft fuel prices and other factors. Reorganizing under Chapter 11 provides us with additional time and flexibility to expand our transformation plan and move Delta towards a more secure future."

As if one was not bad enough, Northwest Airlines (NASD: NWAC), the fourth largest airline, also filed for bankruptcy today. (Northwest's press release can be found here. A statement from Northwest's website can be found here)  Four of the countries six largest airlines are now in Chapter 11.  The United States will be asked to pick up and pay out on most of the airlines underfunded pension plans.  It will come to a staggering amount once the total bill is paid.  Hopefully Congress will use the mess to reevaluate the federal system of pension guarantees.

I am always amazed at how folks continue to trade the stock of these bankrupt companies at rather august values.  The stock should be worth close to zero, pennies at best.  The only value in the stock is the hold up price the creditors must pay to get the shareholders out of the way of the final agreement than spits the company out of bankruptcy proceedings.  For these airlines to come out of chapter 11, the companies will need to restructure their debt, exchanging debt forgiveness for new equity.  The old stock is canceled (or so heavily diluted that it has no value). As a result, for example, the $2 people are paying for NWAC share makes no sense, unless the purchasers are speculating on the leakiness of Chapter 11 in closing out the positions of the worthless shareholders.  They are speculating on the effective of shareholder lawyers in stalling the Chapter 11 proceedings and making a nuisance of themselves to the point where the creditors are willing to give them "grease" money to go away.  For an example of what the parties get, check out this Reuters article on US Airways emerging from Chapter 11, specifically the last three paragraphs. ("General shareholders in the old US Airways will get nothing")

For cnn.com's coverage, click here.

Canaries in the Coal Mine??

Yesterday, Best Buy (NYSE: BBY) reported a 25% rise in earnings, but missed Wall Street's expectations by a penny.  Also, Best Buy guided earnings expectations lower, stating it expects to earn between 28 and 32 cents a share while Wall Street had been expecting 34 cents a share.  (AP's report can be found here.)  Analysts claimed that Best Buy just missed raised expectations, which were caused by an amazing first quarter.  Jim Cramer has issued a " 'mon' back" on Best Buy after it lost 11% during trading on Tuesday. (See his take here.)  However, I believe this is another sign of the beginning of a serious slowdown the "consumer" driven economy.  One cannot miss the negative connations of Cramer's old broadcast partner Kudlow, who is a consistant advocate for current business conditions (based no-doubt on his support of the current Administration), ending his show with a plea to consumers to "keep spending, it's important to the economy."  Good grief.

Walmart (NYSE: WMT) missed Wall Street estimates for August sales (AP Report here) and has not changed its September sales forecasts due to Hurricane Katrina (Reuters Report here).  But, I feel that the cost of oil and other commodities is going to slowly eat away at consumers willingness to spend.

As seen today in the August Retail Sales report, US retail sales dropped a larger than expected 2.1%, the largest decline in nearly four years. (Reuters story here).  Wall Street had been expecting a decline in retail sales of 1.2%.  Most of the decline in retail sales was caused by a lack of automobile sales, which decreased 12% from July, even though most of the car manufacturers are still providing massive discounts.

I believe the writing is starting to appear on the wall that a downturn in the economy is coming, as the consumer will no longer be able to or want to spend as freely as he/she has in the past ten years or so.  And as I have already stated here and here, I believe that the stock market is preparing for a major correction.

Underwriters Downgrade Baidu.com

Shares of Baidu.com (NASD: BIDU) plunged more than 20% this morning when Goldman Sachs and Piper Jaffray rated the stock an "underperform."  This is interesting because both Goldman and Piper were involved in the underwriting of the "Chinese Google." 

An analyst from Piper said that the valuations are "off the chart" and set a price target of $45.  Considering that the stock closed trading on Tuesday at $113.59 a share.  The analyst from Goldman had the same view on Baidu.com, yet his valuation model only valued the stock at $27 a share.

Typically, the investment banks, which participate in the IPO, have always kept their ratings of stocks they helped IPO at no less than a neutral rating, because it helps obtain new business.  But, Goldman and Piper have shown that fuller, more accurate disclosure might be in the future of investment banks, which rate stocks.  The downgrade is evidenced that Spitzer's enforcement efforts against the analysts have borne serious fruit.

S&P Gets Out of the Governance Audit Business

  Standard & Poor's Corporation has thrown in the towel in its new corporate governance rating business.  S&P, for a fee, offered to rate a firm's corporate governance systems.  S&P would score only those companies will to pay and the client had the options of reporting or not reporting the score.  Surprise, surprise... the business failed.  The service got off to a bad start when it rated Fannie Mae a 9 out of 10 on the eve of Fannie Mae's disclosures of problems with accounting and executive compensation.  An embarrassed S&P reduced the score to a 6.  Folks...audits work this way too. The difference is that audits are required of publicly traded companies and that results must (in some fashion) be disclosed.  Otherwise the basic conflict -- the rating of paying clients -- is the same. 

SOX Application to Small Business Delayed Again

   The Securities and Exchange Commission will give small publicly-traded businesses a one-year delay on top of a previous one-year delay to compy with Section 404 (the internal controls section) of the Sarbanes-Oxley Act of 2002.  Smaller businesses have argued that the Section is too expensive and burdensome.  Small companies, according to a survey by FEI, will spend an average of $825,000 a company to comply with the section.  The SEC rules under this section are a mess.   

Commerce Bank Guides Lower, Sites Interest Rates

Commerce Bancorp Inc. (NYSE: CBH), the holding company for Commerce Bank announced today that it expects to miss Wall Street expectations for the next two quarters because of interest rates.  Commerce Bancorp's Chairman Vernon Hill stated that the margin spread (the difference between long and short term interest rates) on treasury bonds has affected earnings more than expected.

As a result, Commerce Bancorp's shares have fallen more than $2.50 or 7%.

The AP Report can be found here

TheStreet.com's report can be found here.

Another M&A Monday

Today three major merger and acquisition transactions were announced.

First, eBay (NASD: EBAY) has agreed to pay at least $2.6B for Skype.  (AP article can be found here)  If Skype hits certain performance goals over the next 3 years, the value of the deal could increase to $4.1B.  Skype is a leader in VoIP, which allows people to make phone calls over the internet.  On CNBC this morning, Meg Whitman noted how the addition of Skype will allow users of eBay to make phone calls with potential customers or buyers to takedown barriers that make buyers and sellers uneasy.  Also, Whitman noted that the deal could allow more detailed transactions, such as real estate, to be done quicker and easier over eBay, because the use of VoIP will allow customers to discuss details without being forced to do so over email.  Finally, Whitman discussed a translating service which would allow eBay customers to increase the efficiency of transactions completed between people who do not speak the same language.

Second, Oracle Corp (NASD: ORCL) has agreed to buy Siebel Systems, Inc. (NASD: SEBL) in a deal valued at $5.85B. (AP article can be found here).  According to the terms, Oracle is offering $10.66 per Siebel share, which is a 16.8% premium over Siebel's close on Friday.  On CNBC, it was reported that the deal will comprise of 30% of Oracle stock and 70% cash, and the final closing price will be determined 10 days before the close of the transaction.  This is an interesting deal because Oracle is purchasing a company in Siebel which had one of the tech bubble's greatest arcs.  In 1997, Siebel shares traded at a split adjusted $2 a share and traded higher than $120 in 2000.  And today, Siebel is being bought out at $10.66 a share.

Finally, Wachovia Corp (NYSE: WB) has decided to make a bet in the auto loan business and has agreed to acquire Westcorp (NYSE: WES), an automobile finance company and WFS Financial Inc. (NASD: WSFI) for nearly $4B in stock. (Reuters article can be found here). After completion of the deals,  Wachovia will become the ninth largest auto loan originator in the country.  Wachovia will pay $3.42B for Westcorp, which owns 84% of independent auto-finance company WSF Financial.  Wachovia will pay $490M for the remaining 16% of WSF Financial's shares.  Under the terms of the deal, Wachovia would be paying a 4.5% premium for Westcorp and a 14% premium for the remaining shares of WSF Financial.