Friday, August 31, 2007
Another potential Material Adverse Change dispute popped up yesterday in the pending $1.5 billion acquisition of Genesco by The Finish Line for $54.50 per share in cash. Yesterday Genesco reported second quarter earnings. The earnings were disappointing but do not appear to be catastrophic. Genesco reported a $4.17 million loss and declining sales at stores open more than a year which it blamed on "the combination of a later start to back-to-school, later sales tax holidays in Texas and Florida and a generally challenging retail environment, especially in footwear."
But Finish Line promptly issued this statement:
The Company is disappointed with Genesco's second quarter fiscal 2008 financial results. Consistent with its responsibilities to The Finish Line's shareholders, the Company is evaluating its options in accordance with the terms of the merger agreement. The Company does not intend to make further comments at this time.
As background here, Finish Line may have buyer's remorse. According to one report, "the deal had come under heavy fire from analysts and investors, who said Finish Line had offered too high a price and was taking on too much debt." Nonetheless, Finish Line appears to be raising the issue that Genesco's second quarter earnings arise to the level of a MAC under the merger agreement. The agreement defines a MAC as:
any event, circumstance, change or effect that, individually or in the aggregate, is materially adverse to the business, condition (financial or otherwise), assets, liabilities or results of operations of the Company and the Company Subsidiaries, taken as a whole; provided, however, that none of the following shall constitute, or shall be considered in determining whether there has occurred, and no event, circumstance, change or effect resulting from or arising out of any of the following shall constitute, a Company Material Adverse Effect: (A) the announcement of the execution of this Agreement or the pendency of consummation of the Merger (including the threatened or actual impact on relationships of the Company and the Company Subsidiaries with customers, vendors, suppliers, distributors, landlords or employees (including the threatened or actual termination, suspension, modification or reduction of such relationships)); (B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (C) any change in applicable Law, rule or regulation or GAAP or interpretation thereof after the date hereof, so long as such changes do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (D) the failure, in and of itself, of the Company to meet any published or internally prepared estimates of revenues, earnings or other financial projections, performance measures or operating statistics; provided, however, that the facts and circumstances underlying any such failure may, except as may be provided in subsection (A), (B), (C), (E), (F) and (G) of this definition, be considered in determining whether a Company Material Adverse Effect has occurred; (E) a decline in the price, or a change in the trading volume, of the Company Common Stock on the New York Stock Exchange (“NYSE”) or the Chicago Stock Exchange (“CHX”); (F) compliance with the terms of, and taking any action required by, this Agreement, or taking or not taking any actions at the request of, or with the consent of, Parent; and (G) acts or omissions of Parent or Merger Sub after the date of this Agreement (other than actions or omissions specifically contemplated by this Agreement).
The carve-outs on this MAC are standard and plentiful, and the carve-out for failure to meet projections which I have highlighted above would appear to exclude much of what happened with Genesco in its second quarter earnings, although the underlying facts could still establish a MAC. I emphasize appear, because we do not know all of the private facts here. But, as I have stated before, Delaware places a high burden on the party asserting a MAC clause: they need to prove that the adverse change consisted of "unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror." In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001). Here, based on the facts available, under Delaware law it does not appear that this threshold is met. Finish Line's rush to issue this press release is therefore surprising, though this may just be Finish Line's last ditch attempt to renegotiate the transaction for a price more satisfactory to its investors.
There is an alternative explanation answer though. The Genesco merger agreement is governed not by Delaware law but by Tennessee law and has a Nashville, Tennessee forum selection clause. Anyone care to tell me what the law on MACs as applicable to acquisition transactions is in the State of Tennessee? Yeah, that is what I thought you would say -- there is none. Finish Line may be taking a flyer on this uncertainty, although it should be careful as Tennessee is Genesco's home state. This is the second time this week, I have highlighted the importance of choice of law and forum selection clauses in acquisition agreements. Too often they are the product of political negotiations among the parties when they should be negotiating for certainty of law and adjudication. I hate to be a shill for Delaware or New York here, but the alternative result is situations like this.