Sunday, September 30, 2007
David Wighton, the New York Bureau Chief for the Financial Times, quotes extensively from my new article Black Market Capital in his lead-in article to today's Report on Fund Management in the Financial Times. The article is entitled SEC seeming perverse about risk and is accessible on the FT website here. You can also get it on the newstand. A few quotes for flavor:
"Told you so," said many critics of hedge funds surveying the damage caused by the summer credit market turmoil. The high-profile collapse of several funds and the dismal performance of many others have provided just the ammunition the sceptics were looking for. Surely it proved that hedge funds were dangerous and should be kept out of the hands of retail investors, they said. How wise of the Securities and Exchange Commission to propose barring individuals with less than $2.5m (£1.2m, €1.8m) in liquid assets from investing in hedge funds, up from the current limit of $1m.
This is nonsense. Average hedge fund returns are generally less volatile than the equity market as a whole and you are much more likely to lose your shirt on an individual stock than on a hedge fund. The rules preventing small investors from putting money into hedge funds are positively perverse.
As Steven Davidoff, a professor at Wayne State University Law School, points out in a new paper, the rules have an even more perverse consequence.
Retail investors may not be able to invest in hedge funds - or private equity funds for that matter - but they can invest in the funds' managers, which Prof Davidoff argues are more risky.
"This is because the future income of an adviser is derivative upon the fund advisers' capacity to continually earn extraordinary positive returns." If they do not earn such returns, investors will shift money away, which means the impact on the investor in the manager will be greater than on the investor in the fund.
Prof Davidoff suggests that the spate of flotations of alternative asset managers - albeit slowed by the credit market turmoil - is partly the result of the rules against public issues by alternative funds. Prevented from buying the funds directly, public investors look for something that replicates their benefits. The financial industry quickly meets that demand. But it does so with less suitable vehicles such as asset managers, special purpose acquisitions companies and the growing array of exchange-traded funds and indexes that attempt to track private equity or hedge fund performance.
These vehicles, which Prof Davidoff dubs Black Market* Investments, tend to be more risky on an individual basis than the hedge fund and private equity funds they substitute for. So public investors who buy them bear more risk and together inject more risk into the US capital markets than if they were allowed to invest in the funds.
Investors' other option is to buy funds on non-US markets, a process that the SEC is considering making easier. But without the benefit of SEC regulatory oversight and the US securities law enforcement, Prof Davidoff argues that this would be more risky and costly than a prohibited US-based purchase of the funds.
Investors should be allowed to make up their own minds on whether hedge funds are good value for money. The asset qualification for retail investors should not be raised. It should be scrapped.
Check it out.
On Friday, 3Com Corporation announced that it had agreed to be acquired by affiliates of Bain Capital Partners, LLC, for approximately $2.2 billion in cash. This is the first big private equity deal announced post-August market crisis. As such, I'm excited for 3Com to file the merger agreement this week; it will give us a good window on how transaction participants and M&A attorneys have reacted to revise previously standard structures in light of market developments. My big bet -- expect there to be no reverse termination fee -- that is, a clause which gives the private equity buyer an absolute right to walk from the deal by paying a pre-set fee, typically 3-5% of the deal value (for more on these see my post here). Instead, expect the parties in 3Com to adopt the structure used in the Avaya transaction where Avaya agreed to be acquired by Silver Lake and TPG Capital for approximately $8.2 billion or $17.50 per common share.
The Avaya merger agreement was one of the only private equity transactions pre-market crisis to specifically provide for the opposite of a reverse termination fee -- specific performance. In Section 7.3(f) of the merger agreement the parties specifically cap monetary damages in case of breach but provide for specific performance. This effectively ends the optionality contained in the other private equity agreements with reverse termination fees. Here is the relevant language:
Notwithstanding the foregoing, it is explicitly agreed that the Company shall be entitled to seek specific performance of Parent’s obligation to cause the Equity Financing to be funded to fund the Merger in the event that (i) all conditions in Sections 6.1 and 6.2 have been satisfied (or, with respect to certificates to be delivered at the Closing, are capable of being satisfied upon the Closing) at the time when the Closing would have occurred but for the failure of the Equity Financing to be funded, (ii) the financing provided for by the Debt Commitment Letters (or, if alternative financing is being used in accordance with Section 5.5, pursuant to the commitments with respect thereto) has been funded or will be funded at the Closing if the Equity Financing is funded at the Closing, and (iii) the Company has irrevocably confirmed that if specific performance is granted and the Equity Financing and Debt Financing are funded, then the Closing pursuant to Article II will occur. For the avoidance of doubt, (1) under no circumstances will the Company be entitled to monetary damages in excess of the amount of the Parent Termination Fee and (2) while the Company may pursue both a grant of specific performance of the type provided by the preceding sentence and the payment of the Parent Termination Fee under Section 7.1(b), under no circumstances shall the Company be permitted or entitled to receive both a grant of specific performance of the type contemplated by the preceding sentence and any money damages, including all or any portion of the Parent Termination Fee.
Practitioners take note for future deals.
Additional Point: Given the difference between the Avaya deal and the other private equity deals, I was surprised to see the wild fluctuation in the Avaya stock price last week. This is a much more certain deal than the SLM Corp. and other private equity deals with reverse termination fees. Unless the buyers here can establish a MAC (which doesn't appear to be the case based on public information) this deal will close so long as the financing letters remain in place. I don't believe Avaya has disclosed these commitment letters, but presumably these are as tight as the merger agreement and can only be terminated for a similar MAC and other customarily significant reasons. Also, presumably if Avaya's lawyers negotiated a specific performance clause in the merger agreement they also demanded one in the commitment letters, so that they could ensure that the debt financing needed for the buyers to specifically perform under the clause above would be available. But perhaps the market is actually efficient here and is seeing something I do not.
Incidentally, Avaya stockholders approved the transaction on Friday -- the deal now goes into the debt marketing stage, and under the merger agreement is required to close by the end of the marketing period. The marketing period ends 20 business days from this past Friday provided Avaya has provided all the relevant information it is required to under the merger agreement to the buyers.
I continue to remain fascinated by the Topps deal and the possibilities that were raised by Crescendo Partners exercise of dissenters' rights. On the day Topps's shareholders approved the takeover of Topps by Michael Eisner's The Tornante Company LLC and Madison Dearborn Partners for $9.75 per share in cash, Crescendo Partners delivered to Topps a written demand for the appraisal of 2,684,700 shares of Topps common stock (or approximately 6.9% of the total number of outstanding shares of Topps common stock). Under DGCL 262, the Delaware law governing appraisal rights, a shareholder dissenting from the Topps transaction was required to deliver notice thereof prior to Topps's shareholder vote. Thus far, Topps has only disclosed that Crescendo Partners has dissented from the merger (though there may still be others Topps has not disclosed).
Assuming that no more than 8.1% of Topps's remaining shares are subject to dissent, Topps will satisfy the condition in the Topps merger agreement that:
holders of no more than 15% of the outstanding shares of our common stock exercise their appraisal rights under Section 262 of the DGCL in connection with the merger . . . .
Given Topps non-disclosure thus far on this point and the fact that it would know by now if this condition is not fulfilled, its silence almost certainly means that the condition was so fulfilled and no more than 15% of the shares dissented.
But, if there were other dissenting shareholders, the dissenter arbitrage possibilities raised with respect to the recent Delaware decision in In re: Appraisal of Transkaryotic Therapies, Inc. may still come to pass albeit on a lower level (access the opinion here; see my blog post on it here). Post-Transkaryotic a number of academics and practitioners raised the concern that this holding would encourage aggressive investors (read hedge funds) to create post-record date/pre-vote positions in companies in order to assert appraisal rights with respect to their shares. This would be particularly the case where the transaction was one being criticized for a low offered price. As outlined in a previous post, I thought Topps was a good candidate for this strategy. It remains to be seen if this was the case.
In any event, Crescendo Partners has now set itself up nicely If no one else has exercised dissenters' rights. There will now be no free-rider problem or multiple litigants for Eisner et al. to negotiate with. Instead, Crescendo can now negotiate a private one-on-one deal with Eisner as to the purchase price for its shares under the shadow of its dissenters' rights litigation. This is a benefit typically unavailable to the average shareholder who cannot afford the litigation expenses and free rider problems of dissenters' rights. Of course, this highlights the problems of dissenters' rights generally in Delaware. Still, expect a press release in a year or two announcing a negotiated disposition of this litigation. While the Delaware courts can technically award a lower price in dissenters' rights litigation, anecdotally they more often split the baby and award a higher amount than the original share price offered. I believe this practically compensates the dissenting shareholders for their extraordinary efforts and highlights the problem of financial valuation in the Delaware courts where each side will put on experts showing a marked disparity in valuation forcing the courts to rectify this difference by again splitting the difference. It also gives Eisner and his cohorts an incentive to settle. Crescendo also has similar incentives to settle given the less likely risk it will receive less than the current offer price.
NB. For more on the problems of Delaware courts and their struggle with valuation practice in dissenters' rights cases see my article Fairness Opinions at pp 1580- 86 where I deconstruct the valuation opinion in Andaloro v. PFPC Worldwide, Inc., 2005 WL 2045640 (Del. Ch. 2005). I do so to illustrate the essential problems of subjectivity and conflicting valuation standards in financial valuation generally and particularly in the Delaware courts amidst a battle of the experts.
On Friday, Finish Line filed its answer to Genesco's complaint. I'm attempting to obtain a copy and will post it with an analysis as soon as I obtain it or it is filed with the SEC. But, from the press release below, there appears to be no surprises. As I predicted last week, Finish Line did indeed bring UBS into the dispute. In the coming weeks we are going to see how closely aligned they are in pursuing a deal termination or renegotiation (my bet is not very much, and that UBS has been driving this MAC claim with Finish Line stuck in between). In addition, in its answer Finish Line counter-claimed for breach of the merger agreement for Genesco's failure to provide information and is requesting a declaratory judgment that a material adverse change occurred. I've previously speculated that Finish Line doesn't have much of a case for a material adverse change, but for me a clearer picture will emerge once I've reviewed the answer. In addition, I believe that the request for information is a red herring; simply designed to portray Finish Line as the good guys here. Despite my inclination that this will settle because of the inherent forces in these cases which push the parties to do so, I'm increasingly hopeful for a decision in order to clarify uncertainties regarding the definitional scope of a MAC and the disproportionality qualifier typically included in the definition. Even if it is under Tennessee law. The press release follows:
Finish Line Files Answer, Counterclaim and Third-Party Claim for Declaratory Judgment INDIANAPOLIS, Sept. 28 /PRNewswire-FirstCall/ -- The Finish Line, Inc. (Nasdaq: FINL) today announced that it has filed an answer, counterclaim and third-party claim for declaratory judgment in connection with the action pending in the Chancery Court in Nashville, Tennessee, regarding the Company's proposed acquisition of Genesco Inc. (NYSE: GCO).
In its filing, The Finish Line is seeking an order that Genesco provide all requested financial data and access to personnel, and that its failure to do so in a timely manner is a breach of the merger agreement. As previously announced, The Finish Line has asked Genesco for certain financial and other information as well as access to Genesco's Chief Financial Officer and financial staff. However, to date Genesco has not responded to and has refused to comply with these requests.
In addition, The Finish Line is seeking a declaratory judgment of whether a "Company Material Adverse Effect" has occurred under the merger agreement, as UBS questions and Genesco denies. As previously announced, UBS provided The Finish Line with a commitment letter regarding financing for its proposed acquisition of Genesco. As UBS is a necessary party whose interests are directly affected by the declaratory relief sought, UBS has been named a third-party defendant in the action.
Friday, September 28, 2007
On Wednesday Fremont General Corporation, the savings and loan and former sub-prime mortgage lender, announced that it has been advised by Mr. Gerald J. Ford that "he is not prepared to consummate the transactions contemplated by the Investment Agreement entered into on May 21, 2007 among the Company, FIL and an entity controlled by Mr. Ford on the terms set forth in that agreement." The Investment Agreement provides for the acquisition by an investor group led by Ford of a combination of approximately $80 million in exchangeable non-cumulative preferred stock of FIL and warrants to acquire additional common stock of Fremont. Fremont stated that the reason for Mr. Ford's new-found hesitance was "in light of certain developments pertaining to the Company and FIL." Well, that is helpful disclosure. But, I surmise that this could be another material adverse change case, and that is how it is being spun in the press.
Our starting point on these things, as always, is the MAC clause itself which is defined in the Investment Agreement as follows:
“Material Adverse Effect” means any material adverse effect on the retail deposit business or financial condition of the Company and its Subsidiaries taken as a whole; provided, however, that none of the following shall be deemed to constitute or shall be taken into account in determining whether there has been a “Material Adverse Effect”: any event, circumstance, change or effect arising out of or attributable to (a) any decrease in the market price of the Common Stock (excluding any event, circumstance, change or effect that is the basis for such decrease), (b) any changes in the United States or global economy or capital, financial or securities markets generally, including changes in interest or exchange rates, (c) any changes in general economic, legal, regulatory or political conditions in the geographic regions in which the Company and its Subsidiaries operate, (d) any events, circumstances, changes or effects arising from the consummation or anticipation of the transactions contemplated by this Agreement or the Sale Transactions or the announcement of the execution of this Agreement or the announcement of the Sale Transactions, (e) any events, circumstances, changes or effects arising from the compliance with the terms of, or the taking of any action required by, this Agreement, (f) any action taken by the Company or any of its Subsidiaries at the request or with the consent of the Investor, (g) any litigation brought or threatened by the stockholders of the Company arising out of or in connection with the existence, announcement or performance of this Agreement or the transactions contemplated hereby or the Sale Transactions, (h) changes in law, GAAP or applicable regulatory accounting requirements, or changes in interpretations thereof by any Governmental Entity, (i) any outbreak of major hostilities in which the United States is involved or any act of terrorism within the United States or directed against its facilities or citizens, wherever located, (j) earthquakes, hurricanes, floods or other natural disasters, (k) a failure by the Company to report earnings or revenue results in any quarter ending on or after the date hereof consistent with the Company’s historic earnings or revenue results in any previous fiscal quarter, including any failure to file with the Commission audited or unaudited financial statements for the year ended December 31, 2006 or any subsequent period, (l) any loss, liability or expense arising out of or relating to the contractual rights of third parties relating to the sale of residential mortgage loans prior to the date of this Agreement, or (m) any matter set forth in Section 1.1(a) of the Company Disclosure Schedule, except in the case of the foregoing clauses (i) and (j), to the extent such changes or developments referred to therein would reasonably be expected to have a materially disproportionate impact on the retail deposit business or financial condition of the Company and its Subsidiaries, taken as a whole, relative to other industry participants or enterprises (solely with respect to clause (i), located in the same geographic region as the Company and its Subsidiaries).
First off, read exclusion clause (m). As an initial matter, placing exclusions in the Disclosure Schedule from the MAC clause is a pet peeve of mine. Since disclosure schedules are not publicly disclosed this allows the parties to maintain these items as confidential. But the practice may in some cases violate the federal securities anti-fraud rules. This is because the merger agreement is considered by the SEC to be public disclosure; Fremont is therefore liable for material omissions -- and these non-disclosed items on the disclosure schedule may arise to that. Whether they do or not we don't know since we can't see them, but the fact that Fremont didn't want them disclosed is telling. Fremont's lawyers would do well to read this article which describes the SEC enforcement case against Titan Corp. on grounds of non-disclosure of items in the disclosure schedule.
More importantly, after exclusion (m) there is a qualifier for clauses (i) and (j). This qualifier states that these exclusions do not count: "except in the case of the foregoing clauses (i) and (j), to the extent such changes or developments referred to therein would reasonably be expected to have a materially disproportionate impact on the retail deposit business or financial condition of the Company and its Subsidiaries, taken as a whole, relative to other industry participants or enterprises (solely with respect to clause (i), located in the same geographic region as the Company and its Subsidiaries)." First, note that unlike SLM, here the lawyers negotiated a materiality qualifier to the requirement of disproportionality. Gold star for that one. But, now read clauses (i) and (j). These clauses deal with an outbreak of hostilities or natural disasters. It is hard to believe that the parties wanted these exclusions to be qualified by disproportionality. For example, under the clause as drafted, any earthquake that effected Fremont materially and disproportionally is still a MAC? It can't be.
This appears to be a mistake by the lawyers on the deal -- Skadden and Gibson, Dunn. Instead, the qualifier was likely meant to qualify clauses (c) and (d) which address industry events. This would be the standard qualifier to these exclusions; the ones where a disproportionality standard is typically applied. I didn't see any amendment correcting this "mistake". The result is to make the MAC much tighter than desired by Ford. Be careful out there folks -- these mistakes do matter, significantly.
Addendum: I haven't looked more particularly at the facts of the Frontier case, but note that this is a very tight MAC without a forward looking element and with wide exclusions, including an exemption from the MAC clause for a failure to meet projections and for a failure to file audited and unaudited financial reports. If Ford is indeed proclaiming a MAC, it will have to be an event which has already occurred and is particularly adverse and unique to Frontier to be sustained. Nonetheless, in its press release Frontier may be admitting that such an event has indeed occurred by its willingness to negotiate with Ford for new terms.
Of course, this all assumes that it is indeed the MAC clause upon which Ford is basing his claims that he is not required to close the transaction. Stay tuned.
Earlier this week, Finish Line issued the following press release in response to Genesco's Tennessee lawsuit to force Finish Line to complete its agreed acquisition of Genesco:
The Finish Line has complied with its obligations under the merger agreement, and as previously announced, continues to work on the closing documents. In that regard, The Finish Line has asked Genesco for certain financial and other information as well as access to Genesco's Chief Financial Officer and financial staff. However, to date Genesco has not responded to and has refused to comply with these requests. These failures constitute a breach of the merger agreement, and The Finish Line is today notifying Genesco of same. We regret that Genesco has chosen to initiate litigation. We are reviewing the Genesco lawsuit and will take the necessary steps to protect the interests of The Finish Line and its shareholders. We have no further comment at this time.
Notice anything interesting about the press release? Nowhere does Finish Line mention a material adverse change. Instead, the breach that Finish Line is talking about is a failure to receive relevant information. Here, it is following the lead of UBS which has also been demanding information about Genesco to make a determination if a MAC occurred. It thus appears that Finish Line's response to Genesco's suit is going to be along the lines of: "We think a material adverse change occurred, but we can't tell because Genesco is not giving us the information we need". Most likely this speaks to the current strength of their MAC claim. As I detailed in a previous post, based on public information it does not appear that Finish Line has a strong case here for a MAC. This agreement, though, is governed by Tennessee law and this analysis depends on the Tennessee court adopting a Delaware analysis, something it is likely but not certain to do. There is no case law currently on MACs in Tennessee. Shame on the lawyers for negotiating a choice-of-law clause that provided no certainty on an important issue.
The other interesting thing about this deal is that Finish Line is really stuck between a rock and a hard place right now. There is no financing condition in the deal, so to the extent UBS is also trying to back out of financing this transaction, Finish Line could be left in a really bad position. In fact, Finish Line may be acting right now to make a MAC claim because of UBS's actions more than its own position. Because of this, I expect Finish Line to answer the Genesco complain by attempting to implead UBS (that is, bring them in as a party to the suit). This will allow all of the legal obligations of the unhappy trio to be resolved in one court, and Finish Line to avoid the catastrophy of being forced to close the Genesco deal without financing firmly in place.
Ultimately, both Finish Line and UBS are buying time for the credit markets to firm up and the results of Finish Line (who reported earnings yesterday) and Genesco to improve. While Genesco is talking a strong game, the incentives are to settle a case like this for a lower renegotiated price, as in the Lone Star/Accredited Home Lenders case. A board simply does not want to take the risk of a completely broken deal. And a renegotiation will requires a new Genesco shareholder vote which would push the deal out into January, buying more time for Finish Line and UBS. As with most other MAC cases this is likely to settle.
NB. In Section 8.1(d) of the merger agreement there is a twenty business day cure period for Genesco to the extent it actually is breaching the agreement for failure to provide this information.
Thursday, September 27, 2007
Harman International is having an investor conference call today at 4:30 p.m. EDT on September 27, 2007. Those who wish to participate in the call should dial (800) 398-9379 (US) or (612) 332-0107 (International), and reference Harman International. Of course, everyone will want to ask questions on the call about the state and unraveling of Harman's deal to be acquired by KKR and Goldman Sachs Capital Partners. Harman's investor friendly response:
In light of matters disclosed in the Company's September 21, 2007 press release, Harman's management cannot accept questions about the proposed merger with affiliates of Kohlberg Kravis Roberts & Co. L.P. and GS Capital Partners VI Fund, L.P.
Re-establishing investor credibility is hard enough in the wake of a failed acquisition transaction and the yet to be defined claims of a MAC here. Harman is not doing themselves any service with this prohibition. I'm not going to be able to make the call, but for those on it, I would ask the following questions (irrespective of Harman's caveat).
- In your press release Dr. Sidney Harman referred to KKR and GSCP as your "former merger partners". What is the status of your merger? Has it been terminated?
- What are the facts underlying KKR's and GSCP's claim that a material adverse effect occurred?
- The Wall Street Journal also reported that you may have breached the requirements in the merger agreement related to limits on capital expenditures. Is this true?
- IF KKRs and GSCP's claims are not true, why have you not initiated litigation to obtain the reverse termination fee of $225 million from them?
- You issued your Form 10-K on Aug. 30. Why did it not contain the new guidance released on Sept 24?
- Why do you believe this failure to disclose until then did not violate the federal securities laws?
- If you weren't fully aware of these developments until now, what explains the substantial delay in filing the proxy statement and registration statement for this transaction?
- When did you first know that GSCP and KKR were claiming a MAC and/or breach of the merger agreement?
- If it was prior to last week, why did you not disclose it? Why did this not violate the federal securities laws?
- Was your Board fully informed by your lawyers at Wachtell of the consequences of agreeing to this reverse termination fee of $225 million?
By the way, the Wall Street Journal report that Harman breached its cape ex covenants in the merger agreement is hard to believe. This covenant simply limits the amount Harman may spend on cap ex and is therefore quite easy to follow. I believe that if Harman did indeed breach this covenant it would be not only surprising but grossly negligent.
The dispute between SLM Corp. and its potential acquirers, J.C. Flowers & Co., Bank of America and JPMorgan Chase, went very live yesterday when SLM issued a press release stating:
SLM Corporation, commonly known as Sallie Mae, announced today that it has been informed by a representative of the buyer group led by J. C. Flowers, Bank of America and JPMorgan Chase that the buyer group does not expect to consummate the acquisition of Sallie Mae under the terms of the merger agreement. Sallie Mae firmly believes that the buyer group has no contractual basis to repudiate its obligations under the merger agreement and intends to pursue all remedies available to it to the fullest extent permitted by law.
Additionally, Sallie Mae noted the following: In response to Congress’ passage of the College Cost Reduction and Access Act of 2007 (the “Act”) and President Bush’s expected signing of the Act tomorrow, Sallie Mae has measured the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K and concluded such changes would reduce “core earnings” net income, between 1.8 percent and 2.1 percent annually over the next 5 years, using business assumptions it has shared with the buyer group.
Translating this press release, the Flowers consortium is likely claiming that the new legislation constitutes a material adverse change to SLM and that consequently it is no longer required to complete the acquisition. Clearly, the Flowers consortium is, at a minimum, posturing for a price renegotiation. As such, SLM's statement is similar posturing to push through the deal.
To determine if either argument is valid, the starting starting point is the merger agreement and its definition of MAE:
"Material Adverse Effect” means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: (a) changes in GAAP or changes in regulatory accounting requirements applicable to any industry in which the Company or any of its Subsidiaries operate; (b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; (c) changes in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic, business, regulatory, political or market conditions or in national or global financial markets; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (d) any proposed law, rule or regulation, or any proposed amendment to any existing law, rule or regulation, in each case affecting the Company or any of its Subsidiaries and not enacted into law prior to the Closing Date; (e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (f) public disclosure of this Agreement or the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement; (g) any change in the debt ratings of the Company or any debt securities of the Company or any of its Subsidiaries in and of itself (it being agreed that this exception does not cover the underlying reason for such change, except to the extent such reason is within the scope of any other exception within this definition); (h) any actions taken (or omitted to be taken) at the written request of Parent; or (i) any action taken by the Company, or which the Company causes to be taken by any of its Subsidiaries, in each case which is required pursuant to this Agreement.
The first issue is the most important -- whether SLM has even experienced a MAC. Here, the agreement is governed by Delaware law. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC. Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant. SLM stated yesterday that the new legislation will reduce "'core earnings' net income, between 1.8 percent and 2.1 percent annually over the next 5 years." The press release is too tightly, and maybe cleverly, drafted for me. After reading it three times, I'm still not sure what "core earnings" net income is nor am I sure whether SLM is stating that this is the total decline or only the decline compared to the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K. But perhaps, I am missing something.
In any event, the test of a MAC is quite fact dependent and looks at the effect on the entire company, and so a significantly adverse decline in revenue or earnings as a whole should theoretically suffice. So, there may be more here that SLM is not currently disclosing which may substantiate a MAC claim. By the way, for those wondering how bad it has to be to be "materially significant", I wish I could give you a definitive answer -- there is little case-law on this, but the practitioner rule of thumb is generally a 10% decline in income would be a MAC. Though some will tell you that the GAAP measurement of 5% is good enough -- there is just not enough case-law on this and it is sometimes conflicting. Compare Pan Am Corp. v. Delta Airlines, Inc., 175 B.R. 438, 493 (S.D.N.Y. 1994) (holding that significant deteriorations of business performance and business prospects – declines of 20% to 40% in advance bookings – constituted a MAC) with Polycast Technology Corp. v. Uniroyal, Inc., 792 F. Supp. 244, 253, 274 (S.D.N.Y. 1992) (deciding that the cancellation of a major profitable customer contract is arguably a MAC). It is clear, though, that IBP and Frontier have set a high bar for proving a MAC. This may be the case here with SLM -- though they have yet to release what the total impact of this new legislation is on them -- a telling non-disclosure.
However, if the Flowers consortium can prove a MAC there is still the matter of the highlighted carve-outs above. On these, expect SLM to argue the following:
- The new legislation is not, on the whole, more adverse than described in its 10-K (exclusion (b)); and
- The change is to the financial services industry generally and is not disproportionate to SLM (exclusion (e)).
In these two carve-outs the parties agree that these events do not constitute a MAC even if they are a materially adverse change. The interesting thing here is that these are not qualified by "materiality". So, the Flowers consortium will likely argue that it need only prove that the change is materially adverse to the company and is either adverse (in the case of 1) or disproportionate (in the case of 2) in any amount to SLM. A cent of adverseness or disproportionality would arguably work here, and SLM has previously admitted there is an adverse impact over and above the matters disclosed in (b) and appears to be doing so in yesterday's press release as well. [Also, note the exclusion in (e) -- it specifically excludes changes excluded from clause (b) under the proviso]. Ultimately, this is again a fact-based determination, but it appears that Flowers has a bit of a way to go here to prove a MAC though it is very much helped by the lack of materiality qualifiers in the carve-outs, and SLM's admissions with respect thereto. And, Flowers has the virtue of being able to highlight the highly negotiated MAC on this point which clearly contemplated this event -- since here it appears that the legislation is worse than expected, Flowers will argue this is exactly what they negotiated for.
And as I stated two weeks ago:
All of this may not matter much as the Flowers consortium also has a walk-away right under the agreement if it pays a reverse termination fee of $900 million dollars. This changes the negotiating position of the Flowers group substantially. Expect them to attempt to preserve their reputation for not walking from deals by publicly proclaim a MAC has occurred, but privately claim that the deal calculus now makes it more economical to walk. The consortium will find encouragement from their bankers who may also now find it more economical to simply pay or share the reverse termination fee with the buyers. This would be a similar renegotiation that occurred in Home Depot's sale of its supply business which ended with a cut of eighteen percent in the deal price.
Reading tea-leaves, I would expect Flowers to use the reverse termination fee and colorable MAC claims to negotiate some form of price cut. But, as with most MAC renegotiations, expect it to happen behind closed doors. Any renegotiation will require a new shareholder vote, so even if there is a renegotiation there will not be a closing in the immediate future.
My prediction still stands, and appears to be coming to pass. However, I would say that litigation over this deal is now more likely than a price renegotiation given the passage of time and continuing failure of the parties to reach an agreement. Remember, if there is any litigation it will not be over whether the deal should be completed but whether a MAC does or does not exist. If it does, the Flowers consortium is not required to complete the deal. If it does not, Flowers is still not required to complete the deal. Rather, the only recourse of SLM is to collect the $900 million dollars and the parties to go their own way or agree to a renegotiated deal, if the Flowers consortium is willing.
As a law professor, I'm rooting for such litigation as the additional case-law will give more definition under Delaware law to what does constitute a MAC and may resolve issues concerning how "disproportional" the MAC change must be under the fairly standard industry exclusions above -- a question which was also at issue in Lone Star/Accredited Home Lenders.
Addendum: One further point -- SLM will also argue that Flowers already knew of the possibility of this legislation at the time of the agreement and accepted that risk. Here they will be relying on the disclosure in the merger agreement and disclosure schedules as well as its public filings but also invoking the spirit of Bear Stearns Co. v. Jardine Strategic Holdings, No. 31371187, slip. op. (N.Y. Sup. Ct. June 17, 1988), aff’d mem., 533 N.Y.S. 2d 167 (App. Div. 1988) which held that a bidder for 20% of Bear Stearns could not rely on MAC to avoid contract despite $100 million loss by Bear Stearns on Black Monday, October 19, 1987 and the first quarterly loss in Bear Stearn’s history. The buyer knew that Bear Stearns was in a volatile cyclical business. In short, the Flowers consortium knew what it was getting into here. But then again clause (b) was clearly meant to address this issue.
Final Conclusion: A number of people emailed me today to ask what my ultimate conclusion was. Well, this is a very fact-dependent analysis and we do not have all the facts, but, I think Flowers has a good case here that a MAC occurred particularly since this issue was so highly negotiated and accounted for in the MAC and what is happening now appears to be worse. Certianly, their case is no slam dunk, but I believe they have enough of a claim to push through a renegotiation of the price if they want. This is a risk which Flowers et al. can more easily take given that their liability is limited to $900 million if they are wrong. So, I once again predict a renegotiated, lower price.
Wednesday, September 26, 2007
Monday, September 24, 2007
Accredited Home Lenders filed the 16th amendment to its recommendation statement on Schedule 14D-9 yesterday. The document is a must read for all M&A lawyers as it details the history of the behind the scenes negotiations MAC settlement between Accredited Home Lenders and Lone Star. Among the tid-bits are:
- On August 29th, Lone Star offered to settle the litigation for $10.50 and Accredited Home Lenders countered with a revised deal at $11.33. This deal was rejected by Lone Star who the next day made a public offer for $8.50 a share. NB. The ultimate settlement between Lone Star and AHL was for $11.75!
- During the last 40 days, AHL was approached by a third party buyer. On Sept. 5, AHL requested "permission" from Lone Star to explore this approach and Lone Star informed AHL on Sept. 7 that any consent from Lone Star should be considered as part of an overall settlement of the Delaware Litigation. No further disclosure is made on this third party offer.
- Bear Stearns refused to provide an updated fairness opinion to AHL because Bear viewed any decision by the AHL board to enter into a restructured transaction at a reduced offer price as a settlement of litigation. The AHL Board ultimately hired Milestone Advisors to provide a financial opinion for $450,000. Bear Stearns was probably right to do this; AHL was better off hiring an advisor more sophisticated in these types of valuation (though I have never heard of Milestone so I am not sure if they are indeed so experienced). Although looking at Milestone's analysis they did not value the litigation but instead conducted a transaction premium and a comparable company analysis -- a bit absurd and highlighting the manipulability of fairness opinion analyses. Another explanation for Bear's refusal is that AHL and Bear could not agree on compensation for this second opinion.
- On Sept. 13, Lone Star increased its offer to $11.75 above the $11.33 originally offered by Lone Star and a raise from its $10.50 offer made on Aug 29 (subsequently reduced to $8.50).
So, this leads to the interesting question of how did AHL get Lone Star to raise its offer from $8.50 to $11.75 and above $11.33 in one meeting on Sept 13? I would have loved to have been a fly on the wall at that one. And ultimately, the AHL/Lone Star history points to an important commonality about MACs -- negotiation during these times is often constant but kept private as the parties struggle to assess risks and settle in a manner that reduces such risk and allocates the losses against the background of the uncertainty of a MAC litigation. The back and forth between AHL and Lone Star once again prove this point.
Thanks to the reader who pointed all of this out.
The press release can be accessed here. While some will find this an encouraging sign for the bigger private equity deals still to clear, remember that Wall Street is getting filled up these days with side-tracked, troubled and collapsed M&A deals, including:
- Harman/GS-KKR (collapsed);
- Genesco/Finish Line (in litigation; claimed MAC);
- Reddy Ice/GCO (substantial financing problems);
- PHH Corp/GE-KKR (substantial financing problems);
- MGIC/Radian (terminated);
- Sallie Mae/Flowers et al (claimed MAC);
- Acxiom/ValueAct Capital Partners & Silver Lake Partners (troubled);
- The Tribune Co./Zell (troubled);
- Penn National Gaming/Fortress (troubled);
- United Rental/Cerebus (troubled);
- Myers/GSCP (troubled);
- Guitar Center/Bain Capital (troubled);
- Manor Care/Carlyle (troubled);
- ABN Amro/Barclays or RBS (troubled);
And this list doesn't include the Home Depot supply business and Accredited Home Lenders acquisitions both of which have been renegotiated. Obviously, some of these deals are less troubled than others, and I believe most are still likely to close, but still, this is a long list. It is going to be a busy Fall (and Winter as these deals get pushed back) despite First Data's successful conclusion.
Addendum: I define a deal as troubled for these purposes if it material information has been disclosed to the market that indicates this or otherwise it is trading at an abnormal discount to its deal premium.
Dealbook today has a post today on the rise in delistings by foreign issuers. The post quotes a USA Today story and states:
Big foreign companies, mostly from Europe, are saying non, nein and nee to being listed on U.S. exchanges.
A surge of foreign companies are bidding adieu to U.S. markets and their American depositary receipts, as lackluster trading in many foreign listings and a feeling the costs of having a stock listed in the U.S. aren’t worthwhile have dampened enthusiasm. . . . Already this year, 34 foreign companies have delisted from the New York Stock Exchange, and nine more have announced they plan to do so, says the exchange. That tops the 21 foreign companies that have joined the N.Y.S.E. Another 20 have said this year they plan to leave the Nasdaq or have done so already.
However, as I stated back on May 30 don't believe that this is a sign that the U.S. markets are losing their status as the premier place for foreign listings. Though they may indeed be losing their status though, this delisting wave is just caused by other reasons. As I stated:
Expect to see more announced delistings from U.S. stock markets by foreign issuers in the next few weeks. This is because the SEC's new rules liberalizing the ability of foreign issuers to deregister their securities and terminate their reporting requirements under the Exchange Act take effect on June 4. Prior to this rule, the Exchange Act was a lobster trap -- deregistering equity securities and terminating or suspending reporting requirements once these securities had been registered was prohibitively difficult if not impossible. Now, under the SEC's new rules if the average daily U.S. trading volume of a foreign issuer is 5 percent or less of its worldwide trading volume it can freely deregister and terminate its Exchange Act reporting requirements. To do so, however, the foreign issuer must also delist its securities from the U.S. stock market (i.e., Nasdaq or NYSE).
So, the new rules will release pent-up demand of foreign issuers who previously desired to deregister their securities and now do so. Most if not all of these issuers will cite Sarbanes-Oxley to justify the termination of their listing. But don't always believe it. These issuers originally listed in the United States for a variety of reasons, and for many a delisting will simply mean the reasons no longer exist (and probably haven't for a long time). For example, many a foreign high-tech company listed on the Nasdaq during the tech bubble seeking the extraordinary high equity premium accorded Nasdaq-listed tech stocks. Post-crash, many of these foreign companies still exist but are much smaller or have remained locally-based and a foreign listing is no longer appropriate for them.
All-in-all, though, the rules are a step in the right direction. Permitting foreign issuers to more freely delist will encourage them to experiment with a U.S. listing in the first place. The SEC would also do well to take the next step and consider whether all foreign listings need to be regulated at the current level. Does the SEC really need to regulate ICI [a company listed on the LSE who recently announced a delisting from the U.S.] to begin with? It is, after all, regulated by the FSA and LSE in England. A form of mutual recognition system for issuers listed in foreign countries who provide an acceptable level of regulation would go a long way to making the U.S. more competitive in the global listings market. It would also provide greater access for U.S. investors to foreign investments. Both good things.
For more on this see my forthcoming article Regulating Listings in a Global Market.
Sunday, September 23, 2007
The Harman deal collapsed spectacularly on Friday. It began with a morning Wall Street Journal story reporting that KKR and Goldman Sachs Capital Partners had soured on their $8 billion purchase of the audio equipment maker. The story reported that KKR & GSCP were trying to claim a material adverse change and otherwise were going to walk from the deal. The Journal correctly noted that KKR and GSCP could simply break their commitments to acquire Harman by paying a reverse termination fee of $225 million. Perhaps most interestingly, the WSJ also reported that "KKR has solicited some of the lending banks to help pay part of that fee, said one person familiar with the matter, but the banks have resisted the effort."
Later in the day just before market close, Harman issued a press release stating:
Harman International Industries, Incorporated (NYSE:HAR - News) announced that it was informed this afternoon that Kohlberg Kravis Roberts & Co. L.P. (KKR) and GS Capital Partners VI Fund, L.P. (GSCP) no longer intend to complete the previously announced acquisition of Harman by a company formed by investment funds affiliated with or sponsored by KKR and GSCP. KKR and GSCP have informed Harman that they believe that a material adverse change in Harman's business has occurred, that Harman has breached the merger agreement and that they are not obligated to complete the merger. Harman disagrees that a material adverse change has occurred or that it has breached the merger agreement.
KKR's and GSCP's MAC claim came as a complete surprise to the market. Harman had filed their annual report on Form 10-K on Aug 29. At the time, it did not appear to have disclosed any materially adverse change with respect to Harman. Moreover, although Harman's second quarter results declined and were below expectations, if there was a further marked deterioration thereafter in July or August Harman was required to disclose it in their Form 10K. But they didn't -- I am therefore unable to see any information in the public domain which substantiates a MAC (please correct me if my conclusion is wrong). I surmise from this that the KKR consortium has soured on this deal for other than financial reasons, perhaps strategic or management related. This conclusion is buttressed by the WSJ news report that the bank didn't want to participate in funding the reverse termination fee. If there were financial problems, you would think the banks would have lunged head first to get out of this deal as with Home Depot, Genesco, PHH, etc. Of course, the information in the Journal could have been planted by the banks -- who knows? In short, the whole thing is a mystery right now -- we need more information.
More importantly, it is not even worth much to go into whether KKR's claim is true (although for those interested I have an analysis at the end here). This is because the Harman/KKR merger agreement has a reverse termination fee and the contract specifically excludes specific performance. This limits KKR's and GS's damages in case of any breach of the agreement to $225 million or 2.7% of the transaction value. Can everyone see why this is different than Accredited Home Lenders/Lone Star and Genesco/Finish Line? There, there was/is no reverse termination fee. So, AHL and Genesco can sue for specific performance and completion of the deal. If Finish Line loses (or Lone Star had lost) they would have been required to complete the deal. Here in Harman, the only issue is over the measly $225 million. If KKR and GS prove a MAC occurred then they do not have to pay it and can walks; if they can prove it then they pay nothing and can walk(except the substantial commitment fees in their financing letters). This deal is dead -- there is no chance of salvaging it -- the only issue is if Harman gets $225 million. And that is one of the reasons why Harman's stock cratered on the news on Friday. It is also why these reverse termination fees are so pernicious in their effects.
So, ultimately, given the lack of information substantiating a MAC, KKR and GSCP may be claiming a MAC almost solely to protect their reputational capital. They do not want to appear to be walking on the deal so are asserting an ostensible claim of a MAC. This provides cover for them so that they do not appear to be the type of buyers who break deals; in short they remain the good guys. But still, there must be something wrong in this deal, given that KKR and GSCP would be willing to walk here, possibly lose reputational capital (for those who see through their MAC claims if indeed they are unsubstantiated) and risk paying the $225 million and losing their commitment fees. Again, what is wrong is a mystery, and yet another reason why Harman's stock price fell so far on Friday -- the market hates uncertainty.
NB. One of the interesting things about this deal was the equity participation right that shareholders had to retain an interest in Harman once it was acquired by KKR & GSCP. At the time, I hailed this structure, stating:
I've blogged before about the perils of management participation in private equity buy-outs. Their participation is likely to give an undue and trumping head start to their chosen private equity firm(s) due to management's head-start, superior information and ability to (unduly) influence the acquisition process even when a special committee is present. To ameliorate this problem, special committees have been negotiating "go-shops" like the one here [in Harman]. . . . But investors have increasingly come to see "go-shop" provisions as cover for unduly large break-up fees and the significant advantage and head-start provided by management participation. . . . . the shareholder participation feature [in Harman is therefore] encouraging. It gives shareholders a real option to participate in what may be seen as a management cash-out. It may be a good solution to some of the problems with management/private equity partnered buy-outs. . . .
Unfortunately, the problem of unintended effects arose here. The registration statement for the stub equity is a document which must be prepared by KKR and GSCP. Thus, the inclusion of this stub equity provided KKR and GSCP the ability to control the timing of the transaction to a greater extent than usual and pushed out the timeline no matter what in order to permit time to prepare this registration statement. This ultimately worked against Harman and its shareholders.
Addendum: MAC analysis
Material adverse change in Section 3.01 of the Harman merger agreement is defined as:
“Company Material Adverse Effect” means any fact, circumstance, event, change, effect or occurrence that, individually or in the aggregate with all other facts, circumstances, events, changes, effects, or occurrences, (1) has or would be reasonably expected to have a material adverse effect on or with respect to the business, results of operation or financial condition of the Company and its Subsidiaries taken as a whole, or (2) that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger, provided, however, that a Company Material Adverse Effect shall not include facts, circumstances, events, changes, effects or occurrences (i) generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate, including effects on such industries, economy or markets resulting from any regulatory and political conditions or developments in general, or any outbreak or escalation of hostilities, declared or undeclared acts of war or terrorism (other than any of the foregoing that causes any damage or destruction to or renders physically unusable or inaccessible any facility or property of the Company or any of its Subsidiaries); (ii) reflecting or resulting from changes in Law or GAAP (or authoritative interpretations thereof); (iii) resulting from actions of the Company or any of its Subsidiaries -which Parent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of the Merger or the proposal thereof or this Agreement and the transactions contemplated hereby, including any lawsuit related thereto or any loss or threatened loss of or adverse change or threatened adverse change, in each case resulting therefrom, in the relationship of the Company or its Subsidiaries with its customers, suppliers, employees or others; (v) resulting from changes in the market price or trading volume of the Company’s securities or from the failure of the Company to meet internal or public projections, forecasts or estimates provided that the exceptions in this clause (v) are strictly limited to any such change or failure in and of itself and shall not prevent or otherwise affect a determination that any fact, circumstance, event, change, effect or occurrence underlying such change or such failure has resulted in, or contributed to, a Company Material Adverse Effect; or (vi) resulting from the suspension of trading in securities generally on the NYSE; except to the extent that, with respect to clauses (i) and (ii), the impact of such fact, circumstance, event, change, effect or occurrence is disproportionately adverse to the Company and its Subsidiaries, taken as a whole.
The MAC here is fairly standard except that it does not include an exception for failure to meet financial projections -- this makes it tighter than usual. It also defines a MAC to include any event "that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger". You see this sometimes, but its inclusion is problematical because it broadens what can be defined as a MAC, and, given the vagueness, obviously provides more grounds for a buyer to claim a MAC has occurred. Ultimately, I am not sure what events the parties meant to cover here but they arguably picked up any problems which delay the financing. Moreover, the drop-dead date is meant to deal with delays. By including material delay here they have to mean something short of postponing a deal past the drop dead date. But I can't believe that was intended. M&A lawyers would do well to avoid including this clause because of these problems. In any event, if KKR & GSCP are indeed claiming a MAC, I would expect them to rely on this clause because of its vagueness and broad scope.
Otherwise, the agreement is governed by Delaware law. Harman's public disclosure thus far does not appear to establish a MAC under the first clause of the definition under Delaware case law, but again perhaps I am missing something or it relates to something not disclosed. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC. Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant. Moreover, KKR & GSCP would also need to prove in this case and under clause (2) of the MAC definition that the change was not disproportional to those "generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate". Unfortunately, what constitutes a disproportional changes was an issue that could have been resolved in the Delaware courts by the AHL/Lone Star case before it settled. Again, we would need more information about the MAC claim here to know if it came under the exception. More mystery.
Final, Final Note: also, as with the SLM MAC clause, note that the need for disproportionality here is not material. So, $1 of disproprotionality will do. Again, M&A lawyers would do well to modify this clause in their own agreements if they do not intend for this.
Update: Harman this morning released financial guidance to the market. Harman stated:
The Company expects fiscal 2008 performance to be impacted by a number of factors including increased R&D to support the development of several new infotainment platforms and associated launch costs. We now expect fiscal 2008 sales to reach $4.1 billion ($3.55 billion in 2007). The Company expects operating income and diluted EPS before merger related costs to equal or exceed last year’s record performance. In 2007, operating income was $397 million and diluted EPS were $4.14 adjusted for non-recurring restructuring charges, merger costs and tax items. . . . .
We expect substantial margin improvements over the course of fiscal 2008 as we work through these costs and begin the launching of new infotainment platforms.”
In light of increases in material costs and faster ramp-up of R&D resources to work on new business awards, equaling the record operating performance of fiscal 2007 is an achievement. The benefits of common platform synergy and scalability will be realized in fiscal 2009 and beyond. Those benefits will strengthen our operating profits. . . . .
To the extent that Harman is legal posturing they are asserting that any decline in earnings or revenue is not long term and merely a short term failure. The Delaware courts in IBP/Tyson found such a short-term event not to constitute a MAC. Although, we are only getting Harman's side of the story. And, for purposes of the merger, it doesn't really matter as the $225 million is the only thing at stake. For those who want more, the company is going to have a conference call at 4:30 p.m. EDT on September 27, 2007, to discuss its current expectations for fiscal 2008. However, Harman helpfully stated in its press release that it will not "accept questions about the proposed merger with affiliates of Kohlberg Kravis Roberts & Co. L.P. and GS Capital Partners VI Fund, L.P."
Friday, September 21, 2007
The press release follows. I'll have commentary on it on Sunday. But my initial thought is that this is plain odd – there is no information out there which I have seen which would support a material adverse change claim. Still, given that KKR’s and GS’s liability is limited under the merger agreement to the reverse termination fee of $225 million they may as well give it a shot. And of course, they may be trying to cover up the reputational issue which would arise if they simply walked away by asserting a claim of a MAC to cover it.
Harman Comments on Previously Announced Merger Friday September 21, 3:53 pm ET WASHINGTON--(BUSINESS WIRE)--Harman International Industries, Incorporated (NYSE:HAR - News) announced that it was informed this afternoon that Kohlberg Kravis Roberts & Co. L.P. (KKR) and GS Capital Partners VI Fund, L.P. (GSCP) no longer intend to complete the previously announced acquisition of Harman by a company formed by investment funds affiliated with or sponsored by KKR and GSCP. KKR and GSCP have informed Harman that they believe that a material adverse change in Harman's business has occurred, that Harman has breached the merger agreement and that they are not obligated to complete the merger. Harman disagrees that a material adverse change has occurred or that it has breached the merger agreement.
As predicted (and as I am quoted on today in the Wall Street Journal), Genesco has filed suit in Tennessee state court to enforce its rights under their agreement. Here is the complaint -- I'll try and have some commentary later today. The press release is below and has some great quotes -- this is the absolute right move by Genesco. And, as I have said before, Genesco appears to have a good case (see my post here outlining the likely legal arguments). The interesting thing to see now will be whether Finish Line attempts to implead UBS here, Finish Line's financing bank who appears to have also asserted a potential MAC against Genesco. If I were Finish Line I would before UBS sues for a declaratory judgment in New York -- the choice of forum for its commitment letter (for more on this possible jurisdictional shopping see my post here).
Genesco Files Lawsuit Against The Finish Line Seeking Specific Performance of Merger Agreement NASHVILLE, Tenn., Sept. 21 /PRNewswire-FirstCall/ --
Genesco Inc. (NYSE: GCO) announced today that it has filed suit in Chancery Court in Nashville, Tennessee, seeking an order requiring The Finish Line, Inc. to consummate its merger with Genesco and to enforce The Finish Line's rights against UBS under the Commitment Letter for financing the transaction.
Commenting on the filing, Genesco Chairman and Chief Executive Officer Hal N. Pennington said, "No more delays by The Finish Line and UBS; no more reservation of rights; no more bankers' putting their pencils down. We want a court of competent jurisdiction to enforce our rights under the Merger Agreement and for The Finish Line and UBS to live up to their obligations."
Pennington continued, "We have launched this litigation in an effort to speed consummation of the merger and to force impartial review of the aspersions that The Finish Line and its bankers have cast on Genesco's business and reputation. I, along with other members of the management team and our Board of Directors, are proud to be the stewards of a company that is a leader and innovator in its industry with a rich history dating to 1924. I am proud to be the leader of a group of employees who have helped build a wonderful business for the benefit of our shareholders."
Robert V. Dale, the presiding independent director of Genesco's Board of Directors, said, "Our Board of Directors stands united in this call for The Finish Line and UBS to perform their obligations and pay our shareholders $54.50 per share in cash. Our Board, our management team and our advisors are confident that the steps we are taking are in the best interests of our shareholders."
Pennington concluded, "Commencing litigation is always a difficult decision, but continued delay by The Finish Line and UBS is simply not acceptable. Accordingly, we are seeking expedited hearings on all of our claims. I caution our shareholders and employees that there will likely be claims made back against Genesco. When they come, we will be ready."
On Wednesday, Crescendo Partners announced in a press release that it would elect to exercise appraisal rights with respect to its 6.9% share ownership in Topps. I noted yesterday that Crescendo's action might spur other shareholders to exercise appraisal rights in this deal. The reason why is that unlike entire fairness litigation in Delaware, which is typically contingency fee based, shareholders in appraisal proceedings shareholders must front the costs. This creates a collective action problem among others -- shareholders, particularly smaller ones, do not want to bear these expenses, do not have the wherewithal to bring an appraisal action and are unable to coordinate their actions to do so. I wrote yesterday that this is a problem ameliorated in the Topps deal now since shareholders know Crescendo will be bearing some, if not all, of these costs. The consequence may be a higher than ordinary number of shareholders exercising appraisal rights. And, the Topps merger agreement is conditioned on no more than 15% of shareholders exercising appraisal rights, so if a sufficient number exercise these rights it will give Eisner's Tornante Company and Madison Dearborn Partners a walk right and put the deal in jeopardy. Topps shareholders opposed to this deal now have an incentive to exercise their rights in order to attempt to crater it.
There is another factor here which may raise the number of shareholders asserting appraisal rights: The recent Delaware decision in In re: Appraisal of Transkaryotic Therapies, Inc. (access the opinion here; see my blog post on it here). This case held that investors who buy target company shares after the record date and own them beneficially rather than of record may assert appraisal rights so long as the aggregate number of shares for which appraisal is being sought is less than the aggregate number of shares held by the record holder that either voted no on the merger or didn’t vote on the merger. As Chancellor Chandler stated:
[a] corporation need not and should not delve into the intricacies of the relationship between the record holder and the beneficial holder and, instead, must rely on its records as the sole determinant of membership in the context of appraisal.
The court ultimately held that since the "actions of the beneficial holders are irrelevant in appraisal matters, the inquiry ends here." [NB. most shareholders own their shares beneficially rather than of record with one or two industry record-holders so this decision will apply to almost all shares held by Topps and in fact any other public company]
Post-Transkaryotic a number of academics and practitioners raised the concern that this holding would encourage aggressive investors (read hedge funds) to create post-record date/pre-vote positions in companies in order to assert appraisal rights with respect to their shares. This would be particularly the case where the transaction was one being criticized for a low offered price.
Topps appears to be a good candidate for this strategy. The price offered by Michale Eisner's consortium has been criticized extensively for being too "low" and led a number of proxy service firms to recommend against the merger. In addition, the record date on the transaction was August 10, which provided a long period for investors adopting this strategy to purchase their shares. Ultimately, it appears that we are watching the first test of the Transkaryotic opinion. It will be interesting to see whether the potential concerns raised by this decision come to pass. And perhaps food for thought for the Delaware Supreme Court if, and when, it ever considers the holding of the Transkaryotic case.
Thursday, September 20, 2007
Accredited Home Lenders has filed the second amendment to their merger agreement with Lone Star. The amendment is a bit odd in that it contains a provision permitting Lone Star to terminate the tender offer if 50% of AHL's shareholders don't tender into the offer within 20 business days of the filing of AHL's amended 14d-9 statement. More specifically, the agreement provides for one 10 business day extension after the first expiration date which will itself be 10 business days after the statement is filed. This provision is probably meant to deal with any objecting shareholders such as Stark Investments who would have preferred that AHL go to trial for the full price. As one person put it to me in better words than I can, it can be read as "if there is any dissent get me out of this crummy deal." By the way for those wondering, exercising dissenter's rights under Delaware here appears problematical as DGCL 262 requires the appraisal valuation to be "the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation . . . ." AHL appears to be worth less here than the price Lone Star is paying, itself a product of contractual commitments made in the Spring before the sub-prime crisis had completely unfolded.
Otherwise, the conditions on the tender offer look very tight. In addition, if one examines the back-end conditions for the merger in the merger agreement they also remain unchanged and are similarly strict. This deal now appears about as contractually certain as one can get. But the stock is trading at about $11.58 which appears to be a big discount of about 2% off the offer price for such a certain deal. And dissent by shareholders is very unlikely given the mechanics of the above provisions -- they are likely to take what they can get. Perhaps I am missing something.
The Topps shareholder meeting occurred yesterday, and it was yet again mired in controversy and accusations of manipulative practices by the Topps board. According to Topps's press release issued yesterday, Topps's shareholders approved the proposal to be acquired by Michael Eisner's Tornante Group and Madison Dearborn Partners. The press release was notable for not mentioning the preliminary count of votes. But, the vote was likely exceedingly close. Earlier in the day, Topps actually postponed the meeting yet again for a few hours because:
Based on preliminary estimates of the vote count and discussions with a number of the Company's stockholders, the Company believes that substantially more votes are in favor of the transaction than against it, including stockholders who are in the process of voting or changing their votes to "FOR." However, at this time, the number of votes cast in favor of the transaction is not sufficient to approve the transaction under Delaware law. The Company has postponed the special meeting in order to provide an opportunity for these stockholders' votes to be received and for additional stockholders to vote "FOR" the merger. The Company intends to continue to solicit votes and proxies in favor of the merger during the postponement. During this time, stockholders will continue to be able to vote their shares for or against the merger, or to change their previously cast votes.
This raises a host of questions, including: who were these shareholders? Why did they not vote favorably the first time around? And what did Topps say or do to get these shareholders to change their minds? In addition, Topps's repeated postponement of the shareholder meeting to gain approval yet again shows their bias as well as the pernicious effects of Strine's recent decision in Mercier, et al. v. Inter-Tel which provided much wider latitude for Boards to postpone shareholder meetings in the takeover context in order to solicit more votes (more on that here).
There is still substantial uncertainty that this deal will close. Almost immediately after the announcement of the shareholder vote, Crescendo Partners issued its own press release announcing that it intended to "assert appraisal rights with respect to the shares it owns of The Topps Company, Inc. in connection with the merger agreement between Topps and entities owned by Michael D. Eisner and Madison Dearborn Partners, LLC." The merger agreement is conditioned upon:
holders of no more than 15% of the outstanding shares of our common stock exercis[ing] their appraisal rights under Section 262 of the DGCL in connection with the merger
According to a recent 13D/A, Crescendo owns 6.9% of Topps. However, assertion of appraisal rights in Delaware tends to be an exercise in herd behavior. Crescendo's steps are likely to lead to more dissident shareholders exercising their appraisal rights, hoping to free-ride on Crescendo's efforts. In any event. given the hostility and distrust of many shareholders of the Topps board's practices here and their criticism of the perceived low price, I would expect there to be significantly more shareholders taking the appraisal route than normal. This may lead to the 15% condition not being satisfied thus putting Eisner & Co. in the position of facing litigation in Delaware with a very uncertain outcome. Topps has already lost once in Delaware court; Eisner may not want to take that chance again by waiving the condition if it is not fulfilled. The Topps board may still lose here.
I'm quoted in both the N.Y. Times and the N.Y. Post today on MAC cases. It is not page six, but as a law professor I will take what I can get:
N.Y. Times: Deal to Buy Sallie Mae in Trouble
N.Y. Post: UBS Unlacing Sneaker Deal
Wednesday, September 19, 2007
Just as I was getting depressed about Accredited Home Lenders/Lone Star settling, the Genesco MAC case is heating up. Below is the letter Genesco sent to Finish Line earlier today. Genesco is making the right move here. Based on public information, Genesco appears to have a strong case that a material adverse change has not occurred, and instead Finish Line simply has buyer’s remorse. Finish Line has suddenly realized, along with its bank UBS, that they are taking on too much leverage on this deal. But it is a bit too late. By Genesco sending this letter they are putting Finish Line on notice that Finish Line is going to have to face litigation if they want completely out of this deal; in other words unlike the Radian/MGIC MAC case this deal will likely not be resolved with the parties simply terminating the merger agreement and walking away. Clearly Finish Line is angling for a price cut – Genesco may well still agree to that but they are going to put up some fight before they compromise. In addition, Genesco’s move here expedites the time table and is a reply to UBS’s request last week for further information – it prevents UBS from going on a fishing expedition and again shifts the burden to Finish Line to make their case publicly for a MAC. Also remember that any litigation in this case between Finish Line and Genesco must to be brought in Tennessee under the merger agreement and will be governed by Tennessee law. This gives an advantage to Genesco in that they can fight this dispute out in their home court (although the lack of case-law on this point creates uncertainty and will encourage the parties to settle). In the end we are largely seeing the AHL deal play out all over again though perhaps with some politer discourse. Hopefully, all of the parties have read that playbook.
Genesco Sends Letter Regarding Merger Agreement Obligations to The Finish Line
NASHVILLE, Tenn., Sept. 19 /PRNewswire-FirstCall/ -- Hal N. Pennington, Chairman and Chief Executive Officer of Genesco Inc. (NYSE: GCO), today sent the following letter to Alan H. Cohen, Chairman of the Board and Chief Executive Officer of The Finish Line, Inc.:
Dear Alan: I am writing this letter to respond to Gary's letter of September 17 as well as to set forth our view of what The Finish Line needs to do to move toward closing. First, let me reiterate that combining our businesses makes great strategic sense. Our team still looks forward to joining with yours.
On an ongoing basis, we have routinely shared detailed financial and operational information with The Finish Line and with UBS, and have responded promptly to numerous requests for specific information. We understand that you need certain information in order to be able to obtain the financing that you need to consummate the transaction, and there are detailed provisions in the Merger Agreement that provide how that cooperative process works. Clearly, UBS' most recent request comes within neither the spirit nor letter of our agreement. It is clear from their own statements that they are looking for a way out of their commitment -- in our view, not because of Genesco's results but because the upheaval in the credit markets makes this deal less profitable for them. We are not going to allow the litigation consulting firm they have hired to go on a fishing expedition. We will, however, continue to provide both The Finish Line and UBS with information related to Genesco in accordance with the detailed processes set forth in the Merger Agreement. As you know, as recently as yesterday, we provided additional information required by UBS for inclusion in your offering memorandum.
The Merger Agreement generally provides that the closing of the merger shall be on a date no later than the second business day after the closing conditions to the merger have been satisfied. Our shareholders met Monday and voted overwhelmingly in favor of the transaction and we have satisfied all our conditions to closing. However, both The Finish Line and UBS have continually failed to meet deadlines that they established for their own actions relative to obtaining the financing to consummate the transaction. Consequently, Genesco hereby makes the following demands:
*that The Finish Line immediately consummate the merger with Genesco; and
*that The Finish Line immediately deliver a substantially completed draft offering memorandum relating to its proposed financing to UBS;
that UBS confirm that such substantially completed draft offering memorandum complies with the terms of the Commitment Letter;
that The Finish Line immediately schedule presentations to the rating agencies for the purpose of obtaining expedited ratings of The Finish Line's securities; and
that The Finish Line enforce all its rights under the Commitment Letter.
I am sure you can appreciate the obligation we have to our shareholders to ensure that The Finish Line complies with its obligations under the Merger Agreement. Alan, I understand that your probable response is going to be to send me a long letter drafted by your lawyers telling me why you can't do the things we have demanded or why you need more time or why things are out of your control. Before you make that response, I encourage you to think about your obligations under the Merger Agreement, to think about the risks to your Company if you fail to comply with your obligations under the Merger Agreement, and whether you are going to continue to stall us or proceed to enforce your rights against UBS under the Commitment Letter. I look forward to hearing from you and working with you to expeditiously consummate the transaction.
Very truly yours, Hal N. Pennington, Chairman and Chief Executive Officer About Genesco Inc.