October 22, 2007
Harman: Bad Reception
After a four week wait, Harman International today finally announced the termination of its merger agreement with Kohlberg Kravis Roberts & Co. L.P. (“KKR”) and GS Capital Partners. According to the press release, the agreement includes the following (surprising) terms:
KKR and GSCP will purchase $400 million of 1.25% senior notes convertible under certain circumstances into Harman common stock, convertible at a price of $104 per share. KKR and GSCP have agreed to not sell or hedge their position for at least one year.
The parties have agreed to terminate their Merger Agreement dated April 26, 2007 without litigation or payment of a termination fee.
In addition, in connection with the investment Harman also announced that Brian F. Carroll, a member of KKR, will join Harman’s Board of Directors, and that Harman will use the proceeds from the KKR/GSCP investment to repurchase Harman common stock through an accelerated share repurchase program.
How bizarre. I've blogged before about the weak case KKR and GSCP appeared to have based on the public information. They have now managed to turn a $225 liability for the termination fee on this deal into an investment that they can keep on their books for years. Win one for the smart general partners at these funds (Flowers et al. take note). The loser here is Harman who could have been $225 million or so richer and also received such an investment in the market from less tainted purchasers. Of course, Harman will say that they settled this dispute in order to move on and avoid the pain of litigation, disclosure of company books and secrets and attorneys fees. Still, this is what happens in any litigation, and I am not sure how it would have detrimentally effected their business to hold KKR and GSCP to their agreement. Their claims are particularly suspect given their strange and disquieting conduct for the past month.
Nonetheless, the lessons for subsequent buyers are clear -- reverse termination fees provide substantial leverage to walk from a deal -- and the subsequent rush by the seller to clean itself up can result in lowering the termination fee even further in the give and take among bargaining positions and the seller's attempts to quickly reposition itself as a "good" company.
Some other points on this announcement also bother me. First, there is a negotiated option on the bond to convert it to equity. I don't have the terms yet to work out a price for this option, but I suspect that given the volatility in Harman stock it masks a sizable interest rate being paid on this bond [On the flip side of this the bond could also be priced to hide the termination fee -- that is KKR and GS could be paying the fee through the bond price]. Moreover, the board seat also strikes me as odd. Here is an investor that was willing to walk away from a deal and leave the company and now they receive a board seat? This is all legal but not the best corporate governance practice as it is bound to create conflict in the future -- the KKR board member has duties to Harman now -- hopefully he will fulfill them ably and in compliance with the law. And for these reasons alone, I would have thought KKR would avoid such a board seat. The plaintiffs' lawyers already have Harman on their radar -- they will again be quick to strike if this board member acts in violation of his duty of loyalty to Harman.
Final note. For those who craft press releases for a living, I include the quote of Sidney Harman issued today as a lesson in what not to say in a press release. He stated:
We are pleased to have reached an understanding with KKR and GSCP. Although we do not agree with the reasons for cancellation of the original merger agreement, we view this $400 million investment as a vote of confidence in our business and its prospects for continued growth.
Not surprisingly, Harman has yet to file the agreement related to this investment and the disposition of this potential claim. I'll have more on this once the agreement is filed which will likely be the full two business days allowed under Form 8-K.
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