Monday, October 22, 2007
I thought I would set forth a few more thoughts on yesterday's SLM hearing. It really is a fun read.
For those who think that SLM's interpretation of the MAC clause is correct, VC Strine may have revealed his initial leanings yesterday. VC Strine mused:
I have to say, the defendants, the weakness from their position is this idea that, basically, one penny on top of what is outlined in the agreement more makes you count the whole thing as an MAE. That is not intuitively the most obvious reading of this. On the other hand, the plaintiffs' position could have been much more clearly drafted if they wished to say that, essentially, all the legislation was a baseline, and you measure the incremental effect.
I have stated before why I disagree with this reading. Nonetheless, for those who read their tea leaves one could infer that VC Strine's initial thought is that SLM's reading is the correct one. To be obvious, though, this case has a long way to go before any decision and Flowers et al. will get many more opportunities to influence VC Strine's thinking.
Otherwise, the transcript is a bit back and forth on this, but VC Strine effectively ruled that there will be a trial in January with reasonable discovery, but only if the parties agree to the covenant waivers in the merger agreement. So, SLM may conclude that the right strategy for it given the above statement is to avoid just such an agreement. This is because VC Strine said he would entertain a "mini-trial" or summary judgment disposition with no ancillary or parol evidence if the parties come back to him on that. Expect SLM to attempt this maneuver, though I think Strine will push back if there is actually no agreement. Strine seemed quite loathe to make any ruling without just such parol evidence and SLM may overreach here.
Another great quote in the hearing was also pointed out to me:
THE COURT: A fairness opinion is just a fairness opinion.
MR. WOLINSKY: A fairness opinion, you know -- it's the Lucy sitting in the box: "Fairness Opinions, 5 cents."
Marc Wolinsky is a partner at Wachtell, a firm which regularly advises clients and investment banks on the legal necessity and provision of fairness opinions. For him to go off message like this in a Delaware court once again exposes the common and openly acknowledged problems with fairness opinions. As I argue in my article Fairness Opinions, the time has long past for Delaware to overrule the implicit requirement for a target fairness opinion established in Smith v. Van Gorkom.
Two mid-sized private equity transactions have been announced in the last few days. On Friday, Radiation Therapy Services, Inc. announced that the company had agreed to be purchased by Vestar Capital for $32.50 per share plus assumed debt, for a deal valued at $1.1 billion. Then today, Goodman Global, Inc. announced that it has agreed to be acquired by Hellman & Friedman LLC in an all-cash transaction valued at approximately $2.65 billion or $25.60 in cash per share. The credit markets must indeed be loosening if private equity deals are once again being announced, even if it is only deals for a billion or so.
Reviewing both press releases one is struck by the absence of any statement concerning the existence or lack thereof of a financing condition. In the case of RTS the reason why became apparent today when RTS filed its merger agreement. There is actually no financing condition but true to form the deal has a cap on the buyer's liability of $40 million. However, per Section 7.2(b), the termination fee is $25 million plus payment of RTS's fees and expenses up to $3 million if the agreement is terminated by RTS if the buyer has breached the agreement or otherwise refused to close upon satisfaction of the conditions. Anyway, the agreement isn't drafted or structured well on these points, but I couldn't find any conflux of events that would result in RTS receiving more than the $25 million. This is because if RTS terminates the agreement then the buyer is only liable for the $25 million still leaving the question open as to what circumstances would lead to the $40 million cap. I suppose just going to court and leaving the agreement open -- but this is an unpalatable situation for any seller as Harman has recently seen to its detriment.
And this explains why there is no financing condition statement in the RTS press release. The parties probably realize that the reverse termination fee is effectively a financing condition. Win one for truth in advertising. Other terms of the RTS agreement are a $25 million termination fee and a seller obligation to pay the buyer's fees up to $3 million if the deal is voted down. There is also a no-shop (whither the go-shop so soon?).
I'll have more on these two deals once the Goodman Global merger agreement is filed.
Bioenvision, Inc. announced yesterday that its stockholders had voted to approve the acquisition of the company by Genzyme at a reconvened meeting of its shareholders. Fifty-six percent of Bioenvision's shares of common stock and preferred stock supported the merger. This represented approximately 67 percent of the total shares voted.
For my prior posts on this deal see:
Here is the transcript of the SLM hearing today. My favorite quote by VC Strine:
SLM Attorney: we are still not terminating the agreement, and I think there is a cloud over this company by virtue of . . .
THE COURT: With having a potentially $900 million receivable, plus interest? I wish I had a cloud like that.
Basically, SLM's attorneys argued that the contract could be decided on its face without resort to parole evidence (i.e., on the plain language of the contract alone without having to look at the facts of the negotiation). SLM consequently argued that VC Strine could decide the matter on a summary judgment motion without substantial discovery. This is a risky strategy by SLM as I do think that their interpretation is a bit stretched (to say the least). Strine wisely noted on this point that there were differing interpretations of the MAC language and in that case a judge almost always has to resort to parol evidence. I suspect SLM is adopting this course because the parole evidence for their case is simply not that great. And I suspect that it will not fly -- Flowers has already disclosed parol evidence justifying its case beyond the fact that the plain language of the merger agreement appears to favor them.
Ultimately, Flowers et al. agreed to waive the no-shop and other portions of the merger agreement limiting SLM's ability to operate freely. On this basis, Strine said he would hold a trial in January unless the parties agreed to limit discovery and set a more expedited schedule. Don't expect Flowers to do so. Time here is on their side as it permits more facts about SLM's position to come out and sober judgment to set in.
Other tidbits: CEO of SLM Lord attended the hearing; Wachtell had six attorneys present including famed litigator Bernie Nussbaum though only Marc Wolinsky from that firm spoke. Expensive trip on Amtrak for Flowers, et al sending them to Delaware. But, given the amount at stake, completely justified.
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.
Today, I'll be looking at the scheme of arrangement. A scheme of arrangement is a reorganization of a company's capital structure or its debts which is binding on creditors and shareholders. It is not a structure available or utilized in the United States, but instead is prevalent in countries modeled upon the English company law system (England, Australia, New Zealand, South Africa, etc.), as currently embodied in Section 425 of the English Companies Act 1985. The structure can be best analogized to a U.S. merger, although there are distinct differences between the two structures.
There are two types of scheme of arrangement: a creditors' scheme and a members' or shareholders' scheme. A creditors' scheme is generally used by companies in financial difficulties; the creditors can agree to defer payments and effect a restructuring of the indebtedness of the corporation. A members' scheme is used to effect corporate reorganizations, particularly a combination with another company. In general, a scheme of arrangement is carried out in three steps:
- The court is approached to order a meeting of creditors or shareholders directly affected;
- The scheme in general must be approved by a vote of more than 50 per cent of the creditors or members present and voting who represent 75 per cent of the total debts or nominal value of the shares of those present and voting at the meeting (the law may vary depending upon the country but this is the law in England); and
- The scheme is referred back to the court for confirmation.
In England, the scheme of arrangement has seen growing popularity. This is for three reasons. First, in the 2003 Debenhams transaction, the unsolicited bidders used a scheme of arrangement to successfully initiate a hostile offer. Previously, the scheme was not thought to be as flexible an instrument, and the offer the only possible structure in unsolicited situations. Post-Debenhams, bidders in English takeovers governed by the takeover code have made wider use of this structure over an offer in both hostile and friendly situations (NB. the same thing has happened in Australia in light of a similar event in the Australian Leisure & Hospitality Limited bid). Second, the scheme of arrangement ensures a squeeze-out with a lesser threshold amount. Under a takeover bid in these countries, 90 percent or more of the target is generally required under the law to trigger compulsory acquisition of the remaining minority shareholders' shares. In contrast, a scheme of arrangement can potentially still succeed with only 75 percent in value and a majority vote. This is particularly important in leveraged buy-outs where a white-wash proceeding is generally necessary because of the financial assistance the target corporation is giving the bidder, and bidders need to meet the voting thresholds of a scheme anyway in order to effect it (for more on what a whitewash proceeding and financial assistance are under English law see here). Finally, a scheme of arrangement can be extended into the United States with only minimum Securities Act and Exchange Act compliance.
This last point is due to the exemption under Section 3(a)(10) of the Securities Act. It states:
Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval . . . .
The exemption was initially promulgated for state fairness hearings which were prevalent prior to the adoption of the Securities Act. And still today, particularly in California, the procedure is used in takeover transactions to issue securities exempt from registration under the Securities Act (for more on California fairness hearings see here; every M&A lawyer in California should be familiar with and advise their clients of this structure where appropriate). Smart U.S. lawyers practicing abroad picked up that this exemption also fit the parameters of the proceedings for a scheme of arrangement and began to petition the SEC for no-action letters to this effect for schemes under the laws of different countries. A practice developed in the early 1990s that the SEC would issue no-action relief on a case-by-case basis for each scheme. Then in October 1999, the SEC issued a legal bulletin specifying the circumstances in which a foreign scheme of arrangement could qualify for the 3(a)(10) exemption. Today, almost all schemes now qualify and the practice is no longer to seek no-action from the SEC, but rather to rely upon the requirements set forth in the October 1999 bulletin.
The scheme of arrangement is a particularly advantageous way to extend an offer into the United States because there are no filing requirements with the SEC and no real substantive requirements other than that the judge be informed of the exemption and rule specifically on the fairness of the terms and conditions of the transaction. These are lesser information and filing requirements than required even by the SEC's Cross-Border exemptions. Because of this, U.S. lawyers often advise their non-U.S. clients to pursue a scheme of arrangement in order to significantly avoid U.S. securities law requirements even when U.S. holders number less than 10% and the cross-border exemptions can be met. This makes no sense, of course -- why U.S. holders do not get the benefits of U.S. registration requirements or the protections of the cross-border rules for this type of structure but not in the case of an offer has never been justified fully by the SEC other than statements that the strictures of 3(a)(10) are met. But if the SEC ever attended one of these scheme hearings they would see that the "fairness" ruling upon which the exemption is based is a pro forma event without significant substance. As I have argued before, the cross-border exemptions are due for some significant fine-tuning. If and when the SEC finally gets around to this acting to make the exemptions more usable, hopefully they will also reconsider the 3(a)(10) exemption for schemes.
Friday, October 19, 2007
Dow Jones filed a revised proxy statement yesterday. For those who love their corporate intrigue, I recommend you read the background to the transaction section -- lots of back and forth and interesting nuggets. It is great weekend reading.
On Oct 11, the SEC approved FINRA's new proposed Rule 2290 regarding fairness opinions (see the SEC approval here; the FINRA rule release here). The eighth extension of the comment period for the Rule was to run until the end of the month. However, the SEC approved the rule on an expedited basis. This is a bit odd -- this rule has been pending for three years, why the rush now?
The Rule obligates member firms of FINRA adhere to the following requirements when preparing and issuing fairness opinions:
- Rule 2290(a)(1) requires that when a member firm acts as a financial advisor to any party to a transaction that is the subject of a fairness opinion issued by the firm, the member must disclose if the member will receive compensation that is contingent upon the successful completion of the transaction, for rendering the fairness opinion and/or serving as an advisor.
- Rule 2290(a)(2) requires that a member firm disclose if it will receive any other significant payment or compensation that is contingent upon the successful completion of the transaction.
- Rule 2290(a)(3) requires that member firms disclose any material relationships that existed during the past two years or material relationships that are mutually understood to be contemplated in which any compensation was received or is intended to be received as a result of the relationship between the member and any party to the transaction that is the subject of the fairness opinion.
- Rule 2290(a)(4) requires that members disclose if any information that formed a substantial basis for the fairness opinion that was supplied to the member by the company requesting the opinion concerning the companies that are parties to the transaction has been independently verified by the member, and if so, a description of the information or categories of information that were verified.
- Rule 2290(a)(5) requires member disclosure of whether or not the fairness opinion was approved or issued by a fairness committee.
- Rule 2290(a)(6) requires member firms to disclose whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation from the transaction underlying the fairness opinion, to the company’s officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company.
- Rule 2290(b)(1) requires that any member issuing a fairness opinion must have written procedures for approval of a fairness opinion by the member.
As I commented before on this Rule:
The broad scope of intended topics in the initial notice to members led some to think that FINRA would finally act to address many of the deficiencies in current fairness opinion practice. However, the initially promulgated rule was a disappointment, and after three amendments at the SEC's behest it has now been watered down into meaninglessness. FINRA ultimately did not go so far as to require member investment banks to disclose “any significant conflicts of interest” as it initially considered. Instead, disclosure requirements in the Rule with respect to contingent consideration and relationships largely overlap with current federal securities law as set out in Item 1015(b)(4) of Regulation M-A. There are two other disclosure obligations in the Rule concerning opinion committees and independent verification of information. These will likely be met with more boiler-plate responses – a practice which the Rule effectively permits. Furthermore, in the amending releases FINRA also watered down the Rule in its interpretation; removing a good bit of the potential for it to go beyond SEC regulation. For example, FINRA took the position in the amending releases that disclosure of contingent compensation and material relationships under the Rule can be descriptive and not quantitative; a statement as to whether it exists or not sufficient. Yet, the number is the important element here: if the amount is high it has more potential to result in bias. In addition, the Rule does nothing about the subjectivity inherent in fairness opinion preparation. It simply addresses the conflicts issue with redundant disclosure requirements that permit the investment banks to engage in the same practices as before with little, if any change.
The only novel aspect of this Rule is the requirement it places on member firms to disclose whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation from the transaction underlying the fairness opinion, to the company’s officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company. I have read and re-read this provision and the FINRA commentary upon it. While the purpose can be easily surmised—addressing inordinate retention and compensation paid in connection with change of control transactions—I look forward to learning how the investment banks implement this provision, because I honestly do not know how they can or will other than via the usual boiler-plate response. In any event, this requirement misapprehends what a fairness opinion does and opines to. Retention and other compensatory arrangements do arguably result in a lower price to acquiree stockholders, but do not affect whether the ultimate price itself is fair within the financial parameters of the value of the corporation or the consideration paid. To rephrase the point, the price can be financially fair in a corporate control transaction but the retention and other compensatory arrangements still egregious. Trying to analyze them together scrambles the egg. FINRA should have addressed these issues separately.
Ultimately, FINRA and the SEC would have done better to address the real problems with fairness opinions (their subjectivity, etc.) rather than piling on more and largely meaningless procedural strictures. For more on this see my article Fairness Opinions.
Two developments in the SLM case. First, all of the business news outlets are reporting on the letter Flowers sent to its limited partners yesterday. I've read it and can confirm that this is what it says. Nonetheless, in the letter Flowers reportedly states that it is liable only for $192 million of the break-up fee. Flowers has signed a guarantee to SLM for $451 million of the $900 million break-up fee; the reduction is reportedly due to side investors investing equity in the deal and therefore also taking on liability for the termination fee (for the N.Y. Times report on this see here). And of course, the buyers can still renegotiate amongst themselves to further reallocate this liability.
I suspect Flowers practice is extremely common and therefore that there is a more general lesson this brings out. When sellers are negotiating reverse termination fees with private equity firms, they hopefully negotiate the size of the fee so as to effect the future actions of the PE firms. But to the extent the PE firms can and do shift off a significant amount of their liability, agency costs are created, the PE firm has less at stake and therefore may be more likely to walk. Food for thought for sell-side M&A attorneys -- they may try and pin the specific figure on the PE firm itself and not permit such allocations or otherwise erect alternative mechanisms to keep PE firms contractually committed.
The second development was the delivery of another letter by SLM to V.C. Strine arguing for an expedited hearing (access the letter here). The letter doesn't state anything particularly new. I do think that SLM makes a very good positioning point that Flowers et al. could terminate the merger agreement as of now if they did indeed think that there was a MAC as they described. SLM cites this fact for justifying an expedited hearing. I'm not sure it gets SLM there and, in any event, believe that Flowers hasn't terminated the agreement yet due to posturing. SLM also makes some further points about the MAC in its letter.
- First, defendants refuse to address the fact that the representation and warranty of Section 4.10 is subject to the preamble language in Article 4, "Except as disclosed in ... the Company 1O-K." (Lord Aff. Ex. A, Art. 4.) The preamble to Article 4 unambiguously establishes, both textually and structurally, that the disclosures in the lO-K are the relevant baseline for any analysis of Sallie Mae's representation that no MAE has occurred.
My thought: SLM is reaching to find support for their prior assertions that a material adverse change under the merger agreement can only be an effect worse than described in the Recent Developments section of their 2006 10-K. I'm not sure I agree with this. The plain language of the MAC definition simply says something different. Picking and choosing among the clauses of the merger agreement to find snippets that justify this argument is not a particularly winning one or a valid method of contract interpretation when the language appears clear as it does here.
SLM also states:
- Third, while the defendants repeatedly argue that the "entire impact" of the enacted legislation must be considered under the MAE clause (e.g., Counterclaims ~ 75), those words are found nowhere in the Agreement. The representation and warranty is expressly subject to the proposed legislation discussed in the Company's 10-K, and the definition of "Material Adverse Effect" states that only those "changes" in law that are "more adverse" to Sallie Mae than changes proposed in the 10-K can be considered for MAE purposes. (Lord Aff. Ex. A, § 1.01.) The unambiguous meaning of this language is that only the incremental impact of changes should be considered. For example, when the parties signed the deal, Sallie Mae's 10-K had already disclosed a legislative proposal to cut special allowance payments on certain student loans by 50 basis points. (See Verified Complaint ~ 17.) The enacted legislation cut those subsidies by 55 basis points. Under the plain language and structure of the contract (including both the MAE definition, as well as the preamble to the Article 4 representations), the only portion of this "change" in law that is "more adverse" is the additional 5 basis points in cuts. The defendants' reading - that all 55 basis points should be counted, despite the disclosure of a proposal for a 50 basis-point cut in the lO-K - would place a $26 billion merger on a razor's edge; the merger would be vulnerable to a breakup not just over 5 basis points, or even over 1 basis point, but even if enacted legislation were a single dollar more adverse to Sallie Mae than any of the proposals disclosed in the 10-K.
My thought: I've addressed elsewhere why the plain meaning of the MAC definition appears to be that the enacted legislation only need be more adverse; it does not add its own materiality qualifier over and above the 10-K recent developments section as SLM is arguing above. And here SLM admits again that it is more adverse -- by 5 basis points. As for the razor's edge argument -- so what? If SLM and Flowers et al. had monetized the potential MAC by saying it could have an effect of no more than $1 billion and then Flowers could walk this would also be a razor's edge. If the effect was $1 more than a billion Flowers et al. could terminate. Could SLM make this same argument in such a case. No. Every contract defines a point where there is breach and no breach, so every contract point is just such a razor's edge. In fact, if you adopted SLM's argument then the razor's edge would now have a materiality qualifier but it would still be there. SLM just doesn't like the fact that the razor's edge here is to low; not that there is a razor's edge at all.
The parties are meeting before Strine this Monday; I expect that he will make his ruling on expedited treatment then.
Final note: you can access SLM's Reply to Counterclaim filed today here. Nothing particularly new.
Thursday, October 18, 2007
Wednesday, October 17, 2007
The Dolan's third attempt to take Cablevision private in a $10.6 billion transaction appears to be teetering on the brink. Earlier this week, Mario Gabelli, whose mutual funds own 8.3 percent of Cablevision, wrote to the company to signal that he would vote against the plan. And the Wall Street Journal is reporting today that ClearBridge Advisors LLC, Cablevision's biggest investor with a 14% interest, plans to vote against the deal. Two other large institutional shareholders T Rowe Price and Marathon Asset Management have also indicated their intention to oppose the buyout. Finally, ISS Governance Services, and Proxy Governance Inc have recommended that their clients vote against the transaction. Last night, Cablevision Chief Executive James Dolan released a statement asserting that the Dolan family would not raise its offer.
Under the merger agreement, the required vote to approve the plan is:
Public Stockholders holding more than 50% of the outstanding shares of Class A Stock held by Public Stockholders other than executive officers and directors of the Company and its Subsidiaries . . . .
Public Stockholders excludes "the Family Stockholders, Family LLC, any Subsidiary of Family LLC and the Other Dolan Entities." These terms as defined in the merger agreement are essentially the Dolan family group. So, in order for the proposal to succeed it needs to be approved by a majority of the minority of the unaffiliated, public stockholders. According to the proxy statement this comprises approximately 113 million shares of Cablevision Class A shares. But, even if the majority of the minority provision is met, the deal can still fail because it is conditioned on no more than 10% of Cablevision's class A shareholders exercising appraisal rights under Delaware law (DGCL 262). The condition specifically requires that:
The total number of Dissenting Shares shall not exceed 10% of the issued and outstanding shares of Class A Stock immediately prior to the filing of the Merger Certificate . . . .
In his 13D filing last week, Mr. Gabelli indicated that he was considering exercising these rights. This would mean only 1.7% more of the Class A shares would need to exercise appraisal rights for the condition not to be met. Appraisal rights in Delaware must be exercised prior to the vote on the transaction, and are typically exercised immediately prior to the meeting. Thus, this deal may still fail even if the majority of the minority condition is met. I seriously doubt the Dolan's would want to face the substantial uncertainty of Delaware appraisal proceedings and the significant extra costs it may impose on their acquisition. If the 10% threshold is met, my instincts are that they will walk.
Oh -- and for those waiting for the plaintiffs' lawyers to bail them out of this mess. Don't. At the time this third attempt at a take private was announced, the press release had the following statement:
Lawyers representing shareholders in the pending going private action in Nassau County Supreme Court actively participated in the negotiations, which led to improvements to the financial terms of the transaction as well as significant contractual protections for shareholders. . . . The parties have agreed in principle to the dismissal of the pending going private litigation, subject to approval by the Nassau County Supreme Court.
In the proxy statement, Cablevision stated:
following participation by representatives of the plaintiffs in the Transactions Lawsuits in the negotiations. . . . the Dolan Family Continuing Investors agreed to a $30 million increase in the merger consideration . . . . For their work on behalf of stockholders in the Transactions Lawsuits and in the actions relating to alleged options backdating in the Nassau County Supreme Court and the U.S. District Court for the Eastern District of New York, plaintiffs’ counsel intends to request that the Nassau County Supreme Court award them fees, including expenses, of $29,250,000. The settling defendants have agreed not to challenge the fees and expenses application for this amount. Cablevision has agreed to pay such amount, if approved by the court, following completion of the merger.
This just doesn't seem right. The shareholders plaintiffs' attorneys are receiving $29.25 million in fees for adding (at best) value of $30 million, and settling well before a full assessment of the transction could be made. For more criticism, I'll link to Vice Chancellor Strine's opinion in In re Cox Communications about the perils of such practice under Delaware law and the possibility of selling minority shareholders short, particularly here where the Dolan family has been repeatedly accused of underbidding for Cablevision.
Tuesday, October 16, 2007
The WSJ Deal Journal had a post yesterday on the Flowers group's allocated liability for the $900 million break fee in connection the SLM merger agreement. The post quoted a source who stated that:
“It has been difficult to get information out of Flowers on this one,” one investor told PE Hub. “We aren’t even sure how the $900 million breakup fee will be allocated among the syndicate.”
The post then linked to a Breakingviews post asserting that the Flowers group was only on the hook for $200 million of the $900 million fee if it was required to be paid (that is a big if).
I'm not sure where these figures come from. In the SLM complaint, SLM states that Flowers has guaranteed $451,800,000, JP Morgan $224,100,000, and BofA $224,100,000 of the $900 million termination fee. So, again, I don't know how breakingviews got from $451 million to $200 million.
Of course, internally and privately the parties may have reordered these guarantees. This may very well be the case as some public reports have stated that JP Morgan and BofA are driving this renegotiation and stand to lose a much greater amount than the termination fee if the deal goes through. It would not be a surprise if they agreed to cover some of Flowers potential liability here in case SLM is successful on its claims in Delaware.
The Flowers consortium filed their answer and counter-claim yesterday in Delaware Chancery Court. The Flowers group counter-claim boils down to a request that the Chancery Court declare that a Material Adverse Effect under the merger agreement with SLM has occurred and that it will be continuing at the time of closing such that Flowers et al. are excused from performance (and paying the $900 million termination fee). This dispute is no longer over whether a deal will be reached -- I think it has devolved into a battle over the $900 million. And after reviewing Flowers et al.'s counter-clam, I continue to believe that they have made a good legal argument that a MAC under the merger agreement definition has occurred. I might add they are following the exact legal arguments I predicted in my prior post here. So, let's begin. The relevant portions of MAC definition in the merger agreement are:
"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: . . . . (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; . . . . (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 . . . .
As an initial matter, Flowers attempts to establish that a "material adverse effect" has occurred. This is the initial requirement under the MAC definition. Flowers et al. state that the recently enacted legislation:
Will cut subsidies to the student loan industry by $22.32 billion over the next five years on a present discounted value basis, and that will cut Sallie Mae’s core income by approximately $316 million, or 15.2% in 2009, rising to a reduction of approximately $595 million, or 23.%% in 2012, as compared to reasonable projections of Sallie Mae’s core net income if the new legislation had not been enacted . . . .
This is the first real quantification of the ultimate effect of this legislation I have seen. To my knowledge, SLM itself has refused to quantify the aggregate impact of this legislation. Instead to date, SLM has only stated that the legislation will have an aggregate adverse impact of 1.8%-2.1% to core earnings over the next five years over above the total impact of the legislation disclosed in the recent developments section of their 10-K. 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. If the Flowers group is correct in their assessment of the detrimental effects, this high bar would likely be met. This could explain why SLM does not argue that there was no "material adverse effect" under the above definition in its own complaint but instead argues that a MAC is barred due to application of one of the exclusions in the definition.
The Flowers group must not only meet their burden of proving that a material adverse effect has occurred, they must show that one of the exclusions above in the MAC definition are not applicable. Here, Flowers first addresses clause (b) -- the "changes in applicable law" exclusion. Remember from my prior post, SLM is arguing that:
the “enacted legislation is entirely excluded from consideration as an MAE unless it is more adverse to Sallie Mae than the” proposals disclosed in the Recent Developments Section of the 10-K. Furthermore, SLM argues that any adverse enacted legislation must be considered in comparison to these proposals. SLM then concludes by asserting that only if the difference between the proposals and the enacted Bill is a material adverse effect with respect to the “totality” of the “financial condition, business, or results of operation” of SLM and its subsidiaries is it not excluded from the definition of MAC.
The Flowers group counters with the same argument I made in my post. Namely on its face the plain language of the MAC definition requires that the enacted legislation be only adverse -- there is no materiality qualifier. The Flowers group states:
The exception is limited however. If a “change in Applicable Law” is “in the aggregate more adverse” to Sallie Mae than the proposals described in the Sallie Mae 10-K, then the new legislation is not a “change in Applicable Law” that is excluded from consideration in evaluating whether there has been a Material Adverse Effect. Accordingly, “changes in Applicable Law” that are in the aggregate more adverse to the company than the proposals described in the Sallie Mae 10-K must be considered in determining whether there has been a Material Adverse Effect.
Flowers then asserts that since this is the plain language of the contract, the court need look no further. Here, I agree. Basic contract interpretation rules require the court to look first to the plain language of this contract. And here the language negotiated by these highly sophisticated parties is clear that it need only be adverse. Nonetheless, the Flowers group makes a strong case in their counter-claim that even if parole evidence (evidence outside the contract) is considered, the parties specifically considered the second Kennedy proposal for inclusion in the MAC definition exclusions and rejected this consideration. The Flowers group states:
On April 14, 2007, after learning the published details of the Kennedy Proposal, Mustang again revised Sallie Mae’s Material Adverse Effect definition, reiterating that Mustang would only accept the risk of enactment of those proposals that were described in the Sallie Mae 10-K, e.g., excluding the Kennedy Proposal, and that Mustang would not accept the risk of any legislation “more adverse” to the Company. During the discussion on April 14, 2007, the parties agreed that the Kennedy Proposal, if enacted, would not be subject to the “changes in Applicable Law” carve-out from the definition of Material Adverse Effect. The Material Adverse Effect language was finalized on April 15, 2007, with Mustang adding language to ensure that the carve-out for the proposals in the Sallie Mae 10-K was for those proposals in the form posed publicly as of the date of the Company 10-K, i.e. March 1, 2007.
While SLM will obviously have a different story, the Flowers group's argument is supported by the fact that the second Kennedy proposal was disclosed in SLM's April 10 10-Q filed just before the merger agreement was announced. The parties could have specifically included this proposal but did not.
Finally, the Flowers group argues that a material adverse effect has also occurred due to a separate 4.9% decline in core earnings for SLM resulting from the current credit crunch. Moreover, the Flowers group argues that the adverse effect is not excluded by clause (e) above -- "general industry changes" because:
While current market conditions have had a negative effect on most financial institutions, the collapse of the securitization market and disruption of the asset-backed commercial paper market have “disproportionately affect[ed]” Sallie Mae relative to similarly sized financial services companies” and this are not excluded from the Merger Agreement’s definition of Material Adverse Effect . . . .
I'm not sure this is a winner. The 4.9% adverse effect is below the 5% materiality threshold for GAAP and, although there is little case law on this, to establish a MAC it is generally thought that the effect to earnings must be significantly higher. Moreover, the general exclusion here is likely to absorb much of this claim. So, I think the Flowers group is keeping this in for form but has a much better claim based on the enacted legislation.
Bottom Line: Obviously, this is all based on the public information and more will come out prior to trial, but as of now, I believe that the Flowers group has a solid claim that a MAC occurred under the merger agreement and that it is not excluded. I think this is particularly true given the quantification of the impact on SLM and the evidence that the second Kennedy proposal was considered and excluded from the MAC definition. The latter point is particularly problematical for SLM because it argues strongly against their own argument that a materiality qualifier should be written into the applicable law exclusion. If this is true then why was the second Kennedy proposal specifically excluded by the parties from the MAC definition?
Final Note: As I stated yesterday on the expedited relief SLM has requested:
I think Flowers makes a good point that this is now only about the $900 million and they are willing to fight it out by permitting SLM to terminate the merger agreement without prejudice. This would alleviate SLM's need for expedited relief. Still, I think the judge on this matter, Vice Chancellor Strine, will grant the request to expedite as it will mean a trial and opinion is more likely. This is a prominent case and Strine will not only want to put his name on another notable opinion, but he has incentives to maintain Delaware as the more certain law on these adjudications by doing so (this will mean more companies choosing Delaware law and forum to adjudicate these disputes). Plus Strine wrote the opinion in IBP v. Tyson, the last big MAC case, and he will likely want to take the opportunity to flesh out the law on that opinion. From my perspective, this is a good thing as we could use more case law on the interpretation of the exclusions from a MAC definition.
On further reflection, I continue to think this is the way things will go. There is a meeting in Strine's chambers next Monday at 1:00 p.m. on scheduling. We will have more information then.
Monday, October 15, 2007
I have a couple of quick thoughts and will give a full analysis tomorrow morning. First, I think it is becoming increasingly clear that the parties are now arguing over the $900 million rather than salvaging a deal. Here, the argument appears to be revolving around whether the enacted bill only needs to be more adverse than what was disclosed in the 10-K or have a material adverse effect over and above the 10-K disclosure. Flowers is arguing the latter and focuses on this point in its counter-claim; SLM is arguing the former. As I've said before and based on publicly available information, I believe the Flowers reading is the better one; it is certainly the plain language of the contract.
On the expedited relief SLM has requested -- I think Flowers makes a good point that this is now only about the $900 million and they are willing to fight it out by permitting SLM to terminate the merger agreement without prejudice. This would alleviate SLM's need for expedited relief. Still, I think the judge on this matter, Vice Chancellor Strine, will grant the request to expedite as it will mean a trial and opinion is more likely. This is a prominent case and Strine will not only want to put his name on another notable opinion, but he has incentives to maintain Delaware as the more certain law on these adjudications by doing so (this will mean more companies choosing Delaware law and forum to adjudicate these disputes). Plus Strine wrote the opinion in IBP v. Tyson, the last big MAC case, and he will likely want to take the opportunity to flesh out the law on that opinion. From my perspective, this is a good thing as we could use more case law on the interpretation of the exclusions from a MAC definition.
Sunday, October 14, 2007
On Friday, Oracle delivered a bear hug letter to BEA Systems, Inc. (BEAS) offering to purchase the company for $17 per share in cash. For those who collect bear hug letters, Oracle wasn't kind enough to release the letter itself instead releasing a press release announcing its delivery. BEAS followed up with two letters later in the day accessible here and here. BEAS's response was standard operating procedure -- "just say no", hire Wachtell and buy time to develop a strategy or continue to say no. Then came Carl Icahn, owner of 13.22 percent of BEAS disclosed his own letter rejecting the Oracle offer and requesting that BEAS put itself for auction or accept a preemptive bid at a compelling valuation (i.e., higher than Oracle's offer). Interestingly, Ichan filed the letter on Form DFAN14A meaning he is preserving his right to conduct his own proxy solicitation to in his own words "seek to nominate individuals for election as directors of the Issuer".
So, the question now is what are BEAS's defenses? First, the really interesting point. BEAS, a Delaware company has not had an annual meeting since July 2006. BEAS is in clear violation of DGCL 211. DGCL requires that:
If there be a failure to hold the annual meeting or to take action by written consent to elect directors in lieu of an annual meeting for a period of 30 days after the date designated for the annual meeting, or if no date has been designated, for a period of 13 months after the latest to occur of the organization of the corporation, its last annual meeting or the last action by written consent to elect directors in lieu of an annual meeting, the Court of Chancery may summarily order a meeting to be held upon the application of any stockholder or director.
This gives Oracle the ability to go to Delaware Chancery Court to force BEAS to hold a shareholder meeting for the election of directors. This is a hole in BEAS's defensive shield, but to make a full assessment let's look at the rest of its defenses:
BEAS has a shareholder rights plan (aka "poison pill") with a 15 percent threshold. It is both a flip-in and flip-over plan and is triggered If a person or group acquires, or announces a tender or exchange offer that would result in the acquisition of, 15 percent or more of BEAS's common stock. This is a standard form of the pill and nothing particularly unusual. For definitions of these terms see here.
The BEAS board is divided into three classes. Each class serves three years, with the terms of office of the respective classes expiring in successive years. The staggered board is a powerful anti-takeover device as it requires successive proxy contests over two years (for more on this generally see Lucian Bebchuk, et al., The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence and Policy)
Action by Written Consent:
Permitted. However, under Delaware law (DGCL 141(k)) the BEAS directors can only be removed for cause since BEAS has a staggered board. So, Oracle can't act by written consent to remove the board. Oracle will have to wait for two annual meetings in a row to gain a majority board. This is likely about sixteen months from now give or take.
Notice of Director Nominations
Notice of the nomination must be delivered not earlier than the close of business on the 120th day prior to such annual meeting and not later than the close of business on the later of the 90th day prior to such annual meeting or the 10th day following the day on which public announcement of the date of such meeting is first made by the corporation. Oracle will thus have 10 days after the meeting is called to make its nominations.
DGCL Section 203
Applicable as BEAS has not opted out of it. This is the Delaware business combination statute, and given the presence of a poison pill here, it is not particularly relevant. This is because Oracle cannot acquire BEAS without gaining board approval and the board's accompanying redemption of the poison pill. Any board that would do this would also exempt out Oracle from this statute by approving their acquisition.
The bottom line is that BEAS has strong takeover defenses in the form of a staggered board in particular. But, Oracle can force BEAS to call a meeting rather quickly and under the nomination provisions above force an election to replace 1/3rd of the board. This would be a quick publicity gain for Oracle and provide it valuable momentum. If BEAS continues to adopt a scorched earth strategy and just say no to a deal (a route permitted under Delaware law), Oracle would then have to wait another year to elect a majority on the board to redeem the poison pill and agree for Oracle to acquire the company. Few companies have this staying power but Oracle did just such thing successfully in the PeopleSoft transaction. For those reading tea leaves, there Oracle revised its initial unsolicited bid for PeopleSoft (including one reduction) five times over eighteen months before finally acquiring it in late 2004. Oracle began at $16/share and ended at $26.50/share in the interim fighting off a DOJ suit to prevent the deal in 2004. And if Oracle wants to be particularly aggressive and risky, it can attempt to chew through BEAS's pill, a strategy which academic Guhan Subramanian thought viable and which he detailed in Bargaining in the Shadow of PeopleSoft's (Defective) Poison Pill. Perhaps BEAS's pill has the same defects (OK -- I'm kidding here, no lawyer would ever recommend this strategy -- way to risky).
For its part, BEAS will take particular pains (as it did in two press release on Friday) to avoid saying that it is up for sale. That is because, once the BEAS board decides to initiate a sale process, Revlon duties under Delaware law apply and the board is required to obtain the highest price reasonably available. By refusing to initiate a sale process, the board adopts a legitimate "just say no" defense. One which Delaware law permits, including the use of a poison pill to avoid a deal. Although, hope springs eternal and perhaps a case is on the horizon where Delaware where readopt Chancello Allen's opinion in Interco and reestablish supervision and court-mandated redemption of poison pills when sufficient time has passed and they are being used solely as a shield. But don't hold your breath.
Ultimately, I predict Oracle will attempt to put pressure on the BEAS board by initiating litigation in Delaware to hold a BEAS annual meeting and running a proxy contest coupled with a tender offer to replace the 1/3rd of the board up for election then. If Oracle wins it will likely put enough pressure on BEAS to reach a deal. Particualrly with Icahn chomping at the bit. Expect BEAS to resist until then knowing that Oracle has, in the past, met such resistance with increased consideration
Technical Tidbit: Any agreed acquisition will likely have to be pursuant to a tender offer rather than a merger. This is because a company that is not current in its financial reporting (i.e., BEAS) can be the subject of a tender offer but, because of an SEC staff interpretation of the proxy rules, that company may not be able to file and mail a merger proxy and thus cannot hold a shareholder vote on the merger.
Topps issued the following press release on Friday:
The Topps Company, Inc. (Nasdaq: TOPP) today announced the closing of the acquisition of Topps by Michael Eisner's The Tornante Company LLC and Madison Dearborn Partners, LLC. Under the terms of the agreement, Topps stockholders will receive $9.75 in cash for each share of Topps common stock held, for a total aggregate purchase price of approximately $385 million payable to stockholders.
"This is a great day for Topps and its shareholders," said Arthur T. Shorin, Chief Executive Officer of Topps. "This transaction provides our former investors with full value for their shares and ensures the further success of our iconic company."
Topps President and Chief Operating Officer Scott Silverstein added, "We are pleased to have an experienced and talented group of investors who are committed to growing our company and to delivering added value to our partners, the people who enjoy our products every day, and our terrific team of employees whose efforts have made this transaction possible."
"Topps is a wonderful company with a rich history and a strong brand portfolio. We look forward to working with the company's outstanding management and employees to grow Topps in new and innovative ways," Eisner said on behalf of the investors.
Given the way the Topps board manipulated the takeover process and spurned a higher offer from Upper Deck, both over vociferous shareholder objections, I'm not sure how great a day it was for Topps' shareholders. They have now lost out on the potential upside Eisner et al. have purchased. Eisner wins again for now.
There was also no mention in the above release of the final number of dissenting shareholders, but it must have been below the 15% condition set in the merger agreement. Still, Crescendo Partners has 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). In a nice maneuver, they will not get to negotiate for a higher price outside the takeover process.
Despite the loss of Topps as a public company we will still have a Delaware decision (In re Topps Shareholders Litigation, 2007 WL 1732586 (Del.Ch. June 14, 2007)) and a great case study in how not to run a takeover process. Sayanora Topps. For my prior posts on the Topps deal see the following:
Friday, October 12, 2007
Yesterday, the Chancery Court of Tennessee issued an order order setting a trial date for Dec. 10 in the material adverse change dispute between Finish Line and Genesco. In doing so, the Chancery Court rejected the arguments of UBS [the intervenor] to set the trial for Jan. 7. The Chancery Court stated:
In setting the MAE trial for December 10, 2007, and rejecting the Intervenor's request for a January 7, 2008 trial date, the Court has concluded that the provision of the Merger Agreement that allows Genesco to cure an MAE before December 31, 2007 is not a ripe issue, and, therefore, does not warrant delaying the trial to January 7, 2008. The Court's conclusion is that under the terms of the Merger Agreement, as applied to the circumstances of this case, Genesco's right to assert that it has cured a defect in its performance is not an issue until a defect in performance has been demonstrated.
The Chancery Court's conclusion here appears right. Likely UBS was arguing that the Court should only decide the issue once it was impossible for Genesco to cure the MAC under the merger agreement which has a drop dead date of Dec 31, 2007. Here, the judge I think correctly says that issue is not ripe--if there is no MAC now there is nothing to cure.
Also, it appears that UBS has dropped its objections to being brought into the suit. It was granted intervenor status in the dispute by the Judge pursuant to the order. UBS likely asked for intervenor status in order to preserve its option under its commitment letter with Finish Line to require any litigation between the two to be in a New York court.
Finally, the Judge accepted Genesco's offer to respond to Finish Line's and UBS's information requests and set an Oct 31 hearing to discuss any further information disputes. The Judge in part stated:
Construing and applying the terms of the Merger Agreement, the Court concludes that a 77% drop in second quarter earnings from the previous year is sufficient on its face to trigger Genesco's obligation to respond to the request of the defendants to provide information about the second quarter loss in earnings in connection with the MAE provisions ofthe Merger Agreement.
I wouldn't make to much of the judge's statement about the 77%. If there is such a decline and it is sustained it would likely be MAC to the extent Finish Line was not aware of it at the time of the agreement or it otherwise wasn't excluded from the agreement. All of these are big outs. So, the Judge still has a long ways to go before finding a MAC. In this regard, retail is a highly cyclical business as a whole and the MAC clause in the merger agreement excludes out:
(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;
as well as:
(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
This dispute will now revolve in large part on what Finish Line finds during its information hunt. Even if Finish Line discovers any new information, Genesco will attempt to show that Finish Line already knew of these facts as the deal was reached a good month into the quarter Finish Line is now complaining produced a MAC. Genesco will also argue that any MAC is excluded under the exceptions above. Here, it will rely for publicity on (D) to claim no MAC has occurred. Something to the effect of "how dare you say there was a MAC when we explicitly excluded out failure to meet projections". But this exclusion does not except out the underlying changes which actually did produce the MAC. So, ultimately, to the extent Finish Line can even establish that something materially adverse occurred, Genesco will fall back on (B). In this regard, Finish Line's results were none to great this last quarter either. Bottom Line: There is still a long journey for Finish Line and UBS before they can find the facts to establish a MAC, though I will say the Judge appears open to their arguments. And they will now have the opportunity to find such facts. Ultimately, I think the argument will center on whether any adverse event is excluded by (B).
Though the incentives of the party are still strongly biased towards a settlement shortly before trial, I continue to hope for at least one MAC decision out of all of these cases. If it is a Tennessee one and not Delaware, so be it. For more on the legal arguments see my prior post here.
NB. The Judge's order also likely cures Finish Line's other claim that Genesco breached the merger agreement by failing to provide information to it as required under the merger agreement's terms.
For those who can't get ehough of this dispute click here to access Genesco's brief filed prior to the Judge's order, UBS's motion o be granted intervenor status and UBS's answer to Genesco's complaint.
As timely as ever, Nixon Peabody has their Annual MAC Survey out (you can download it here). They state:
We completed this year’s survey before the onset of the credit crisis that began in July 2007. As such, we have not reviewed agreements since that date to determine the impact the crisis will have on deal terms in general and MAC clauses in particular. However, we do believe that the credit crisis will have a chilling effect on the larger transactions and would expect that the overheated pro-seller market will cool off significantly as a result of less leverage being available to private equity buyers. Accordingly, we would expect deal terms (including the MAC provision) to become more buyer-friendly. The extent and swiftness of the change is difficult to predict and may take some time to work its way into the agreements themselves.
I'm not sure I agree with that completely. While buyers may indeed bargain harder because there are fewer deals, you will also see seller attorneys negotiating harder over MAC clauses and reverse termination fees in response to the recent problems in the market. In particular, sellers are likely to insist on more and tighter exclusions to the MAC definition and less likely to accept reverse termination fees in private equity deals (though 3Com is not a good omen for this). There is also the liklihood of a significant rework of these clauses in response to a court decision in either SLM, Genesco/Finish Line or any of the other MAC cases brewing.
It is being reported that Och-Ziff, the hedge fund adviser, set a price range of $30 to $33 a share for its proposed initial public offering of 36 million shares. When it occurs, this will be the third hedge fund or private equity fund adviser ipo after Blackstone and Fortress and marks a return of these ipos post-August market crisis. KKR is the next one on-deck, but expect more of them. I outline the reasons why in my recent paper Black Market Capital:
In my paper, I note that retail investors cannot invest in hedge funds or private equity funds but they can invest in the funds' managers. I argue that the trend of hedge fund and private equity fund adviser initial public offerings is in part due to the SEC rules which prohibit public investment in these funds. Prevented from buying the funds directly, public investors look for something replicating their benefits. The investment banks and other financial actors act quickly meet this demand, but with less suitable and riskier investment vehicles such as fund adviser IPOs, special purpose acquisition companies, business development companies, structured trust acquisition companies, and specialized exchange traded funds all of which largely attempt to mimic private equity or hedge fund returns and have been marketed to public investors on this basis. I term these investments “black market” capital since they are a product of the ban on direct hedge fund and private equity public investing. I argue that these investment 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. These are a perverse consequence of the SEC’s current prohibition. I argue that the SEC should resolve these issues by amending the securities laws to permit public investors to invest directly in private equity and hedge funds. This would recognize the costs in the current regime, end black market capital and allow investors to access the benefits of hedge funds and private equity: excess returns and diversification.
You can download Black Market Capital here.