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Thursday, December 13, 2007

SLM -- Mistakes Were Made

The SLM saga trended towards farce yesterday when SLM issued a press release stating:

To address recent reports in the marketplace regarding the proposed buyout of Sallie Mae by a group led by J.C. Flowers, Bank of America and JP Morgan Chase, the company's Board of Directors states the following:

-- Over the past eight weeks, in a series of discussions between the company and senior representatives of the Flowers group, Sallie Mae has indicated that, to resolve the dispute between the parties, the company offered to consider an alternative transaction with the Flowers group, and to give them the opportunity to update their due diligence and submit a new proposal to acquire the company with no pre-conditions.

-- The buyer's group has indicated to Sallie Mae that it does not wish to pursue these opportunities.

-- The Board remains committed to protecting the rights of our shareholders, and will pursue all available recourse, including the company's existing lawsuit against the buyer's group.

-- The company has indications of interest, subject to customary terms and conditions, from 10 financial institutions for new secured warehouse funding significantly in excess of $30 billion.

Reading through this press release, I believe that SLM went back to the Flowers group and expressed its willingness to accept a reduced price in light of SLM's continuing deteriorating financial position. The Flowers group rejected this proposal.  This is something I would also do -- the Flowers group is likely waiting for SLM to stabilize if it indeed wants to still pursue this transaction -- and the bottom does not seem quite there yet.  And, in any event, financing this transaction to the extent it would be renegotiated would be quite difficult in today's credit market -- SLM's statement about no pre-conditions would likely not have permitted any large financing outs.  A few other observations:

  • SLM clearly made a mistake refusing to accept the Flower's Group October proposal to reduce the consideration to $50 a share plus a likely valueless warrant given SLM's relatively weak position that a MAC did not occur.  They should have realized this at the time and the fact that they didn't is attributable either to 1) bad-decision-making by Albert L. Lord, the executive chairman of the board at SLM and the other executives at SLM, and/or 2) bad advice from their advisors.
  • Under either explanation, I doubt Lord and the CEO of SLM, C.E. Andrews, can survive.  Whether or not they received bad advice, they have presided over the destruction of billions of dollars of shareholder value -- money that did not have to be lost.  Lord in particular appears to have been responsible for the "no-compromise" October strategy. 
  • I hesitate to blame the advisors here -- one scenario is that they provided SLM the right advice and Lord and the other executive officers at SLM ignored it.  Not a great situation to be in and perhaps a lesson in dealing with head-strong? executives. 
  • By returning to the Flowers group to suggest a reworking of the transaction, SLM is essentially now admitting that a MAC occurred due to the October legislation. 
  • SLM arguably did not have to release the above information.  I suspect that they are doing so in order to set up a de minimis settlement announcement in the near future (i.e., $25-$50 million).

Finally, SLM yesterday also announced another expected decline in earnings:

The company is lowering its 2008 core earnings EPS guidance from $3.25 to a range of $2.60 to $2.80 due primarily to increased costs from replacing the company's interim funding facility.

For those who are wondering if this is further evidence of a MAC, the percentage decline would likely qualify but if it is indeed related to a one-time event it would unlikely be a MAC under IBP v. Tyson which requires a MAC to be of a long-term, durational nature.  The MAC might also be excluded under the MAC exclusion in the merger agreement for changes in the industry of SLM generally.  It states: 

(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;

Note that in clause (b) of the MAC -- the exclusion for changes in Applicable Law -- the merger agreement speaks of changes effecting companies in the education finance industry, so under (e) we are talking of a wider sub-set of financial institutions in the consumer credit business generally.  Whether SLM's results are worse than these other institutions I am not sure, but the industry is certainly not doing well. 

Finally, remember that if the Flowers Groups was required to close when it first declared a MAC, any subsequent events vould not be used to support a MAC claim -- so if the first MAC declaration was invalid (unlikely), then this deterioration arguably would not matter to the extent the SLM transaction would have closed before this time.  This I am unsure of since the transaction was still waiting for clearance to transfer SLM's Utah bank at the time of Flower's MAC declaration and this could have delayed things through now. 

SLM closed yesterday at $28.49 a share.  As we say in the law in the tort context, res ipsa loquitor

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