June 16, 2007
Vacation -- Returning in One Week (Monday, June 25)
I´ll be enjoying this week off. But I´ll be returning on June 25 with more legal commentary on the pressing M&A issues and news of our time. In the interim, have a great week!
June 14, 2007
The winner of the funnest takeover rumor of the week is undoubtedly today's one that Ihop Corp. has made a $2 billion plus offer to acquire Applebee's International Inc. Applebee's current stock-market value is about $1.92 billion. (see the Bloomberg story here). The rumor is not surprising given the heated M&A rumor mill and the significant M&A activity occurring in the restaurant sector. Just earlier this week, Back Yard Burgers Inc., a southern regional burger chain, announced an agreement to be acquired by an investment consortium comprising Cherokee Advisors, Pharos Capital Group, LLC, based in Nashville, Tennessee and C. Stephen Lynn, former Chairman and CEO of Shoney’s, Inc. and Sonic Corp, in a transaction valued at $38 million.
Moreover, Applebee's in particular has come under pressure from the investor Richard Breeden. In April, Applebees settled Breeden's proxy contest for four board seats by giving Breeden and one of his nominees board seats. At that time, Applebee's also announced it had received several takeover proposals.
But enough background -- the combination is simple fun -- the nation's largest pancake house and, well, Applebee's -- which I would definitely call AHop. And think of the potential to achieve tremendous synergies and cost savings in not only pancakes (happy face and otherwise), but pork and other good old American staples. In a similar vein, Dealbreaker calls the combination Ihoppabees and has compiled a list of analysts comments much funnier than mine. Here they are:
“The merger will never go through for antitrust reasons. The resulting chain would be too American, and therefore subject to a host of patent violations."
"A combination of IHOP and Applebees would be an unstoppable force in the American suburb. People wouldn't leave, and the branches would develop into self-sufficient communities like the Arcologies in SimCity 2000 or the Bio-Dome invented by Pauly Shore or your average Wal Mart Super Center.”
“If you thought soccer moms were dangerous now or that ratings of Two and a Half Men were artificially inflated, just wait until IHOP buys Applebees. I don’t think the result will be a society any of us want to live in.”
“The last thing your inspirational high school indoor track assistant coach needs is a stack of pancakes to soak up his tears after learning that his picture made the restaurant wall. That’s what a $16 barrel of oriental chicken salad is for.”
“America is not ready for a Pancake and Riblet Platter.”
There is no humor like analyst humor. Thank you Dealbreaker for compiling it.
Revlon Duties in Negotiated Acquisitions
On the business law professor listserv, the following question was circulated yesterday:
Are Revlon duties triggered if a corporation receives a(n unsolicited) time-sensitive offer for an acquisition (say 3 days) at an obviously large premium (say twice the valuation of the corporation) and the board is convinced that there can possibly be no better deal down the line?
If indeed Revlon duties are triggered, can one say they are satisfied anyway by procedurally structuring the deal to be an arms-length transaction e.g. getting proper fairness opinion that convinces the board it is in the best interests of the shareholders to sell? Differently put, does the board have to actually seek other potential acquirers (or at least spend some reasonable time seeking) for it to discharge its Revlon duties?
The question generated a number of responses, the most comprehensive was from Professor Stephen Bainbridge, and he has kindly posted it here. It's a worthwhile read.
For what its worth on my front, the answer to the first question is almost certainly no. Revlon duties are only triggered if the board affirmatively decides to initiate a sale or break-up process. The only countervailing case law is Chancellor Allen's opinion in City Capital Assocs. Ltd. P’ship v. Inc., 551 A.2d 787, 800 (Del. Ch. 1988) where he forced a board adopting a "just say no" strategy to redeem its poison pill. See also Grand Metro. Pub. Ltd. Co. v. Pillsbury Co., 558 A.2d 1049, 1061–62 (Del. Ch. 1988). But the validity of Interco in light of Paramount and other, subsequent Delaware decisions is dubious at best. So, the board can "just say no" to the offer though it does need to consider it. Here, the board should be mindful of the procedural requisites of Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) and allow enough time for it and the company's officers to consider the acquisition and the board's financial advisors to analyze the offer. See, e.g, Weinberger v. UOP, 457 A.2d 701, 712 (Del. 1983) (finding a lack of fair dealing where corporation failed to disclose 'cursorily’ prepared fairness opinion which was brought to the board meeting with price left blank). In this case, three days time for the board to properly consider the offer and the financial advisors to prepare their required analysis is likely insufficient. A week would be more appropriate and is a time frame which has previously passed muster with the Delaware courts.
Bainbridge aptly answers the second part of the question concerning the need for a market-check under Delaware law, and so I will not address it here. I will point out, however, that in In re Pennaco Energy, Inc. S'holders Litig, 787 A.2d 691, 705-06 (Del. Ch. 2001) and In re MONY Group S'holder Litig, 852 A.2d 9, 18-24 (Del. Ch. 2004), the Delaware courts held as reasonable deal protection devices non-solicit provisions combined with >3% termination fees by equity value; and in both cases these provisions were agreed to prior to the acquiree’s solicitation of any competing offers. These holdings were effectively reconfirmed in In re Toys "R" Us, Inc. S'holder Litig., 877 A.2d 975 (Del. Ch. 2005) (upholding termination fee of 3.75% of the acquiree’s equity value and 3.25% of the acquiree’s enterprise value). And when I was in private practice, we regularly advised clients that, in light of these decisions, a no solicit and 3% break-up fee was acceptable without shopping the company pre-announcement provided an initial check was established via the mandatory fairness opinion (small comfort, but one of the last relics of Van Gorkom which effectively requires these anyway). So, in the question at hand, the board could likely agree to this deal and also agree to some rather strong transaction defenses under Delaware law without pre-announcement contact of other bidders. Of course, the board would need to negotiate a fiduciary-out, subject to these break-up fees and other transaction defenses, if a higher, competing bid emerges and is superior.
I’ve been thinking that with the rise of the go-shop, the Delaware courts might claw-back on the above, current case-law and incorporate this practitioner-driven development into its jurisprudence, particualrly the practice of certain go-shop deals to have a lower break-up fee during the solictiation period of approximately 1% of equity value. But I do not have anything in particular to stand on for this (other than my own doctrinal thoughts and some direction gleaned from the tangentially related Netsmart case (2007 Del. Ch. LEXIS 35) in which the Chancery Court held that a board breached its Revlon duties by, in the context of a go-shop, limiting its solicitation to private equity buyers and excluding strategic buyers). If anyone has any better thoughts on this, please feel free to comment.
The New Junior Investment Banker
Highlighting that even investment bankers may need to fear globalization, Merrill Lynch & Co. has announced an $11 million dollar investment in Copal Partners. Copal is an analytics and research Indian outsourcing firm which, according to the Wall Street Journal, specializes in creating "deal books" for corporate mergers and takeovers. Merrill is the third investment bank to invest in Copal along with Deutsche Bank and Citi. The three banks now own approximately 25% of Copal.
And Copal is a growth business. Founded only five years ago, it is officially based in the United Kingdom but maintains a research staff of about 540 near New Delhi. Initially focused on the business of outsourcing by investment banks of research and deal preparation tasks, Copal is now expanding into other research opportunities, including research in credit and equity, as well as starting up a consulting business. As Copal and other Indian firms grow their experienced talent base in this area, expect the investment banks to shift even more junior preparation work abroad.
June 13, 2007
Hedge Funds Good
Ivy Asset Management in conjunction with Columbia Business School released two studies today related to hedge funds. According to the press release:
The first is entitled, "Do Activist Hedge Funds Create Value", and looks a hedge fund shareholder activism. According to the study, based on nearly 800 events in the United States from 2001-2005, hedge fund activists are significantly more successful than other institutions, such as pension funds and mutual funds, in their activist efforts. Two thirds of the time they are successful in achieving their stated goals or gaining significant concessions from their target. The study finds that activist hedge funds generate above benchmark returns of 5% to 7%. Interestingly, hostile activism received a more favorable market response than non hostile activism.
The second study entitled, "Which Shorts are Informed? A Practitioners Guide", found that over 12.9% of the volume on the New York Stock Exchange was generated from short selling both large and small stocks and that this number has been increasing over the last few years. This study shows that
institutional short sellers have in fact " ... identified and acted on important value-relevant information that has not yet been impounded into price" and that within 30 days the most heavily shorted stocks did indeed change in relative price by 1.43% (19.6% annualized). In addition, the findings showed that short sellers " ... are important contributors to more efficient stock prices."
I'll add links to the actual studies once they are posted (a quick search on the SSRN found nothing). But these new studies are likely to add to the growing body of literature finding substantial beneficial micro and macro market effects in the rise of hedge funds.
"Covenant-Lite" Deals and The New York Times
The New York Times Dealbook has made posts two days in a row about the perils of "covenant-lite" deals. First, yesterday Dealbook drew parallels between the current problems in the subprime housing mortgage market and "covenant-lite" loans which banks have been providing to private equity shops. "Covenant-lite" loans do not contain the usual heavy restrictive high yield covenants which require maintenance of debt ratios and limit operations and significant transactions. Then today, Dealbook asserted that the possible problems with these loans were leading banks to distance themselves by collateralizing them in the market. Dealbook went on to report that:
Covenant-lite loans have grown to about 15 percent of bank debt outstanding, from 1 percent at the beginning of 2006, Goldman Sachs estimates. But U.S. banks hold 7 percent of the leveraged loans underwritten, compared with 30 percent or more in the mid-1990s, the report noted. Instead, institutional investors, including collateralized loan obligations, hold 75 percent of the high-yield loans, compared with 16 percent in 1995.
Investors have replaced the banks. The amount of collateralized loan obligations rose to $47.3 billion this year, up from $32.8 billion in the same period of 2006, according to S&P’s Leveraged Commentary & Data unit. Collateralized loan obligations rose to a record $47.3 million last year.
Dealbook's posts seem a bit stretched. First, the leverage loan market is populated by very sophisticated parties involving the largest banks and investment banks lending to private equity advisers, analogizing it to the subprime market with its fly-by-night lenders and mortgage brokers and lower income, unsophisticated customers is a bit tenuous. Moreover, Dealbook misses the main point. The most important figures for private equity loans are the leverage ratios and cash generated. It is only when leverage is too high and cash is not generated sufficiently that the ratio covenants truly matter. And here, the reports are indeed a bit worrisome. According to one report, average debt levels are a record 5.9 times cash flow, and debt multiples of eight or nine times are common. And according to the Wall Street Journal:
Companies that have gone private in buyouts are generating cash that exceeds their debt interest payments by just 1.7 times, versus 2.4 times last year and 3.4 times in 2004, according to Standard & Poor's Leveraged Commentary & Data. The ratio is at a 10-year low and shows how the margin for error for companies is shrinking as their profit growth is slowing.
It is in these times that covenant-lite provisions can actually help. They provide flexibility for debtors to avoid default if they enter into a riskier cash-flow situation. True, the downside is that the banks cannot take early action in case of possible default -- but more often then not tripping your debt covenants means simply paying your banks a fee for a waiver, and the banks through inspection and financial statement convenants can still obtain early warning if not take early action. And covenant lite debt provides companies greater leeway to operate more effectively, generate more income, and thereby avoid these credit crunches. Ultimately, this may lead to lower levels of default than if banks exercised early control in these situations -- the companies, after all, likely know best how to operate themselves.
Finally, the second days' point about collaterilization is a non sequitor. Any sophisticated financial institution these days collateralizes its debt as part of prudent risk management and to maintain tier capital requirements for additional loans. The fact that the collateralization rates have gone up over the years speaks to nothing other than the increasing thickness of this market and greater ability for banks to collateralize this debt. Ultimately, the jury is still out on "covenant-lite" deals and likely only to be fully assessed once more information comes in about default rates. For this, we'll have to wait for the next downturn.
Another Day, Another Asset Manager Files to Go Public
Pzena Investment Management, Inc. today filed an S-1 registration statement to go public. Founded in late 1995, Pzena is, according to its S-1, a value-oriented investment management firm with approximately $28.5 billion in assets under management. Pzena is selling Class A shares with one vote apiece; the current owners and employees of Pzena will convert their holdings in the initial public offering into Class B shares with five votes apiece. In addition and similar to Blackstone, the purchasers of Class A stock in the offering will buy shares in a holding company -- the holding company's sole interest will be shared economic ownership of the main operating company with the Class B shareholders.
The S-1 does not yet disclose the exact offering amount and percentage share of votes the Class A shareholders will acquire post-ipo. But even at this point the offering does not go as far as Blackstone's -- unlike Blackstone, the shareholders here will at least have voting rights and the 23 current Pzena owners/shareholders are not selling in the initial public offering -- the proceeds here are being used to buy-out three former employee shareholders. Since the Pzena offering is not as hot, or maybe public, as the Blackstone or Fortress ipos the Pzena owners maybe felt compelled to at least offer some enfranchisement to purchasing shareholders and maintain standard no-sale ipo practices. Still, the trend among investment management firms to offer dual class stock with low or no votes is troubling, and likely to have ramifications down the line. Given its increasing use, it may be time for the SEC to once again look at the appropriateness of this type of stock as they last did in the 1980s when they promulgated rule 19c-4 (for more on that attempt and its subsequent failure in the D.C. Court of Appeals see Bainbridge's article here). But until then, investors in these initial public offerings have been warned.
And for those who don't care Blackstone announced its ipo date today: June 25. The units will trade on the New York Stock Exchange under the symbol BX.
The SEC and Hedge Funds
I'm spending the summer researching and writing on the sometimes irrational effects of SEC regulation of hedge funds and private equity. In this vein, I'd like to recommend a recent short essay on the SEC and hedge funds by Troy Paredes, a law professor at Washington University School of Law. The article is entitled Hedge Funds and the SEC: Observations on the How and Why of Securities Regulation. Here is the abstract:
This short Essay addresses three topics on one aspect of the hedge fund industry - the SEC's recent efforts to regulate hedge funds. First, this Essay summarizes the regulation of hedge funds under U.S. federal securities laws insofar as protecting hedge funds is concerned. The discussion highlights four basic choices facing the SEC: (1) do nothing; (2) substantively regulate hedge funds directly; (3) regulate hedge fund managers; and (4) regulate hedge fund investors. Second, this Essay addresses the boundary between market discipline and government intervention in hedge fund regulation. To what extent should hedge fund investors be left to fend for themselves? Third, this Essay highlights two factors impacting regulatory decision making that help explain why the SEC pivoted in 2004 to regulate hedge funds when it had abstained from doing so in the past. These two factors are politics and psychology.
The essay is a follow-up to his longer article: On the Decision to Regulate Hedge Funds: The SEC's Regulatory Philosophy, Style, and Mission. For anyone with an interest in the SEC's repeated seemingly inexplicable attempts in this new millennium to regulate hedge funds, they are both must reads.
June 12, 2007
Ford's Historic M&A Legacy
It is being reported today that Ford Motor Co. is seeking buyers for its Premier Automotive Group (the potential deal is code-named Project Swift). The group includes the Volvo, Jaguar and Land Rover brands. Ford bought Jaguar in 1989 for $2.38 billion, Volvo in 1999 for $6.45 billion, and Land Rover in 2000 for $2.73 billion. Ford has previously agreed to sell Aston Martin to a U.K. investing consortium led by auto-racing champion David Richards for $848 million.
If it happens, the deal will be a historic one for many reasons, but for M&A history buffs it will mark closure on the first modern-day U.K./U.S. cross-border acquisition. Ford's acquisition of Jaguar plc in 1989 was made via a cash tender offer. However, unlike in other prior cross-border takeovers, Jaguar had a large shareholder presence: Jaguar’s American Depositary Securities were quoted on the Nasdaq and registered under the Exchange Act, at least 25% of Jaguar’s holders were located in the United States, and Ford itself held approximately 13.4% of Jaguar’s securities. The Ford offer was therefore required to comply with the governing takeover codes in two jurisdictions: the Williams Act in the United States and the City Code on Takeovers and Mergers and the Rules Governing Substantial Acquisition of Securities issued by the U.K. Panel on Takeovers and Mergers. According to M&A lore, the first time harmonization of the two systems was quite a nightmare and required extensive cooperation between the regulators of both nations and many a late night for lawyers attempting to coordinate the process across the Atlantic (all prior to the time of email and when phone calls were actually expensive).
But the lawyers and regulators succeeded. It was the first true cross-border acquisition and it stirred the SEC to begin a decade -long process to adopt specialized rules for cross-border takeovers culminating in the Cross-Border Release Exemptions adopted in 1999. Truly a land-mark transaction.
Why The New York Times is Not Dow Jones
The latest news on Dow Jones is that the Bancroft family has submitted to News Corp. revised proposals for the post-acquisition editorial independence of the Wall Street Journal. And the street is starting to bet on a deal: Dealbreaker's "Murdoch Meter" measuring chances of a News Corp. takeover of Dow Jones is at 85%. So, in this day of rampant M&A rumor, people are starting to wonder if this puts greater pressure on The N.Y. Times for its own sale.
At first glance they appear to be in similar situations. They both have families who exercise a controlling interest in their company through a dual class voting structure. And that voting interest is much less than their economic interest. Moreover, both companies have come under shareholder pressure to initiate a sale or other significant structural transaction. But there are significant differences.
First, let's look at Dow Jones. The Bancroft family has a controlling voting stake in Dow Jones through Class B shares but own only 25% of the economic interests. More particularly, per Dow Jones' certificate of incorporation, the family's Class B shares are entitled to ten votes each. The family exercises these votes on all shareholder matters, but the Class A shareholders (i.e., the public shareholders), voting separately as a class, elect seven of the directors. Importantly, the Bancroft family own their interests separately through a number of trusts and personally and they have no shareholder agreement among them to govern the voting or sale of their Class B shares.
Next, the New York Times. The Ochs-Sulzberger family own approximately 19% of the Company's equity mostly in the form of Class B shares. Per The New York Times certificate of incorporation, holders of Class A shares (i.e., the public shareholders) are entitled to elect 30% of the N.Y. Times board and to vote, with Class B shareholders (i.e., the Ochs-Sulzberger family), on the reservation of shares for equity grants, certain material acquisitions and the ratification of the selection of auditors. Holders of Class B shares are entitled to elect the remainder of the board and to vote on all other matters.
Accordingly, the Ochs-Sulzbergers and the Bancrofts effectively have the same negative vote on a sale of their family company, though the Ochs-Sulzbergers have a tighter effective control on The N.Y. Times. But here is the big difference; according to the N.Y. Times 2007 proxy statement, the Ochs-Sulzberger family shares are largely held in a single family trust. It holds 88% of the outstanding Class B shares. As a result, the trust has the ability to elect 70% of The N.Y. Times board and to direct the outcome of any matter that does not require a vote of the Class A shares. Under the terms of the trust agreement, trustees are directed to retain the Class B shares held in trust and to vote such stock against any merger, sale of assets or other transaction pursuant to which control of The Times passes from the trustees, unless they determine that the primary objective of the trust can be achieved better by the implementation of such transaction. Moreover, the trust is party to a stockholders agreement which restricts the transfer of Class B stock that is held by the trust by requiring, prior to any sale or transfer, the offering of those shares among the other family stockholders and then to The N.Y. Times itself at the Class A stock market price then prevailing and the conversion into Class A shares upon a sale. Similar conversion provisions apply if the N.Y. Times is acquired via a merger.
The Ochs-Sulzbergers therefore, unlike the Bancrofts, operate as a single unit. Moreover, per the Ochs-Sulzberger family trust instrument, a sale cannot be effected unless it is pursuant to the primary purpose of the trust (I couldn't find disclosure on this but assume it likely has something to do with maintaining the editorial integrity of The N.Y. Times). Finally, the Bancroft's can extract a premium for their sale of control -- something that they can legally do but politically might be hard, while the Ochs-Sulzbergers must always sell their shares at the same price as the Class A shares.
The end result is that the N.Y. Times' destiny is determined by those eight trustees of the Ochs-Sulzberger family trust and they have adamantly stated that they do not want to sell; and even if they did they would still have to determine if the acquiring entity (e.g., News Corp.) was a buyer within the parameters of the trust instrument. Compare this to Dow Jones which is controlled by a fragmented family who are not required to vote or act uniformly and have no requirements in a sale to preserve the editorial integrity of the Wall Street Journal. This is the big difference; The N.Y. Times is more bulletproof, and a sale impossible unless those Ochs-Sulzberger family trustees decide to change their minds. Unfortunately, things are not so certain for the Wall Street Journal.
FSA Announces Further Oversight of U.K. Private Equity Lending
The U.K. Financial Services Authority today published feedback to its discussion paper on private equity (download the feedback here, and the discussion paper here). In the feedback, the FSA stated that it will continue to focus on what it perceives to be the "significant risks" of private equity market abuse (insider trading) and conflicts of interest. In order to strengthen its oversight of the market, the FSA also announced increased data collection requirements. This will encompass:
- Conducting a bi-annual survey on banks' exposures to leveraged buyouts; and
- Enhancing regulatory reporting requirements for private equity firms to incorporate information on committed capital in addition to the existing requirement to report drawn down capital.
These initiatives appear to be moderate and prudent ones designed to ensure that creditors do not over-commit capital to private equity fostering a collapse similar to the one which occurred at the end of the 1980s.
Also yesterday, Treasury Assistant Secretary for Financial Markets, Anthony W. Ryan, made yet another speech warning of the systematic risks posed by hedge funds. To illustrate the problems of fat tails and outlier risk he cites the paper Thomas J. Miceli, Minimum Quality Standards in Baseball and the Paradoxical Disappearance of the .400 Hitter, Economics Working Papers, University of Connecticut (May 2005). Ryan cites the paper gor statistical information, but otherwise it is a solid paper about the problems of minimum quality standards in markets with imperfect information. Enjoy.
June 11, 2007
The Perils of "Deal Counsel" -- Metcap Securities LLC v. Pearl Senior Care, Inc.
Vice Chancellor Noble has issued an opinion in Metcap Securities LLC v. Pearl Senior Care Inc., 2007 WL 1498989 (Del. Ch., May 2007). The case concerns the perils of serving as deal counsel and highlights the potential problems with the common practice of having clients sign signature pages so that the deal can be completed in their absence.
The facts of the dispute are complicated and the opinion should be read in full to completely grasp the situation but sum into this: an entity with no assets of its own, named North American Senior Care, Inc. or NASC, was formed specifically to acquire a nursing home chain. It then retained an investment bank, Metcap Securities, and agreed to pay it a standard success fee upon completion of a transaction. NASC, along with two other acquiring entities, eventually entered into a merger agreement with a target company. Three months later, the parties agreed that the three acquiring entities would be exchanged for three other acquiring entities, who would assume the obligations of the original group of acquirers. The agreement initially required that the new group also assume Metcap's success fee. But according to the facts of the complaint, as summarized by Vice Chancellor Noble, this would soon change:
Late into the final evening of negotiation of the last set of amendments to the merger agreement, the two principals representing the original acquiring entities, who had previously delivered their signature pages to a fellow law partner, left the negotiations and went home. They gave him no instructions, limitations, or conditions on which to proceed during the negotiations. A few hours later, another partner, still negotiating the terms of the amendment, would agree to delete the merger agreement’s one reference to the financial advisor’s fee. The practical effect of this amendment was that the obligation to pay the success fee was neither assigned to nor assumed by the second group of acquirers.
Both Metcap and NASC brought suit for reformation. Metcap also brought several other claims related to its lost fee. In the part of relevance here, the Chancery Court denied a motion to dismiss NASC's cause of action to reform the contract. The Court stated:
The Complaint carefully and somewhat flimsily—but sufficiently—alleges facts that would support an inference—one that must be given in the “plaintiff-friendly” confines of Court of Chancery Rule 12(b)(6)—that, during the evening of November 20, Dickerson [deal-counsel] was somehow conflicted because of his role as “deal counsel” and the payment of his fees by Pearl (or its related entities) [Ed. Note: Pearl was the second acquirer and a defendant in the action].
Of particular note, the Court in footnote 71 continued:
The Complaint was carefully drafted with respect to Dickerson’s role. It alleges that he did not have the authority to bind NASC. It alleges that he was paid for some of his work by Pearl or its related entities. It alleges that he was “deal counsel,” but it provides no basis for gaining a full understanding of Dickerson’s role. Without an understanding of Dickerson’s actual role, it is difficult for the Court, within the confines imposed by Court of Chancery Rule 12(b)(6), to determine whether or not Dickerson had the authority to do what he did or, more importantly, whether Dickerson’s knowledge may be imputed to NASC. Because the Court must give NASC the benefit of any reasonable inference that can be drawn from the allegations of the Complaint, the Complaint must be read to suggest that Dickerson was somehow conflicted and that his conflicted status would make it improper or inequitable to attribute his conduct or his knowledge to NASC, even though the Complaint scrupulously avoids any such express allegation and that inference is far from the one most likely to be drawn from the allegations of the Complaint. Ultimately, Dickerson’s role will be a factual matter, one informed by an understanding of the ethics of the practice of law, and, if NASC has no more to offer than what has been set forth in its Complaint, its claim for reformation might fail not only because it is fairly charged with Dickerson’s knowledge, but also because it is bound by Dickerson’s conduct. NASC’s position must be something more than a whine that it did not like what its lawyer did during the final hours of negotiation of the Third Amendment. Parties to a transaction and their counsel must be able to rely—and to act accordingly—on the negotiating authority generally accorded transactional attorneys. This is especially true when the negotiations are ongoing and the principals have abandoned the negotiation field after leaving signature pages. Nothing in this Memorandum Opinion should be viewed as undercutting that dynamic. The result here is more the product of Court of Chancery Rule 12(b)(6) than it is of substantive law.
While the Court's language is comforting it still means that the case will proceed. And while the case is likely to be limited to its very complicated set of facts which I have only provided a flavor of here, it is a clear warning to lawyers of the general hazards of serving as deal counsel and the particular complications which can arise with having clients pre-sign agreements.
Endeavor and the Troubling Pursuits of SPACs
Today's DealBook has a funny/interesting post about the special purpose acquisition company (SPAC) Endeavor Acquisition, which has agreed to buy American Apparel for $385 million. Endeavor today filed the preliminary proxy for the deal and in the history of the transaction, Endeavor details its fruitless attempts to buy almost any other company. According to the preliminary proxy, Endeavor looked at the following entities before agreeing to acquire American Apparel (Endeavor presumably omitted the names to protect the innocent and as required by confidentiality agreements):
1. A branded restaurant chain with franchising operations that was headquartered in Los Angeles, California and owned by a private equity firm.
2. A well-known national chain of weight loss centers headquartered in California also owned by a private equity firm.
3. A restaurant chain headquartered in California that had strong regional brand recognition on the West Coast.
4. A regional ethanol producer headquartered in the Midwestern United States
Endeavors first three buy-out attempts were trumped by other buyers; it withdrew from bidding on the fourth potential acquisition over price. Then, according to the proxy, things got better:
In July 2006, Mr. Ledecky [CEO of Endeavor] met with Endeavor consultant Mr. Martin Dolfi to discuss deal flow. He discussed with Mr. Dolfi the philosophy espoused by Mr. Peter Lynch to “invest in what you know.” Mr. Ledecky then asked for examples of products that Mr. Dolfi used and enjoyed. Mr. Dolfi indicated that he enjoyed the clothing sold at American Apparel. As a way to reinforce the discussion, Mr. Ledecky instructed Mr. Dolfi to research the American Apparel company. Mr. Dolfi returned in August 2006 with a research book presentation on American Apparel.
And the rest is history.
SPACs have been on the rise of late as the public shareholder's substitute for private equity. But they are a poor one. As I've written before:
The rise of SPACs has been a discussion point and concern among M&A practitioners for almost three years now . . . . SPACs were big in the 1970s but fell into disfavor due to a number of high-profile implosions and complaints over the quality of their acquisitions. But like Frankenstein arisen from the dead, the Times reports that SPACs represented 26 percent of the 73 initial public offerings this year, and 15 percent of the money raised.
The rise of SPACs is a derivative effect of the private equity bubble. The Investment Company Act of 1940 effectively makes impossible the public listing of a private equity fund. And Investors shut off from private equity are turning to SPACs as a substitute. Given the past troubles with SPACs this is a dubious effect at best. There is also no real reason to permit SPACs yet shut-off private equity funds from the public markets. It is yet another reason why the SEC should take steps to fully revise the Investment Company Act to bring it into the modern era.
Today's filing by Endeavor supports my previous thoughts.
Blackstone Cashs In
Blackstone filed its fourth amendment to its registration statement today. Blackstone intends to sell approximately 133.33 million common units at between $29 and $31 per unit giving Blackstone a market cap of over $33 billion if it prices at $31 per unit. The amendment also finally discloses the size of the payday for Blackstone's founders, Stephen Schwarzman and Peter Peterson. Schwarzman, Blackstone’s chief executive officer, will receive $449 million and up to $677 million if the greenshow is exercised. Based on an offering price of $30 per unit, Schwarzman's post-ipo stake will be worth $7.7 billion and constitute a 24 percent stake in the company.
Peterson, who has announced his retirement for next year, is expected to receive $1.88 billion (no greenshoe option here -- he is going out full in the initial offering). He will retain a four percent holding. All told, the total haul for Blackstone's founders will be about $2.33 billion assuming the exercise of the greenshoe.
For those who wonder whether the Blackstone founders are cashing out at the top, the filing also disclosed that in 2006 cash distributions for the two were $398.3 million for Schwarzman and $213 million for Peterson. As for the offering itself and leaving aside whether there is indeed a private equity bubble, I wonder who would want to buy these non-voting interests in Blackstone at a time when one of the founders is leaving and cashing in and the other is pocketing a significant stake and monetizing the remainder. At least with internet ipos, the founders had to wait 180 days to sell and offered their shareholders a vote in the operation of the company. Caveat Emptor.