September 28, 2007
Mistakes M&A Lawyers Make (A Continuing Series)
On Wednesday Fremont General Corporation, the savings and loan and former sub-prime mortgage lender, announced that it has been advised by Mr. Gerald J. Ford that "he is not prepared to consummate the transactions contemplated by the Investment Agreement entered into on May 21, 2007 among the Company, FIL and an entity controlled by Mr. Ford on the terms set forth in that agreement." The Investment Agreement provides for the acquisition by an investor group led by Ford of a combination of approximately $80 million in exchangeable non-cumulative preferred stock of FIL and warrants to acquire additional common stock of Fremont. Fremont stated that the reason for Mr. Ford's new-found hesitance was "in light of certain developments pertaining to the Company and FIL." Well, that is helpful disclosure. But, I surmise that this could be another material adverse change case, and that is how it is being spun in the press.
Our starting point on these things, as always, is the MAC clause itself which is defined in the Investment Agreement as follows:
“Material Adverse Effect” means any material adverse effect on the retail deposit business or financial condition of the Company and its Subsidiaries taken as a whole; provided, however, that none of the following shall be deemed to constitute or shall be taken into account in determining whether there has been a “Material Adverse Effect”: any event, circumstance, change or effect arising out of or attributable to (a) any decrease in the market price of the Common Stock (excluding any event, circumstance, change or effect that is the basis for such decrease), (b) any changes in the United States or global economy or capital, financial or securities markets generally, including changes in interest or exchange rates, (c) any changes in general economic, legal, regulatory or political conditions in the geographic regions in which the Company and its Subsidiaries operate, (d) any events, circumstances, changes or effects arising from the consummation or anticipation of the transactions contemplated by this Agreement or the Sale Transactions or the announcement of the execution of this Agreement or the announcement of the Sale Transactions, (e) any events, circumstances, changes or effects arising from the compliance with the terms of, or the taking of any action required by, this Agreement, (f) any action taken by the Company or any of its Subsidiaries at the request or with the consent of the Investor, (g) any litigation brought or threatened by the stockholders of the Company arising out of or in connection with the existence, announcement or performance of this Agreement or the transactions contemplated hereby or the Sale Transactions, (h) changes in law, GAAP or applicable regulatory accounting requirements, or changes in interpretations thereof by any Governmental Entity, (i) any outbreak of major hostilities in which the United States is involved or any act of terrorism within the United States or directed against its facilities or citizens, wherever located, (j) earthquakes, hurricanes, floods or other natural disasters, (k) a failure by the Company to report earnings or revenue results in any quarter ending on or after the date hereof consistent with the Company’s historic earnings or revenue results in any previous fiscal quarter, including any failure to file with the Commission audited or unaudited financial statements for the year ended December 31, 2006 or any subsequent period, (l) any loss, liability or expense arising out of or relating to the contractual rights of third parties relating to the sale of residential mortgage loans prior to the date of this Agreement, or (m) any matter set forth in Section 1.1(a) of the Company Disclosure Schedule, except in the case of the foregoing clauses (i) and (j), to the extent such changes or developments referred to therein would reasonably be expected to have a materially disproportionate impact on the retail deposit business or financial condition of the Company and its Subsidiaries, taken as a whole, relative to other industry participants or enterprises (solely with respect to clause (i), located in the same geographic region as the Company and its Subsidiaries).
First off, read exclusion clause (m). As an initial matter, placing exclusions in the Disclosure Schedule from the MAC clause is a pet peeve of mine. Since disclosure schedules are not publicly disclosed this allows the parties to maintain these items as confidential. But the practice may in some cases violate the federal securities anti-fraud rules. This is because the merger agreement is considered by the SEC to be public disclosure; Fremont is therefore liable for material omissions -- and these non-disclosed items on the disclosure schedule may arise to that. Whether they do or not we don't know since we can't see them, but the fact that Fremont didn't want them disclosed is telling. Fremont's lawyers would do well to read this article which describes the SEC enforcement case against Titan Corp. on grounds of non-disclosure of items in the disclosure schedule.
More importantly, after exclusion (m) there is a qualifier for clauses (i) and (j). This qualifier states that these exclusions do not count: "except in the case of the foregoing clauses (i) and (j), to the extent such changes or developments referred to therein would reasonably be expected to have a materially disproportionate impact on the retail deposit business or financial condition of the Company and its Subsidiaries, taken as a whole, relative to other industry participants or enterprises (solely with respect to clause (i), located in the same geographic region as the Company and its Subsidiaries)." First, note that unlike SLM, here the lawyers negotiated a materiality qualifier to the requirement of disproportionality. Gold star for that one. But, now read clauses (i) and (j). These clauses deal with an outbreak of hostilities or natural disasters. It is hard to believe that the parties wanted these exclusions to be qualified by disproportionality. For example, under the clause as drafted, any earthquake that effected Fremont materially and disproportionally is still a MAC? It can't be.
This appears to be a mistake by the lawyers on the deal -- Skadden and Gibson, Dunn. Instead, the qualifier was likely meant to qualify clauses (c) and (d) which address industry events. This would be the standard qualifier to these exclusions; the ones where a disproportionality standard is typically applied. I didn't see any amendment correcting this "mistake". The result is to make the MAC much tighter than desired by Ford. Be careful out there folks -- these mistakes do matter, significantly.
Addendum: I haven't looked more particularly at the facts of the Frontier case, but note that this is a very tight MAC without a forward looking element and with wide exclusions, including an exemption from the MAC clause for a failure to meet projections and for a failure to file audited and unaudited financial reports. If Ford is indeed proclaiming a MAC, it will have to be an event which has already occurred and is particularly adverse and unique to Frontier to be sustained. Nonetheless, in its press release Frontier may be admitting that such an event has indeed occurred by its willingness to negotiate with Ford for new terms.
Of course, this all assumes that it is indeed the MAC clause upon which Ford is basing his claims that he is not required to close the transaction. Stay tuned.
Finish Line's MAC Claim?
Earlier this week, Finish Line issued the following press release in response to Genesco's Tennessee lawsuit to force Finish Line to complete its agreed acquisition of Genesco:
The Finish Line has complied with its obligations under the merger agreement, and as previously announced, continues to work on the closing documents. In that regard, The Finish Line has asked Genesco for certain financial and other information as well as access to Genesco's Chief Financial Officer and financial staff. However, to date Genesco has not responded to and has refused to comply with these requests. These failures constitute a breach of the merger agreement, and The Finish Line is today notifying Genesco of same. We regret that Genesco has chosen to initiate litigation. We are reviewing the Genesco lawsuit and will take the necessary steps to protect the interests of The Finish Line and its shareholders. We have no further comment at this time.
Notice anything interesting about the press release? Nowhere does Finish Line mention a material adverse change. Instead, the breach that Finish Line is talking about is a failure to receive relevant information. Here, it is following the lead of UBS which has also been demanding information about Genesco to make a determination if a MAC occurred. It thus appears that Finish Line's response to Genesco's suit is going to be along the lines of: "We think a material adverse change occurred, but we can't tell because Genesco is not giving us the information we need". Most likely this speaks to the current strength of their MAC claim. As I detailed in a previous post, based on public information it does not appear that Finish Line has a strong case here for a MAC. This agreement, though, is governed by Tennessee law and this analysis depends on the Tennessee court adopting a Delaware analysis, something it is likely but not certain to do. There is no case law currently on MACs in Tennessee. Shame on the lawyers for negotiating a choice-of-law clause that provided no certainty on an important issue.
The other interesting thing about this deal is that Finish Line is really stuck between a rock and a hard place right now. There is no financing condition in the deal, so to the extent UBS is also trying to back out of financing this transaction, Finish Line could be left in a really bad position. In fact, Finish Line may be acting right now to make a MAC claim because of UBS's actions more than its own position. Because of this, I expect Finish Line to answer the Genesco complain by attempting to implead UBS (that is, bring them in as a party to the suit). This will allow all of the legal obligations of the unhappy trio to be resolved in one court, and Finish Line to avoid the catastrophy of being forced to close the Genesco deal without financing firmly in place.
Ultimately, both Finish Line and UBS are buying time for the credit markets to firm up and the results of Finish Line (who reported earnings yesterday) and Genesco to improve. While Genesco is talking a strong game, the incentives are to settle a case like this for a lower renegotiated price, as in the Lone Star/Accredited Home Lenders case. A board simply does not want to take the risk of a completely broken deal. And a renegotiation will requires a new Genesco shareholder vote which would push the deal out into January, buying more time for Finish Line and UBS. As with most other MAC cases this is likely to settle.
NB. In Section 8.1(d) of the merger agreement there is a twenty business day cure period for Genesco to the extent it actually is breaching the agreement for failure to provide this information.
September 27, 2007
10 or So Questions for Harman
Harman International is having an investor conference call today at 4:30 p.m. EDT on September 27, 2007. Those who wish to participate in the call should dial (800) 398-9379 (US) or (612) 332-0107 (International), and reference Harman International. Of course, everyone will want to ask questions on the call about the state and unraveling of Harman's deal to be acquired by KKR and Goldman Sachs Capital Partners. Harman's investor friendly response:
In light of matters disclosed in the Company's September 21, 2007 press release, Harman's management cannot accept questions about the proposed merger with affiliates of Kohlberg Kravis Roberts & Co. L.P. and GS Capital Partners VI Fund, L.P.
Re-establishing investor credibility is hard enough in the wake of a failed acquisition transaction and the yet to be defined claims of a MAC here. Harman is not doing themselves any service with this prohibition. I'm not going to be able to make the call, but for those on it, I would ask the following questions (irrespective of Harman's caveat).
- In your press release Dr. Sidney Harman referred to KKR and GSCP as your "former merger partners". What is the status of your merger? Has it been terminated?
- What are the facts underlying KKR's and GSCP's claim that a material adverse effect occurred?
- The Wall Street Journal also reported that you may have breached the requirements in the merger agreement related to limits on capital expenditures. Is this true?
- IF KKRs and GSCP's claims are not true, why have you not initiated litigation to obtain the reverse termination fee of $225 million from them?
- You issued your Form 10-K on Aug. 30. Why did it not contain the new guidance released on Sept 24?
- Why do you believe this failure to disclose until then did not violate the federal securities laws?
- If you weren't fully aware of these developments until now, what explains the substantial delay in filing the proxy statement and registration statement for this transaction?
- When did you first know that GSCP and KKR were claiming a MAC and/or breach of the merger agreement?
- If it was prior to last week, why did you not disclose it? Why did this not violate the federal securities laws?
- Was your Board fully informed by your lawyers at Wachtell of the consequences of agreeing to this reverse termination fee of $225 million?
By the way, the Wall Street Journal report that Harman breached its cape ex covenants in the merger agreement is hard to believe. This covenant simply limits the amount Harman may spend on cap ex and is therefore quite easy to follow. I believe that if Harman did indeed breach this covenant it would be not only surprising but grossly negligent.
SLM: The Legal Case (Redux)
The dispute between SLM Corp. and its potential acquirers, J.C. Flowers & Co., Bank of America and JPMorgan Chase, went very live yesterday when SLM issued a press release stating:
SLM Corporation, commonly known as Sallie Mae, announced today that it has been informed by a representative of the buyer group led by J. C. Flowers, Bank of America and JPMorgan Chase that the buyer group does not expect to consummate the acquisition of Sallie Mae under the terms of the merger agreement. Sallie Mae firmly believes that the buyer group has no contractual basis to repudiate its obligations under the merger agreement and intends to pursue all remedies available to it to the fullest extent permitted by law.
Additionally, Sallie Mae noted the following: In response to Congress’ passage of the College Cost Reduction and Access Act of 2007 (the “Act”) and President Bush’s expected signing of the Act tomorrow, Sallie Mae has measured the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K and concluded such changes would reduce “core earnings” net income, between 1.8 percent and 2.1 percent annually over the next 5 years, using business assumptions it has shared with the buyer group.
Translating this press release, the Flowers consortium is likely claiming that the new legislation constitutes a material adverse change to SLM and that consequently it is no longer required to complete the acquisition. Clearly, the Flowers consortium is, at a minimum, posturing for a price renegotiation. As such, SLM's statement is similar posturing to push through the deal.
To determine if either argument is valid, the starting starting point is the merger agreement and its definition of MAE:
"Material Adverse Effect” means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: (a) changes in GAAP or changes in regulatory accounting requirements applicable to any industry in which the Company or any of its Subsidiaries operate; (b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; (c) changes in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic, business, regulatory, political or market conditions or in national or global financial markets; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (d) any proposed law, rule or regulation, or any proposed amendment to any existing law, rule or regulation, in each case affecting the Company or any of its Subsidiaries and not enacted into law prior to the Closing Date; (e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (f) public disclosure of this Agreement or the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement; (g) any change in the debt ratings of the Company or any debt securities of the Company or any of its Subsidiaries in and of itself (it being agreed that this exception does not cover the underlying reason for such change, except to the extent such reason is within the scope of any other exception within this definition); (h) any actions taken (or omitted to be taken) at the written request of Parent; or (i) any action taken by the Company, or which the Company causes to be taken by any of its Subsidiaries, in each case which is required pursuant to this Agreement.
The first issue is the most important -- whether SLM has even experienced a MAC. Here, the agreement is governed by Delaware law. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC. Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant. SLM stated yesterday that the new legislation will reduce "'core earnings' net income, between 1.8 percent and 2.1 percent annually over the next 5 years." The press release is too tightly, and maybe cleverly, drafted for me. After reading it three times, I'm still not sure what "core earnings" net income is nor am I sure whether SLM is stating that this is the total decline or only the decline compared to the Act’s adverse changes versus the impact of similar legislation described in the company’s SEC Form 10-K. But perhaps, I am missing something.
In any event, the test of a MAC is quite fact dependent and looks at the effect on the entire company, and so a significantly adverse decline in revenue or earnings as a whole should theoretically suffice. So, there may be more here that SLM is not currently disclosing which may substantiate a MAC claim. By the way, for those wondering how bad it has to be to be "materially significant", I wish I could give you a definitive answer -- there is little case-law on this, but the practitioner rule of thumb is generally a 10% decline in income would be a MAC. Though some will tell you that the GAAP measurement of 5% is good enough -- there is just not enough case-law on this and it is sometimes conflicting. Compare Pan Am Corp. v. Delta Airlines, Inc., 175 B.R. 438, 493 (S.D.N.Y. 1994) (holding that significant deteriorations of business performance and business prospects – declines of 20% to 40% in advance bookings – constituted a MAC) with Polycast Technology Corp. v. Uniroyal, Inc., 792 F. Supp. 244, 253, 274 (S.D.N.Y. 1992) (deciding that the cancellation of a major profitable customer contract is arguably a MAC). It is clear, though, that IBP and Frontier have set a high bar for proving a MAC. This may be the case here with SLM -- though they have yet to release what the total impact of this new legislation is on them -- a telling non-disclosure.
However, if the Flowers consortium can prove a MAC there is still the matter of the highlighted carve-outs above. On these, expect SLM to argue the following:
- The new legislation is not, on the whole, more adverse than described in its 10-K (exclusion (b)); and
- The change is to the financial services industry generally and is not disproportionate to SLM (exclusion (e)).
In these two carve-outs the parties agree that these events do not constitute a MAC even if they are a materially adverse change. The interesting thing here is that these are not qualified by "materiality". So, the Flowers consortium will likely argue that it need only prove that the change is materially adverse to the company and is either adverse (in the case of 1) or disproportionate (in the case of 2) in any amount to SLM. A cent of adverseness or disproportionality would arguably work here, and SLM has previously admitted there is an adverse impact over and above the matters disclosed in (b) and appears to be doing so in yesterday's press release as well. [Also, note the exclusion in (e) -- it specifically excludes changes excluded from clause (b) under the proviso]. Ultimately, this is again a fact-based determination, but it appears that Flowers has a bit of a way to go here to prove a MAC though it is very much helped by the lack of materiality qualifiers in the carve-outs, and SLM's admissions with respect thereto. And, Flowers has the virtue of being able to highlight the highly negotiated MAC on this point which clearly contemplated this event -- since here it appears that the legislation is worse than expected, Flowers will argue this is exactly what they negotiated for.
And as I stated two weeks ago:
All of this may not matter much as the Flowers consortium also has a walk-away right under the agreement if it pays a reverse termination fee of $900 million dollars. This changes the negotiating position of the Flowers group substantially. Expect them to attempt to preserve their reputation for not walking from deals by publicly proclaim a MAC has occurred, but privately claim that the deal calculus now makes it more economical to walk. The consortium will find encouragement from their bankers who may also now find it more economical to simply pay or share the reverse termination fee with the buyers. This would be a similar renegotiation that occurred in Home Depot's sale of its supply business which ended with a cut of eighteen percent in the deal price.
Reading tea-leaves, I would expect Flowers to use the reverse termination fee and colorable MAC claims to negotiate some form of price cut. But, as with most MAC renegotiations, expect it to happen behind closed doors. Any renegotiation will require a new shareholder vote, so even if there is a renegotiation there will not be a closing in the immediate future.
My prediction still stands, and appears to be coming to pass. However, I would say that litigation over this deal is now more likely than a price renegotiation given the passage of time and continuing failure of the parties to reach an agreement. Remember, if there is any litigation it will not be over whether the deal should be completed but whether a MAC does or does not exist. If it does, the Flowers consortium is not required to complete the deal. If it does not, Flowers is still not required to complete the deal. Rather, the only recourse of SLM is to collect the $900 million dollars and the parties to go their own way or agree to a renegotiated deal, if the Flowers consortium is willing.
As a law professor, I'm rooting for such litigation as the additional case-law will give more definition under Delaware law to what does constitute a MAC and may resolve issues concerning how "disproportional" the MAC change must be under the fairly standard industry exclusions above -- a question which was also at issue in Lone Star/Accredited Home Lenders.
Addendum: One further point -- SLM will also argue that Flowers already knew of the possibility of this legislation at the time of the agreement and accepted that risk. Here they will be relying on the disclosure in the merger agreement and disclosure schedules as well as its public filings but also invoking the spirit of Bear Stearns Co. v. Jardine Strategic Holdings, No. 31371187, slip. op. (N.Y. Sup. Ct. June 17, 1988), aff’d mem., 533 N.Y.S. 2d 167 (App. Div. 1988) which held that a bidder for 20% of Bear Stearns could not rely on MAC to avoid contract despite $100 million loss by Bear Stearns on Black Monday, October 19, 1987 and the first quarterly loss in Bear Stearn’s history. The buyer knew that Bear Stearns was in a volatile cyclical business. In short, the Flowers consortium knew what it was getting into here. But then again clause (b) was clearly meant to address this issue.
Final Conclusion: A number of people emailed me today to ask what my ultimate conclusion was. Well, this is a very fact-dependent analysis and we do not have all the facts, but, I think Flowers has a good case here that a MAC occurred particularly since this issue was so highly negotiated and accounted for in the MAC and what is happening now appears to be worse. Certianly, their case is no slam dunk, but I believe they have enough of a claim to push through a renegotiation of the price if they want. This is a risk which Flowers et al. can more easily take given that their liability is limited to $900 million if they are wrong. So, I once again predict a renegotiated, lower price.
September 26, 2007
On Hiatus Today
I'll be back Thursday.
September 24, 2007
Accredited Home Lenders: The Anatomy of a MAC Negotiation
Accredited Home Lenders filed the 16th amendment to its recommendation statement on Schedule 14D-9 yesterday. The document is a must read for all M&A lawyers as it details the history of the behind the scenes negotiations MAC settlement between Accredited Home Lenders and Lone Star. Among the tid-bits are:
- On August 29th, Lone Star offered to settle the litigation for $10.50 and Accredited Home Lenders countered with a revised deal at $11.33. This deal was rejected by Lone Star who the next day made a public offer for $8.50 a share. NB. The ultimate settlement between Lone Star and AHL was for $11.75!
- During the last 40 days, AHL was approached by a third party buyer. On Sept. 5, AHL requested "permission" from Lone Star to explore this approach and Lone Star informed AHL on Sept. 7 that any consent from Lone Star should be considered as part of an overall settlement of the Delaware Litigation. No further disclosure is made on this third party offer.
- Bear Stearns refused to provide an updated fairness opinion to AHL because Bear viewed any decision by the AHL board to enter into a restructured transaction at a reduced offer price as a settlement of litigation. The AHL Board ultimately hired Milestone Advisors to provide a financial opinion for $450,000. Bear Stearns was probably right to do this; AHL was better off hiring an advisor more sophisticated in these types of valuation (though I have never heard of Milestone so I am not sure if they are indeed so experienced). Although looking at Milestone's analysis they did not value the litigation but instead conducted a transaction premium and a comparable company analysis -- a bit absurd and highlighting the manipulability of fairness opinion analyses. Another explanation for Bear's refusal is that AHL and Bear could not agree on compensation for this second opinion.
- On Sept. 13, Lone Star increased its offer to $11.75 above the $11.33 originally offered by Lone Star and a raise from its $10.50 offer made on Aug 29 (subsequently reduced to $8.50).
So, this leads to the interesting question of how did AHL get Lone Star to raise its offer from $8.50 to $11.75 and above $11.33 in one meeting on Sept 13? I would have loved to have been a fly on the wall at that one. And ultimately, the AHL/Lone Star history points to an important commonality about MACs -- negotiation during these times is often constant but kept private as the parties struggle to assess risks and settle in a manner that reduces such risk and allocates the losses against the background of the uncertainty of a MAC litigation. The back and forth between AHL and Lone Star once again prove this point.
Thanks to the reader who pointed all of this out.
First Data Closes
The press release can be accessed here. While some will find this an encouraging sign for the bigger private equity deals still to clear, remember that Wall Street is getting filled up these days with side-tracked, troubled and collapsed M&A deals, including:
- Harman/GS-KKR (collapsed);
- Genesco/Finish Line (in litigation; claimed MAC);
- Reddy Ice/GCO (substantial financing problems);
- PHH Corp/GE-KKR (substantial financing problems);
- MGIC/Radian (terminated);
- Sallie Mae/Flowers et al (claimed MAC);
- Acxiom/ValueAct Capital Partners & Silver Lake Partners (troubled);
- The Tribune Co./Zell (troubled);
- Penn National Gaming/Fortress (troubled);
- United Rental/Cerebus (troubled);
- Myers/GSCP (troubled);
- Guitar Center/Bain Capital (troubled);
- Manor Care/Carlyle (troubled);
- ABN Amro/Barclays or RBS (troubled);
And this list doesn't include the Home Depot supply business and Accredited Home Lenders acquisitions both of which have been renegotiated. Obviously, some of these deals are less troubled than others, and I believe most are still likely to close, but still, this is a long list. It is going to be a busy Fall (and Winter as these deals get pushed back) despite First Data's successful conclusion.
Addendum: I define a deal as troubled for these purposes if it material information has been disclosed to the market that indicates this or otherwise it is trading at an abnormal discount to its deal premium.
The Foreign Delisting Wave
Dealbook today has a post today on the rise in delistings by foreign issuers. The post quotes a USA Today story and states:
Big foreign companies, mostly from Europe, are saying non, nein and nee to being listed on U.S. exchanges.
A surge of foreign companies are bidding adieu to U.S. markets and their American depositary receipts, as lackluster trading in many foreign listings and a feeling the costs of having a stock listed in the U.S. aren’t worthwhile have dampened enthusiasm. . . . Already this year, 34 foreign companies have delisted from the New York Stock Exchange, and nine more have announced they plan to do so, says the exchange. That tops the 21 foreign companies that have joined the N.Y.S.E. Another 20 have said this year they plan to leave the Nasdaq or have done so already.
However, as I stated back on May 30 don't believe that this is a sign that the U.S. markets are losing their status as the premier place for foreign listings. Though they may indeed be losing their status though, this delisting wave is just caused by other reasons. As I stated:
Expect to see more announced delistings from U.S. stock markets by foreign issuers in the next few weeks. This is because the SEC's new rules liberalizing the ability of foreign issuers to deregister their securities and terminate their reporting requirements under the Exchange Act take effect on June 4. Prior to this rule, the Exchange Act was a lobster trap -- deregistering equity securities and terminating or suspending reporting requirements once these securities had been registered was prohibitively difficult if not impossible. Now, under the SEC's new rules if the average daily U.S. trading volume of a foreign issuer is 5 percent or less of its worldwide trading volume it can freely deregister and terminate its Exchange Act reporting requirements. To do so, however, the foreign issuer must also delist its securities from the U.S. stock market (i.e., Nasdaq or NYSE).
So, the new rules will release pent-up demand of foreign issuers who previously desired to deregister their securities and now do so. Most if not all of these issuers will cite Sarbanes-Oxley to justify the termination of their listing. But don't always believe it. These issuers originally listed in the United States for a variety of reasons, and for many a delisting will simply mean the reasons no longer exist (and probably haven't for a long time). For example, many a foreign high-tech company listed on the Nasdaq during the tech bubble seeking the extraordinary high equity premium accorded Nasdaq-listed tech stocks. Post-crash, many of these foreign companies still exist but are much smaller or have remained locally-based and a foreign listing is no longer appropriate for them.
All-in-all, though, the rules are a step in the right direction. Permitting foreign issuers to more freely delist will encourage them to experiment with a U.S. listing in the first place. The SEC would also do well to take the next step and consider whether all foreign listings need to be regulated at the current level. Does the SEC really need to regulate ICI [a company listed on the LSE who recently announced a delisting from the U.S.] to begin with? It is, after all, regulated by the FSA and LSE in England. A form of mutual recognition system for issuers listed in foreign countries who provide an acceptable level of regulation would go a long way to making the U.S. more competitive in the global listings market. It would also provide greater access for U.S. investors to foreign investments. Both good things.
For more on this see my forthcoming article Regulating Listings in a Global Market.
September 23, 2007
The Mystery of Harman
The Harman deal collapsed spectacularly on Friday. It began with a morning Wall Street Journal story reporting that KKR and Goldman Sachs Capital Partners had soured on their $8 billion purchase of the audio equipment maker. The story reported that KKR & GSCP were trying to claim a material adverse change and otherwise were going to walk from the deal. The Journal correctly noted that KKR and GSCP could simply break their commitments to acquire Harman by paying a reverse termination fee of $225 million. Perhaps most interestingly, the WSJ also reported that "KKR has solicited some of the lending banks to help pay part of that fee, said one person familiar with the matter, but the banks have resisted the effort."
Later in the day just before market close, Harman issued a press release stating:
Harman International Industries, Incorporated (NYSE:HAR - News) announced that it was informed this afternoon that Kohlberg Kravis Roberts & Co. L.P. (KKR) and GS Capital Partners VI Fund, L.P. (GSCP) no longer intend to complete the previously announced acquisition of Harman by a company formed by investment funds affiliated with or sponsored by KKR and GSCP. KKR and GSCP have informed Harman that they believe that a material adverse change in Harman's business has occurred, that Harman has breached the merger agreement and that they are not obligated to complete the merger. Harman disagrees that a material adverse change has occurred or that it has breached the merger agreement.
KKR's and GSCP's MAC claim came as a complete surprise to the market. Harman had filed their annual report on Form 10-K on Aug 29. At the time, it did not appear to have disclosed any materially adverse change with respect to Harman. Moreover, although Harman's second quarter results declined and were below expectations, if there was a further marked deterioration thereafter in July or August Harman was required to disclose it in their Form 10K. But they didn't -- I am therefore unable to see any information in the public domain which substantiates a MAC (please correct me if my conclusion is wrong). I surmise from this that the KKR consortium has soured on this deal for other than financial reasons, perhaps strategic or management related. This conclusion is buttressed by the WSJ news report that the bank didn't want to participate in funding the reverse termination fee. If there were financial problems, you would think the banks would have lunged head first to get out of this deal as with Home Depot, Genesco, PHH, etc. Of course, the information in the Journal could have been planted by the banks -- who knows? In short, the whole thing is a mystery right now -- we need more information.
More importantly, it is not even worth much to go into whether KKR's claim is true (although for those interested I have an analysis at the end here). This is because the Harman/KKR merger agreement has a reverse termination fee and the contract specifically excludes specific performance. This limits KKR's and GS's damages in case of any breach of the agreement to $225 million or 2.7% of the transaction value. Can everyone see why this is different than Accredited Home Lenders/Lone Star and Genesco/Finish Line? There, there was/is no reverse termination fee. So, AHL and Genesco can sue for specific performance and completion of the deal. If Finish Line loses (or Lone Star had lost) they would have been required to complete the deal. Here in Harman, the only issue is over the measly $225 million. If KKR and GS prove a MAC occurred then they do not have to pay it and can walks; if they can prove it then they pay nothing and can walk(except the substantial commitment fees in their financing letters). This deal is dead -- there is no chance of salvaging it -- the only issue is if Harman gets $225 million. And that is one of the reasons why Harman's stock cratered on the news on Friday. It is also why these reverse termination fees are so pernicious in their effects.
So, ultimately, given the lack of information substantiating a MAC, KKR and GSCP may be claiming a MAC almost solely to protect their reputational capital. They do not want to appear to be walking on the deal so are asserting an ostensible claim of a MAC. This provides cover for them so that they do not appear to be the type of buyers who break deals; in short they remain the good guys. But still, there must be something wrong in this deal, given that KKR and GSCP would be willing to walk here, possibly lose reputational capital (for those who see through their MAC claims if indeed they are unsubstantiated) and risk paying the $225 million and losing their commitment fees. Again, what is wrong is a mystery, and yet another reason why Harman's stock price fell so far on Friday -- the market hates uncertainty.
NB. One of the interesting things about this deal was the equity participation right that shareholders had to retain an interest in Harman once it was acquired by KKR & GSCP. At the time, I hailed this structure, stating:
I've blogged before about the perils of management participation in private equity buy-outs. Their participation is likely to give an undue and trumping head start to their chosen private equity firm(s) due to management's head-start, superior information and ability to (unduly) influence the acquisition process even when a special committee is present. To ameliorate this problem, special committees have been negotiating "go-shops" like the one here [in Harman]. . . . But investors have increasingly come to see "go-shop" provisions as cover for unduly large break-up fees and the significant advantage and head-start provided by management participation. . . . . the shareholder participation feature [in Harman is therefore] encouraging. It gives shareholders a real option to participate in what may be seen as a management cash-out. It may be a good solution to some of the problems with management/private equity partnered buy-outs. . . .
Unfortunately, the problem of unintended effects arose here. The registration statement for the stub equity is a document which must be prepared by KKR and GSCP. Thus, the inclusion of this stub equity provided KKR and GSCP the ability to control the timing of the transaction to a greater extent than usual and pushed out the timeline no matter what in order to permit time to prepare this registration statement. This ultimately worked against Harman and its shareholders.
Addendum: MAC analysis
Material adverse change in Section 3.01 of the Harman merger agreement is defined as:
“Company Material Adverse Effect” means any fact, circumstance, event, change, effect or occurrence that, individually or in the aggregate with all other facts, circumstances, events, changes, effects, or occurrences, (1) has or would be reasonably expected to have a material adverse effect on or with respect to the business, results of operation or financial condition of the Company and its Subsidiaries taken as a whole, or (2) that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger, provided, however, that a Company Material Adverse Effect shall not include facts, circumstances, events, changes, effects or occurrences (i) generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate, including effects on such industries, economy or markets resulting from any regulatory and political conditions or developments in general, or any outbreak or escalation of hostilities, declared or undeclared acts of war or terrorism (other than any of the foregoing that causes any damage or destruction to or renders physically unusable or inaccessible any facility or property of the Company or any of its Subsidiaries); (ii) reflecting or resulting from changes in Law or GAAP (or authoritative interpretations thereof); (iii) resulting from actions of the Company or any of its Subsidiaries -which Parent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of the Merger or the proposal thereof or this Agreement and the transactions contemplated hereby, including any lawsuit related thereto or any loss or threatened loss of or adverse change or threatened adverse change, in each case resulting therefrom, in the relationship of the Company or its Subsidiaries with its customers, suppliers, employees or others; (v) resulting from changes in the market price or trading volume of the Company’s securities or from the failure of the Company to meet internal or public projections, forecasts or estimates provided that the exceptions in this clause (v) are strictly limited to any such change or failure in and of itself and shall not prevent or otherwise affect a determination that any fact, circumstance, event, change, effect or occurrence underlying such change or such failure has resulted in, or contributed to, a Company Material Adverse Effect; or (vi) resulting from the suspension of trading in securities generally on the NYSE; except to the extent that, with respect to clauses (i) and (ii), the impact of such fact, circumstance, event, change, effect or occurrence is disproportionately adverse to the Company and its Subsidiaries, taken as a whole.
The MAC here is fairly standard except that it does not include an exception for failure to meet financial projections -- this makes it tighter than usual. It also defines a MAC to include any event "that prevents or materially delays or materially impairs the ability of the Company to consummate the Merger". You see this sometimes, but its inclusion is problematical because it broadens what can be defined as a MAC, and, given the vagueness, obviously provides more grounds for a buyer to claim a MAC has occurred. Ultimately, I am not sure what events the parties meant to cover here but they arguably picked up any problems which delay the financing. Moreover, the drop-dead date is meant to deal with delays. By including material delay here they have to mean something short of postponing a deal past the drop dead date. But I can't believe that was intended. M&A lawyers would do well to avoid including this clause because of these problems. In any event, if KKR & GSCP are indeed claiming a MAC, I would expect them to rely on this clause because of its vagueness and broad scope.
Otherwise, the agreement is governed by Delaware law. Harman's public disclosure thus far does not appear to establish a MAC under the first clause of the definition under Delaware case law, but again perhaps I am missing something or it relates to something not disclosed. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC. Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant. Moreover, KKR & GSCP would also need to prove in this case and under clause (2) of the MAC definition that the change was not disproportional to those "generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets, in the United States or other countries in which the Company or its Subsidiaries operate". Unfortunately, what constitutes a disproportional changes was an issue that could have been resolved in the Delaware courts by the AHL/Lone Star case before it settled. Again, we would need more information about the MAC claim here to know if it came under the exception. More mystery.
Final, Final Note: also, as with the SLM MAC clause, note that the need for disproportionality here is not material. So, $1 of disproprotionality will do. Again, M&A lawyers would do well to modify this clause in their own agreements if they do not intend for this.
Update: Harman this morning released financial guidance to the market. Harman stated:
The Company expects fiscal 2008 performance to be impacted by a number of factors including increased R&D to support the development of several new infotainment platforms and associated launch costs. We now expect fiscal 2008 sales to reach $4.1 billion ($3.55 billion in 2007). The Company expects operating income and diluted EPS before merger related costs to equal or exceed last year’s record performance. In 2007, operating income was $397 million and diluted EPS were $4.14 adjusted for non-recurring restructuring charges, merger costs and tax items. . . . .
We expect substantial margin improvements over the course of fiscal 2008 as we work through these costs and begin the launching of new infotainment platforms.”
In light of increases in material costs and faster ramp-up of R&D resources to work on new business awards, equaling the record operating performance of fiscal 2007 is an achievement. The benefits of common platform synergy and scalability will be realized in fiscal 2009 and beyond. Those benefits will strengthen our operating profits. . . . .
To the extent that Harman is legal posturing they are asserting that any decline in earnings or revenue is not long term and merely a short term failure. The Delaware courts in IBP/Tyson found such a short-term event not to constitute a MAC. Although, we are only getting Harman's side of the story. And, for purposes of the merger, it doesn't really matter as the $225 million is the only thing at stake. For those who want more, the company is going to have a conference call at 4:30 p.m. EDT on September 27, 2007, to discuss its current expectations for fiscal 2008. However, Harman helpfully stated in its press release that it will not "accept questions about the proposed merger with affiliates of Kohlberg Kravis Roberts & Co. L.P. and GS Capital Partners VI Fund, L.P."