October 5, 2007
On Hiatus Today
I'll be back Monday.
October 4, 2007
SLM: A Shareholder Speaks
Here is the letter QVT Financial, holder of 1.4 million shares of SLM, sent to the SLM board today. The letter is worth a read since it is the best look to date at the financial case for why no MAC occurred to SLM. It also doesn't look very kindly on the warrant component of the buy-out groups latest renegotiation proposal. In any event, the letter is similar to the one Stark investments sent to Accredited Home Lenders in the midst of its MAC dispute with Lone Star. There -- Stark couldn't avert a settlement though it may have led to AHL bargaining harder than it otherwise would have. This is arguably the aim here. Though, remember here they are bargaining under the buy-out group's absolute right to walk by paying $900 million.
Better Know a Deal Structure: Dual Listed Companies
This is the first in what may be a longer series, if readers like it. Today, I'll be looking at the dual listed company structure. It's something that any good M&A will love for its complexity and real legal "thought" required to implement. The dual listed company is where M&A lawyers truly add value.
A dual listed company structure is a virtual merger structure utilized in cross-border transactions. The companies do not actually effect an acquisition of one another, but instead enter into an unbelievably complex set of agreements in which they agree to equalize their shares, run their operations collectively and share equally in profits, losses, dividends and any liquidation. Examples of these arrangements are BHP/Billiton (BHP an Australian company and Billiton an English Company), Carnival (an English and Panamanian company), and Rio Tinto Group (an Australian and English company).
The structure is usually characterized by the parties as a true merger of equals since there is no acquiring company. It is a way for companies in different jurisdictions to preserve beneficial dividend treatment (e.g., the franking credit in Australia) and inclusion in their home country indexes. It is also a mechanism to stem flow-back into one country or another as the shares in one company are not exchangeable for the other. Finally, because no company actually takes over the other and each remains domiciled in their home country, it is one way to salve issues of nationality or national security. Often, the arrangements are viewed a stepping stone to a full merger (as was the case of Brambles which unwound in 2005). But these arrangements are unwieldy and governance of multiple boards and nationalities sometimes a problem. This was why Unilever (the Anglo-Dutch DLC) unwound its structure in 2005. After Unilever, these structures fell out of favor -- viewed by practitioners as too unwieldy, though this appears to be no longer the case. And finally, there can be some bizarre results -- it is sometimes rumored that BHP/Billiton will make a bid for Rio Tinto Group; if it does so, the BHP English company would likely make a bid for RT's English pair; the BHP Australian company for RT's Australian pair. How the mechanics of each jurisdiction would work to accommodate this bid is uncertain.
The pending Reuters/Thomson transaction is the latest to use the DLC structure and sparks a single deal resurgence. The parties there likely employed a dual listed structure in order to preserve the inclusion of the combined company in the FTSE 100 among other reasons. I am not aware of any prior Canadian/English DLC. So the complex tax, accounting and legal aspects of a DLC structure have no doubt perplexed Thomson's and Reuters' attorneys and accountants for awhile. And for that matter there is still no true U.S. DLC. BP came close in 1998 with Amoco, but the SEC refused to allow pooling accounting and so it was at the last minute converted into a true acquisition [NB. I was tangentially involved in that deal and I've never seen attorneys work harder -- all of the dual listed company agreements were finalized at the time the SEC blew-up the structure -- Wachtell and Sullivan -- deal counsel on that transaction still have them in their files for those who contemplate this structure again]. But Carnival is pretty close, the Panamanian company has equivalent U.S. corporate governance provisions and is treated as a U.S. tax-domiciled entity.
Legal geeks should note that the SEC recently revised its position on the requirement to register the shares of newly-formed DLCs. Historically, the SEC did not require a new registration statement to be filed as the shares of both companies remained outstanding and there was no triggering offering. But, with the Carnival DLC the SEC took the position that the changes in the character of the securities of the company were so fundamental that a registration statement is now required with respect to both sets of shares of the DLC. More ways for U.S. lawyers to earn money.
And for those looking for M&A nirvana, there is always the tri listed company to shoot for. This would encompass a current dual listed company adding a third leg forming the world's first tri listed company. The agreements to do this would reach new levels of complexity (hence my thoughts of M&A nirvana), and the operation of the company could become a bit complex to say the least. For example, the shareholder meeting for the company may have to last a full day depending upon their location in order to encompass meetings on multiple continents for three companies. But the structure is theoretically feasible. I thought this might come to pass with Rio Tinto's bid for Alcan, but instead it was structured as a full acquisition. Still, M&A lawyers can dream.
October 3, 2007
EADS Report on Insider Trading
The always excellent White Collar Crime Prof Blog has a post on the preliminary investigation by the French financial regulator Autorité des marchés financiers (AMF) indicating that a number of senior executives at Franco-German aircraft manufacturer European Aeronautic Defense & Space Co. NV (EADS) sold shares before the announcement of problems with the company's largest development project ever, the A380. As the White Collar Crime Prof notes, "Insider trading cases in [France] are fairly uncommon, at least as compared to the United States. It will be interesting to see how the investigation develops, especially when it involves a company with the political significance of EADS."
Yesterday, the SLM buy-out consortium issued a mid-market day proposal to renegotiate the SLM transaction. The buy-out consortium offered a renegotiated price of $50 per share plus 0.2694 of a warrant per share. The warrants would be exercisable five years after issuance and pay out based on the earnings of SLM over that five year period. The maximum pay-out for each warrant would be capped at $10 per warrant. The warrants would pay-out only if the buyers achieved a 15% IRR over that five year period.
Sallie Mae quickly issued a brief statement later in the day holding firm. SLM stated:
Our contract is with Bank of America and JPMorgan Chase, two of America's largest and strongest banks. We expect these banks to honor that contract, not breach the contract."
For those trying to determine which of the buyers is driving this MAC renegotiation note that SLM made no mention of the third buy-out partner here, J.C. Flowers.
A few more points:
- The Times and others are playing this offer as a "clever" way for SLM to show its hand. The reasoning is that the warrants will force SLM to admit that a MAC has occurred since they can no longer stand by their projections. I guess so. But really the issue is over the parties' assessment of the MAC claim and their negotiating positions. The buy-out group doesn't have to offer warrants to get SLM to make this assessment -- they already have. And remember, this negotiation is happening under the specter of the $900 million reverse termination fee which limits the buy-out group's liability.
- The warrants here are a form of an earn-out. Every few years or so you see the use of warrants in this situation to close a price gap. It permits the buyer to appear to be offering more consideration and is a way to close a gap between the projections of the seller and the buyer. But these warrants are hard to price. Here, they are European options so you can use Black-Scholes to do so. But to calculate the Black-Scholes value you would have to estimate what the volatility is for this new company. A hard and uncertain thing. Because of these problems, when I was in private practice the bankers typically and privately ignored this type of consideration as a cosmetic. Here, the warrants certainly do not have a $10 value -- estimates are that they are worth about $.50-$1.50 at best.
- If a warrant component is included it will push out the SLM deal timetable 2-4 months in order to prepare a registration statement and file it with the SEC. More time for further Fed rate cuts and an improvement in the credit markets. This will also give the buy-out group more control over the timing of the transaction as they will be responsible for preparing this registration statement. NB. the use of an equity-type instrument in this manner and the slowing of the time-table it brings is partly responsible for cratering the Harman deal.
- The buy-out group is now negotiating publicly with SLM presumably because SLM is refusing to strike a reduction of the buy-out price. This is something you often see in hostile takeovers, but not in renegotiations which typically happen behind closed doors. SLM and the buyer group are likely far apart at this point for the buyer group to go public in this manner.
- Flowers has a partial MAC analysis in their press release. They state that not only has a material adverse change occurred but that it is not excluded under the applicable law disproportionality test in clause (b) of the MAC definition because:
A "change in Applicable Law" does not have to be "materially more adverse" to trigger an MAE. The word "material" is not there. "Any" legislative change "more adverse" to Sallie Mae than the already material legislative changes described in the 10-K counts.
Here, they agree with my full analysis (see the SLM Legal Case (Redux). In addition, the buy-out group make a good point about how the MAC clause was specifically negotiated to address these issues, and clearly something worse has occurred. The buy-out group states:
Near the end of our negotiations, Senator Kennedy made a proposal that called for subsidy cuts deeper than the cuts described in the 10-K. The company asked us to accept the risk that the Kennedy proposal would become law. We refused. We drew the final line -- the maximum pain we were willing to take -- at the Bush Budget Proposal.
The bottom-line is that, although far from certain, the buy-out group still appears to have 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. SLM may not be buying into this argument -- but they know they are playing a dangerous game given the $900 million termination fee and the buy-out group's case. This may be the buy-out group's first offer and therefore lower than what they are willing to pay, but the incentives are still for SLM to settle. Ultimately, I take the warrants more seriously than others and illustrative of the strong position the buy-out group thinks it has. People who talk of the warrants not passing the "giggle" test in my view may be seriously under-estimating the buy-out group's negotiating position.
October 2, 2007
FINRA's Fairness Opinion Rules (RIP?)
Does anyone remember the rules proposed by FINRA (the agency formerly known as the NASD) to govern the issuance of fairness opinions? Back in November 2004, FINRA sent a minor shock wave through the investment banking community by promulgating a notice to members requesting comment on whether to propose new rules “that would address procedures, disclosure requirements, and conflicts of interest when members provide fairness opinions in corporate control transactions.” More specifically, FINRA requested comment concerning methods to “improve the processes by which investment banks render fairness opinions and manage inherent conflicts.”
FINRA put forth three reasons for requesting comment. First, the disclosure mandated under SEC regulation for fairness opinions could be perceived as insufficient “to inform investors about the subjective nature of some opinions and their potential biases.” Second, fairness opinion are by nature subjective and consequently there has arisen a “perceived tendency” that these opinions often support management. Finally, unaffiliated stockholders sometimes do not receive the benefits in a corporate control transaction that management, directors or other employees do; FINRA hypothesized that this disparity may create biases in favor of the transaction if the people involved in the current or future hiring of the investment bank are those with a differential benefit.
FINRA subsequently proposed Rule 2290 in response to its solicited member comments. Rule 2290 was announced and filed with the SEC for approval on June 22, 2005. Well, that was 2005. Since that time, the rule has been stuck in the SEC approval process. Presumably at SEC behest, it has been amended three times since then. The latest amendment was on June 7, 2007 (access the rest of the amendments here).
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. 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.
Given the current state of the Rule, FINRA would be better to simply pull it until such time as the SEC is more willing to contemplate reform. Unfortunately, the SEC does not appear ready to act any time soon on these issues. Anyway, if anyone still cares, the eighth extension of the comment period for this proposed rule expires on Oct. 31, 2007.
The Unbearable Lightness of Wilson Sonsini
I wanted to reiterate a point that may have been lost in my long post on 3Com yesterday concerning the role of Wilson Sonsini in that deal and in the failed Acxiom/Silver Lake & ValueAct transaction. In both deals Wilson Sonsini represented the targets. So, I was doubly surprised that Wilson negotiated the same reverse termination fee structure in 3Com as it did in Acxiom. In both cases it provides the private equity buyer an absolute right to walk from the transaction if it pays a termination fee, a fee which is substantially reduced if the buyer walks due to the financing banks failure to fund committed debt financing. As a base-line matter, I was a bit put-off that in such an unstable credit market, any lawyer would advise their clients to agree to the reverse termination fee structure 3Com did. And it essentially means that the buyer will have a right to walk by paying the lower fee -- an excuse will always come that the credit could not come from.
But I was doubly surprised that this would come from Wilson. In the midst of negotiating 3Com and aware of the significant credit market problems, Wilson was also negotiating the termination of the Acxiom deal under the same fee structure, a fee structure agreed to before the August troubles. I cannot see how they would not at least point 3Com to the publicly available information about Acxiom and highlight the problems this structure creates and was creating for Acxiom. If so, I would also be surprised 3Com would still agree to these terms, particularly the staggered fee. I am still struggling to justify the logic here. Did Wilson merely take its last private equity deal off the shelf and push the auto-pilot button? I'd like to think other factors were at work, but I'm finding it hard to do. Hopefully, target lawyers in future private equity deals will avoid Wilson's path by and convince their clients to forgo this very risky structure.
And, as I outlined in my post yesterday, this is the most significant but clearly not the only problem with the legal terms of the 3Com deal negotiated by Wilson for its client.
3Com -- Surprise. Surprise.
Yesterday, 3Com filed its merger agreement. As I read it, I felt like one of those cult members who predicts the end of the Earth on a date certain and wakes the day after to find everything still there. Do they repent? No, they fit the new facts into their situation and keep their belief.
Well, 3Com did not go the Avaya route as I predicted. Instead, they kept to the old private equity structure and included a highly negotiated reverse termination fee structure. Essentially, 3Com and their lawyers (Wilson Sonsini) agreed that the buyers (Bain and Huawei) have a pure walk right if they pay a termination fee of $110,000,000 (Section 8(j) of the merger agreement). This is about 5% of the transaction value of $2.2 billion. And in certain situations, such as if the debt financing falls through, the buyers would only be liable for $66,000,000 if they breach the merger agreement and walk (I spell out these situations at the end of this post).
So, how do we explain this? Well, one of the other interesting things about the 3Com merger agreement is that it is not conditioned upon financing; a fact 3Com did not even publicize in its press release or make an explicit condition in the merger agreement. So, I think the conversation went something like this: 3Com -- we can't agree to this reverse termination fee as it will give you too much optionality. Bain -- OK, well we can't expose our investors to liability for the full purchase price; if you won't agree to this then we need a financing condition. Plus, we are really nice people and would never do that to you. Banks piling on -- we won't finance this deal if there is specific performance on our commitment letters. 3Com -- OK -- no financing condition -- but we want a high termination fee of 5% to compensate us if you do indeed walk without a reason. So, like the cult survivor this is my best explanation in order to keep my belief in rational negotiating, although there is a lower termination fee if the financing falls through, so I am still struggling to see the logic of the terms here. In their conference call on Friday, 3Com was particularly unhelpful in talking about the terms of the agreement -- refusing to answer questions on the amount of the Huawei investment and instead stating "you’re going to have to wait a couple days or a little while before you can get specific answers to those questions." They were also a bit defensive about the fact that one analyst suggested that if you exclude 3Com's ownership of H3C it values the remainder of 3Com at "$0.75, $0.80" a share. Ouch.
I'm also a bit troubled by some of the other terms which 3Com and its lawyers negotiated. First, there is no go-shop in the transaction. Even though these provisions have their problems (see my post on this here), it does provide some opportunity for other bidders to emerge and shields the seller from claims of favoritism, so I am a bit surprised 3Com did not include it. In addition, if 3Com shareholders vote down the transaction, 3Com agreed in clause 8.3(b)(v) to reimburse the buyers for their fees and expenses up to $20 million. This is unusual and an excessive amount of money for 3Com to pay merely because its shareholders exercised their statutory voting rights to reject the deal. The termination fee in case of a competing bid is a market standard of $66 million (3% of the deal value) and does not require that the company pay the fees and expenses of the buyers.
I think the most annoying part of the agreement from my perspective was this clause 7.1(b) which conditioned the merger occurring on:
(b) Requisite Regulatory Approvals. (i) Any waiting period (and extensions thereof) applicable to the transactions contemplated by this Agreement under the HSR Act shall have expired or been terminated, (ii) any waiting periods (and extensions thereof) applicable to the transactions contemplated by this Agreement under the Antitrust Laws set forth in Schedule 7.1(b) shall have expired or been terminated, and (iii) the clearances, consents, approvals, orders and authorizations of Governmental Authorities set forth in Schedule 7.1(b) shall have been obtained.
Read the highlighted condition. Of course, 3Com did not disclose Schedule 7.1(b) and refused to answer questions on the agreement on their conference call yesterday. So, investors at this point still don't know all of the conditions to the deal. I can't see how this is not a material omission in violation of the federal securities laws (read my post on the SEC action against Titan). I really wish the SEC would crack down on this practice since a shareholder action on this claim is a loser because of the holding in Dura Pharmaceuticals (see my post on this here). It is particularly important here because the inclusion of a Chinese buyer might lead to an Exon-Florio filing for this deal. And the condition that we can't see might be exactly that -- a condition that Exon-Florio clearance is required to complete the deal. Given that this is a Chinese buyer it is bound to attract CFIUS scrutiny whether justified or not. In this case, it may be justified -- apparently sharing 3Com's networking technology with the Chinese does raise national security concerns. (By the way, for an explanation of the Exon-Florio process and the term CFIUS see my first post today here). Shame on 3Com for not disclosing the condition immediately or even informing the public of the amount of the Chinese investment at this time. If 3Com is indeed going to clear Exon-Florio in this transaction they need to handle their public relations better.
Finally the MAC clause is in the definitions and states:
“Company Material Adverse Effect” shall mean any effect, circumstance, change, event or development (each an “Effect”, and collectively, “Effects”), individually or in the aggregate, and taken together with all other Effects, that is (or are) materially adverse to the business, operations, condition (financial or otherwise) or results of operations of the Company and its Subsidiaries, taken as a whole; provided, however, that no Effect (by itself or when aggregated or taken together with any and all other Effects) resulting from or arising out of any of the following shall be deemed to be or constitute a “Company Material Adverse Effect,” and no Effect (by itself or when aggregated or taken together with any and all other such Effects) resulting from or arising out of any of the following shall be taken into account when determining whether a “Company Material Adverse Effect” has occurred or may, would or could occur: (i) general economic conditions in the United States, China or any other country (or changes therein), general conditions in the financial markets in the United States, China or any other country (or changes therein) or general political conditions in the United States, China or any other country (or changes therein), in any such case to the extent that such changes, effects, events or circumstances do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (ii) general conditions in the industries in which the Company and its Subsidiaries conduct business (or changes therein) to the extent that such changes, effects, events or circumstances do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (iii) any conditions arising out of acts of terrorism, war or armed hostilities to the extent that such conditions do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (iv) the announcement of this Agreement or the pendency or consummation of the transactions contemplated hereby, including the impact thereof on relationships (contractual or otherwise) with suppliers, distributors, partners, customers or employees; (v) any action taken by the Company or its Subsidiaries that is required by this Agreement, or the failure by the Company or its Subsidiaries to take any action that is prohibited by this Agreement; (vi) any action that is taken, or any failure to take action, by the Company or its Subsidiaries in either case to which Newco has approved, consented to or requested in writing; (vii) any changes in Law or GAAP (or the interpretation thereof); (viii) changes in the Company’s stock price or change in the trading volume of the Company’s stock, in and of itself (it being understood that the underlying cause of, and the facts, circumstances or occurrences giving rise or contributing to such circumstance may be deemed to constitute a “Company Material Adverse Effect” (unless otherwise excluded) and shall not be excluded from and may be deemed to constitute or be taken into account in determining whether there has been, is, or would be a Company Material Adverse Effect; (ix) any failure by the Company to meet any internal or public projections, forecasts or estimates of revenues or earnings in and of itself (for the avoidance of doubt, the exception in this clause (ix) shall not prevent or otherwise affect a determination that the underlying cause of such failure is a Company Material Adverse Effect); or (x) any legal proceedings made or brought by any of the current or former stockholders of the Company (on their own behalf or on behalf of the Company) resulting from, relating to or arising out of this Agreement or any of the transactions contemplated hereby.
For those of you who have better things to do than slog through this definition, it is favorable to 3COM -- it contains no forward-looking element and specifically excludes failure to meet projections from the definition among other things.
Final Conclusion: 3Com is an unusual deal for a variety of reasons. In addition, the model in 3Com is one that Wilson Sonsini has negotiated in other deals (see, e.g., Acxiom). It may indeed signal that past practices here with respect to private equity deals and reverse termination fees will continue as the norm albeit with higher buyer reverse termination fees. But, like the cult survivor, for now I'm going to keep my belief and hope that its singularity will not effect future practice and that the Avaya model will become the standard. Or at least that firms other than Wilson Sonsini might learn quicker and go that route.
Addendum: Reverse Termination Fee.
The relevant termination clause here is clause 8.1(g) which permits termination:
(g) by the Company, in the event that (i) all of the conditions to the obligations of Newco and Merger Sub to consummate the Merger set forth in Section 7.1 and Section 7.2 have been satisfied or waived (to the extent permitted hereunder), (ii) the Debt Financing contemplated by the Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement (or any replacement, amended, modified or alternative Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement permitted by Section 6.4(b)) has funded or would be funded pursuant to the terms and conditions set forth in such Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement upon funding of the Equity Financing contemplated by the Equity Commitment Letters; (iii) Newco and Merger Sub shall have breached their obligation to cause the Merger to be consummated pursuant to Section 2.2 and (iv) a U.S. Federal regulatory agency (that is not an antitrust regulatory agency) has not informed Newco, Merger Sub or the Company that it is considering taking action to prevent the Merger unless the parties or any of their Affiliates agree to satisfy specified conditions (which may but need not include divestiture of a material portion of the Company’s business) other than as contemplated by Section 5.5 of the Company Disclosure Schedule, or such regulatory agency has informed the parties that it is no longer considering such action; or
If the agreement is terminated under this clause then the buyers are required to pay the Newco Default Fee ($110 million). The clause limiting the buyers to paying this amount is in 8.3(g) (Limitation of Remedies) and 9.7 (Specific Performance). Of particular importance, note that the debt financing must be funded for this termination provision to be triggered. If the debt financing or other conditions above are not met, the buyers are then liable for the lesser amount of $66 million for breaching the agreement (clause 8.3(c)(i)).
Nasdaq, Borse Dubai and Exon Florio
Last week, Nasdaq announced a series of transactions which included a 19.99% equity investment by Borse Dubai, with voting rights on this stake limited to 5%. In addition, a Borse Dubai affiliate is to be the beneficiary of a trust holding another 8.4%, a stake without voting rights that would be managed by an independent trustee and eventually sold. The deal was reached in furtherance of Nasdaq's increasingly winning bid for OMX and its disposition of its shareholding in the London Stock Exchange.
An issue in this deal appears to be CFIUS approval. CFIUS stands for the Committee on Foreign Investment in the United States, an inter-agency committee chaired by the Secretary of Treasury. It is charged with administering the Exon-Florio Amendment. This law grants the President authority to block or suspend a merger, acquisition or takeover by a foreign entity if there is “credible evidence” that a “foreign interest exercising control might take action that threatens to impair the national security” and existing provisions of law do not provide “adequate and appropriate authority for the President to protect the national security in the matter before the President." The President has delegated this review process largely to CFIUS.
The statute was enacted in 1988 in response to the 1987 attempt by Fujitsu, a Japanese electronics company, to acquire Fairchild Semiconductor Corporation. That was back when the Japanese were going to take over the United States (who could forget Gung-Ho and Rising Sun?!). Congress struck back at this "menace" by passing the Exon-Florio Amendment. And in July of this year, Congress passed The National Security Foreign Investment Reform and Strengthened Transparency Act. The bill further enhanced the CFIUS review process, and adds to the factors for review critical infrastructure and foreign government-controlled transactions. In either instance CFIUS can initiate a mandatory review. Like the 1988 bill, this amendment was a response to perceived foreign investment "threats". This time it was the acquisition of Peninsular & Oriental Steam by Dubai Ports and the ensuing political brawl and heavy congressional protest which led to Dubai Ports terminating the U.S. component of its acquisition.
Nasdaq has helpfully not filed the agreements for this transaction, so the extent of Borse Dubai's control over Nasdaq post-transaction are unknown, but the 5% voting stake indicates that it will not exercise indicia of control. Therefore, arguably CFIUS does not have authority to initiate mandatory review (or even jurisdiction for a voluntary one). Nonetheless, Nasdaq is making a big deal of voluntarily initiating an Exon-Florio review here. But, Exon-Florio has always been a voluntary process until the recent amendments -- making such a filing and clearing the review process removes the ability of the President to later unwind the transaction on national security grounds.
Of late, CFIUS has been much more attentive to foreign takeover transactions. According to one news report, CFIUS considered 113 transactions in 2006, up 74 percent from the previous year. And CFIUS conducted seven second-stage investigations in 2006, equaling the number of the previous five years combined. Nonetheless, I can't see why CFIUS would object here -- this appears to be merely a 5% voting stake and I would suspect that Nasdaq has put limitations on their acquiring an increased controlling stake in Nasdaq (which would require a new CFIUS review in any event). Though again, we don't have the agreements so don't know. you would think since Nasdaq was a regulator it would more fully disclose. Nonetheless and as noted, the spur for the most recent legislative reform was congressional protest at another Dubai acquisition. That dispute was always puzzling: Dubai Ports was acquiring an English company with port operations in the United States and Dubai Ports is headquartered in the United Arab Emirates, one of our strongest allies in the Mid-East. Here, Dubai may have been scarred by that experience and asked for this review themselves. Better safe than sorry, and likely why Nasdaq and Borse Dubai are initiating this voluntary review. They are playing to political concerns more than the legal prerequisites of Exon-Florio. Our economy reached the stature it has today as a result of direct investment from abroad; hopefully for our sake we will remain hospitable this time around. This is likely given the legal case.
For a summary of the final legislative provisions of the CFIUS reform bill, see this client memo by Wiley Rein here. For more on Exon Florio and the CFIUS process see my prior posts: CFIUS Reform to Become Law; GE, The Saudis and Exon-Florio; and The Politics of National Security.
The Acxiom deal was terminated yesterday. It is the second post-market crisis deal termination after MGIC/Radian and the first private equity one. In the merger agreement, the maximum damages payable by the buyers in case of breach of the agreement was $111.25 million, although in certain circumstances, such as a falling through of debt financing, the buyers could pay a reduced reverse termination fee of $66.75 million (a similar structure to 3Com -- hmm Wilson Sonsini was counsel for the targets on this deal and 3Com also -- shocking I know). The fact that the parties agreed that the buyers only needed to pay $65 million to terminate the deal likely reflects the parties assessment of their chances of success in litigation over a material adverse change dispute and the continuing availability of financing for the transaction. It would also be interesting to know which of the buyers, Silver Lake or ValueAct was driving the termination here. This is because ValueAct still owns 12.8% of Acxiom; the termination must have particularly hurt them. But, in any event, Acxiom now begins the hard task of restoring market credibility and proving that it is no longer "damaged goods". Silver Lake's likely reaction, "best of luck in your endeavors." The press release follows:
LITTLE ROCK, Ark.--(BUSINESS WIRE)--Acxiom® Corporation (NASDAQ: ACXM; www.acxiom.com) announced today that it has reached an agreement with Silver Lake and ValueAct Capital to terminate the previously announced acquisition of Acxiom by Axio Holdings, LLC, a company controlled by Silver Lake and ValueAct Partners. Acxiom, Silver Lake and ValueAct Partners have signed a settlement agreement pursuant to which Acxiom will receive $65 million in cash to terminate the merger agreement. Charles Morgan, Acxiom Chairman and Company Leader, said, "Acxiom has been an industry leader for over three decades, and we will continue to execute on our long-term strategy to remain the market leader in database marketing, services and data products. While I am disappointed that we could not conclude the merger, we have renewed energy and remain focused and committed to delivering value for our shareholders and clients." About Acxiom Corporation Acxiom Corporation (NASDAQ: ACXM - News) integrates data, services and technology to create and deliver customer and information management solutions for many of the largest, most respected companies in the world. The core components of Acxiom's innovative solutions are Customer Data Integration (CDI) technology, data, database services, IT outsourcing, consulting and analytics, and privacy leadership. Founded in 1969, Acxiom is headquartered in Little Rock, Ark., with locations throughout the United States and Europe, and in Australia, China, and Canada. For more information, visit www.acxiom.com. Acxiom is a registered trademark of Acxiom Corporation.
Addendum: Acxiom refers to the $111.25 million fee above as a cap on damages. They do so because it is phrased as a limitation on the maximum amount Acxiom can collect if the buyers breach their agreement and walk. They argue it is not a reverse termination fee per se because they affirmatively have to sue and prove damages up to the cap to collect on it rather than a notice provision where the buyers need to sue. In contrast, the $66.75 million is specifically contemplated as a break fee if financing isn't available.
October 1, 2007
Finish Line's Answer: The Analysis
Finish Line's answer is accessible here. My reaction: wow. In its answer, Finish Line does not even assert that a material adverse change to Genesco has occurred or even set out facts substantiating a MAC claim. In paragraph 72 Finish Line states:
Defendants are without sufficient knowledge or information at this time to know if there has been a "Material Adverse Effect" in Genesco's business and deny that Finish Line has ever stated or taken the position that there has been a "Material Adverse Effect" in Genesco's business.
It now clearly appears that UBS is driving Finish Line's hesitance. Finish Line confirms this by stating in the answer that:
UBS has indicated it believes a Material Adverse Effect may have occurred; Genesco denies this, and, thus, an actual case or controversy exists. A resolution of this issue is a prerequisite to the closing of the merger.
Notice Finish Line is absent from this above statement. And since it is UBS who is claiming the MAC, Finish Line, as I predicted it would do last week, attempts in the answer to join UBS as a party. Finish Line also pursues its prior counter-claim that Genesco breached the merger agreement by failing to provide the information requested by UBS.
Finish Line's answer shows that it is caught flailing between UBS and Genesco. The Genesco merger agreement contains no financing out, but If UBS does succeed in ending its financing commitment, Finish Line will likely be unable to secure financing and complete the acquisition sending it into insolvency. Now we wait for UBS's response. One option is for them to bring litigation in New York against Finish Line to terminate its obligations (see my post on this here). Another is that they answer the complaint and fight this case out in Tennessee. In either case, UBS is likely to also claim that they need further information to determine if a MAC occurred. To reword an overly used adage "you know a MAC when you see it". If UBS needs to look this hard perhaps it isn't there. But what is there is UBS's $3.4 billion write-down announced today, which is likely driving this case to a large extent. UBS is seeking to cut its losses, but it still appears to have a weak hand. Finish Line may be the one to suffer.
September 30, 2007
Black Market Capital Quoted Extensively in the Financial Times Today
David Wighton, the New York Bureau Chief for the Financial Times, quotes extensively from my new article Black Market Capital in his lead-in article to today's Report on Fund Management in the Financial Times. The article is entitled SEC seeming perverse about risk and is accessible on the FT website here. You can also get it on the newstand. A few quotes for flavor:
"Told you so," said many critics of hedge funds surveying the damage caused by the summer credit market turmoil. The high-profile collapse of several funds and the dismal performance of many others have provided just the ammunition the sceptics were looking for. Surely it proved that hedge funds were dangerous and should be kept out of the hands of retail investors, they said. How wise of the Securities and Exchange Commission to propose barring individuals with less than $2.5m (£1.2m, €1.8m) in liquid assets from investing in hedge funds, up from the current limit of $1m.
This is nonsense. Average hedge fund returns are generally less volatile than the equity market as a whole and you are much more likely to lose your shirt on an individual stock than on a hedge fund. The rules preventing small investors from putting money into hedge funds are positively perverse.
As Steven Davidoff, a professor at Wayne State University Law School, points out in a new paper, the rules have an even more perverse consequence.
Retail investors may not be able to invest in hedge funds - or private equity funds for that matter - but they can invest in the funds' managers, which Prof Davidoff argues are more risky.
"This is because the future income of an adviser is derivative upon the fund advisers' capacity to continually earn extraordinary positive returns." If they do not earn such returns, investors will shift money away, which means the impact on the investor in the manager will be greater than on the investor in the fund.
Prof Davidoff suggests that the spate of flotations of alternative asset managers - albeit slowed by the credit market turmoil - is partly the result of the rules against public issues by alternative funds. Prevented from buying the funds directly, public investors look for something that replicates their benefits. The financial industry quickly meets that demand. But it does so with less suitable vehicles such as asset managers, special purpose acquisitions companies and the growing array of exchange-traded funds and indexes that attempt to track private equity or hedge fund performance.
These vehicles, which Prof Davidoff dubs Black Market* Investments, 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.
Investors' other option is to buy funds on non-US markets, a process that the SEC is considering making easier. But without the benefit of SEC regulatory oversight and the US securities law enforcement, Prof Davidoff argues that this would be more risky and costly than a prohibited US-based purchase of the funds.
Investors should be allowed to make up their own minds on whether hedge funds are good value for money. The asset qualification for retail investors should not be raised. It should be scrapped.
Check it out.
Avaya and 3Com: Why are these PE Deals Different From All Other PE Deals?
On Friday, 3Com Corporation announced that it had agreed to be acquired by affiliates of Bain Capital Partners, LLC, for approximately $2.2 billion in cash. This is the first big private equity deal announced post-August market crisis. As such, I'm excited for 3Com to file the merger agreement this week; it will give us a good window on how transaction participants and M&A attorneys have reacted to revise previously standard structures in light of market developments. My big bet -- expect there to be no reverse termination fee -- that is, a clause which gives the private equity buyer an absolute right to walk from the deal by paying a pre-set fee, typically 3-5% of the deal value (for more on these see my post here). Instead, expect the parties in 3Com to adopt the structure used in the Avaya transaction where Avaya agreed to be acquired by Silver Lake and TPG Capital for approximately $8.2 billion or $17.50 per common share.
The Avaya merger agreement was one of the only private equity transactions pre-market crisis to specifically provide for the opposite of a reverse termination fee -- specific performance. In Section 7.3(f) of the merger agreement the parties specifically cap monetary damages in case of breach but provide for specific performance. This effectively ends the optionality contained in the other private equity agreements with reverse termination fees. Here is the relevant language:
Notwithstanding the foregoing, it is explicitly agreed that the Company shall be entitled to seek specific performance of Parent’s obligation to cause the Equity Financing to be funded to fund the Merger in the event that (i) all conditions in Sections 6.1 and 6.2 have been satisfied (or, with respect to certificates to be delivered at the Closing, are capable of being satisfied upon the Closing) at the time when the Closing would have occurred but for the failure of the Equity Financing to be funded, (ii) the financing provided for by the Debt Commitment Letters (or, if alternative financing is being used in accordance with Section 5.5, pursuant to the commitments with respect thereto) has been funded or will be funded at the Closing if the Equity Financing is funded at the Closing, and (iii) the Company has irrevocably confirmed that if specific performance is granted and the Equity Financing and Debt Financing are funded, then the Closing pursuant to Article II will occur. For the avoidance of doubt, (1) under no circumstances will the Company be entitled to monetary damages in excess of the amount of the Parent Termination Fee and (2) while the Company may pursue both a grant of specific performance of the type provided by the preceding sentence and the payment of the Parent Termination Fee under Section 7.1(b), under no circumstances shall the Company be permitted or entitled to receive both a grant of specific performance of the type contemplated by the preceding sentence and any money damages, including all or any portion of the Parent Termination Fee.
Practitioners take note for future deals.
Additional Point: Given the difference between the Avaya deal and the other private equity deals, I was surprised to see the wild fluctuation in the Avaya stock price last week. This is a much more certain deal than the SLM Corp. and other private equity deals with reverse termination fees. Unless the buyers here can establish a MAC (which doesn't appear to be the case based on public information) this deal will close so long as the financing letters remain in place. I don't believe Avaya has disclosed these commitment letters, but presumably these are as tight as the merger agreement and can only be terminated for a similar MAC and other customarily significant reasons. Also, presumably if Avaya's lawyers negotiated a specific performance clause in the merger agreement they also demanded one in the commitment letters, so that they could ensure that the debt financing needed for the buyers to specifically perform under the clause above would be available. But perhaps the market is actually efficient here and is seeing something I do not.
Incidentally, Avaya stockholders approved the transaction on Friday -- the deal now goes into the debt marketing stage, and under the merger agreement is required to close by the end of the marketing period. The marketing period ends 20 business days from this past Friday provided Avaya has provided all the relevant information it is required to under the merger agreement to the buyers.
Topps: The End Game of Dissenters' Rights
I continue to remain fascinated by the Topps deal and the possibilities that were raised by Crescendo Partners exercise of dissenters' rights. On the day Topps's shareholders approved the takeover of Topps by Michael Eisner's The Tornante Company LLC and Madison Dearborn Partners for $9.75 per share in cash, Crescendo Partners 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). Under DGCL 262, the Delaware law governing appraisal rights, a shareholder dissenting from the Topps transaction was required to deliver notice thereof prior to Topps's shareholder vote. Thus far, Topps has only disclosed that Crescendo Partners has dissented from the merger (though there may still be others Topps has not disclosed).
Assuming that no more than 8.1% of Topps's remaining shares are subject to dissent, Topps will satisfy the condition in the Topps merger agreement that:
holders of no more than 15% of the outstanding shares of our common stock exercise their appraisal rights under Section 262 of the DGCL in connection with the merger . . . .
Given Topps non-disclosure thus far on this point and the fact that it would know by now if this condition is not fulfilled, its silence almost certainly means that the condition was so fulfilled and no more than 15% of the shares dissented.
But, if there were other dissenting shareholders, the dissenter arbitrage possibilities raised with respect to the recent Delaware decision in In re: Appraisal of Transkaryotic Therapies, Inc. may still come to pass albeit on a lower level (access the opinion here; see my blog post on it here). Post-Transkaryotic a number of academics and practitioners raised the concern that this holding would encourage aggressive investors (read hedge funds) to create post-record date/pre-vote positions in companies in order to assert appraisal rights with respect to their shares. This would be particularly the case where the transaction was one being criticized for a low offered price. As outlined in a previous post, I thought Topps was a good candidate for this strategy. It remains to be seen if this was the case.
In any event, Crescendo Partners has now set itself up nicely If no one else has exercised dissenters' rights. There will now be no free-rider problem or multiple litigants for Eisner et al. to negotiate with. Instead, Crescendo can now negotiate a private one-on-one deal with Eisner as to the purchase price for its shares under the shadow of its dissenters' rights litigation. This is a benefit typically unavailable to the average shareholder who cannot afford the litigation expenses and free rider problems of dissenters' rights. Of course, this highlights the problems of dissenters' rights generally in Delaware. Still, expect a press release in a year or two announcing a negotiated disposition of this litigation. While the Delaware courts can technically award a lower price in dissenters' rights litigation, anecdotally they more often split the baby and award a higher amount than the original share price offered. I believe this practically compensates the dissenting shareholders for their extraordinary efforts and highlights the problem of financial valuation in the Delaware courts where each side will put on experts showing a marked disparity in valuation forcing the courts to rectify this difference by again splitting the difference. It also gives Eisner and his cohorts an incentive to settle. Crescendo also has similar incentives to settle given the less likely risk it will receive less than the current offer price.
NB. For more on the problems of Delaware courts and their struggle with valuation practice in dissenters' rights cases see my article Fairness Opinions at pp 1580- 86 where I deconstruct the valuation opinion in Andaloro v. PFPC Worldwide, Inc., 2005 WL 2045640 (Del. Ch. 2005). I do so to illustrate the essential problems of subjectivity and conflicting valuation standards in financial valuation generally and particularly in the Delaware courts amidst a battle of the experts.
Finish Line Answers
On Friday, Finish Line filed its answer to Genesco's complaint. I'm attempting to obtain a copy and will post it with an analysis as soon as I obtain it or it is filed with the SEC. But, from the press release below, there appears to be no surprises. As I predicted last week, Finish Line did indeed bring UBS into the dispute. In the coming weeks we are going to see how closely aligned they are in pursuing a deal termination or renegotiation (my bet is not very much, and that UBS has been driving this MAC claim with Finish Line stuck in between). In addition, in its answer Finish Line counter-claimed for breach of the merger agreement for Genesco's failure to provide information and is requesting a declaratory judgment that a material adverse change occurred. I've previously speculated that Finish Line doesn't have much of a case for a material adverse change, but for me a clearer picture will emerge once I've reviewed the answer. In addition, I believe that the request for information is a red herring; simply designed to portray Finish Line as the good guys here. Despite my inclination that this will settle because of the inherent forces in these cases which push the parties to do so, I'm increasingly hopeful for a decision in order to clarify uncertainties regarding the definitional scope of a MAC and the disproportionality qualifier typically included in the definition. Even if it is under Tennessee law. The press release follows:
Finish Line Files Answer, Counterclaim and Third-Party Claim for Declaratory Judgment INDIANAPOLIS, Sept. 28 /PRNewswire-FirstCall/ -- The Finish Line, Inc. (Nasdaq: FINL) today announced that it has filed an answer, counterclaim and third-party claim for declaratory judgment in connection with the action pending in the Chancery Court in Nashville, Tennessee, regarding the Company's proposed acquisition of Genesco Inc. (NYSE: GCO).
In its filing, The Finish Line is seeking an order that Genesco provide all requested financial data and access to personnel, and that its failure to do so in a timely manner is a breach of the merger agreement. As previously announced, 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.
In addition, The Finish Line is seeking a declaratory judgment of whether a "Company Material Adverse Effect" has occurred under the merger agreement, as UBS questions and Genesco denies. As previously announced, UBS provided The Finish Line with a commitment letter regarding financing for its proposed acquisition of Genesco. As UBS is a necessary party whose interests are directly affected by the declaratory relief sought, UBS has been named a third-party defendant in the action.