M & A Law Prof Blog

The Art of Leaving in High Time

Robert F. Bruner has graciously sent his thoughts on the recent announced spin-off of AOL from Time Warner.  Dr. Bruner is Dean and Charles C. Abbott Professor of Business Administration and Distinguished Professor of Business Administration at the Darden Graduate School of Business Administration, University of Virginia where he teaches M&A courses in the MBA program.  He is also the auithor of multiple books, articles and case studies on M&A.     

 

“If you have made a mistake, cut your losses as quickly as possible” -- Bernard Baruch

 

 Late last week, Time Warner announced that it would spin off its AOL division.  This ends one of the most notorious stories in M&A history.  In my book, Deals from Hell, I dubbed the AOL/Time Warner merger one of the worst in business history, a genuine nightmare for almost everyone involved.   The announcement of the merger in 2000 pitched it as a deal from heaven, converging old and new media, content and distribution.  But it turned out otherwise.   While AOL’s shareholders did very well in the deal, Time Warner’s did not.  The deal was closed in January 2001.  The transplanted organ was not accepted by the host; intramural fighting ensued.  Civil and criminal litigation sprouted.  Executives were sacked.  All of this occurred against the bursting Internet bubble, the recession of 2001, and the slow recovery.  AOL’s business withered.   By 2003 the rise of broadband and wireless connectivity and the demise of AOL’s dial-up business were clear.  AOL’s number of subscribers fell from about 27 million in 2002 to under 10 million at the end of 2007. 

 One wonders, why did they do this deal?—this is the subject of numerous books and articles.  But there is an equally compelling question that has received much less consideration: Why did it take so long to unwind the deal?  In contrast to Bernard Baruch’s advice, corporations generally seem slow to cut their losses quickly.  Perhaps Time Warner found a way to squeeze cash out of the business, and therefore tarried.  The illiquidity of a company’s assets is an obvious reason; under the best of circumstances, selling a business can take a while.  But there is more to the story of slow corporate divestitures:

1.       Measurement and information problems.  It is tough to identify the point of inflection where the acquired business begins to turn sour.  Five years ago, newspaper publishers had little clue that classified advertisers would begin to flock to Craigslist and other Internet marketplaces.  Those publishers today are taking a pounding from the Internet that would have been very hard to foresee in 2003.  Similarly, the demise of the dial-up Internet connectivity (in favor of wired broadband and WIFI) has been faster than many forecasters expected in 2000.  Monitoring the trends within the portfolio of a firm’s businesses is difficult to do and fraught with error. 

2.       Biased thinking.  This is what economists call “behavioral factors,” such as denial, loss aversion, and “sunk cost” mentality: “I can’t just sell a $100 billion investment for $50 billion”—even though it might be rational to do so if $50 billion is a fair value today.  Sunk cost thinking regards the business the way it used to be, not the way it is or will be. 

3.       Corporate governance practices and incentives.  There is a well-known correlation between firm size and CEO pay.  This can prompt management to think that bigger is better and that smaller is not better.   Boards of directors may not monitor and challenge the thinking of management as vigorously as they should.  And various kinds of takeover defenses or share voting restrictions may prevent shareholders from directly challenging the board and managers to sell ailing businesses.

4.       Barriers to exit.  The Federal Communications Commission took a year to approve the merger of Time Warner and AOL.  It might take that long to approve a divesture.  A small number of buyers or the existence of unusual liabilities very nearly scratched the sale of Bear Stearns.  A price tag in the billions of dollars along with the reluctance of banks to finance a purchase (that, as many private equity firms will tell you, is the situation today) could kill a sale.  Uncertain environmental clean-up costs or generous union agreements (think of the auto industry) can drive potential buyers away.

CEOs require strong will and strength of character to cut its losses in the face of these kinds of problems.  Plainly, it takes a bias for action, regard for opportunities, careful due diligence, and tough-minded concern for your investors’ return.  We want firms to exploit the flexibility to enter and exit from businesses because it promotes dynamism and growth in the global economy.  But the devil is in the details.  Economic discipline, timeliness of response, and focus on action are all vital.

 - Robert F. Bruner
   May 30, 2009

 

“Vigorous Antitrust Enforcement” Begins

A couple of days ago, Michael posted about the renewed interest in “vigorous antitrust enforcement” by the Obama Administration.  Over the last couple of days there has been some movement on this front.  The WSJ reports today that the FTC just recently filed a complaint against CSL Ltd and Cerberus-Plasma Holdings to prevent CSL’s $3.1 billion acquisition of Talecris Biotherapeutics.   Why Cerberus?  Well, Cerberus has a 74% stake in Talecris. The redacted version of the FTC’s administrative law complaint is here.

The essence of the FTC’s complaint is that the acquisition of Talecris will leave the plasma therapies market too concentrated to ensure adequate levels of competition resulting in higher prices for consumers.  As evidence, the FTC notes that following the proposed acquisition, the combined entity will comprise over 80% of “alpha-1” market. In other plasma products, the post-merger entity would control between 40-80% of market in which it participates.

The deal documents are not easily available as Talecris is a private company and CSL is traded in Australia.  But the FTC”s complaint provides us some details about the merger, including that it has a $75 million break-up fee (2.4% of transaction value).  The deal's drop dead date is August 12, 2009 providing either party the right to walk if the regulatory hurdles prevent the deal from closing with the termination fee payable at that point.  The parties also entered into a separate agreement that commits CSL to supply plasma to Talecris for 5 years even if the transaction does not go forward.

CSL has indicated that they will fight this suit.  Here’s their statement, released to the Australian Stock Exchange.  CSL also had a conference call in which they provided their view of the FTC’s suit.

According to the complaint, the administrative hearing will be held in October.  Expect a motion for a preliminary injunction to prevent the deal from closing to be filed in a federal district court to be filed soon.

-   - bjmq

Deals from Hell, cont

For the sake of completeness Time Warner announced the spin-off of AOL this morning.  Either the board meeting started really early, or they didn't have much to talk about.  Here's the press release.

- bjmq

Matching Rights in Merger Agreements

Rights of first refusal in merger agreements are a little bit of a hobby horse of mine.  Except for papers by David Walker (here) and another by Marcel Kahan (here) they don’t get much attention.  This is always a bit surprising to me.  In the Deals class, the incentive effects of rights of first refusal take up a full class period, but yet there isn’t much attention given them.  Maybe they don’t get much attention because their incentive effects are so obvious.

I take that back.  Match rights were a central argument in the Toys R Us case.  But there Vice Chancellor Strine evaluated the expert opinions of Prof. Guhan Subramanian and Prof. Prescott McAfee and found their conclusion – that the presence of a match right can/should dampen the effects of a competitive auction by deterring potential second bidders – lacking.  In fact, he noted that examples of matching rights in merger agreements “are simply not that unusual.”  He’s right on that mark.  Matching rights in merger agreement are pervasive.  In some research I have percolating on matching rights in merger agreements, I found that the vast majority of the merger agreements in my sample had one form or another of a matching right.  So, Vice Chancellor Strine is right so far as that goes.  On the other hand, I found that transactions with matching rights also had statistically significant lower prices.    [An aside: It looks like Toys just announced an acquisition of FAO Schwarz today.]

However, because matching rights come in a variety of flavors – from weak to strong – they are a coding nightmare.  For example, take a look at the matching right at question in the Toys case (merger agreement here):

6.5 Acquisition Proposals … (b) Notwithstanding anything in this Section 6.5 to the contrary, … the Company may terminate this Agreement and/or its Board of Directors may approve or recommend such Superior Proposal to its stockholders …;  provided, … however, that the Company shall not exercise its right to terminate this Agreement and the Board of Directors shall not recommend a Superior Proposal to its stockholders pursuant to this Section 6.5(b) unless the Company shall have delivered to Parent a prior written notice advising Parent that the Company or its Board of Directors intends to take such action with respect to a Superior Proposal, specifying in reasonable detail the material terms and conditions of the Superior Proposal, this notice to be delivered not less than three Business Days prior to the time the action is taken, and, during this three Business Day period, the Company and its advisors shall negotiate in good faith with Parent to make such adjustments in the terms and conditions of this Agreement such that such Acquisition Proposal would no longer constitute a Superior Proposal.

There is a three day matching period that’s not uncommon.  What is less common and gives this right of first refusal its real teeth is the requirement that Toys negotiate in good faith with the initial bidder until such time as the second bid no longer constitutes a superior proposal.  This type of match right (the ‘good faith negotiation right’) is the strong form. There are weaker forms.

For example, in AMD’s acquisition of Broadcom last year, the parties included the mildest form of a matching right – ‘information rights.’  Here’s the relevant language (merger agreement):

4.2 No Solicitation (b) … In addition to the foregoing, if … Seller or any of its Representatives receive any Competing Proposal or Inquiry, Seller shall immediately notify Purchaser thereof and provide Purchaser with the details thereof, including the identity of the Person or Persons making such Competing Proposal or Inquiry, and shall keep Purchaser fully informed on a current basis of the status and details of such Competing Proposal or Inquiry and of any modifications to the terms thereof, in each case to the extent not prohibited by a confidentiality, nondisclosure or other agreement then in effect and entered into prior to the date hereof …

This language places no obligations on the seller other than to keep the initial bidder fully informed.  Presumably a fully informed initial bidder that is actively interested in completing a purchase will be able to use such information to engage in ongoing negotiations and match any other offer on the table.  Still, information rights are the weakest form of matching right – mostly because there is no “right” involved. 

There is another matching right solution.  This involves a combination of information rights and a delay before the seller is permitted to terminate the agreement, change its board recommendation, or have its board meet to consider a superior proposal – a ‘delayed termination right’.  For example, you can find an example in the D&E Communications transaction (merger agreement here).

6.2 No Solicitation of Transactions … (4)  f)      Notwithstanding the foregoing, at any time prior to obtaining the Company Shareholder Approval …, the Board of Directors may (x) make a Company Adverse Recommendation Change or (y) cause the Company to terminate this Agreement pursuant to Section 8.4(b) if: …  the Company delivers written notice to Parent (a “Notice of Superior Competing Transaction”) advising Parent that the Board of Directors intends to take such action and specifying the reasons therefor, including the material terms and conditions of any Superior Competing Transaction that is the basis of the proposed action by the Board of Directors (it being understood and agreed that any amendment to the financial terms or any other material term of such Superior Competing Transaction shall require a new Notice of Superior Competing Transaction and a new five Business Day period), and after the fifth Business Day following delivery of the Notice of Superior Competing Transaction to Parent the Board of Directors continues to determine in good faith that the Competing Transaction constitutes a Superior Competing Transaction …

In the example above, the initial bidder gets information rights combined with a 5 day delay during which time the initial bidder can presumably negotiate its way back into the picture. 

Or, what the heck, you could just draft a match right that all elements of the above – below is Sumtotal Systems recent agreement (merger agreement) that includes information rights, good faith negotiation rights and a delayed fuse on both termination and a board recommendation.

5.3 No Solicitation (f) (iv) in the case of clauses (x) and (y) above, (A) the Company shall have provided prior written notice to Newco at least three (3) Business Days in advance (the “Notice Period”), to the effect that absent any revision to the terms and conditions of this Agreement, the Company Board has resolved to effect a Company Board Recommendation Change and/or to terminate this Agreement pursuant to this Section 5.3(f), which notice shall specify the basis for such Company Board Recommendation Change or termination, including in the case of Section 5.3(f)(y) the identity of the party making the Superior Proposal, the material terms thereof and copies of all relevant documents relating to such Superior Proposal; and (B) prior to effecting such Company Board Recommendation Change or termination, the Company shall, and shall cause its financial and legal advisors to, during the Notice Period, (1) negotiate with Newco and any representative or agent of Newco (including, without limitation, any director or officer of Newco) (collectively, “Newco Representatives”) in good faith (to the extent Newco desires to negotiate) to make such adjustments in the terms and conditions of this Agreement such that the Company Board would not effect a Company Board Recommendation Change and/or terminate this Agreement, and (2) permit Newco and the Newco Representatives to make a presentation to the Company Board regarding this Agreement and any adjustments with respect thereto (to the extent Newco desires to make such presentation); provided, that in the event of any material or substantive revisions to the Acquisition Proposal that the Company Board has determined to be a Superior Proposal, the Company shall be required to deliver a new written notice to Newco and to comply with the requirements of this Section 5.3 (including this Section 5.3(f)) with respect to such new written notice

 

The effect of all of these common provisions is to reinforce the position of the initial bidder and dissuade second bidders unless the second bidder has a private valuation that it believes is substantially higher than the private valuation of the initial bidder.  I’ll post some more thoughts on matching rights another day.

- bjmq

 

Update:  I've posted a draft of my paper (Match That!: An Empirical Assessment of Rights of First Refusal in Merger Agreements) on SSRN.  It includes data from from my review of transactions with rights of first refusal, etc.

Interview with Justice Jacobs

J.W. Verret's interview with Delaware Supreme Court Justice Jacobs is here.  It's worth your time.  Below is a link to the recent Brennan Lecture on the State Courts at NYU Law School given by Justice Jacobs in February 2009.  His talk is a reflection on the role of federalism in corporate law and is well worth listening to. Among other topics, he provides a nice historical overview of the development of Delaware corporate law.  He also discusses CA 2115 (Vantage Point v Examen, etc) and the internal affairs doctrine starting at around 44 minutes in.

- bjmq 

The Kauffman Foundation Wants to Friend You

    "The Kauffman Foundation invites scholars who are interested in discovering new insights into the field of entrepreneurship to join a group on Facebook for entrepreneurship scholars to connect and interact.

     View/join the Kauffman Entrepreneurship Scholars group at: http://www.facebook.com/group.php?gid=91330724824

     This group provides an opportunity for you to interact via discussion boards, news posts, link sharing, and other methods with other scholars of entrepreneurship. We hope you will take advantage of the group to connect with other researchers in the field of entrepreneurship."

MAW

Deals from Hell

In his book, Deals from Hell , Robert Bruner catalogs many of the worst M&A deals of recent memory.  These deals are great for teaching purposes -- mostly to help students get a handle on how and why parties do transactions.  One of the lessons of these deals is that even very smart people, who are making lots of money, can make big mistakes.  Buried in chapter 12 is the Time Warner - AOL deal.  While the bubble-like hype of that deal suggested AOL Time Warner would be on the cutting edge of the new media world that the dot com bubble was creating for us, the truth turned out to be somewhat less than that.   Bruner quotes a WSJ reporter as writing about the deal - "A company without assets was buying a company without a clue."   By the time the deal finally closed in January 2001 it was a deal that should not have made any sense to anyone.  The dot com bubble had already collapsed - revealing the true valuation the company whose shareholders now held 55% of the stock of the combined company.

One wonders what was motivating all that talk of synergies and next generation media was about.  Road Runner -- Time Warner's version of @Home (another cable-based Internet service provider, but at the time owned by Cox, Comcast, and TCI) - never cottoned on to creating a cable-based AOL broadband service.  Seems like the creation of a cable-based AOL broadband service would have been the very first thing the parties should have done after the transaction closed.  But they didn't.  The Road Runner brand lived on and the AOL dial-up service has been dying a slow death for years.  That the FTC required an open access policy for ISP providers on TW's networks didn't help.  

Well, the good news is that after having years ago written of the cost of the acquisition and dropping the AOL name from corporate moniker, it now looks like AOL will be spun off and go its own way.   According to TechCruncher the Time Warner board will meet tomorrow to decide to spin off AOL.  This decision has been a long time in coming.  More as the deal develops.  

- bjmq

OTS Approves Bank Purchase by a Consortium of Private Equity Firms in Switch of Policy

The Office of Thrift Supervision recently approved the purchase of a thrift (BankUnited FSB) under its supervision by a consortium of private equity firms. This decision makes the OTS the first bank regulatory authority to approve the acquisition of a controlling interest in a U.S. bank by private equity firms.  My firm's memo on the approval is here.

Delaware Weighs in on Poison Puts

The credit crisis has brought the issue of the poison put to fore.  A "poison put" is a change of control provision in an indenture that prevents a debtor from having its board replaced as a consequence of a hostile acquisition without triggering a default event.   NRG has been waving the potential of such a default as a reason for its shareholders not to tender into Exelon's hostile bid for control of NRG ("NRG: Exelon's board proposal would accelerate $8B in debt").  

In April, the WSJ ran an article on the role of poison puts in slowing down the market for corporate control during the credit crisis.  Whereas in better times, potential sellers with restrictive debt covenants. ("Poison puts undercut mergers").  Below is a discussion from the WSJ on the effect of "poison puts" on the M&A market.  

  

The Delaware courts recently had a chance to weigh in on the validity of poison puts in the Amylin case.  The opinion is here: Download Amylin-Poison Put. The core issue in the Amylin case was whether a board can, in effect, tie their own hands, as well as the hands of shareholders by leaving it to third party creditors to decide whether or not a hostile bidder is acceptable.  If you'r familiar with the deadhand/slowhand poison pill cases, then it's hard to imagine a Delaware court deciding that a board may, consistent with its fiduciary duties, agree to poison put that effectively neuters shareholders' voting rights.

In the Anylin case, creditors sued to enforce the covenant and prevent a new board that won a proxy contest from taking their seats on the board.  Shareholders and the board opposed.  The court ruled with the board. The effect of which is that poison puts must be read more generously and in a manner that does not have the effect of entrenching management and disenfranchising shareholders.   There is a nice post on this decision on the Harvard Corporate Governance Blog (here). 

- bjmq

Merger Pricing

Baker, Pan, and Wurgler recently posted a paper, The Psychology of Pricing in Mergers, analyzing the pricing of mergers.  They conclude that the 52-week high provides an important psychological anchor in the pricing of mergers.  This paper got a nice write up in today's WSJ.  Here's the abstract.

Psychology-driven pricing practices are evident in mergers and acquisitions and appear to be economically important. In particular, offer prices are highly influenced by the target's 52-week high stock price. This price probably serves as a psychological anchor-a starting point from which actual bid prices do not sufficiently adjust to reflect only current information (Tversky and Kahneman (1974)). A substantial fraction of bidders offer the target precisely its 52-week high, whether it was achieved recently or nearly a year ago. Bidders who pursue targets with 52-week highs that are well above their current prices experience more negative offer announcement effects; their investors perceive such bids as more likely to be overpaying. The probability of deal success is substantially and discontinuously increased by offering the target a price above its 52-week high, indicating that psychology-driven prices have real effects.

- bjmq

Rubinovitz on Fixed Costs

Robert Rubinovitz's paper, "The Role of Fixed Cost Savings in Merger Analysis" is now appearing in the Journal of Competition Law & Econ.  Here's the abstract:  

Among the many motivations for mergers, clearly one of the more important considerations is the extent to which the merger will generate cost savings for the firms involved. Standard economic models demonstrate that a decrease in marginal cost leads to a lower price, whereas a decrease in fixed costs does not necessarily have this effect. Thus, from the Antitrust Agencies' perspective, in a merger analysis, emphasis should be placed on marginal cost savings because these efficiencies will create short-run benefits for consumers, in terms of lower price and higher output, and should be given the most weight. Of late, increasing attention has been given to how fixed cost savings can improve consumer welfare. One key insight is that demonstrating the direct effects of fixed cost savings on consumer welfare may require a longer time horizon than marginal cost savings or may require embedding these savings in a dynamic context. This paper exhibits an approach that provides straightforward predictions on the relationship between fixed costs, prices, and consumer welfare. When the fixed cost of producing quality decreases, it is shown that consumer welfare increases. The clear implication of this model is that fixed cost savings should be given weight in the analysis of the potential effects of a merger on consumer welfare.

- bjmq