June 26, 2009
BAC-ML: The E-Mail
The internal e-mail disclosed as part of the House Oversight Committee's hearings on the BAC/Merrill deal make for some interesting reading. In the exchange below Scott Alvarez, General Counsel for the Federal Reserve Board, lays out the major legal issues surrounding the last minute "MAC-attack" by Lewis. He correctly identifies the disclosure issue with respect ML's losses as the real hot button legal problem for Lewis.
From: Scott Alvarez
To: [Ben Bernanke]
Date: 12/23/08, 10:18AM
Shareholder suits against management for decisions like this are more a nuisance than successful. Courts will apply a “business judgment” rule that allows management wide discretion to make reasonable business judgments and seldom holds management liable for decisions that go bad. Witness Bear Stearns. A different question that doesn’t seem to be the one Lewis is focused on is related to disclosure. Management may be exposed if it doesn’t properly disclose information that is material to investors. There are also Sarbanes-Oxley requirements that the management certify the accuracy of various financial reports. Lewis should be able to comply with all those reporting and certification requirements while completing this deal. His potential liability here will be whether he knew (or reasonably should have known) the magnitude of the ML losses when BAC made its disclosure to get the shareholder vote on the ML deal in early December. I’m sure his lawyers were much involved in that set of disclosures and Lewis was clear to us that he didn’t hear about the increase in losses till recently.
All that said, I don’t think it’s necessary or appropriate for us to give Lewis a letter along the lines he asked. First, we didn’t order him to go forward – we simply explained our views on what the market reaction would be and left the decision to him. Second, making hard decisions is what he gets paid for and only he has the full information needed to make the decision – so we shouldn’t take him off the hook by appearing to take the decision our of his hands.
Let me know if you’d like any more information on this.
From: [Ben Bernanke]
To: Scott Alvarez
Date: 12/23/08, 11:08AM
Thanks, Scott. Just to be clear, though we did not order Lewis to go forward, we did indicate that we believed that [not] going forward would detrimental to the health of (safety and soundness) of his company. I think this is remote and so this question may be just academic, but anyway: What would be wrong with a letter, not in advance of litigation but if requested by the defense in the litigation, to the effect that our analysis supported the safety and soundness case for proceeding with the merger and that we communicated that to Lewis?
From Bernanke's response, it's pretty clear that while the Fed didn't order BAC to close the deal, they probably told Lewis that if he decided not to close the deal that the world economy would implode and it would be all his fault. Hmm. Tough choice. Tough choices like these are just examples of the "Big Deal" in action.
On the other hand, to the Chairman's question about preparing a letter to help with Lewis' potential defense in any lawsuit - through the combined wonders of e-mail and discovery, the letter he thinks might be helpful isn't required!
Recap of Bernanke's testimony:
June 17, 2009
Breaking the Bank
Last night's Frontline episode gives a blow-by-blow of the BoA/Merrill deal in crisp Frontline style. Watch it over lunch at your desk.
For those of you keeping score at home, the material adverse change language is from the merger agreement is below. Having it in front of you will come in handy at certain points while watching the show.
3.8 Absence of Certain Changes or Events. (a) Since June 27, 2008, no event or events have occurred that have had or would reasonably be expected to have, either individually or in the aggregate, a Material Adverse Effect on Company. As used in this Agreement, the term “Material Adverse Effect” means, with respect to Parent or Company, as the case may be, a material adverse effect on (i) the financial condition, results of operations or business of such party and its Subsidiaries taken as a whole (provided, however, that, with respect to clause (i), a “Material Adverse Effect” shall not be deemed to include effects to the extent resulting from (A) changes, after the date hereof, in GAAP or regulatory accounting requirements applicable generally to companies in the industries in which such party and its Subsidiaries operate, (B) changes, after the date hereof, in laws, rules, regulations or the interpretation of laws, rules or regulations by Governmental Authorities of general applicability to companies in the industries in which such party and its Subsidiaries operate, (C) actions or omissions taken with the prior written consent of the other party or expressly required by this Agreement, (D) changes in global, national or regional political conditions (including acts of terrorism or war) or general business, economic or market conditions, including changes generally in prevailing interest rates, currency exchange rates, credit markets and price levels or trading volumes in the United States or foreign securities markets, in each case generally affecting the industries in which such party or its Subsidiaries operate and including changes to any previously correctly applied asset marks resulting therefrom, (E) the execution of this Agreement or the public disclosure of this Agreement or the transactions contemplated hereby, including acts of competitors or losses of employees to the extent resulting therefrom, (F) failure, in and of itself, to meet earnings projections, but not including any underlying causes thereof or (G) changes in the trading price of a party’s common stock, in and of itself, but not including any underlying causes, except, with respect to clauses (A), (B) and (D), to the extent that the effects of such change are disproportionately adverse to the financial condition, results of operations or business of such party and its Subsidiaries, taken as a whole, as compared to other companies in the industry in which such party and its Subsidiaries operate) or (ii) the ability of such party to timely consummate the transactions contemplated by this Agreement.
June 01, 2009
Graduation season and Bernanke's commencement address
A second away from M&A to note that it's graduation season at most law schools. Ben Bernanke, chairman of the Federal Reserve, gave the commencement address at this year's graduation here at Boston College Law School. It was a nice talk about the unlikely story of a boy from a small town in South Carolina who by a mixture of luck and hard work came to run the world's largest economy. The text of his talk is here.
May 30, 2009
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
“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
December 30, 2007
The Top Ten M&A Events of 2007
[Moving to the top for the new year]
My wholly subjective list of the top ten M&A events for 2007:
- The MAC Daddy. It began with Accredited Home Lenders/Lone Star. But the August turmoil subsequently brought material adverse change (MAC) claims in MGIC/Radian; Harman/KKR & GSCP; SLM/Flowers et al.; Genesco/Finish Line; Home Depot Supply/various; Fremont General Corporation/Gerald J. Ford; and H&R Block subsidiary Option One/Cerberus. You can speculate whether some of these MACs were asserted for bargaining leverage in a renegotiation or as reputational cover for exercise of a reverse termination fee. Nonetheless, it is clear that these MAC assertions and the subsequent deal terminations left their targets wounded and struggling to restore market credibility. We still have yet to see a court decision out of any these cases. However, the opinion in Genesco is due any day now and there is also pending Delaware litigation in the SLM deal, but given SLM's recent implosion I would suspect that dispute quietly settles before trial for a de minimis amount. So, we are likely to be left with one decision under Tenn. law -- a disappointment as an opinion providing further interpretation of a MAC clause under Delaware or New York law is sorely needed.
- The Great Private Equity and Bank Finance Blow-out. As the deal pipe-line sluggishly moved through Fall private equity firms increasingly became less worried about reputational issues and more willing to cut their losses by exercising reverse termination provisions -- this was ably illustrated in Acxiom/Silver Lake and ValueAct; URI/Cerberus and Myers Industries/GSCP. Banks got into the act too as, faced financing sure losers, they leveraged the terms of their own commitment letters to force renegotiations or deal terminations -- illustrated here by Genesco and Home Depot Supply. The tag-team worked on some deals such as Home Depot Supply but left everyone with a bad taste and distrustful of both private equity firms and financing banks. The Street generally has a short memory. But the private equity firms do not -- I doubt Cerberus will be able to contract with any of their brethren (from Drexel or otherwise) using their form of agreement for a very, very long time.
- The Return of the Cash Tender Offer. The '80s stalwart is back baby. Cash tender offers became increasingly frequent this year as SEC amendments to the best price rule made them more palatable, foreign investors provided cash to fund many deals and the market shifted from private equity deals (which need a longer lead time for finance marketing and therefore use a merger structure) to strategic transactions. But almost eight years after the SEC purportedly put stock-for-stock exchange offers and cash tender offers on parity the exchange offer remained notably absent as a utilized deal structure.
- CFIUS Reform & Sovereign Wealth Funds. On July 26, the President signed into law H.R. 556,The National Security Foreign Investment Reform and Strengthened Transparency Act, which enhanced the review authority of the Committee on Foreign Investment in the United States (CFIUS). The reforms were ultimately mild. But in the Fall sovereign wealth funds took minority positions in Citi, Merrill, Morgan Stanley, Bear Stearns, Carlyle, and Och-Ziff. The applicability of recently adopted CFIUS mandatory review in these circumstances was unclear and the effect of this investment uncertain. Foreign buyers are notorious for buying at the top of the market but here one was left to wonder who was taking advantage of the other and whether the current CFIUS review structure was adequate to review them. At the very least, the political element to some of these deals was a bit worrisome (e.g., a condition of Morgan Stanley's deal with CIC, the Chinese investment company was that Morgan operate in China).
- Cross-Border M&A. The largest completed deal of the year and announced deal, respectively were non-U.S. cross border deals (RBS et al./ABN Amro and BHP Billiton/Rio Tinto respectively). M&A activity outside the United States again exceeded domestic M&A. Expect these trends to continue -- U.S. M&A attorneys would accordingly do well to do a stint abroad preferably in a place with a good exchange rate if one still exists. Notably, the RBS/ABN Amro deal was U.S. registered under the Tier II exemption so U.S. lawyers got a cut however small (Shearman & Sterling ably represented RBS on the U.S. side here).
- The Rise and Fall of the Go-Shop. Go-shops were all the rage during the private equity boom and the subject of judicial scrutiny in In re Topps Shareholders Litigation, 2007 WL 1732586 (Del.Ch. June 14, 2007). However, in the Fall go-shops faded from the scene as private equity deals became few and go-shops themselves came under increasing scrutiny for being an ineffective cosmetic functioning to provide cover for management participation in deals.
- Mercier, et al. v. Inter-Tel. My pick as the most important M&A decision of 2007. In Inter-Tel, V.C. Strine held that a target's postponement of a shareholder meeting to permit the solicitation of more yes votes passed muster under the Blasius strict scrutiny test. This was despite the fact that the deal would have been voted down without the delay. Topps quickly adopted the tactic to gain approval of its own controversial private equity buy-out. In the future, expect more target companies in troubled deals to adopt this tactic providing them yet more leverage in the proxy process. The decision also has long term implications for the doctrinal integrity of Blasisus review generally.
- SPACs. According to the Wall Street Journal special purpose acquisition companies (SPACs) accounted for 23% of the total number of U.S. IPOs and 18% of the money raised. The $12 billion raised will sustain a significant amount of M&A activity in the coming years. But given the well-known problems with SPACs, I question whether their investors will similarly benefit. But for now it is boom times -- even former University of Notre Dame football coach Lou Holtz and Dan Quayle are directors on the SPAC Heckman Corp. Before it is too late, the SEC should consider updating Rule 419 which regulated blank check companies to apply to these companies (they currently escape application of the rule through an asset test loop-hole)
- Fairness Opinions. The SEC finally approved FINRA Rule 2290 regulating the procedures used by investment banks issuing fairness opinions. The Rule was a watered down version of the one originally proposed and imposed largely redundant procedural requirements on investment banks. Later in the year, Marc Wolinsky, a partner at Wachtell, Lipton, Rosen & Katz referred to fairness opinions as: “the Lucy sitting in the box: ‘Fairness Opinions, 5 cents.’”. He's right and Delaware, the SEC and FINRA should acknowledge it instead of promulgating rather useless fairness opinion requirements upon the deal process.
- Hedge Fund M&A. Hedge fund M&A made a fitful debut as hedge fund managers walked on deals (ValueAct in the Acxiom deal/Cerberus in the URI deal) and shareholder activism sometimes came up short (H&R Block and perhaps Applebee's). Ultimately, hedge fund growing assets under management and their unrelenting search for alpha will lead them to attempt more M&A deals, but clearly there is a learning process here.
- Contract Drafting (Tied for Tenth). Chandler's opinion in URI/Cerberus says it all.
THE M&A RAZZIE
Finally, its not in the top ten list but a big M&A razzie!? to all of those post-August companies and deal lawyers who agreed to reverse termination fees, particularly those with management involvement where such an option is unecessary and likely harmful (I'm talking about you Waste Industries -- see the merger agreement here -- a 29.9 million termination fee in a management involved leveraged buy-out is just an option that the special committee should not have agreed too -- Waste Industries lawyers' Robinson, Bradshaw & Hinson, P.A. and Wyrick Robbins Yates & Ponton LLP should have advised their client better).
Runner-up goes to the deal lawyers who let their clients put closing conditions in disclosure schedules which then go undisclosed (e.g., 3Com & Harrahs) so that we have no true idea what the conditions to closing the deal are. I wish the SEC would crack down on this.
THE M&A AWARDS:
- M&A deal of the year -- Tribune Co./Sam Zell -- Zell acquired the Tribune Co. with only $315-$500 million of his own money using an ESOP tax-efficient structure only an M&A lawyer could love. OK maybe also a tax lawyer. Credit to Zell for closing this highly-leveraged deal during a period of market turbulence and with only a $25 million reverse termination fee to hold him there. That is reputation for you.
- M&A deal team of the year -- I'm still thinking about this one -- comments or suggestions welcome.
- M&A litigation team of the year -- Willkie Farr & Gallagher for URI in the URI/Cerberus litigation-- dealt a bad hand they almost won it all on summary judgment.
- Hangover of the year -- The newly formed Arcelor Mittal was unable to break the the Netherlands Strategic Steel Stichting to which Arcelor gave ownership of Dofasco to try to thwart a takeover by Mittal Steel last year. Instead the trustees rejected a request to sell the Canadian steel unit in November of 2006. In January. Arcelor Mittal decided that it would not sue the trust as it would have no chance of winning -- an event which led to an unsuccessful lawsuit by ThyssenKrupp brought over Mittal's alleged promise to sell if Dofasco it bought Arcelor. Certainly a hangover for Arcelor Mittal, but a year late congratulations to Scott Simpson of Skadden, counsel for Arcelor, who devised this strategy bringing back to life a legal structure which initially came into widespread use to protect assets from the Nazis.
Have a good new year all. May your deals be plentiful and close with a success fee. And may you find the time to spend it with family and friends.
December 09, 2007
The Future of Private Equity M&A
Last week, I posted the Wounded and the Dead, discussing the abnormally high number of deals in today's M&A market which are either dead or walking wounded. But, as a bright market observer pointed out to me, even the majority of private equity deals, over thirty of them in fact, have completed during this time of extreme market turbulence. And some of them, such as Coinmach Service/Babcock and Catalina Marketing/Hellman & Friedman Capital, could also have been classified as walking wounded prior to their close. So, for those who make their money on these deals -- sponsors, investment banks, lawyers and even arbitrageurs -- it is not time to retire or otherwise go into a new business (NB. academia is great). We can learn from deals that have succeeded during this time to structure more certain transactions. So, here are my thoughts on the dos and don'ts for future private equity deals -- some are short-term recommendations based on current economic and market conditions; others more lasting. And obviously, they are aspirational and may bend to commercial realities. At the end of the list, I put forth a non-exclusive list of the thirty or so private equity deals which have closed with some notes.
The Do's and Don'ts of Private Equity
- Don't Sign Options, sign deals.
- Be in the right business. Don't be in the mortgage lending business (AHL, Fremont, Option One, MGIC/Radian); Don't be tied into housing in any way or in retail or service businesses that subsidize sales with credit to customers without more general access to credit. Be careful generally if you are in a cyclical retail industry. This may change, but right now the credit markets are too unstable to finance these types of deals on a certain basis.
- Keep Things Simple. Don't deal with equity syndicates, consortiums, multiple sponsors and the like (SLM, etc.)--no closings contingent on other closings (PHH).
- Restructuring an agreed deal is not necessarily a good thing. Don't allow a sponsor to reduce equity exposure pre-closing (Home Depot); Don't leave financing as a post-announcement condition (CKX).
- Know thyself. Don't blow your quarterly numbers; Especially, don't blow your covenants (Harman). Fire your CFO if the latter happens. Small consolation but a necessity. EBITDA conditions are actually that.
- Reputation matters. Work with established private equity firms with lots of clout. They have been in this business for years and will need to be there in the coming ones. This is not the time to work with new entities no matter how good their principals are. Here, I believe Blackstone and Fortress being public actually make them less likely to try to walk on deals because of their increased public profile. Note this KKR.
- Reputation goes both ways. Don't lie or stretch the truth too much prior to executing a contract. It may not be fraud; but it is not nice and it pisses people off (GCO, maybe).
- Avoid Hedge Fund deals. Hedge funds have less reputational capital at stake. They are in these deals to seek alpha and will change style and go back to trading oil if the playing field suddenly changes.
- Leverage Stapled-Financing. Pick your banks carefully -- use staple-financing negotiations to firm up your financing letters and provide flexibility to restructure deals if you so agree.
Get Good Lawyers. Retain experienced M&A counsel. Think hard about retaining counsel which has such sell-side experience but does not regularly represent private equity firms (the excellent M&A lawyers at Shearman & Sterling and Wachtell, despite their difficulties, spring to mind). Do not retain Wilson Sonsini (3Com, Acxiom).
Get an independent Financial Advisor. Think hard about hiring an independent M&A bank (Greenhill, Perella have some terrific people). It is increasingly clear that the majors lack internal leverage with their own financing departments. If things get difficult -- don't expect them to be there for you or otherwise ignore the conflict.
Remember. Do not do a deal with Cerberus; do not do a deal financed by UBS. Remember, even Goldman Sachs via GS Capital Partners invoked a MAC and a breach in Harman. Ask your lawyers specifically about closing risks -- point them to the Avaya deal as a good example of a specific performance clause. See the trading prices of Acxiom, Harman, URI, etc. to remind you of the effects of a cratered deal in light of reverse termination fees and heightened optionality. Note the shareholder lawsuits in their wake.
- Do not negotiate options, negotiate deals. Look at the Avaya model as precedent -- negotiate specific performance of the financing letters. Strongly advise your clients of the commercial risks if they do agree to a pure reverse termination fee. Negotiate higher reverse termination fees if you do have to make such a deal.
- Two-tiered termination fees mean nothing. The recent trend (3Com, etc.) is to have a two-tiered termination fee -- the lower if financing is unavailable, the higher for a pure breach. Realize that in a renegotiation, the private equity firm is always going to have a strong case for the lower one and that it is the starting point and settlement will only be lower (Acxiom). It is highly unlikely that the fee will ever go much above the lower one. A two-tiered break up fee is a cosmetic.
- A MAC Clause is nothing but a negotiating tool in the hands of the willing. Remember this.
- Avoid complex drafting. If any section of your agreement has one or more "to the extent applicables", "Notwithstanding", or otherwise has too many caveats redraft it to make it clearer and unambiguous. Stay awake the extra two hours to do this.
- Choice of Forum clauses matter. Don't give your buyer leverage for settlement and postponement by being able to litigate in multiple jurisdictions (Genesco, URI). Delaware is again proving themselves in these disputes as the place to litigate.
- Choice of Law clauses matter. N.Y. is the law for financing documents. Delaware is generally the law for merger agreements. Neither is likely to change. Find a work-around that deals with this disparity.
- Do not boilerplate deals. For example, Wilson Sonsini using the same structure for 3Com the week a similar structure they used in Acxiom cratered. Market forces require a rethink of how these documents work -- don't simply use the olds ones.
- Financing Documents matter. Think about third party beneficiary clauses in equity commitment and financing letters (URI).
- Guarantees matter. If you have a specific performance model make it clear the guarantee is unaffected. Read these letter thoroughly and make sure they interact correctly with the merger agreement.
- Think three steps ahead. Spend an hour talking through scenarios in light of what happens. For example, these disputes inevitably span shareholder litigation -- have MAC and rep carve-outs for such eventualities (if possible).
- Go-shops are ephemeral. Go-shops have seldom turned up competing bids. Management and the private equity buyer have too much of a head start. And when they do come in (Restoration Hardware, Topps), management is still likely to attempt to manipulate the process towards their favored pe firm.
- If it is seems shaky, it is. If, upon deal announcement, the analysts think it is over-leveraged, it likely is.
- Avoid deals where management is too cute on their disclosure. For example, putting closing conditions in a schedule and then not disclosing what they are (3Com); not disclosing a possible renegotiation (URI), etc. This not only is a possible violation of the federal securities laws, it is a trap for the unwary (of course, in some cases we won't know this until it happens).
- Nothing is Certain. Leave this type of investing to the professionals.
Here is a non-exclusive list of private equity deals which have closed since August. Read them, study them, learn.
- 1-800 Contacts/Fenway Partners closed September 6. 2007. Per the merger agreement, reverse termination fee of $10,330,550 rising to $13,774, 000 if there is a willful breach by Fenway with Fenway guaranteeing; language appears to permit specific performance if no termination.
- Aeroflex/Vertitas Capital closed in August--Per the merger agreement, $20,000,000 reverse termination fee; specific performance clause nullified.
- Alltel/GS Capital Ptners/TPG Capital closes late November despite market jitters. Per the merger agreement, $625,000,000 reverse termination fee.
- Applebees/IHOP closes late November despite jitters over whether financing would fall through --Per the merger agreement, deal had specific performance with no outs for IHOP.
- Archstone-Smith/Lehman Bros Tishman Speyer closes in early October -- Per the merger agreement, very large $1.5 billion reverse term fee but no specific performance (25% of Lehman's equity commitment and 100% of Tishman Speyer's),
- Avaya/Silverlake-TPG Capital closes in October -- a very good merger agreement with specific performance of the debt and equity financing required (similar to Affiliated Data Services). Every M&A attorney should read this agreement.
- Bausch & Lomb/Warburg Pincus closes late October--merger agreement states Bausch & Lomb cannot seek specific performance and its reverse termination fee of $120mm is sole exclusive remedy. I was surprised B&L was so accommodating in a competitive situation.
- BISYS/Citigroup and J.C. Flowers closed early August -- merger agreement provided for $36 million reverse termination fee as sole and exclusive remedy for BISYS.
- Catalina Marketing/Hellman & Friedman Capital partners closed early October -- a walking wounded deal -- per the merger agreement, a $50,640,000 reverse termination fee with specific performance excluded.
- CDW Corp/Madison Dearborn Partners-Providence Equity Partners closed mid Oct -- per the merger agreement, a $146,000,000 reverse termination fee with $292,000,000 cap on damages -- no right of specific performance.
- Ceridan/Thomas H. Lee and Fidelity National Financial closed in early November; per the merger agreement, Cerdian had right to enforce specific performance. A $165,000,000 reverse termination fee.
- Coinmach Service/Babcock and Brown Infrastructure--closed in late November; a walking wounded deal; per the merger agreement, a $15,000,000 million reverse termination fee (small); oddly no specific performance clause at all; equity was syndicated; weak sponsor; closing delayed day by day waiting for equity to show up (I guess).
- Crescent Real Estate Equities/Morgan Stanley Real Estate closes in August -- per the merger agreement, $300 million reverse termination fee -- no specific performance.
- Deb Shops/Lee Equity Partners closed late October -- per the merger agreement, $15,000,000 reverse termination fee; no specific performance clause.
- Equity Inns/Whitehall Street Global Real Estate Limited Partnership closed late October -- per the merger agreement, a $75,000,000 reverse termination fee. Odd tax language concerning treatment of such payment (may be useful?). Good limitation language on specific performance.
- First Data/KKR closes late September -- walking wounded deal -- per the merger agreement, $700 million reverse termination fee; specific performance excluded; much clearer agreement than URI; negotiated by Simpson for KKR.
- Friendly Ice Cream/Sun Capital Partners closed late August -- per the merger agreement, a low $5,000,000 reverse termination fee; ambiguous on specific performance. I love Reeses Pieces sundaes.
- Guitar Center/Bain Capital closed early Oct; a walking wounded deal -- per the merger agreement, a $58,000,000 reverse termination fee with a higher damages cap of $100,000,000. Another ambiguous agreement as to whether specific performance is available.
- John Nuveen/Madison Dearborn Partners closed mid November -- per the merger agreement, $200,000,000 reverse termination fee doubling to $400,000,000 under certain conditions; no specific performance.
- MC Shipping/ Bear Stearns Merchant Banking Partners closed mid Sept; per the merger agreement, a plain vanilla deal with a standard specific performance clause (if you count a merger under Liberian law plain vanilla).
- National Home Health Care/Angelo Gordon finally closes late November; drop-dead date extended due to issues obtaining regulatory approvals and EBDITDA condition of merger agreement; per the merger agreement, the deal was conditioned on financing and there was no reverse termination fee.
- Ryerson/Platinum Equity closed mid October -- per the merger agreement, $25,000,000 reverse termination fee -- no specific performance clause.
- Sequa/Carlyle closed last week -- per the merger agreement, no specific performance and a $60,570,000 reverse termination fee.
- Samsonite/CVC Cap Partner -- per the merger agreement, specific performance available -- although some ambiguity; $50,000,000 reverse termination fee; all equity financed.
- Smith & Wollensky/Patina Restaurant Group closed in August; merger agreement had no specific performance fee or specific performance clause -- competing bidder -- companion asset sale of NYC restaurant assets to Stillman entity also closed simultaneously.
- Smithway Motor Express/Western Express closed end of October; per the merger agreement; this had only a $1,000,000 reverse termination fee with an ambiguous specific performance fee which excludes such a remedy when the financing is unavailable; was expected to close in August and had lots of delays. Western Express represented by inexperienced private equity counsel.
- Station Casinos/Fertitta Colony Partners closed in November -- per the merger agreement, reverse termination fee of $160,000,000. Good provision on this being the sole and exclusive remedy of Station Casinos.
- Symbion/Crestview Partners (equity partner Northwestern Mutual) closed in late August -- per the merger agreement, $12,500,000 reverse termination fee, but specific performance still available. Not a standard agreement (looks like a sell-side merger agreement drafted by counsel which did not regularly do pe deals).
- Topps/Tornante closed in October -- complex -- with an intervening bid by Upper Deck. per the merger agreement, a $12,000,000 reverse termination fee but also specific performance.
- TXU/KKR-TPG-GS closed in October -- per the merger agreement, $1 billion reverse termination fee -- a bit of ambiguity but likely no specific performance permitted.
- Vertrue/One Equity; Rho Ventures (Oak Investment dropped from the deal); Brencourt Advisors closed in mid August -- per the merger agreement ,$17,500,000 reverse termination fee with no specific performance.
December 03, 2007
The Wounded and the Dead
One of the more interesting and distressing things about today's M&A market is the number of deals which are either dead or walking wounded.
- For example, take the pending acquisition of PHH Corp. by General Electric Capital Corp. GE's acquisition is conditioned on The Blackstone Group being "ready, willing and able" to consummate GE's on-sale of PHH's mortgage operations [Yes, the quoted language is actually in the negotiated merger agreement]. On September 14, 2007, GE notified PHH that it had received a letter from Blackstone's acquisition vehicle that it had a financing short-fall of up to $750 million in available debt financing. Since that time, PHH's shareholders have approved the deal but no word from Blackstone -- they don't seem to be ready, willing or able. The deal is on life support and GE is likely waiting for December 31, 2007, the drop-dead date on the merger agreement, to terminate the deal. PHH is clearly the walking wounded verging on dead.
- Another deal in this category is the "pending" acquisition of SLM Corp. by a consortium led by the Flowers Group. After a flurry of litigation, the merger agreement is still pending but any trial is months if not longer out, and it appears that the fight has been reduced to a dispute over the $900 million reverse termination fee. Given what I believe is SLM's weak case, expect this one to also linger for a while and then be resolved quietly -- likely in some type of settlement akin to what happened in Harman (i.e., the Flowers consortium invests an amount directly in SLM so both sides can proclaim victory and the merger agreement is terminated). SLM is another of the walking wounded -- more like walking dead.
I think this is rather unprecedented and symbolic of the state of this market. Can anyone remember when so many deals have either been renegotiated, or are otherwise wounded or troubled? And I think it is problematical in the long term. Going-forward, targets and M&A target lawyers will be much more wary, rationally over-negotiating deals in order to tighten up provisions which have come to light as ambiguous or otherwise providing too much leeway to buyers. This will create its own problems as overly-complex and heavily negotiated language inevitably creates further ambiguity (see, e.g., Section 8.2(e) of the URI/Cerberus merger agreement), and targets are less willing to rely on reputation to cover gaps. And, of course, all of this backlog must still be cleared out. Another interesting development is how wary investors have become of private equity deals with reverse termination provisions. Take the first four big private equity deals announced post August: 3Com ($2.2 billion), Radiation Therapy Services $(1.1 billion), Goodman Global ($2.65 billion), and Puget Energy ($7.4 billion). As of Nov. 30 their deal spreads were 23%, 8.8%, 4.5%, and 6.6%, respectively. These are much wider spreads than one would expect (although in fairness 3Com and Puget have regulatory issues and Goodman has an EBITDA condition perhaps explaining some of this).
In any event, for those keeping score here is the full holiday list of the Dead, Wounded and Troubled. Happy Hanukkah!
- MGIC/Radian Group -- An Aug. MAC case. The parties mutually agreed to terminate their merger agreement after MGIC asserted a MAC had occurred.
- Harman/KKR & GS Capital Partners -- The merger agreement was terminated and $400 million invested by KKR & GSCP in Harman after the buyers asserted a MAC and breach of the merger agreement by Harman. This investment was a face-saving way out for Harman as a negotiated disposition of the $200 million reverse termination fee.
- Acxiom/Silver Lake & ValueAct -- The merger agreement was terminated and $65 million paid by the buyers to Acxiom after a MAC was asserted by the buyers. This amount was $1.75 million less than the reverse termination fee in the merger agreement.
- Fremont General Corporation/Gerald J. Ford -- Investment Agreement abandoned after buyer stated he was not prepared to "proceed"; another likley MAC claim.
- H&R Block subsidiary Option One/Cerberus -- parties mutually agree to terminate deal after "certainclosing conditions" could not be met.
- PHH Corp./GE & Blackstone -- see above
- SLM Corp./Flowers et al. -- see above
- Genesco/Finish Line & UBS -- litigation in Tennessee over MAC and negligent misrepresentation claims by Finish Line and fraud claim by UBS. UBS has also sued in a New York court to terminate its financing obligations to Finish Line concerning the merger.
- URI/Cerberus -- litigation in Delaware over specific performance after Cerberus repudiated its obligations under the merger agreement. Cerberus has sued in New York claiming that its guarantee limits its damages to $100 million.
- Reddy Ice/GCO-- Morgan Stanley asserted back in Sept. that it no longer is required to finance the deal. According to the merger agreement, the deal is in a marketing period which ends on Jan 31, 2007. With a low reverse termination fee of $21 million this deal is walking wounded. To boot Reddy Ice's recent results have not been too hot (weak attempt at a pun), and their CEO resigned earlier this week for health reasons.
- 3Com/Bain Capital & Huawei (23% deal spread) -- Appears to be held up in CFIUS review under the Exon-Florio amendment -- in fact it appears that 3Com has yet to even disclose whether the deal is so conditioned upon CFIUS approval (see my post on their seemingly poor disclosure practices here). Reverse termination fee of $66/$110 million.
- CKX/Robert Sillerman (9.7% deal spread but hard to estimate) -- Proxy statement yet to be filed after five months. The financing on this deal appears yet to be firmly committed.
- Cumulus Media/Merrill Lynch (42.4% deal spread) -- $15 million reverse termination fee.
- Goodman Global/Hellman Friedman (8.8% deal spread) -- reverse termination fee of $75/$139 million and merger conditioned on $255 million in EBITDA in 2007.
- Myers Industries/Goldman Sachs (11.1% deal spread) -- marketing period ends Dec. 15 after being extended previously.
- Penn National Gaming/Fortress Investment Corp. (12.8% deal spread) -- shareholder meeting on Dec. 12 to approve deal/reverse termination fee of $200 million.
- Tribune/Sam Zell (10.6% deal spread) -- $25 million reverse termination fee.
NB. I define troubled deals as those with a greater than 10% deal spread as of Nov. 30 and which are not industry buy-outs (i.e., they are private equity and management buy-outs) or deals that otherwise have reverse termination fees and abnormal deal spreads.
Settled at Reduced Price/Closed
- Accredited Home Lenders/Lone Star -- closed after MAC asserted and price lowered.
- Home Depot Wholesale Supply/Bain Capital Partners, The Carlyle Group and Clayton, Dubilier & Rice -- closed after MAC asserted and price lowered.
Addendum: I am sure I missed a few so if anyone has more just put in a commen or email me and I will add them in throughout the day.
November 21, 2007
I'll be on hiatus for the rest of the week, returning on Monday. In the interim, here are some tidbits to keep your M&A mind working over the Thanksgiving holiday:
- CKX, Inc. yesterday filed a Form 8-K finally detailing the financing commitment letters for its pending acquisition by Robert F.X. Sillerman and Simon R. Fuller. Kudos to CKX for making the filing only two days before Thanksgiving instead of later today. I'll have more on this Monday when people are back -- but in the interim feel free to figure out on your own the amount of financing now being provided by Sillerman and whether these "commitment letters" are really as firm as they should be. Moreover, in addition to possibly shaky financing, five months in the parties have yet to file a preliminary proxy statement with the SEC, and CKX cannot terminate the deal for failure of Sillerman's financing until June 1, 2008 at the earliest -- in a going private deal the type of long-term optionality being provided here to Sillerman, et al. really is remarkable. For more on this see my prior post: CKX: The Fine Art of Cramped Disclosure.
- Buttressing Genesco's case, Footlocker announced poor third quarter results yesterday. This should help Genesco argue that the MAC carve-out for industry-wide down-turns in its agreement with Finish Line applies. For more on this argument, see my prior post: Hell is Other People: Genesco/Finish Line/UBS.
- Sears Holding Corporation filed a Schedule 13D announcing it had acquired 13.67% of Restoration Hardware. The purchase took place in two transactions on November 8 and November 12, respectively. Restoration Hardware is clearly in Revlon mode right now and its Board is thus required to accept the highest price reasonably available. Sears' foray has come during Restoration's go-shop period so a break-fee on the deal is the lower $6,675,000 instead of $10,680,000. For more on Restoration's pending deal with Catterton Partners and its transaction defenses, see my post: Restoration Hardware Sold!
- Remember the SPAC Endeavor Acquisition Corp.'s agreement to acquire American Apparel? It has been so long few do; the transaction was announced on December 18, 2006. But a year later Endeavor has yet to clear its merger proxy with the SEC. The latest proxy filing contemplates a December 12 meeting to approve the transaction, but has yet to be mailed. They are certainly cutting it close: if they do not complete the acquisition by December 15, 2007, Endeavor will be required under its organizational documents to be dissolved. Note that on November 7, 2007, the acquisition agreement was amended to, among other things:
- increase the number of shares of Endeavor being issued to Dov Charney [CEO and majority owner of American Apparel] at the closing of the acquisition from 32,258,065 to 37,258,065;
- increase the level of American Apparel’s net debt above which there would be an adjustment in the number of shares issued to Mr. Charney at closing of the acquisition from $110 million to $150 million;
- increase the size of the 2007 performance equity plan from 2,710,000 shares to 7,710,000 shares and to provide that stock awards from an aggregate of 2,710,000 shares would be allocated and issued thereunder . . . .;
- eliminate as a closing condition American Apparel’s hiring of a chief financial officer, chief operating officer and chief information officer; and
- Revise Dov Charney's compensation under his employment agreement (wonder which way it went?).
In my next life, I want to be acquired by a SPAC.
November 18, 2007
N.Y. Times on PE Buy-outs
The N.Y. Times today has an article by Sorkin: "If Buyout Firms Are So Smart, Why Are They So Wrong?". It's about the recent spate of private equity firms reneging on their deals. I'm quoted in it.
November 09, 2007
CKX: The Fine Art of Cramped Disclosure
CKX filed its own Form 10-Q yesterday. In it was the following disclosure about the company's pending sale and its contingency on financing:
Completion of the Merger is not conditioned upon 19X receiving financing, however, upon termination due to a failure of 19X to obtain necessary financing 19X must pay CKX a termination fee of $37 million, payable at the option of 19X in cash or shares of CKX common stock valued at a price of $12.00 per share.
Umm, so it really is conditioned on financing? Right!? Then, upping the opacity of their disclosure, CKX stated:
On November 8, 2007, 19X, Inc. (“19X”) delivered fully executed financing letters which provide for capital sufficient to complete the merger on the previously disclosed terms. The financing letters delivered by 19X include firm commitments from, as well as other detailed arrangements and engagements with, three prominent Wall Street firms and expressions of intentions from management and other significant investors in CKX. On October 30, 2007, 19X had delivered unsigned copies of the letters to allow the CKX Board of Directors to complete a review of the financing package. Upon completion of the Board’s review, 19X delivered the fully signed financing letters.
This disclosure raises more questions for me than it answers, including:
- Who are these Wall Street Banks?
- How much are their financing commitemtnts for? In particular, the use of the statement "capital sufficient" seems funny. Financing letters is also undefined. So, is the term inclusive of the equity commitment and other "expressions of interest"? It appears to be. But if this is true, the amendment to the merger agreement requires that:
- "The Financing Letters shall reflect debt and equity commitments from such equity investors and financial institutions, which together with any equity to be issued in connection with the Contribution and Exchange Agreements or to be issued in exchange for securities of Parent, shall be sufficient to pay the full Merger Consideration . . . ."
- This provision requires all of the debt and equity financing for the deal to be "committed" not an "expression of interest". If the financing letters referred to in the discloaure above do include the financing other than that committed to by the banks, it is not in accord with the merger agreement as I interpret it.
- What does the company mean by "expressions of intentions from management and other significant investors in CKX"? Is this part of the financing or the equity commitment? And, in either case, why is it an "expression of interest" and not a firm commitment. An expression of interest is below even a highly confident letter to me and is along the lines of "I express an interest in eating a sundae tonight".
So, on this basis, I would say there appears to be some trouble with the financing of this transaction, a problem which may not be cured. But, perhaps I am reading too much into this -- cramped disclosure can do that to you. In any event, this deal still has a ways to go. CKX has not even filed its proxy statement yet -- instead giving management and its controlling shareholder five months to work out a deal with a pending merger agreement. I wish I could get that option to buy.
November 01, 2007
Wachtell's Client Memos
Wachtell regularly sends out one to two page client memos notifying clients of recent developments and commenting upon them. It is great marketing for the firm; it daily keeps them in the minds of clients and other industry actors and positions them as superbly on top of M&A developments.
Nonetheless, a few of the memos that have crossed my in box in the past few weeks have made me wonder. The new generation at Wachtell is continuing to take the pro-board stances Marty Lipton has historically taken. These memos often set out an ideological position on this side of the fence. This is likely good business -- Wachtell is still the go-to law firm for takeover defense. But, I'm not sure that the new generation is making their case in the same thoughtful manner. Moreover, is Wachtell necessarily serving their clientele well by taking an ideological stance in a client memo and asserting it as truth to their clients?
So, let's take a few examples. The first is the Wachtell memo which went out last week on the new FINRA fairness opinion rules. After summarizing the rule in the first page, the memo ends with the following statement:
The disclosure and procedural requirements of Rule 2290 should address many of the concerns arising from potential or perceived conflicts of interest resulting from relationships and arrangements that are not inappropriate but may be of interest to stockholders in determining whether or not to support a particular transaction.
Well, OK then. You mean this rule, which everyone acknowledges largely overlaps SEC requirements and has been described by Debevoise as "not likely to result in significant changes to current practice" solves all of these concerns? Of course not. It does nothing to address the inherent conflicts in investment bank fairness opinion practice (contingent consideration, stapled financing, the need for future business, etc.). A conflict which is exacerbated by the subjectivity in fairness opinion valuation and the failure to follow best practices by many banks in the preparation of these opinion (use Fama French factors folks not CAPM). And just to pile on, remember, this memo went out the same week a Wachtell partner called fairness opinions "the Lucy sitting in the box: 'Fairness Opinions, 5 cents.'" David Katz, the partner at Wachtell who prepared this memo is their go-to partner for the highly complex cross-border stuff. He is very smart and should know better.
When you’re right, you’re right. And when you’re wrong, you are very wrong. Here is yet more evidence of the value to stockholders of staggered boards. Anyone listening up there in that ivory tower?
The memo, entitled, Classified Boards Once Again Prove Their Value to Shareholders in Recent Takeover Battle, states:
Takeover protections such as classified boards continue to be under assault from academics and shareholder activists, who argue that they reduce the opportunity of shareholders to receive takeover premiums by making takeovers more difficult to complete. In response to shareholder proposals and the current governance environment, the number of companies in the S&P 500 Index with classified boards has decreased from 56% to 45% since 2004.
Academic theory, however, is often divorced from the real world of corporate takeover practice. The use of classified boards to increase shareholder value was demonstrated again in the recent takeover battle for Midwest Air.
This memo cites to two sources for this. The first is the recent takeover battle for Midwest where Midwest eventually received a much higher bid than AirTrans initially offered. Well that never happens. . . . The note also cites a recent paper by Thomas Bates et al., Board Classification and Managerial Entrenchment: Evidence from the Market for Corporate Control which found that "the evidence is inconsistent with the conventional wisdom that board classification is an anti-takeover device that facilitates managerial entrenchment." Nonetheless, the study still finds significantly lower value for firms with a staggered board and a lower bid rate. And the Wachtell memo did not mention that a significant body of research finds that the staggered board's primary justification is to ward off challenges for control. This includes a recent paper authored by former Wachtell partner John Coates with Lucian Bebchuk and Guhan Subramanian, The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy. Nowhere does the memo mention this substantial evidence on the other side to Wachtell's clients. So, Wachtell may ultimately prove right here but as of now the evidence is at best mixed, leaning against their position.
Additionally, I am one of those academics Mirvis criticizes in his post (though in Michigan my tower ain't so ivory), but I also practiced M&A for ten years and know anecdotally what Mirvis knows in his own heart. In my experience, bidders, particularly foreign ones, are strongly deterred by staggered boards. They know any takeover battle could be very long and public and are unwilling to risk spending their scarce management resources on the time-consuming activity of a hostile bid for the extended amount of time it could take in the presence of a staggered board. Moreover, the current takeover system discourages toe-holds meaning that a bidder may not even be able to hedge their risk and take a position which would pay off if their bid is unsuccessful and another bidder acquires the company.
Ultimately, Wachtell would have done better to inform their clients of the conflicted academic and practitioner evidence than promoting their platform. The two examples they cite -- Midwest and this lone paper do not make a case. It is sort of like saying that because my wife likes me everyone else does. Assuming the truth of the former does not also mean the latter is true. Attacking academics isn't going to get you past that.
And finally, there was this gem the other day also on the Harvard Corporate Governance Blog by Theodore Mirvis:
Many car advertisements on TV bear a legend explaining that the driving depicted is by professional drivers on a closed track–and warning viewers not to try the twists and turns at home. Well, maybe something like that could or should be said of the European Court of Justice’s recent decision, a precis of which appears here, striking down Germany’s “Volkswagen law” and seeming to pave the way for Porsche to acquire the company.
One might recall the earlier periods over here when state anti-takeover statutes bit the dust one by one, yielding to a perceived national policy of unrestrained takeover activity and opposition to the local interest of states (especially non-chartering states) in preserving the independence of their corporate residents. There are probably more twists and turns to come as the EC works out what is meant by the “free movement of capital.”
So, Mirvis thinks European state protection of companies is a good thing for their economies and their shareholders (e.g., French protection of Danone, their chief yogurt maker, as a national champion)? Has he been getting enough sleep lately?
And I close with the following query: Are Wachtell client memos the ultimate in "Lucy in the Box". Five cents please.
October 31, 2007
Harman's Conference Call
I just finished listening to the Harman conference call last week (access the transcript here). I was hoping that it would answer some of my still remaining questions. These include the exact internal pricing on the issued bonds to KKR et al., the propriety of a KKR board member now sitting on the Harman board, the intentions of Harman with respect to this KKR et al. investment, and the validity of settling the dispute in this manner. The number of actual analysts questions with respect to any of this? None. In fact, the analysts did not ask a single question about the settlement, the dispute or the underlying financial causes of it. That is a shame, because if I was investing in Harman these are some of the first things I would like to know. I realize it is not easy being an analyst these days, but still, you would think they would have the gumption to ask the hard questions and let Harman decide whether to respond.
Maxim Integrate Products has problems. Due to an options back-dating investigation, the company has not filed its financial reports with the SEC since May 2006. This internal investigation ultimately concluded that stock option grants to employees and directors had been either back-dated or otherwise manipulated for a seven year period starting in 2000. Then on Oct. 2, Nasdaq delisted Maxim for seven "deficiencies," including delinquent reports for three quarters, two missing annual reports, a late proxy filing and failure to hold its annual shareholder meeting. The company now trades on the Pink Sheets. It expects to restate and file its past due reports in the first quarter of 2008, when it has stated it will seek relisting in the Nasdaq.
So, it was with a bit of surprise that I ran across this tidbit from a Form 8-K filed by Maxim earlier this month:
Maxim Integrated Products, Inc. suspended stock option exercises starting September 23, 2006 . . . . The Company will continue to prohibit the exercise of stock options until the Company completes its financial restatement and becomes current in its reporting obligations with the Commission. During the period which the exercise of stock options has been and will be suspended, stock options held by current and former employees have expired and will expire due to the expiration of their 10-year terms. The Company has implemented a program to provide cash payments to individuals who hold options granted from September 1996 through March 1998 that expire due to their maximum 10-year terms. . . . . . Approximately 525 individuals will be eligible for this program, and the aggregate payments are expected to total approximately $98 million . . . . .
So, does everyone get this? Maxim is making whole employees who cannot exercise their about to expire options due to the imposed black-out period. Maxim lists out the main beneficiaries of this program in this 8-K. This includes, surprise, a $5.21 million dollar payment to the current CEO of Maxim Tunç Doluca who is actually the largest beneficiary of the program. Now, I'm not against making whole employees who were not at fault or otherwise involved in this back-dating scandal. This could be a reasonable and justified business expense. But, to make-whole the CEO at a time when the failure to exit the black-out period is due to a restatement process he is driving and ultimately responsible for simply sends the wrong message. I realize that Mr Doluca replaced the old CEO of Maxim who left allegedly in connection with this scandal. But he is the one who now has responsibility to clean up this mess. He should be penalized for his failure to do so on a timely basis -- as his shareholders have been. Not made whole.
So, it is not M&A, but I thought I would put my two cents in on this one.
October 25, 2007
Harman: Bad to the Bone
Well, not surprisingly Harman waited the maximum four business days allowed under the Form 8-K rules to file the agreements related to its settlement with its former purchasers, KKR and GSCP. Here they are:
First, the settlement agreement. And once I started reading, it didn't take long for me to be shocked. Right there in the recitals the agreement states:
WHEREAS, Parent and Merger Sub have determined that they are not obligated to proceed with the Merger based on their belief that a Company Material Adverse Effect has occurred and their belief that the Company has violated the capital expenditures covenant in the Merger Agreement.
WHEREAS, the Company steadfastly denies that a Company Material Adverse Effect has occurred or that the Company violated the capital expenditures covenant in the Merger Agreement.
I had heard street rumors that Harman had allegedly violated the cap ex requirement in their merger agreement but I had refused to believe it as too far-fetched. Nonetheless, there is hte allegation (underlined). But to see why I am so schocked, let's take a look at the actual cap ex requirement in Section 5.01(b)(vi) of the Harman merger agreement. It requires that Harman shall not:
(vi) make any capital expenditures (or authorization or commitment with respect thereto) in a manner reasonably expected to cause expenditures (x) to exceed the capital expenditure budget for the 2007 fiscal year previously provided to Parent or (y) for the 2008 fiscal year to exceed the 2008 capital expenditure budget taking into account reasonably anticipated expenditures for the balance of the year as well as expenditures already committed or made (assuming for this purpose that fiscal 2008 capital expenditure budget will not exceed 111% of the fiscal 2007 capital expenditure budget);
This is a bright line test. Typically, right after the merger agreement is signed the M&A attorneys will sit down with the CFO and other financial officer and point this restriction out (actually these officers are also involved in the negotiation of this restriction since this is their bailiwick). Since there is a set dollar amount in this covenant it is very easy to follow and thus for a company not to exceed its dollar limitations. The CFO or other financial officer simply puts in place systems to make sure that the company does not violate the covenant by spending more than that amount. This is no different than my wife telling me I can't spend more than $500 this month on entertainment. It is a direction I can easily follow and I know there are consequences if I do not (Oh, and I do follow it). This is no different here -- a violation of the cap ex covenant provides grounds for the buyers to terminate the agreement. But this is and should be a problem for sellers.
Because of all this, if your attorneys have done their job and informed you of this covenant and included you in its negotiation, to violate it is really just plain old gross negligence. And such a violation is just the allegation made by the buyers here. Harman denies them, but if it is true people should be fired over this. Also expect the class action attorneys to amend their pending suits to include this claim to the extent it is not already in there.
I also spent a fair bit of time this morning trying to work out the value of these $400 million notes. To do so you need to add on the value of the option to convert the notes into Harman shares. The formula in the indenture for this conversion is a bit complicated, so I want to check my math. It is also an American option so Black-Scholes can't be used. In any event, I'll post my back of the envelope calculations tomorrow. If anyone else does this exercise, send me your results and we'll cross-check.
Also note that the Indenture has a substantial kicker in Section 10.13(c) if there is a change in control in Harman. That is a nice bonus: lucky limited partners of KKR and GSCP.
The notes were purchased as follows:
KKR I-H Limited $ 171,428,000.00
GS Capital Partners VI Fund, L.P. $ 26,674,000.00
GS Capital Partners VI Parallel, L.P. $ 7,335,000.00
GS Capital Partners VI Offshore Fund, L.P. $ 22,187,000.00
GS Capital Partners VI Gmbh & Co. KG $ 948,000.00
Citibank, N.A $ 85,714,000.00
HSBC USA, Inc. $ 85,714,000.00
But Citibank and HSBC have quickly hedged (really disposed of) their ownership risks and benefits under the notes per the following language in the Form 8-K:
Concurrently with the purchase of the Notes by Citibank and HSBC, each of them entered into an arrangement with an affiliate of KKR pursuant to which the KKR affiliate will have substantial economic benefit and risk associated with such Notes
And for those who love MAC definitions (who doesn't), just for fun I blacklined the new definition in the note purchase agreement against the old one in the merger agreement. Here it is:
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 CompanyMaterial 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 whichParent has expressly requested or to which Parent has expressly consented; (iv) to the extent resulting from the announcement of theMerger 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, inthe 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 CompanyMaterial 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.
Note the addition of a litigation exclusion for the pending shareholders class actions. Smart move.
October 11, 2007
SLM Earnings Released and It Doesn't Look Good
The earnings release is accessible here. A few initial very preliminary observations:
- SLM's core earnings fell 19% to $259 million, or 59 cents a share, from $321 million, or 73 cents a share, a year earlier, missing average analysts forecasts by about three cents a share. This includes an 11 cents a share in charges from recent legislative changes and the buyout ($28 million and $18 million, respectively). On this basis, I calculate that the earnings drop attributable to the new Bill is thus far about a nine percent drop in earnings for the 3rd quarter. That is a big drop but according to SLM the hit this quarter is non-recurring and therefore would likely not be considered a MAC by Delaware in the earnings context. So, we will need another quarter to begin to see the full effects of the Bill on SLM's earnings and whether it does indeed arise to the level of a MAC. Unfortunately, SLM does not make any statements about this in their press release. I haven't listened to the conference call yet, but I assume many analysts will be asking this (and I assume they will defer any answer due to the pending litigation).
- With the exception of growing assets, SLM missed guidance on EPS growth, loan spread and other income growth. Note that SLM withdrew this guidance on April 24, 2007 after a deal was reached with the Flowers group. I don't have enough information on this to speculate as to whether this further sustains a MAC claim but it no doubt is a driver in the Flowers group's current hesitancy to complete this deal at $60 a share. While the MAC definition does not exclude out failure to meet projections in IBP v. Tyson the Delaware court's refused to find a short term failure a MAC; rather any change to earnings must be long term and materially significant. It remains to be seen whether these failures meet that test.
- SLM makes no mention of the dispute with Flowers or otherwise any statements on the current litigation. They also make no forecasts about future earnings or as I said before, the effect of the Bill on the entirety of their operations and core earnings generally.
So, on initial glance not a great quarter for SLM, but I'm still not sure how this plays into the MAC interpretation other than as a driver for the Flowers group to use SLM's deteriorated position to renegotiate a price. I'll have more tomorrow once I listen to the earnings call.
Final Note: My sources say no food at the SLM in-person meeting today. Only soda and tap water.
SLM Earnings Release Today
SLM Corporation is to release third quarter earnings today, before noon. For those wanting some free coffee and perhaps even food there will be a live presentation at noon EDT at the New York Palace Hotel in New York City and will conclude by 1 p.m. EDT.
To participate in the earnings call, dial (877) 356-5689 (USA and Canada) or dial (706) 679-0623 (International) and use access code 5437761 starting at 11:45 a.m. EDT, Thursday, Oct. 11. The conference call will be replayed continuously beginning at 3 p.m. EDT, Oct. 11, 2007, and concluding at midnight, Oct. 25, 2007. To access the replay, please dial (800) 642-1687 (USA and Canada) or dial (706) 645-9291 (International) and use access code 5437761.
I'll have some commentary on it later today or first thing tomorrow. Expect SLM to be spinning the earnings to show how great their business is and (relatively) unaffected by the recent market turbulence. It would also be nice if they quantified the full extent the new Bill will have on their revenue and earnings -- but given the litigation, I'm not sure they will or should.
October 10, 2007
The Continuing Mystery of Harman
Remember Harman Industries? Back on Sept 21 its deal to be acquired by Goldman Sachs Capital Partners and KKR spectacularly collapsed. At the time 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.
Since that time Harman has helpfully refused to comment on the status of its merger agreement with GSCP & KKR. The only mention I could find is a reference in a later press release by Dr. Sidney Harman which referred to KKR and GSCP as its "former merger partners".
Am I the only one who finds this bizarre? It has now been about two and a half weeks since that initial announcement and Harman has provided no update on the status of its merger agreement or announced its termination. Technically, the agreement is still in effect and Harman is continuing to operate under it. Well, that doesn't make sense. And, if there has been a repudiation of the merger agreement by the buyers without a material adverse change, the buyers are required to pay Harman $225 million.
If Harman's goal is to move forward from the spectra of GSCP's and KKR's claim of a material adverse change you would have thought they would have dealt with the above issues by now and attempted to collect the $225 million in litigation or otherwise. Instead, Harman is permitting them to linger in uncertainty. Harman is already subject to a number of shareholder class actions over alleged faulty disclosure practices during the time of this transaction. Harman may want to take some lessons from this.
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.
September 24, 2007
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.
September 05, 2007
Movie Gallery's Death Spiral
Movie Gallery, Inc. yesterday announced that the holder of a majority of principal amount of its 11% Senior Notes, had agreed to forbear until September 30, 2007 from exercising its rights and remedies arising from MG's cross-default under its indenture for these notes. The cross-default had occurred due to MG's prior default on its first lien credit facility. MG had previously signed a forbearance agreement for its default under its financial covenants contained in its first lien credit facility. But, because of this default, MG has now cross-defaulted on its $175 million second lien facility. MG is now in default on all three of its major debt financing instruments. And to make matters worse, because of MG's non-compliance with the covenants contained in the first lien facilities, MG has disclosed that its liquidity is now threatened since "many of our significant vendors have discontinued extending us trade credit, requiring us to pay for product before it is shipped, and we have experienced additional tightening of terms with other vendors." In light of these problems the stock is now a penny one, and MG is no longer in compliance with Nasdaq Marketplace Rule 4450(a)(5), which requires a minimum bid price of $1.00 per share. MG is about to be relegated to the small-cap market in a best case scenario; bankruptcy court is also now a possibility.
This mess all started on July 2 when the nation's second-biggest video rental chain announced that it was unable to meet financial covenants due to "significantly" weaker-than-expected second-quarter results. Specifically, the company disclosed that it blew through the Interest Coverage Ratio set forth in Section 6.7(a) and Leverage Ratio requirements set forth in Section 6.7(b) and Section 6.7(c) under the First Lien Credit and Guaranty Agreement. This default set off the chain-reaction described above. And it took Movie Gallery only four months to breach these covenants, the first lien credit facility was signed on March 8. A review of the 10-Q for MG's second quarter shows a deterioration of MG's results but one that appears at quick glance to be expected. The quick timing between the execution of the first lien agreement and the event of default appears just a bit too quick, particularly since MG was a troubled business even at the time the facility was executed. This is just an educated guess, but perhaps MG lost the ball here and unwittingly agreed to covenants it could never meet. I hope not, but there is a story here -- hopefully a diligent reporter will find it so we can all learn from it. This is beside the obvious one of the perils of cross-default provisions. In the meantime, MG continues its death spiral.