Friday, September 21, 2007
The press release follows. I'll have commentary on it on Sunday. But my initial thought is that this is plain odd – there is no information out there which I have seen which would support a material adverse change claim. Still, given that KKR’s and GS’s liability is limited under the merger agreement to the reverse termination fee of $225 million they may as well give it a shot. And of course, they may be trying to cover up the reputational issue which would arise if they simply walked away by asserting a claim of a MAC to cover it.
Harman Comments on Previously Announced Merger Friday September 21, 3:53 pm ET WASHINGTON--(BUSINESS WIRE)--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.
As predicted (and as I am quoted on today in the Wall Street Journal), Genesco has filed suit in Tennessee state court to enforce its rights under their agreement. Here is the complaint -- I'll try and have some commentary later today. The press release is below and has some great quotes -- this is the absolute right move by Genesco. And, as I have said before, Genesco appears to have a good case (see my post here outlining the likely legal arguments). The interesting thing to see now will be whether Finish Line attempts to implead UBS here, Finish Line's financing bank who appears to have also asserted a potential MAC against Genesco. If I were Finish Line I would before UBS sues for a declaratory judgment in New York -- the choice of forum for its commitment letter (for more on this possible jurisdictional shopping see my post here).
Genesco Files Lawsuit Against The Finish Line Seeking Specific Performance of Merger Agreement NASHVILLE, Tenn., Sept. 21 /PRNewswire-FirstCall/ --
Genesco Inc. (NYSE: GCO) announced today that it has filed suit in Chancery Court in Nashville, Tennessee, seeking an order requiring The Finish Line, Inc. to consummate its merger with Genesco and to enforce The Finish Line's rights against UBS under the Commitment Letter for financing the transaction.
Commenting on the filing, Genesco Chairman and Chief Executive Officer Hal N. Pennington said, "No more delays by The Finish Line and UBS; no more reservation of rights; no more bankers' putting their pencils down. We want a court of competent jurisdiction to enforce our rights under the Merger Agreement and for The Finish Line and UBS to live up to their obligations."
Pennington continued, "We have launched this litigation in an effort to speed consummation of the merger and to force impartial review of the aspersions that The Finish Line and its bankers have cast on Genesco's business and reputation. I, along with other members of the management team and our Board of Directors, are proud to be the stewards of a company that is a leader and innovator in its industry with a rich history dating to 1924. I am proud to be the leader of a group of employees who have helped build a wonderful business for the benefit of our shareholders."
Robert V. Dale, the presiding independent director of Genesco's Board of Directors, said, "Our Board of Directors stands united in this call for The Finish Line and UBS to perform their obligations and pay our shareholders $54.50 per share in cash. Our Board, our management team and our advisors are confident that the steps we are taking are in the best interests of our shareholders."
Pennington concluded, "Commencing litigation is always a difficult decision, but continued delay by The Finish Line and UBS is simply not acceptable. Accordingly, we are seeking expedited hearings on all of our claims. I caution our shareholders and employees that there will likely be claims made back against Genesco. When they come, we will be ready."
Thursday, September 20, 2007
Accredited Home Lenders has filed the second amendment to their merger agreement with Lone Star. The amendment is a bit odd in that it contains a provision permitting Lone Star to terminate the tender offer if 50% of AHL's shareholders don't tender into the offer within 20 business days of the filing of AHL's amended 14d-9 statement. More specifically, the agreement provides for one 10 business day extension after the first expiration date which will itself be 10 business days after the statement is filed. This provision is probably meant to deal with any objecting shareholders such as Stark Investments who would have preferred that AHL go to trial for the full price. As one person put it to me in better words than I can, it can be read as "if there is any dissent get me out of this crummy deal." By the way for those wondering, exercising dissenter's rights under Delaware here appears problematical as DGCL 262 requires the appraisal valuation to be "the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation . . . ." AHL appears to be worth less here than the price Lone Star is paying, itself a product of contractual commitments made in the Spring before the sub-prime crisis had completely unfolded.
Otherwise, the conditions on the tender offer look very tight. In addition, if one examines the back-end conditions for the merger in the merger agreement they also remain unchanged and are similarly strict. This deal now appears about as contractually certain as one can get. But the stock is trading at about $11.58 which appears to be a big discount of about 2% off the offer price for such a certain deal. And dissent by shareholders is very unlikely given the mechanics of the above provisions -- they are likely to take what they can get. Perhaps I am missing something.
I'm quoted in both the N.Y. Times and the N.Y. Post today on MAC cases. It is not page six, but as a law professor I will take what I can get:
N.Y. Times: Deal to Buy Sallie Mae in Trouble
N.Y. Post: UBS Unlacing Sneaker Deal
Wednesday, September 19, 2007
Just as I was getting depressed about Accredited Home Lenders/Lone Star settling, the Genesco MAC case is heating up. Below is the letter Genesco sent to Finish Line earlier today. Genesco is making the right move here. Based on public information, Genesco appears to have a strong case that a material adverse change has not occurred, and instead Finish Line simply has buyer’s remorse. Finish Line has suddenly realized, along with its bank UBS, that they are taking on too much leverage on this deal. But it is a bit too late. By Genesco sending this letter they are putting Finish Line on notice that Finish Line is going to have to face litigation if they want completely out of this deal; in other words unlike the Radian/MGIC MAC case this deal will likely not be resolved with the parties simply terminating the merger agreement and walking away. Clearly Finish Line is angling for a price cut – Genesco may well still agree to that but they are going to put up some fight before they compromise. In addition, Genesco’s move here expedites the time table and is a reply to UBS’s request last week for further information – it prevents UBS from going on a fishing expedition and again shifts the burden to Finish Line to make their case publicly for a MAC. Also remember that any litigation in this case between Finish Line and Genesco must to be brought in Tennessee under the merger agreement and will be governed by Tennessee law. This gives an advantage to Genesco in that they can fight this dispute out in their home court (although the lack of case-law on this point creates uncertainty and will encourage the parties to settle). In the end we are largely seeing the AHL deal play out all over again though perhaps with some politer discourse. Hopefully, all of the parties have read that playbook.
Genesco Sends Letter Regarding Merger Agreement Obligations to The Finish Line
NASHVILLE, Tenn., Sept. 19 /PRNewswire-FirstCall/ -- Hal N. Pennington, Chairman and Chief Executive Officer of Genesco Inc. (NYSE: GCO), today sent the following letter to Alan H. Cohen, Chairman of the Board and Chief Executive Officer of The Finish Line, Inc.:
Dear Alan: I am writing this letter to respond to Gary's letter of September 17 as well as to set forth our view of what The Finish Line needs to do to move toward closing. First, let me reiterate that combining our businesses makes great strategic sense. Our team still looks forward to joining with yours.
On an ongoing basis, we have routinely shared detailed financial and operational information with The Finish Line and with UBS, and have responded promptly to numerous requests for specific information. We understand that you need certain information in order to be able to obtain the financing that you need to consummate the transaction, and there are detailed provisions in the Merger Agreement that provide how that cooperative process works. Clearly, UBS' most recent request comes within neither the spirit nor letter of our agreement. It is clear from their own statements that they are looking for a way out of their commitment -- in our view, not because of Genesco's results but because the upheaval in the credit markets makes this deal less profitable for them. We are not going to allow the litigation consulting firm they have hired to go on a fishing expedition. We will, however, continue to provide both The Finish Line and UBS with information related to Genesco in accordance with the detailed processes set forth in the Merger Agreement. As you know, as recently as yesterday, we provided additional information required by UBS for inclusion in your offering memorandum.
The Merger Agreement generally provides that the closing of the merger shall be on a date no later than the second business day after the closing conditions to the merger have been satisfied. Our shareholders met Monday and voted overwhelmingly in favor of the transaction and we have satisfied all our conditions to closing. However, both The Finish Line and UBS have continually failed to meet deadlines that they established for their own actions relative to obtaining the financing to consummate the transaction. Consequently, Genesco hereby makes the following demands:
*that The Finish Line immediately consummate the merger with Genesco; and
*that The Finish Line immediately deliver a substantially completed draft offering memorandum relating to its proposed financing to UBS;
that UBS confirm that such substantially completed draft offering memorandum complies with the terms of the Commitment Letter;
that The Finish Line immediately schedule presentations to the rating agencies for the purpose of obtaining expedited ratings of The Finish Line's securities; and
that The Finish Line enforce all its rights under the Commitment Letter.
I am sure you can appreciate the obligation we have to our shareholders to ensure that The Finish Line complies with its obligations under the Merger Agreement. Alan, I understand that your probable response is going to be to send me a long letter drafted by your lawyers telling me why you can't do the things we have demanded or why you need more time or why things are out of your control. Before you make that response, I encourage you to think about your obligations under the Merger Agreement, to think about the risks to your Company if you fail to comply with your obligations under the Merger Agreement, and whether you are going to continue to stall us or proceed to enforce your rights against UBS under the Commitment Letter. I look forward to hearing from you and working with you to expeditiously consummate the transaction.
Very truly yours, Hal N. Pennington, Chairman and Chief Executive Officer About Genesco Inc.
The press release says it all. This was expected (and only mere hours after the Fed Rate cut -- funny how that happens). But still, from a law professor perspective, a trial would have been nice to settle issues on the interpretation of MAC clauses generally and the disproportionality standard in particular. While not providing any legal precedent, this is a very good omen for Sellers who arguably do not set a very firm liquidated damages cap on a Buyer's ability to breach by trumping up a MAC claim. Expect to see a turn towards this model and against reverse termination fees in private equity deals.
Tuesday, September 18, 2007
Accredited Home Lenders filed its quarterly report on Form 10-Q yesterday. The filing comes in advance of next week's trial in Delaware Chancery Court to determine if there has been a material adverse effect under Accredited Home Lender's agreement to be acquired by Lone Star. I'm going to leave the number-crunching on the 10-Q to others, but the filing did have some interesting tid-bits for those following the company and its travails. AHL is clearly going out of its way to show that the changes effecting it are not disproportional as those in its industry as a whole -- a key requirement for it to avoid Lone Star establishing that a MAC has occurred. And so, in its form 10-Q it provides a list of thirty other recent, significant events in the industry affecting other lenders such as bankruptcy, liquidation, etc. The list provides good support for AHL's case. Beyond that, there is this fun risk factor disclosure:
We face steeply declining employee morale, and our inability to retain qualified employees could significantly harm our business.
As a result of the ongoing turbulence in the non-prime mortgage industry, our headcount has declined from approximately 4,200 at December 31, 2006 to approximately 1,000 following the completion of the restructuring we have implemented in September 2007. In light of the decision to suspend substantially all U.S. lending as part of the restructuring, it will be very difficult to motivate and retain the remaining sales personnel who expect to derive significant income from commissions and bonuses on closed loans. It will also be difficult to motivate and retain non-commissioned personnel who are faced with great uncertainty regarding their future employment and advancement prospects with the Company. The inability to retain or replace sufficient qualified personnel may jeopardize our ability to run our downsized operations or successfully resume U.S. lending operations should the opportunity arise.
Another issue with AHL is what the company would be worth without its current litigation claim against Lone Star. In other words, how is the market pricing this stock. Is there still any value in AHL or has the stock simply become the right to a litigation claim? Here, AHL has disclosed that it may not be able to continue as a going concern if it is not acquired by Lone Star. But, perhaps the canary in the mine-shaft is whether AHL has defaulted on its debt covenants. Such a default on any of its instruments would create cross-defaults on the remainder and likely send it into a death spiral similar to what is happening with Movie Gallery. AHL made what appears to be very careful disclosure on this point in the 10-Q, not commenting upon it either way. AHL's banks and debt-holders have incentives to take a similar course, as they would much prefer AHL to be acquired and do not want to create further issues for Lone Star to support its MAC claim. Nonetheless, I would expect Lone Star to raise this issue at trial -- tripping your debt covenants is clearly a MAC though maybe not disproportional in this environment. For those attending next week, it's going to be the trial of the year in Delaware Chancery (if there is not a settlement before then).
Sunday, September 16, 2007
The Genesco material adverse change dispute is starting to heat up in advance of the Genesco special meeting to vote on the transaction today. On Friday, The Finish Line, Inc. announced that it had received two letters from UBS which it helpfully forwarded to Genesco Inc. The Finish Line did not disclose the full text of the letters, but did disclose a portion. According to The Finish Line, UBS stated in one letter:
[O]ur agreement to perform under the Commitment Letter may be terminated if a Material Adverse Effect has occurred with respect to Genesco. As of today, we are not yet satisfied that Genesco has not experienced a Material Adverse Effect. ... Based on the foregoing, we ask that you cause Genesco and its representatives and advisors to provide all financial and other information that we request so that we may conclude whether a Material Adverse Effect has occurred.
You get the idea. It appears that UBS and Finish Line are now attempting to follow the strategy played out in the Home Depot supply business sale renegotiation. UBS and Finish Line, together with Finish Line's newly hired uber-banker Ken Moelis, are trying to tag-team in order to renegotiate or terminate the Genesco deal based on claims of a material adverse change. This is a strategy that we will likely see often this Fall as banks and private equity buyers attempt to renegotiate deals that are no longer as financially attractive. The Finish Line and UBS also appear to be following the successful strategy used by MGIC to terminate its deal with Radian based on a similar MAC claim. Essentially, UBS (I believe likely at Finish Line's behest) are claiming that more information is needed in order to buy time to renegotiate the transaction or otherwise obtain Genesco's agreement to terminate the deal. UBS is asking for "all financial and other information that we request", hardly a narrow request. This maneuver permits them to avoid litigation for the moment, buy time and appear to be the good guys here.
The strategy doesn't appear to be working. Genesco responded to these letters after market close with its own press release which stated:
In response to The Finish Line's announcement, Genesco Inc. reiterates that no "material adverse effect" under the previously announced merger agreement with Finish Line has occurred with respect to Genesco.
In a previous post I outlined why, based on public information, it appears that The Finish Line has a weak case to claim a MAC, at least under Delaware law. The MAC clause in the financing commitment letter for The Finish Line issued by UBS is identical to the one in the merger agreement with one critical exception. The commitment letter is governed by New York law, the Genesco/Finish Line merger agreement by Tennessee law. I previously criticized the lawyers in this deal for selecting the law of a state with no defined case law on merger agreements, particularly MACS. Their choice has now raised the prospect of a court in New York finding a MAC while a court in Tennessee finds the opposite. Now that would be fun (at least from my perspective). This is unlikely from a practical perspective -- who could see courts consciously reaching this result? -- still M&A lawyers in the future would do well to avoid this difficulty.
The Genesco shareholder meeting will be held at 11:00 a.m., local time, at Genesco's executive offices, located at Genesco Park, 1415 Murfreesboro Road, Nashville, Tennessee. I encourage any Genesco shareholders in the area to attend, not only for the free food, but for the interesting situation a yea vote will create. If the merger is approved, all of the conditions to the merger in the merger agreement would now presumably be satisfied (assuming no MAC -- see Article 7 of the agreement). But what Genesco will do is uncertain and likely depend upon the non-public information they have as to whether a MAC occurred. If they are confident in their position, a quick injunctive suit in Tennessee would do them well in order to gain first mover advantage and position them to consolidate in Tennessee a New York lawsuit brought by UBS which could over-shadow their own litigation. Such a suit would also likely be a good move even if they are not as confident in order to establish a firm bargaining position. More to come.
Tuesday, September 11, 2007
Yesterday, Stark Investments converted its Schedule 13G with respect to Accredited Home Lenders into a Schedule 13D. A Schedule 13D is required to be filed by any person or entity who holds greater than 5% of a publicly traded issuer. The switch to a 13D is required whenever a previously passive investor changes their intentions with respect to control of the issuer. Stark's letter is great reading, and I set it out in full as it again highlights the bind Lone Star is in. Although their letter is a bit over-dramatic, I also tend to agree with Stark's fears that Accredited is likely to cut a deal with Lone Star despite Lone Star's relatively weak case. Accredited's directors are likely to prefer the certainty of a lower deal versus the risk (however minute) that the Delaware court will rule against it, a decision they have substantial latitude to make since it is likely reviewable under the business judgment rule. The letter is also yet more ammunition for those advocating the benefits of hedge funds as valuable shareholder activists. Here it is:
Ladies and Gentlemen:
Stark Investments and its affiliated investment funds (collectively, “Stark”) hold approximately 8.2% of the outstanding common shares of Accredited Home Lenders Holding Co. (“Accredited”). Based upon publicly available information, Stark appears to be Accredited’s second largest shareholder. We are writing with respect to the Agreement and Plan of Merger dated June 4, 2007, as amended June 15, 2007 (the “Agreement”), with Lone Star Fund V (U.S.), L.P. and its affiliates (collectively, “Lone Star”) and the related litigation pending in the Delaware Chancery Court.
On August 30, 2007, Lone Star publicly disclosed that it had made an offer to the Accredited Board of Directors to reduce the purchase price under the Agreement from $15.10 to $8.50 in exchange for resolving the pending litigation between Lone Star and Accredited. We believe that this offer is nothing more than an attempt to divert attention from the inherent weakness in Lone Star’s litigation position under the Agreement. Based on our review of the Agreement, it is evident that Accredited endeavored to obtain, and did successfully negotiate, unambiguous terms preventing Lone Star from terminating the Agreement based upon the changes in Accredited’s operations or financial condition that have occurred since execution of the Agreement. We read the express language of the Agreement as being clear that Lone Star assumed the entire risk of a diminution of value of Accredited in the present circumstances. The fact that these terms were obtained from a seasoned and sophisticated buyer of troubled assets, which was advised by a law firm that is a recognized expert in advising parties to merger and acquisition transactions, is clear evidence of Lone Star’s unqualified desire and intent to acquire Accredited while assuming the aforementioned risk.
We are pleased that the Board of Directors recognizes the strength of Accredited’s position under the Agreement and has rejected Lone Star’s revised offer. We support this decision and offer our support to the Board of Directors as it continues to appropriately carry out its fiduciary duties, which duties, in our view, require Accredited to pursue all available remedies under the Agreement. The strong protections included in the Agreement were designed to benefit and protect Accredited and its shareholders in circumstances such as those now faced by Accredited, and should be used accordingly.
We believe that the greatest risk now faced by Accredited’s shareholders is neither the possibility of further deterioration of the non-prime residential mortgage loan market in which Accredited competes, nor the risk of an adverse outcome at trial. The first risk was eliminated when Lone Star signed the Agreement and a proper application of the facts and law by the Delaware Chancery Court should eliminate the second risk. Instead, we believe that the greatest risk facing Accredited’s shareholders is that the Board of Directors will attribute too much significance to the unlikely possibility of an adverse outcome at trial and settle for a price far removed from the value of Accredited’s existing claims against Lone Star.
After a thorough review of the Agreement, the facts in the public domain (including the prevailing market conditions at the time the Agreement was executed) and relevant case law, we believe that the Delaware Chancery Court will see this case as we see it – an experienced and sophisticated buyer (with a long history of successfully stepping into adverse industry environments, purchasing companies or assets at distressed prices and reaping significant rewards when recovery occurs) that is now trying to back away from a transaction and the risks it explicitly agreed to assume, when it appears to have concluded that its timing was inopportune in this instance. Moreover, Delaware courts require parties such as Lone Star to meet a heavy, and we believe insurmountable here, burden of proof when attempting to terminate obligations in reliance upon material adverse effect (“MAE”) clauses of the nature contained in the Agreement. When Lone Star agreed to acquire Accredited, it did so after a long due diligence exercise and a multi-bidder process that Accredited detailed in its Schedule 14D-9, filed with the Securities and Exchange Commission on June 19, 2007. There can be little question that Lone Star was aware prior to signing the Agreement of the impact already being felt by Accredited as a result of existing and ongoing adverse market conditions.
As Accredited’s second largest shareholder, we fully support and encourage the Board to continue to make decisions consistent with the strength of Accredited’s legal position. It appears that we are certainly not alone in this assessment. Given that the trading price of Accredited’s common stock on the New York Stock Exchange has been materially in excess of $8.50 since the announcement of Lone Star’s offer on August 30, 2007, we believe the market also recognizes the weakness of Lone Star’s position and is anticipating a recovery well in excess of today’s closing price of $10.14. Given the significant number of Accredited’s shares that have changed hands over the past few trading days, any shareholder that does not agree with the strength of Accredited’s position has had ample opportunity to sell its shares at levels far exceeding Lone Star’s proposed amended price. Accordingly, we believe that the current shareholder base is strongly supportive of Accredited’s decision to enforce the Agreement’s terms and to pursue all available remedies thereunder. Please note that we currently expect to include a copy of this letter with the Schedule 13D filing that we plan to make next week. We are available to discuss these matters with you at your convenience.
Very truly yours,
/s/ Brian J. Stark
Brian J. Stark Principal
cc: Mr. Len Allen
Lone Star U.S. Acquisitions
It has now been almost two weeks since Genesco reported its second quarter earnings and its agreed acquirer, Finish Line promptly issued a statement that it was "evaluating its options in accordance with the terms of the merger agreement." Finish Line's statement appeared to raise the issue that Genesco's second quarter earnings are a material adverse change under the merger agreement. As I posted at the time, the impetus for this statement may also be a case of buyer's remorse. According to one report, "the deal had come under heavy fire from analysts and investors, who said Finish Line had offered too high a price and was taking on too much debt." Someone probably needs to send their financial advisers a copy of Bernard Black's classic Bidder Overpayment in Takeovers.
Since that time Genesco has not made any public statement on Finish Line's press release. Nor has Finish Line made any subsequent statements. The special meeting of Genesco's shareholders to vote on the acquisition is to be held on September 17. In the meantime, there is a heavy discount on Genesco's shares which closed yesterday at $45.50 compared to the $54.50 Finish Line has agreed to pay. The market is predicting a lower price or a broken deal [NB. I'm a little surprised at the large discount given the apparently weak case of Finish Line based on publicly available information]. Meanwhile, the deal parties are on radio silence.
The silence here is typical of MAC negotiations in public deals which tend to go on behind closed doors without public signaling to shareholders. A recent example is the Radian/MGIC negotiations which led to an abrupt and unexpected termination of the deal. I can see the benefits of this approach -- it permits rational, closed door business negotiations without play-by-play announcements which could result in wild fluctuation of the target's price, not to mention potential liability exposure. Nonetheless, if you were a shareholder of Genesco right now you'd be more than a little uncomfortable. A brief statement by Genesco of the status of nay negotiations would likely go a long way to assuaging this concern and better price Genesco's stock in the market. There are benefits to a continuous disclosure regime.
Addendum: The Genesco merger agreement contains the following clause which contractually limits public communication:
Section 6.9 Public Disclosure. The initial press release concerning the Merger shall be a joint press release and, thereafter, so long as this Agreement is in effect, neither Parent, Merger Sub nor the Company will disseminate any press release or other public announcement concerning the Merger or this Agreement or the other transactions contemplated by this Agreement to any third party, except as may be required by Law or by any listing agreement with the Nasdaq National Market, NYSE or CHX, without the prior consent of each of the other parties hereto, which consent shall not be unreasonably withheld; provided, however, that Parent’s consent will not be required, and the Company need not consult with Parent, in connection with any press release or public statement to be issued or made with respect to any Acquisition Proposal or with respect to any Change in Recommendation. Notwithstanding the foregoing, without prior consent of the other parties, the Company and Parent (a) may communicate with customers, vendors, suppliers, financial analysts, investors and media representatives in the ordinary course of business in a manner consistent with its past practice and in compliance with applicable Law and (b) may disseminate the information included in a press release or other document previously approved for external distribution by the other parties hereto.
It is not as restrictive as you think because it exempts out statements required by law or by the party's exchange listing agreement or with the consent of the other party (not to be unreasonably withheld). To circumvent this provision lawyers typically advise their clients that, in their reasonable belief, federal securities disclosure rules require the statement. The party opposing the communication cannot really do anything -- no court is likely to penalize a party for complying with the federal securities laws based on the reasonable advice of their lawyers. Here, Genesco can take the position that it must make a statement to correct prior disclosure -- a position which has the virtue of likely being correct.
Monday, September 10, 2007
On Friday, Congress approved legislation cutting subsidies to student-loan providers, including SLM Corp., by $20.9 billion over the next five years. The Bill now goes to President Bush for signature; his spokesperson has stated that he will sign it.
The signing of this Bill will trigger a potential renegotiation of the SLM Corp. acquisition agreement with affiliates of J.C. Flowers & Co., Bank of America and JPMorgan Chase. The argument will center over whether a material adverse change has occurred giving the buyers the ability to terminate the transaction. As backdrop, the financing for this deal has also become uncertain given the current credit crisis, and the banks financing this transaction will likely lose a significant amount of money on their committed financing if the acquisition goes through at its current price. Given that this is their position in a number of large LBO deals, the banks are desperate for relief and a solution.
The starting starting point is the merger agreement and its definition of MAE:
"Material Adverse Effect” means a material adverse effect on the financial condition, business, or results of operations of the Company and its Subsidiaries, taken as a whole, except to the extent any such effect results from: (a) changes in GAAP or changes in regulatory accounting requirements applicable to any industry in which the Company or any of its Subsidiaries operate; (b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority; (c) changes in global, national or regional political conditions (including the outbreak of war or acts of terrorism) or in general economic, business, regulatory, political or market conditions or in national or global financial markets; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (d) any proposed law, rule or regulation, or any proposed amendment to any existing law, rule or regulation, in each case affecting the Company or any of its Subsidiaries and not enacted into law prior to the Closing Date; (e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein; (f) public disclosure of this Agreement or the transactions contemplated hereby, including the initiation of litigation by any Person with respect to this Agreement; (g) any change in the debt ratings of the Company or any debt securities of the Company or any of its Subsidiaries in and of itself (it being agreed that this exception does not cover the underlying reason for such change, except to the extent such reason is within the scope of any other exception within this definition); (h) any actions taken (or omitted to be taken) at the written request of Parent; or (i) any action taken by the Company, or which the Company causes to be taken by any of its Subsidiaries, in each case which is required pursuant to this Agreement.
The first issue is the most important -- whether SLM has even experienced a MAC. Here, the agreement is governed by Delaware law. In In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001) and Frontier Oil Corp. v. Holly, the Delaware courts set a high bar for proving a MAC. Under these cases the party asserting a MAC has the burden of proving that the adverse change will have long-term effects and must be materially significant. Here we need more information as to the effect of this change. The only thing I have seen is SLM's statement that it "estimates the adverse impact of [this Bill] to 2008-2012 net income to be less than 10 percent as compared to the matters already disclosed to the Buyer." Remember this is only the adverse impact and SLM has not given a more specific number as to total impact. Thus, we may be touching into this realm here, though we do not know all of the facts and MAC disputes are notoriously fact-dependent (and therefore judge-dependent too!).
However, if the Flowers consortium can prove a MAC there is still the matter of the highlighted carve-outs above. On these, expect SLM to argue the following:
- The new legislation is not, on the whole, more adverse than described in its 10-K (exclusion (b));
- The law was proposed in some form at the time of the agreement; and
- The change is to the financial services industry generally and is not disproportionate to SLM (exclusion (e)).
1 and 3are carve-outs highlighted in the definition above which the parties agree do not constitute a MAC even if they are a materially adverse change. The interesting thing here is that both 1 and 3 are not qualified by "materiality". So, the Flowers consortium will likely argue that it need only prove that the change is materially adverse to the company and is either adverse (in the case of 1) or disproportionate (in the case of 3) in any amount to SLM. A cent of adverseness or disproportionality would arguably work here, and as noted above SLM has admitted there is an adverse impact. [Also, note the exclusion in (e) -- it specifically excludes changes excluded from clause (b) under the proviso]. Ultimately, this is again a fact-based determination, but it appears that Flowers has a long way to go here to prove a MAC though it is helped by the lack of materiality qualifiers in the carve-outs.
All of this may not matter much as the Flowers consortium also has a walk-away right under the agreement if it pays a reverse termination fee of $900 million dollars. This changes the negotiating position of the Flowers group substantially. Expect them to attempt to preserve their reputation for not walking from deals by publicly proclaim a MAC has occurred, but privately claim that the deal calculus now makes it more economical to walk. The consortium will find encouragement from their bankers who may also now find it more economical to simply pay or share the reverse termination fee with the buyers. This would be a similar renegotiation that occurred in Home Depot's sale of its supply business which ended with a cut of eighteen percent in the deal price.
Reading tea-leaves, I would expect Flowers to use the reverse termination fee and colorable MAC claims to negotiate some form of price cut. But, as with most MAC renegotiations, expect it to happen behind closed doors. Any renegotiation will require a new shareholder vote, so even if there is a renegotiation there will not be a closing in the immediate future.
Addendum: One point of clarification on the above -- when I say that SLM will argue that the law is proposed, I am not referring to the MAC carve-out on proposed laws, but that SLM will argue that Flowers already knew of the possibility of this legislation at the time of the agreement.
Wednesday, September 5, 2007
MGIC Investment Corporation and Radian Group Inc. jointly announced today that they have terminated their pending merger. Here were the very nice comments each had for the other in their joint press release:
Curt Culver, MGIC Investment's CEO, said, "I am pleased MGIC and Radian were able to reach this amicable resolution. During the course of the merger process, our MGIC team met many fine people from Radian. We wish them the best."
S.A. Ibrahim, Radian Group's CEO, said, "Our mutual decision to terminate the pending merger represents the best outcome for both companies under the circumstances. We wish MGIC and its employees well."
MGIC is clearly the much happier of the two, though, as MGIC had previously asserted that a material adverse change had occurred to Radian permitting MGIC to terminate their merger arrangement. To my knowledge, this is the first deal to be terminated on MAC grounds because of the sub-prime mortgage crisis. And a quick review of the termination and release agreement finds that it will be a clean break. MGIC will not pay any funds to Radian in connection with this termination. I have to admit, I am a bit surprised about this. Based on the publicly available facts, Radian appeared to have reasonable grounds to deny that a MAC had occurred. Nonetheless, advised by Wachtell, Radian has chosen to drop any claims and the value in them. Presumably, they know more than I do.
Ultimately, the case points to why there is so little case-law on MACS out there -- the parties typically settle these cases by terminating the deal or renegotiating the price (as appears to be the trajectory of the Lone Star/Accredited Home deal). And given the settlement and the lack of full disclosure here, it is hard to draw any conclusions from this termination for the other pending MAC cases out there. Oh -- and those nice comments above -- well expect them in all of the parties' comments on the terminated deal. Each agreed in the termination agreement to a non-disparagement clause for the next 18 months. Hopefully, this clause will not chill their speech and prevent full disclosure by Radian to its shareholders of the facts which led to this deal termination. They are having a hard enough day today as it is.
Saturday, September 1, 2007
Accredited didn't even wait until Tuesday to respond and reject Lone Star's settlement offer. It is a nice, strong move, but expect there to be behind the scenes negotiations through to September and for VC Lamb to push the parties towards a settlement. Here's the response for your files:
Friday, August 31, 2007
Another potential Material Adverse Change dispute popped up yesterday in the pending $1.5 billion acquisition of Genesco by The Finish Line for $54.50 per share in cash. Yesterday Genesco reported second quarter earnings. The earnings were disappointing but do not appear to be catastrophic. Genesco reported a $4.17 million loss and declining sales at stores open more than a year which it blamed on "the combination of a later start to back-to-school, later sales tax holidays in Texas and Florida and a generally challenging retail environment, especially in footwear."
But Finish Line promptly issued this statement:
The Company is disappointed with Genesco's second quarter fiscal 2008 financial results. Consistent with its responsibilities to The Finish Line's shareholders, the Company is evaluating its options in accordance with the terms of the merger agreement. The Company does not intend to make further comments at this time.
As background here, Finish Line may have buyer's remorse. According to one report, "the deal had come under heavy fire from analysts and investors, who said Finish Line had offered too high a price and was taking on too much debt." Nonetheless, Finish Line appears to be raising the issue that Genesco's second quarter earnings arise to the level of a MAC under the merger agreement. The agreement defines a MAC as:
any event, circumstance, change or effect that, individually or in the aggregate, is materially adverse to the business, condition (financial or otherwise), assets, liabilities or results of operations of the Company and the Company Subsidiaries, taken as a whole; provided, however, that none of the following shall constitute, or shall be considered in determining whether there has occurred, and no event, circumstance, change or effect resulting from or arising out of any of the following shall constitute, a Company Material Adverse Effect: (A) the announcement of the execution of this Agreement or the pendency of consummation of the Merger (including the threatened or actual impact on relationships of the Company and the Company Subsidiaries with customers, vendors, suppliers, distributors, landlords or employees (including the threatened or actual termination, suspension, modification or reduction of such relationships)); (B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (C) any change in applicable Law, rule or regulation or GAAP or interpretation thereof after the date hereof, so long as such changes do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate; (D) the failure, in and of itself, of the Company to meet any published or internally prepared estimates of revenues, earnings or other financial projections, performance measures or operating statistics; provided, however, that the facts and circumstances underlying any such failure may, except as may be provided in subsection (A), (B), (C), (E), (F) and (G) of this definition, be considered in determining whether a Company Material Adverse Effect has occurred; (E) a decline in the price, or a change in the trading volume, of the Company Common Stock on the New York Stock Exchange (“NYSE”) or the Chicago Stock Exchange (“CHX”); (F) compliance with the terms of, and taking any action required by, this Agreement, or taking or not taking any actions at the request of, or with the consent of, Parent; and (G) acts or omissions of Parent or Merger Sub after the date of this Agreement (other than actions or omissions specifically contemplated by this Agreement).
The carve-outs on this MAC are standard and plentiful, and the carve-out for failure to meet projections which I have highlighted above would appear to exclude much of what happened with Genesco in its second quarter earnings, although the underlying facts could still establish a MAC. I emphasize appear, because we do not know all of the private facts here. But, as I have stated before, Delaware places a high burden on the party asserting a MAC clause: they need to prove that the adverse change consisted of "unknown events that substantially threaten the overall earnings potential of the target in a durationally-significant manner. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror." In re IBP, Inc. Shareholders Litigation (“IBP”), 789 A.2d 14 (Del. Ch. 2001). Here, based on the facts available, under Delaware law it does not appear that this threshold is met. Finish Line's rush to issue this press release is therefore surprising, though this may just be Finish Line's last ditch attempt to renegotiate the transaction for a price more satisfactory to its investors.
There is an alternative explanation answer though. The Genesco merger agreement is governed not by Delaware law but by Tennessee law and has a Nashville, Tennessee forum selection clause. Anyone care to tell me what the law on MACs as applicable to acquisition transactions is in the State of Tennessee? Yeah, that is what I thought you would say -- there is none. Finish Line may be taking a flyer on this uncertainty, although it should be careful as Tennessee is Genesco's home state. This is the second time this week, I have highlighted the importance of choice of law and forum selection clauses in acquisition agreements. Too often they are the product of political negotiations among the parties when they should be negotiating for certainty of law and adjudication. I hate to be a shill for Delaware or New York here, but the alternative result is situations like this.
Last night Lone Star delivered a letter to the board of Accredited Home Lenders offering up a compromise to resolve their material adverse change litigation. In the letter Lone Star offered to amend their merger agreement to lower the consideration being paid to $8.50 a share, a 44% cut from the $15.10 it has agreed to pay but well above the closing price of Lone Star yesterday, $6.31. If AHL agrees to this proposed amendment Lone Star stated that it would waive all breaches of the agreement that it claimed occurred prior to the date of amendment, including the MAC event that is the subject of the litigation. In connection with the agreement, Lone Star also offered up a go-shop to permit AHL to solicit and entertain acquisition proposals from third parties.
First the easy part, the go-shop. Don't read too much into this. Given the poor state of AHL's business, the stock price of AHL today is not a piece of equity in a functioning business but rather almost wholly a potential claim to receive Lone Star's offered price. Given this, no third party bidder is likely to emerge and Lone Star is probably offering this up for cosmetics more than anything else.
Second, one can surmise that Lone Star sent this letter for one of two reasons:
1. Lone Star has now come to the realization that it has a shaky MAC case and is trying to compromise to cut its losses. (For more on this see my prior post here)
2. Lone Star has always known that it had a shaky MAC case and this letter is part of its strategy to cut its losses.
The Lone Star people are smart money, so I'd prefer to think that they are following option two. If so, they are making the best of a bad hand. By asserting a MAC and permitting the stock to free-fall, their new offer looks like a god-send to many shareholders. Moreover, given that AHL has admitted it might not be able to continue as an operating business it has a real incentive to bring Lone Star to the table. Litigation is always uncertain and so both AHL and Lone Star also have an additional incentive to compromise. Thus, I would expect the parties to now agree at a figure in between Lone Star's offer and the previous offer price. But by asserting a MAC in this way Lone Star has effected the course of the negotiation to a large extent; a move that will likely save it millions if not hundreds of millions of dollars. Other acquirers in a similar position should take note.
Addendum: Lone Star's move is a bit surprising coming a month before the hearing in Delaware court and the day before Labor Day weekend Friday -- a slow trading day. That it would move this early is perhaps a suggestion that the credit and other markets are stabilizing and Lone Star wants to act before AHL can itself stabilize and demand a higher price.
Thursday, August 30, 2007
Well, this just crossed the wire. I think it speaks for itself (and was expected), but I'll have a little bit of commentary on it tomorrow morning. These are great times to be watching the market from the sidelines.
Accredited Home Lenders Holding Co.
15253 Avenue of Science
San Diego, CA 92128
Attention: Board of Directors
We write regarding the Agreement and Plan of Merger, dated as of June 4, 2007 (as amended by the First Amendment dated as of June 15, 2007) (the "Merger Agreement"), by and among Accredited Home Lenders Holding Co. (the "Company"), LSF5 Accredited Investments, LLC ("Parent") and LSF5 Accredited Merger Co., Inc. ("Purchaser" and, together with Parent and its affiliates, "Lone Star"). All capitalized terms not defined herein shall have the meanings set forth in the Merger Agreement.
As you are aware, Parent and Purchaser recently extended the expiration date for the current Offer until September 12, 2007, our fourth extension. It is very clear to us that the Company is unlikely to be able to satisfy the conditions to the Offer prior to September 12, 2007, and will in all likelihood not be able to meet those conditions even if the Offer is extended beyond that date.
The current impasse between the Company and Lone Star over the completion of the Offer, which is the subject of the litigation in Delaware Chancery Court, ultimately benefits neither Lone Star nor the Company's stockholders. Among other things, we believe, and apparently the Company also believes based on its previous public statements, that under current conditions the Company may suffer further declines in value and have a difficult time surviving as a going concern. It is patently clear that swift action by the Board of Directors is needed to preserve the Company's existing enterprise value.
We believe there is a way forward that would benefit all of the relevant constituencies. Lone Star is prepared, with the consent of the Company, to amend the Offer immediately to change the Offer Price to $8.50 per Company Common Share, which represents a premium of 35% over the closing price of the Company Common Shares on August 30, 2007. As part of the amended Offer, we would modify the conditions to the Offer such that the only substantial condition to the consummation of the Offer would be the Minimum Condition. While we propose also to retain a condition regarding compliance with representations, warranties and covenants in the Merger Agreement, we would waive all breaches that occurred prior to the date of amendment, including those that are the subject of the litigation.
Immediately following the announcement of the amended Offer, each of the Company and Lone Star would obtain a dismissal, with prejudice, of the claims and counterclaims constituting the current litigation in Delaware Chancery Court. We would then extend the Offer for a period of ten business days following the filing of the revised Offer Documents. Upon commencement of the amended Offer, Lone Star would deposit with an escrow bank all of the funds required to pay for tendered Company Common Shares immediately after the minimal conditions to consummation of the Offer have been met. Lone Star would also propose to amend the Merger Agreement so that, during the pendency of the amended Offer, the Board of Directors would be free to solicit and entertain acquisition proposals from third parties and to terminate the Agreement in favor of any offer that the Board determines to be superior, subject to entry into mutual releases of claims and Lone Star's right to match any such offer.
As we are certain you appreciate, time is of the essence, and while we understand that the Board of Directors will have to carefully consider the proposal outlined in this letter, it is essential that we have a prompt response from you. Please note that the text of this letter will be released publicly and filed as an exhibit to our Offer Documents. Nothing contained in this letter should be considered an express or implied consent or waiver with respect to any provision of the Merger Agreement or a waiver of any past or future breach of the Company's obligations and covenants under the Merger Agreement. We expressly reserve all rights, claims, causes of action and prerogatives under the Merger Agreement and applicable law.
Very truly yours,
LSF5 ACCREDITED INVESTMENTS, LLC
By /s/ Marc L. Lipshy
Name: Marc L. Lipshy
Title: Vice President
Wednesday, August 29, 2007
The MGIC Investment and Radian Group Inc. merger took an interesting turn this past week. On August 7, MGIC in a public filing disclosed that it believed a material adverse change had occurred with respect to Radian in light of the C-BASS impairment announced that previous week. C-Bass is the subprime loan subsidiary jointly owned by MGIC and Radian; it has been hit hard by the subprime crisis and has experienced greater than $1 billion in losses in the last few months. MGIC further stated that it had requested additional information from Radian and expected to complete its MAC analysis the week of August 13. Radian, not surprisingly, refuted MGIC's assertion in its own filing. At the time, Radian stated that it was "compelled to carefully assess the proprietary nature of the subsequent information requests [of MGIC] to ensure that Radian does not provide MGIC with an unfair competitive advantage in the event that MGIC decides that it does not have an obligation to complete the merger.."
The Radian/MGIC deal raises similar issues as the Lone Star/Accredited Home Lenders deal, and they are both governed by Delaware law. In particular they both raise mixed legal/factual issue of whether any material adverse change is disproportionate to Radian to an extent greater than the adverse changes to the industry generally (see my post on this here; see the MAC clause in the merger agreement at pp. 7-8). Given the similarities between the Lone Star/AHL deal and this one, I expected Radian and MGIC to wait until VC Lamb issues his decision and opinion in the Lone Star/AHL litigation in late September/early October before proceeding. And that appears to be what is happening. On Aug 21, MGIC sued Radian in federal district court in Milwaukee (its home town), to obtain information from Radian it believes is required to be delivered under the merger agreement and it needs to properly assess whether a MAC occurred (see news report here). MGIC is stalling for time through a nice legal maneuver. The deal is now likely on hold for the next month.
The MGIC/Radian litigation also highlights the importance of tight forum selection clauses. Clause 9.11 of the merger agreement stipulates that the parties accept jurisdiction in any suit for specific enforcement of the transactions contemplated by the agreement in any New York court. But this is not mandatory submission to jurisdiction. This may or may not have been the parties bargained for intent in future disputes (i.e., it may have just been a quick negotiation following the form late at night without really thinking through the possibilities of such an agreement). But, whatever the case, by suing for information in a Milwaukee court, Radian has now established home court advantage for any subsequent MAC litigation fight.
Sunday, August 26, 2007
The Wall Street Journal is reporting that Home Depot has agreed to cut the sale of its wholesale supply unit to $8.5 billion, eighteen percent less than the $10.325 billion agreed to a few months earlier. The sale to affiliates of Bain Capital Partners, The Carlyle Group and Clayton, Dubilier & Rice will likely close this week on this basis. The deal is important because it is the first time in this market crisis that private equity firms have relied upon their reverse termination fee "option" to substantially drive down the price of an acquisition. It is also shows how stretched the banks are these days and the lengths that they are going to keep private equity debt off their books.
Like may other private equity agreements, the sale agreement for HD Supply specifically limited the private equity consortium's damages in case it decided not to close the transaction for any reason whatsoever, and specifically excluded the option of specific performance. Here, the agreement limited the consortium's damages of no more than $309,750,000. As I have written before, many private equity deals contain this provision; and in this volatile market and the current credit-squeeze the option like nature of these provisions cannot be ignored. This was the case here as, according to the Journal, the banks who agreed to finance this transaction, including JP Morgan Chase, actually offered at one point to pay this fee on behalf of the private equity consortium if they agreed to walk. This is bad, folks.
That the banks would go these lengths shows how desperate they are to avoid the situation First Boston found itself back in '80s when it got stuck in the "burning bed", unable to redeem hundreds of millions it had lent for the leveraged buyout of Ohio Mattress Company, maker of Sealy mattresses. First Boston only escaped bankruptcy by being acquired by Credit Suisse. In the case of HD Supply, the banks apparently asserted that they were no longer required to comply with their commitment letters to finance the acquisition because of the prior agreed change in the purchase price and the revised market conditions it reflected. The position seems a bit tenuous, but I don't have all the facts, and the letters aren't publicly available. Ultimately, though, it appears the need of all the parties to save reputation in the markets as well as Home Depot's need to finance its share buy-back, pushed them to a deal; according to the Journal, Home Depot is providing guarantees on part of the six billion dollars in bank financing provided in connection with the leveraged buyout deal as well as taking up to 12.5% of the equity, while the private equity firms are putting in more equity.
Of greater significance is the fact that the parties would go to these lengths to renegotiate a deal, and make the threats they have around the reverse termination fee. This doesn't bode well for the many other private equity deals in the market today that have this similar reverse termination fees (e.g., SLM, TXU, Manor Care, etc.). As we move into Fall and the banks begin to sweat their liability exposure, expect more re negotiations and a high chance that the economics of one of these many deals will become so bad that either the private equity firms or their financing banks will blink, taking the reputation hit, walking away from the deal and paying this fee. Food for thought as you chew your hot dog over this upcoming Labor Day weekend.
Final Point. The banks and private equity consortium will spin this as a MAC case, but a review of the definition of MAC on pp. 5-6 of the merger agreement finds a weak case for that (the MAC contains the standard carve-out for changes in the industry generally and markets except for disproportionate impact; it appears to be a tough case to establish here). I believe the banks and buying consortium will claim the MAC in order to publicly cover for the raw negotiating position they have taken by using the reverse termination fee and threatening to walk.
NB. Home Depot's counsel on this transaction was again Wachtell. Interesting, given the criticism Marty Lipton received in advising Nardelli on his infamous "take no questions" shareholder meeting.
Thursday, August 23, 2007
Earlier this week, Lone Star filed its answer and counter-claims to Accredited Home Lender's lawsuit which seeks to force Lone Star to complete its pending acquisition of AHL. Lone Star bases its counter-claims on two core assertions 1) AHL has breached its representations and warranties and covenants under the merger agreement, and 2) a Material Adverse Effect (as defined in the merger agreement) has occurred or is reasonably likely to occur. Lone Star asserts that these claims entitle it to terminate the merger agreement and limits its liability in the transaction to no more than the reverse termination fee, or $12 million.
More specifically: Lone Star's claim of breach of the merger agreement by AHL is in part premised upon Section 7.01 of the merger agreement which requires AHL “to conduct its business in the ordinary course and [to] use its commercially reasonable efforts to preserve substantially intact the business organization of the Company and to preserve the current relationships of the Company and the Company Subsidiaries . . . .” Lone Star here claims that AHL breached this agreement by failing to take the necessary steps, including slashing employees and overhead, to preserve its sub-prime lending business. Lone Star also asserts a claim that AHL breached Section 8.02 of the merger agreement, which requires AHL to afford Lone Star access to the “books and records of the Company and the Company Subsidiaries, and all other financial, operating and other data and information as [Lone Star] may reasonably request.” Lone Star also alleges that AHL has:
breached its representations, warranties and covenants by, among other things, its (i) acts and omissions that drastically weakened the financial and operating condition of the Company, (ii) acts and omissions that hastened the Company’s descent into a severe liquidity crisis, (iii) acts and omissions that have, or soon will, restrict the Company’s access to the its revolving loans, (iv) violations of covenants in the Company’s core credit facilities, and (v) misstatements regarding and mismanagement of the failing retail loan origination program.
Finally, Lone Star asserts that AHL has suffered a Material Adverse Effect and therefore is in breach of the merger agreement.
As an initial matter, Lone Star's claims surrounding breach of the representations and warranties and covenants look tough to prove, and though Lone Star does well to dress them up, appear to be just a MAC claim in disguise (and, in fact, any breach of a representation or warranty has to be a MAC to justify termination; the breach of covenant does not require that Lone Star prove a MAC, merely a material breach). Nonetheless, to the extent Lone Star is challenging AHL's business decisions, the court is likely to look at the actions of AHL within the context of the business judgment rule and commercial reasonableness. This is a question of fact, but based on the known facts and given the crisis AHL's actions appear reasonable reactions to the sub-prime lending crisis. Moreover, there is a 60 day cure period in the contract for AHL to cure any breaches. Today, AHL announced that it was taking several restructuring initiatives, including terminating 1,000 employees, closing substantially all of the retail lending business and no longer accepting new U.S. loan applications. AHL is likely to claim that these actions, which Lone Star asserts in its counter-claim that AHL had previously failed to take, are such a cure. In fact, I interpret AHL's actions today as a direct response to this claim by Lone Star, though it likely had no other choice from a business perspective given the market situation.
As for the MAC claim, the question boils down to two issues: 1) what did Lone Star know and when did they know it, and 2) is the MAC in Lone Star's business "disproportionate" to the adverse changes in the sub-prime lending business generally. This is important because the definition of MAC in the merger agreement specifically excludes events resulting from any circumstance or condition existing and known to Lone Star as of the date of the merger agreement as well as those that do not disproportionately affect AHL as compared to other companies operating in the industry in which AHL operates.
Here, AHL attempts to prove lack of knowledge by relying on the issuance of a "going concern" qualification by AHL's auditors and the revision in AHL management’s projections from an estimated loss for the third quarter of $64 million to a $230 million loss for the third quarter. It is hard to assess these claims without full information, but my gut reaction is that Lone Star cannot escape the sub-prime implosion, which unfortunately for Lone Star was in full swing at the time of its agreement. I believe that knowledge is likely to be attributed, but this is now a question of fact that will ultimately be decided by Vice Chancellor Lamb. And even if Lone Star can establish that knowledge was absent, it still must prove the MAC to be "disproportional".
Lone Star thus also goes out of its way to prove dis proportionality citing specific lawsuits against the company and other alleged facts to prove that the events occurring at AHL are either specific to AHL or so disproportionate as to be a MAC. Here, Lone Star again cites the disproportionate effect of the implosion of AHL's retail business which AHL shut today. But again, given the mass industry turmoil -- Lehman today shut its sub-prime unit for example -- dis proportionality is going to be hard to prove even in AHL's catastrophic circumstances. Also -- look for the parties to argue over which industry the disproportionality should be measured against; Lone Star is going to argue it is the broader mortgage lending business -- AHL will argue it is the sub-prime business.
Lone Star's claims of a MAC thus appear at this point to be less than solid. Nonetheless, things will reach more clarity as the facts are disclosed at the hearing before VC Lamb. For now, though, two things appear certain. First, given AHL's moves today to shut down its business, purchasing its stock is, more than ever, essentially the purchase of a litigation claim. And whatever the ultimate outcome, VC Lamb will have an important opportunity in this case to clarify Delaware law on MACs and issue an opinion that could have wider consequences for a number of other pending transactions.
Monday, August 20, 2007
RARE Hospitality International, Inc. announced on Friday that it will be acquired by Darden Restaurants, Inc. for $38.15 per share in cash in a transaction valued at approximately $1.4 billion. The acquisition will be effected via tender offer, showing yet again that the cash tender offer is reemerging as a transaction structure (see my post the Return of the Tender Offer). Darden is financing the acquisition through cash and newly committed credit facilities. And the deal is the latest in the super-hot M&A restaurant-chain deal sector.
A perusal of the merger agreement shows a rather standard industry agreement. RARE's main restaurant chain is LoneHorn Steakhouse, and so merger sub is called Surf & Turf Corp. -- the bounds of creativity in M&A. There is a top-up which is also fast becoming a standard procedure in cash tender offers. This top-up provision provides that so long as a majority of RARE’s shares are tendered in the offer, RARE will issue the remaining shares to put Darden over the 90% squeeze-out threshold. RARE's stock issuance here cannot be more than 19.9% of the target's outstanding shares due to stock exchange rules, and cannot exceed the authorized number of outstanding shares in RARE’s certificate of incorporation.
I looked for any new gloss on the Material Adverse Change clause to address current market conditions. There was nothing that appeared to address the particular situation, although any non-disproportionate "increase in the price of beef" is a MAC-clause trigger; apropos for a steakhouse chain. Finally, for those interested in topping Darden’s bid, the termination fee is $39.6 million. If another bidder makes a superior proposal, then under Section 5.02(b) of the merger agreement, RARE cannot terminate the agreement "unless concurrently with such termination the Company pays to Parent the Termination Fee and the Expenses payable pursuant to Section 6.06(b)". The only problem? Expenses is used repeatedly throughout the Agreement as a defined term everywhere except 6.06(b) -- which makes no references to Expenses or even expenses. In fact, it appears that nowhere does the agreement define Expenses. Transaction expenses can sometimes be 1-2% of additional deal value, a significant amount that any subsequent bidder must account for. So how much should a subsequent bidder budget here? Or to rephrase, what expenses must RARE pay if a higher bid emerges? And how can RARE terminate the deal to enter into an agreement with another bidder if RARE does not know which expenses it is so required to pay? Darden may also want similar certainty as to its reimbursed expenses, if any, in such a paradigm. Lots of questions in this ambiguity. Not the biggest mistake in the world, but Wachtell, attorneys for the buyer, and Alston & Bird, attorneys for the seller, both have incentives to fix this one.