Wednesday, September 19, 2007
The Wall Street Journal yesterday ran an article on PHH Corp. which has an agreement to be acquired by General Electric Capital Co. and Blackstone Group LP for $1.7 billion. GE is buying the entire business and on-selling PHH's mortgage lending business to Blackstone. On Monday, PHH Corp. announced that J.P. Morgan Chase & Co. and Lehman Brothers Holdings Inc., the banks who had committed to finance Blackstone's purchase, had "revised [their] interpretations as to the availability of debt financing". This revision could result in a shortfall of up to $750 million in available debt financing for Blackstone's purchase. According to PHH, the GE acquisition vehicle Pearl Acquisition had:
stated in the letter that it believes that the revised interpretations were inconsistent with the terms of the debt commitment letter and intends to continue its efforts to obtain the debt financing contemplated by the debt commitment letter as well as to explore the availability of alternative debt financing. Pearl Acquisition further stated in the letter that it is not optimistic at this time that its efforts will be successful and there can be no assurances that these efforts will be successful or that all of the conditions to closing the merger will be satisfied.
In their article, The Wall Street Journal spun the story as illustrating the increasing willingness of investment banks to assertively rely on contractual terms to back away from financing commitments to private equity groups, clients which have been some of the bank's best customers in recent years. This may clearly be the case here, and if so, this highlights the lingering problems in the credit and deal markets (at least pre-Fed cut -- moral hazard, folks), and the bad financial position of the banks on these loans which makes them willing to challenge their best customers. But there is perhaps an alternative explanation -- the banks as well as Blackstone no longer like this deal and are now both incentivized to back away from it. However, for public relations purposes Blackstone is trying to play the good guy.
This explanation -- the purchasers and banks are all working together to stem losses from a bad deal -- finds support in the agreements PHH struck to be acquired. In the merger agreement, PHH agreed to condition the obligations of GE on:
All of the conditions to the obligations of the purchaser under the Mortgage Business Sale Agreement to consummate the Mortgage Business Sale (other than the condition that the Merger shall have been consummated) shall have been satisfied or waived in accordance with the terms thereof, and such purchaser shall otherwise be ready, willing and able (including with respect to access to financing) to consummate the transactions contemplated thereby . . . .
Does everyone see the problem with this language? I usually hesitate to criticize drafting absent knowing the full negotiated circumstances and without having context of all the negotiations, but this is poor drafting under any scenario. "ready, willing and able"? I have no idea what the parties and DLA Piper, counsel for PHH intended this to mean, but arguably Blackstone -- the mortgage business purchaser here -- can simply say that is not a willing buyer for any reason and GE can then assert the condition to walk away from the transaction. You can read "ready" and "able" in similarly broad fashion. This is about as broad a walk-away right as I have ever seen -- I truly hope that PHH realized this, or were advised to this, when they agreed to it.
Here, note that the walk-away right is GE's. GE can either waive or assert the condition if Blackstone is not "ready, willing or able". It does not appear that PHH has disclosed the agreement between GE and Blackstone with respect to the Mortgage Business Sale. But, in PHH's proxy, PHH states that the mortgage business sale is conditioned upon the satisfaction or waiver of the closing conditions pertaining to GE in the merger agreement. In addition PHH stated that:
In connection with the merger agreement, we entered into a limited guarantee, pursuant to which Blackstone has agreed to guarantee the obligations of the Mortgage Business Purchaser up to a maximum of $50 million, which equals the reverse termination fee payable to us under certain circumstances by the Mortgage Business Purchaser in the event that the Mortgage Business Purchaser is unable to secure the financing or otherwise is not ready, willing and able to consummate the transactions contemplated by the mortgage business sale agreement.
I can't read the actual terms because the agreement is unavailable, but this may ameliorate a bit the bad drafting. PHH has essentially granted a pure option to Blackstone to walk for $50 million. The interesting thing here is how all of this works with GE in the middle. We can't see the termination provisions of the mortgage business sale agreement between GE and Blackstone but presumably Blackstone can walk from that agreement by paying the $50 million to PHH -- what its obligations to GE in such a case are we don't know.
Ultimately, though, the problem is that these provisions provide too much room for all three of GE, Blackstone and the Banks to maneuver to escape this transaction. GE can simply work with Blackstone to have it assert that it is unwilling to complete the transaction for any plausible reason; Blackstone can similarly rely upon the Banks actions and what is likely a loosely drafted commitment letter to make such a statement or come up with another one. The end-result is to place very loose reputational restraints on the purchasers' ability to walk from the transaction. Compare this with other private equity deals with similar option-type termination fees. There, the private equity firms have to actually breach the merger agreement and their commitments to walk. This is a powerful constraint as the private equity firms do not want to squander their reputational capital by appearing to be unreliable on their deal commitments. Here, the problem is that the drafting of the merger agreement condition allows Blackstone to walk for any reason and GE to rely on that to terminate its own obligations. This is a much lighter reputational constraint -- they do not need to breach the agreement and their commitments to terminate the deal. The result is exactly what is happening here. If the deal goes bad the purchasers have little incentive to keep from cutting their losses and walking, and wide latitude to appear to be doing so for the right reasons and in accordance with their commitments. And this is why this is not only poor drafting, but a poor agreement for PHH to have made.
Addendum: As a comment notes there are also disclosure issues here. Although Form 8-K and Form 14A (for proxy statements) arguably don't require PHH to disclose the on-sale agreement since PHH is only a third party beneficiary and not a party to this agreement, they likely should have disclosed the agreement on general materiality grounds.
Thursday, August 30, 2007
On Monday, Taiwanese based Acer Inc. announced that it had agreed to acquire Gateway, Inc. Under the agreement, Acer will commence a cash tender offer to purchase all the outstanding shares of Gateway for $1.90 per share, valuing the company at approximately $710 million. For those who bought at $100 a share in 2000, I am very, very sorry. The acquisition is subject to CFIUS review and a finding of no national security issues (more on this at the end).
For language hogs, the merger agreement contains some solid contract language dealing with Gateway's exercise of its right of first refusal to acquire from Lap Shun (John) Hui all of the shares of PB Holding Company, S.ar.l, the parent company for Packard Bell BV. In Section 5.11 (pp. 36-37), Acer agrees to fund the purchase of Packard Bell by Gateway. The interesting stuff is in Section 7.2 which deals with what happens to Packard Bell if the agreement is terminated. In almost all circumstances of termination Gateway is required to on-sell Packard or its right to buy Packard to Acer. The big exception is in the case of a superior proposal. In such circumstance, if the third party bidder elects, Gateway is required to auction off Packard or its right to buy Packard to the highest bidder. According to one report on The Deal Tech Confidential Blog, Lenovo is contemplating an intervening bid for Gateway in order to acquire Packard; their lawyers should take a look at these provisions. In any event, Gateway did not disclose in its public filings that, if the Acer deal fails, it is highly unlikely to remain the owner of Packard Bell if it succeeds in purchasing it.
For those who track such things the deal has a no-solicit and a $21.3 million break fee -- about normal. It is also yet another cash tender offer with a top-up option.
The other interesting thing about this transaction is the Exon Florio condition. The Congress enacted the Exon-Florio Amendment, Section 721 of the Defense Production Act of 1950, as part of the Omnibus Trade and Competitiveness Act of 1988. The statute grants the President authority to block or suspend a merger, acquisition or takeover by a foreign entity if there is “credible evidence” that a “foreign interest exercising control might take action that threatens to impair the national security” and existing provisions of law do not provide “adequate and appropriate authority for the President to protect the national security in the matter before the President."
The Exon-Florio provision is implemented by the Committee on Foreign Investment in the United States ("CFIUS"), an inter-agency committee chaired by the Secretary of Treasury. Exon Florio was amended in July by The National Security Foreign Investment Reform and Strengthened Transparency Act. For a summary of the final legislative provisions, see this client memo by Wiley Rein here. The legislation is Congress's response to the uproar over the acquisition of Peninsular & Oriental Steam by Dubai Ports and the ensuing political brawl and heavy congressional protest which led to Dubai Ports terminating the U.S. component of its acquisition. The dispute was always puzzling: Dubai Ports was acquiring an English company with port operations in the United States and Dubai Ports is headquartered in the United Arab Emirates, one of our strongest allies in the Mid-East. Nonetheless, the controversy has now spawned a change in the CFIUS review process. And on the whole, the measure is fairly benign, endorsed by most business organizations and will not bring any significant change to the national security process. However, the bill does come on the heels of a significant upswing of CFIUS scrutiny of foreign transactions. According to one news report, CFIUS considered 113 transactions in 2006, up 74 percent from the previous year. How this will all ultimately effect the willingness of foreigners to invest in the U.S. is still unclear, though you can make a prediction.
Back to the Acer transaction. The tender offer is conditioned on:
the period of time for any applicable review process by the Committee on Foreign Investment in the United States (“CFIUS”) under Exon-Florio (including, if applicable, any investigation commenced thereunder) shall have expired or been terminated, CFIUS shall have provided a written notice to the effect that review of the transactions contemplated by this Agreement has been concluded and that a determination has been made that there are no issues of national security sufficient to warrant investigation under Exon-Florio, or the President shall have made a decision not to block the transaction.
This Exon-Florio condition appears prudent given that Lenovo had to make concessions to clear CFIUS review when it bought IBM's computing division. CFIUS review, though, has a minimum review period of 30 days which is longer than the 20 business day minimum required for a tender offer to remain open. Given this, I'm surprised Acer and Gateway went the tender offer route; typically in these situations you would use a merger structure which allows for a longer time period between signing and closing, but is more certain to get 100% of the shares in a more timely fashion. One likely reason is that they did so because they anticipate clearing Exon-Florio quickly. This, of course, is now in the hands of the U.S. government.
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.