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Editor: Brian JM Quinn
Boston College Law School

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Friday, October 12, 2007

Och-Ziff and Black Market Capital

It is being reported that Och-Ziff, the hedge fund adviser, set a price range of $30 to $33 a share for its proposed initial public offering of 36 million shares.  When it occurs, this will be the third hedge fund or private equity fund adviser ipo after Blackstone and Fortress and marks a return of these ipos post-August market crisis.  KKR is the next one on-deck, but expect more of them.  I outline the reasons why in my recent paper Black Market Capital:

In my paper, I note that retail investors cannot invest in hedge funds or private equity funds but they can invest in the funds' managers. I argue that the trend of hedge fund and private equity fund adviser initial public offerings is in part due to the SEC rules which prohibit public investment in these funds. Prevented from buying the funds directly, public investors look for something replicating their benefits. The investment banks and other financial actors act quickly meet this demand, but with less suitable and riskier investment vehicles such as fund adviser IPOs, special purpose acquisition companies, business development companies, structured trust acquisition companies, and specialized exchange traded funds all of which largely attempt to mimic private equity or hedge fund returns and have been marketed to public investors on this basis.  I term these investments “black market” capital since they are a product of the ban on direct hedge fund and private equity public investing.  I argue that these investment tend to be more risky on an individual basis than the hedge fund and private equity funds they substitute for.  So, public investors who buy them bear more risk and together inject more risk into the US capital markets than if they were allowed to invest in the funds.  These are a perverse consequence of the SEC’s current prohibition.  I argue that the SEC should resolve these issues by amending the securities laws to permit public investors to invest directly in private equity and hedge funds. This would recognize the costs in the current regime, end black market capital and allow investors to access the benefits of hedge funds and private equity: excess returns and diversification.

You can download Black Market Capital here

October 12, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Tuesday, October 2, 2007

3Com -- Surprise. Surprise.

Yesterday, 3Com filed its merger agreement.  As I read it, I felt like one of those cult members who predicts the end of the Earth on a date certain and wakes the day after to find everything still there.  Do they repent?  No, they fit the new facts into their situation and keep their belief. 

Well, 3Com did not go the Avaya route as I predicted.  Instead, they kept to the old private equity structure and included a highly negotiated reverse termination fee structure.  Essentially, 3Com and their lawyers (Wilson Sonsini) agreed that the buyers (Bain and Huawei) have a pure walk right if they pay a termination fee of $110,000,000 (Section 8(j) of the merger agreement).  This is about 5% of the transaction value of $2.2 billion.  And in certain situations, such as if the debt financing falls through, the buyers would only be liable for $66,000,000 if they breach the merger agreement and walk (I spell out these situations at the end of this post).

So, how do we explain this?  Well, one of the other interesting things about the 3Com merger agreement is that it is not conditioned upon financing; a fact 3Com did not even publicize in its press release or make an explicit condition in the merger agreement.  So, I think the conversation went something like this:  3Com -- we can't agree to this reverse termination fee as it will give you too much optionality.  Bain -- OK, well we can't expose our investors to liability for the full purchase price; if you won't agree to this then we need a financing condition.  Plus, we are really nice people and would never do that to you.  Banks piling on -- we won't finance this deal if there is specific performance on our commitment letters.  3Com -- OK -- no financing condition -- but we want a high termination fee of 5% to compensate us if you do indeed walk without a reason.  So, like the cult survivor this is my best explanation in order to keep my belief in rational negotiating, although there is a lower termination fee if the financing falls through, so I am still struggling to see the logic of the terms here.  In their conference call on Friday, 3Com was particularly unhelpful in talking about the terms of the agreement -- refusing to answer questions on the amount of the Huawei investment and instead stating "you’re going to have to wait a couple days or a little while before you can get specific answers to those questions."  They were also a bit defensive about the fact that one analyst suggested that if you exclude 3Com's ownership of H3C it values the remainder of 3Com at "$0.75, $0.80" a share.  Ouch. 

I'm also a bit troubled by some of the other terms which 3Com and its lawyers negotiated.  First, there is no go-shop in the transaction.  Even though these provisions have their problems (see my post on this here), it does provide some opportunity for other bidders to emerge and shields the seller from claims of favoritism, so I am a bit surprised 3Com did not include it.  In addition, if 3Com shareholders vote down the transaction, 3Com agreed in clause 8.3(b)(v) to reimburse the buyers for their fees and expenses up to $20 million.  This is unusual and an excessive amount of money for 3Com to pay merely because its shareholders exercised their statutory voting rights to reject the deal.  The termination fee in case of a competing bid is a market standard of $66 million (3% of the deal value) and does not require that the company pay the fees and expenses of the buyers. 

I think the most annoying part of the agreement from my perspective was this clause 7.1(b) which conditioned the merger occurring on:

(b) Requisite Regulatory Approvals. (i) Any waiting period (and extensions thereof) applicable to the transactions contemplated by this Agreement under the HSR Act shall have expired or been terminated, (ii) any waiting periods (and extensions thereof) applicable to the transactions contemplated by this Agreement under the Antitrust Laws set forth in Schedule 7.1(b) shall have expired or been terminated, and (iii) the clearances, consents, approvals, orders and authorizations of Governmental Authorities set forth in Schedule 7.1(b) shall have been obtained.

Read the highlighted condition.  Of course, 3Com did not disclose Schedule 7.1(b) and refused to answer questions on the agreement on their conference call yesterday.  So, investors at this point still don't know all of the conditions to the deal.  I can't see how this is not a material omission in violation of the federal securities laws (read my post on the SEC action against Titan).   I really wish the SEC would crack down on this practice since a shareholder action on this claim is a loser because of the holding in Dura Pharmaceuticals (see my post on this here).  It is particularly important here because the inclusion of a Chinese buyer might lead to an Exon-Florio filing for this deal.  And the condition that we can't see might be exactly that -- a condition that Exon-Florio clearance is required to complete the deal.  Given that this is a Chinese buyer it is bound to attract CFIUS scrutiny whether justified or not.  In this case, it may be justified -- apparently sharing 3Com's networking technology with the Chinese does raise national security concerns.  (By the way, for an explanation of the Exon-Florio process and the term CFIUS see my first post today here).  Shame on 3Com for not disclosing the condition immediately or even informing the public of the amount of the Chinese investment at this time.  If 3Com is indeed going to clear Exon-Florio in this transaction they need to handle their public relations better.

Finally the MAC clause is in the definitions and states: 

“Company Material Adverse Effect” shall mean any effect, circumstance, change, event or development (each an “Effect”, and collectively, “Effects”), individually or in the aggregate, and taken together with all other Effects, that is (or are) materially adverse to the business, operations, condition (financial or otherwise) or results of operations of the Company and its Subsidiaries, taken as a whole; provided, however, that no Effect (by itself or when aggregated or taken together with any and all other Effects) resulting from or arising out of any of the following shall be deemed to be or constitute a “Company Material Adverse Effect,” and no Effect (by itself or when aggregated or taken together with any and all other such Effects) resulting from or arising out of any of the following shall be taken into account when determining whether a “Company Material Adverse Effect” has occurred or may, would or could occur: (i) general economic conditions in the United States, China or any other country (or changes therein), general conditions in the financial markets in the United States, China or any other country (or changes therein) or general political conditions in the United States, China or any other country (or changes therein), in any such case to the extent that such changes, effects, events or circumstances do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (ii) general conditions in the industries in which the Company and its Subsidiaries conduct business (or changes therein) to the extent that such changes, effects, events or circumstances do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (iii) any conditions arising out of acts of terrorism, war or armed hostilities to the extent that such conditions do not affect the Company and its Subsidiaries in a disproportionate manner relative to other participants in the industries in which the Company and its Subsidiaries conduct business; (iv) the announcement of this Agreement or the pendency or consummation of the transactions contemplated hereby, including the impact thereof on relationships (contractual or otherwise) with suppliers, distributors, partners, customers or employees; (v) any action taken by the Company or its Subsidiaries that is required by this Agreement, or the failure by the Company or its Subsidiaries to take any action that is prohibited by this Agreement; (vi) any action that is taken, or any failure to take action, by the Company or its Subsidiaries in either case to which Newco has approved, consented to or requested in writing; (vii) any changes in Law or GAAP (or the interpretation thereof); (viii) changes in the Company’s stock price or change in the trading volume of the Company’s stock, in and of itself (it being understood that the underlying cause of, and the facts, circumstances or occurrences giving rise or contributing to such circumstance may be deemed to constitute a “Company Material Adverse Effect” (unless otherwise excluded) and shall not be excluded from and may be deemed to constitute or be taken into account in determining whether there has been, is, or would be a Company Material Adverse Effect; (ix) any failure by the Company to meet any internal or public projections, forecasts or estimates of revenues or earnings in and of itself (for the avoidance of doubt, the exception in this clause (ix) shall not prevent or otherwise affect a determination that the underlying cause of such failure is a Company Material Adverse Effect); or (x) any legal proceedings made or brought by any of the current or former stockholders of the Company (on their own behalf or on behalf of the Company) resulting from, relating to or arising out of this Agreement or any of the transactions contemplated hereby.

For those of you who have better things to do than slog through this definition, it is favorable to 3COM -- it contains no forward-looking element and specifically excludes failure to meet projections from the definition among other things. 

Final Conclusion:  3Com is an unusual deal for a variety of reasons.  In addition, the model in 3Com is one that Wilson Sonsini has negotiated in other deals (see, e.g., Acxiom). It may indeed signal that past practices here with respect to private equity deals and reverse termination fees will continue as the norm albeit with higher buyer reverse termination fees.  But, like the cult survivor, for now I'm going to keep my belief and hope that its singularity will not effect future practice and that the Avaya model will become the standard.   Or at least that firms other than Wilson Sonsini might learn quicker and go that route. 

Addendum:  Reverse Termination Fee.

The relevant termination clause here is clause 8.1(g) which permits termination:

   (g) by the Company, in the event that (i) all of the conditions to the obligations of Newco and Merger Sub to consummate the Merger set forth in Section 7.1 and Section 7.2 have been satisfied or waived (to the extent permitted hereunder), (ii) the Debt Financing contemplated by the Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement (or any replacement, amended, modified or alternative Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement permitted by Section 6.4(b)) has funded or would be funded pursuant to the terms and conditions set forth in such Debt Commitment Letters, Senior Secured Credit Agreement and/or Bridge Agreement upon funding of the Equity Financing contemplated by the Equity Commitment Letters; (iii) Newco and Merger Sub shall have breached their obligation to cause the Merger to be consummated pursuant to Section 2.2 and (iv) a U.S. Federal regulatory agency (that is not an antitrust regulatory agency) has not informed Newco, Merger Sub or the Company that it is considering taking action to prevent the Merger unless the parties or any of their Affiliates agree to satisfy specified conditions (which may but need not include divestiture of a material portion of the Company’s business) other than as contemplated by Section 5.5 of the Company Disclosure Schedule, or such regulatory agency has informed the parties that it is no longer considering such action; or

If the agreement is terminated under this clause then the buyers are required to pay the Newco Default Fee ($110 million).  The clause limiting the buyers to paying this amount is in 8.3(g) (Limitation of Remedies) and  9.7 (Specific Performance).  Of particular importance, note that the debt financing must be funded for this termination provision to be triggered.  If the debt financing or other conditions above are not met, the buyers are then liable for the lesser amount of $66 million for breaching the agreement (clause 8.3(c)(i)).   

October 2, 2007 in Material Adverse Change Clauses, Private Equity, Takeovers | Permalink | Comments (1) | TrackBack (0)

Sunday, September 30, 2007

Black Market Capital Quoted Extensively in the Financial Times Today

David Wighton, the New York Bureau Chief for the Financial Times, quotes extensively from my new article Black Market Capital in his lead-in article to today's Report on Fund Management in the Financial Times.  The article is entitled SEC seeming perverse about risk and is accessible on the FT website here.  You can also get it on the newstand.  A few quotes for flavor:

"Told you so," said many critics of hedge funds surveying the damage caused by the summer credit market turmoil. The high-profile collapse of several funds and the dismal performance of many others have provided just the ammunition the sceptics were looking for. Surely it proved that hedge funds were dangerous and should be kept out of the hands of retail investors, they said. How wise of the Securities and Exchange Commission to propose barring individuals with less than $2.5m (£1.2m, €1.8m) in liquid assets from investing in hedge funds, up from the current limit of $1m.

This is nonsense. Average hedge fund returns are generally less volatile than the equity market as a whole and you are much more likely to lose your shirt on an individual stock than on a hedge fund. The rules preventing small investors from putting money into hedge funds are positively perverse.

As Steven Davidoff, a professor at Wayne State University Law School, points out in a new paper, the rules have an even more perverse consequence.

Retail investors may not be able to invest in hedge funds - or private equity funds for that matter - but they can invest in the funds' managers, which Prof Davidoff argues are more risky.

"This is because the future income of an adviser is derivative upon the fund advisers' capacity to continually earn extraordinary positive returns." If they do not earn such returns, investors will shift money away, which means the impact on the investor in the manager will be greater than on the investor in the fund.

Prof Davidoff suggests that the spate of flotations of alternative asset managers - albeit slowed by the credit market turmoil - is partly the result of the rules against public issues by alternative funds. Prevented from buying the funds directly, public investors look for something that replicates their benefits. The financial industry quickly meets that demand. But it does so with less suitable vehicles such as asset managers, special purpose acquisitions companies and the growing array of exchange-traded funds and indexes that attempt to track private equity or hedge fund performance.

These vehicles, which Prof Davidoff dubs Black Market* Investments, tend to be more risky on an individual basis than the hedge fund and private equity funds they substitute for. So public investors who buy them bear more risk and together inject more risk into the US capital markets than if they were allowed to invest in the funds.

Investors' other option is to buy funds on non-US markets, a process that the SEC is considering making easier. But without the benefit of SEC regulatory oversight and the US securities law enforcement, Prof Davidoff argues that this would be more risky and costly than a prohibited US-based purchase of the funds.

Investors should be allowed to make up their own minds on whether hedge funds are good value for money. The asset qualification for retail investors should not be raised. It should be scrapped.

Check it out. 

September 30, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Avaya and 3Com: Why are these PE Deals Different From All Other PE Deals?

On Friday, 3Com Corporation announced that it had agreed to be acquired by affiliates of Bain Capital Partners, LLC, for approximately $2.2 billion in cash. This is the first big private equity deal announced post-August market crisis.  As such, I'm excited for 3Com to file the merger agreement this week; it will give us a good window on how transaction participants and M&A attorneys have reacted to revise previously standard structures in light of market developments.  My big bet -- expect there to be no reverse termination fee -- that is, a clause which gives the private equity buyer an absolute right to walk from the deal by paying a pre-set fee, typically 3-5% of the deal value (for more on these see my post here).  Instead, expect the parties in 3Com to adopt the structure used in the Avaya transaction where Avaya agreed to be acquired by Silver Lake and TPG Capital for approximately $8.2 billion or $17.50 per common share.

The Avaya merger agreement was one of the only private equity transactions pre-market crisis to specifically provide for the opposite of a reverse termination fee -- specific performance.  In Section 7.3(f) of the merger agreement the parties specifically cap monetary damages in case of breach but provide for specific performance.  This effectively ends the optionality contained in the other private equity agreements with reverse termination fees.   Here is the relevant language:

Notwithstanding the foregoing, it is explicitly agreed that the Company shall be entitled to seek specific performance of Parent’s obligation to cause the Equity Financing to be funded to fund the Merger in the event that (i) all conditions in Sections 6.1 and 6.2  have been satisfied (or, with respect to certificates to be delivered at the Closing, are capable of being satisfied upon the Closing) at the time when the Closing would have occurred but for the failure of the Equity Financing to be funded, (ii) the financing provided for by the Debt Commitment Letters (or, if alternative financing is being used in accordance with Section 5.5, pursuant to the commitments with respect thereto) has been funded or will be funded at the Closing if the Equity Financing is funded at the Closing, and (iii) the Company has irrevocably confirmed that if specific performance is granted and the Equity Financing and Debt Financing are funded, then the Closing pursuant to Article II will occur.  For the avoidance of doubt, (1) under no circumstances will the Company be entitled to monetary damages in excess of the amount of the Parent Termination Fee and (2) while the Company may pursue both a grant of specific performance of the type provided by the preceding sentence and the payment of the Parent Termination Fee under Section 7.1(b), under no circumstances shall the Company be permitted or entitled to receive both a grant of specific performance of the type contemplated by the preceding sentence and any money damages, including all or any portion of the Parent Termination Fee.

Practitioners take note for future deals.

Additional Point:  Given the difference between the Avaya deal and the other private equity deals, I was surprised to see the wild fluctuation in the Avaya stock price last week.  This is a much more certain deal than the SLM Corp. and other private equity deals with reverse termination fees.  Unless the buyers here can establish a MAC (which doesn't appear to be the case based on public information) this deal will close so long as the financing letters remain in place.  I don't believe Avaya has disclosed these commitment letters, but presumably these are as tight as the merger agreement and can only be terminated for a similar MAC and other customarily significant reasons.  Also, presumably if Avaya's lawyers negotiated a specific performance clause in the merger agreement they also demanded one in the commitment letters, so that they could ensure that the debt financing needed for the buyers to specifically perform under the clause above would be available.  But perhaps the market is actually efficient here and is seeing something I do not. 

Incidentally, Avaya stockholders approved the transaction on Friday -- the deal now goes into the debt marketing stage, and under the merger agreement is required to close by the end of the marketing period.  The marketing period ends 20 business days from this past Friday provided Avaya has provided all the relevant information it is required to under the merger agreement to the buyers.   

September 30, 2007 in Private Equity | Permalink | Comments (0) | TrackBack (0)

Friday, September 21, 2007

Topps and In re: Appraisal of Transkaryotic Therapies

On Wednesday, Crescendo Partners announced in a press release that it would elect to exercise appraisal rights with respect to its 6.9% share ownership in Topps.  I noted yesterday that Crescendo's action might spur other shareholders to exercise appraisal rights in this deal.  The reason why is that unlike entire fairness litigation in Delaware, which is typically contingency fee based, shareholders in appraisal proceedings shareholders must front the costs. This creates a collective action problem among others -- shareholders, particularly smaller ones, do not want to bear these expenses, do not have the wherewithal to bring an appraisal action and are unable to coordinate their actions to do so.  I wrote yesterday that this is a problem ameliorated in the Topps deal now since shareholders know Crescendo will be bearing some, if not all, of these costs.  The consequence may be a higher than ordinary number of shareholders exercising appraisal rights.  And, the Topps merger agreement is conditioned on no more than 15% of shareholders exercising appraisal rights, so if a sufficient number exercise these rights it will give Eisner's Tornante Company and Madison Dearborn Partners a walk right and put the deal in jeopardy. Topps shareholders opposed to this deal now have an incentive to exercise their rights in order to attempt to crater it. 

There is another factor here which may raise the number of shareholders asserting appraisal rights:  The recent Delaware decision in In re: Appraisal of Transkaryotic Therapies, Inc. (access the opinion here; see my blog post on it here).  This case held that investors who buy target company shares after the record date and own them beneficially rather than of record may assert appraisal rights so long as the aggregate number of shares for which appraisal is being sought is less than the aggregate number of shares held by the record holder that either voted no on the merger or didn’t vote on the merger.  As Chancellor Chandler stated:

[a] corporation need not and should not delve into the intricacies of the relationship between the record holder and the beneficial holder and, instead, must rely on its records as the sole determinant of membership in the context of appraisal.

The court ultimately held that since the "actions of the beneficial holders are irrelevant in appraisal matters, the inquiry ends here."  [NB.  most shareholders own their shares beneficially rather than of record with one or two industry record-holders so this decision will apply to almost all shares held by Topps and in fact any other public company]

Post-Transkaryotic a number of academics and practitioners raised the concern that this holding would encourage aggressive investors (read hedge funds) to create post-record date/pre-vote positions in companies in order to assert appraisal rights with respect to their shares.  This would be particularly the case where the transaction was one being criticized for a low offered price. 

Topps appears to be a good candidate for this strategy.  The price offered by Michale Eisner's  consortium has been criticized extensively for being too "low" and led a number of proxy service firms to recommend against the merger.  In addition, the record date on the transaction was August 10, which provided a long period for investors adopting this strategy to purchase their shares.  Ultimately, it appears that we are watching the first test of the Transkaryotic opinion.  It will be interesting to see whether the potential concerns raised by this decision come to pass.  And perhaps food for thought for the Delaware Supreme Court if, and when, it ever considers the holding of the Transkaryotic case.

September 21, 2007 in Delaware, Hedge Funds, Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Thursday, September 20, 2007

Topps: Not Over Yet

The Topps shareholder meeting occurred yesterday, and it was yet again mired in controversy and accusations of manipulative practices by the Topps board.  According to Topps's press release issued yesterday, Topps's shareholders approved the proposal to be acquired by Michael Eisner's Tornante Group and Madison Dearborn Partners.   The press release was notable for not mentioning the preliminary count of votes.  But, the vote was likely exceedingly close.  Earlier in the day, Topps actually postponed the meeting yet again for a few hours because: 

Based on preliminary estimates of the vote count and discussions with a number of the Company's stockholders, the Company believes that substantially more votes are in favor of the transaction than against it, including stockholders who are in the process of voting or changing their votes to "FOR." However, at this time, the number of votes cast in favor of the transaction is not sufficient to approve the transaction under Delaware law. The Company has postponed the special meeting in order to provide an opportunity for these stockholders' votes to be received and for additional stockholders to vote "FOR" the merger. The Company intends to continue to solicit votes and proxies in favor of the merger during the postponement. During this time, stockholders will continue to be able to vote their shares for or against the merger, or to change their previously cast votes.

This raises a host of questions, including:  who were these shareholders?  Why did they not vote favorably the first time around?  And what did Topps say or do to get these shareholders to change their minds?  In addition, Topps's repeated postponement of the shareholder meeting to gain approval yet again shows their bias as well as the pernicious effects of Strine's recent decision in Mercier, et al. v. Inter-Tel which provided much wider latitude for Boards to postpone shareholder meetings in the takeover context in order to solicit more votes (more on that here). 

There is still substantial uncertainty that this deal will close.  Almost immediately after the announcement of the shareholder vote, Crescendo Partners issued its own press release announcing that it intended to "assert appraisal rights with respect to the shares it owns of The Topps Company, Inc. in connection with the merger agreement between Topps and entities owned by Michael D. Eisner and Madison Dearborn Partners, LLC."  The merger agreement is conditioned upon:

holders of no more than 15% of the outstanding shares of our common stock exercis[ing] their appraisal rights under Section 262 of the DGCL in connection with the merger

According to a recent 13D/A, Crescendo owns 6.9% of Topps.  However, assertion of appraisal rights in Delaware tends to be an exercise in herd behavior.  Crescendo's steps are likely to lead to more dissident shareholders exercising their appraisal rights, hoping to free-ride on Crescendo's efforts.  In any event. given the hostility and distrust of many shareholders of the Topps board's practices here and their criticism of the perceived low price, I would expect there to be significantly more shareholders taking the appraisal route than normal.  This may lead to the 15% condition not being satisfied thus putting Eisner & Co. in the position of facing litigation in Delaware with a very uncertain outcome.  Topps has already lost once in Delaware court; Eisner may not want to take that chance again by waiving the condition if it is not fulfilled.  The Topps board may still lose here. 

September 20, 2007 in Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 19, 2007

PHH Corp's Vague Condition

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. 

September 19, 2007 in Merger Agreements, Private Equity | Permalink | Comments (1) | TrackBack (0)

Tuesday, September 18, 2007

Topps Shareholder Meeting Tomorrow

In advance of the Topps shareholder meeting tomorrow, Michael Eisner's Tornante and Madison Dearborn issued a helpful press release entitled "Tornante and Madison Dearborn Will Not Raise Price for Topps Company Group Reiterates Final Price Prior to Wednesday’s Shareholder Vote".  In it they state that:

Topps is a wonderful company with a rich history, and we are prepared to buy it at the price of $9.75 per share set forth in our agreement. We thoroughly analyzed the value of Topps prior to entering into our deal with the company in March. We believed $9.75 per share was more than a full and fair price for the company then, and we continue to believe that to be the case now especially considering the current economic environment.  If Topps shareholders feel differently and vote against our deal this week, we wish them well, but our price is final and we will not increase it.

The statement comes on the heels of the recommendations by ISS, Glass, Lewis and Proxy Governance, Inc. that shareholders reject Eisner's merger proposal.  The ISS one is particular was interesting as it rested in part on the fact that "the original sales process exhibited something less than M&A 'best practices,' an opinion apparently shared by the Delaware courts."  ISS's focus on these issues for its recommendations is admirable.   

Topps had previously postponed its meeting based on VC Strine's recently issued decision in Mercier, et al. v. Inter-Tel, upholding the Inter-Tel's board's decision to postpone a shareholder meeting in circumstances of almost certain defeat.  It appears that the postponement still hasn't done Topps much good and the shareholders are likely to still vote down this transaction. 

Ultimately, the Topps board has done a disservice to its shareholders -- it has run this process in a biased manner, raised questions with respect to its dealings with Upper Deck, and been chastised in Delaware court for its failings in In Re Topps Shareholder Litigation.  A no vote will likely lead to a subsequent proxy contest by Crescendo Partners to remove the board members who supported this transaction.  In the meantime, under the merger agreement, Eisner would walk away with a payment of up to $4.5 million as reimbursement for his expenses. 

The Topps meeting is tomorrow, September 19, 2007 at 11:00 a.m., local time, at Topps' executive offices located at One Whitehall Street, New York, NY 10004.  If anyone attends and has some interesting information please let me know and I will post it.  Perhaps Topps will even give out souvenir cards -- shareholders would then at least have something to show for the deal.

September 18, 2007 in Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Sunday, September 16, 2007

Morgan Stanley's Big Freeze

I previously celebrated the Reddy Ice deal and the joys of M&A by proclaiming Reddy Ice's slogan "Good Times are in the Bag", the day the company announced that it would be acquired by GSO Capital Partners for $681.5 million in a deal valued at $1.1 billion including debt.  I should have known better -- it now appears that the celebration might have been a bit too soon.  Last week Reddy Ice filed its definitive proxy statement for the transaction.  The transaction history discloses a deal in crisis with Reddy Ice being hit by shareholder protests against the deal by Noonday Asset Management, L.P. and Shamrock Activist Value Fund L.P., the company's results for July coming below budget and recent guidance for 2007, and GSO proclaiming that it needed more time to finance the deal given the state of the debt markets and Reddy Ice.

In light of these problems, the parties ultimately agreed to amend the merger agreement to cap the future dividends Reddy Ice could pay while the transaction was pending, extend GSO's marketing period for the debt financing, move up the date of the Reddy Ice shareholder meeting to October 15, 2007, and reduce the maximum fee payable to GSO if Reddy Ice's shareholders rejected the transaction from $7 million to $3.5 million. Notably, Reddy Ice backed away from its initial position vis-a-vis GSO that it required an extension of the go-shop period and a postponement of the shareholder meeting in exchange for these amendments.  For those who don't believe that private equity reverse termination provisions will be a factor in this Fall's deal renegotiations, I suggest you read this transaction history very carefully.  The Reddy Ice board specifically cites its fears that GSO would simply walk from the transaction by paying the reverse termination fee of $21 million as a factor in its renegotiation.  Note that this amendment still preserves this option. 

Now Morgan Stanley is objecting to the amendment.  MS has agreed to provide GCO with debt financing for this transaction, and MS is claiming that the merger amendment was entered into without its consent thereby disabling its obligations under the commitment letter, a fact MS is reserving its rights with respect thereto.  MS agreed to a $485 million term loan facility, an $80 million revolving credit facility, and a $290 million senior secured second-lien term loan facility.  GSO and RI are disputing MS's claim and the transaction is not contingent on financing, i.e., unless it claims a MAC GSO has no other choice but to take this position.  The MS debt commitment letter is not publicly available but they are likely relying on the following relatively standard clause: 

[Bank] shall have reviewed, and be satisfied with, the final structure of the Acquisition and the terms and conditions of the Acquisition Agreement (it being understood that [Bank] is satisfied with the execution version of the Acquisition Agreement received by [Bank] and the structure of the Acquisition reflected therein and the disclosure schedules to the Acquisition Agreement received by [Bank]). The Acquisition and the other Transactions shall be consummated concurrently with the initial funding of the Facilities in accordance with the Acquisition Agreement without giving effect to any waivers or amendments thereof that is material and adverse to the interests of the Lenders, unless consented to by [Bank] in its reasonable discretion. Immediately following the Transactions, none of Borrower, the Acquired Business nor any of their subsidiaries shall have any indebtedness or preferred equity other than as set forth in the Commitment Letter.

I am not involved in the bank finance industry these days, but still, it is hard to see how this amendment is adverse to the position of MS (assuming that the clause in their debt commitment letter is similar to the one above).  If anything, the extension of the marketing period is beneficial to MS.  The remainder of the amendment does not appear to effect MS except perhaps the dividend provision, but GSO can always fund that if necessary.  But, Marty Lipton -- a man much smarter than me -- was recently on the wrong side of this debate when he made a similar argument in the context of the Home Depot supply deal, though that deal was more substantially renegotiated.  Ultimately, MS's position is likely similar to one taken by banks in the recent Home Depot and Genesco deals -- they are using ostensible contractual claims to attempt to renegotiate deals that no longer are attractive and they are likely to lose money on.  Here, based on a number of big assumptions, MS's claims seem a bit over-stated, though it may be enough to engender a further renegotiation of the deal premised upon MS's implicit threat to walk.  Good Times are NOT in the Bag. 

Final Note:  In a developing market with a number of situationa like this, MS is taking a shot at this strategy with a lower priority client first.  I doubt they would take the same position with KKR. 

September 16, 2007 in Investment Banks, Private Equity, Takeovers | Permalink | Comments (1) | TrackBack (0)

More on Black Market Capital

Allaboutalpha, a leading blog on the hedge fund industry, has a nice, extensive discussion of my latest paper:  Black Market Capital.  Black Market Capital discusses the federal regulation of hedge funds and private equity and the rise of fund adviser ipos, special purpose acquisition companies, structured trust acquisition companies and exchange traded funds all of which attempt to mimic hedge fund or private equity performance and are marketed to public investors on this basis.  My paper was posted to the SSRN last week.  According to Allaboutalpha: 

[Davidoff] concludes the paper by methodically walking through many of the positive arguments for hedge funds that we have also made on this website (he even cites some of the same sources).  This dispassionate, methodical style may destine Davidoff’s paper to be a beacon for the industry as it struggles to debunk commonly-held misperceptions. 

You can read their further analysis here.  You can download my paper on the SSRN here

September 16, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Thursday, September 6, 2007

House Hearing on Taxing Private Equity and Hedge Funds

The House Ways & Means Committee is holding hearings today starting at 10:00 a.m. on the taxation of private equity and hedge fund adviser compensation.  The meetings will be simulcast on the web live.   

In advance of the hearing, the Joint Committee on Taxation has released Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues:

Despite the long title, it is a fascinating look at the state and business of private equity and hedge funds.  In any event, the hearings show that the issue of fund taxation continues to have momentum.

September 6, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 5, 2007

Black Market Capital

Last Friday, the Wall Street Journal ran an interesting article on the large number of individual investor comments the SEC is receiving for its pending rule proposal to raise the wealth requirements for investment in hedge funds and private equity.  Apparently, the bulk of these comments criticize the SEC for depriving these investors of the opportunity to invest in hedge funds and private equity.  These investors rather want unrestricted access to these investments.  The article was fortuitously timed as I have just finished up my summer writing project --  Black Market Capital -- which touches upon this subject and argues for just such investor access (download the article on the SSRN here).  I'll be presenting parts of this article to the securities reg. section meeting at AALS in January.  Here is the abstract: 

Hedge funds and private equity offer unique investing opportunities, including the possibility for diversified and excess returns. Yet, current federal securities regulation prohibits the public offer and purchase in the United States of these investments. Public investors, foreclosed from purchasing hedge funds and private equity, instead seek to replicate their benefits. This demand drives public investors to substitute less-suitable, publicly available investments which attempt to mimic the characteristics of hedge funds or private equity. This effect, which this Article terms black market capital, is an economic spur for a number of recent capital markets phenomena, including fund adviser IPOs, special purpose acquisition companies, business development companies, structured trust acquisition companies, and specialized exchange traded funds all of which largely attempt to replicate private equity or hedge fund returns and have been marketed to public investors on this basis. Black market capital has not only altered the structure of the U.S. capital market but has shifted capital flows to foreign markets and engendered the creation of U.S. private markets such as Goldman Sachs' GSTrUE. This Article identifies and examines the ramifications of black market capital. It finds this effect to be an irrational by-product of current hedge fund and private equity regulation, one that is likely harmful to U.S. capital markets. A solution is to restore equilibrium in U.S. markets and enhance their global competitiveness by amending the Investment Company Act and Investment Advisers Act to permit public offerings of hedge funds and private equity funds. Though further study is warranted, the economic benefits of such a regime prospectively outweigh objections previously raised by regulators and others. Current market volatility and distress does not affect this conclusion. Black market capital is also an example of the unintended effects of regulating under the precautionary principle and difficulty of regulating in an era of market proliferation.

September 5, 2007 in Hedge Funds, Private Equity | Permalink | Comments (0) | TrackBack (0)

Sunday, August 26, 2007

Home Depot and the Private Equity "Problem"

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. 

August 26, 2007 in Material Adverse Change Clauses, Private Equity, Private Transactions | Permalink | Comments (0) | TrackBack (0)

Thursday, August 16, 2007

Private Equity's Option to Buy

In times of market stress, agreements that at the time seemed reasonable can cause dilemma for the parties.  Perhaps the most interesting of these right now is the one associated with the liability limiting provisions that private equity actors have sometimes negotiated in their acquisition agreements.  These provisions limit the liability of the private equity companies to a set amount no matter whether they intentionally breach the deal or not.  The amount is typically at three-four percent of deal value.  And, these provisions exclude the possibility of specific performance to require the private equity firm to consummate the transaction.  So, the net effect is to give the private equity adviser a walk-away right with a cap on their liability at a fixed dollar amount.  A number of troubled deals have this provision, including Manor Care, SLM, TXU (see the provisions here, here and here).  Lone Star did not have this provision in its agreement; the result is that its liability exposure is substantially higher (see my post on this here). 

These clauses essentially give the private equity fund an "option" on the acquired company.  They can rationally assess at the time of closing whether it is worth it to close in numerical dollar terms.  This makes for a very interesting calculus, particularly in these times.  Private equity firms who have negotiated these clauses must be making some hard, number-crunching decisions.  No one likes to pay the size of these possible payments ($1 billion in the case of TXU, $900 million in the case of SLM), tarnish their reputation as a bad player or admit to your investors that you made a bad decision, but sometimes cutting your losses is the better part of valor.  Or at least it is a good negotiating chip. 

Nonetheless, I'm not sure that sellers have fully appreciated the impact of these clauses.  I suspect the conversation goes something like this:  "Buyer:  We're a private equity firm and our investors require that we cap our losses.  You have a three percent break fee, shouldn't that be the same for us?  Seller:  Well, that makes sense".  OK, it probably doesn't go exactly like that, but the point is that the three percent here may not be the right price.  Would a correctly priced option cost that little? (interestingly, if you have some reasonable certainty as to a closing date this would be a European option so you could actually try and use Black-Scholes).  Does this amount properly compensate the company and its shareholders for a blown deal?  And should the private equity firms even have this option; this is not something that would seem rational with an industry buyer?  Seller's counsel would do well to highlight these issues to their clients, particularly the optionality embedded in these liability limiting clauses.   

NB.  It is not quite a private equity deal but the Tribune deal has similar provisions which limit the liability of Sam Zell to $25 million (see Sec. 8.20 of the Zell purchase agreement).  Not bad on an $8 billion transaction. 

Addendum:  a reader has pointed me to a clause in the Avaya merger agreement which more thoughtfully addresses this issue.  In Section 7.3(f) the parties specifically cap monetary damages in case of breach but provide for specific performance.  This effectively ends the optionality contained in the other agreements discussed above.   Here is the relevant language:

Notwithstanding the foregoing, it is explicitly agreed that the Company shall be entitled to seek specific performance of Parent’s obligation to cause the Equity Financing to be funded to fund the Merger in the event that (i) all conditions in Sections 6.1 and 6.2  have been satisfied (or, with respect to certificates to be delivered at the Closing, are capable of being satisfied upon the Closing) at the time when the Closing would have occurred but for the failure of the Equity Financing to be funded, (ii) the financing provided for by the Debt Commitment Letters (or, if alternative financing is being used in accordance with Section 5.5, pursuant to the commitments with respect thereto) has been funded or will be funded at the Closing if the Equity Financing is funded at the Closing, and (iii) the Company has irrevocably confirmed that if specific performance is granted and the Equity Financing and Debt Financing are funded, then the Closing pursuant to Article II will occur.  For the avoidance of doubt, (1) under no circumstances will the Company be entitled to monetary damages in excess of the amount of the Parent Termination Fee and (2) while the Company may pursue both a grant of specific performance of the type provided by the preceding sentence and the payment of the Parent Termination Fee under Section 7.1(b), under no circumstances shall the Company be permitted or entitled to receive both a grant of specific performance of the type contemplated by the preceding sentence and any money damages, including all or any portion of the Parent Termination Fee.

Practitioners take note.

August 16, 2007 in Private Equity | Permalink | Comments (0) | TrackBack (0)

Wednesday, August 15, 2007

AirTran Returns

Yesterday, AirTran reentered the bidding for Midwest Air Group.  In a press release, AirTran announced an offer to acquire Midwest for $16.25 per share.  The consideration under the new proposal would consist of $10 a share in cash and 0.6056 shares of AirTran common stock and values Midwest at $445 million in total value.  As I write, AirTran's stock is trading at $10.49 valuing the offer at $16.35.  The offer is slightly higher than the $16 a share offer from TPG Capital, L.P. the Midwest board announced on Monday that they were accepting.

My initial reaction is that AirTran management may want to read Bernard Black's classic Stanford law review article Bidder Overpayment in TakeoversProfessor Black ably analyzes the factors which go into the documented effect of bidder overpayment and the puzzling persistence of takeovers when studies have shown that they are at best wealth neutral for buyers.  These include the classic winner's curse which is a product of information asymmetry and a bidder's consequent over-estimation of value (Think about competing with another bidder to buy a home).  But it is also effected by other factors such as management optimism and uncertainty and simple agency costs (i.e., the risk of the acquisition is largely borne by AirTran's post-transaction shareholders).  Some analysts have claimed that AirTran would be better positioned without Midwest, so perhaps these factors are in play here.  Of course, we will only know the answer post-transaction if and when Midwest is acquired by AirTrans. 

Finally, the Midwest board still has leeway to prefer the TPG offer.  The Midwest board is governed by Wisconsin law, not Delaware and therefore the typical Revlon duties do not apply.  In fact, the duties of a board under Wisconsin law in these circumstances have never been fully elaborated.  Moreover, Wisconsin has a constituency statute which permits a board considering a takeover to consider constituencies other than shareholders, such as employees.  The Midwest board has before invoked this constituency statute to justify rejection of Airtran's bid.  It may do so again.  And even if Revlon duties did apply, the Midwest board could make the reasonable judgment that AirTran stock was likely to trade lower in the future, and therefore Airtran's offer was not a higher one than TPG's all-cash bid.  Here, the strong shareholder support for Airtran's stock component will make such a board decision harder to support.  But AirTran still has a ways to go before it actually reaches an agreement to acquire Midwest. 

August 15, 2007 in Hostiles, Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Tuesday, August 14, 2007

Midwest Chooses?

Midwest Air Group, owner of Midwest Airlines, yesterday announced that it had determined to pursue an all-cash offer from TPG Capital, L.P. to acquire all of the outstanding shares of Midwest for $16.00 per share in a transaction valued at about $424 million.  Midwest and TPG expect to execute an agreement by tomorrow, August 15.  Midwest did not disclose it at the time, but it subsequently was reported that Northwest Airlines would be an investor in this transaction with "no management role" in the operations of Midwest.  Miudwest's announcement comes on the heels of AirTran Holdings Inc.'s weekend disclosure that it had allowed its own "hostile" cash and stock offer valued at $15.75 a share to expire.

The market is still uncertain about the prospects of a completed deal.  On the announcement, Midwest's stock actually closed down 1.62% yesterday at $14 a share.  To understand why, one need only read this excerpt from a letter delivered yesterday to the Midwest board from its largest shareholder (8.8%) Pequot Capital:

We have significant concerns with this Board’s decision to pursue an all-cash proposal from a private equity firm and its consortium. We are not convinced that this taxable, all-cash indication of interest is superior to the enhanced cash and stock offer that you indicated was made by Airtran this past weekend. In addition, we fail to see how TPG and Northwest will be able to match the job creation and growth opportunities promised by Airtran for the benefit of Midwest’s employees, suppliers, customers and communities.

Midwest's behavior throughout this transaction has been problematical.  Their scorched earth policy has produced clear benefits -- Midwest's initial bid was $11.25, but their "just say no" policy to AirTran has highlighted the problems with anti-takeover devices and their potential use to favor suitors.  Midwest management may have succeeded in preserving their jobs with this gambit, but it may be to the detriment of its shareholders. 

It is also to the detriment of AirTran.  AirTran has now incurred significant transaction costs, including lost management time expended on this transaction, and, assuming the bidding is done, now has nothing to show for it:  TPG is a free-rider on AirTran's efforts.  Here, I must admit I am a bit puzzled as to why AirTran did not establish a toe-hold; that is a pre-offer purchase of Midwest shares.  If they had taken this route, AirTran would have paid for its expenses through its gain from this pre-announcement stock purchase.  But instead, AirTran purchased only a few hundred shares for proxy purposes.  This may have been due to regulatory reasons, but if not, it appears to be poor planning by AirTran.  And AirTran is not alone.  Toeholds are common in Europe (KKR recently used the strategy quite successfully in the Alliance Boots Plc transaction), but in the United States they are less utilized due to regulatory impediments such as HSR filings and waiting periods, Rule 14e-5 which prohibits purchases outside an offer post-announcement, and Schedule 13D ownership reporting requirements.  Consequently, one study has found that at least forty-seven percent of initial bidders in the United States have a zero equity position upon entrance into a contest for corporate control.  M&A lawyers may do well, though, to advise bidders to rethink this hesitancy.  For more on this issue, see my post, The Obsolescence of Rule 14e-5

August 14, 2007 in Hostiles, Private Equity, Takeovers, Tender Offer | Permalink | Comments (0) | TrackBack (0)

Thursday, August 9, 2007

SLM Corporation: Playing Hardball

SLM Corporation's press release on Tuesday and its Wednesday 10-Q filing focused primarily on rebutting the buyer consortium's claim that a Material Adverse Effect would occur if Congress passes pending legislation which would adversely effect SLM (for more see my post SLM Corporation's Material Adverse Change Clause).  But in its press release, SLM also asserted that it could force the buyer consortium to raise the $4 billion in high-yield debt required to finance and close the transaction:

Sallie Mae has been advised by the Buyer that FDIC approval for the application pending before the FDIC regarding the transfer of Sallie Mae Bank is likely to be obtained in September. If FDIC approval is not obtained in September, Sallie Mae believes it can take steps that will trigger the Buyer’s debt marketing period to begin in September. As previously announced, all other material conditions to closing the transaction will have been met on Aug. 15, 2007 . . . .

SLM is playing hardball here.  It is not only asserting that there is no MAE, but that, under the terms of the merger agreement, it can force the private equity consortium to raise the necessary financing and close the transaction.  Here, SLM is relying not only on the buyer's agreement in Section 8.01 of the merger agreement to use all "reasonable best efforts" to complete the deal but the specific buyer obligations with respect to financing in Section 8.10.  The Section states:

Parent shall . . . . complete the Equity Financing as part of the consummation of the Merger and shall use its reasonable best efforts to arrange the Debt Financing . . . . In the event any portion of the Debt Financing becomes unavailable . . . . Parent shall use its reasonable best efforts to arrange to obtain alternative financing from alternative sources . . . .  in an amount sufficient to consummate the transactions contemplated by this Agreement, as promptly as possible.

The Section then spells out specific provisions related to the necessary high-yield financing:

For the avoidance of doubt, in the event that (i) all or any portion of the high yield notes issuance described in the Debt Commitment Letter (the “"High-Yield Financing”) has not been consummated, (ii) all closing conditions contained in Article 9 (other than those contained in Section 9.02(a)(iii) and Section 9.03(iii)) shall have been satisfied or waived, and (iii) the bridge facilities contemplated by the Debt Commitment Letter are available on the terms and conditions described in the Debt Commitment Letter, then Parent shall cause the proceeds of such bridge financing to be used in lieu of such contemplated High-Yield Financing, or a portion thereof, as promptly as practicable following the final day of the Marketing Period.

This effectively means that SLM can require the buying consortium to use a bridge loan to finance and close the acquisition following the Marketing Period.  And Marketing Period is defined in the Section to mean:

the first period of 30 consecutive calendar days (i) during and at the end of which Parent shall have (and its financing sources shall have access to), in all material respects, the Required Information (as herein defined) and (ii) throughout and at the end of which the conditions set forth in Section 9.01 and Section 9.02 (other than the receipt of the certificate referred to therein) shall be satisfied. . . . provided further that the Marketing Period shall end on any earlier date that is the date on which the High-Yield Financing and the Debt Financing (other than any portion of the Debt Financing that constituted bridge financing with respect to such High-Yield Financing) is consummated; provided further that the Marketing Period must occur either entirely before or entirely after the periods (i) from and including August 18, 2007 through and including September 3, 2007 or (ii) from and including December 22, 2007 through and including January 1, 2008.

In plain English, this means that once SLM provides the necessary information and the other conditions to the completion of the merger are satisfied, the Marketing Period begins.  The buyers will then have 30 consecutive calendar days to obtain its $4.0 billion in high-yield financing and confirm its approximately $12 billion in remaining financing.  But if the buyers do not obtain the necessary high-yield financing during this 30 day period, then SLM can force the buyers to close using a bridge loan for the $4.0 billion.   Also, note that the Marketing Period cannot start during the last few weeks of summer -- everyone has to have a vacation every once in a while. 

So, the question now comes down to whether the other conditions to closing the agreement will be satisfied such that the Marketing Period can be triggered by SLM.  Here, assuming SLM stockholder approval is obtained, all of the conditions to the merger would be satisfied except the one requiring that "no Applicable Law shall prohibit the consummation of the Merger".  This provision refers to the required approval of the FDIC.  Since SLM owns and operates Sallie Mae Bank, a Utah chartered industrial bank, the buyer consortium is required to file a notice under the Change in Bank Control Act with the FDIC and obtain FDIC approval prior to acquiring control of the bank.  FDIC approval has not yet been obtained.  At first blush, it would therefore appear that SLM must wait until this approval comes before it can claim that all of the conditions to the agreement are satisfied and trigger the Marketing Period. 

However, note that SLM claimed in its press release that it did not need such approval to begin the marketing period.  What's going on?  Here, SLM is relying on the hold-separate clause in Section 8.01 of the merger agreement.  This Section states:

Parent shall agree to hold separate or to divest any of the businesses or properties or assets of the Company and its Subsidiaries, and the Affiliates of Parent agree to restructure the equity ownership of Parent and the related governance rights with respect to Parent or the Company and its Subsidiaries to obtain HSR Act clearance (the “Specified Actions”), if and as may be required (i) by the applicable Governmental Authority in order to resolve such objections as such Governmental Authority may have to such transactions under any Applicable Law (it being understood and agreed that the foregoing shall include the prompt divestiture, liquidation, sale or other disposition of, or other appropriate action (including the placing in a trust or otherwise holding separate) with respect to Company Bank, if Parent has been unable to obtain the requisite regulatory approvals relating to Company Bank in a reasonably timely manner customary for other transactions of a similar nature) . . . .

In its proxy statement, SLM asserts that this clause would require the buyers to "divest, hold separate or take other appropriate action with respect to Sallie Mae Bank, if necessary" to obtain FDIC and other bank regulator approval.  If SLM is correct then the buyer group would have to take such steps to satisfy the applicable law condition, and SLM is also likely correct that as of Sept. 3 it could force the buyers to begin the marketing period provided the customary time period for approval of these transactions by the FDIC had elapsed.  So easy right? 

Well, not so fast.  The above provision is (intentionally or unintentionally) not very clearly drafted.  The inclusion of the modifier HSR Act in it (my bold) could lead one to conclude that this hold-separate clause only requires such actions to obtain HSR clearance, not FDIC clearance.  But, the clause then goes on to refer to clearances to be obtained for the Sallie Mae Bank (referred to as the Company Bank) which clearly implicate obtaining FDIC approval.  In short, the clause is ambiguous enough that the buyers can reasonably take the position it only applies to clearances to be obtained under the HSR Act and, consequently, SLM cannot force the marketing period to begin without such approval.  Whether the buyer group actually takes this position depends upon their own assessment of the likelihood a court will interpret a clause this way and how much hard ball they also want to play.   

In sum, it appears that SLM is on uncertain ground in it assertion that it can force the marketing period to begin and trigger a close without necessary FDIC approval. 

Addendum:  Note there appear to be other possible arguments the buyer consortium could raise to dispute SLM's assertion, such as claiming that a customary time period for FDIC approval has not elapsed and the hold-separate clause consequently not triggered.  Also, the financing banks themselves could invoke the MAE in their own debt commitment letters thereby forestalling the buyer group's obligation to close -- but this would expose them to significant liability, something they would be loathe to do -- and so, it is an unlikely event. 

August 9, 2007 in Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Tuesday, August 7, 2007

Upper Deck Ducks a Second Request

The Topps Company, Inc. announced yesterday that it has been advised by The Upper Deck Company that the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, with respect to Upper Deck's offer to acquire Topps had expired without a second request, an event which would have delayed Upper Deck's bid by several months.  The antitrust condition to Upper Deck's offer is now satisfied and Upper Deck can now proceed with its $416 million bid.  Upper Deck's offer of $10.75 a share is materially higher than the current agreement Topps has to be acquired by Michael Eisner's The Tornante Company LLC and Madison Dearborn Partners, LLC for $9.75 a share in cash, or about $385 million. 

Topps stated in its press release that "it continues to negotiate with Upper Deck to see if a consensual transaction can be reached."  As I stated before, "[i]f and when [Upper Deck clears its offer with the antitrust regulators], expect the bidding for Topps to continue."  The next move is Tornante's and Madison's.  If they walk, they will split a break fee of $12 million, higher than the $8 million fee payable during the go-shop period when Topps initially spurned Upper Deck's bid.   

August 7, 2007 in Hostiles, Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Tuesday, July 31, 2007

Bausch & Lomb's Wary Eye

The Board of Directors of Bausch & Lomb Inc. yesterday responded in a letter to Advanced Medical Optics' proposal to acquire B&L for $75 per share in cash and AMO stock.  B&L currently has an agreement to be acquired by affiliates of Warburg Pincus for $65 per share in cash.

In their letter, the B&L board and special committee expressed uncertainty as to the ability of AMO to complete an acquisition of B&L.  ValueAct Capital, the owner of 8.8 million shares of AMO common stock, representing 14.7% of the outstanding AMO shares, has publicly stated it will vote against the acquisition.  AMO is required to have its own shareholder vote on the proposal in order to approve the share component of the offered consideration.  Given this completion risk, the B&L board stated that the $50 million reverse termination fee proposed by AMO was too low. 

AMO had previously been designated by B&L as a party who B&L could continue to negotiate with despite the end of the "go shop" period in the Warburg Pincus merger agreement.  However, in yesterday's letter the B&L board threatened to withdraw this status if AMO was not more cooperative.  The effect of such a redesignation would be to require B&L, if it ultimately accepts the AMO bid, to pay Warburg a $120 million termination fee rather than the lower $40 million required if a bid was received during the "go shop" period.

B&L's actions appear to be appropriate considering the uncertainty surrounding the AMO proposal.  However, the threat of a redesignation of AMO seems a bit odd -- such a move would only hurt B&L shareholders and make it harder for AMO to pay the consideration offered.  It therefore seems motivated to assuage likely complaints of Warburg more than anything else.  B&L is currently in discussions with AMO's shareholders concerning their intentions with respect to any AMO vote, and apparently is in a dispute with AMO concerning the provision of information to these shareholders.  the actions of AMO's large shareholder have clearly thrown a monkey-wrench into AMO's bid and put them in the role of "decider" for this acquisition contest.  Another victory for institutional shareholder activists.   

July 31, 2007 in Hostiles, Private Equity, Takeovers | Permalink | Comments (0) | TrackBack (0)

Monday, July 30, 2007

New Article on Private Equity M&A Litigation

Joseph S. Allerhand and Bradley R. Aronstam at Weil, Gotshal & Manges have recently published an article in the New York Law Journal, entitled New Wave of M&A Litigation Attacks Private Equity Deals.  According to an author posting on the Harvard Corporate Governance Blog, the article "addresses several recent decisions from the Delaware Court of Chancery involving private equity firms and management buyouts.  The article concludes that, while the players in the M&A market may have changed, the rules of the game remain the same where the board of directors decides that it’s time to sell the company." 

July 30, 2007 in Private Equity | Permalink | Comments (0) | TrackBack (0)