Tuesday, July 31, 2007
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.
Monday, July 30, 2007
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."
Sunday, July 22, 2007
On Friday, Orbitz Worldwide Inc., the online travel company, had its first day of post-IPO trading opening at $14.90 but falling 50 cents to close at $14.50. This came a day after its IPO had priced at $15 a share below expectations of between $16 and $18. The Orbitz IPO also occurred in a bad week as four of the ten companies making initial offerings (including Orbitz) priced below their offering range and three fell below that range in their first day of trading.
The IPO of Orbitz was unique, though. It had been criticized for impenetrable financial statement disclosure in its prospectus and nominated by one blogger as "The Worst IPO of 2007". Not a great harbinger. Moreover, Orbitz was a "quick-flip". According to the final prospectus, Orbity is owned by Travelport which itself is wholly-owned by a Blackstone-controlled fund. Orbitz sold stock worth $510 million in the offering but remitted all of the proceeds to Travelport which retains a controlling interest in Orbitz. And the quick-flip here was due to the fact that its IPO occured less than a year after Blackstone acquired Orbitz. Blackstone, in particular, has made some spectacular sums with quick-flips. For example, Blackstone scored a tremendous return with Celanese, taking the company public only eleven months after acquiring it; Blackstone has made over 2 billion dollars thus far on its $650 million equity investment.
But quick-flip offerings are not as sweet for investors. In their article, The Performance of Reverse Leveraged Buy-Outs, professors Josh Lerner and Jerry Cao found that quick flips - defined for their purposes as when private equity firms sell off an investment within a year after acquisition - under perform. This compared with private equity-sponsored IPOs generally which the authors found consistently outperformed other IPOs and the stock market as a whole. Investors take note.
Tuesday, July 17, 2007
It is being reported that Apollo Management, L.P., the private equity fund adviser, will offer shares and list itself on Goldman Sachs' new, private exchange GS Tradable Unregistered Equity OTC Market, known by the more catchy acronym "GSTrUE". Similar to Blackstone's ipo sale of a significant stake to the Chinese government, Apollo is also reportedly selling an approximate 10% non-voting stake in itself to the Abu Dhabi Investment Authority, the investment arm of the Abu Dhabi government, and possibly another significant stake to the California Public Employees' Retirement System.
This is GSTrUE's second listing. In May Oaktree Capital Management LLC, an alternative investment firm with over $40 billion in assets under management, sold approximately 14% of itself for more than $800 million to less than 50 investors listing its shares on GSTrUE. According to reports, Goldman is hoping that GSTrUE will become a viable alternative listing market for hedge funds, private equity and operating companies who wish to avoid SEC regulation. Accordingly, so as to permit Rule 144A offerings, the market will be limited to qualifying investment funds with over $100 million in investable assets. As I posted at the time of the Oaktree offering:
GSTrUE, however, will live under the shadow of U.S. regulation. In order to avoid triggering Exchange Act reporting requirements for any listed company, Goldman and any such listed U.S. entity will need to make sure that the company does not exceed more than 500 shareholders. This will likely place Goldman in the position of forced market maker when the cap is reached. It will also even further reduce liquidity by limiting the number of trading shareholders and shares traded. Moreover, Goldman has not disclosed whether there will be any other market makers for this market, but given the likely low liquidity and shareholder trading limitations, Goldman is likely to set fat spreads on trades. Pricing is also likely to be opaque due to information and analysts' coverage gaps. While Goldman has incentives to maintain lower spreads in order to attract listings, these problems may be why Oaktree's offering values it at only $5.7 billion, a much lower valuation than Fortress and the one mooted for Blackstone. Time will tell if GSTrUE is a success, and it is certainly a worthwhile economic experiment on the validity of private markets, but I believe that GSTrUE's handicaps will likely make it more of a stepping stone for companies on their way to a full public market listing more than anything else.
Monday, July 16, 2007
Lear Corporation, yesterday announced that at its Annual Meeting of Stockholders its shareholders failed to approve a merger proposal with Carl Icahn's American Real Estate Partners L.P. As a result of this vote, Lear's merger agreement with AREP will terminate in accordance with its terms. The vote is a victory for Lear shareholders who had actively opposed the Icahn bid claiming it significantly undervalued the company. The leader of this charge had been Pzena investment management which had repeatedly asserted its opposition to the bid. The California State Teachers Retirement System and Institutional Shareholder Services had also actively opposed the transaction.
In a last ditch bid to push the transaction through, Lear on July 10 had agreed to amend its merger agreement with AREP to increase AREP's offer price for shares of Lear common stock from $36 to $37.25 per share. The $100 million increase in aggregate consideration paid had valued Lear at approximately $2.9 billion. However, in connection with this increase, Lear had agreed to pay AREP $12.5 million in cash as well as 335,570 shares of Lear common stock (valued at about $12.35 million) if Lear's stockholders did not approve the merger. The provision was unusual; bidders are usually lucky to get their expenses in a deal that is not approved by shareholders. The provision, though likely legal, is even more suspect now that Lear shareholders have voted against the transaction. Icahn's AREP will now pocket this sum.
Lear will continue to operate as a stand-alone, publicly-traded company, though its future is now uncertain. But the Lear shareholder vote is a milestone; it is the first real rejection of a private equity/management initiated leveraged buy-out. Though activist investors have in other similar transactions such as Clear Channel and OSI Restaurant Partners succeeded in obtaining an increase in the consideration offered, none had resulted in a rejected bid. And according to MergerMetrics, only eight deals have been rejected by shareholders since 2003, out of more than 1,000 deals which required shareholder approval.
The reasons are fairly obvious. An outright rejection of a management initiated or participating buy-out leaves the company in uncertain hands, and the continued retention of management as well as the direction of the company unclear. Lear is the first big deal in recent memory where this has occurred. But, if Lear succeeds in its independent direction, it may chart a course for shareholders in similar situations involving management/private equity buy-outs. Apparently, the market is also optimistic about Lear's future. Lear's shares yesterday rose 60 cents, or 1.6%, to $37.50, showing that Wall Street, at least, for now agrees with the Lear shareholder decision. Lucky for the arbs.
Thursday, July 12, 2007
The tender offer for Biomet closed last night at midnight. According to the acquiring private equity consortium press release, 82.85% of Biomet’s outstanding shares were tendered in the offer. The deal had had a 75% minimum tender condition due to the vagaries of Indiana law where Biomet is organized and which requires a 75% vote to approve a merger. The Biomet merger agreement had a top-up option -- a provision which permits the consortium to now purchase, at a price per share equal to the offer price, a number of newly issued shares that will constitute 90.0005% of the total shares then outstanding. Accordingly, the acquiring group will exercise this option to bring their holdings up to 90% of the company and initiate a short-form merger under Indiana law. This will spare the consortium the shareholder vote and proxy requirements of a long-form merger permitting the deal to close today rather than in another month or two. Practitioners should take note.
The Securities and Exchange Commission yesterday voted unanimously to adopt a new antifraud rule under the Investment Advisers Act. The new rule makes it a fraudulent, deceptive, or manipulative act, practice, or course of business for an investment adviser to a pooled investment vehicle to make false or misleading statements to, or otherwise to defraud, investors or prospective investors in that pool. The rule will apply to all investment advisers to pooled investment vehicles, regardless of whether the adviser is registered under the Advisers Act.
The rule comes on the heels of the D.C. Circuit's decision in Goldstein v. Securities and Exchange Commission, striking down the SEC's attempt to make all hedge fund advisers register under the Investment Advisers Act. But, this new rule is much less ambitious. It is more of a clarification of enforcement powers that the SEC likely previously had than anything else. The SEC has yet to post the final rules release on its website, but the proposing release can be accessed here. And more importantly, the SEC has yet to act on the more ambitious and controversial other rule proposed in that proposing release which would revise the definition of accredited investor under Regulation D to raise the required net worth thresholds for private investors to invest in private equity and hedge funds.
Monday, July 9, 2007
The Financial Times is reporting that Moody's will today issue a report taking "issue with the argument that private ownership frees companies from the short-term pressures of the equity markets, enabling them to invest and plan for the long term." The report states that:
The current environment does not suggest that private equity firms are investing over a longer-term horizon than do public companies despite not being driven by the pressure to publicly report quarterly earnings.
The report also asserts that private equity's "tendency to increase a portfolio group’s indebtedness to pay themselves large dividends runs counter to their claim of being long-term investors." And it takes issue with private equity's "claim that improvements in companies’ performance are driven by more focused management teams" rather than due to leverage and other financial engineering.
One of the keystone benefits often cited by supporters of private equity is their longer term horizon and ability to limit management agency costs to produce superior returns. Some have argued that these benefits combined with the rapid rise of private equity will result in an eclipse of the public corporation. While this report will give these supporters pause, the jury is still out and more study is needed in this area to truly understand whether the private equity model is indeed superior to the public one, as well as its benefits.
And on a related note, the FT also publishes today the results of a White & Case survey of finance professionals which found that 60 percent of respondents believe that "[t]he European leveraged finance market is an unsustainable bubble."
Thursday, July 5, 2007
The day before Independence Day, KKR & Co. LP filed its registration statement to go public in a $1.5 billion offering. Another day another fund adviser ipo. Anyway, out of curiosity, I've prepared a chart comparing the two ipos on key shareholder measures:
Amount of Offering
Amount Sold by Current Partners in Offerng
$4.57 billion with greenshoe exercise (it is more than the offering amount due to the concurrent sale of $3 billion in Blackstone non-voting units to the Chinese government)
Only limited voting rights relating to certain matters affecting the units. No right to elect or remove the Managing Partner or its directors.
In addition, KKR’s current partners generally will have sufficient voting power to determine the outcome of any matter that may be submitted to a unitholder vote.
Quarterly cash distributions to unitholders in amounts that in the aggregate are expected to constitute substantially all of our adjusted cash flow from operations each year in excess of amounts determined by the Managing Partner.
Priority of Cash Distributions
First, so that unitholders receive $______ per common unit on an annualized basis for such year;
Second, to the other holders of Group Partnership units until an equivalent amount on a per unit basis has been distributed to such other holders for such year; and
Thereafter, pro rata to all partners.
After ______, priority allocation ends and all partners receive pro rata distributions.
First, so that common unitholders receive $1.20 per common unit on an annualized basis for such year;
Second, to the other partners of the Blackstone Holdings partnerships until an equivalent amount of income on a partnership interest basis has been allocated to such other partners for such year; and
Thereafter, pro rata to all partners.
After December 31, 2009, priority allocation ends and all partners receive pro rata distributions.
Pre-ipo Partner Distributions
Distributions of $______ million.
Distributions estimated at $610.4 million.
Highlighted Return of Selected Underlying Funds
(Blanks in the KKR column are figures KKR will fill in in subsequent registration statement amendments)
So, there is not much difference between the two in terms of shareholder voting and distribution rights. Both equally disenfranchise investors and both have the same distribution policies giving priorty distribution to investors through a set period of time. KKR has yet to disclose this period but it will likely be similar to Blackstone's and end on December 31, 2009. If I were aninvestor I'd be a little worried about the quantity of distributions thereafter as it will likely be well past the current private equity boom and the funds' new partners will likely be chomping for market-rate compensation by then. Ultimately, the only significant difference on the above chart is that the KKR partners are not selling in the ipo which is a good sign, but they may be effectively making a sale through a significantly large pre-ipo cash distribution -- the KKR registration statement has yet to disclose the exact amount of the distribution.
So, ultimately, in terms of shareholder and distribution rights they both appear to be equally troublesome. Also, for those who are wondering, the Fortress and Och-Ziff ipos are a bit different in terms than KKR and Blackstone but effectively accomplish the same shareholder disenfranchisement and distribution policies.
The Financial Times published an interview yesterday with Chancellor of the Exchequer Alistair Darling. In the interview, Darling ruled out an imminent change to the taxation rate of private equity in the United Kingdom. He stated
I think we should be very, very wary indeed of a knee-jerk reaction or a reaction to a day’s headlines into making a tax change that could result in unintended consequences and undesirable consequences . . . .
In the United Kingdom, the carried interest earned by private equity partners on their investments is treated as capital gains and entitled to taper relief. This often reduces the rate to 10 percent compared with the U.K.'s 40 percent rate on income. The system has come under heated criticism in recent months, with one private equity boss decrying the system, stating that private equity "enjoy a lower tax rate than that paid by a janitor." Note that there is a similar, less-public debate about similar tax treatment enjoyed by U.S. private equity firms (for more on this read Victor Fleischer's Two and Twenty: Taxing Partnership Profits in Private Equity Funds).
Interestingly, Darling drew an analogy to Sarbanes-Oxley to support his position:
I am reminded of Sarbanes-Oxley in the US....and they’re now looking at how they can get out of it. There is no doubt it has damaged the US market, [he said.] When or if we make any changes they must be made at the proper time in the context of the Budget or the pre-Budget report and in the context of making tax reform which is beneficial to the country.
Darling, who is not trained as an economist would likely have been on firmer grounds focusing on the micro effects of such a tax and how it would effect the current incentive structure for private equity managers. And of course there are the redistributive justice aspects. Still, Sarbanes-Oxley still has such a bad name in Europe it was easier for Darling to make this analogy. But, whatever Darling's assertions on the subject, the jury is still out on Sarbanes-Oxley's effects, particularly in light of the numerous foreign ipos in the U.S. market this year.
Monday, July 2, 2007
Och-Ziff Capital Management Group LLC today filed a registration statement for an initial public offering of up to $2 billion of series A stock units. Och-Ziff is one of the largest alternative asset managers in the world, with approximately $26.8 billion of assets under management as of April 30, 2007. It is run by former Goldman Sachs Group Inc. equities trader Daniel Och, and was founded with Ziff family money. The number of shares and the price for the offering weren't disclosed. But all of the offering proceeds will go to the current partners of Och-Ziff. Yet another pay-day for hedge fund managers.
And it is yet another offering where investors will have only limited voting rights. According to the registrations statement, the current owners of Och-Ziff will retain their ownership interest through Class B share units which will have no economic rights but will have voting rights. So long as these Class B owners continue to hold more than 40% of the total voting power of the outstanding shares, the Class B holders will have the right to designate nominees for election to the company's board of directors, based on their ownership of outstanding voting securities. Initially, this will give the Class B shareholders the ability to designate five of the seven nominees for election to the Och-Ziff board.
Not a great deal -- once again fund managers are not only cashing out, but doing so in a way which disenfranchises investors -- setting the stage for future conflict. Still, this is a bit better than Blackstone which gave its investors no voting rights. For those still contemplating investing, you'd likely be much better off investing directly in Och-Ziff's main fund (OZ Master Fund, Ltd.) which Och-Ziff disclosed has returned 17% since inception a total return basis, net of all fees and expenses compared to only 11.6% by the S&P 500 during the same time. But, unfortunately, SEC rules foreclose this for all but wealthy investors (see my post on this irrational distinction here).
The filing also shows that the industry still sees an active ipo market for fund advisers in the wake of the Blackstone ipo. This appears true despite the recently introduced congressional bill to tax as corporations publicly traded partnerships that directly or indirectly derive income from investment adviser or asset management services. In the past few weeks, GLG Partners LP, Europe's third-largest hedge-fund manager, announced that it will go public in the United States through a $3.4 billion transaction with the Special Purpose Acquisition Company Freedom Acquisition Holdings Inc., creating GLG Partners Inc. a publicly traded company on the New York Stock Exchange. In addition, Pzena Investment Management, Inc, a value-oriented investment management firm with approximately $28.5 billion in assets under management also filed to go public. And Third Point LLC , a New York-based hedge-fund firm with $5.1 billion in assets under management founded in 1995 by the notorious Europe-hater Daniel S. Loeb , announced on June 14 that it plans to raise $666 million in an IPO on the London Stock Exchange. So it goes . . . .
Sunday, July 1, 2007
On Saturday, BCE, the Canadian telecommunications company, announced that it had agreed to be acquired by an investor group led by Teachers Private Capital, the private investment arm of the Ontario Teachers Pension Plan, Providence Equity Partners Inc. and Madison Dearborn Partners, LLC. The offer price is C$42.75 in cash per common share and the transaction is valued at C$51.7 billion (U.S.$48.5 billion), including the assumption of C$16.9 billion in debt. The equity ownership of BCE post-transaction will be as follows: Teachers Private Capital 52%, Providence 32%, Madison Dearborn 9% and other Canadian investors 7%. NB. Canadian investment rules require that BCE be majority owned by Canadian entities.
Showing signs that last weeks constant talk of a slow-down in private equity may have come too soon, the transaction if completed would be the largest leveraged buy-out in history beating out the pending U.S.$32 billion takeover of TXU, the Texas utility, by a private equity consortium comprising Kohlberg Kravis Roberts & Co. and TPG. And a syndicate of banks has committed financing for the transaction showing similar confidence in the debt markets.
Perhaps the most interesting aspect of the transaction is the involvement of Teachers Private Capital. TPC has more than C$16 billion in assets and is part of the C$106 billion Ontario Teachers' Pension Plan. According to this slick brochure they have put out, TPC actively makes sole and co-investments in companies throughout the globe and has co-invested with KKR in over $5 billion of acquisitions in prior years. Their activity and investment highlight the strength of pension plans in the current investment market. Although ERISA rules would likely forestall a similar majority acquisition by a U.S. pension plan, expect these funds to take a more active role in investing in the near future, working to drive investments rather than follow their historical practice of passively investing through funds themselves.
Addendum: According to the New York Times, "the auction featured several bizarre twists, including accusations that Bell’s board was manipulating the process, the withdrawal of big-name bidders and an atmosphere that many characterized as lacking any transparency. 'It was a black box,' said Brent D. Fullard, the executive managing director of Catalyst Asset Management who is urging Bell shareholders to push for recapitalization rather than a sale." And apparently, losing bidders Telus and Cerberus Capital Management are considering counter-offers.
Tuesday, June 12, 2007
The U.K. Financial Services Authority today published feedback to its discussion paper on private equity (download the feedback here, and the discussion paper here). In the feedback, the FSA stated that it will continue to focus on what it perceives to be the "significant risks" of private equity market abuse (insider trading) and conflicts of interest. In order to strengthen its oversight of the market, the FSA also announced increased data collection requirements. This will encompass:
- Conducting a bi-annual survey on banks' exposures to leveraged buyouts; and
- Enhancing regulatory reporting requirements for private equity firms to incorporate information on committed capital in addition to the existing requirement to report drawn down capital.
These initiatives appear to be moderate and prudent ones designed to ensure that creditors do not over-commit capital to private equity fostering a collapse similar to the one which occurred at the end of the 1980s.
Also yesterday, Treasury Assistant Secretary for Financial Markets, Anthony W. Ryan, made yet another speech warning of the systematic risks posed by hedge funds. To illustrate the problems of fat tails and outlier risk he cites the paper Thomas J. Miceli, Minimum Quality Standards in Baseball and the Paradoxical Disappearance of the .400 Hitter, Economics Working Papers, University of Connecticut (May 2005). Ryan cites the paper gor statistical information, but otherwise it is a solid paper about the problems of minimum quality standards in markets with imperfect information. Enjoy.
Monday, June 11, 2007
Blackstone filed its fourth amendment to its registration statement today. Blackstone intends to sell approximately 133.33 million common units at between $29 and $31 per unit giving Blackstone a market cap of over $33 billion if it prices at $31 per unit. The amendment also finally discloses the size of the payday for Blackstone's founders, Stephen Schwarzman and Peter Peterson. Schwarzman, Blackstone’s chief executive officer, will receive $449 million and up to $677 million if the greenshow is exercised. Based on an offering price of $30 per unit, Schwarzman's post-ipo stake will be worth $7.7 billion and constitute a 24 percent stake in the company.
Peterson, who has announced his retirement for next year, is expected to receive $1.88 billion (no greenshoe option here -- he is going out full in the initial offering). He will retain a four percent holding. All told, the total haul for Blackstone's founders will be about $2.33 billion assuming the exercise of the greenshoe.
For those who wonder whether the Blackstone founders are cashing out at the top, the filing also disclosed that in 2006 cash distributions for the two were $398.3 million for Schwarzman and $213 million for Peterson. As for the offering itself and leaving aside whether there is indeed a private equity bubble, I wonder who would want to buy these non-voting interests in Blackstone at a time when one of the founders is leaving and cashing in and the other is pocketing a significant stake and monetizing the remainder. At least with internet ipos, the founders had to wait 180 days to sell and offered their shareholders a vote in the operation of the company. Caveat Emptor.
Friday, June 8, 2007
The use of a tender offer also removes from the equation proxy advisory firms such as Institutional Shareholders Services, which criticized the earlier offer. The recommendations of such firms hold great sway over institutional investors. An I.S.S. spokeswoman told DealBook that the firm generally did not issue recommendations in tender offers, though it would provide an analysis for its clients.
Private equity buyers making controversially low offers take note.
The New York Times also makes the point that tenders offers are now a more palatable structure for private equity buyers since the SEC adopted a safe-harbor for employee compensation from the all-holders best price rule. Tender offers permit quicker deal consummation; a tender offer can be completed in twenty business days as opposed to two-three months for a merger. The Times is right, but you haven't seen, and likely won't see, more tender offers in private equity deals because of the pervasive use of go-shops in these transactions and the extra time they require anyway, making a merger a preferred option.
Also, Biomet has filed its revised agreement for the transaction. In the agreement, the minimum condition for the offer is set at 75% of the outstanding shares or that:
number of Shares that is not less than the number of such Shares . . . . that, when added to the number of Shares beneficially owned . . . . by Parent, any of its equity owners or any of their respective Affiliates, and any Person that is party to a voting agreement with Parent or Purchaser obligating such Person to vote in favor of Merger . . . . represents at least 75% of the total number of Shares outstanding immediately prior to the expiration of the Offer.
So, it appears that Biomet did not effectively lower the minimum condition to approve the transaction by changing its structure. Good for them.
The Wall Street Journal has a nice article today on the rising number of private equity buy-outs which are getting into trouble. The Journal cites the $1.3 billion purchase of retailer Linens 'n Things Inc.; $530 million buyout of the Star Tribune Minneapolis's newspaper; and $17.6 billion deal for Freescale Semiconductor Holdings. Each of these companies is struggling to generate the cash flow to service its newly-imposed debt burden. Still, of late, things have been unbelievably good for the credit market. According to Standard & Poor’s Leveraged Commentary & Data, there was not a single default in the leveraged-loan market in the past six months,and in the 12 months ended in May there were only two defaults on $490 million of debt. This is a twelve month default rate of 0.29%, the lowest ever; compare this with the average historical rate of 4%-5%.
But I wouldn't expect these low rates to last, and the problems the Journal cites may be a harbinger. According to the Journal:
Companies that have gone private in buyouts are generating cash that exceeds their debt interest payments by just 1.7 times, versus 2.4 times last year and 3.4 times in 2004, according to Standard & Poor's Leveraged Commentary & Data. The ratio is at a 10-year low and shows how the margin for error for companies is shrinking as their profit growth is slowing.
Moreover, there is no perfection in private equity. The massive number of new transactions means that there will inevitably be companies who cannot service their debt burden; expect a few to reach the point of insolvency. But, whether this will become a problem significant enough to adversly effect the economy or the private equity industry is still very unclear. Interest rates are nudging up this week and the economy is slowing -- so at the very least if these trends continue expect fewer private equity deals and more companies experience problems generating the necessary cash to service their debt.
But many private equity deals have taken advantage of the credit bubble to get extraordinary deals on this debt. Freescale, for example, one of the problem children cited above, has negotiated the ability with its creditors to turn off and on cash interest payments on approximately $1.5 billion of its debt through an option to pay with payment-in-kind notes. Still other recent leveraged buy-out deals are covenant-lite; they do not contain the multitude of restrictions on operations that creditors typically require. This leaves more leeway for the company to avoid a default. The end-result is that the problems the Journal cites and inevitable private equity failures may be significantly fewer than in the 1980s when the last private equity bubble deflated.
Thursday, June 7, 2007
Texas Pacific Group's $560 million offer for a controlling interest in JVC, the Japanese consumer electronics company, is struggling to obtain the necessary debt financing from banks. But don't take this as a sign that the credit/private equity bubble is deflating yet. TPG's problems appear to be related to the specifics of JVC. According to Reuters:
[B]anks have resisted funding the acquisition of JVC, whose official name is Victor Co. of Japan Ltd., because they are unconvinced that TPG could turn around a company heading for its fourth straight annual loss. "The business plan was not outlandish for a profitable company, but for a company that is losing money like JVC, it seemed too ambitious," a banking source said.
Matsushita, owner of 52.4% of JVC, chose TPG as its preferred bidder back in March, over a rival bid from private equity firms Cerberus and Permira. But TPG and Matsushita have yet to agree on a final price and amount of equity infusion by TPG. U.S. private equity firms have struggled to gain entry-way into the Japanese market; this transaction may yet be another failed attempt. Or perhaps Cerberus and Permira may now use this stumble as a way step-up again and put their own investors' equity into this struggling venture.
Biomet, Inc., the orthopedic company, announced today that it had agreed to an increased offer from a private equity consortium to acquire Biomet for $46.00 per share in cash, for an equity value of $11.4 billion. The increase comes on the heels of a recommendation by Institutional Shareholder Services that Biomet shareholders vote against the transaction. ISS based this recommendation on that fact that "[a]lthough the deal terms appear fair as of the time of the deal's announcement in December, the rally of the peer group" and Biomet's main joint reconstruction business "imply that there is little takeover premium in the [previous] $44 offer price." (For more on this recommendation, see my previous blog post ISS Recommends Against Biomet Deal)
In connection with the increase, Biomet also revised the structure of the acquisition from a merger to a tender offer. The amended merger agreement now requires the consortium – which includes affiliates of the Blackstone Group, Goldman Sachs Capital Partners, Kohlberg Kravis Roberts & Co. and TPG – to commence a tender offer on or before June 14, 2007, to acquire all of the outstanding shares of Biomet’s common stock. Biomet previously planned to have a shareholders meeting to vote on the merger agreement on June 8, 2007. That meeting is now canceled.
Per the Biomet Certificate of Incorporation, a merger must be approved by at least 75% of Biomet’s common shares. Since the vote is based on the number of common shares outstanding rather than the number of votes cast, this would have meant that any failure to vote and broker non-votes would effectively have been votes against the transaction.
In converting to a tender offer structure Biomet has fiddled with the minimum condition. According to Biomet:
Completion of the tender offer is subject to the condition that at least 75% of the Biomet common shares have been tendered in the offer – the same percentage approval requirement as with the previous merger structure. The amended merger agreement permits the investor group to revise the condition regarding minimum acceptance of the tender offer to decrease the minimum acceptance threshold to a number that, together with shares whose holders have agreed to vote to approve the second-step merger, represents at least 75% of the Biomet common shares.
The second sentence is a bit unclear to me and Biomet has yet to file the amended agreement. But it likely means that the private equity group and Biomet agreed to the provision in order to obtain agreements to vote from management in connection with the tender offer. If this is the intention, I'm still not sure why there was a need to convert to a tender offer -- the transaction could have closed quicker had Biomet simply postponed or adjourned the shareholder meeting and management could have also voted for the transaction then. But my hunch is that in this language there is an effective lowering of the required shareholder approvals. I'll have more once the amended agreement is actually filed.
Note to Biomet shareholders: there are no dissenter's rights available under Indiana law for this transaction (a different result than in Delaware; Biomet is organized under the laws of Indiana).
Tuesday, June 5, 2007
The shareholders of OSI Restaurant Partners yesterday approved the amended merger agreement for the company to be acquired by an investor group consisting of Bain Capital Partners, LLC, Catterton Management Company, LLC, OSI's founders and its executive management. OSI did not disclose the exact vote in its press release announcing the results, but it has been reported that the merger agreement would not have been approved had OSI not acted to lower the threshold required vote a few weeks ago. OSI now expects the transaction to now close on June 19, 2007. Presumably, the extra time is to rearrange the financing for the transaction.
I've written a lot on this deal (see posts Bloomin' Onion, Bloomin' Onion (Redux), Bloomin' Onion Part III, Free Food! OSI Restaurant Partners Shareholder Meeting Today, and Games People Play). I was also quoted yesterday in a piece in the St. Petersburg Times (OSI is headquartered there) where I stated that this deal is "an interesting case study in management buyouts with private equity and how the process can be, for lack of a better word, manipulated . . . ." More specifically, I believe that management's undue influence on the OSI sale process left the OSI shareholders with a Hobson's choice -- giving shareholders no other option than to accept this bid. The St. Petersburg article chronicles management's impropriety here, and its effect is also illustrated by Institutional Shareholder Services statement recommending the transaction:
We recognize the shortcomings in the process and the conflicts of interest of management and founders . . . . but given the downside of a failed transaction resulting in a loss of premium and likely continued deterioration of fundamentals, support for the transaction is warranted.
Hopefully, OSI was at least nice enough to serve their soon to be former shareholders some tasty, free food at the meeting yesterday. They deserve that at least.
I had a long plane ride yesterday and took the opportunity to again flip through the latest Blackstone S-1 filing. It is now perfect plane reading -- bound to put you quickly to sleep at approximately 300 pages excluding exhibits and financial statements. But I did stay awake long enough to note this interesting development:
Previously in its initial S-1 filing, Blackstone had stated that it would adopt SFAS No. 159 (The Fair Value Option for Financial Assets and Financial Liabilities). Adoption of SFAS 159 would have permitted Blackstone to treat its carry (i.e., its 20% share of profits) as though it was an option allowing Blackstone to record its value as income immediately. This was highly controversial because it would allow Blackstone to book fees up-front based on its estimate of its future profits on a transaction -- a practice associated with the implosion of Enron (for more on this controversy see the WSJ article here).
In its May 21, 2007 second S-1 amendment, however, Blackstone revised its position, deciding not to early adopt SFAS 159. Instead, with respect to carry Blackstone will record as revenue the amount that would be due to it at each period end as if the fund agreements were terminated at that date. This is similar to Fortress Investment Group's accounting practices. According to Blackstone, had it adopted SFAS 159 it would have increased its 2006 pro-forma net income by $595 million, or 22 percent.
The AFL-CIO had previously written the SEC arguing that private equity group Blackstone's planned initial public offering should be halted because it violated the Investment Company Act (a copy of the letter can be downloaded here). The AFL-CIO based its argument on Blackstone's intended use of SFAS 159 arguing that it turned carry into a form of call option. Since call options are securities, and more than 40% of Blackstone's assets are in carry, the AFL-CIO argued that Blackstone should fall under the regulatory schematic of the Investment Company Act.
I wrote previously as to my doubtfulness as to the validity of the AFL-CIO's argument. And it is unclear whether Blackstone revised its S-1 filing at the SEC's behest or otherwise decided that use of this accounting was too problematical and controversial. Nonetheless, given the high publicity surrounding this ipo and its landmark nature, Blackstone's decision appears to be the right one. The first private equity adviser public listing should be one that establishes a good reputation for private equity with public investors; not one raising warning flags due to problematical accounting practices.