Earlier this week, I blogged about how activist strategies are evolving to target different parts of a company’s capital structure. This Wachtell memo discusses an example of just such a strategy – “net short” debt activism. This excerpt summarizes how it works:
The playbook of the net-short debt activist starts with the investor identifying a transaction, no matter how old, that it can claim did not comply with a covenant in an issuer’s debt documents. Next, the investor amasses both a short position in the company’s debt (in some cases through a credit default swap that collects upon a default) and a long position in the debt, albeit one that is smaller than the short position, so the investor is “net short.” The investor, finally, asserts the alleged default, often in a public letter; and if its long position is large enough (usually 25 percent of a bond tranche), it can also serve a formal default notice, triggering a high-stakes litigation.
Net-short debt activism can be highly effective, in part because of the asymmetric risk that it presents to the target company. Even without a formal notice of default, a public letter asserting a covenant violation can by itself increase the value of a short position and affect the target company’s ability to transact in the markets. And once a notice of default is served, the company has the burden of going to court to demonstrate that no default has occurred.
The memo notes that this strategy can really throw sand in a company’s gears – not only is it exposed to claims from the activist based on alleged defaults, but the allegations may raise the specter of cross-defaults and make counterparties hesitant to deal with the company until the situation is resolved.
– John Jenkins
Yesterday, President Trump signed into law the Foreign Risk Review Modernization Act – which is intended to strengthen the ability of the Committee on Foreign Investment in the United States (CFIUS) to address national security risks posed by certain foreign investments. Here’s an excerpt from this Latham memo summarizing the statute’s key provisions:
– The new legislation extends CFIUS’ jurisdiction to cover non-controlling investments in the areas of critical infrastructure, critical technology, and sensitive personal information.
– The new law alters CFIUS review procedures, authorizes filing fees, and provides for greater resources for CFIUS that may allow for both increased flexibility regarding mitigation and for more active monitoring of transactions not filed.
– The new law requires certain foreign investments in the United States to be submitted to CFIUS for review.
– Forthcoming regulations will determine crucial details of the new law’s implementation, including the regulatory specification of statutory terms such as “emerging and foundational technologies,” relevant to the jurisdictional boundaries of the new law.
We’re posting lots of memos in our “National Security Considerations” Practice Area.
– John Jenkins
Here’s a recent memo from Kirkland & Ellis on how activist tactics continue to evolve in response to more sophisticated corporate defensive strategies and the entry of new activist funds. This excerpt reviews how activists may target different parts of a company’s capital structure:
With the multitude of securities and undisclosed derivatives available for investment and hedging up and down the capitalization structure, activists are increasingly using various entry points to deploy activist measures in situations where their true economic motivations may not be evident. For example, debtholders with economic positions designed to profit from a default in a company’s debt (i.e., through credit default swaps) are more frequently threatening to assert a default directly.
Strategies include raising the possibility of tripping the change of control covenants by buying up large equity stakes on the cheap, acquiring a position sufficient to block a shareholder vote for a transaction necessary to stave off insolvency, or,as Aurelius is pursuing at Windstream, formally asserting a technical covenant default on a transaction approved and consummated years ago. While the CFTC has publicly suggested that other strategies involving a company and creditor “manufacturing” a default designed to trigger credit default swap payments to the creditor may constitute market manipulation, we expect continued creativity from activist investors seeking to profit from their varied and hedged debt and equity positions.
The memo also says that activists are more often pursuing proxy contests for board control, rather than running a short slate of one or two nominees. They are also increasingly willing to use “withhold campaigns” to address events arising after director nomination deadlines, and are using ESG-based strategies to increase their support among passive investors.
– John Jenkins
Last October, we blogged about a Nasdaq proposal to ease the listing requirements for SPACs. The NYSE put forward a similar proposal in November. However, This Olshan blog says that the exchanges have backed off those rule proposals. Here’s the intro:
Last month, both the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq) withdrew proposals that sought to ease the listing rules for blank check companies, also known as special purpose acquisition companies or SPACs. The proposals would have, among other things, reduced the minimum number of round lot holders (holders of 100 or more shares) required for initial listing from 300 to 150. Each Exchange also wanted to eliminate the continued listing requirement of at least 300 round-lot holders that applies until the SPAC makes one or more acquisitions. Nasdaq first submitted its proposal in September 2017 and the NYSE submitted its proposal in November 2017.
The Securities and Exchange Commission (SEC) had sought additional analysis for both proposals. The round-lot requirements are intended to ensure that public companies have a sufficient investor base to permit stable trading while limiting price volatility. The SEC requested additional information from the Exchanges to confirm that the proposals would not upset this balance. Neither Exchange offered an explanation as to why it withdrew its proposal.
– John Jenkins
A third-party “quality of earnings” study has become a fairly common part of the M&A due diligence process. This recent blog from the investment bankers at SRD Ventures says that commissioning such a study provides 3 major benefits to sellers – avoiding price re-negotiation, shortening the deal timeline, and positioning the business for the marketing process. This excerpt summarizes how a Q of E study can shorten a deal’s timeline:
– Most buyers will not engage their legal counsel to draft closing documents until the Q of E is complete because of the risk of uncovering something important that may jeopardize the deal.
– Nearly 40% of private equity deals in 2015 and 2016 have taken 15 or more weeks to close after the letter of intent because of financial due diligence issues that were not known prior to due diligence commencing.
– Q of E studies typically take around 30 days. Completing this concurrently with your investment banker’s process may eliminate altogether post-LOI delay.
– The cliché “time kills all deals” comes into play. Every day that a deal is under letter of intent is another day something could change in your business.
The blog notes that Q of E studies aren’t cheap – generally costing between $20K to $80K, depending on the company. However, it is important not to cut corners, because it is essential that the end product can withstand scrutiny from a skeptical buyer.
– John Jenkins
This Davis Polk memo discusses the whopping €124.5 million fine that the European Commission imposed on Altice for implementing its acquisition of PT Portugal without receiving required antitrust clearance. The memo says that the fine – which is the largest ever imposed – was meant to send a message:
The EC is clearly determined to impose high-value fines where a company has deliberately or negligently failed to notify a transaction reviewable under the EU Merger Regulation or has implemented a transaction before it has been cleared. Commissioner Vestager noted that companies that “implement mergers before notification or clearance undermine the effectiveness of our merger control system” and that the level of fine imposed in the Altice case “reflects the seriousness of the infringement and should deter other firms from breaking EU merger control rules.”
– John Jenkins
According to this MergerMarket report, megadeals made a strong comeback in 2017. PE played a big role in that resurgence, with PE funds or portfolio companies involved in 26 deals valued at $4 billion or greater. The report says that continued growth in megadeals is expected this year – and results so far suggest that this prediction is on-the-money.
Private equity remains a prominent player in these megadeals – as evidenced by Carlyle Group’s $12.5 billion acquisition of Akzo-Nobel’s specialty chemicals business. According to this Intralinks blog, there are two reasons behind the growth in PE megadeals:
Analysts say that the biggest drivers of today’s mega deals are cheap debt and a robust fundraising environment. Another factor relates to the natural evolution of PE, which is becoming more institutionalized and widespread—the inventory of PE-backed companies exceeded 12,000 as of 2017. The institutionalization has resulted in many large firms being able to successfully raise billion-dollar-plus vehicles for PE. It’s also important to note that limited partners are growing larger in size and need to commit larger sums to maintain allocations—and consequently those sums are going to the larger fund vehicles.
– John Jenkins
When high-profile issues emerge that have a potentially big bottom-line impact, you can usually count on specific reps & warranties about them finding their way into deal documents – even if they’re likely already covered by other more general reps. This recent Steve Quinlivan blog points out that the #MeToo movement is no exception.
Steve flags a handful of recent deals that have included reps addressing the absence of sexual harassment allegations against senior executives. This excerpt lays out a fairly detailed rep dealing with both settlements and the absence of allegations from Del Frisco Restaurant Group’s recent acquisition of Barteca:
Except as set forth on Schedule 2.12(j), none of the Barteca Entities is party to a settlement agreement with a current or former officer, employee or independent contractor of any Barteca Entity resolving allegations of sexual harassment by either (i) an officer of any Barteca Entity or (ii) an employee of any Barteca Entity. There are no, and since January 1, 2015 there have not been any Actions pending or, to the Company’s Knowledge, threatened, against the Company, in each case, involving allegations of sexual harassment by (A) any member of the Senior Management Team or (B) any employee of the Barteca Entities in a managerial or executive position.
– John Jenkins
This recent blog from Fox Rothschild’s Carl Neff reviews the Chancery Court’s decision last week to rely on a DCF analysis, instead of the merger price, in an appraisal proceeding. Here’s a excerpt:
In the recent decision of Blueblade Capital Opportunities v. Norcraft Company, Inc., C.A. No. 11184-VCS (Del. Ch. July 27, 2018), Vice Chancellor Slights found that “the evidence reveals significant flaws in the process leading to the Merger that undermine the reliability of the Merger Price as an indicator of Norcraft’s value.” Slip op. at 3. This is so because the Court found that there was no pre-signing market check, that Norcraft and its advisors “fixated on Norcraft and never broadened their view to other potential partners”, and that Norcraft’s lead negotiator “was at least as focused on securing benefits for himself as he was on securing the best price available for Norcraft.” Id.
Accordingly, the Court declined to rely upon deal price, but instead determined fair value by turning to the discounted cash low analysis presented by the parties, and “borrowed the most credible components of each expert’s analysis to conduct [the Court’s] own DCF valuation”. In so doing, the Court’s DCF valuation yielded a fair value of $26.16 a share, up slightly from the deal price at $25.50 a share.
While the plaintiffs didn’t exactly hit the jackpot, the Court’s decision is another indication that reports of DCF’s demise in appraisal proceedings are at least somewhat exaggerated.
Still, it wasn’t a good week or so for appraisal arbs – even DCF only got them a little more than a 2% bump in Norcraft. Worse, as this Seyfarth Shaw memo points out, the Chancery’s use of the merger price as a valuation guidepost in its subsequent decision in the Solera appraisal left them holding the bag with a valuation that, after deducting synergies, was 3% lower than the deal price.
– John Jenkins
This recent blog from Weil’s Glenn West is a reminder that asking for a pound of flesh in a commercial transaction can still buy you a lot of trouble – particularly if you choose the wrong state’s law to govern your deal. Usury laws are alive & well in many states, and this excerpt says that they’re extremely complicated to boot:
But it is important to note that it is not just the stated rate that can count as interest, any other compensation for the “use, forbearance or detention of money,” such as fees, grants of equity, the amount of any debt of others assumed, or just about any other contractually extracted consideration tied to the loan, might well be counted as interest too (although Texas has certain specified statutory exceptions for equity grants, loan assumptions and other common lender add-ons for certain specifically defined types of loans). And what constitutes a loan as opposed to an investment or purchase is a fact specific exercise. In general, any transaction that requires the absolute repayment of the funds advanced is subject to the risk of being re-characterized as a loan.
In light of this complexity, its important to choose your governing law carefully. As an example, the blog cites the Delaware Superior Court’s recent decision in Change Capital Partners Fund I, LLC v. Volt Electrical Systems, LLC, C.A. No. N17C-05-290 RRC (Del. Super. Ct.; 4/18). In that case, the Court rejected a challenge to a Delaware governing law provision in a receivables sale transaction that the plaintiff alleged was actually a loan – with a staggering 102% interest rate! The plaintiff contended that the transaction – which involved less than $2.5 million – should be governed by New York or Texas law.
Had the plaintiff succeeded in having the case governed by New York or Texas law, the transaction could have been recharacterized as a loan and may well have run afoul of either state’s usury laws. However, Delaware “provides no cap on interest rates, but instead allows interest to be charged in an amount pursuant to the agreement governing the debt.” Since that was the case – and because the Court ruled that Delaware law applied – there was no upside for the plaintiff in attempting to recharacterize the deal.
The blog says that there’s a particular lesson for PE firms, who often engage in small financing transactions with portfolio companies. Blindly calling for New York law to govern those arrangements can have severe consequences – including potential criminal liability – if the amounts involved are less than the $2.5 million cut-off for application of New York’s usury statute. It also points out that some states, such as Texas, have no upper limit on their usury statute. So, it suggests that Delaware – which does not have a usury statute – should be considered as a default option for these transactions.
Yeah, it sure would be nice if I could spell. Of course, it’s “usury,” not “usery”, as I originally spelled it throughout this – and thanks to the member who kindly tipped me off to my error.
– John Jenkins