DealLawyers.com Blog

Andrew Sorkin’s column in Sunday’s NY Times discusses the growing trend of including “go shop” provisions in recent merger agreements. Here is an excerpt from that column (and a sample provision and commentary from the “Truth on the Market” Blog):

“Instead of the typical “no shop” term that has long been standard issue in merger deals — to keep sellers from soliciting higher offers after reaching an agreement to be sold — some boards of directors are now taking the opposite tack. Sellers are cutting deals with buyers that allow them to actively seek higher offers after reaching agreement. So, in the case of this week’s deal, Kerzner International, owner of the Atlantis resort, and its advisers literally began an auction for Kerzner the day it agreed to be sold.

If this doesn’t seem to make much sense, don’t worry, it’s complicated — and, in reality, it may not make sense anyway.

Over the last year, about a half-dozen deals have included a go-shop provision. The purpose, ostensibly, is to make sure that companies receive the highest possible price in a sale.

The most prominent example so far was when Maytag agreed last May to be sold to Ripplewood Holdings. But the agreement included a go-shop provision, and Maytag put it to work. After signing up and announcing its deal with Ripplewood, it canvassed more than 100 other bidders and smoked out Whirlpool to make an offer worth $1.36 billion, which it accepted only after a mini-bidding war that pushed the price even higher, to $1.7 billion. (It’s unclear whether that was the right move, because regulators may still try to quash the deal.)

In a perfect world, that is the way a go-shop provision is supposed to work. But in practice, it may be more a disingenuous article that boards are including in deals to protect themselves from angry shareholders who may think that a transaction was a sweetheart deal to a favored bidder. A go-shop gives board members instant cover from their fiduciary duty because it effectively says, “We made this deal, but we’re still open to higher bids.” The buyer effectively acts as a stalking horse. His price provides a floor for other potential buyers and a sense of certainty to shareholders.

The question, though, is why a company wouldn’t hold an open auction to begin with? Sometimes there are valid reasons. In the case of Kerzner, the company’s board took the go-shop approach because management and some major shareholders had already signed on with the consortium of investors, believing that there was only one real bidder. Had the board put the company up for sale, the management could have bolted, creating an enormous amount of uncertainty.

And Kerzner has given its adviser, J. P. Morgan Chase, an incentive by basing the bank’s fee on its ability to find a higher offer. (A question for another column: J. P. Morgan provided a fairness opinion to Kerzner based on the original deal price of $76 a share. If it is able to find a better price, was the first fairness opinion right?)

More often than not, it would seem that an open auction is the best way to go. In fact, the biggest problem with a go-shop provision is that by default, other potential bidders start at a huge disadvantage. Not only do they have to get up to speed quickly — most of these provisions allow only a 45-day period to find a higher offer — but the new buyer has to pay a breakup fee.

IF you’re wondering why the first suitor would ever agree to a go-shop provision, the breakup fee may be part of it. Nobody buys a business to get a breakup fee, but the option does provide buyers with some comfort, covering their costs and then some if they end up losing the deal.

More important, buyers often have no choice. A seller can easily say: either take the deal with a go-shop provision or submit to an open auction. And, of course, there’s no evidence so far that any would-be buyer would choose the auction route.”