February 8, 2007

Go Shop or No Shop?

From today’s WSJ, which includes this blurb from ‘Go shop” provisions have become a common feature of the LBO landscape. These clauses are meant to sound shareholder-friendly because they lock in a bidder while allowing a board to beat the bushes for others. So how to explain the extra $3 billion that EOP extracted for shareholders after agreeing to a “no shop” with Blackstone in November?

As the jargon implies, a “no shop” limits boards from soliciting rival offers. So “go shops” must be better for shareholders, right? Not so fast. Two of the biggest buyouts of the past year, of hospital chain HCA and chip maker Freescale, included “go shop” clauses. And in neither case did competitors emerge.

This is partly why investors regard “go shops” with suspicion. They see it as a form of legal cover for independent directors worried they will be perceived as favoring managers buying out the companies they run on the cheap. But that leaves the question of how EOP, despite a “no shop,” got such a robust battle going between Blackstone and Vornado.

Rather more critical to the outcome was the size of the fee that anyone wanting to top Blackstone’s first bid would have had to pay. At the outset, EOP insisted on just a 1% break fee, well below the industry standard of 3%. As a carrot to Blackstone, EOP ratcheted that up as the private-equity firm raised its offer.

This suggests that what’s more important than the shopping label is the intent of directors to seek the highest price. And an extra low break fee is a better signal that directors are looking out for shareholders.