Dechert recently published its 2023 Global Private Equity Outlook Survey, which surveyed 100 senior executives of PE firms with $1 billion or more in assets under management in the North American, EMEA and APAC markets. The survey includes a spotlight on each of the major global markets and addresses a range of topics relating to the current and anticipated market environment. These include the impact of higher interest rates on valuations, creative approaches to dealmaking, and fundraising challenges.
Given the sharp decline in stock prices over the past year, I was a bit surprised to learn that, when asked to rank how likely their firms were to engage in a particular transaction, respondents said that they were least likely to become involved a take private deal with a public company. This excerpt suggest that this may have a lot to do with the increasingly dysfunctional nature of the U.S. public markets:
Unexpectedly, take-privates are the least favored deal choice, with over half of respondents saying they are either not very likely to consider a public-to-private as an option (26%), or reservedly saying it would depend entirely on the specific deal (26%). Some of the largest buyouts in 2022 have involved publicly listed targets, such as Atlantia and Citrix. However, these deals are not for everyone. US publicly traded companies have grown larger in value and smaller in number over the decades.
A paper published on the Harvard Law School Forum on Corporate Governance found that, as of early 2017, the average market capitalization of a US-listed company was US$7.3 billon, the median being US$ 832m. For all but the largest fund managers, this puts swathes of the stock market off-limits for PE firms managing diversified fund portfolios. Therefore, although valuations have come down off their 2021 highs, making take-privates more attractive, this activity will be concentrated among the larger sponsors in a case of value over volume.
The type of transactions that respondents identified as being the most attractive to them highlight the desire of PE buyers to leverage their financial resources. For example, 75% of respondents said that their firms were highly likely to pursue partnerships with strategic buyers, 57% said they were highly likely to pursue club deals, and 50% said that GP led secondaries/continuation funds fell into the “highly likely” category.
It isn’t often that you see a stockholders’ representative argue that funds held in escrow shouldn’t be released to the seller, but that’s the situation the Chancery Court recently confronted in American Healthcare Administrative Services v. Aizen, (Del. Ch.; 11/22). The case arose out of an asset purchase agreement providing for the sale of two lines of business to a third-party buyer. The selling company’s stockholders were also parties to the agreement, and its CEO was appointed to serve as their representative. In that capacity, he had the authority to make certain decisions about the escrowed funds.
After the closing, the CEO’s employment was terminated, and he and the seller ended up enmeshed in a lawsuit. Meanwhile, the contractual escrow period ended without any claims from the buyer, and the seller’s stockholders sought to have the funds released from escrow and paid over to the seller. Apparently concerned that if the selling company received the funds and distributed them to its stockholders it would become judgment-proof, the former CEO refused. He pointed to the terms of the agreement providing him with sole discretionary authority in his capacity as the sellers’ rep to support this position.
Vice Chancellor Laster disagreed. He concluded that the plain meaning of the escrow provision required the funds to be disbursed because each of the requirements set forth in the agreement had been satisfied. As a result, the sellers’ rep was contractually obligated to join with the buyer in instructing the escrow agent to release the funds. While acknowledging that the sellers’ rep was granted broad discretionary authority, the Vice Chancellor said that authority couldn’t be used to override the plain language of the agreement:
Section 10.10 vests Aizen with the discretion to carry out his post-closing duties and obligations as Sellers’ Representative. That discretion extends to his duties and obligations under the Escrow Release Provisions, but it does not give Aizen the authority to ignore a mandatory provision of the Purchase Agreement governing the release of the escrowed funds. It would create an internal contradiction to read the Purchase Agreement as mandating that Aizen release the escrowed funds, while at the same time granting Aizen the authority to ignore that mandate. Aizen cannot cherry-pick the contractual provisions that he finds advantageous, while simultaneously ignoring the contractual obligations that he finds inconvenient.
In reaching this conclusion, VC Laster said that the defendant’s argument ignored the constraints imposed by the implied covenant of good faith. After reviewing Delaware precedent, the Vice Chancellor reached the following conclusion about the role of the implied covenant in the present action:
Applying these principles, the Delaware Supreme Court has made clear that the implied covenant of good faith and fair dealing restrains a party’s exercise of discretion under an agreement. The general rule is that the implied covenant requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain. That rule operates with special force “when a contract confers discretion on a party.”
He concluded that the defendant was empowered under the agreement to use his “sole and absolute discretion” to act on behalf of the seller’s stockholders. The defendant could not use his discretion to act on behalf of himself as a contingent creditor or on behalf of creditors in general – and in doing so, he exceeded his authority.
With valuations of many early-stage companies tumbling, some of those companies are staring at the possible need for a “down round” equity financing. Down rounds are a hard pill to swallow for founders and existing investors, and often require companies to manage anti-dilution rights and other protections for existing investors. This Bloomberg Law article discusses some options that might be available to companies to help navigate these rights in order to clear the way for new financing. This excerpt discusses the potential willingness of existing investors to swap enhanced contractual rights for a waiver of anti-dilution protections:
Anti-dilution provisions and related shareholder rights can be negotiated if a company wishes to enter a new round of fundraising with a lower, flat, or increased valuation, or for the extension of an ongoing round. By enhancing certain contractual rights, companies can convince investors to waive anti-dilution rights, extend ongoing rounds, or even pay a higher share price despite adverse economic trends.
Recently, companies have successfully negotiated favorable terms by enhancing preferred shareholders’ rights to include warrant coverage, liquidation preferences of 2x to 3x compared to typical rates of one to one, or accruing dividends participating preferences.
Alternatively, rather than initiate a new fundraising round, which may warrant a revised valuation, a company may simply continue an ongoing round. Investors commonly allow for the extension of a round when a company has yet to achieve performance benchmarks already set. Extensions keep valuation and contractual terms static.
The article says that while down rounds are disfavored, they are sometimes in the company’s best interests, and investors may reach that same conclusion. In these situations, investors have proven willing to negotiate reductions in or waivers of anti-dilution rights.
Last week, the NY Times published an epic account of the decline and fall of the corporate marriage between Time Warner and AT&T under the title “Was this $100 Billion Deal the Worst Merger Ever?” The article is full of juicy details about the clashes of personality & corporate culture that supposedly unmade the deal, but the punch line appears just a few paragraphs into the article:
Less than four years after the merger, AT&T abandoned its grand initiative. It spun off its Warner Media assets and ceded management control to Discovery. The new company, Warner Bros. Discovery, took on $43 billion of AT&T’s debt, and AT&T shareholders kept 71 percent of the company, a stake worth less than $20 billion. That amounts to a loss of about $47 billion for AT&T shareholders, based on AT&T’s $109 billion valuation of the deal at the time it was announced.
AT&T disputes those numbers and contends the deal was accretive. Whatever. I think the point is that by any measure, this deal isn’t the worst in history. In fact, it’s probably not even the worst deal that Time Warner was involved in. Now, I don’t want to brag, but I was involved in a number of deals that turned into complete trainwrecks during my career, so I consider myself a bit of a connoisseur of crappy deals, and I have my own candidate for the worst deal in history.
The merger that I nominate for the worst of all time has a lot to recommend it. It resulted in the largest bankruptcy in American history prior to Enron, roiled the commercial paper markets, nearly put Goldman Sachs out of business & ultimately resulted in the government’s decision to nationalize an entire industry. What deal am I talking about? The 1968 merger between The Pennsylvania Railroad and The New York Central. Don’t take my word for it, check out what Goldman Sachs has to say about the fallout from the deal:
The Penn Central Transportation Company was not only the largest railroad in the country; it was also the sixth largest firm in the United States and the owner of the most valuable real estate portfolio. Penn Central controlled more than 20,000 miles of track, one-eighth of the nation’s freight, and a network going from St. Louis and Chicago to Boston and Montreal. While its book value and assets were significant, problems lurked beneath the surface. Penn Central was asset-rich but cash-poor. And that was just the beginning.
Penn Central had been formed in February 1968 by the merger of two formidable rivals: the New York Central and the Pennsylvania Railroad. Together they controlled over US$6.5 billion in assets, yet combining forces did not yield an efficient or resilient entity. Freight cars were lost, switchyards were jammed and poor service and delays plagued both the passenger and freight lines. Penn Central had a highly complex corporate structure and experienced a number of management failures. As losses mounted, the dividend was cut and the stock price plunged; Penn Central had to rely on issuing commercial paper at ever-increasing interest rates. After an unsuccessful government attempt to rescue the firm, Penn Central filed for bankruptcy on June 21, 1970.
For Goldman Sachs, the bankruptcy posed enormous challenges on several fronts. In addition to the chaos descending on the firm’s client — Gus Levy’s client — Penn Central, the bankruptcy sent shock waves through the commercial paper market. As the market leader, the firm served nearly 300 other commercial paper-issuing clients who suddenly faced widespread redemptions from panicked investors. Market liquidity vanished and companies rushed to secure funding to buy back their paper.
Penn Central alone had US$87 million in issued paper in default. The potential losses for the firm were greater than its capital, posing a threat to its very existence. Goldman Sachs partners banded together to work through a series of litigation and settlements and the firm would ultimately see its way through.
Now that’s a bad deal! Although I think I make a compelling case, I’ve got to admit that I have a bias here. Both of my grandfathers worked for The Pennsylvania Railroad for decades (and my dad worked for them for a time too), so I remember this bankruptcy being viewed as a truly cataclysmic event by my family when I was growing up.
Activists & their advisors are seeing red over some changes to advance notice bylaws being implemented by companies in response to the universal proxy rules. In a recent “Open Letter” to directors & activist investors, Olshan warns boards against adopting advance bylaw amendments that add an array of new disclosure requirements that the firm argues aren’t necessary or appropriate responses to the universal proxy rule:
We urge you to be vigilant when reviewing and approving any new bylaws to avoid inadvertently adopting bylaw amendments that are predicated on misleading narratives and do not align with responsible corporate governance practices. In particular, be on the lookout for proposed amendments to nomination procedures requiring additional disclosure designed to make it more difficult, expensive or even impracticable to nominate directors or intended to chill permitted communications among shareholders such as provisions requiring disclosure of (i) the ownership interests of the nominating shareholder’s limited partners or distant family members in the company, competitors of the company or counterparties to any litigation involving the company, (ii) the nominating shareholder’s past or future plans to nominate directors at other public companies or (iii) the nominating shareholder’s prior communications with fellow shareholders concerning its plans or proposals relating to the company.
While Olshan doesn’t drop any names, the bylaw provisions it highlights are the same ones that Masimo Corporation implemented in response to a campaign by activist hedge fund Politan Capital Management. Those parties are currently brawling in Delaware Chancery Court over the legality of the amendments.
Why does the activist community have its nose out of joint over bylaw amendments like these? In a recent blog, Prof. John Coffee notes that identifying limited partners of an activist shareholder might prove embarrassing to certain of those partners, particularly public sector funds. But he says there’s a bigger reason for their concern with these bylaws:
What most concerns the activist community appears to be the attempt of the Masimo bylaw to obtain disclosure about the recent track record of the activist seeking a board seat. What similar campaigns has it launched at other companies? To this end, the Masimo bylaw’s critical term – “Covered Person” – includes persons “Acting in Concert” (as defined) with the nominating shareholder, even though they do not have any express agreement.
In part, the intent here appears to have been to identify shareholders who have a special agenda (say, environmental activism) and have developed an ongoing association with the nominating person in order to pursue a common agenda (which may have little to do with the maximization of shareholder value). Corporate management’s apparent premise here is that, with universal proxy voting, such informal alliances with single-issue activists may become more common and that shareholders deserve information about such associations.
Coffee’s article takes a sympathetic view of the Masimo bylaw amendments, but if you’re interested in a different perspective, check out this blog from Prof. Lawrence Cunningham. Cunningham contends that Delaware courts are okay with advance notice bylaws so long as they don’t interfere with the exercise of the stockholders’ franchise. He argues that the provisions of the Masimo bylaw “almost certainly cross the line, particularly in its call for a nominating shareholder to disclose its limited partners.”
Today’s episode of “antitrust regulators slinging stuff against the wall to see if it sticks” features the DOJ’s Antitrust Division, which raised a novel argument in an effort to derail Booz Allen’s acquisition of EverWatch. Here’s the intro from this Freshfields blog:
On June 29, the Department of Justice’s Antitrust Division (DOJ) challenged Booz Allen Hamilton’s (Booz Allen’s) $440 million dollar acquisition of EverWatch, alleging that, as the only two viable suppliers of “signal intelligence” services to the National Security Agency (NSA), the transaction not only would result in harm to competition for the services post-close, but also that the mere entry into the transaction agreement caused the parties to reduce the intensity with which they were competing for an upcoming NSA contract for signal intelligence services, even before the transaction closed. The District Court rejected DOJ’s challenge on October 11, and the parties closed the transaction on October 14.
The case stands out for DOJ’s attempt to use Section 1 of the Sherman Act to challenge the alleged pre-closing competitive harm. Traditionally, the US antitrust agencies rely on Section 7 of the Clayton Act, which is specifically designed to address mergers – however in Booz Allen, DOJ also alleged a Section 1 claim. In evaluating DOJ’s claims, the court addressed themes that have arisen from some of DOJ’s other recent merger challenges, namely, the government’s buyer power as a countervailing factor against merging parties’ incentive and ability to harm competition post-close, as well as what constitutes a proper market definition.
The two companies were the only bidders for an upcoming NSA contract, so the DOJ not only made the traditional Clayton Act argument that the deal would harm future competition, but also contended that by entering into the merger agreement, the parties already harmed competition in violation of Section 1 of the Sherman Act because they were no longer competing aggressively in the bidding process. The Court rejected that argument, noting that the DOJ produced “little evidence” supporting this allegation.
In fairness to the DOJ, this use of Section 1 of the Sherman Act doesn’t seem to be anywhere near as audacious as the FTC’s new policy statement, but it provides further evidence that judicial reluctance to countenance novel enforcement theories under Section 7 of the Clayton Act is prompting antitrust regulators to think outside the box in their efforts to stop mergers that they view as anticompetitive.
Earlier this year, I blogged about Totta v. CCSB Financial, (Del. Ch.; 6/22), in which Chancellor McCormick held, among other things, that a charter provision prohibiting a stockholder from exercising more than 10% of its voting power interfered with stockholders’ exercise of the franchise. In a subsequent letter decision, Chancellor McCormick concluded that the insurgent stockholders conveyed a substantial benefit upon the company and granted their request for attorneys’ fees.
The company argued that the insurgents gained an exclusively personal benefit, because only their votes were positively impacted by the Court’s interpretation of the antitakeover provision in the charter document, and because their actions advanced the interests of their affiliate in obtaining control of the company. Chancellor McCormick disagreed:
I do not view the benefit conferred in this case so narrowly. While in a strict sense the Post-Trial Opinion only affected Plaintiffs’ votes, the judgment fortifies the Company’s stockholder franchise generally. By bringing this litigation, Plaintiffs vindicated not only their own votes, but also the majority vote of the unaffiliated stockholders who properly elected the insurgent nominees.
The result obtained by this litigation prevents future stockholders from being similarly harmed by an erroneous application of the Voting Limitation. Plaintiffs’ success in this case confers a substantial benefit on CCSB by retroactively correcting the incumbent board’s interpretation of the Voting Limitation and, in effect, proactively setting the interpretation for future elections. The corporation is better off for a rectified election process.
The Chancellor ultimately concluded that the substantial benefits conferred on the company justified the insurgents request for reimbursement of approximately $385,000 in fees and expenses.
Intralinks recently published its M&A Leaks Report, which analyzes deal leaks over the period from 2009-2021, and breaks them down by world region, country & business sector. The report also looks into the effect of leaks on the premiums paid, emergence of rival bidders & time to closing. Here are some of the highlights:
– 8.8% of all deals announced during 2021 involved a leak compared to 8.2% during 2020. These were both above the 7.8% average for all years dating back to 2009.
– The total value of leaked deals was up 105% in 2021 ($142 billion) vs. 2020 ($69 billion). The average dollar value of leaked deals was also up 60% in 2021 ($1.7 billion) vs. 2020 ($1.1 billion).
– The three sectors with the highest amount of pre-announcement abnormal trading activity in 2021 vs. 2020 were Healthcare (12.5%), Retail (11.9%) and Industrials (11.3%). None of these cracked the top three on average over the last several years, and their prominence may reflect the challenges and opportunities that companies in these sectors faced during the pandemic.
As always, one of the most interesting findings was the extent to which takeover premiums for target companies involved in leaked deals exceeded those paid in more stealthy transactions. In 2021, the median premium for leaked deals was 54.3%, which was nearly twice the 27.7% premium paid in non-leaked deals. Deals with leaks also closed over a week faster than those that didn’t leak. The median time to closing for a leaked deal was 92 days, compared with approximately 100 days for non-leaked deals.
Last week, the FTC issued a policy statement setting forth a sweeping new claim to enforcement authority under Section 5 of the Federal Trade Commission Act. Up until now, that statutory provision has been a rarely used tool to address “unfair methods of competition” arising in situations where other major antitrust statutes didn’t apply. The policy statement is premised on the FTC’s position that Section 5 wasn’t just intended to protect consumers, but also to “protect the smaller, weaker business organizations from the oppressive and unfair competition of their more powerful rivals.”
What are the implications of this new policy statement? Well, as this Goodwin memo explains, the FTC is likely to try to wield that authority in merger enforcement cases targeting acquisitions of nascent competitors – exactly the kind of transactions it’s been having a hard time persuading the courts are prohibited under Section 7 of the Clayton Act:
The 2022 Policy Statement goes on to provide a “non-exclusive set of examples” of the type of business conduct that may violate Section 5. While this list covers a broad range of business activities, most striking among these activities are references to M&A deal activity that the FTC has now declared could be prohibited under the FTC Act:
– Mergers or acquisitions, or joint ventures that have the tendency to ripen into violation of the antitrust laws.
– A series of mergers, acquisitions, or joint ventures that tend to bring about the harms that the antitrust laws were designed to prevent, but individually may not have violated the antitrust laws.
– Mergers or acquisitions of a potential or nascent competitor that may tend to lessen current or future competition.
Taking an unprecedented interpretive position on one federal antitrust statute to avoid getting clobbered in court for taking that same position on another more directly applicable statute is. . . well . . . let’s just say it’s “a bold strategy”. But according to this Wilson Sonsini memo, that’s far from the limit of what the FTC’s new policy statement might mean. As this excerpt says, it could also substantially broaden the risks of enforcement actions targeting director interlocks:
The FTC’s policy statement lists “interlocking directors and officers of competing firms not covered by the literal language of the Clayton Act” as one example of a “violation” of Section 5. Under this new interpretation, the FTC appears to be asserting the authority to obtain injunctive relief against “interlocks” not prohibited by the terms of the Clayton Act.
This likely includes, at minimum, “interlocks” involving board observers. This would include a situation in which:
– an individual serves as a board observer at two competing corporations,
– an individual serves as a board observer at one corporation and a director or officer of its competitor, or
– an entity such as a private equity or venture capital fund is represented by a board observer at one corporation and is represented by a board observer or director at another corporation.
It is possible that the FTC would also use this authority to challenge interlocks that fall within the safe harbor exemptions of Section 8 of the Clayton Act.
I’m not usually impressed by overheated claims about the “Regulatory State,” but holy cow! This statement is about as aggressive an attempt to rewrite important provisions of federal law as I’ve ever seen an agency undertake – and I can’t imagine it’s going to fare well in the federal courts as they’re currently configured.
According to Dykema’s “18th Annual M&A Outlook Survey,” dealmakers aren’t quite as downbeat about the M&A climate over the next 12 months as you might expect given the gloomy 2023 forecasts we’ve seen. In fact, 65% of the executives and financial advisors surveyed expect the U.S. M&A market to strengthen in the next 12 months. But this excerpt from the survey says that in the current environment, buyers with plenty of dry powder are likely to be the ones getting deals done:
Dealmakers named rising interest rates, economic conditions, and growing inflationary pressure as the top deterrents to M&A activity—while citing the financial markets, economic conditions, and rising interest rates as its biggest drivers. This suggests we may be entering a market of haves and have-nots, in which buyers with a large amount of liquidity—and consequently, no need to borrow at high interest rates—expect to take advantage of buying opportunities and close more deals in the coming year. In contrast, buyers who have routinely relied on banks to finance a large percentage of their acquisitions are anticipating greater roadblocks to funding their deals.