In Teamsters Local v. Martell, (Del. Ch.; 2/23), the Chancery Court dismissed breach of fiduciary duty claims against the former CEO of Core Logic. Those allegations were premised on claims that, in order to preserve his job post-closing, the CEO steered the board toward an all-cash transaction with a financial buyer over a competing all-stock proposal from a strategic buyer with a higher implied valuation.  Vice Chancellor Cook rejected those claims and held that the board’s decision to enter into the transaction was entitled to business judgment review under Corwin.

This Fried Frank memo reviews the Vice Chancellor’s decision and offers up the following key takeaways:

– The court dismissed claims that an officer steered an independent board to favor a financial buyer’s bid over a strategic buyer’s bid based solely on speculation that the officer had an implicit entrenchment motive. The court held that the plaintiff had alleged no particularized facts from which it could be inferred that CoreLogic’s CEO had an entrenchment motive; that he had in fact steered the board away from a deal with CoStar; nor, in any event, that he had influenced the independent and unconflicted board.

The claims were not sustainable based solely on “speculation and innuendo” arising from the CoStar CEO’s public comments about the sale process, particularly as the plaintiff had conducted a Section 220 investigation of the corporate books and records and had cited nothing in these documents to substantiate the claims.

– The court’s opinion reinforces that a board’s concerns about antitrust-related delay and value uncertainty can justify a determination to select a financial buyer’s cash bid over a nominally higher strategic buyer’s stock bid. The court rejected the plaintiff’s contention that, given that there were no “meaningful” antitrust issues associated with CoStar’s deal, the Board’s purported antitrust concerns about the bid must have been a pretext.

The court noted that a deal with no meaningful antitrust issues is different from a deal with no antitrust issues. The court also found no basis on which to reasonably infer that the Board did not actually have a concern about value certainty of CoStar’s stock deal, particularly given that CoStar’s stock, although high, had been steadily declining.

Another interesting aspect of this case is the Vice Chancellor’s accommodating approach to the idea of disclosure through incorporation by reference – which is something that Delaware courts can be persnickety about.  Specifically, in this excerpt from his opinion, VC Cook rejected claims that information incorporated by reference into the target’s proxy statement from its 10-K was inadequately disclosed:

Nor is it “a per se disclosure violation to disclose information in public filings incorporated in the proxy instead of the proxy itself.” Where, as here, a document referenced in a proxy statement is “explicitly incorporated” and not “buried” such that “a reasonable stockholder reading the [proxy statement] could find it without difficulty,” it is considered “to be a part of the total mix of information available to stockholders.”

– John Jenkins

Public company mergers of equals aren’t uncommon, but since the stock of private companies isn’t liquid, an MOE involving private companies has been a relatively unusual deal structure.  However, they say that necessity is the mother of invention, and this Gunderson memo notes that the difficult funding environment has resulted in more companies & investors considering MOE deals for private companies to accelerate growth & to pool financial and operational resources.

The memo provides a primer on these transactions, including an overview of their risks and benefits, alternative transaction structures, approaches to valuation, post-closing risk allocation, governance considerations and employee retention & right-sizing issues. This excerpt addresses some of the valuation allocation issues that private companies may face:

Liquidation Preferences: Typically in an MOE the liquidation preferences of each of the parties’ preferred stock investors will be preserved in some fashion in the combined entity’s capitalization. However, how those preferences “stack up” with each other (e.g., all pari passu or ranked seniority) will depend on the specific transaction and the existing rights (including whether some of the preferred stock in the legacy companies is “participating preferred”). In some MOEs, however, the parties elect to eliminate preferences in a bid for “cleaner” capitalization for the go-forward company.

Note: In a non-MOE private company stock consideration deal, buyers will often propose that selling stockholders receive buyer’s common stock, but with the business understanding that such common stock should be evaluated as if valued at the valuation used in the buyer’s last private preferred financing round (rather than on the basis of a “409A” valuation of the common stock). How such proposals are evaluated by selling stockholders is highly transaction-specific. Because of the instinct for mutuality in MOEs, by contrast, the negotiations around whether the preferred stock in the constituent companies is converted into preferred stock of the combined company are typically less fraught.

Wiping Out Common: Depending on the valuation assigned to each constituent company, it is possible that such valuation would not clear the collective liquidation preferences of one or both companies. If that is the case, while often the existence of the common stock is preserved (especially if liquidation preferences are likewise preserved), the parties sometimes consider cancelling the common stock for no consideration. However, as fiduciaries for common  stockholder interests, parties should be extremely focused on fulfilling their fiduciary duties in this scenario, and should consult closely with counsel to construct a decision-making process that can withstand review.

– John Jenkins

Companies are likely to see continued investor & activist pressure to divest non-core businesses in order to generate higher multiples for the parent or the divested business. This Skadden memo discusses some of the reasons that, in the current environment, companies that are looking to divest businesses may want to consider some form of spin-off transaction. Here’s an excerpt:

As 2023 unfolds, boards and management can anticipate even more calls to “unlock value” by separation. One catalyst is the capital markets, where equity multiples generally have declined but growth sectors and businesses with predictable cashflows sometimes command premiums. Another factor is increased shareholder activism in response to the uncertain outlook for corporate performance due to macro-economic factors like higher interest rates, inflation and hampered demand.

As boards and management teams evaluate business portfolios and potential separation transactions, they confront an M&A environment in which carve-out sales face headwinds, including mismatches between buyer and seller valuation expectations, increased financing costs due to higher interest rates and market dislocation, uncertainty around the macro-economic outlook and increasingly aggressive regulatory reviews.

Faced with such an uncertain environment, boards and management teams contemplating separations would be well-advised to consider carefully spin-off and similar transactions like Morris Trusts, Reverse Morris Trusts, split-offs and incubator joint ventures — transactions we will refer to collectively as spin-offs. If well designed, these can not only unlock value for shareholders, but leave the company with flexibility regarding the final structure, so they can pivot along the way in response to input from shareholders or changing market conditions.

The memo highlights a number of the benefits of a spin-off, including the tax advantages to the parent, the ability to better align compensation incentives for executives at both companies, the ability to control the timing of the transaction, and the flexibility to revise the transaction structure based on shareholder input.

Large cap companies that find themselves facing a need to divest a sizeable business should definitely consider the many potential advantages of a spin-off alternative, but based on the one Reverse Morris Trust deal I worked on in my not-particularly illustrious career, one more thing they should consider is that some of these deals can be more complicated than nuclear fusion.

– John Jenkins