Tune in tomorrow for the webcast – “Joint Ventures: Practice Pointers (Part II)” – to hear Troutman Sanders’ Robert Friedman, Proskauer’s Ben Orlanski, Cooley’s Marya Postner and Aon’s Chuck Yen provide an encore to our popular June webcast with even more practical advice on navigating your next joint venture. The topics include:
1. Joint Ventures vs. Contractual Collaboration
2. IP Issues: JVs Based on An Owner’s Platform Technology
3. Negotiating “Divorce” Up Front
4. Consider Piloting a JV Before Full Commitment
5. Majority/Minority Dynamics
6. Acting By Written Consent
7. Clarifying JV’s Purpose
8. Pay Principles: Benchmarking & Long-Term Incentives
9. How Key Pay Decisions Are Made
Non-disclosure agreements often distinguish between the parties with whom information may be shared and those parties who are bound by the agreement. This recent Weil blog highlights a 6th Circuit case that addresses the consequences of that distinction and the perils of entering into an NDA with an intermediary.
Knight Capital Partners v. Henkel AG, (6th Cir.; 7/19) involved an expired NDA entered into between Henkel, a subsidiary of Henkel AG, and Knight Capital Partners, or KCP, an intermediary who hoped to establish a distribution arrangement for a novel cleaning product. After the NDA lapsed without a deal, KCP filed a lawsuit allegations that Henkel AG breached the NDA by using confidential information acquired under it to develop a new product. The trial court rejected those contentions, and the 6th Circuit affirmed. This excerpt from the blog summarizes the Court’s reasoning:
The Sixth Circuit affirmed the trial court’s judgement. While Henkel Parent Co. was clearly an “affiliate” of a “Party” to the NDA (i.e., “any individual, corporation or other business entity, which directly or indirectly, controls a Party, is controlled by a Party, or is under common control with a Party”), and therefore entitled to receive the confidential information as a defined “Receiving Party” under the NDA, Henkel Parent Co. was not actually bound by and liable for breaches of the NDA as a contracting Party, only Henkel US was. In other words, only Henkel US was responsible for alleged breaches of the NDA, whether they were the result its own actions or those of Henkel Parent Co., its parent
The blog notes that this distinction between parties with whom information may be shared and those who are bound by the NDA is a very common approach in private equity settings. It’s also a widely used approach outside of the private equity context. Perhaps more importantly, the case highlights the perils of entering into an NDA with an intermediary:
Although summary judgment was ultimately obtained, this dispute was litigated for over three years because a middleperson with whom a potential counterparty had entered into an NDA apparently felt cut out of a deal that in fact was never consummated. That’s the potential nightmare that needs to be considered anytime these intermediary arrangements are contemplated. Getting the language right in the NDA is paramount, of course, but avoiding these situations unless absolutely necessary is even better.
Rising stock prices may be good for your 401(k), but this WSJ article says they’re putting the squeeze on private equity funds:
Rising stock valuations are forcing private-equity firms to contribute more cash to their leveraged buyouts. That is likely to drag down performance in the long term even as pensions and other investors increasingly turn to private equity to boost returns.
Private-equity firms contributed 52% to the purchase prices of companies they bought in the second quarter of the year, according to data from research firm Covenant Review, a unit of Fitch Solutions, up from 45% in the first quarter. That compares to an average of 47% and marks the highest quarterly figure since Covenant Review began tracking the data in January 2017.
The problem is that while the rising stock market is driving equity valuations higher, banks are still not willing to lend more than 6x EBITDA, which leaves PE funds with a gap that they need to fund with equity if they want to play in today’s deal market. Because the magic of private equity is using other people’s money to leverage your own capital & generate higher returns, the need to use more equity means the returns to private equity investors are likely to get squeezed.
Since private equity has driven so much M&A activity in recent years, does this potential squeeze on returns mean the party’s over? Maybe, but then again, this isn’t the first time PE funds have been forced to pony up more equity for acquisitions. In fact, it’s not even the second time. . . or the third time. . .
Depending on the circumstances, public companies may have make Form 8-K filings disclosing the terms of an acquisition or divestiture. That filing obligation may arise under Item 1.01 of Form 8-K, which requires an 8-K to be filed when a company enters into a material definitive agreement, and under Item 2.01, which requires a filing upon completion of an acquisition or disposition that exceeds certain bright line size tests.
This Bass Berry blog provides a good review of the circumstances under which public company buyers may need to file a Form 8-K with the SEC disclosing an acquisition. Here’s an excerpt addressing things to consider when assessing whether a purchase agreement for a deal that falls outside of the bright lines laid out in Item 2.01 of Form 8-K triggers an Item 1.01 filing obligation:
If an acquisition is significant to a registrant but Item 2.01 is not triggered, then the registrant may have a challenging judgment as to whether the acquisition agreement should trigger a filing under Item 1.01 of Form 8-K. In this regard, relevant factors may include:
– Key income statement metrics of the acquired business compared to the registrant (which may include revenue, operating income, net income and EBITDA)
– The book value of the assets of the acquired business compared to the registrant
– The purchase price paid by the registrant in comparison to the book value of the registrant’s assets
– The purchase price paid by the registrant in comparison to the enterprise value and/or market cap of the registrant
– Whether the acquisition would result in a significant increase in the debt leverage of the registrant and/or would require additional debt or equity financing sources
– Whether the acquired business would give rise to a new product or business line or reporting segment of the registrant or otherwise further any key strategic initiatives or goals of the registrant
– Whether the registrant is particularly acquisitive (if this is the case, this may somewhat move the needle against Item 1.01 being triggered in connection with any particular acquisition)
– Whether any members of the management team of the target company will become executive officers or directors of the registrant
– Whether there are other obligations or benefits (including under ancillary agreements) material to the registrant related to the acquisition
– The past practice of the registrant with respect to whether it has filed acquisition agreements under Item 1.01 (if a similar past acquisition of a registrant has triggered an Item 1.01 filing, this may support the decision to similarly file a subsequent similar acquisition)
The blog notes that in assessing the income statement, balance sheet & purchase price metrics referenced above, some practitioners use a “rule of thumb” that if one or more of these comparisons exceeds 5% or 10%, that may indicate materiality, although qualitative factors also need to be considered.
I think most M&A lawyers would agree that working with experienced people usually results in a much smoother transaction process than what you experience working with folks who are new to the M&A game. When it comes to getting a deal done, there’s just a lot to be said for experience. This recent McKinsey study says that experience also matters a lot when it comes to getting the most out of an acquisition. Here’s an excerpt:
Nearly a decade ago, we set out to answer a critical management question: What type of M&A strategy creates the most value for large corporations? We crunched the numbers, and the answer was clear: pursue many small deals that accrue to a meaningful amount of market capitalization over multiple years instead of relying on episodic, “big-bang” transactions. Between 1999 and 2010, companies following this programmatic approach to M&A generally outperformed peers.
That pattern is even more pronounced in today’s fast-moving, increasingly uncertain business environment. A recent update of our research reflects the growing importance of placing multiple bets and being nimble with capital: between 2007 and 2017, the programmatic acquirers in our data set of 1,000 global companies (or Global 1,000) achieved higher excess total shareholder returns than did industry peers using other M&A strategies (large deals, selective acquisitions, or organic growth). What’s more, the alternative approaches seem to have under-delivered. Companies making selective acquisitions or relying on organic growth, on average, showed losses in excess total shareholder returns relative to peers
The study suggests a number of factors account for the success of programmatic M&A, including effective integration of M&A planning with the company’s overall strategy, incorporating integration planning into the due diligence process, careful consideration of cultural issues, and an approach that views M&A as an enduring capability rather than a one-off project or occasional event.
We’ve previously blogged about the growing importance of cybersecurity due diligence in M&A. The UK Information Commissioner’s Office brought home some of the risks of inadequate diligence in this area when it announced its intention to impose a £99 Million fine on Marriott for GDPR violations associated with a data breach at Starwood Hotels, which Marriott acquired in 2016.
The press release announcing the fine specifically said that the ICO’s investigation “found that Marriott failed to undertake sufficient due diligence when it bought Starwood and should also have done more to secure its systems.” This excerpt from a recent Debevoise memo says that the ICO’s reference to inadequate diligence was unprecedented:
The proposed Marriott fine is the first major regulatory action anywhere to specifically call out a company for purportedly inadequate cyber due diligence in connection with an M&A deal. The proposed fine comes hot on the heels of the ICO’s notice of intent to fine British Airways £183 million. That proposed fine relates to British Airways’ 2018 data breach affecting approximately 500,000 customers.
The ICO has not yet published the details of Marriott’s alleged GDPR violations. Hence it remains to be seen exactly what more the ICO thinks Marriott could or should have done to identify and remediate the Starwood breach, whether pre- or post-closing of the acquisition.
The Starwood data breach apparently occurred in 2014, but the resulting exposure of customer data wasn’t discovered until 2018. The memo notes that approximately 339 million people across the world were affected by the breach, including 7 million in the UK.
After the Supreme Court’s decision in Aruba Networks, most lawyers probably thought that Vice Chancellor Laster’s “unaffected market price” approach to appraisal valuation was dead & buried. Last week, Vice Chancellor Slights issued a 144-page opinion in In re: Appraisal of Jarden Corporation, (Del. Ch.; 7/19) that says the doctrine still has some life left in it.
The Jarden decision is intriguing in many respects. Not only did the Vice Chancellor reject the valuation approach that the Delaware Supreme Court so recently endorsed & adopt the exact approach that it strongly rejected, but he also waded into the subjective mire of DCF analysis to an extent that most post-Dell opinions have tried to avoid.
First, VC Slights decided that the deal price minus synergies approach endorsed in Aruba Networks was inappropriate due to flaws in the sale process that may have put an artificial cap on the price & significant uncertainties regarding the value of anticipated synergies. Instead, as this Cleary Gottlieb blog notes, the Vice Chancellor returned to the unaffected market price approach rejected by the Supreme Court:
The Court first found that the market for Jarden’s stock was efficient based on testimony by the company’s expert, who looked at factors such as Jarden’s market capitalization, trading volume, bid-ask spread, number of analysts, and event studies. The Court rejected the petitioners’ argument that the unaffected market price was unreliable because the market was unaware of material facts about Jarden’s standalone prospects.
Notably, the Court dismissed the materiality of the projections Jarden’s management prepared in connection with the merger, which were not disclosed until after the deal was announced (in Jarden’s proxy), largely based on an event study by the company’s expert showing that the buyer’s stock declined when such projections were disclosed (noting it should have climbed if the market believed those projections showed Jarden had previously been undervalued, as petitioners claimed).
And although there was a gap between the date on which the unaffected price was calculated and the closing (which is the valuation date for purposes of a statutory appraisal), the Court found that, if anything, Jarden’s fair value was declining in that period.
What about discounted cash flow analysis? Well, VC Slights took a deep dive into that valuation approach as well. Not surprisingly, the competing DCF analyses put forward by the plaintiff & defendant were “fantastically divergent,” so the Vice Chancellor conducted his own DCF analysis that supported a conclusion that the unaffected market price of Jarden’s stock represented its “fair value.”
So, for now at least, it looks like reports of the demise of the unaffected market price approach to valuation are greatly exaggerated. Over the longer term, it will be up to the Delaware Supreme Court to determine whether it’s actually alive – or just a dead man walking.
This July-August issue of the Deal Lawyers print newsletter was just posted – & also mailed – and includes articles on:
– RSI Holdco: Delaware Chancery Court Upholds Seller’s Privilege Claim
– Important State & Local Tax Considerations in M&A
– Revlon Lives: Delaware Chancery Declines to Apply Corwin Doctrine
– Delaware Appraisal: The Road to Aruba Networks
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Subscription credit facilities, which provide a debt financing source for PE funds secured by investors’ capital commitments, can be a useful tool to address liquidity needs & provide short-term bridge financing in advance of a capital call. This recent Prequin report surveys the state of the market for these credit facilities. Here’s an excerpt from a segment written by Fitch’s Meghan Neenan that lays out some of the potential issues associated with a fund manager’s decision to draw on a subscription facility:
Subscription facilities can also accelerate the recognition of incentive income for the manager in an upside scenario, as LP capital calls can be delayed and investment returns can be generated on borrowed money, leading to higher IRRs which can put fund returns over high-water marks sooner in the fund life. Earlier investment ‘wins’ may lead some investment managers to realize incentive income sooner in the fund life, increasing the risk that those returns could be clawed back (returned to LPs) at a later date if fund investments ultimately underperform expectations. Additionally, there is a borrowing cost on the subscription facilities (albeit modest) that is borne by the funds which can make mediocre fund returns look modestly worse.
The report notes that if LPs don’t understand these cost & incentive dynamics, the fund sponsor’s reputation could suffer and may make it more difficult to raise capital in the future.
I confess that I haven’t spent a lot of time on the SEC’s rule proposal on M&A financial statement requirements, but I thought that there might be a few potential bombshells lurking in there. Sure enough, it looks like Wachtell Lipton found a big one. Here’s an excerpt from the firm’s recent memo:
Article 11 of Regulation S-X currently precludes inclusion of pro forma adjustments for the potential effects of post-acquisition actions expected to be taken by management. As explained in the SEC Division of Corporation Finance’s Financial Reporting Manual, “highly judgmental estimates of how historical management practices and operating decisions may or may not have changed as a result of that transaction” are “considered a projection and not an objective of S-X Article 11.”
The proposed amendments would replace the existing pro forma adjustment criteria with, among other things, “Management’s Adjustments” that would include “synergies and other effects of the transaction, such as closing facilities, discontinuing product lines, terminating employees, and executing new or modifying existing agreements, that are both reasonably estimable and have occurred or are reasonably expected to occur.” The proposed rules would require, for each Management’s Adjustment, “a description, including the material uncertainties, of the synergy or other transaction effects; disclosure of the underlying material assumptions, the method of calculation, and the estimated time frame for completion; qualitative information necessary to give a fair and balanced presentation of the pro forma financial information; and to the extent known, the reportable segments, products, services, and processes involved; the material resources required, if any; and the anticipated timing.”
For synergies and other transaction effects that are not reasonably estimable and will not be included in Management’s Adjustments, the proposed rules would require “that qualitative information necessary for a fair and balanced presentation of the pro forma financial information also be provided.”
What is it with everybody’s obsession with synergies these days? First the Delaware Supreme Court deducts them in appraisals and now the SEC wants them filed with your pro formas. The thing is, well, there’s usually a big problem with synergies, as another excerpt from Wachtell’s memo explains:
“Pro formas are an imperfect vehicle for communicating synergy predictions for many reasons, including the timing disconnect, the fact that synergies are not always a material element of transactions, and the practical reality that synergy targets identified upon transaction announcements are inherently uncertain and based on limited information exchanged during due diligence.”
In other words, even the best synergy estimates often include a fair amount of wishful thinking. That’s not a good place to be if the information in question is going to be included or incorporated by reference in a proxy statement or a 1933 Act filing.