A third-party “quality of earnings” study has become a fairly common part of the M&A due diligence process. This recent blog from the investment bankers at SRD Ventures says that commissioning such a study provides 3 major benefits to sellers – avoiding price re-negotiation, shortening the deal timeline, and positioning the business for the marketing process. This excerpt summarizes how a Q of E study can shorten a deal’s timeline:
– Most buyers will not engage their legal counsel to draft closing documents until the Q of E is complete because of the risk of uncovering something important that may jeopardize the deal.
– Nearly 40% of private equity deals in 2015 and 2016 have taken 15 or more weeks to close after the letter of intent because of financial due diligence issues that were not known prior to due diligence commencing.
– Q of E studies typically take around 30 days. Completing this concurrently with your investment banker’s process may eliminate altogether post-LOI delay.
– The cliché “time kills all deals” comes into play. Every day that a deal is under letter of intent is another day something could change in your business.
The blog notes that Q of E studies aren’t cheap – generally costing between $20K to $80K, depending on the company. However, it is important not to cut corners, because it is essential that the end product can withstand scrutiny from a skeptical buyer.
This Davis Polk memo discusses the whopping €124.5 million fine that the European Commission imposed on Altice for implementing its acquisition of PT Portugal without receiving required antitrust clearance. The memo says that the fine – which is the largest ever imposed – was meant to send a message:
The EC is clearly determined to impose high-value fines where a company has deliberately or negligently failed to notify a transaction reviewable under the EU Merger Regulation or has implemented a transaction before it has been cleared. Commissioner Vestager noted that companies that “implement mergers before notification or clearance undermine the effectiveness of our merger control system” and that the level of fine imposed in the Altice case “reflects the seriousness of the infringement and should deter other firms from breaking EU merger control rules.”
According to this MergerMarket report, megadeals made a strong comeback in 2017. PE played a big role in that resurgence, with PE funds or portfolio companies involved in 26 deals valued at $4 billion or greater. The report says that continued growth in megadeals is expected this year – and results so far suggest that this prediction is on-the-money.
Private equity remains a prominent player in these megadeals – as evidenced by Carlyle Group’s $12.5 billion acquisition of Akzo-Nobel’s specialty chemicals business. According to this Intralinks blog, there are two reasons behind the growth in PE megadeals:
Analysts say that the biggest drivers of today’s mega deals are cheap debt and a robust fundraising environment. Another factor relates to the natural evolution of PE, which is becoming more institutionalized and widespread—the inventory of PE-backed companies exceeded 12,000 as of 2017. The institutionalization has resulted in many large firms being able to successfully raise billion-dollar-plus vehicles for PE. It’s also important to note that limited partners are growing larger in size and need to commit larger sums to maintain allocations—and consequently those sums are going to the larger fund vehicles.
When high-profile issues emerge that have a potentially big bottom-line impact, you can usually count on specific reps & warranties about them finding their way into deal documents – even if they’re likely already covered by other more general reps. This recent Steve Quinlivan blog points out that the #MeToo movement is no exception.
Steve flags a handful of recent deals that have included reps addressing the absence of sexual harassment allegations against senior executives. This excerpt lays out a fairly detailed rep dealing with both settlements and the absence of allegations from Del Frisco Restaurant Group’s recent acquisition of Barteca:
Except as set forth on Schedule 2.12(j), none of the Barteca Entities is party to a settlement agreement with a current or former officer, employee or independent contractor of any Barteca Entity resolving allegations of sexual harassment by either (i) an officer of any Barteca Entity or (ii) an employee of any Barteca Entity. There are no, and since January 1, 2015 there have not been any Actions pending or, to the Company’s Knowledge, threatened, against the Company, in each case, involving allegations of sexual harassment by (A) any member of the Senior Management Team or (B) any employee of the Barteca Entities in a managerial or executive position.
This recent blog from Fox Rothschild’s Carl Neff reviews the Chancery Court’s decision last week to rely on a DCF analysis, instead of the merger price, in an appraisal proceeding. Here’s a excerpt:
In the recent decision of Blueblade Capital Opportunities v. Norcraft Company, Inc., C.A. No. 11184-VCS (Del. Ch. July 27, 2018), Vice Chancellor Slights found that “the evidence reveals significant flaws in the process leading to the Merger that undermine the reliability of the Merger Price as an indicator of Norcraft’s value.” Slip op. at 3. This is so because the Court found that there was no pre-signing market check, that Norcraft and its advisors “fixated on Norcraft and never broadened their view to other potential partners”, and that Norcraft’s lead negotiator “was at least as focused on securing benefits for himself as he was on securing the best price available for Norcraft.” Id.
Accordingly, the Court declined to rely upon deal price, but instead determined fair value by turning to the discounted cash low analysis presented by the parties, and “borrowed the most credible components of each expert’s analysis to conduct [the Court’s] own DCF valuation”. In so doing, the Court’s DCF valuation yielded a fair value of $26.16 a share, up slightly from the deal price at $25.50 a share.
While the plaintiffs didn’t exactly hit the jackpot, the Court’s decision is another indication that reports of DCF’s demise in appraisal proceedings are at least somewhat exaggerated.
Still, it wasn’t a good week or so for appraisal arbs – even DCF only got them a little more than a 2% bump in Norcraft. Worse, as this Seyfarth Shaw memo points out, the Chancery’s use of the merger price as a valuation guidepost in its subsequent decision in the Solera appraisal left them holding the bag with a valuation that, after deducting synergies, was 3% lower than the deal price.
This recent blog from Weil’s Glenn West is a reminder that asking for a pound of flesh in a commercial transaction can still buy you a lot of trouble – particularly if you choose the wrong state’s law to govern your deal. Usury laws are alive & well in many states, and this excerpt says that they’re extremely complicated to boot:
But it is important to note that it is not just the stated rate that can count as interest, any other compensation for the “use, forbearance or detention of money,” such as fees, grants of equity, the amount of any debt of others assumed, or just about any other contractually extracted consideration tied to the loan, might well be counted as interest too (although Texas has certain specified statutory exceptions for equity grants, loan assumptions and other common lender add-ons for certain specifically defined types of loans). And what constitutes a loan as opposed to an investment or purchase is a fact specific exercise. In general, any transaction that requires the absolute repayment of the funds advanced is subject to the risk of being re-characterized as a loan.
In light of this complexity, its important to choose your governing law carefully. As an example, the blog cites the Delaware Superior Court’s recent decision in Change Capital Partners Fund I, LLC v. Volt Electrical Systems, LLC, C.A. No. N17C-05-290 RRC (Del. Super. Ct.; 4/18). In that case, the Court rejected a challenge to a Delaware governing law provision in a receivables sale transaction that the plaintiff alleged was actually a loan – with a staggering 102% interest rate! The plaintiff contended that the transaction – which involved less than $2.5 million – should be governed by New York or Texas law.
Had the plaintiff succeeded in having the case governed by New York or Texas law, the transaction could have been recharacterized as a loan and may well have run afoul of either state’s usury laws. However, Delaware “provides no cap on interest rates, but instead allows interest to be charged in an amount pursuant to the agreement governing the debt.” Since that was the case – and because the Court ruled that Delaware law applied – there was no upside for the plaintiff in attempting to recharacterize the deal.
The blog says that there’s a particular lesson for PE firms, who often engage in small financing transactions with portfolio companies. Blindly calling for New York law to govern those arrangements can have severe consequences – including potential criminal liability – if the amounts involved are less than the $2.5 million cut-off for application of New York’s usury statute. It also points out that some states, such as Texas, have no upper limit on their usury statute. So, it suggests that Delaware – which does not have a usury statute – should be considered as a default option for these transactions.
Yeah, it sure would be nice if I could spell. Of course, it’s “usury,” not “usery”, as I originally spelled it throughout this – and thanks to the member who kindly tipped me off to my error.
This Paul Weiss memo discusses the Delaware Chancery Court’s decision in Olenik v. Lodzinski (Del. Ch.; 7/18), which addressesMFW’s requirement that a deal must be conditioned upon approval by an independent committee & an uncoerced majority of the minority shareholder vote “ab initio” – from the beginning. Here’s an excerpt:
MFW’s “ab initio” requirement mandates that the controller condition the transaction on final approval by the special committee and a majority of the minority stockholders “before any negotiations [take] place,” which is when a “proposal is made by one party which, if accepted by the counter-party would constitute an agreement between the parties regarding the contemplated transaction.” The Olenik opinion is particularly notable for helping to clarify this timing mandated by the ab initio requirement. While the court noted that, consistent with prior decisions, “ab initio” requires that the protections be in place at the outset of negotiations, it clarified that they may be agreed to after certain discussions between the parties that are merely “exploratory in nature.”
Here, Earthstone first included these conditions at the outset of negotiations in its first offer letter to Bold. The fact that Earthstone’s CEO engaged in discussions with EnCap and Bold before that point, however, was not fatal to the transaction’s satisfaction of the ab initio requirement. Although the court labeled these pre-offer discussions as “extensive,” they were not negotiations defined by “bargain[ing] toward a desired contractual end” and were “exploratory in nature.” Thus, the court found that the ab initio condition had been met.
As the memo notes, the Chancery Court’s decision is consistent with prior case law interpreting the “ab initio” requirement to apply once negotiations have commenced, but demonstrates the Court’s willingness to apply this requirement in a flexible manner.
Last fall, the DOJ formalized its corporate enforcement policy for FCPA violations – which provides strong incentives for voluntary corporate disclosure & remediation efforts. Earlier this month, the DOJ clarified that the policy extends to successor entities in M&A transactions. Here’s an excerpt from this Sullivan & Cromwell memo summarizing the application of the DOJ’s policy to successor entities:
During a speech delivered on July 25, 2018 at the American Conference Institute 9th Global Forum on Anti-Corruption Compliance in High Risk Markets, Deputy Assistant Attorney General Matthew Miner, who oversees the U.S. Department of Justice’s (“DOJ”) Fraud Section (which includes the DOJ’s Foreign Corrupt Practices Act (“FCPA”) Unit), announced that successor companies that identify potential FCPA violations in connection with a merger or acquisition and disclose that conduct to the DOJ will be treated in conformance with the DOJ’s FCPA Corporate Enforcement Policy (the “Policy”).
The Policy, which went into effect in November 2017, created a presumption that the DOJ would decline to prosecute a company for potential FCPA violations when the company has satisfied the Policy’s standards for voluntary self-disclosure, cooperation, and remediation (although the company still is responsible for paying any applicable disgorgement, forfeiture, and/or restitution), absent certain aggravating factors.
The memo points out that the policy does not represent a significant departure from prior DOJ practice when it comes to the FCPA liability of successor entities. The DOJ has long taken the position that a successor is generally responsible for FCPA liability incurred by a company that it acquires, but can reduce the risk of an enforcement action through voluntary disclosure, remediation and cooperation with authorities.
The DOJ’s position also highlights the importance of FCPA due diligence in connection with a potential acquisition and the need to take appropriate action based on the results of that due diligence.
In public company deals, target company equity awards are frequently converted into awards under the buyer’s equity plan, and new awards under the buyer’s plan are also often made to target executives who will be retained post-closing. This Hunton Andrews Kurth memo outlines exemptions under NYSE & Nasdaq rules that a buyer can use to make M&A related awards without putting a dent in the shares reserved under its shareholder approved equity plans. This excerpt addresses how shares available under the target’s plan can be used for post-closing awards:
The share reserve under a preexisting shareholder-approved target equity plan may be used for post-transaction grants without additional shareholder approval under certain circumstances. Shares available under such a preexisting plan may be used for post-transaction grants of acquiror equity awards (assuming the acquiror remains a publicly-traded company), under either the preexisting target equity plan or another plan (such as the acquiror’s equity plan), without further shareholder approval, under the following conditions:
– The shares must be available under a plan that was not adopted in contemplation of the M&A transaction.
– The number of shares available for grants is appropriately adjusted to reflect the M&A transaction.
– The time during which those shares are available for grant is not extended beyond the period when they would have been available under the preexisting plan absent the M&A transaction.
– The equity awards are not granted to individuals who were employed, immediately before the transaction, by the acquiror and such grants are therefore generally limited to grants to employees of the target and its subsidiaries who continue employment with the acquiror post-transaction.
The memo also outlines exemptions that would permit outstanding target equity awards to be converted into or replaced by awards denominated in shares of the buyer’s stock without shareholder approval.
In light of Papa John’s recent decision to adopt a “poison pill” rights plan targeting its founder, former chair & largest stockholder, Bloomberg’s Matt Levine has devoted a couple of columns this week to poison pills. His most recent column discusses the complexity of pills, and how that complexity has recently tripped up an investor looking to play hardball with a small cap company.
Like the Selectica situation almost a decade ago, the one Matt flagged involved an investor in a small cap company who decided to intentionally trigger the company’s pill. Unfortunately, this press release issued by the company – Tix Corporation – suggests that he didn’t understand what he was getting himself into. After buying shares that sent him above the pill’s threshold, the investor apparently issued a statement to the effect that “I/we dare you to proceed with the poison pill”; and, “if my estimates are correct, CEO Mitch Francis, you will dilute yourself out of control.”
This excerpt from the company’s press release points out that this isn’t how it works:
Mr. Bhakta’s correspondence clearly demonstrates no comprehension of how a shareholder rights plan operates and which shareholders risk having their ownership diluted. Under the Shareholder Rights Plan, every shareholder EXCEPT the acquiring person and its “group” has the right to purchase a significant number of new shares at a very low price. As a result, all shareholders who exercise their rights will protect and increase their proportionate ownership of the Company, while the acquiring person and his “group” would have their ownership percentage effectively wiped out. The issuance of so many new shares would also ensure that the acquiring person, in this case Mr. Bhakta and his group, would suffer significant financial losses on their investment.
It is important to note that the effect of a company activating a shareholder rights plan and issuing shares is so financially devastating to the acquiring person, that it has never been done in US history. No shareholder would ever deliberately trip a poison pill because their entire investment could be virtually wiped out.
That last paragraph is a bit of an overstatement, because people have triggered pills intentionally. In fact, pills were deliberately triggered on at least two other occasions in addition to Selectica – although the terms of those pills weren’t as formidable as those contained in more modern versions.
Harold Simmons technically triggered the “flip-in” provisions of NL Industries’ pill in 1986, by acquiring 20% of its shares, but that poison pill did not provide that merely crossing the ownership threshold would result in the dilution to the bidder. In 1985, Sir James Goldsmith acquired a controlling position in Crown-Zellerbach and triggered its pill, but because that pill contained only a flip-over provision, he was able to avoid dilution by refraining from a second-step transaction.
What’s more, one study actually suggests triggering a pill as part of a strategy to avoid its full impact in the event of a takeover, so not everybody thinks that the idea of triggering a pill is completely nuts. However, one thing that people didn’t really focus on until Selectica was that if you trigger a pill, the company’s not out of ammo – instead, it can just reload and blast you with round after round of dilution.
What am I talking about? After Selectica’s pill was triggered, it essentially reloaded its pill by promptly declaring a new dividend of preferred share purchase rights. As a result, any additional purchases by the investor would trigger another round of dilution. Since fractional preferred shares backstopped the pill, the company’s board could theoretically do the same thing over & over again. That’s the really toxic part of a poison pill.