Here’s an excerpt from this Fortune article:
“I think this ruling will put a substantial chill on activist-corporate team ups,” says John Coffee, a law professor at Columbia University. “The decision contained a sharp rebuke of Ackman’s tactics. My guess is Lipton is very happy they got that.”
What’s more, the judge making the ruling was in the 9th circuit court in California, which is not where key rulings in M&A cases get made, and therefore holds a little less sway when it comes to setting precedent. That’s usually the job of the 2nd Circuit Court of Appeals in New York for federal cases, or the Delaware court system, because that’s where many companies are incorporated, for state cases. Allergan has said it is going to appeal the ruling.
A look at Dykema’s “10th annual M&A Outlook Survey” shows that this year’s respondents remain cautiously optimistic about the economy and the M&A market, but they reveal interesting areas of growth and opportunity, such as:
– China’s drive to open itself up to foreign investment shows, with 45% of respondents expecting an increase in deals outbound from the U.S. to China (up from 22% last year).
– Privately-owned companies will be a core factor of future economic strength, with 82% of respondents expecting an increase in M&A.
– Cash, not economic growth, is the primary factor driving M&A activity—for the first time in two years—according to the survey.
And this survey include 10 years worth of observations, such as:
– In 2005: 51% of respondents had a positive/somewhat positive outlook about U.S. economy; 81% in 2014 saw the future of the M&A market with that same positivity.
– In 2014: 62% of respondents are positive about the U.S. economy; 59% feel the M&A market will be stronger next year.
– In 2005: Technology was the sector respondents felt would fuel the most M&A activity in the coming year.
– In 2014: Healthcare was overwhelmingly the sector respondents felt would fuel the most M&A activity next year.
Here’s news from Wachtell Lipton’s David Katz & William Savitt (and here’s the related WSJ article):
A federal district court today ruled that serious questions existed as to the legality of Pershing Square’s ploy to finance Valeant’s hostile bid for Allergan. Allergan v. Valeant Pharmaceuticals Int’l, Inc., Case No. SACV-1214 DOC (C.D. Cal. November 4, 2014). As we wrote about in April, Pershing Square and Valeant hatched a plan early this year attempting to exploit loopholes in the federal securities laws to enable Pershing Square to trade on inside information of Valeant’s secret takeover plan, creating a billion dollar profit at the expense of former Allergan stockholders that could then be used to fund the hostile bid. Since then, Pershing Square and Valeant have trumpeted their maneuver as a new template for activist-driven hostile dealmaking.
Today’s decision makes clear that the securities laws, and the equities that underlie the ban on insider trading, are not so easily evaded. Ruling on a motion for preliminary injunction brought by Allergan and one of its individual stockholders, Judge David O. Carter of the Central District of California held that there existed serious doubt as to legality of the Pershing Square-Valeant gambit. The judge refused to credit each of the defendants’ technical defenses to insider trading under Section 14(e) of the Securities Exchange Act, holding that Allergan had raised serious questions regarding both whether Pershing Square had taken “substantial steps” to commence a tender offer before it began its trading program and whether Pershing Square could possibly be an “offering person” exempt from the insider trading rules, given that it not purchasing stock in Valeant’s offer and is not bound to participate in Valeant’s offer. The court thus determined that Allergan and its stockholder had “raised serious questions going to the merits of their Rule 14e-3 claim” for insider trading. Judge Carter concluded that the practice was reminiscent of the practice of “warehousing” shares for the benefit of a hostile offer, which the SEC has disapproved as “unfair to investors who are trading at an information disadvantage.”
The Court also found serious questions as to the sufficiency of Pershing Square and Valeant’s public disclosures under Section 14(a) of the Exchange Act. Judge Carter enjoined Pershing Square from voting its shares at Allergan’s forthcoming Special Meeting unless and until it discloses “the facts underlying Defendants exposure to liability” for insider trading and other details of its conduct. The Court declined to consider more searching relief because he found that Allergan did not have standing under Rule 14e-3 (a finding now subject to appeal).
The District Court’s decision indicates that the Pershing Square/Valeant maneuver is not a sustainable blueprint for activist dealmaking. It is neither fair, nor legal, nor responsible corporate law, to allow activist investors to finance hostile takeovers on the strength of ill-gotten profits derived from inside information.
Here’s analysis from Chris Cernich, Head of ISS’ M&A and Proxy Contest Research drawn from ISS’ “M&A Edge Note“:
Statistically speaking, one of the worst strategies for buying a company is to push your hostile bid all the way to a vote of your target’s shareholders. In the past five years, only one hostile bidder which has gone all the way to a shareholder vote – CF Industries – walked away with the prize. In each of the other six contests – including the other one where, like CF, the bidder’s nominees were elected by shareholders – the target remained independent. But this much is already widely known. What is less well-known is how all this has worked out for the potential sellers – not the executives and directors who lead the “Just Say No” defense, but the shareholders themselves who, in five of these six cases, voted to continue saying No.
Measured on an absolute basis, the median cumulative Total Shareholder Return (TSR) for targets which remained independent through Oct. 20, 2014, following an M&A proxy contest was 50.4 percent. But absolute return is a naive view of the issue: the real question is what return shareholders might have had by redeploying their capital into the next best alternative to keeping the target standalone. Relative to those next best alternatives, it turns out, the median return to shareholders of saying No is profoundly negative.
Had shareholders in these six firms sold at the closing price the day before the contested meeting and reinvested in:
– the broader market, as through an S&P 500 Index fund, they would have earned at the median an additional 25.0 percentage points through Oct. 20, 2014; and
– the sector, through a group of close peers, they would have realized at the median an additional 78.4 percentage points through the same date.
In the case of all six of these targets, the underperformance relative to investors’ next-best alternatives began immediately after the show-me moment of the M&A proxy contest, and was generally sustained throughout the first one, three, six, and 12 months after the contested election. At the median, the six firms underperformed the broader market by 2.0, 7.1, 21.5, and 10.6 percentage points over these periods, respectively. Despite mitigating measures like post-contest buybacks, moreover, these firms generally posted negative absolute performance over most of those four measurement periods. Only a small amount of this underperformance appears to have been due to the sector in which they operated. The six targets underperformed the median of their peers, over the same four time periods, by 0.5, 8.4. 14.9, and 13.6 percentage points, respectively.
For the full period from the contested election through Oct. 20, 2014 (which ranged from 2.4 to 5.3 years), three of the six eventually recovered some ground versus the broader market performance. Only two of them – Illumina and AirGas – reversed the negative trend relative to the median of their peers.
What Differentiates Good Bets from Bad?
The conventional wisdom is that giving additional time to a board facing a hostile bid improves the outcome for shareholders. This makes some intuitive sense, if the board uses that time to better inform the market about sources of hidden value: ideally, the target board convincingly demonstrates higher intrinsic value to investors, or wins a more compelling offer after initially saying No, or both, without ever going to a contested vote. For those which do go all the way to a vote yet remain independent, however, the abysmal subsequent returns relative to shareholders’ next best alternatives suggest something in the process has gone awry.
The real question for shareholders looking at this data – or considering their voting strategies in upcoming M&A contests, such as the expected Dec. 18 special meeting at Allergan – is what differentiates the good bets from the bad?
Verifiable Scarcity Value Matters
In only one of the six cases was leaving the company standalone a clear homerun – though in the heat of the contested election, that may not have been so obvious from outside the boardroom. In 2012, Illumina, a leading equipment maker in the nascent DNA sequencing market, faced a hostile tender offer from Roche Holding. Approximately one-third of Illumina’s revenues came from the National Institutes of Health, but in the wake of the 2011 government shutdown, the ongoing uncertainty about the nature and extent of forthcoming federal budget cuts drove a steep decline in Illumina’s stock price. At the point of the shareholder vote, the $51.00 in cash per share which the hostile bidder was offering represented an 88 percent premium to the undisturbed price from six months earlier. It also appeared to represent significant premium when measured by traditional M&A metrics, such as LTM EV/EBTIDA multiples.
Illumina argued, however, that its true value was intimately tied to the development of the broader genetic sequencing market, which it contended was much closer to viability than Roche had argued. As much as the stand-alone strategy held risk for Illumina shareholders, moreover, the risk for Roche of not having Illumina – a market leader already on its way to ubiquity in the first sequencing market, and with all the beneficial network effects that implies – was likely still larger, and should thus drive a much headier valuation. Completely aside from its stand-alone prospects and valuation, Illumina argued, it had significant scarcity value for a strategic bidder–and for this bidder in particular.
The arguments about the potential addressable market, and particularly about the scarcity value of the asset, resonated with shareholders, who overwhelmingly rejected the bidder’s nominees. And though Illumina’s shares did not begin to outperform the next best alternatives – the S&P 500 and the median of its peers – for as much as a year, both arguments have since been borne out in the company’s operating results. As a consequence, saying No–and remaining invested in Illumina as a standalone entity over the subsequent two-and-a-half years – has delivered TSR of 304 percent, significantly outperforming the next best alternatives of the broader market (by 257 percentage points) and sector peers (by 247 percentage points).
Credibility on Business Dynamics Maters
Two years before Illumina, the board at AirGas, the largest U.S. distributor of industrial, medical, and specialty packaged gases, made a similar argument about scarcity value…
In her blog, Cooley’s Cydney Posner notes how Professors John Coffee and Larry Hamermesh recently testified at the SEC’s recent Investor Advisory Committee meeting about whether the SEC should get involved in the debate over fee-shifting bylaws. Here’s an excerpt from Cydney’s blog (and here’s a blog from John himself about it):
What is Coffee’s prescription for the SEC? Coffee suggests, unless the provision at issue expressly precluded application in cases involving the federal securities laws, that the SEC file amicus briefs in litigation arguing that these provisions are contrary to public policy as expressed in the federal securities laws and therefore any state law permitting them is preempted.
Meanwhile, Keith Bishop weighs in with a blog entitled “Why The SEC Should Stay Out Of The Fee-Shifting Charter Debate.” In addition, MoFo’s Bradley Berman blogs about how the SEC’s Investor Advisory Committee recommended that the definition of “accredited investor” in Rule 501(a) undergo some significant changes…
IPO Trends: “Loser Pays” Fee Shifting?
In this article, Alison Frankel of Reuters identifies this:
You’d better hope that the stock price is as solidly based as it seems, because if Alibaba’s officers and directors are engaged in fraud, shareholders will have a very tough time suing for their losses. That’s certainly what the company intends. On the very last page of its 38-page articles of association, Alibaba includes a provision stating that any shareholder who initiates or assists in a claim against the company must pay the company’s defense fees and costs unless shareholders win a judgment on the merits. This sort of “loser pays” fee-shifting is an exception to the general rule in the United States that each side bears its own costs of litigating – and it effectively precludes shareholder class actions suits because investors and their law firms don’t want to risk paying defendants’ legal fees.
In our “Minority Holders” Practice Area, we have posted a bunch of memos on the new KKR Financial opinion, including this one from Fried Frank, summarized below:
In KKR Financial Holdings LLC Stockholder Litigation, the Delaware Chancery Court has continued its march to the drumbeat of business judgment deference. In a putative class action by shareholders of KKR Financial (KFN), who were claiming breach of fiduciary duty by KFN’s board in having approved a $2.6 billion merger with private equity firm KKR, Chancellor Bouchard found that KKR had not been a controlling stockholder of KFN — because KKR held less than 1% of KFN’s voting power and had no right to appoint or remove directors or block board actions (even though KKR had “total managerial control” of KFN).
Thus, the Chancellor found, the KFN board had been free to exercise its judgment in determining whether to approve the merger. The Chancellor also found that KFN’s directors had been independent of KKR (even though they had been nominated by and had various ties to KKR); and that KFN’s merger proxy statement had provided for a fully informed stockholder vote. The court applied business judgment review and dismissed the case at the pleading stage. Moreover, the court indicated that, in a non-controller transaction, it will apply business judgment review if the transaction has been approved by disinterested, non-coerced stockholders in a fully informed vote, even if the directors approving the transaction had not been independent. The court can be expected to apply business judgment deference to board decisions whenever possible, apparently in an ongoing effort to combat the prevalence of stockholder litigation challenging M&A deals.
Here’s a Wachtell Lipton memo that went out last night from Eric Robinson & Sabastian Niles:
This morning, Institutional Shareholder Services (ISS) issued a note to clients entitled “The IRR of ‘No’.” The note argues that shareholders of companies that have resisted hostile takeover bids all the way through a proxy fight at a shareholder meeting have incurred “profoundly negative” returns following those shareholder meetings, compared to alternative investments. ISS identified seven cases in the last five years where bidders have pursued a combined takeover bid and proxy fight through a target shareholder meeting, and measured the mean and median total shareholder returns from the dates of the contested shareholder meeting through October 20, 2014, compared to target shareholders having sold at the closing price the day before the contested meeting and reinvesting in the S&P 500 index or a peer group.
A close look at the ISS report shows that it has at least two critical methodological and analytical flaws that completely undermine its conclusions:
– ISS’s analysis refers to Terra Industries as one of the seven cases in the last five years where a target had resisted a hostile bid through a shareholder vote on a bidder’s nominees, but the analysis then excludes Terra from its data analysis, by limiting it to targets that ultimately remained standalone. Terra is one of the great success stories of companies that have staunchly resisted inadequate hostile takeover bids, even after the bidder succeeded in electing three nominees to its board, and ultimately achieved an outstanding result for shareholders. As ISS notes, if the pre-tax cash proceeds of the final cash-and-stock offer for Terra had been reinvested in shares of the bidder, Terra shareholders would have seen a total return of 271% from the date of the initial shareholder meeting through October 20, 2014, significantly beating the S&P 500 Index and the median of peers by 181 and 211 percentage points, respectively. Had ISS properly included Terra in its analysis of “The IRR of ‘No’”, the mean return of the seven companies would have beaten the S&P index by 18.4 percentage points (compared to a shortfall of 8.7 percentage points when Terra was excluded) and beaten the ISS peer groups by 10.0 percent (compared to a shortfall of 23.6 percentage points excluding Terra).
– Of the seven cases discussed in the analysis, one was a micro-cap company with a market cap of $250 million (Pulse Electronics) and one was a nano-cap company with a market cap of $36 million (Onvia). The other five companies, including Terra, had market caps between approximately $2 billion – $8 billion, yet ISS treats them all equally. A market-cap weighted analysis would have had dramatically different results. Excluding the micro-cap and nano-cap companies from the analysis, the mean and median returns for the five companies (including Terra) exceeded the S&P Index by 65.4 percentage points and 1.4 percentage points, respectively, and exceeded the respective peer groups by 57.6 percentage points and 20.8 percentage points, respectively.
More broadly, the real world of corporate takeover practice demonstrates that prudent use of structural protections and “defensive” strategies provides boards – and shareholders – with the benefits of substantial negotiating leverage and enhanced opportunity to demonstrate that the company’s stand-alone strategy can deliver superior value.
Here’s news from Carol Bowie, Head of ISS Americas Research:
Some key developments this proxy season suggest that investor sensitivity is growing in regard to perceived windfalls accruing to executives in connection with change in control transactions. For one, this year’s majority supported shareholder proposals included four on the topic of equity vesting related to a CIC. Specifically, proposals at Gannett Co., Boston Properties, Valero Energy, and Dean Foods garnered support from 52.2 percent, 53.1 percent, 56.2 percent, and 60.6 percent of votes cast for and against, respectively, at their 2014 shareholder meetings.
That level of support is a first for this topic, and unprecedented since say-on-pay became the focus of investor concerns about compensation. Shareholder campaigns around the issue of CIC-related vesting, dating from 2010, have evolved from a focus on “double vs. single triggers” (i.e., requiring employment termination, rather than automatic vesting acceleration upon a CIC) to the current proposal language, which asks companies to permit only pro rata, rather than full, vesting of awards in connection with a transaction. The latest resolution has been submitted to a total of 22 companies so far this year, including the four cited above where it was backed by a majority of votes cast. Overall, the 20 proposals for which vote results are available at this writing have averaged 35.8 percent support this year.
At the same time, companies have been increasingly embracing the concept of “double-triggered” CIC related equity vesting–or at least providing an alternative to automatic full vesting as soon as a transaction occurs. ISS’ QuickScore data indicates that the proportion of S&P 500 companies adopting new equity plans that provide solely for automatic vesting declined from 48 to 28 percent from 2012 to 2014. While not as dramatic, the decline has also been significant at companies in the broader Russell 3000 index, where new plans with automatic vesting provisions slid from 55.5 to 42.9 percent over the same period. Instead, equity incentive plans are increasingly providing for the possibility of assumption or substitution of outstanding awards, with any accelerated vesting then linked to an executive’s subsequent employment termination.
While automatic vesting may be declining as “the norm,” many change-in-control transactions–all cash deals, for example–may nevertheless preclude the possibility of awards being assumed or substituted. Thus, investor focus appears to have gravitated to a campaign encouraging only pro rata vesting, based on time served by the executive, in order to avoid “windfall” compensation resulting from the change in control.
The issue remains in flux, but another vote result this year provides further evidence that–despite generally robust investor support for “say on golden parachute” proposals–sensitivity about CIC-related windfall pay remains high. At Time Warner Cable’s June 5, 2014, shareholder meeting, some 40 percent of votes cast opposed the company’s advisory vote on compensation, and compensation committee chair Peter R. Haje also received unusually high opposition–about 23 percent of votes cast for and against.
Given that TWC’s executive pay levels as of 2013 were aligned with company performance, the driver of that opposition is likely a decision made in anticipation of the company’s proposed acquisition by Comcast Inc., to accelerate, to early 2014, grants of long-term incentive shares that otherwise would not have been made to managers (including named executive officers) until 2015 and 2016. The “advance” awards also lacked any performance conditions. Vesting of this extra equity may fully accelerate upon a change in control with employment termination–that will likely enhance the golden parachute packages of many executives, including recently promoted CEO Robert P. Marcus, whose additional grants will contribute about $17 million of the $79 million in total benefits the company reported he could receive upon the merger. A pro rata vesting policy would, of course, curtail some of that and may be the message shareholders wanted to send.