M&A Update Bowne/PLI Securities Law Update December 11, 2006 Nicole E. Clark Bowne/PLI Securities...

M&A UpdateM&A Update

Bowne/PLI Securities Law UpdateDecember 11, 2006

Nicole E. Clark

Bowne/PLI Securities Law UpdateDecember 11, 2006

Nicole E. Clark

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This presentation is for general informational purposes and does not constitute legal advice.

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• Hedge fund activism

• Private equity club deals

• “Go-shop” provisions

• Tender offer best-price rules

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Hedge fund activismHedge fund activism

“Now, instead of being called a corporate raider, I’m an activist.”

— Carl Icahn

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From Raiders to “Activists”• 1980’s

– Takeover boom– Emergence of junk bond market for M&A finance– Corporate America mobilizes to repel corporate raiders– Creation of poison pill and rise of takeover defenses– Late ’80s market bust

• 1990’s– Demise of cash bids and hostile deals– Era of all-stock deals, synergy claims and MOEs– Emergence of corporate governance activism

• Anti poison pill resolutions• Antagonism to takeover defenses spreads among institutional holders

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From Raiders to “Activists”• Today

– Continued corporate governance activism• Continued success of anti-poison pill and board

declassification proposals• Majority voting proposals

– Hedge Funds emerge as the new M&A sharks– Marty Lipton, renowned adviser to corporate boards and

veteran of the takeover wars of the 1980s, lists “attacks by hedge funds” as the number one key issue for directors

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The Hedge Fund Market

• Over 8,000 hedge funds manage in excess of $1.2 trillion in assets – In 1990, approximately 500 hedge funds managed less than

$40 billion in assets– More money, but fewer opportunities for outsized returns– Intrigued by M&A and activism opportunities

• Hedge funds are largely unregulated– Recent attempts by the SEC to increase regulation have been

thwarted (See Goldstein v. SEC, 2006 WL 1715766 (D.C. Cir. June 23, 2006))

– Future of hedge fund regulation uncertain (SEC currently mulling its options)

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• General objective is to increase share value quickly

• Primary focuses of hedge fund activism– Changes in governance or financial policy

• Change in business strategy• Stock buyback or payment of dividends• Force divestitures• Changes in Board/management

– Opposition of overvalued M&A deals on the acquiror side– Push for better terms in M&A deals on the target side– Takeovers (convergence with private equity)

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Hedge fund activism — TacticsHedge fund activism — Tactics

Toehold investment •Acquisition of target stock•Overture to management to precipitate desired change or action

Publicity •If management is uncooperative, increase in ownership accompanied by 13D filing and possible other public disclosures

“Wolf pack” •Other hedge funds acquire stock in the target company and lend support

Escalation •Proxy fight to change the Board•Initiate litigation

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Hedge fund activism — “Success”Hedge fund activism — “Success”

• In 2005, the Altman Group tracked 20 instances of shareholder activism involving hedge funds and in 15 of those cases the target company conceded or was forced to accept to some degree the demands of the dissident shareholder.

• Hedge funds often enjoy support from ISS and institutional stockholders.

• Whether this “success” has generated long-term economic improvement is debatable.– Excluding activism surrounding the successful sale of a company, it

is not clear that hedge fund activism has resulted in significant long-term value creation for other stockholders.

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Hedge fund activism —Concerns for the target and its stockholdersHedge fund activism —Concerns for the target and its stockholders

• Conflicts of interest– The hedge fund may face conflicts if it is bidding to acquire

the company– The hedge fund may face conflicts as a result of its ownership

interest in multiple parties to a proposed transaction, particularly as a result of the derivative nature of interests held

• Short-term focus– Performance fees and other management incentives– Use of derivatives (e.g., vote buying)

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Hedge fund activism — Characteristics of potential hedge fund targetsHedge fund activism — Characteristics of potential hedge fund targets

Small to mid-cap company– Median market cap of targeted companies in 2004-2005 was

approximately $780 million according to 9/05 Citigroup study

Substantial pool of cash

Debt capacity

Undervalued assets, such as real estate

Underperformance relative to peers

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Hedge fund activism — Preventing and defending against attacksHedge fund activism — Preventing and defending against attacks

Investor Relations:

Monitor Investor Base:

• Be proactive• Maintain regular contact with

institutional investors (but be wary of Reg FD concerns)

• Monitor analyst and media reports

• Anticipate and respond to questions about performance and other concerns

• Review shareholder list and trading activity

• Review Schedule 13D/G filings and Section 16 filings

• Monitor HSR filings

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Hedge fund activism — Preventing and defending against attacks (cont.)Hedge fund activism — Preventing and defending against attacks (cont.)

Inform the Board:

Company Defenses:

• Regular updates on company strategy and operations and on the industry

• Review dividend policy and capital structure

• Review defensive mechanisms:– Staggered board– Poison pill– State business combination

statutes– Written consent thresholds– Special meeting provisions (e.g.,

advance notice provisions in by-laws)

– Special voting stock

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Hedge fund activism — Preventing and defending against attacks (cont.)Hedge fund activism — Preventing and defending against attacks (cont.)

Company responses to hedge fund approach• No duty to discuss, though the company may want to listen• No duty to disclose (unless leak from within), though disclosure

may be advisable• If no confidentiality agreement is signed (which likely will be the

case), do not share material non-public information• Keep the Board informed• Consider litigation

– 13D/G filing requirements– Section 16 filing and profit disgorgement requirements– “Group” status considerations– HSR filing requirements for investments in excess of $56 million if the

purpose is for control

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Private equity club dealsPrivate equity club deals

2006 is “Year of the Deal” according to Forbes:• Biggest year ever for global M&A, with deal volume soaring to

$3.4 trillion (beats previous record of $3.3 trillion set in 2000)• This year’s biggest theme is the leveraged buyout• Nine LBOs topping the $10 billion mark

(compared to three in 2005 and none in 2000)• Two Biggest LBO deals to date

(eclipsing KKR’s LBO of RJR Nabisco):– 11/06 $33 billion LBO of HCA by Bain, KKR and Merrill Lynch

– 11/06 announced $36 billion LBO of Equity Office by Blackstone

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Private equity club deals — Dramatic growth in U.S. private equity fundsPrivate equity club deals — Dramatic growth in U.S. private equity funds

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60

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100

120

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1995 1997 1999 2001 2003 2005

Capital raised(Dollars in billions)Source: Buyouts

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Private equity club dealsPrivate equity club deals

• Two or more private equity funds join together to purchase a company

• Club deals have become increasingly prevalent in the M&A market

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Private equity club deals — 2006 private equity club deals over $10 billionPrivate equity club deals — 2006 private equity club deals over $10 billion

Investment Buyers Value ($bn excl. debt)

HCA Bain, KKR, Merrill Lynch, Management $21.2

Clear Channel Communications (San Antonio-based)

Thomas H. Lee, Bain $18.7

Freescale Semiconductor (Austin-based)

TPG, Blackstone, Permira, Carlyle $17.6

Harrah’s – bid received 10/06 Apollo, TPG $15.5

Kinder Morgan (Houston-based)

Goldman Sachs, AIG, Carlyle, Riverstone, Management

$14.6

Univision Communications Madison Dearborn, Saban, Providence, TPG, Thomas H. Lee

$12.1

Albertson’s SuperValu, CVS, Cerberus $11.0

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Private equity club deals — Reasons underlying growth in club dealsPrivate equity club deals — Reasons underlying growth in club deals

• Deal Size– Company sizes are increasing

• Average S&P 500 market cap grew from $9 billion in 1995 to $21 billion in 2005

– Increase in competition for mid-size deals has driven increased interest for large deals

• Sharing of risks and burdens– Private equity funds generally have internal limits on investments in

any single transaction– Share costs of due diligence and failed deals

• Access to Financing– Pool relationships with financing resources

• Pooling Expertise– Industry expertise– Knowledge of local or foreign market

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Private equity club deals —Sell-side issues in club dealsPrivate equity club deals —Sell-side issues in club deals

• Balancing a need for consortiums to form in order to achieve necessary scale against a diminution in the number of bidders and increased deal uncertainty

• Use of confidentiality agreement to manage the process– Standstill– Restrictions on equity partnering without target consent– Restrictions on debt financing lock-up

• Buyer group may seek several (and not joint and several) liability amongst buyer group for breaches

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Private equity club deals —Buy-side issues in club dealsPrivate equity club deals —Buy-side issues in club deals

• Policing entry and exit of consortium members before a deal is signed

• Governance– Need to balance consensus against hold up value– Allocation of board seats– Exit strategies

• Club deals have not yet weathered a high-profile failure

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Private equity club deals —Financing outs and “reverse termination fees”Private equity club deals —Financing outs and “reverse termination fees”

• Background

– Large private equity deals historically had financing outs

– Merger agreement and shell company acquisition sub designed to insulate buy-out group from liability

– Sponsors sought to have buyers rely on their track record

– Over time, use of equity commitment letters increased

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Private equity club deals —Financing outs and “reverse termination fees” (cont.)Private equity club deals —Financing outs and “reverse termination fees” (cont.)

• Standard financing condition vs. “reverse termination fee” approach– There have been limited (SunGard) or no (Neiman Marcus,

Hertz) financing conditions in certain large club deals• Transaction agreement provides for an agreed upon

“marketing period” for obtaining financing• If financing not obtained, a reverse termination fee (often

equal to the break-up fee) is payable by the buyer and guaranteed by the private equity funds (on a several basis). In certain transactions, a higher fee is payable if the buyer is otherwise in breach.

• Reverse termination fee serves as a cap on damages well below the amount of the sponsors’ equity commitment

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Target Company Value of Transaction

Amount of “Reverse Termination Fee” (% of Transaction Value)

Buyer Potentially Liable Beyond Reverse Termination Fee?

Sungard Data Systems

$11.0 billion $300 million (2.73%) No – reverse termination fee exclusive remedy

Neiman Marcus Group

$5.1 billion $140 million (2.75%) Yes – buyer potentially liable up to $500 million (9.8%)

Hertz Corporation $5.6 billion $125 million (2.23%) Yes – buyer potentially liable up to $300 million (5.4%)

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• Issues

– Cannot divorce the willingness of private equity firms to contemplate limitations on financing conditions from the availability of very tight financing commitments

– If financing commitments fully cover all debt financing (including a bridge for the high yield) and have no incremental conditionality, is the removal of the financing condition in tandem with a liability cap more favorable to sellers or buyers?

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Go-shop provisionsGo-shop provisions

What is a “Go-Shop” provision?• A “Go-Shop” is a provision in a merger agreement involving a

change of control that permits a target to solicit competing bids for a specified period of time following the signing of the merger agreement.

• A go-shop provision is typically negotiated between the parties as protection for a target board subject to “Revlon” duties when the target has not engaged in a pre-signing auction.

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• A no-shop provision, in contrast, typically permits a target to receive only unsolicited competing offers. A traditional no-shop prohibits the target from providing confidential information to another bidder or negotiating with another bidder unless the competing bidder has made a proposal likely to lead to a superior deal.

• Typically, though not always, a no-shop provision is negotiated following at least some form (even limited) of market check.

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Duration: The go-shop periods typically range from 20-50 days. After expiration of the go-shop period, a traditional no-shop provision generally will prohibit the target from making further solicitations, but not prohibit the target from receiving unsolicited offers.

Limitations on Solicitations:

Typically, there are no limitations on the number of bidders that may be solicited, although there are exceptions.

Matching Rights: The first bidder often reserves the right to match or top the competing bid and almost always requires the target to keep it informed of negotiations with other bidders.

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Breakup Fees: A breakup fee typically is payable to the first bidder.

–In some cases, the breakup fee is discounted for bids received during the go-shop period. (In some cases, the breakup fee does not differ or differs only if the original deal is actually abandoned during the go-shop period.)Discounts typically are between 1/3 and 2/3.

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Recent Examples of Go-Shop Provisions

• HCA ($21.2 billion)• Freescale Semiconductor ($17.6 billion)• Kerzner International ($3.6 billion)• Maytag ($1.1 billion)

Despite the recent attention they have received, go-shop deals remain rare.

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• Maytag

– In May 2005, Maytag announced a $1.13 billion definitive merger agreement with Ripplewood, a private equity fund.

– Agreement provided for a 30-day go-shop provision. During this period, Maytag approached more than 100 potential acquirors and received a bid from a consortium that included a Chinese appliance maker and leading private funds. Whirlpool then lobbed in a $1.36 billion offer, which ultimately reached $1.7 billion. The Whirlpool agreement included a $120 million reverse breakup fee payable to Maytag if the deal did not receive antitrust clearance on terms satisfactory to Whirlpool.

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• Kerzner (Atlantis)

– On March 20, Kerzner International, the owner of the Atlantis resort in the Bahamas, announced an agreement to be acquired by an investor group for $3.6 billion. The merger agreement provided for a 45-day window-shop period. On May 1, the investor group raised its bid from $76.00 to $81.00 Bahamian dollars in cash, and Kerzner agreed to cease the shopping process.

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Pros:• Accelerated timing (most agreements require that the proxy be filed as promptly

as practicable)• Avoidance of potentially disruptive pre-signing auction• Avoidance of leaks• Increased certainty of deal

Cons:• The breakup fee may be a deterrent to competing bids• The go-shop period may not be sufficiently long enough to allow competing

bidders to perform adequate diligence and present their highest bid• Management allegiances

Open questions remain:• Do go-shop provisions result in increased shareholder value?• Do go-shop provisions deter litigation?

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Tender offer best price rulesTender offer best price rules

• SEC adopted amendments to the “best price” rules to clarify that the rules apply only to consideration offered and paid for securities tendered.

• Effective Date: December 8, 2006• Amendments include:

– Change in language of rules

– Exemptions for employment compensation, severance or other employee benefit arrangements

– Safe harbor that permits the compensation committee or other independent committee to approve such arrangements

• Result: acquiring companies are more likely to consider using tender offers instead of statutory mergers that also involve such arrangements

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Tender offer best price rules ―BackgroundTender offer best price rules ―Background

• Before these amendments, the best price rules required that the “consideration paid to any security holder pursuant to the tender offer is the highest consideration paid to any other security holder during such tender offer” (emphasis added).

• Source of significant litigation – Plaintiffs have alleged violations when bidders have implemented or

assumed employee compensation, severance or other employee benefit plans in connection with tender offer acquisitions

• Additional risk and uncertainty– Courts have been split between “bright line” and “integral part” tests

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Tender offer best price rules ―Amendments to the rulesTender offer best price rules ―Amendments to the rules

Amended language (emphasis added):

The consideration paid to any security holder for securities tendered in the tender offer is the highest consideration paid to any other security holder for securities tendered in the tender offer.

The SEC believes that the replacement of the phrases “pursuant to the tender offer” and “during such tender offer” with the phrase “for securities tendered in the tender offer” will clarify that other arrangements that are not payments for tendered securities should not be considered.

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Tender offer best price rules ―Exemptions for compensatory arrangementsTender offer best price rules ―Exemptions for compensatory arrangements

• Specific exemption for consideration offered and paid pursuant to employment compensation, severance and other employee benefit arrangements that are entered into with the security holders of the subject company.– Not limited to employees and directors

• Two-part test:– paid or granted as compensation for past services performed, future

services to be performed, or future services to be refrained from performing, by the security holder (and matters incidental thereto); and

– is not calculated based on the number of securities tendered or to be tendered in the tender offer.

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Tender offer best price rules ―Safe harborTender offer best price rules ―Safe harbor

An arrangement will be deemed to be subject to the exemption if approved by certain independent directors of the subject company’s or, in certain circumstances, the bidder’s board of directors.

• Third-party tender offers ―arrangements should be approved by:– Compensation committee (or a committee performing similar

functions) of the subject company; or– If the bidder is a party to the arrangment, the compensation

committee (or a committee performing similar functions) of the bidder.

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Tender offer best price rules ―Safe harborTender offer best price rules ―Safe harbor

• Issuer tender offers ―arrangements should be approved by:– Issuer’s compensation committee (or a committee performing

similar functions).

• If no compensation (or similar) committee or if none of the members are independent, the safe harbor allows establishment of a special committee of independent directors.

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Tender offer best price rules ―Provisions not adoptedTender offer best price rules ―Provisions not adopted

• Other types of commercial arrangements:– No express exemption– SEC stated that this does not raise any inference that

payment under any such other arrangement constitutes consideration paid for securities in a tender offer

M&A Update Bowne/PLI Securities Law Update December 11, 2006 Nicole E. Clark Bowne/PLI Securities...

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