The Perfect Private Equity Deal

The perfect deal, that’s what many private equity firms are searching for.  That’s, a buyout of a company with years of stable to growing free cash flow, moderately high and defensible profit margins and a management team right out of central casting.

The competition for those perfect deals is intense and results in private equity groups paying relatively high prices to win.  My colleague, Randy Schwimmer, author of the online newletter, “The Lead Left” reports the latest statistics in this excerpt from his recent issue:

Excerpt

For one thing, total leverage seems again to be reaching radioactive levels. Thomson Reuters LPC reports total debt to EBITDA for middle market institutional buyouts “skyrocketed” to 6.5x for the third quarter. Admittedly, that’s on a relatively small sampling, but the statistic points to a broader trend.

Higher leverage is being driven by similarly gravity-defying purchase price multiples. Of the four middle market LBOs where information is available, all were over 12x, and three were over 15x. This speaks to the fierce competition for new properties being engaged in by both private equity and strategic corporate buyers.

How long this lasts is anyone’s guess.   But, while it lasts, if your company fits the criteria, you might consider a sale.

To read “The Lead Left”, a subscription newsletter, click here.

M&A Deal Term Study by Practical Law

CvrImgPractical Law, the Thomson Reuters online resource for corporate legal information, produced its yearly study of M&A deal terms.

Practical Law also produced a valuable webinar describing a portion of its survey results.

This material is most useful for M&A professionals but may also be helpful to corporate executives active in M&A.

Click here to go to the webinar at Practical Law.

Click here to go to Practical Law to review their service offerings.

 

Court Finds Conflicts in Rural/Metro Sale

WarningSignThe Delaware Court of Chancery has found the Board of Directors of Rural/Metro Corporation breached its fiduciary duties to its shareholders in its 2011 sale.  The Court also found the company’s lead adviser liable for aiding and abetting the breach.

The Rural Board was subject to undisclosed conflicts and failed to probe the company’s lead adviser for additional potential conflicts.

This case and prior high profile cases of conflict, such as the Del Monte and El Paso cases, should alert boards to be vigilant.

Click here to go to an article by White & Case, the law firm on JDSupra, the online legal magazine or click on the download button below.

Take Privates with Control Shareholder Rules Clarified

Taking a public company private when this involves a control shareholder has always been fraught with potential conflicts and litigation risk.

Recently, the Delaware Supreme Court upheld a Chancery Court decision setting the conditions under which a board of directors’ decision on a take private transaction with a control shareholder would be evaluated using the business judgement rule.

Katten Muchin Rosenman, the law firm, posted an article on JDSupra, the online legal magazine on this case.  Article excerpt:

In upholding the Chancery Court’s decision, the Delaware Supreme Court held that the business judgment standard of review would apply to a going private acquisition by a controlling stockholder if, but only if, the following facts were established: (1) the controlling stockholder conditioned the transaction on the approval of both a special committee, and a majority-of-the-minority stockholders; (2) the special committee was independent; (3) the special committee was empowered to freely select its own advisors and to say no definitively; (4) the special committee acted with care; (5) the minority vote was informed; and (6) there was no coercion of the minority.

Click here to read the article on JDSupra, by attorneys at Katten Muchin Rosenman LLP.

Click here to read an article on JDSupra by attorneys at Perkins Coie.

Click here to read an article on JDSupra by attorneys at Fenwick & West.

Also, another recent case in the Delaware Chancery Court spells out procedural rules and implications for the parties if there are any defects in the process.

Lathm & Watkins, the law firm, offers the following helpful analysis and recap of the case.  Additional articles from Latham & Watkins are available on its website, www.lw.com.

 

March 2014

 

 

In re Orchard Enterprises, Inc. Stockholder Litigation,
C.A. No. 7840 (Del. Ch. Feb. 28, 2014)

 

 

 

Delaware Court of Chancery applies entire fairness review to a take-private merger with a controlling stockholder, despite approval by a special committee and a majority-of-the-minority, and holds that disclosure claims may give rise to post-closing money damages where the duty of loyalty is at issue.

 

Summary

The Delaware Court of Chancery largely denied summary judgment, thereby paving the way for trial on the merits of a take-private merger in which the common stockholders of The Orchard Enterprises Inc. were cashed out by Orchard’s controlling stockholder. In a 90-page opinion, Vice Chancellor Laster found “evidence of substantive and procedural” unfairness in the process and price negotiated by a five-member special committee of directors and approved by holders of a majority-of-the-minority of the stock. The Court declined to apply business judgment review — or even shift the burden of persuasion under entire fairness review — in light of evidence that the structural protections outlined in In re MFW and CNX Gas may have failed to operate effectively to protect the interests of the minority stockholders.

The controlling stockholder, Dimensional Associates, LLC, held 53 percent of the voting power of Orchard through ownership of 42 percent of the common stock and 99 percent of the Series A convertible preferred stock. In October 2009, Dimensional made a proposal to buy out Orchard’s minority stockholders for $1.68 per share in cash. Orchard’s Board formed a five-member Special Committee, which was fully authorized to negotiate with Dimensional and potential third-party bidders and to hire independent legal and financial advisors. The Court of Chancery found evidence that the lead Special Committee director was neither independent nor disinterested in light of his long-standing relationships with family members of Dimensional’s founder and his solicitation of a post-closing consulting engagement with Dimensional.

Valuation of Dimensional’s Series A was a pivotal fact in the Court’s analysis. The Special Committee’s financial advisor preliminarily valued the common stock at $4.84, based on total equity value divided by the outstanding common stock — and assuming that the Series A would be converted to common stock and participate on a pro rata basis. This assumption effectively valued the Series A at about $7 million. Allegedly at the direction of the Special Committee, the financial advisor later changed its approach and valued the Series A based on a $25 million liquidation preference. The Court of Chancery found that, although Orchard’s charter entitled the Series A to a $25 million liquidation preference in a dissolution, asset sale or sale to third-party, none of these circumstances applied to a take-private transaction with Dimensional. Nonetheless, the price negotiation reflected Dimensional’s bargaining leverage given the unlikely scenario that any third party would value Orchard high enough to pay the $25 million Series A preference and pay a price for the common stock that would be undiminished by the preference payment.

Orchard’s public announcement of Dimensional’s initial proposal of $1.68 per share led to third party interest and generated a higher offer by a third party. Dimensional assured the Special Committee that Dimensional would be willing to support a sale to a third party if it received the full liquidation preference. The Special Committee allowed Dimensional to negotiate directly with the third party and at least one other bidder — but no deal was reached. The Court of Chancery found evidence that Dimensional may have misled the Special Committee by negotiating with the third parties for a premium above the Series A liquidation preference.

Meanwhile, in the negotiations between the Special Committee and Dimensional, Dimensional offered $2.10 per share without a majority-of-the-minority approval condition, but eventually agreed on a price of $2.05 per share with a go-shop and a majority-of-the-minority condition. The Special Committee’s financial advisor issued an opinion that the price was fair from a financial point of view to Orchard’s common stockholders — but the advisor assumed that the Series A should be allocated $25 million of the equity value of Orchard with the rest allocated to the common stock.

Orchard’s proxy statement recommended approval of the merger and of an amendment to the Series A Certificate to enable the merger (which otherwise would have prohibited a change of control via a take-private transaction with Dimensional). In July 2010, holders of a majority of the common stock not controlled by Dimensional approved the merger and the transaction closed. After closing, certain stockholders brought an appraisal action. In 2012, then-Chancellor Strine of the Court of Chancery (now Chief Justice of the Delaware Supreme Court) ruled that the merger did not trigger the Series A liquidation preference and appraised the common stock at $4.67 based on an assumed pro rata participation by the Series A on an as-converted basis. Two months later, other stockholders brought a class action challenging the process and price of the transaction.

Vice Chancellor Laster issued a 90-page opinion analyzing issues presented in dueling motions for summary judgment brought by plaintiffs and defendants.

The Court granted summary judgment to the plaintiffs on their claim that the proxy statement contained materially misleading disclosures regarding whether the merger triggered the Series A liquidation preference. The Court found that the proxy statement incorrectly stated in two places that the liquidation preference would be triggered unless the amendment was approved. One of those incorrect disclosures was material as a matter of law because the inaccuracy appeared in the description of the amendment to the Series A Certificate, which is a statutorily required disclosure under Section 242(b)(1) of the Delaware General Corporation Law (DGCL).

The Court also granted summary judgment to the plaintiffs on their arguments that the entire fairness standard of review should apply at trial, finding that Dimensional’s failure to agree at the outset to approval by both the Special Committee and a majority-of-the-minority precluded review under the business judgment rule. Furthermore, the Court held that neither of those protective measures, even though ultimately deployed, warranted shifting the burden of persuasion from defendants to plaintiffs because (a) the stockholder vote was tainted by the disclosure violation and (b) plaintiffs had raised triable issues of fact as to the integrity of the Special Committee process, including the issues with the chairman described above.

The Court of Chancery rejected the Special Committee members’ argument that they were automatically shielded from liability by the DGCL § 102(b)(7) exculpation clause in Orchard’s certificate of incorporation. That provision only immunizes directors for breach of the duty of care. Given the context of a controlling stockholder transaction subject to entire fairness review, where there was evidence of both procedural and substantive unfairness, the Court was unable to conclude, as a matter of law, that the evidence did not also implicate the duty of loyalty for all directors. Therefore, the four members of the Special Committee whose independence and disinterestedness had not been challenged by the plaintiffs were also required to prove at trial that they did not breach their duty of loyalty and were entitled to exculpation.

Finally, the Court of Chancery denied defendants’ argument that rescissory damages and quasi-appraisal damages were unavailable, finding that both measurements were possible given the failure to fully inform the stockholder electorate. (Rescissory damages is the monetary equivalent of rescission; quasi-appraisal damages is essentially monetary damages tied to the difference in equity value resulting from the non-disclosure.) The Court also rejected the defendants’ argument that In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008) barred any post-closing claim for money damages for a disclosure violation, finding that a money damages claim is possible where the disclosure violation implicates the duty of loyalty, or where plaintiffs can otherwise prove reliance, causation, and calculable damages.

 

Implications for our Clients

 

·         To obtain business judgment review of a transaction with a controlling stockholder, it is critically important that procedural safeguards be established before substantive negotiations begin.

o    The controlling stockholder must agree at the outset to condition any transaction on approval by an independent special committee and the affirmative vote of a majority-of-the-minority of stockholders (these cannot be “deal points” to be negotiated).

o    Unless both of these procedural safeguards are implemented at the outset (even if both are implemented ultimately), the most the parties can obtain is entire fairness review with a shift in the burden of persuasion to the plaintiffs (business judgment review will not be available).

·         Where entire fairness review applies, if there is “evidence of procedural and substantive unfairness,” the exculpatory provision in a company’s charter does not automatically protect even facially independent and disinterested special committee directors from potential liability for breach of the duty of loyalty; rather, each director must establish at trial that he or she is entitled to exculpation.

·         Evidence that the special committee chairman was not independent and acted in self-interest may require other facially independent and disinterested special committee members to defend their own conduct.

o    Special committee membership must be vetted carefully for potential conflicts of interest and lack of independence; if warranted, the special committee should be re-constituted.

o    Directors considering special committee service should pay careful attention to the conflicts and independence of other possible committee members when considering whether to accept the committee appointment.

·         Under entire fairness review, post-closing damages may be awarded if disclosures to stockholders in the solicitation of majority-of-the-minority approval contain material inaccuracies.

o    Further, even in arms-length third-party merger cases, post-closing damages may be available for materially misleading disclosures, subject to plaintiff’s proof of reliance, causation and quantifiable damages.

o    This may lead to a reduction in pre-closing settlement of merger cases based on disclosures, or an increase in the cost of those settlements.

·         The decision may be appealed eventually, and it is possible that certain of the holdings, particularly those concerning the availability of exculpation for facially conflict-free and independent directors and of money damages for disclosure claims post-closing, may be considered further.

 

Discussion

Delaware Court of Chancery precedent has established that the business judgment rule can apply to squeeze-out mergers by controlling stockholders where certain procedural safeguards are adopted. In re CNX Gas Corporation Shareholders Litigation, 4 A.3d 397 (Del. Ch. 2010), established that a transaction with a controlling stockholder may be subject to deferential business judgment review if the transaction is conditioned on approval by an independent special committee and by a majority of the minority stockholder vote. In re MFW Shareholders Litigation, 67 A.3d 496, 502 (Del. Ch. 2013), clarified that, to obtain business judgment review, the special committee must have authorization to negotiate and the controlling stockholder must agree to the dual independent approval process up front, before beginning negotiations.

 

In re Orchard reiterates this timing requirement when attempting to secure business judgment protection for a transaction with a controlling stockholder. Although the transaction ultimately was approved by a special committee vested with the authority to negotiate, and by a majority–of-the-minority stockholder vote, the Court of Chancery declined to apply the business judgment rule because the controller did not agree up-front to both of those protections (and, indeed, used the majority–of-the-minority approval as a deal point to reduce the purchase price). In re Orchard confirms (resolving a question left open by CNX Gas and In re MFW), however, that the burden of persuasion may be shifted from the defendants to the plaintiff under the entire fairness standard if a controller agrees to one but not both protections. While a shift in the burden of persuasion is commonly viewed as an inferior procedural benefit because it does not obviate a potentially costly and time-consuming post-closing trial on the merits, a shift in the burden still may be valuable to defendants by incentivizing plaintiffs to settle before trial.

 

The decision also concludes that, in a controlling stockholder transaction subject to entire fairness review, an exculpatory clause in the company’s charter under DGCL § 102(b)(7) does not automatically shield even facially independent and disinterested directors from potential liability where there is evidence of procedural and substantive unfairness indicating a breach of the duty of loyalty. A trial is required to determine whether the transaction was entirely fair, and, if it was not, then an analysis on a director-by-director basis at trial is required to determine whether they committed any breach of loyalty. In re Orchard thus diminishes the opportunity for dismissal of facially independent and disinterested directors at an early stage in merger litigation (and increases the potential cost and hassle of service on a special committee). While DGCL § 102(b)(7) remains a strong substantive protection for directors who can reap the benefits of its protection at trial—even when the transaction was not entirely fair — In re Orchard meaningfully increases the risk that otherwise “clean” Special Committee members may need to bear the burden of preparation for and participation in a trial, as well as the associated reputational risks.

 

Finally, the Court held that monetary damages for alleged disclosure deficiencies in soliciting stockholder approval may continue to be available even after a merger closes. Although injunctive relief to correct disclosure deficiencies may be granted before a merger vote in order to prevent “irreparable harm” the Court rejected defendants’ inference that there can be no post-closing “remedy” in the form of monetary damages. However, plaintiffs who assert post-closing disclosure-based claims must still prove reliance, causation and quantifiable damages.

 

If you have any questions about this M&A Client Alert, please contact one of the authors listed below
or the Latham attorney with whom you normally consult:

 

Stephen B. Amdur

Mark G. Gerstein

Rachel J. Rodriguez

Blair Connelly

Pamela S. Palmer

Bradley C. Faris

Sarah M. Lightdale

 

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Recent Revlon Ruling Reaffirms Rules

In a recent New York Superior Court decision applying Delaware Law, the court held that what are known as the “Revlon Duties” do not apply in a stock for stock merger where there is no true change of control.

In the specific case, the stock merger resulted in a combined corporation in which there was no controlling shareholder, only a larger group of non-controlling shareholders.  This was key to the decision as the language of the court decision makes clear:

“In the context of a stock-for-stock merger, a change of control for Revlon purposes can be triggered if the target’s shareholders are relegated to a minority in the resulting entity, and the resulting entity has a controlling stockholder or stockholder group. Where, however, ownership of the merged company will remain in “a large, fluid, changeable and changing market,” Revlon is not implicated.”(1)

Rather than holding the corporation’s board’s decision to approve the merger to the standards in “Revlon”, the board’s decision was held to the standards of the business judgement rule which defers to the judgement of the board if it acts in an informed basis, in good faith, and in the honest belief that its actions are in the best interests of the company.

Click here to read ReedSmith, the law firm’s, post on this decision.

(1) Badowski, at *7 (citing, inter alia, Arnold v. Society for Savings Bancorp. Inc., 650 A.2d 1270, 1290 (Del 2009); Smurfit-Stone Container Corp. S’holder Litig., No. 6164-VCP, 2011 WL 2028076, *12 n. 92 (Del Ch. May 24, 2011)).

New Tender Offer Rules Working

Companies are taking advantage of the new tender offer rules to avoid a time-consuming and costly second step merger.  As Brad Farris, attorney with Latham & Watkins, described on a panel reviewing tender offers done since the new rules were permitted.

For background on the issue, please click here to review my prior post.

For a summary of the recent panel including Brad Farris’ remarks, click here.

 

 

M&A Trends In 2013

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com – 

Stats now confirm what many of us in the M&A business have recognized for some time (link).  Middle market M&A activity has gotten stronger over the last several quarters.

The stats that I mention are courtesy of Mergermarket, the well-regarded source for M&A data.  Mergermarket reports that middle market M&A value is up 40% so far in 2013 vs  the same period last year as reported in its “Q1-Q3 M&A Trend Report”.

Stats like these are valuable but they’re a lagging indicator of deal activity because M&A projects typically take months from initiation to completion.   This report captures M&A deals that closed during this last three quarters ended September 30, 2013.  Companies embarked on those projects many months before, many in 2012, for example.

Now, another point to consider.  The fourth quarter of last year was a very strong quarter for M&A deals because deals  closed in 2012 qualified for favorable tax treatment. So the full year 2013 results may not show such a dramatic increase because last year’s fourth quarter was such a big M&A quarter.

I think the trend of increasing middle market M&A activity will continue; the conditions driving the trend remain favorable.

I’ve attached a link to the Mergermarket report below.

Please contact me to help your company to successfully complete an M&A deal or any capital market project.

Click here to go to the Mergermarket Q1-Q3 M&A Trend Report

CoverImage
  Google

Tender Offer Rule Fix Webinar

Delaware has modified its tender offer rules to streamline the second step merger process as I described in my post, Tender Offer Rule Fix.

Latham & Watkins hosted a valuable webinar on this topic recently with the replay available below.

The link to the sign up page and a description of the webinar are presented below.

Sign up link.

A Complimentary 60-minute Webcast

Amendments to Delaware Merger Statutes:
An Arrow in Your Quiver, Not a Silver Bullet

Program

The Delaware State Bar Association recently proposed amendments to the Delaware General Corporation Law (DGCL) intended to facilitate the use of tender offers in acquisitions of publicly traded corporations. If adopted, these amendments will, in many circumstances, permit the purchaser of a simple majority of a target’s outstanding shares (as opposed to the current 90 percent threshold) to effect a short-form merger immediately, saving substantial expense, eliminating the delay associated with SEC review of disclosure materials and facilitating financing for leveraged transactions.

 

Registration

 

Click here to register for this webcast. A confirmation message will be sent to your email address with instructions for logging on to the webcast.

 

In this 60-minute webcast, we will explore the intended benefits of the proposed amendments, why they represent a positive step in the recent evolution of tender offer practice, and what private equity firms in particular need to consider regarding this transaction structure.

 

Speakers
Michael Allen, Director, Richards, Layton and Finger

David S. Allinson, Partner, New York
Bradley C. Faris, Partner, Chicago
Timothy P. FitzSimons, Partner, Chicago
Howard A. Sobel, Partner, New York

Questions

For more information and questions about this event, please contact Michele Bravo at michele.bravo@lw.com or +1.213.892.3054.

Sponsors

Latham & Watkins LLP is a leading global law firm dedicated to working with clients to help them achieve their business goals and overcome legal challenges anywhere in the world. The firm has earned considerable market recognition based on a record of landmark matters and a unified culture of innovation and collaboration. From a global platform of offices covering the world’s major financial, business and regulatory centers, the firm’s lawyers help clients succeed. For more information, visit www.lw.com.

Google

Tender Offer Rule Fix

Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com –

Delaware is pro-actively modifying the rules for friendly tender offers for public companies to streamline the process.

The proposed rule change would eliminate the need for a formal second step merger vote if the tender offer achieves the corporation’s merger threshold but doesn’t get to 90%, the squeeze out threshold.

Under current rules, the company must hold a time-consuming formal merger vote, which is a “fait accompli” because passage is certain, the buyer has the votes.

Elimination of the time-consuming formal second step merger vote will help financial and other buyers that use debt financing supported by the acquired company.

There still remains a technical timing issue that makes it difficult to hold a same day closing of the tender offer and second step merger.

This rule change, however, is a definite improvement.  It is expected to be effective in August of this year.

I’ve included several helpful articles in my post at Capital Market Alerts for more background on this topic.

Please contact me to help your company to complete an M&A transaction or any capital markets project.

Background articles and links are included below:

Harvard Law School Forum

Proposed Amendments to Delaware Law Would Facilitate Tender Offer Structures

Posted by Igor Kirman, Wachtell, Lipton, Rosen & Katz, on Thursday April 4, 2013 at9:25 am
Editor’s Note: Igor Kirman is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz, where he focuses on mergers and acquisitions, corporate governance, and general corporate and securities law matters. This post is based on a Wachtell Lipton firm memorandum by Mr. Kirman, Victor Goldfeld, and Edward J. Lee. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

The Delaware bar has recently proposed an amendment to the Delaware General Corporation Law that is likely to facilitate the use of tender offer structures, especially in private equity deals. The new proposed Section 251(h), which is expected to be approved by the legislature and governor with an effective date of August 1, would permit inclusion of a provision in a merger agreement eliminating the need for a stockholder meeting to approve a second-step merger following a tender offer, so long as the buyer acquires sufficient shares in the tender offer to approve the merger (i.e., 50% of the outstanding shares, unless the company’s charter provides a higher threshold).

Currently, a two-step merger in which the buyer acquires less than 90% of the target’s shares in the first step tender offer (which would allow it to close the merger almost immediately by the use of Delaware’s short-form merger statute) necessitates stockholder approval of the merger, with its attendant delays and a “fait accompli” stockholder vote. As such possible delays have proved to be a significant deterrent to many tender offers, especially those with private equity buyers who need to close on the first and second steps concurrently in order to facilitate their acquisition financing, the market has evolved a workaround in the form of a “top-up” option. When included in a merger agreement, a top-up option permits the buyer to “top-up” its stake with newly issued shares to reach the required 90% short-form threshold. However, due to the extremely dilutive effect of the top-up issuance, a target company may lack sufficient authorized but unissued shares to ensure that the buyer reaches the needed 90% threshold, thus adding deal uncertainty. To deal with such circumstances, buyers and targets have resorted to other imperfect workarounds, for example a “dual-track” structure in which the parties file a proxy statement while the tender offer is pending (in order to start the clock on SEC review of the proxy statement), and switch to the merger process if the tender offer fails.

The proposed amendment simplifies this landscape by eliminating the need for top-up options and “dual-track” structures in most cases, and also would diminish the use of subsequent offering periods. Although there may be questions about whether the new mechanism will provide incentives for some deal opponents to not tender, since there would be no comparative “cost” to doing so on account of there being no delay in receiving the merger consideration, the changes are expected to facilitate tender offers. The proposed amendment also illustrates the State of Delaware’s commitment to revise its corporate laws to ensure they remain state-of-the-art as inefficiencies are identified through an evolving deal landscape.

Link to Harvard Law School Forum: http://blogs.law.harvard.edu/corpgov/2013/04/04/proposed-amendments-to-delaware-law-would-facilitate-tender-offer-structures/#more-43166

King & Spalding’s Public Company Practice Group, May 30, 2013

King & Spalding’s Public Company Practice Group periodically publishes the Public Company Advisor to provide practical insights into current corporate governance, securities compliance and other topics of interest to public company counsel.

Recent M&A Developments

1.   Tender Offers

Due largely to their timing advantages, tender offers have been used by strategic and
financial buyers in numerous transactions to acquire control of public companies.   It is unclear, however, whether tender offers will continue to be a popular transaction structure, at least when debt financing is required.   On the one hand, recent developments in Delaware law with respect to “top-up options” should simplify tender offers and promote their use.   On the other hand, a renewed focus by the U.S. Securities and Exchange Commission (the “SEC”) on financing conditions in tender offers may make these structures more complex when an acquirer needs to obtain financing to complete a transaction.

a. Top-Up Options

Top-up options (which permit a purchaser to acquire newly issued shares of a target in
order to consummate a “short form” merger without a shareholder vote immediately after the completion of a tender offer) have been used in most tender offers in recent years.   Although top-up options have been upheld by the Delaware courts and are an effective way to shorten a transaction timeline, they have been described by practitioners as a “clunky workaround” that introduce an undue amount of complexity to address what is largely a mechanical matter.

To address these issues, the State of Delaware is expected to approve an amendment to the Delaware General Corporation Law (the “DGCL”) that would permit a so called “medium form” merger with respect to merger agreements entered into on or after August 1, 2013.   This new rule would permit an acquirer in a tender offer to consummate a merger without a shareholder vote if the following conditions are met:

         the target company is a public company;

         the tender offer is for “any and all” of the target’s outstanding voting stock;

         after the completion of the tender offer, the acquirer owns at least the percentage of stock (and, if applicable, of each class or series of stock) that would otherwise be

required to adopt the merger agreement pursuant to the DGCL and the target’s charter

(i.e., generally over 50%, unless the charter provision requires a supermajority);

         all target shares not acquired in the front end tender offer must be converted in the

merger into the same type and amount of consideration as such shares were acquired

for in the offer;

         no party to the merger agreement may be an “interested stockholder” under the DGCL at the time the target board approves the merger agreement; and

         the merger agreement expressly provides that the merger will be governed by this new section of the DGCL (i.e., the short form merger can only be used in non-hostile

transactions).

b. Financing Conditions

In recent tender offers that contain a financing condition, the SEC Staff has emphasized what it views to be a longstanding Staff position regarding the satisfaction of such financing condition and the closing of the tender offer.

This SEC Staff position provides that, when an offer is not financed or when a bidder’s ability to obtain financing is uncertain, a material change will occur in the information previously disclosed when the offer becomes fully financed (e.g., when financing is obtained or the financing condition is otherwise satisfied).   Accordingly, once a financing condition is satisfied, the tender offer must remain open for at least five business days following this change, which is problematic for transactions that are attempting to close with the back-end merger on the same day (which is typically required by the financing for a variety of reasons).

In responses to SEC Staff comments, some purchasers have argued that this position is inapplicable to their offers by attempting to distinguish a “financing condition” (i.e., a condition relating to the ability of the purchaser to obtain committed financing) from a “funding condition” (i.e., a condition relating only to the receipt of proceeds from committed financing). The SEC Staff, however, has refused to recognize this distinction.

In response to this position, the following are two approaches acquirers can take:

         The bidder could waive the financing condition five business days in advance of the expiration of the tender offer.

         The bidder could mirror in the tender offer conditions those conditions that are set forth in the financing papers.

Both of these approaches are less than ideal for bidders, however, as they leave

purchasers with the risk of having to accept shares tendered in the face of a failure of a

financing source to fund its commitment.   Accordingly, it remains to be seen how future tender offers that involve financing will address this issue.

About King & Spalding’s Public Company Practice Group

King & Spalding’s Public Company Practice Group is a leader in advising public companies and their boards of directors in all aspects of corporate governance, securities offerings, mergers and acquisitions and regulatory compliance and disclosure.

About King & Spalding

Celebrating more than 125 years of service, King & Spalding is an international law firm that represents a broad array of clients, including half of the Fortune Global 100, with 800 lawyers in 17 offices in the United States, Europe, the Middle East and Asia.   The firm has handled matters in over 160 countries on six continents and is consistently recognized for the results it obtains, uncompromising commitment to quality and dedication to understanding the business and culture of its clients. More information is available at www.kslaw.com.

The Public Company Advisor provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice.   For more information on this issue of the Public Company Advisor, please contact:

C. William Baxley           Robert J. Leclerc

(404) 572-3580                 (212) 556-2204

bbaxley@kslaw.com      rleclerc@kslaw.com

Link to King & Spaulding Article: http://www.jdsupra.com/legalnews/public-company-adviser-may-2013recent-25228/

 

NY Times Article Oct. 14, 2009

The Peculiarities of Tender Offers

The return of the tender offer to deal-making is changing the way that transactions are

accomplished. The list of recent deals using tender offers includes ASP / Gentek, Johnson & Johnson / Omrix, Bankrate / Apax and Parallel Petroleum/Apollo. According to MergerMetrics, 26.15 percent of acquisitions so far this year were structured as tender offers, compared with 16.28 percent in 2007 and 23.34 percent in 2008.

The rise of the tender offer will ultimately spell faster transactions. Tender offers complete in a quicker timetable of a minimum of 20 business days, compared with the two to three months required for a merger. The longer period for a merger is a result of the time needed to file and clear a proxy statement with the Securities and Exchange Commission and stock exchange and state minimum notice requirements for such a vote.

Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate lawyer at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. He is the author of a new book, “Gods at War: Shotgun Takeovers, Government by Deal and the Private Equity Implosion,” that explores modern-day deals and deal-making.

The tender offer, however, creates certain issues that do not arise in the merger context. These quirks arise mainly because of the two-step nature of the tender offer. In a merger, the shareholders approve the transaction by a 50 percent majority of the shares and the transaction can close immediately thereafter (assuming satisfaction of all other conditions), with the acquirer taking full control and ownership of 100 percent of the target stock.

In a tender offer, however, the acquirer completes the tender offer and purchases majority but not full control. There are always some shares that do not tender into the offer.

To purchase these remaining shares, the acquirer must perform a merger. If the tender offer reaches more than the 90 percent threshold, then under the laws of most states and Delaware no shareholder vote is needed and the merger can occur immediately after the tender offer completion. However, if the acquirer purchases less than 90 percent of the outstanding shares, a shareholder vote must be held to complete this merger. This means that the proxy statement to be filed and cleared and, for a shareholder vote to occur, must run again.

A tender offer is thus a quicker means to control but not necessarily full ownership. With that primer in mind here are some of the issues that are arising as the tender offer becomes ubiquitous:

Financing

If an acquirer is financing the acquisition with the target’s cash on hand or debt secured by the target’s assets, the lack of a full ownership “gap” in a tender offer can create problems. The acquirer cannot simply arrange for the target to dividend out any cash, since that dividend would be paid to the still-remaining shareholder who are waiting to be squeezed out.

One way to deal with this issue is to have the target simply loan the acquirer the money from cash on hand or new borrowings. For example, in the recently announced $411 million tender offer by American Securities for GenTek, there is a condition to the obligations of American Securities (or AS) to complete the acquisition that:

(g) GenTek Holding, LLC has not entered into agreements or arrangements on terms acceptable to [AS] providing that, subject to and as promptly as possible following the receipt of funds by GenTek Holding, LLC pursuant to the Debt Financing, GenTek Holding, LLC will loan to [AS], by no later than the date determined by the [AS], all or a portion of such funds in excess of the amount used to repay the existing indebtedness of GenTek, the specific amount of which shall be determined by [AS]…

If an acquirer cannot arrange for a target loan, it can alternatively borrow the money and use the shares purchased as security. However, the margin rules, Regulations U and X, limit a lender’s ability to lend money on margin stock. “Margin stock” includes any publicly traded security (e.g., GenTek stock). A company that wants to do a debt-financed tender offer can get around this problem by structuring the deal to comply with these margin rules and limit the amount of its borrowing to 50 percent of the value of the collateral pledged to secure the loan (i.e., GenTek). But this obviously places a limit on borrowing.

The rise of the tender offer may thus lead to a preference for all-equity financed tender offers with any debt arranged after completion. This trend may be enhanced in middle-market transactions as a result of mistrust of private equity firms by targets to close transactions with debt financing and an accompanying reverse termination fee. Evidence of this comes from the Parallel and Bankrate private equity acquisitions; both used this all-equity model for their tender offers.

Index Funds

Deal lawyers need to be aware that with respect to a tender offer, an index fund may have a policy not tender into an offer if the share price is trading above the offer price no matter the reason.

This sounds like a quaint point, but this is a real issue in a world of active arbitrage. Stocks can trade above the offer price briefly because of this activity, pushing back tender offer expiration dates. Alternatively, because of short-sale settling, stocks can trade above the offer price after the close of the initial offer period and in the subsequent offer period as arbitragers purchase stock to settle short positions. For example, if too many index funds hold your stock, and you are at 89.8 percent, you may have to persuade the funds to sell the stock to get over the hump.

In pharmaceutical deals with contingent value rights, or C..V.R.’s, it can get even more complicated because the market price is almost always above cash offer price because of discounted value of the C.V.R. reflected in market price. This issue is further complicated by the fact that most funds cannot hold C.V.R.’s, so they are stuck between two policies — one telling them they cannot sell while stock is in index or offer price is below market price and the other policy saying they cannot hold C.V.R.’s.

The solution to all of this is recommended in a recent client note David Fox, Daniel Wolf and Susan Zachman of Kirkland & Ellis. They highlight the need to assess index fund ownership early in the tender offer process and work with the funds to arrange a market sale prior to the offer expiration date if their ownership is going to be a problem.

Minimum Conditions

The disconnect between control and full ownership in tender offers has spurred the rise of the top-up. This is an option issued by the target which allows the acquirer to purchase shares from the target after the closing of the tender offer. The top-up typically allows the acquirer to purchase sufficient shares to put the acquirer over the 90 percent level forgoing the need for a shareholder vote if the acquirer only acquires say 60 percent of the shares. According to MergerMetrics, more than 90 percent of tender offers so far this year included a top-up option. You can read more about top-ups in my prior post.

In a recent tender offer, Dainippon Sumitomo Pharma’s offer for Sepracor, a top-up option was provided that was set off when the acquirer achieved only a bare majority of the outstanding shares. This option provided Dainippon the right to purchase that number of shares to maintain a majority of the outstanding shares. The option effectively allowed Dainippon to consummate the merger if it acquired 50 percent of the outstanding shares rather than the more normal formulation of 50 percent of a fully diluted majority (i.e., including options and other rights convertible into common stock).

This meant that Dainippon could obtain full ownership by purchasing less than a full majority of the stock. Nonetheless, this situation was averted when the Dainippon tender offer closed on Tuesday night and Dainippon purchased 78.2 percent of the outstanding Serpacor shares.

There is some talk over whether this type of top-up option is appropriate since it allows acquirers to theoretically gain control when they do not actually have it. I for one feel uncomfortable about it. However, absent some egregious facts and given independent and arms-length bargaining, I am not sure this is a legal issue, at least in Delaware under its standards. The same threshold of a bare majority of outstanding shares applies in mergers. This is merely putting tender offers on parity with mergers. I expect this type of option to spread and become more common in tender offers.

Click to go to the original article: http://dealbook.nytimes.com/2009/10/14/the-peculiarities-of-tender-offers/

 

In M&A, Is Flat the New Up?

By Dennis McCarthy – (213) 222-8260 – dennis@mbsecurities.com – 

In my experience with M&A deals, everything increases; it goes up.

All projections show increases in revenues and profits.  If you buy a company today, you’ll sell it for more money later.  Deals get bigger. Debt leverage goes up.  M&A multiples go up.  The M&A business, itself, goes up.  But what if…?

That’s the sobering message from  a study of middle market M&A published by Deloitte, the international accounting firm, looking back over 2011 and 2012.

Deloitte reports that between 2011 and 2012, middle market M&A was flat.  Deal volume was flat. Average deal value was flat.  Purchase price multiples were flat. Senior debt multiples were flat.  You get the idea.

But look on the bright side.  At least those metrics were flat.

International acquisitions of US middle market companies declined.

Purchase price multiples of LBOs declined.

All things considered, flat may not be so bad.  Maybe flat is the new up.

Supposedly, statistics don’t lie.  But 2012 certainly seemed to me to be a better, more active year than 2011.

Company executives I know seemed to be more confident that the economy was stable.  Not big growth but no big problems either.

Maybe we won’t see the impact of the improved environments until this year, 2013, given how long it takes to close an M&A deal,

I know I’m looking forward to an active 2013.  In any event, I’ll take flat over down every time.

I’ve attached a link to the Deloitte report below.

Please contact me to help your company with M&A or any capital market project. 

Deloitte US Middle Market M&A Stats 2012

 

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