Table of Contents
Title Page
Copyright Page
Dedication
Preface
Prologue
Chapter 1 - The Modern Deal
The Import of Personality
The Evolution of the Takeover
The Takeover Revolution
Chapter 2 - KKR, SunGard, and the Private Equity Phenomenon
KKR and the Origins of Private Equity
SunGard and the Transformation of Private Equity
Private Equity in the Sixth Wave
Chapter 3 - Accredited Home Lenders and the Attack of the MAC
The Fall of Accredited Home Lenders
Material Adverse Change Clauses
The MAC Wars of Fall 2007
The MAC Clause in Flux
The Future of the MAC
Chapter 4 - United Rentals, Cerberus, and the Private Equity Implosion
The Cerberus-United Rentals Dispute
The Implosion of Private Equity
Fault and the Failure of Private Equity
The Future of Private Equity
Chapter 5 - Dubai Ports, Merrill Lynch, and the Sovereign Wealth Fund Problem
The Financial Wave of Sovereign Fund Investment
The Sovereign Wealth Fund Problem
CFIUS and Foreign Investment
Chapter 6 - Bear Stearns and the Moral Hazard Principle
Saving Bear Stearns
JPMorgan’s Dilemma
The Fight for Bear Stearns
Lessons Learned from Bear’s Fall
Chapter 7 - Jana Partners, Children’s Investment Fund, and Hedge Fund Activist Investing
A Brief Overview of the “Agency Problem”
The Rise of Hedge Fund Activism
The 2008 Proxy Season
The Future of Hedge Fund Activism
Chapter 8 - Microsoft, InBev, and the Return of the Hostile Takeover
Microsoft-Yahoo!
InBev-Anheuser-Busch
The Elements of a Successful Hostile Takeover
Delaware and Hostile Takeovers
The Future of Hostile Takeovers
Chapter 9 - Mars, Pfizer, and the Changing Face of Strategic Deals
The Changing Structure of Strategic Transactions
The Phenomenon of the Distressed Deal
Do Takeovers Pay?
Delaware Law and Strategic Transactions
The Future of Strategic Transactions
Chapter 10 - AIG, Citigroup, Fannie Mae, Freddie Mac, Lehman, and Government by Deal
The Nationalization of Fannie Mae and Freddie Mac
The Week the Investment Bank Died
TARP, Citigroup, Bank of America, and Beyond?
Assessing Government by Deal
Chapter 11 - Restructuring Takeovers
Federal Takeover Law
Delaware Takeover Law
DealMaking
Chapter 12 - DealMaking Beyond a Crisis Age
Notes
About the Author
Acknowledgements
Index
Copyright © 2009 by Steven M. Davidoff. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials.The advice and strategies contained herein may not be suitable for your situation.You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.
Davidoff, Steven M., 1970-Gods at war : shotgun takeovers, government by deal, and the private equity implosion / Steven M. Davidoff. p. cm.
Includes bibliographical references and index.
eISBN : 978-0-470-54330-6
1. Consolidation and merger of corporations—United States. 2. Private equity—United States. 3. Financial crises—United States. I. Title. HG4028.M4D.8’30973—dc22 2009016546
For Idit
Preface
I wrote this book for two reasons. First, readers of my New York Times DealBook column often ask me if there is a book explaining the mechanics of the deal and takeover markets. Prior to this time, there was nothing that quite fit. I hope this book fills this gap and provides even the most inexperienced reader and student an inside look into the intricacies, legal and otherwise, of deals and dealmaking.
Second, recent catastrophic events in our capital markets have left many baffled, unable to understand what occurred and what it means for the future. This book is an attempt to order and make sense of the events leading up to and through the financial crisis. Gods at War is therefore the story of dealmaking in the sixth takeover wave and through this crisis. It is about the private equity boom and its implosion, the return of the strategic transaction and hostile takeover, the failure of the investment banking model, the government’s dealmaking during the financial crisis, and the changes occurring in the capital markets during this time.
This book is ordered chronologically. I begin in Chapter 1 with a brief history of takeovers and a discussion of the key elements driving deals in today’s capital markets. In Chapter 2, I trace the origins of private equity through a history of its creator, Kohlberg Kravis & Roberts Co. This detour is necessary because private equity is a key force driving the changes in today’s deal market.
In Chapters 3 and 4, I move to fall 2007 and spring 2008. In these two chapters, I discuss the multiple implosions of private equity and other transactions and what it means for the future of dealmaking, as well as private equity itself. I do so by first discussing in Chapter 3 the initial material adverse change disputes in the fall of 2007 and the key battles during this time, particularly that of Accredited Home Lenders, the mortgage originator, versus Lone Star Funds, the private equity firm. In Chapter 4, I discuss the second wave of deal disputes, which began in November 2007 with Cerberus’s successful
attempt to terminate its acquisition of United Rentals, the equipment rental company.This second wave of disputes would be driven by private equity’s repeated attempts to terminate deals agreed to prior to the financial crisis and would be shaped by the material adverse change disputes earlier in the fall.
In Chapter 5, I discuss the sovereign wealth fund phenomenon. I use Temasek Holding’s investment in Merrill Lynch as a launching board to discuss the nature of these investments during the initial phase of the financial crisis. Sovereign wealth funds may have had a brief heyday, but these investments tell us much about the regulation and importance of foreign capital. In Chapter 6, I move to the next phase of the book, discussing the fall of Bear Stearns. Much has already been written on this event, but my focus is new. In this chapter, I principally examine the innovative deal structures created and the deal’s significance for later dealmaking and government action.
In Chapters 7, 8, and 9, I turn to the time after Bear Stearns’s fall. In Chapter 7, I discuss the rise of the hedge fund activist investor and its potential for transforming change in the deal market. I do so by detailing two significant shareholder activist battles in the spring of 2008: Jana Partners’ targeting of CNET Networks, Inc., the Internet media company, and Children’s Investment Fund’s and 3G Capital Partner’s targeting of CSX Corp., the railroad operator.
In Chapter 8, I discuss the increasing role of hostile takeovers in dealmaking through the lens of Microsoft Co.’s hostile bid for Yahoo! Inc. and InBev NV/SA’s hostile bid for the Anheuser-Busch Companies Inc. I connect the rise in shareholder activism detailed in Chapter 7 with the increased rate of hostile activity in recent years.
Chapter 9 discusses the changing nature of strategic transactions through and beyond the financial crisis. I examine the innovation that has recently occurred in the strategic deal market, in particular the deal structures used in the acquisitions of Wm. Wrigley Jr. Co. by Mars Inc. and Wyeth by Pfizer Inc. Both transactions borrowed heavily from the private equity model and were engineered to address the issues raised by the serial implosion of private equity deals in 2007 and 2008, discussed in earlier chapters.
I conclude with Chapters 10, 11, and 12. Chapter 10 discusses the government as dealmaker in the serial bailouts of AIG, Bank of America, Citigroup, and others and the implications of “government by deal” for our economy and for dealmaking specifically.The last two chapters look to the future. In Chapter 11, I discuss potential reform of the nation’s takeover law. In the final chapter, Chapter 12, I draw on the conclusions of the prior 11 chapters to sketch the future of dealmaking in a crisis age and beyond. In this final chapter, I also discuss whether deals and dealmaking add value to our economy and examine the related question of the role of deals and dealmaking in precipitating the global financial crisis.
We live in a time where many corporate veterans wonder whether a long 50-year cycle of dealmaking that began with the go-go 1960s has come to an end, an end driven by a massive deleveraging of the financial system. But I am more hopeful believing that deals and dealmaking will continue to be an integral, substantial, and necessary part of our capital markets. Either way, the events covered in this book are likely to set the course for deals and dealmaking for the foreseeable future.
Ultimately, Gods at War is about the factors that drive and sustain dealmaking. It is a legal-oriented history of the recent events that will alter and strongly influence the future of dealmaking. It is also the story of the deal machine, the organizations built up to foster dealmaking as well as the increasingly important role of shareholders themselves. In the midst of these forces sit the corporate executives and their advisers who decide whether to deal or not. Their own individual personalities and ego-driven decisions further shape and drive dealmaking. It is here where I draw the title for this book. These individuals, like gods, can determine the future of companies and our economy.
Author’s Note
Portions of this book cover topics first written about in the New York Times “DealBook” and the M&A Law Prof Blog. In addition, parts of this book were taken or based on my following prior writings: “Regulation by Deal: The Government’s Response to the Financial Crisis” Administrative Law Review (forthcoming) (with David Zaring); “The Failure of Private Equity,” 82 Southern California Law Review 481 (2009); “Black Market Capital,” 2008 Columbia Business Law Review 172; “The SEC and the Failure of Federal Takeover Regulation,” 34 Florida State University Law Review 211 (2007); and “Accredited Home Lenders v. Lone Star Funds: A MAC Case Study” (February 11, 2008) (with Kristen Baiardi).
Prologue
The social caste of NewYork is still set by money and the power to control it. Money provides an entrée into New York society, but the power quotient—your position in the financial industry—ranks you among your peers. It was thus no coincidence that the New York social event of 2007 was the 60th birthday party of Stephen Schwarzman, chief executive officer (CEO) and co-founder of the private equity firm the Blackstone Group.
The $3 million Valentine’s Day-themed gala was held on February 13 at the Seventh Regiment Armory on Park Avenue. Amid the bomb-sniffing dogs and paparazzi, a who’s who of finance, government, and media attended. These included John Thain, now the embattled former CEO of Merrill Lynch & Co., Inc.; Sir Howard Stringer, chairman of Sony Corp. of America ; Leonard A. Lauder, chairman of the board of Estée Lauder Inc.; former Secretary of State Colin L. Powell; and Maria Bartiromo, the proclaimed money honey of CNBC. Rod Stewart and Patti LaBelle serenaded the guests, and the party ended at a punctual midnight, sufficiently early to allow everyone to return to work the next day.1
The media publicity and attendance were not just because it was an expensive birthday party thrown for a billionaire. Rather, this was the unofficial coronation of Schwarzman as the new king of private equity. Henry Kravis, along with Jerome Kohlberg Jr. and George R. Roberts, founded the private equity industry back in the 1970s and 1980s.Their firm, Kohlberg Kravis Roberts & Co., known as KKR, had dominated the field until the 1990s. Schwarzman’s Blackstone had recently surpassed KKR as the largest of the private equity shops with assets under management of $78.7 billion.2 This was Schwarzman’s coming out party. Henry Kravis, still co-CEO of KKR, did not attend, and would not even publicly state whether he was invited.
And so what if the press coverage in the New York Times, the Wall Street Journal, and elsewhere was less than favorable, describing Schwarzman as “controlling” and nouveau riche, a man who would complain about his staff ’s squeaky sneakers and who regularly feasted on $400 apiece stone crabs.3 Schwarzman, Blackstone, and the entire private equity industry were on top of the capital markets. In 2006, private equity would be responsible for 25.4 percent of all announced takeovers in the United States.4 The year 2007 was shaping up to be even better. In the prior year, private equity had globally raised $229 billion in new funds to invest.5 Given the availability of easy credit, these funds provided private equity with the ability to make more than a trillion dollars in new acquisitions. No company seemed immune from takeover.
Blackstone had proved this only a few days before. On February 9, Blackstone had completed the $39 billion leveraged buy-out of real estate company Equity Office Properties Trust. The buy-out was the largest private equity acquisition ever, even bigger than KKR’s historic RJR/ Nabisco acquisition. Blackstone had beaten out Steven Roth’s Vornado Realty Trust in an epic takeover battle begun by an e-mail sent to Roth by Equity Office’s founder, the cantankerous Samuel Zell. The e-mail had simply stated: “Roses are red, violets are blue; I hear a rumor, is it true?” Roth’s reply: “Roses are red, violets are blue. I love you Sam, our bid is 52.”6 Schwartzman’s Blackstone had trumped Vornado’s love offer with a bid of $55 a share.
Schwartzman’s party was thus not just for him, but for private equity. In a few short years, Schwarzman and his cohorts had revolutionized the takeover market. It was not just Schwarzman and private equity. The period from 2004 through 2008,
a time of extraordinary growth and near financial calamity, transformed the U.S. capital markets. The financial revolution, globalization, and the financial crisis permanently changed dealmaking, creating perils and opportunities for dealmakers and regulators. It is a pace of change and innovation so fast that regulators have yet to account for the new takeover scene and its systemic risks, a failure ably on display in recent years.
But Schwarzman’s party not only marked this new paradigm but also was symbolic in the way of prior lavish Wall Street social events such as the Roman Empire-themed party Tyco International Ltd. CEO L. Dennis Kozlowski threw for his wife on the island of Sardinia or Saul Steinberg’s 1988 party for his daughter’s wedding in the Temple of Dendur at the Metropolitan Museum of Art. These parties not only heralded a new king but also ominously foreshadowed the perils of hubris and coming market disruption.7
In the years after Schwarzman’s celebration, the federal government would implement the largest capital markets bailout in history; Blackstone would trade as low as a fifth of its initial public offering price; the stock market would viciously decline; the private equity market would evaporate; distressed acquisitions would overshadow a chastened and diminished takeover market; Bear, Stearns & Co., Inc. and Lehman Brothers Holdings, Inc. would implode; the credit markets would dry up; sovereign wealth funds would invest billions in ailing U.S. financial institutions; and both Anheuser-Busch Companies, Inc. and Yahoo! Inc. would be the subject of historic hostile offers. But all of this would be the future. Instead, on that night, February 13, 2007, Schwarzman was the symbol of private equity’s wealth and dominance and the enduring nature of money in the city of New York. He was the epitome of the revolution occurring in the capital markets.
Chapter 1
The Modern Deal
I begin with a short deal story.
In 1868, Cornelius Vanderbilt, the railroad baron, went to war against the Erie Gang—Jay Gould, Daniel Drew, and James Fisk. The dispute’s genesis was the rather reprehensible conduct of the Erie Gang with respect to the hapless New York & Erie Railroad.The three men had acquired a majority interest in the company, treating it as their personal piggy bank. Not content with the millions in profit reaped through outright theft, the gang further took advantage of Erie’s public shareholders by manipulating Erie’s stock to their benefit. The gang’s machinations so financially weakened the Erie that it defaulted on its debt payments.
Gods at War: Shotgun Takeovers, Government by Deal, and the Private Equity Implosion Page 1