Gods at War: Shotgun Takeovers, Government by Deal, and the Private Equity Implosion

by Steven M. Davidoff

  Strategic transactions will remain the market mainstay, but the mega-deals of the past are unlikely as pricing continues to be difficult. Industries that are particularly suitable to consolidation and with vast cash reserves, such as the pharmaceutical sector, are particularly likely for further consolidation. Buyers and sellers will continue to struggle with consideration types and valuation gaps. Still, the lack of credit will spur the increased usage of stock consideration, and market volatility will lead to more unique types of contingent value arrangements or alternative consideration forms in transactions to close this gap. Strategic transactions will remain more opportunistic and confined to consolidating industries for the near future, as strategics eschew risk taking.

  Private equity will also be lurking in the background with significant war chests, ready to return to dealmaking, particularly in distressed acquisitions. In the process, though, like the banks, private equity will have to restore trust among targets for its actions of the past years. This will mean that private equity is apt to focus on smaller, easier-to-consummate transactions in stable, particularly cash-generative industries for the time being—at least to the extent such companies still exist.The private equity mega-deal is probably dead for a long time as private equity seeks forgiveness for its misdeeds.

  The one growth area in strategic and private equity transactions is likely to be the distressed one. In March 2009, global bankruptcy takeover volume reached a four-year high at $698 million for the month.4 This upward trend will continue, but the need for debtor-in-possession financing and the reforms from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 will continue to hamper the ability of distressed companies in the United States to enter bankruptcy. Instead, lacking available credit and facing liquidation in the bankruptcy process, these companies are likely to turn to the acquisition process for salvation. The result will be buyers pushing the envelope in deal-protection devices to make these takeovers, mechanisms apt to be validated in the Delaware courts that may creep into normal, strategic dealmaking. It may also spur reform to the bankruptcy process to assist companies in reorganizing rather than liquidating.

  The government is now one of the largest shareholders in our financial system. Their continued dealmaking and their need to eventually dispose of these stakes will drive yet more dealmaking. As in distressed acquisitions, the creative structures the government has created to bail out the financial system are likely to seep into general dealmaking. Again, it is likely for now that Delaware will tolerate this stretching. Eventually, though, if it reacts as it has in past crises, Delaware should react to curb these shareholder-unfriendly terms when the crisis diminishes.

  Secretary Paulson and his crew showed their deal-junkie mettle, likely out of necessity adopting an investment banker mentality to the bailout. The financial crisis became a problem to be addressed through seriatim dealmaking; dealmakers structured, negotiated, and then moved on. Dealmaking, while more fun, can create rigid, inflexible structures and lacks a more comprehensive view, and the federal response was criticized for lacking just such coherency. Future reform is likely to give the government the flexibility it needs to deal with financial crises, or at least the one that just occurred since every crisis is different and regulation tends to be backward looking. Still, dealmakers would do well to take a step back during this downturn and rethink their own strategy based on the lessons of the government’s actions and recent events. Forms should be rethought and redrafted, and dealmakers should rethink fundamental deal structures and financing arrangements. A deal should not just be done in the heat of the moment, but planned.

  In the background, globalization will continue haphazardly, even during this crisis age.The near-term strength of the dollar will dampen inward investment, to be offset by the role of the United States as a safe-haven economy. But absent a new wave of protectionism, the dealmaking world is too globalized at this point. The networks created and the attitudes of corporate leaders are too global to dampen the secular trend toward global dealmaking. Mega-deals like BHP Billiton’s failed $180 billion hostile takeover of Rio Tinto show that the potential of cross-border deals is immense and increasingly real. In fact, the sigh of relief that greeted Fiat’s agreement to assist Chrysler ably illustrated this. But still, foreign acquisitions will continue to have political and public overtones that will need to be managed properly.

  Finally, in all of this, the dealmakers will remain central. The ability to structure deals in this perilous environment means navigating all of these issues, as well as the new regulatory regime, and putting forth a deal that makes sense for a buyer and a target. Personality will continue to remain a key component of deals, asexecutives seek to manage their empires. It will be a less public ego, as the financial crisis has made the perils of a public CEO profile amply apparent. Nonetheless, the personality element of deals will continue to affect dealmaking in a less public role.

  The role of lawyers in the deal machine has become even more important. Over the course of the year, attorneys made a difference in a number of deals for the good and the bad. The lessons of the past years for lawyers and dealmakers generally were apparent.

  • No Deal Is a Deal Until It Is Complete. In a number of private equity transaction deals in 2007 and 2008, prospective buyers were able to escape from their contractual obligations. In a pattern begun in 2007, either explicit language or ambiguities in agreements repeatedly allowed buyers to leverage their position and use litigation or the threat thereof to exit their commitments at a reduced cost. For example, in the failed acquisition of BCE, the transaction went through twist and turn, only to be felled at the last moment by an auditor’s inability to issue a solvency opinion. Had the lawyers negotiated the condition so it wasn’t to the benefit of BCE’s buyers, BCE would at least have been entitled to the $C1.2 billion reverse termination fee. In these troubled times, lawyers should continue to take this lesson to heart by fighting for deal certainty and structuring transactions to close more quickly through, for example, the use of tender offers. It also leads to the next lesson.

  • The Details Matter. Following the litigation between Cerberus and United Rentals, disputes again erupted over ambiguous contract language among ADS and Blackstone and Huntsman and Hexion. Moreover, in a number of transactions, including Jana’s proxy contest with CNET, ambiguities in organizational documents allowed shareholders or bidders to circumvent staggered boards and nomination waiting periods. In other transactions, such as BCE and a number of other reverse termination private equity deals, like Reddy Ice-GSO, actual contract terms worked badly against targets. Once again, these failed deals represent the need for clear and simple drafting, as well as the importance of contract terms generally. Lawyers would do well to spend the extra hour to get the wording right in these documents, and clients would do equally well to realize the importance of such time.

  • An Optional Deal Structure Is an Option. The private equity type of optional deal structure crept into the strategic model in 2008 and 2009. Wrigley-Mars, Pfizer-Wyeth, Foundry-Brocade, and Hercules-Ashland had optional-type structures, where the buyer could, in certain circumstances or any circumstance, terminate the deal for a reverse termination fee. Like private equity, some of these deals also foundered on their optionality. Foundry-Brocade was renegotiated, as Brocade leveraged an ostensible contractual right to walk to lower the purchase price, and i2 balked at a similar attempted maneuver by JDA Associates in i2’s own deal. Similarly, management teams repeatedly took advantage of similar optionality in the Landry’s, Zones, and the now-terminated CKX management buyouts to attempt to renegotiate their deals. Optionality may be the only available option to achieve a bargain, but lawyers should attempt to negotiate for termination fees and other provisions that approximate the risk along the lines of the Pfizer model.

  • Complexity Can Kill. Citigroup was burned ever so badly on the Wachovia deal. Unable to negotiate an asset purchase in the space of a day, Citigroup instead n
egotiated a letter of intent with no break fee. Wells Fargo used this time period to take advantage of the delay and take Wachovia, leaving Citigroup struggling and forced into a federal bailout. The Citigroup case shows that complexity is sometimes necessary but in a distressed and volatile market is probably not worth the delay.

  These are lessons that dealmakers and their attorneys have taken to heart. At conference rooms and internal team meetings, they now rehash the failed deals of the past years and the lessons learned, the more important of which have been highlighted here. The result will be a further shift in the details and structure of transactions, as attorneys respond to the cases of the past years, for example, the more explicit drafting and tightening of MAC clauses in light of the Huntsman-Hexion and Genesco-Finish Line cases. This is another reminder that dealmakers can add their own costs to transactions. Members of the dealmaking community and those who train them (i.e., law and business schools) should be aware of this capacity and train future dealmakers to recognize and compensate for these costs allowing for lawyers and their clients to more efficiently bargain.

  Finally, the coming regulatory reform will strongly affect dealmaking. Hedge funds, derivatives, and the securitization process are likely to come under firmer regulatory supervision. Banks and other financial institutions will also be subject to stronger capital requirements and monitoring for systemic risk.

  This will further shift capital flows for dealmaking and give companies a clearer picture of shareholder activity with respect to their securities and derivatives thereupon. But in the short term, regulators will be addressing the systemic issues rather than the more particular areas of needed reform in dealmaking highlighted in this book. This systemic regulation is likely to further reduce credit, as higher capital requirements are placed upon financial institutions. All of this will also further raise the importance of regulation and public relations for the course and success of dealmaking. It will also take place in a world where capital more freely flows and the financial revolution allows market actors to structure around regulation. The question will be if this regulation responds appropriately or merely drives capital market activity abroad or to new, unregulated markets and securities. In this regard, we do not know what the next crisis will be. Congress would do well to respond by creating regulation that not just addresses past events but any future response and adjustment to any regulatory regime by the deal machine.

  In this book, I have attempted to document the transforming deal machine. How recent event have irrevocably changed our capital markets and the way deals are structured and completed. These coming changes, the ones foreshadowed in this book and the unexpected events that will certainly occur, will make dealmaking exciting both to watch and to participate in. It will result in more creativity in takeovers and a shift in dealmaking profiles and structures, as lawyers and bankers struggle to accommodate this new regime.

  It will also mean that the Ken Lewises of the world will be increasingly hampered in pushing through their big deals, as conservatism and shareholder pressure fight ego and the deal machine. The next few years are likely to see reduced dealmaking activity and the massive deleveraging that has occurred in the past year will continue to further diminish dealmaking activity. In the longer term, though, as the deal market revives and continues its sustained activity, takeovers are likely to enter a new stage of transformation, taking shape from the creative and disruptive trends of the past years described in this book. Our capital markets may have been irrevocably changed by recent events, but I believe the doom-sayers of the deal market are mistaken and that deals will continue to be a driving force in corporate America.

  Notes

  Prologue

  1 For newspaper coverage of the party, see “Inside Stephen Schwarzman’s Birthday Bash,” New York Times DealBook, Feb. 14, 2007.

  2 Blackstone Group LP, Registration Statement (Form S-1), at 1, filed on Mar. 22, 2007.

  3 For less than glowing coverage of Schwarzman in the Wall Street Journal and New York magazine, see “How Blackstone’s Chief Became $7 Billion Man: Schwarzman Says He’s Worth Every Penny; $400 for Stone Crabs,” Wall Street Journal, June 13, 2007; and Kurt Anderson, “Greed Is Good and Ugly,” New York ( July 23, 2007).

  4 Dealogic Database.

  5 Thomson/Reuters Database.

  6 See Andrew Ross Sorkin and Terry Pristin, “Takeover Battle Ends in Sale of Big Landlord,” New York Times, Feb. 8, 2008.

  7 For accounts of these affairs, see Landon Thomas Jr., “Turning 60, and Doing So with 1,500,” New York Times, Jan. 27, 2007; Andrew Ross Sorkin, “This Tyco Videotape Has Been Edited for Content,” New York Times, Oct. 28, 2003. Dennis Kozlowski, in particular, suffered a humiliating downfall. In 2005, he was found guilty of stealing hundreds of millions of dollars from Tyco to pay for his lavish lifestyle. He was sentenced to serve a prison term of up to 25 years. Meanwhile, Saul Steinberg suffered a stroke, and his company, Reliance Group Holdings, went bankrupt in 2001. Steinberg was forced to sell off his art collection, including a $2 million antique bronze-plated commode. Ironically, Steinberg also sold his $35 million apartment in storied 740 Park Avenue to none other than Stephen Schwarzman.

  Chapter 1: The Modern Deal

  1 See John Steele Gordon, An Empire of Wealth: The Epic History of American Economic Power (2004), 214.

  2 This account of the battle for the Erie Railroad is based on the histories set forth in Gordon, An Empire of Wealth, 213-18 and Jerry W. Markham, A Financial History of The United States (2002), 257-260.

  3 See Owen Thomas, “Craig Newmark, Filthy Rich on eBay’s Millions,” Valley Wag, July 26, 2007.

  4 Nick Wingfield, “eBay Buys Stake in craigslist,” Wall Street Journal, Aug. 13, 2004.

  5 This account of the craigslist-eBay dispute is taken from the facts alleged in the complaints filed by eBay in Delaware Chancery Court on April 29, 2008, and by craigslist in California Superior Court on May 13, 2008. Complaint, eBay Domestic Holding, Inc. v. Newmark, No. 3705-CC (Del. Ch. Apr. 29, 2008); Complaint, craigslist, Inc. v. eBay, Inc., No. CGC-08-475276 (Cal. Super. Ct. May 13, 2008).

  6 Connie Bruck has an account of this battle in The Predators’ Ball: The Inside Story of Drexel Burnham and the Rise of the Junk Bond Raiders (1989).

  7 See George Mair, The Barry Diller Story: The Life and Times of America’s Greatest Entertainment Mogul (1998). See also “Indecent Proposals (Rival Bids for Paramount Studios),” Economist, September 1993; Ehud Kamar, “The Story of Paramount Communications v. QVC Network” in Corporate Stories ( J. Mark Ramseyer, ed., 2009).

  8 See Patrick A. Gaughan, Mergers, Acquisitions, and Corporate Restructurings (1996), 33. For a history of the conglomerateurs, see the classic financial history of the 1960s by John Brooks, The Go-Go Years: The Drama and Crashing Finale of Wall Street’s Bullish 60s (1999), 150-181.

  9 See Robert F. Bruner, Deals from Hell (2005), 265-280. See also Nina Munk, Fools Rush In: Steve Case, Jerry Levin, and the Unmaking of AOL Time Warner (2004).

  10 See Bernard S. Black, Bidder Overpayment in Takeovers, 41 Stanford Law Review 597 (1989).

  11 See Carol J. Loomis, “KKR: The Sequel,” Fortune, June 13, 2005. See also Bryan Burrough and John Helyar, Barbarians at the Gate: The Fall of RJR Nabisco (1990), 133-136.

  12 For a biography of Bruce Wasserstein, see Charles D. Ellis and James R. Vertin, Wall Street People:True Stories of Today’s Masters and Moguls (2001), 149. Wasserstein’s book is Bruce Wasserstein, Big Deal: Mergers and Acquisitions in the Digital Age (2001).

  13 Wall Street Journal reporter Dennis Berman has written quite perceptively on the effect of the Deal Machine. See, e.g., Dennis K. Berman, “Kellner Thwarts the Voracious Deal Machine: Continental CEO Bucks Powerful Forces in an 11th-Hour Rejection of UAL Merger,” Wall Street Journal, May 6, 2008.

  14 Smith v.Van Gorkom, 488 A.2d 858 (Del. 1985).

  15 See, e.g., In re Netsmart Tech., Inc., Shareholders Litig., Del. Ch., C.A. No. 2563 (Del. Ch. Ma
r. 6, 2007).

  16 For a discussion of Ken Lewis’s misadventures, see Julie Creswell, “Price Paid for Merrill Is Rising,” New York Times, Jan. 23, 2009.

  17 The figure is as of 1904. See John Moody, The Truth about the Trusts (1904). These figures also appear in Lawrence E. Mitchell, The Speculation Economy (2007), 12-13.

  18 See generally Naomi R. Lamoreaux, The Great Merger Movement in American Business, 1895-1904 (2008).

  19 See Mitchell, The Speculation Economy, 122. As Professor Lawrence Mitchell notes, this was perhaps the closest to date the country has come to enacting a federal incorporation act.

  20 See inter alia Sherman Antitrust Act, ch. 647, 26 Stat. 209 (1890) (codified as amended at 15 U.S.C. §§ 1-7 (2000)); Clayton Act, ch. 323, 38 Stat. 730 (1914) (codified as amended at 15 U.S.C. §§ 12-27 (2000)); Federal Trade Commission Act, Pub. L. No. 63-203, 38 Stat. 717 (1914) (codified as amended at 15 U.S.C §§ 41-58 (2000)); Interstate Commerce Act, ch. 104, 24 Stat. 379 (1887) (codified as amended in scattered sections of 49 U.S.C.).

  21 Act of June 18, 1898, ch. 466, 30 Stat. 476 (creating the Industrial Commission to investigate questions pertaining to immigration, labor, agriculture, manufacturing, and business); Act Establishing the Department of Commerce and Labor § 6, Pub. L. No. 57-87, ch. 552, 32 Stat. 825 (1903) (establishing therein the Bureau of Corporations to investigate “the organization, conduct, and management of the business of any corporation, joint stock company or corporate combination”).

  22 See Gaughan, Mergers, Acquisitions, and Corporate Restructurings, 18-26.

  23 The primary source for the remainder of this subsection is my article, “The SEC and the Failure of Federal Takeover Law,” 34 Florida State University Law Review 211 (2007).