A little Friday reading:
Via CLS Blue Sky Blog, Lawrence Cunningham on the wily Oracle of O vs. Modern Finance Theory:
Threatened by Buffett’s performance, stubborn devotees of modern finance theory resorted to strange explanations for his success. Maybe he is just lucky—the monkey who typed out Hamlet— or maybe he has inside access to information that other investors do not. In dismissing Buffett, modern finance enthusiasts still insist that an investor’s best strategy is to diversify based on betas or dart throwing, and constantly reconfigure one’s portfolio of investments.
Buffett responds with a quip and some advice: the quip is that devotees of his investment philosophy should probably endow chaired professorships at colleges and universities to ensure the perpetual teaching of efficient market dogma; the advice is to ignore modern finance theory and other quasi-sophisticated views of the market and stick to investment knitting. That can best be done for many people through long-term investment in an index fund. Or it can be done by conducting hard-headed analyses of businesses within an investor’s competence to evaluate. In that kind of thinking, the risk that matters is not beta or volatility, but the possibility of loss or injury from an investment.
And NYT's Deal Professor, Steven Davidoff, tells a gripping tale of hedge fund vs family hegemony playing out in Maryland's courts. CommonWealth REIT is controlled by the Portnoy family, which has made a pretty penny in the process, and 2 hedge funds are trying to get it to change its ways.
First, the story has implications for the future of shareholder arbitration provisions. I knew the SEC objects to these puppies at IPO, but didn't think that a board might turn around post-IPO and and adopt amend the bylaws to require arbitration to resolve disputes with shareholders. Shady. But apparently that's what happened at CommonWealth REIT.
And there's more to the story.
On March 1, CommonWealth’s board passed a bylaw amendment that purports to require that any shareholder wishing to undertake a consent solicitation must, among other things, own 3 percent of the company’s shares for three years. This is an extremely aggressive position that if upheld would stop Corvex and Related in their tracks.
Not satisfied with this attempted knockout blow, CommonWealth appears to have lobbied the Maryland Legislature to amend the Maryland Unsolicited Takeover Act. This law allows companies to have a mandatory staggered board.
CommonWealth already has such a board, but the company has also reportedly lobbied the legislature to make a change that companies opting into this statute would now be unable to have their directors removed by written consent. Again, this would kill Corvex and Related’s campaign. When the two funds got wind of this, they fought back, and the Maryland legislature adjourned without adopting CommonWealth’s proposal.
CommonWealth still announced this week that it had opted into the act. The REIT is claiming that even though the Maryland Legislature did not adopt any amendment, the law still implicitly has this requirement. The funds will now have to sue CommonWealth to force them to change their interpretation.
Go read the whole thing. Some wacky shenanigans from my home state. If it does come down to arbitration I'd love to see CommonWealth's arbitrator, allegedly a friend of its controlling family, go toe to toe with the hedge funds' choice-- former Delaware Chancellor Bill Chandler.
Perhaps I should have mentioned at the outset that my posts on the Georgetown's Williams Act conference would be part of a series! So here is another installment. Professor Sam Thompson gave a thought-provoking presentation, based on an article published in the Business Lawyer, concerning the creation of what he calls a "Change of Control Board ("COCB")”. His presentation not only emphasized the importance of enabling the SEC to appoint an independent board to oversee mergers and acquisitions, but also pinpointed how the appointment of such a board likely would have generated a different outcome in the context of Microsoft's offer for Yahoo!
Under his proposal, if a public corporation becomes the target of a bona fide M&A offer, the SEC would appoint a three person independent board--the Change of Control Board--to respond to the offer. The COCB (whose members would be paid by the target corporation) would have the authority to hire counsel, investment bankers, and other advisors to help accurately and independently evaluate the offer. In addition, the COCB would have complete authority over the acquisition process. Moreover, a federal uniform business judgment rule standard of review would be applied in determining if the board acted appropriately, thereby preempting state law in the area of takeovers. Professor Thompson emphasized that his proposal was designed to respond to the many conflicts of interests that arise in the takeover context. Professor Thompson also argued that his proposal would reduce litigation involving fiduciary duties, replace confusing state law standards of review in this area, and enhance the efficiency of the M&A market, which he argued was too often inefficient because of the sometimes unlimited ability of boards to block hostile acquisitions.
Applying this concept to Yahoo!, Professor Thompson essentially pointed out that, under the current regime, Yahoo!'s decision to avoid an acquisition by Microsoft would be protected despite the premium being offered and shareholder litigation challenging the decision (and hence suggesting shareholder desire for the acquisition). Moreover, he noted that the decision would be protected even though there were potential of conflicts of interests by the Yahoo! CEO. However, under his proposal, a COCB would have been appointed, essentially avoiding those conflicts. Moreover, the Yahoo! board would only have been able to enter into transactions in the ordinary course of business, thereby prohibiting extraordinary actions such as Yahoo!'s proposed arrangement with Google. Professor Thompson concludes that, after evaluating the Microsoft offer, a COCB most likely would have found the offer to be financially beneficial to shareholders, and thus would have let shareholders make a decision on the transaction. Instead, Yahoo!’s stock price has fallen and shareholders apparently were left dissatisfied.
Professor Thompson’s presentation provoked many comments. On the other hand, there was recognition that state law may allow boards too much discretion in this area, and hence may prevent potentially advantageous acquisitions. Moreover, as Professor Thompson points out, federal and state law have come to rely heavily on independent boards, and hence his proposal may be viewed as an extension of that reliance. On the other hand, there was concern about whether and to what extent a corporation and its shareholders really could put their faith and fate in the hands of an SEC created independent board. As I mentioned, an interesting discussion all around.
As I noted in my post on Wednesday, I was at the Georgetown Conference commemorating the Williams Act this week. The first panel on Thursday was entitled "Balancing Federal and State Takeover Regulation" and the panelists were John Olson, Michele Anderson (new head of the SEC’s office of mergers and acquisitions), R. Franklin Balotti, Professor Ed Rock, and Vice Chancellor Leo Strine. As the title suggest, the panel focused on the interplay between state and federal regulation, and was an enlightening conversation about the ways in which the federal/state interplay could led to some unintended (and usually undesirable) consequences.
The panelists focused on some examples of that interplay and their consequences. One example was the way in which federal rules narrowed a bidder's prospective choices for acquiring a target's assets. At first glance, there appears to be three choices for structuring such an acquisition--an asset purchase, a merger, and a stock purchase, i.e., the tender offer for a public company. And yet, as panelists noted, for many companies, federal rules often narrowed these choices down to one. On the one hand, tax laws made the asset deal unattractive. And on the other hand, federal court's interpretation of the Best Price Rule (the SEC rule requiring that the amount paid to any stockholder be the highest price paid to any other stockholder) made the stock deal less attractive. This is because federal courts had interpreted that Rule to apply to executive compensation paid in connection with a tender offer under the notion that such compensation was being paid as part of the consideration in a tender offer. Of course the SEC has now altered the Rule to make clear that it does not apply to executive compensation. When the question was raised regarding why it took the SEC so long to make such a clarification, it was observed that the SEC never intended the Rule to cover compensation arrangements, and thus did not think courts would interpret the rule in favor of such coverage. When it was clear that courts were "getting it wrong," the SEC realized the need to step in.
Another example focused on the impact of federal rules on the state requirement for annual meetings. Indeed, federal proxy rules prohibit any proxy solicitation unless it is accompanied or preceded by an annual report including recent financial statements. This means that federal law would prohibit a company that does not have current financial information from soliciting the proxies it would need for its annual meeting, making it difficult for companies to comply with the state law requirement of holding an annual meeting. Several panelists noted that not only did the federal rule have unintended and undesirable consequences under state law, but it also had the peculiar impact of burdening a right that many corporations would rather not even exercise. To paraphrase Vice Chancellor Strine (and I hope I am getting it right!)--it is a bit like telling your children that if they do not finish their homework, they will not have to eat their spinach. In other words, given some companies reluctance to hold annual meetings (particularly when there is the potential for stockholder confrontation) the federal rule may give such companies an easy out. And the companies most likely to get such an out are those companies experiencing some financial difficulties (hence the late filing), and thus the companies most likely to be confronted with shareholder discontent at the annual meeting. Again, this phenomenon represents another example of the federal and state rules working at cross purposes. Like the tender offer rules, the SEC recently amended its proxy solicitation rules to allow for exemptive relief from the provision regarding the type of information necessary for soliciting proxies. Hence, the SEC has reacted.
In the end, the discussion demonstrated some of the pitfalls of having a dual system of regulation. Moreover, it revealed that too often, even when many recognize fairly quickly the negative consequences of a particular rule, it often takes quite some time before that rule is altered. So perhaps the discussion was yet another cautionary tale about federal regulation in general as well as an important reminder about the limits of state law.
I am attending Georgetown's conference commemorating the 40th anniversary of the Williams Act entitled "The History and Future of US and Global Takeover Regulation. . .The Williams Act 40 Years On." Thus far it has been an extremely interesting conference and set of conversations, about which I will be posting. One interesting conversation revolved around the future of hostile takeovers in the US. Everyone pointed out that hostile takeovers comprise a relatively small portion of the M&A market in the US. The consensus was that such takeovers comprised a small portion of the market because of the combination of state regulation and takeover defenses less prevalent in other markets. However, there was disagreement about whether the low number of US hostile takeovers would persist. Indeed, one by-product of shareholder activism is that such activism has weakened certain traditional takeover defense measures such as staggered boards and poison pills. As one panelist noted, the apparent weakening of these measures coupled with the increased adoption of majority vote provision could create a more hospitable environment for hostile takeovers. It is too soon to tell if this prediction will play out. But even it it does not, it may be that even if overtly hostile transactions do not increase in the US, the reduction in defense measures could lead to increased negotiated transactions from companies seeking to avoid the (now more realistic) threat of a hostile transaction.
I just saw a wonderful presentation on trends in private equity deal terms, part of Emory's M&A Workshops sponsored by our Center for Transactional Law and Practice. Two M&A lawyers from Paul Hastings in Atlanta, Frank Layson and Erik Belenky, presented results of a study of 48 private equity acquisitions of public companies signed between January '06 and May '07. Deal trends for the period reflect a marked shift in bargaining power toward sellers and away from buyers. No surprise, given the easy financing and wealth of buyers in the market during the sample period. To the M&A lawyer, these trends may be old news, but we academics don't always get down to (or even near!) the front lines as much as we'd like. What was especially appealing about this talk was that instead of the standard offering of war stories and impressionistic assessments, they actually had data! Pie charts and everything!
Interesting trends include the following:
1. Reverse break-up fees:
74% of the deals contained reverse break-up fees, payable by the buyer for failing to close or failing to perform a material covenant or obligation. Fees ranged between 1% and 4% of the deal value, and often mirrored the amount of the seller's break-up fee.
An interesting legal question is the interplay between the reverse break-up fee and other affirmative buyer obligations (e.g., best efforts clauses). Is the fee the equivalent of an option for the seller to walk away from the deal? Or might there be additional liability for failing to exert best efforts? See the recent Delaware Chancery Court decision in United Rentals, Inc. v. RAM Acquisition Corp. (Cerberus).
2. No financing contingencies:
98% of the deals contained no financing contingency.
3. Financing commitment letters delivered at signing:
96% of the deals required delivery of commitment letters, with sellers often enjoying either third-party beneficiary status to sue the lender or a provision requiring the buyer-sponsor to take enforcement action against a breaching financer.
4. Sponsor guarantees of obligations and covenants of the acquisition vehicle (66% of deals).
5. Go-shop provisions:
66% of deals contained a go-shop clause, which allows the seller to solicit competing bids for some period post-signing.
Our next M&A workshop is on February 22. Emory's own Bill Carney will be debating Chancellor William Chandler on the continuing value of Delaware corporate law. Also don't forget our Center's conference next May on Teaching Drafting and Transactional Skills: The Basics and Beyond. For information on our events and activities, please contact Tina Stark, who directs the Center.
UPDATE: Steven Davidoff, the newly minted NYT Deal Professor, has a post today on M&A deal points as well. He looks at 4 recent private equity deals (announced since December, as compared to the not-so-recent deals covered in the study I describe above), and it appears that the credit crunch has not affected deal terms too much.
Two interesting recent empirical papers address the issue of information leakage from private lenders that affects securities trading and takeovers. Private lenders receive confidential information about their borrowers as part of their lending activities. These papers document channels through which this private information leaks into securities markets and the market for corporate control.
One paper, Institutional Investors and Loan Market Information Spillover, by Victoria Ivashina (HBS) and Zheng Sun (Stern), marshalls evidence that private lenders also trade on this information, though not in the securities of the borrower but in the securities of firms in the same industry, or firms whose earnings or stock returns highly correlate with those of the borrower. Institutional investors who buy commercial loans do better in the stock market than those who don't.
The second paper, Bank Debt and Corporate Governance, by Victoria Ivashina, Vinay Nair (Wharton), Anthony Saunders (Stern), Nadia Massoud (York), and Roger Stover (Iowa State), finds evidence that banks facilitate takeovers by producing information as part of their lending activities and then transmitting this information to potential acquirers. In particular, (a) greater bank lending "intensity" for a firm (as measured by the number, amount, and maturity of loans by a bank to a borrower, among other things) improves the likelihood that the firm will be the target of a takeover bid; (b) a firm with lending relationships with banks that have more clients in the same industry are more likely to receive a takeover bid; (c) the bank lending intensity effect is stronger where the target and acquirer have a relationship with the same bank; and (d) potential acquirers who switch to a new relationship bank are more likely to bid for other clients of the new bank.
Not yet, but News Corp's surprise bid will test the resolve and cohesion of the Bancroft family, which holds voting control:
While the Bancrofts have the power to block any deal, thanks to supervoting "B" shares that carry 10 times the voting power of "A" shares, the family also is now far-flung and comprises at least 35 members. More than two-thirds of the Class A shares changed hands yesterday, likely putting many in the hands of merger arbitrageurs who typically push for a deal.
This story is still developing, but early reports suggest that the Bancroft's are opposed to selling to News Corp. (but not to someone else?). The market for Dow Jones' shares spiked, suggesting that many investors are looking forward to the possibility of an auction.
If Dow Jones decided to sell, who else might be interested? One name that was mentioned in the W$J and some other early reports: Google.
UPDATE: The Bancroft family has issued a statement that they would vote against the proposal by News Corp.
UPDATE2: Apparently, some News Corp. shareholders are concerned that 76-year-old Rupert Murdoch is just trying to provide a capstone to his career, rather than pursuing the long-term financial interests of News Corp. That sounds like a reasonable concern to me.
As a semi-frequent flyer, I have been watching with some concern the consolidation talks floating around various airlines. The latest development in US Airways’ effort to takeover Delta is a plan submitted to the federal bankruptcy court by Delta’s management. The plan rejects US Airways $8.5 billion takeover offer in favor of keeping Delta independent by engaging in a five-year restructuring campaign that purports to generate profits by the beginning of the year and provide better value than a merged company. Because they have to approve any reorganization plan, ultimately Delta’s creditors will judge of the kind of entity that provides the best value.
What I find especially interesting in the Delta-US Airways saga is the efforts by employees to rebuff the takeover attempts. Delta employees have created buttons with the slogan “Keep Delta My Delta” to express their opposition to a merger with US Airways. And apparently there is a high demand for the buttons among both employees and customers. What is “My Delta?” Apparently not just a Delta that is independent, but Delta is also a company that employees believe responds to their concerns. Indeed, one of the primary reasons why employees object to the US Airways takeover is that they feel it would jeopardize Delta’s corporate culture. Not surprisingly, Delta has expressed its support for employees’ Keep Delta My Delta campaign. What is surprising is that employee’s favorable impression of Delta’s culture has survived even through its bankruptcy. And employees may be willing to preserve that culture even at the cost of foregoing better wages. Indeed, the CEO of US Airways not only claims that his merger plan will cut $1.65 billion in costs without cutting jobs, but that he intends to raise salaries of employees. Perhaps employees do not believe such a claim. And perhaps employees believe that Delta’s management can improve their wages in the long run. Employees campaign certainly reflects a strong belief in the strength and importance of their company’s culture.
Ultimately, however, employees concerns about culture may be pitted against creditors desire for better value. Of course there is debate regarding whether a standalone Delta is more valuable than one that merges with US Airways. Indeed, Delta’s unions appear to support management’s belief that an alliance with US Airways would not produce good value. One union representative noted that the union’s opposition to the merger meant that they were in the “unusual” position of being on common ground with Delta’s management. However, if such a merger does prove valuable, then Delta employee’s campaign spotlights an interesting issue regarding whether a company seeking to emerge from bankruptcy can oppose a deal that may provide some value to its creditors in order to preserve its corporate culture.
As each day’s headlines attest, the world’s stock exchange
business is consolidating. The NYSE has bid
for Euronext, the company that owns and operates the Paris, Amsterdam, Brussels, and
The conventional story for this consolidation seems to be
the inexorable scale economies that come from pushing more trading volume
through expensive computerized trading systems with unlimited capacity. Given the technological advances, the world’s
securities trading may be a winner-take-all market, and once the large start-up
costs of the trading infrastructure are sunk, it behooves each exchange to
gobble up as much volume as possible. For consumers, the story goes, benefits will come in the form of cheaper
trades at better prices.
This conventional story comes with a number of interesting
complications, though—economic, regulatory, and political. On the economics, while competition among exchanges to capture scale economies is surely an important impetus to consolidation, as the Economist points out, the exchanges are also coming under increasing pressure from alternative trading venues. First off, the big Wall Street firms are increasingly internalizing their crossing trades--matching buy and sell orders internally instead of sending them to the exchanges for execution. In addition, brokerage firms are registering their internal crossing networks as alternative trading systems with the SEC, thereby bringing in regulatory oversight, which allows for connections with external networks and increased liquidity. Second, over-the-counter trading via brokers is becoming more and more popular. Third, block trading by institutions is more and more being conducted over private electronic trading systems like Liquidnet and Pipeline, where anonymity is more readily available. So exchanges as a group are losing market share. Up to two-thirds of British share trading and 75% of German trading now occur off-exchange. The consolidation of exchanges turns out to be as much survival strategy as innovative cost cutting strategy.
On the regulatory side, Sarbanes-Oxley is the big gorilla everyone is trying to keep behind the closet door. The UK’s Financial Services Authority has received comfort from the SEC that a NASDAQ-LSE merger would not by itself trigger an attempt by the SEC to apply SOX or other US regulation to LSE-listed firms. SEC commissioner Anne Nazareth has been publicly commenting to similar effect, and last week, the SEC issued a blunt fact sheet stating that:
– Joint ownership of a U.S. exchange and a non-US exchange would not result in automatic application of U.S. securities regulation to the listing or trading activities of the non-U.S. exchange.
– Whether a non-U.S. exchange, and thereby its listed companies, would be subject to U.S. registration depends upon a careful analysis of the activities of the non-U.S. exchange in the United States.
– The non-U.S. exchange would only become subject to U.S. securities laws if that exchange is operating within the U.S., not merely because it is affiliated with a U.S. exchange.
This is of course no small concern. In 2000, ninety percent of the world’s IPO dollars were raised in the US; in 2005, ninety percent of the world’s IPO dollars were raised outside the US. SOX has largely been blamed for this IPO flight from the US. FSA chair Callum McCarthy did note, however, the possibility that the merged NASDAQ-LSE entity itself might seek to rationalize its regulatory structure by consolidating its operations within one jurisdiction in order to subject itself to only one regulatory regime. He went so far as to suggest the possibility that some day the LSE might not be subject to UK regulation.
On the political end, it’s not difficult to imagine the nationalistic pressures being brought to bear on these various deals. The French are keen to preserve a strong French exchange overseen by French regulators, and the NYSE promoted itself as Euronext's best merger partner for augmenting Paris as the premier European financial center. OTOH, the NYSE has also made noises about starting an new exchange in London to compete with LSE, thereby undermining its professed commitment to promoting Paris. Deutsche Borse has also found itself in political hot water over the conduct of its Euronext bid. Just the other day, DB sweetened its offer for Euronext, attempting to appease the French by promising that the office of the chairman of the supervisory board of the merged company would be in Paris, and that the merged company would use French technology for trading shares. Not only was Euronext not impressed, but German politicians and DB employees on its supervisory board moved to block attempts to shift businesses elsewhere. A politician from the German state of Hesse, DB's home state, professed that DB "has definitely gone too far," and threatened to revoke DB's license if concessions cost too many jobs in Frankfurt. Germany's minister for trade and industry noted that any deal would have to preserve "the central role of Frankfurt."
It's complicated! Stay tooned.
I have to admit it’s due in large part to my love for movies that I have paid particular attention to the happenings at Time-Warner. And hence I am not sure that the upcoming proxy contest featuring Carl Icahn will prove beneficial to shareholders and the movie-watching public.
Icahn certainly appears to be gaining some momentum with a backing by former Viacom chief Frank Biondi. As the New York Times report, Time-Warner has recently announced that it would speed up the pace of its $12.5 million stock repurchase plan, repurchasing some $1.4 million in stock each month for the next three months—just in time for the annual shareholders meeting in May. Of course, an aggressive repurchase plan is precisely what Icahn requested that Time-Warner implement when he began his proxy battle. But the timing of the increased buyback begs the question. Is this an effort to boost earnings and signal confidence in the value of Time-Warner stock or an attempt to undermine the upcoming proxy battle? Fortunately for Time-Warner’s management, the stepped-up repurchases might achieve both results.
Today was filled with preparations for Christmas, so I am a bit late to blogging. In looking at the current headlines in the W$J, I am struck by the number of private equity deals in the works. Albertson's, a piece of Texas Instruments, and Tommy Hilfiger all appear above the fold, so to speak. The most recent issue of BusinessWeek noted:
Nine of the top 10 biggest-ever private equity deals were announced in 2005, according to deal tracker Dealogic. (The largest is still the $25 billion buyout of RJR Nabisco in 1988.)
It looks like 2006 is shaping up to be the year of private equity.