Every era in dealmaking has its landmark mergers whose implications M&A professionals spend years pondering and whose lessons shape the advice they give to clients. Some of the deals result in significant legal decisions; some are embedded in merger agreements whose terms become standard; some mark significant changes in tactics.
With the M&A market in a deep slump, it's an opportune time to look back on the signal deals between 2000 and 2008 -- or, put another way, between Time Warner Inc.'s 2000 merger with America Online Inc. and J.P. Morgan Chase & Co.'s 2008 shotgun purchase of Bear Stearns Cos. The two transactions bookend a period in which three trends had a powerful impact on M&A case law and contract drafting: the rise of private equity; increasing shareholder activism; and a shift in how hostile deals were done.
Time Warner's $105 billion merger with AOL signaled the peak of an
M&A market cycle. A big, bold stock swap meant to transform both
companies, it was emblematic of the deals of the second half of the
'90s. This wasn't necessarily a compliment. Less than three months
after Time Warner CEO Gerald Levin and his AOL counterpart, Steve Case,
preened for the cameras, the equity boom that fueled such deals topped
out as steep declines in stock indexes sapped M&A. And the AOL deal
turned out to be a disaster.
After AOL, a different deal market took shape. Cheap debt replaced
cheap equity, which gave a big role to private equity. In late 2002, Blackstone Group LP agreed to buy TRW Inc.'s automotive parts unit for $4.7 billion. The deal was a sideshow to Northrop Grumman Corp.'s
hostile takeover of TRW, though at the time it was the largest
leveraged buyout since that of RJR Nabisco Inc. in 1989. By the time
the buyout frenzy reached its zenith in 2007, PE had moved from
periphery to center, and an LBO of that size would have elicited yawns.
There were other currents at work as well. In part because of the
failures of so-called transformative combinations such as AOL-Time
Warner, imperial CEOs became objects of derision, a change hastened by
the fraud and failure of companies such as Enron Corp. and WorldCom
Inc. Skepticism of CEOs made it harder for target companies to resist
hostile bids. As CEOs lost power, shareholders, particularly the
increasing numbers of hedge funds, seized it, demanding that companies
remove poison pills, eliminate staggered boards and subject management
to more vigorous board oversight. Shareholders became more inclined to
throw their weight around after the announcement of a deal.
Though shareholders continued to fixate over takeover defenses,
target managements and boards rarely used them to thwart hostile bids.
Instead, targets wielded defenses to extract the best possible offer, a
trend captured by two watershed deals where determined bidders
outlasted intransigent targets: Weyerhaeuser Co.'s pursuit of Willamette Industries Inc., which ended in 2002, and Oracle Corp.'s of PeopleSoft Inc., which closed in 2004.
These trends reinforced each another. Shareholder opposition to
aggressive takeover defenses not only led to the demise of the
spectacular pitched battles of the '80s; it also made managers more
receptive to private equity, which offered freedom from the prying eyes
of analysts, the intrusive reach of shareholders and the possibility,
if successful, of reaping staggering paydays. But shareholders quickly
became as suspicious of LBOs as they had been of takeover defenses and
by the last year of the boom were winning price bumps from buyers after
a deal was signed up -- in retrospect, just another sign of the
Here, then, are the M&A deals that defined one of the great boom periods in American dealmaking.
The taming of the hostile bid
Weyerhaeuser Co. -- Willamette Industries Inc.; Northrop Grumman Corp. -- TRW Inc.; and Oracle Corp. -- PeopleSoft Inc.
Hostile bids were the central issue in M&A law in the 1980s and the first half of the 1990s. In 10 years of jurisprudence, Delaware's Court of Chancery and Supreme Court never definitively answered whether a target could flatly reject a hostile bid regardless of price -- could "just say no," in a phrase dealmakers lifted from Nancy Reagan's anti-drug campaign. Many state legislatures, including those in Pennsylvania and Ohio, passed statutes that expressly gave target boards that right.
The second half of the 1990s threw little light on the issue. "By the end of the 1990s, we'd come to the conclusion that the cases in which the Delaware courts have overturned pills were unusual," says Richard Hall, a partner at Cravath, Swaine & Moore LLP in New York who represented Portland, Ore.-based Weyerhaeuser on the Willamette bid. "So by the late 1990s, if a client asked you how to do a hostile and you saw a staggered board and a pill, particularly in a jurisdiction with a constituency statute, you said the client had to be prepared to go through two years of a proxy fight. We all knew what to do, but no one did it."
Well, almost no one. In 1996, U.S. Surgical Corp. made a $262 million hostile bid for Circon Corp. The bidder won two seats on Circon's staggered seven-member board in 1997 but dropped the bid when it agreed to sell to Tyco International Ltd. in 1998. Shareholder rights advocates pointed to Circon as a prime example of the abuse of takeover defenses.
Two years later, Weyerhaeuser offered $5.2 billion for crosstown papermaking rival Willamette, which rejected the bid. Weyerhauser launched a tender offer within weeks and picked up 48% of the target's shares, then ran a proxy fight and won three seats. The key break may have come in September 2001, almost a year after Weyerhaeuser's bid, when a Willamette founding family member and leading shareholder urged the company to explore a sale. Richard Clark, the representative of the estate of Maurie Dooly Clark, son of Willamette's founders, hoped to settle Clark's estate and said he would back a sale if Weyerhaeuser raised its bid to $55 a share, from $50. The companies agreed on $55.50 per share on Jan. 22, 2002.
A month later, Northrop Grumman Corp. launched a $5.9 billion bid for Cleveland-based TRW Inc. worth $47 a share. As an Ohio corporation, the Cleveland-based aerospace and automotive group had the statutory right to "just say no," to take into account interests of constituencies other than shareholders and to install aggressive takeover defenses.
But instead of digging in, TRW responded by saying it would sell its aeronautical unit and spin out its automotive business. Northrop raised its bid, TRW opened its books and the parties signed a deal at $60 per share on July 1, little more than four months after Northrop launched its bid. TRW agreed to sell its aeronautical systems unit to Goodrich Corp. for $1.5 billion in June, and Blackstone Group LP paid $4.7 billion for the automotive parts unit in November.
"In TRW," says Andrew Bogen, a retired partner at Gibson, Dunn & Crutcher LLP in Los Angeles who represented Northrop, "we got to act on a theory that I had always held, which is that takeover laws didn't change the equation in any important way. I always thought all the pressure a target board would come under would be the same for both a Delaware and a Ohio company."
TRW didn't adopt a scorched-earth defense. PeopleSoft Inc. CEO Craig Conway, also a Bogen client, did in his quest to fend off a bid for the business software company from Oracle Corp. Conway personalized the battle from the June 2003 day when Oracle CEO Larry Ellison announced an offer at a scant 10% premium. Conway called the bid "atrociously bad behavior from a company with a history of atrociously bad behavior." He urged the U.S. Department of Justice to file suit to stop the bid on antitrust grounds. Claiming Oracle sought to ruin PeopleSoft by scaring off customers, Conway had his lawyers develop a so-called customer assurance program in which PeopleSoft customer contracts had clauses that would require that a buyer meet certain conditions or be liable to customers for as much as 5 times the fee paid to license PeopleSoft software.
A federal judge ruled for Oracle after a trial on the antitrust case, setting the stage for a showdown between Ellison and Conway in Delaware's Court of Chancery in October 2004. On the eve of the trial, PeopleSoft's board fired Conway, who somehow refrained from bashing his former employer when he testified before Vice Chancellor Leo E. Strine Jr. Two days later, the judge asked Ellison about Conway's comparison of him to Genghis Khan. Ellison called the Khan "an illiterate Mongol but a hell of general."
But the personalities in the case didn't determine the outcome. After seizing control from Conway, the PeopleSoft board tried to get the best deal it could for shareholders. Despite low-balling the target in its initial bid and threatening to reduce its offer, Oracle agreed to pay $24.50 a share. Strine nudged the parties to come to an agreement but never issued a ruling in what might have been the most important takeover case in a decade. Takeover practice had become so routinized that even the Genghis Khan of Silicon Valley couldn't upset its dictates.
"Since Weyerhaueser and Oracle, we have seen a drop in the use of staggered boards, and I think we've seen a shift in the attitude of hostile bidders and targets," Hall says. "I wonder if the impact of these two deals is that targets just won't try to dig in their heels any more because they know they'll eventually lose. If you're a target, put the buyer to a meaningful test and then get the best price you can."
Shareholders step up
VNU NV and IMS Health Inc.
The rise of shareholder activism has long been one of the most powerful trends in U.S. corporate governance. Institutional investors have held an ever-increasing percentage of the equity of U.S. companies and have become steadily more vocal since the early '80s. As Hall, Bogen and numerous others note, shareholder opposition to poison pills, staggered boards and other takeover defenses have reduced the number of situations where targets try to thwart a bidder. Shareholder pressure has helped lead to a reduction in average CEO tenure and drive the leveraged buyout boom as CEOs found working for PE firms more appealing than answering to public markets.
Pervasive as its effect have been, shareholder power has grown over time, perhaps because shareholders have only a few basic rights. They elect directors and may remove those they deem unworthy. Target shareholders have a vote on mergers and may decide whether to tender their shares into an offer. Shareholders of would-be acquirers listed on U.S. exchanges have a vote on a deal if the buyer is issuing more than 20% of its outstanding stock in the transaction.
This is the right shareholders of VNU NV used to kill the market research company's proposed acquisition of IMS Health Inc. in 2005 for $6.9 billion in stock. Fidelity Management & Research Co. and Templeton Global Advisors Ltd., which respectively owned 15% and 14% of VNU, came out against the deal on Sept. 30, 2005, two months after it was announced; six weeks later the companies parted ways. They didn't even bother putting the deal to shareholders. VNU was listed in the U.S. but based in the Netherlands, which may have made Fidelity's decision to oppose the deal easier; the mutual fund giant has historically shied away from pressuring U.S. companies publicly.
VNU's shareholders weren't finished. The company agreed to sell for $10.3 billion to a private equity consortium that included AlpInvest Partners NV, Blackstone Group LP, Carlyle Group, Hellman & Friedman LLC, Kohlberg Kravis Roberts & Co. and Thomas H. Lee Partners LP in March 2006. Shareholders said the offer was too low, and Institutional Shareholder Services Inc. agreed, forcing the buyers to sue for peace by hiking their bid to €29.50 ($38.15) from €28.75 per share -- a gambit that became common in the final 18 months of the PE boom.
The sale also illustrates two effects of private equity on M&A: the symbiotic relationship between activist shareholders and LBO firms and the rise of buyout activity in Europe, which for several years in this decade topped U.S. levels.
MAEs made clear
Tyson Foods Inc. -- IBP Inc.
Despite its robust body of jurisprudence on defenses in hostile bids, Delaware has little case law on when a buyer may walk from a merger agreement. Strine issued the most important ruling in at least the past decade when he forced Tyson Foods Inc. to complete its purchase of IBP Inc. in 2001. By finding that IBP had not suffered a so-called material adverse effect, the judge showed a reluctance to let a buyer walk from an agreement absent a clear right to do so in an opinion that significantly affected M&A practice.
"For so many years, people would come to me asking, 'Can I sue to get out of this deal?' and I would advise them based on the specific language of their contract, but everyone was kind of guessing because no one had ever pulled the trigger," by trying to walk from a deal, says Alan Stone, who joined Milbank, Tweed, Hadley & McCloy LLP in New York after practicing for 20 years at Morris, Nichols, Arsht & Tunnell LLP in Wilmington. "It was potentially too devastating for someone to try to back out of the deal, given the magnitude of the damages. IBP really set the standard for all the MAC cases that came after it."
Tyson, a chicken processor, agreed to buy beef processor IBP for $4.7 billion on Jan. 1, 2001. The timing was unfortunate, since fears of mad cow disease in Europe generated lots of media coverage that month. Tyson walked from the deal March 29, saying it had been fraudulently induced to sign the agreement. IBP sued in Delaware to force Tyson to close the deal, and Strine heard a two-week trial in May.
Tyson argued that fraud at an IBP unit gave it the right to bail out. IBP countered by arguing that Tyson founder Don Tyson, the father of then-CEO John, decided to kill the deal because of mad cow fears. Strine chose the latter explanation and held that under the terms of the agreement Tyson couldn't walk merely because it was suffering from "buyer's remorse," a term that still echos in Delaware case law. The clause that allowed Tyson to walk if IBP suffered an MAE "is best read as a backstop protecting the acquirer from the occurrence of unknown events that subsequently threaten the overall earnings potential of a target in a durationally significant manner," Strine wrote in his opinion.
Tyson complied with the ruling and closed the deal; Richard Bond, IBP's chief executive, held the same position at Tyson from 2006 to January of this year.
The decision made clear that Chancery would award specific performance of a merger agreement. Many lawyers had wondered whether a judge would grant such an aggressive remedy. By doing so, Strine forced parties to focus even more closely on the negotiation of MAE clauses and other mechanisms allowing buyers to walk.
"IBP still looms huge," says Mark Gordon, a partner at Wachtell, Lipton, Rosen & Katz in New York. (Wachtell represented IBP, but Gordon did not work on the deal.) "The decision basically says buyers should understand that they will never be able to get out of a deal based on an MAE, and deal drafting since then has moved even further in the 'no out' direction. What you ended up with almost says there's no such thing as an MAE in Delaware. People basically agree with it and follow it. The practice with respect to MAEs has taken that further. The MAE definition in IBP was, in that case, about three lines, and now the typical definition is 25 to 40 lines. The increase is due to exceptions that narrows what an MAE was in IBP. As a result, people believe the MAE is like the unicorn -- something that doesn't exist in the real world."
The IBP view of the MAE, combined with the possibility of specific performance, affected the drafting of private equity contracts as well, Gordon says. However carefully merging parties crafted their MAE definition, sellers almost invariably retained the right to sue for specific performance. Buyout firms, on the other hand, did not want to be subject to that liability.
Setting the PE standard
Sungard Data Systems Inc.
The leveraged buyout craze of the 1980s flamed out soon after the RJR Nabisco Inc. buyout when First Boston Corp. was unable to sell hundreds of millions of dollars it had lent to the buyout of Ohio Mattress Co. The deal almost killed the firm, which had to sell to Credit Suisse Group to save itself. After the "burning-bed" episode, private equity became a much lower-profile, if profitable, business, where deals of more than $1 billion were rare and which accounted for 5% or less of M&A volume in most years.
Several factors combined to change that. Stock market declines in 2001 made many strategic buyers reluctant to use what they viewed as undervalued equity for acquisitions, meaning PE funds could compete with strategics on more equal footing. The strong performance of many funds in the 1990s helped them raise more money. And as the U.S. went into recession, the Federal Reserve Bank cut the prime rate from 9.5% in May 2000 to as low as 4% in June 2003, which reduced the PE funds' cost of borrowing.
PE gained momentum from 2002 to 2004, accounting for a larger share of the M&A market in each of those years. As PE firms targeted larger public companies, lawyers had to adapt. After the burning bed, buyout shops and lenders realized the importance of the ability to walk if financing fell through and demanded such a right. PE buyers also saw that they would suffer damage to reputations if they used the financing out to walk and rarely threatened to do so.
But there was a critical exception in 2002 when Diageo plc agreed to sell Burger King Corp. to TPG Capital, Bain Capital LLC and Goldman Sachs Capital Partners for $2.25 billion. The fast-food chain missed performance targets set out in the agreement, and the buyers extracted a 37% price cut from Diageo. Technically, the acquirer was a shell, but the buyers' lawyers were still concerned about the liability of their PE clients if they walked. "We were facing a situation where if the deal went down, we called a [material adverse change] and we were wrong, we were facing a small chance on a large liability," says R. Newcomb Stillwell, a partner at Ropes & Gray LLP in Boston who represented Bain. "Everyone for the first time in a significant way asked if the old technology worked as well as we thought in the context of what was a very large deal at the time. Did the threat of a small chance of a large loss give the seller too much leverage?"
The PE firms wanted to retain their financing out and make absolutely clear that the parent would not be liable for specific performance even if it violated the terms of a contract by walking. They got their wish in a series of deals announced in spring of 2005, most importantly the $10.6 billion buyout of SunGard Data Systems Inc. That deal established as a market standard the reverse termination fee, a provision in the contract that allows the buyer to walk for any reason upon payment of a fee that was usually set at about 3% of deal value to correspond with the breakup fee the bidder would receive from a target that took a better offer. Seen another way, the reverse breakup fee acted as a cap on the bidder's damages, an aspect of the structure that became critical when lending markets collapsed in 2007.
SunGard became a landmark in part because so many advisers had a hand in the deal. Silver Lake Partners LP led a consortium of buyers that included Bain, Blackstone Group LP, Kohlberg Kravis Roberts & Co., TPG, Goldman Sachs and Providence Equity Partners Inc., insuring that those PE shops and their lawyers were exposed to the papers on the deal and understood how they worked. The large number of partners in the buyout group required the creation of a so-called intersponsor agreement that detailed how they would run SunGard and became standard in the many club deals that followed.
Parties in other deals did reach different resolutions on the issue of buyer liability. Neiman Marcus Group Inc. established the concept of a two-tier breakup fee in its 2005 sale to TPG and Warburg Pincus, under which a welshing buyer would pay perhaps 3% of the deal's value if financing fell through and a higher percentage, say 4.5%, if it walked for a reason not otherwise permitted under the merger agreement. A few companies such as Avaya Inc. and Michaels Stores Inc. that sold in robust auctions even got private equity buyers to allow for specific performance.
Despite these exceptions, Stillwell says, "SunGard set up the mechanics that got tested when the deals fell apart."
Setting the PE standard
Lear Corp., Netsmart Technologies Inc. and Topps Co.
One judge pondered the mechanics of buyouts at length. Delaware's Strine issued four key decisions on PE sales, three of which came at the peak of the cycle and displayed a skepticism of all actors in the process and, implicitly, a belief that targets have a reasonable chance at a better deal.
In the first, Strine largely endorsed the auction Toys 'R' Us Inc. used to sell to Texas Pacific Group and Warburg Pincus in 2005. "It is not the concern of our law to set up a process that promotes endless incremental bidding," he wrote. "To do so risks creating an incentive for a lower initial deal price because initial buyers will have less closing certainty."
But in 2007, Strine offered more ambivalent assessments of the proposed buyouts of Netsmart Technologies Inc., Topps Co. and Lear Corp., closely scrutinizing the conditions of a sale. In Netsmart, he noted that as a technology company with a market capitalization of about $100 million, the target was unlikely to attract unsolicited bids from larger rivals once it had agreed to sell in a leveraged buyout.
Strine offered a nuanced view of Topps' sale. The trading card company agreed to a deal with Michael Eisner that included a go-shop clause giving Topps the right to seek out a higher bidder. So far, so good.
But the judge censured the Topps board for refusing to seriously consider a topping bid from industry rival Upper Deck Co. LLC, which, as Strine noted, had made halfhearted passes at Topps before, history that in a less frothy era might have made a judge sufficiently skeptical of Upper Deck to bless the conduct of the Topps board.
Lear ran the most thorough sales process of the three companies. The automotive parts company got rid of its poison pill in 2004. Cerberus Capital Management LP suggested an LBO of Lear at $17 a share in April 2006, but Lear CEO Robert Rossiter rejected the idea.
That was the right call; Rossiter agreed to sell the company to 24% shareholder Carl Icahn for $36 a share in 2007. That wasn't good enough for Strine. He ordered Lear to make additional disclosures on the CEO's talks with the board about restructuring his pension and expressed dismay that the board had not watched Rossiter more closely as he negotiated the deal.
Strine did recognize a good price when he saw it. Lear shareholders did not. They rejected the deal. As of early March, Lear traded at about 50 cents a share.
Strine's four buyout rulings are among the most thorough descriptions of LBOs yet to appear. They're also part of Delaware corporate law, and as such their meaning will continue to evolve as lawyers interpret them in different contexts. Beyond that, they show the influence of the broader economy on corporate law. On Aug. 14, 2007, just a few weeks after the credit markets collapsed, Strine ruled that Inter-Tel Inc.'s board had the right to postpone the shareholder vote on its sale from June 29 to Aug. 2. Inter-Tel was poised to lose the earlier vote because Institutional Shareholder Services had recommended against a $723 million sale to Mitel Networks Corp. and Francisco Partners that Inter-Tel had taken over a higher but less certain offer.
The target's shareholders ended up accepting the deal. By August 2007, the world had changed for judges, shareholders and everyone else.
A trio of collapses
HD Supply, United Rentals Inc. and Hexion Specialty Chemicals-Huntsman
Targets provided the most vulnerable group of players. As Stillwell notes, when buyouts started coming apart, the SunGard template came into play. That template strongly favored the PE firms that crafted it.
The first buyout to come under pressure set the pattern for many that followed. In August 2007, Bain Capital, Carlyle and Clayton, Dubilier & Rice Inc. threatened to walk from their agreement to buy HD Supply from Home Depot Inc. for $10.3 billion. The buyers claimed the target had suffered a material adverse change that gave them the right to walk from a deal they had announced two months earlier. The funding banks lined up beside the buyers.
The merits of the claim mattered less than the parties' negotiating leverage. If buyers walked and Home Depot sued, the most it could have recovered was the $310 million reverse termination fee set out in the sale agreement. But Home Depot wanted the deal and accepted a $1.8 billion price cut to complete it. Home Depot turned out to be lucky.
Many buyers walked rather than renegotiate deals whose pricing no longer made sense. Some paid reverse termination fees; others invested token amounts in the spurned seller; a few escaped scot-free.
Two such standoffs led to trials in Chancery. In December 2007, Chancellor William Chandler III ruled that Cerberus could walk from its $6.6 billion agreement to buy United Rentals Inc. upon payment of a $100 million breakup fee. Chandler called the matter "a good, old-fashioned contract case prompted by buyer's remorse" but found that motive irrelevant in a situation where the merger agreement didn't give the seller the right to seek specific performance.
Huntsman Corp.'s fight to force Hexion Specialty Chemicals Inc. to complete its purchase of Huntsman was long, nasty and convoluted -- the perfect end to a stunning chapter in U.S. finance. Huntsman agreed to sell to Basell NV in June 2007 but accepted a topping bid from Hexion, a portfolio company of Apollo Management LP.
As both credit and chemicals markets deteriorated last spring, Apollo sought a way out of the deal and obtained an opinion from Duff & Phelps Corp. stating Hexion would be insolvent if it closed the deal.
After six days of trial, Vice Chancellor Stephen Lamb found that Hexion had "knowingly and intentionally" breached the agreement. Huntsman had not suffered an MAE, Lamb ruled, leaning heavily on Strine's opinion in IBP Inc. Huntsman finally agreed to let Apollo off the hook in December after payment of $750 million and the purchase of $250 million in Huntsman debt. Huntsman continues to pursue claims in Texas state court against Deutsche Bank AG and Credit Suisse Group, the funding banks.
The week the Huntsman trial ended, a new era in dealmaking -- and, quite possibly, in U.S. history -- began with the bankruptcy of Lehman Brothers Holdings Inc. Some of the old lessons proved immediately relevant. Pfizer Inc. and Wyeth, for example, followed the Neiman Marcus Group Inc. leveraged buyout by barring specific performance and agreeing to a two-tier reverse termination fee in their January agreement. And Pfizer is paying enough cash that its shareholders don't have a vote, perhaps because the parties to the deal wanted to avoid giving them the veto VNU stockholders used to thwart the IMS Health merger. Other lessons will become relevant or irrelevant as time passes and conditions change. It's why we have lawyers and judges.