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— Analysis —
A handful of deals, however, with transaction values generally in the $1 billion range, have been signed during this period. Although it is clearly still too early (and the number of deals too few) to trumpet the arrival of any new "market" practice, we did want to summarize a few of the recurring terms we are seeing in today's going-private deals. They provide an interesting view into how private equity professionals and target company boards are allocating deal execution risk in a market in which getting a deal to the finish line can be a bit more complicated than it used to be.
Financing outs. Many have wondered whether private equity buyers, who have faced some sticky situations recently in getting sandwiched between a target company and waffling lenders, would insist on restoring a financing closing condition in their purchase agreements. Financing conditions were the norm in private equity deals until early 2005, when sellers in going-privates or hot auctions started resisting them. But the pendulum has not swung back as of now: none of the announced deals gave the buyer a financing condition. Most of these deals do, however, provide that the buyer's obligation to close does not arise until after the buyer has had the benefit of a "debt marketing period" of 20 to 30 days (with appropriate blackout periods around certain holidays). A debt marketing period does not commence until, among other things, the seller provides the buyer with a defined set of materials to be used in the marketing efforts. How broadly or narrowly this set of materials is defined -- and there has been a range of practice on this -- will give the buyer more or less flexibility in discussions about whether or not the debt marketing period has begun. Given the state of the market, it should not be surprising that more than a few recent deals defined the required materials broadly, even including any material customarily included in a registration statement or other offering document or otherwise required or advisable in connection with the financing. Also, a few of the deals did include a minimum Ebitda closing condition, which likely mirrors an identical condition in the buyer's commitment papers and obviously adds a layer of conditionality not seen until recently. Specific performance. The absence of a financing condition in the purchase agreement has been touted in press releases by a few of the selling companies in these deals. But the absence of a financing condition is not the same thing as having a legal right to force the buyer to close if all of the other conditions are satisfied. United Rentals Inc. learned that painful fact after seeking to force Cerberus Capital Management LP's acquisition vehicle to close the going-private they signed in July 2007. As reported, the Delaware Court of Chancery rejected United Rentals' claim, finding that the language in the agreement, although somewhat internally inconsistent, did not permit the legal remedy of specific performance. This is one issue on which private equity firms have not shown any willingness to yield: All of the deals signed since last October have explicitly provided that the seller will have no right to force the closing. At least one deal did allow the seller the right to seek specific performance of the financing covenant (i.e., the obligation of the buyer to seek to obtain the financing), but for most, the only remedy if a buyer just refused to chase its lenders would be a claim for damages. Reverse Termination Fee. Without exception, these recent deals limit the recourse of a target against a defaulting buyer to a limited amount of damages. As a percentage of equity value, a termination fee of between 2% and 3.5% was common. Interestingly, some of these deals provided for a two-tier recourse regime. The first tier was recourse to the termination fee, which could be collected without the need to prove damages. The target would then also have the right to seek to prove and recover damages in excess of the first tier of the termination fee up to an additional specified amount, which was generally no higher than 7% of equity value. This two-tier regime was found in some deals a few years ago, but may be making a resurgence as target companies argue for greater compensation in the event the time and opportunity cost sunk into a deal is wasted. Of course, there is a question of whether a target (as distinguished from the target stockholders, who will likely see the value of their public shares drop meaningfully if a deal busts) will actually be able to prove damages in excess of the first tier of the termination fee. Strategic deals: moving to the private equity paradigm? Interestingly, the paradigm outlined above regarding specific performance and termination fees is consistent with the announced $23 billion strategic acquisition of Wm. Wrigley Jr. Co. by Mars Inc. Wrigley has no right to seek an injunction or seek to specifically enforce the obligations of the Mars parties (other than to prevent disclosure of confidential information). And the financing covenant expressly provides that the Mars entities have no obligation to commence litigation or commence an action against their financing sources, which is perhaps not surprising given that one of the financing sources is Berkshire Hathaway Inc. In exchange for these limitations on recourse, Mars has agreed to
pay a termination fee of $1 billion if the deal doesn't close in
certain circumstances. Obviously, this isn't a small amount of money.
But measured as a percentage of the deal, this fee isn't substantially
larger than recent PE-led deals, especially given that a merger of
strategics such as this can sometimes give rise to regulatory scrutiny
and this deal could therefore linger in preclosing mode, becoming
exposed to market risks for a considerable period. Whether this is a
"one-off" situation driven by the comfort the parties have in each
other and the deal financing or if it is indicative of a new "market"
in strategic mergers remains to be seen. If it is the latter, it would
seem to provide further evidence that the allocations of risk in the
PE-led deals that we have described above are here to stay. Kevin Schmidt is a partner at Debevoise & Plimpton LLP. A version of this article previously appeared in the Spring 2008 issue of the Debevoise & Plimpton Private Equity Report. |
The clampdown on private equity-led going-private deals that began late last summer has shown little sign of abating. 
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