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— Follow the Money —
 What's a reverse breakup fee worth? It's a straightforward question with no simple answer. As reverse termination fees become more commonplace in strategic M&A, deal practitioners debate the value of those fees to sellers' boards. Some suggest that the fees, which allow buyers to walk away from transactions under certain conditions after paying an agreed-upon fee, amount to conditional put options for the buyers and should be valued as such by selling boards. The next question is, how does one go about assigning value to them? The reverse termination fees effectively give the buyers an option to return the deal back to the seller at a nominal fee, allowing them to walk for a fraction of the deal cost. This is what happened in December 2007 when Cerberus Capital Management LP abandoned its proposed $6.6 billion buyout of Greenwich, Conn.-based United Rentals Inc., the largest construction equipment rental company in the world, simply by paying a $100 million reverse termination fee.
While reverse breakup fees frequently appeared in leveraged buyouts before the credit crunch, in recent months several strategic deals featured reverse termination fees of 3% of total deal value in their transaction agreements. These include Macrovision Solutions Corp.'s $2.8 billion acquisition of Gemstar-TV Guide International Inc.; Ashland Inc.'s $3.3 billion deal for Hercules Inc.; and Brocade Communications Systems Inc.'s $3 billion purchase of Foundry Networks Inc. Some deal lawyers argue that what is effectively an insurance policy for buyers protecting them from such exogenous events as credit crunches should be valued accordingly. However, according to several lawyers and bankers, selling boards generally do not choose to quantify the value of this option. In a recent high-profile leveraged buyout featuring a reverse termination fee, Bain Capital LLC and Thomas H. Lee Partners LP's buyout of Clear Channel Communications Inc., the board did not look at the $500 million reverse termination fee as a specific put option, says Frank Reddick, co-head of the corporate law practice at Akin Gump Strauss Hauer & Feld LLP, which advised the company's board. Instead, at the time the deal was struck, the directors saw the fee as a basic price of doing business, given that none of the potential buyers of the company would sign without the conditional put. In addition, the board felt the chances the transaction would fall apart were slim. James Woolery, a partner in Cravath, Swaine & Moore LLP's M&A practice, argues that boards cannot properly view these fees as a simple cost of doing business. He makes the case that reverse termination fees, typically set at around 3%, often understate the risk of deal failure. Valuing the fee as an option, he argues, would allow boards to set the value at a level more commensurate with the risk to the seller of deal failure. He concedes, however, that quantifying the value of that option is no easy task. "It's more of an art than science," he says, adding that placing the fee at a level that is too low effectively transfers the real risk of deal failure onto the company. "It's a terrible idea for corporate sellers," he adds. For practical purposes, the reverse termination fee is actually a form of insurance for selling boards, argues David Katz, a partner at Wachtell, Lipton, Rosen & Katz. "It's really about protecting your downside," he says. Because there can be no absolute guarantee that any deal will close, a reverse breakup fee may give sellers comfort that they will at least get a little something if a deal falls apart. John Coates IV, a Harvard Law School professor of law and economics, believes the debate over whether termination fees should be valued as options misses the more critical issue, which is the tightness of a merger agreement and the more important worry for sellers that an agreed-upon transaction will close as scheduled. "The fee is just greater acknowledgement on the part of the transactionists that deal uncertainty exists," says Coates. "All the fee does is provide a consolation prize to the seller." |
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