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

by Steven M. Davidoff

  24 See Malcolm Salter and Wolf Weinhold, Merger Trends and Prospects for the 1980’s (1980), excerpted in Ronald J. Gilson and Bernard S. Black, The Law and Finance of Corporate Acquisitions (2d ed., 1995),12, 16-17.

  25 The rise of the tender offer is evidenced numerically: in 1966, there were more than 107 tender offers on the New York Stock Exchange, contrasted with just 8 in 1960. See S. Comm. on Banking and Currency, Full Disclosure of Equity Ownership and in Corporate Takeover Bids, S. Rep. No. 90-550, at 2 (1967).

  26 See, e.g., M. A. Weinberg, TakeOvers and Amalgamations § 2404 (2d ed., 1967), 270.

  27 Williams Act, Pub. L. No. 90-439, 82 Stat. 454 (1968).

  28 There was a profuse amount of academic commentary at the time on this issue. See, e.g., Arthur M. Borden, “Going Private—Old Tort, New Tort, or No Tort?” 49 New York University Law Review 987 (1974); Victor Brudney, “A Note on ‘Going Private,’” 61 Virginia Law Review 1019 (1975); Victor Brudney and Marvin A. Chirelstein, “A Restatement of Corporate Freezeouts,” 87 Yale Law Journal 1354 (1978); Edward F. Greene, “Corporate Freeze-Out Mergers: A Proposed Analysis,” 28 Stanford Law Review 487 (1976); Edmund H. Kerr, “Going Private: Adopting a Corporate Purpose Standard,” 3 Securities Regulation Law Journal 33 (1975); F. Hodge O’Neal and Ronald R. Janke, “Utilizing Rule 10b-5 for Remedying Squeeze-Outs or Oppression of Minority Shareholders,” 16 Boston College Industrial and Commercial Law Review (1975); Anne Jentry, “Note, The Developing Law of Corporate Freeze-Outs and Going Private,” 7 Loyola University Chicago Law Journal 431 (1976); “Note, Going Private,” 84 Yale Law Journal 903 (1975).

  29 Notice of Public Fact-Finding Investigation and Rulemaking Proceeding in the Matter of “Going Private” Transactions by Public Companies and Their Affiliates, Exchange Act Release No. 11231, [1974-1975 Transfer Binder] Fed. Sec. L. Rep. (CCH) 80, 104, at 85,092 (Feb. 6, 1975).

  30 See Green v. Sante Fe Indus., Inc., 430 U.S. 462 (1977).

  31 Going Private Transactions by Public Companies or Their Affiliates, Exchange Act Release No. 16075, [1979 Transfer Binder] Fed. Sec. L. Rep. (CCH) 82,166 (Aug. 2, 1979).

  32 Salter and Weinhold, Merger Trends and Prospects, 32.

  33 Gaughan, Mergers, Acquisitions, and Corporate Restructurings, 26. See also Laurence Zuckerman, “Shades of the Go-Go 80’s:Takeovers in a Comeback,” New York Times, Nov. 3, 1994, A1.

  34 Fortune magazine, Dec. 26, 1983.

  35 For a discussion of these developments, see John C. Coffee et al. (eds.), Knights, Raiders, and Targets: The Impact of the Hostile Takeover (1988).

  36 See “Yahoo! Completes Acquisition,” Wall Street Journal, June 1, 1999.

  37 Jessica Hall, “Global M&A Falls in 2008, Ends 5 Years of Growth,” Reuters, Dec. 22, 2008.

  Chapter 2: KKR, SunGard, and the Private Equity Phenomenon

  1 Private equity refers to the acquisition of both public and private companies by private investment funds utilizing a highly leveraged financing structure.

  2 Dealogic Database.

  3 This author was one of these people in another context, arguing that the financial revolution had made the private markets more important than the public ones. See “Paradigm Shift: Securities Regulation in the New Millennium,” 2 Brooklyn Journal of Corporate, Financial & Commercial Law 339 (2008).

  4 This history of KKR is generally drawn and based on the following sources: Brian Cheffins and John Armour,“The Eclipse of Private Equity,” 33 Delaware Journal of Corporate Law 1 (2008); Allen Kaufman and Ernest J. Englander, “Kohlberg Kravis Roberts & Co. and the Restructuring of American Capitalism,” 67 Business History Review 52 (1993).

  5 See ibid. at 66 n. 37.

  6 See Eric J. Weiner, What Goes Up; The Uncensored History of Modern Wall Street as Told by the Bankers, Brokers, CEOs, and Scoundrels Who Made It Happen (2005), 204.

  7 Kaufman and Englander, “Kohlberg Kravis Roberts & Co.,” 67.

  8 See George Anders, Merchants of Debt: KKR and the Mortgaging of American Business (1992), 45.

  9 See Weiner, What Goes Up, 208.

  10 Bryan Burrough and John Heylar, Barbarians at the Gate (2003), 139.

  11 For more background on the establishment of this fund, see Anders, Merchants of Debt, 46.

  12 See Kaufman and Englander, “Kohlberg Kravis Roberts & Co.,” 71.

  13 See KKR Website, KKR Company: History, available at www.kkr.com/company/history.cfm.

  14 Ibid.

  15 See George P. Baker and George David Smith, “Leveraged Management Buyouts at KKR: Historical Perspectives on Private Equity, Debt Disciplines, and LBO Governance,” in Private Equity and Venture Capital (Rick Lake and Ronald Lake, eds., 2000).

  16 Henry R. Kravis, keynote speech delivered at the Private Equity Analyst Conference (Sept. 22, 2004). See also Henny Sender, “Inside the Minds of Kravis, Roberts—Private-Equity Icons Opine on Their Craft; ‘Any Fool Can Buy,’” Wall Street Journal, Jan. 3, 2007, C1.

  17 Kaufman and Englander, “Kohlberg Kravis Roberts & Co.,” 72.

  18 See Sarah Bartlett, The Money Machine: How KKR Manufactured Power and Profits, (1992), 107.

  19 Ibid., 118.

  20 Ibid., 146.

  21 Carol J. Loomis, “KKR: The Sequel, ” Fortune, June 13, 2005, 64. See also George Baker and George David Smith, The New Financial Capitalists (1998), 207-208.

  22 See Burrough and Heylar, Barbarians at the Gate, 140.

  23 Ibid. See also Roy C. Smith, The Money Wars (2000), 180.

  24 See Anders, Merchants of Debt, 125; Adam Lashinsky, “How Teddy Forstmann Lost His Groove,” Fortune ( July 26, 2004).

  25 During this time, one of the key drivers was the growth in the high-yield market. See Glenn Yago, Junk Bonds: How High Yield Securities Restructured Corporate America (1991), 210. For a discussion of how the tax-deductibility of debt can provide private equity a financing advantage, see Robert P. Bartlett, Taking Finance Seriously: How Debt-Financing Distorts Bidding Outcomes in Corporate Takeovers, 76 Fordham Law Review 1975 (2008).

  26 Michael C. Jensen first put forth this theory in his seminal article,“The Eclipse of the Public Corporation,” Harvard Business Review (Sept.-Oct. 1989). For a summary of empirical research findings on the factors driving private equity performance, see Nicolaus Loos, Value Creation in Leveraged Buyouts (2006).

  27 See Jensen, “The Eclipse of the Public Corporation.”

  28 See Cheffins & Armour, “The Eclipse of Private Equity,” 2-5. This would be a topic that would be revisited in the private equity boom of 2004-2007, with some proclaiming that it was driven in part by a desire by companies to go private to avoid the costs of the Sarbanes-Oxley Act. See generally Robert P. Bartlett, “Going Private but Staying Public: Reexamining the Effect of Sarbanes-Oxley on Firms’ Going-Private Decisions,” 76 University of Chicago Law Review 7 (2009).

  29 Baker and Smith, The New Financial Capitalists.

  30 For a somewhat negative history of Milken’s creation of a high-yield market, see Connie Bruck, Predator’s Ball (1988), 100. See also Anders, Merchants of Debt, 86.

  31 See Bruck, Predator’s Ball, 73, 119; Kaufman and Englander, “Kohlberg Kravis Roberts & Co.,” 65-66.

  32 See Anders, Merchants of Debt, 76.

  33 Mergers & Acquisitions, May-June 1991, 52, and March-April 1990, 116.

  34 See Maria Mallory, “The Burning Bed,” Business Week, May 7, 1990, 127.

  35 George W. Fenn et al., “The Private Equity Market: An Overview,” 6 Financial Market, Institutions and Instruments 19 (1997).

  36 “KKR’s New Deal: A Kinder, Gentler Barbarian,” Economist, Sept. 17, 1994, 83.

  37 See Anise C. Wallace, “Capital Spending Cut by RJR,” New York Times, July 2, 1991.

  38 See Loomis, “KKR:The Sequel.”

  39 Dealogic Database.

  40 See Federal Reserve Statistical Release, Flow of Funds Accounts of the United States (Dec. 6, 2007)

  41 Thomson/Reuters Database (includes global buy-out, m
ezzanine, recap, and turnaround funds).

  42 See Dennis Berman and Nicole Lee, “Blackstone Fund Sets a Record at $15.6 Billion,” Wall Street Journal, July 12, 2006, C4.

  43 See KKR & Co. LP Registration Statement (Form S-1), 133, filed on July 3, 2007 (hereinafter KKR Form S-1).

  44 See Blackstone Group LP Registration Statement (Form S-1), 5, filed on Mar. 22, 2007 (hereinafter Blackstone Form S-1).

  45 See Steven N. Kaplan and Antoinette Schoar, “Private Equity Performance: Returns, Persistence and Capital Flows,” 60 Journal of Finance 1791, 1792, 1812 (2005). For other studies with similar findings, see Josh Lerner et al., “Smart Institutions, Foolish Choices? The Limited Partner Performance Puzzle,” 62(2) Journal of Finance 731, 733 (2007); Alexander Ljungqvist and Matthew Richardson, “The Cash Flow, Return and Risk Characteristics of Private Equity” (draft dated Jan. 9, 2003); Ludovic Phalippou and Oliver Gottschalg, “Performance of Private Equity Funds” (draft dated Mar. 28, 2008).

  46 See Christine Idzelis,“Blackstone Gains on Celanese,” Daily Deal (May 11, 2006).

  47 See David Carey and Vipal Monga, “KKR Quadruples PanAmSat Exit,” Daily Deal (Aug. 30, 2005).

  48 See Alexander Peter Groh and Oliver Gottschalg, The Risk-Adjusted Performance of U.S. Buyouts (draft dated Nov. 14, 2006).

  49 See Merissa Marr et al., “Sony Group to Buy MGM for $3 Billion,” Wall Street Journal, Sept. 14, 2004, A3.

  50 See Dow Jones, “KKR Leaves Rivals Standing with Record $104.5B Buyout Volume” (Apr. 3, 2007).

  51 This history of private equity financing arrangements is based on Steven M. Davidoff, “The Failure of Private Equity,” 82 Southern California Law Review 481 (2009).

  52 See Andrew Ross Sorkin, “Private Investment Firms to Pay $11.3 Billion for SunGard Data,” New York Times, Mar. 28, 2005.

  53 The structure of the SunGard deal is detailed in the SunGard Data Systems, Inc. Definitive Proxy Statement, (Schedule 14A), at 49-54, filed on June 27, 2005.

  54 See Martin Sikora,“LBO Funds Offer Incentives to Drive High-Priced Deals: Groups Propose ‘Reverse’ Breakup Fees, Dropping the Financing Out While Angling for SunGard and Neiman Marcus Buys,” M&A: The Dealmakers’ Journal, Sept. 1, 2005.

  55 This figure excludes transactions involving strategic buyers or families. Thomson/Reuters Database.

  56 See Dennis K. Berman and Henny Sender, “Probe Brings ‘Club Deals’ to Fore,” Wall Street Journal, Oct. 11, 2006, C1. One study found that target shareholders were paid approximately 10 percent less in deals involving multiple private equity firms than in private equity acquisitions involving only one firm. See Micah S. Officer et al.,“Club Deals in Leveraged Buyouts” (draft dated Oct. 28, 2008).

  57 See Steven Davis et al., Private Equity and Employment, U.S. Census Bureau Center for Economic Studies Paper No. CES-WP-08-07 (2007), 6.

  58 See Frank R. Lichtenberg and Donald Siegel, “The Effects of Leveraged Buyouts on Productivity and Related Aspects of Firm Behavior,” 27 Journal of Financial Economics (1990), 165-194. One later study sponsored by the Private Equity Council found that for companies with an acquisition value greater than $250 million, the average growth in capital spending was 14.6 percent versus a U.S. average of 3.5 percent. See Robert Shapiro and Nam Pham, The Impact of Private Equity Acquisitions and Operations On Capital Spending, Sales, Productivity, and Employment (draft dated Jan. 2009).

  59 See Morten Sorensen et al., Private Equity and Long-Run Investment: The Case of Innovation (draft dated Feb. 1, 2008).

  60 See Kurt Andersen, “Greed Is Good and Ugly,” New York ( July 23, 2007).

  61 Ibid. See also “ 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.

  62 KKR had also resorted to hiring a public relations firm and congressional lobbyist back in the 1980s to combat accusations that it had “looted” targets it acquired. See Bartlett, The Money Machine, 257-270.

  63 See Christine Idzelis, “Postponing the Inevitable?” The Deal, Oct. 31, 2008. For a review of companies acquired prior to 2008 with PIK toggles, see S&P Global Fixed Income Research, Credit Comment: PIK-Tock, PIK-Tock, Delaying the Inevitable, June 2008.

  64 See Jason Kelly and Elizabeth Hester, “Blackstone Sells More Shares after IPO,” Bloomberg News, June 27, 2007.

  65 See Letter from Richard L.Trumka to Messr. John White & Andrew Donohue, re: The Blackstone Group L.P. Initial Public Offering, dated May 15, 2007.

  66 Thomson/Reuters Database (includes global buyout, mezzanine, recap, and turnaround funds).

  67 KKR Form S-1, iii (KKR figures are as of Mar. 31, 2007); Blackstone Form S-1, 1 (Blackstone figures are as of Mar. 1, 2007).

  68 Dealogic Database.

  69 See, e.g., Ronald Gilson and Charles Whitehead, “Deconstructing Equity: Public Ownership, Agency Costs, and Complete Capital Markets,” 108 Columbia Law Review 231 (2008).

  70 See Bartlett, The Money Machine.

  71 Liz Moyer, “The Sunny Sides of the Street,” Forbes ( Jan. 4, 2008).

  Chapter 3: Accredited Home Lenders and the Attack of the MAC

  1 See Floyd Norris and Jeremy W. Peters, “Wall St. Tumble Adds to Worries about Economies,” New York Times, Feb. 28, 2007, A6.

  2 For a review of the subprime industry and its many failures during this period, see Gary Gorton, The Panic of 2007, at 3 (draft dated Aug. 4, 2008); Atif Mian and Amir Sufi, The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis (draft dated Dec. 12, 2008).

  3 Thomas K. Brown, It’s Time to Be Greedy, bankstocks.com, Feb. 27, 2007. In hindsight, perhaps the fact that “greedy” was in the title of this article should have put investors on alert.

  4 See Accredited Home Lenders Holding Co. Press Release, “Accredited Pursuing Strategic Options” (Mar. 13, 2007).

  5 For a profile of Grayken, see Brendan M. Case and Eric Torbenson, “Lone Star Funds Chief John Grayken Is Value Spotter,” Dallas Morning News, July 4, 2008.

  6 For a full history of this auction and for further background to Accredited’s sale, see Accredited Home Lenders Holding Co. Solicitation/ Recommendation Statement, (Schedule 14d-9) at 10, filed on June 19, 2007.

  7 The terms of Lone Stars’s original tender offer are set forth in the Offer to Purchase of LSF5 Accredited Merger Co., Inc. and LSF5 Accredited Investments, LLC (Schedule TO), Exhibit 99.(A)(1)(A), filed June 19, 2007.

  8 Annual Report of Accredited Home Lenders Holding Co. (Form 10-K), 34, filed on Aug. 2, 2007.

  9 See Gretchen Morgenson, “Bear Stearns Says Battered Hedge Funds Are Worth Little,” New York Times, July 18, 2007.

  10 Charley Blaine and Elizabeth Strott, “Stocks Storm Back from Steep Losses,” MSNMoney.com, July 18, 2007.

  11 See Defendant’s Answer to Complaint and Counterclaims at 19, filed as an exhibit to the Schedule TO of LSF5 Accredited Merger Co., Inc., and LSF5 Accredited Investments, LLC, filed on Aug. 21, 2007.

  12 The requirements are under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. 15 U.S.C. § 18a(a)(2)(A). In addition, if the acquisition is between $65.2 million and $260.7 million, the acquisition is subject to a filing requirement and waiting period, depending upon whether certain size requirements are met. FTC Revised Jurisdictional Thresholds for Filings Made Pursuant to the Hart-Scott-Rodino Act, Jan. 6, 2009.

  13 MAC clauses became an important focus point of negotiation only in the 1980s. See Ronald J. Gilson and Alan Schwartz, “Understanding MACs: Moral Hazard in Acquisitions,” 21 Journal of Law, Economics and Organization 330, 331 (2005).

  14 Agreement and Plan of Merger by and among Accredited Home Lenders Holding Co., LSF5 Accredited Investments, LLC, and LSF5 Accredited Merger Co., Inc., dated as of June 4, 2007, at § 1.01.

  15 See Gilson and Schwartz, “Understanding MACs,” 336-340. Two other professors have theorized that a MAC serves as a litigation screening device whereby the cost
s of litigation “enable the seller to better signal private information at the time of closing, in order to promote ex post efficiency in terminating or executing the acquisition.” Albert H. Choi & George G. Triantis, Vagueness in Contract Design: The Case of Corporate Acquisitions (Apr. 3, 2009). See also Robert T. Miller. “The Economics of Deal Risk: Allocating Risk Through MAC Clauses in Business Combination Agreements” 50 William & Mary Law Review 2007 (2009) (arguing that MAC clauses are efficiently negotiated to take into account the risk of MAC claims by counterparties).

  16 Gilson & Schwartz, “Understanding MACs.”

  17 For further discussion of the scope and content of an MAC, see Kenneth A. Adams, “Understanding ‘Material Adverse Change’ Provisions,” 10(6) M & A Law 3 (2006); Dennis J. Block and Jonathan M. Hoff,“Material Adverse Change Provisions in Acquisition Agreements,” New York Law Journal 226(38), 5 (2001); Jonathon M. Grech, “‘Opting Out’: Defining the Material Adverse Change Clause in a Volatile Economy,” 52 Emory Law Journal 1483 (2003); Kari K. Hall, “How Big Is the MAC? Material Adverse Change Clauses in Today’s Acquisition Environment,” 71 University of Cincinnati Law Review 1061 (2003).

  18 In re IBP, Inc. S’holders Litig., 789 A.2d 14 (Del. Ch. 2001).

  19 The history of this transaction is detailed in Tyson Food Inc. Information Statement (Schedule 14C), filed on Jan. 9, 2001.

  20 IBP, 789 A.2d at 23. See generally Greg Winter, “IBP Inc. Sues Tyson Foods for Axing Sale,” New York Times, Mar. 31, 2001.

  21 IBP, 789 A.2d at 68.

  22 Ibid.

  23 Ibid. 82-84. See also Agreement and Plan of Merger, dated as of January 1, 2001, among IBP, Inc., Tyson Foods, Inc. and Lasso Acquisition Corp., filed as an Exhibit to Amendment 9 (Schedule TO), filed on Jan. 5, 2001.

  24 Frontier Oil Corp. v. Holly, No. Civ.A. 20502, 2005 WL 1039027 (Del. Ch. April 29, 2005).

  25 Ibid. at ∗34.

  26 Ibid. at ∗36.

  27 For example, the court in Pan Am Corp. v. Delta Airlines, Inc., 175 B.R. 438, 493 (S.D.New York, 1994), held that a significant deterioration of business performance and business prospects—declines of 20 percent to 40 percent in advance bookings—constituted an MAC. However, the case highlighted the extreme deterioration necessary to show an MAC—the range of a 10 percent to 20 percent decline remains a gray area.