Delaware Supreme Court Sides with Blackstone

Posted on June 20, 2009 by Geoffrey Parnass
The Delaware Supreme Court recently sided with Blackstone in its dispute with Alliance Data Systems, affirming last January's ruling by Vice Chancellor Leo E. Strine, Jr. of the Delaware Chancery Court.  The ruling lets stand the dismissal of ADS's action against the Blackstone fund that sponsored the acquisition.  As you may recall, the deal failed to close after a federal bank agency required financial guarantees directly from the Blackstone fund.  ADS sued Blackstone for the $170 million reverse termination fee, contending that the Blackstone fund's failure to satisfy the demands of the regulatory agency required payment of the reverse termination fee.
 
The additional guarantees demanded by the bank agency were not covered by the letters that the Blackstone fund provided to ADS at the time the deal was signed  The letters covered only the reverse termination fee and the equity commitment.  As is typical in private equity transactions, the fund itself was on the hook for nothing more than this.

This structure is typical of private equity deals.  At least until recently, the target contracts with thinly capitalized shells created by the private equity fund. The only commitments of the private equity fund itself are made through a guarantee of the payment of the reverse termination fee and an equity commitment letter. The private equity fund is technically on the hook for nothing more. If it doesn’t want to show up for regulatory hearings or sign a necessary regulatory filing, the agreements do not obligate it to do so.

ADS negotiated no greater commitment from the private equity fund than this.  The reverse termination fee was triggered only if the shell company did not perform under the agreement. But the Blackstone shell did what it could. It just had no money to satisfy the bank regulators. Because the shells complied with the agreement, the reverse termination fee was not payable.

If and when large private equity transactions return, the ADS ruling and others like it will compel targets to demand greater financial commitments from the private equity funds themselves.  Boards of directors of public companies will not want to put themselves in play with a buyer whose financial commitment to the transaction is materially limited.  This in turn will restrain the willingness of private equity forms to bid up prices for targets.  All in all, another reason why it will be years before an M&A market driven by private equity deals returns to this earth.

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Crocodile Tears?

Posted on April 8, 2009 by Geoffrey Parnass

The gospel according to the Delaware Chancery Court is that a board of directors owes a duty to obtain the highest price for shareholders once a decision to sell the company has been made.  So it was a surprise to learn that Leo Strine, an outspoken member of the Delaware Chancery Court, said at a recent M&A conference that the duty to squeeze out every last penny in every takeover was “not productive for society.”

Sounds like blasphemy.  For years the Delaware courts have been advocates for the view that once a decision to sell has been made, the role of the directors is to pursue the best price with singular intensity.  The consequences of this orthodoxy are on display today.  During the LBO heyday, this approach led to acquisitions, such as the purchase of cyclical technology manufacturer Freescale by a Blackstone-led private equity consortium, with borrowed funds totaling 8.5 times the company’s EBITDA.  Clearly, the need to service this massive amount of debt from the cash flow of a cyclical company with high cap ex requirements will likely crowd out other uses of cash, such as hiring more engineers, investing in research and development, or just weathering a cyclical downturn in the economy.  

Despite these dire consequences, on display everywhere today, the view that the good of society is best served by paying shareholders the very last dollar in an acquisition still prevails.  I guess it’s fair to ask where that last dollar went.  If it went back into the market, then today it is very likely much less than it was a year ago.  Vice Chancellor Strine may therefore be right in asking whether the benefits of the singular focus on shareholder returns is the most productive result for society.

We are of course going through a severe deleveraging phase in the history of finance capitalism, and the prevailing mood is to question the wisdom of the past.  In all likelihood, this too will pass.  As the poet Elvis Costello has said:

“History repeats the old conceits,
The glib replies the same defeats,
Keep your finger on important issues
With crocodile tears and a pocketful of tissues.”   

 

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Blackstone on Current Conditions

Posted on November 16, 2007 by Geoffrey Parnass

Deep within Blackstone's recent 10Q, in the MD&A section, the company discusses the negative impact that the "considerable turbulence" in the housing and sub-prime mortgage markets has had on other fixed income markets. 

"Deteriorating conditions in fixed income markets prevented lenders from syndicating senior loans and high yield debt."

Translation:  when the music stopped the the banks got stuck holding our last deals.

"[T]he backlog resulting from pending private equity-led transactions reached record levels."

Translation:  the banks can't get rid of the paper.

"This backlog resulted in lenders becoming less willing to fund new, large-sized acquisitions and as a consequence, the volume of new private equity acquisitions declined significantly in the quarter."

Translation:  until the pipeline gets opened we can't get the big dogs closed.

"Recently announced private equity-led acquisitions have mostly been smaller in size, with less leverage and less favorable terms for the debt provided, including more onerous loan covenants."

Translation:  looks like it's back to Plan A.

"The duration of current conditions in the credit markets is unknown."

No translation needed.

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