Increased Resistence by Public Shareholders

Posted on May 28, 2007 by Geoffrey Parnass

Going-private transactions sponsored by private equity firms are facing increased resistance from public shareholders.  The resistance takes many forms, all designed to improve the price.  Like any seller these days, the opportunities to leverage competing bids typically bear fruit. 

A sponsor that faces stiff public stockholder resistance, and that wants to keep pricing within reason, has a few strategic alternatives:

Stub Equity

“Stub equity” has been included as a feature in several recent transactions, including Harman, Clear Channel and Aeroflex in the United States. Stub equity gives public stockholders the option to choose either cash or stock in the company post-leveraged buyout. Stub equity is intended to deflect concerns that the going concern value of the target is worth more than the sponsor takeout price by offering the public stockholders the ability to choose, at least in part, to roll its investment going forward (possibly on a tax deferred basis). The amount of stock that may be issued to public stockholders is typically capped by the sponsors. Generally, caps have been in the 20% to 30% range of the company’s equity post-leveraged buyout, although in at least one transaction, Countryside, the cap was set at 55%. Stub equity has a number of disadvantages to sponsors, such as the requirement to register with the Securities and Exchange Commission the shares to be issued to the public stockholders and the requirement that the target remain a public company and file Securities and Exchange Commission reports for some period of time after the closing. This structure also has certain drawbacks for public stock-holders, particularly retail investors, as the sponsors may not be required to maintain a NYSE or NASDAQ listing for the stub equity so there may be very limited liquidity. 

Contingent Value Rights

Similar to earn-out rights in a private company transaction, contingent value rights provide a mechanism to bridge a perceived value gap, and thereby help mitigate public stockholder opposition. Contingent value rights give public stockholders additional value if future hurdles are met and, as an example, can be tied to future financial targets or the sales price in the event of a divestiture of a division or key assets. However, unlike stub equity, contingent value rights customarily give public stock-holders limited upside potential and don’t carry any downside risk. A variation of contingent value rights was recently part of a stockholder derivative settlement in the Sabre Holdings going private transaction. The sponsors agreed to pay the public stockholders a percentage of any profits above a certain benchmark price if the sponsors flipped the company or divested certain crown jewel assets within a six month period following closing. This type of supplemental payment for public stockholders may become more common in merger agreements.

Time will tell how the great push back by public stockholders affects the going private trend.

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Stub Equity -- The Next Big Thing

Posted on May 2, 2007 by Geoffrey Parnass

The recently announced LBO of Harman International Industries by KKR and Goldman Sachs Capital Partners offers the great unwashed public the chance to own a piece of the post-acquisition company alongside the sponsors.  We have until the record date of the meeting called to approve the merger in which to buy the current shares of Harman and elect to exchange them for a piece of the "stub" post-closing equity.  The terms of the exchange will put us on the same terms as KKR and Goldman, that is, each dollar we roll over into the stub will travel the same road to riches as the dollar invested by our new partners.  Who's your daddy now?

Taking the stub is not mandatory.  We can also take cash.

If there is widespread interest in holding a slug of the leveraged equity, up to 27% of the company could remain in public hands.  With the steady stream of SEC filings the company will be required to make, we'll be able to follow the progress of our investment.

You can count on one hand the number of recent deals in which stub equity has been offered to the public.  Does the Harman deal presage a new wave of investing, reflecting the stronger negotiating power of sellers?  Or is this a one-time thing. 

I guess that will depend on how well the stub does.  If it does as well as the historic performance of these PE sponsors, then the boards of directors of future sellers may even come under pressure to provide stockholders the opportunity to hold a piece of the stub.  From the PE sponsor side, offering a piece of stub equity may deflate the pressure to overpay.

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