Going-private trends

Author: | Published: 1 Apr 2007
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A significant number of recent large US private equity transactions were entered into without the target company first running an auction or otherwise publicly announcing the possibility of a going-private transaction. For example, each of the recent leveraged buyouts of HCA and TXU was negotiated and executed without first canvassing the market for all potential buyers. But notably in both of these transactions, as well as in other recent transactions in which the target company eschewed an auction or pre-signing public announcement, the resulting acquisition agreement contained a so called go-shop provision that permitted the target company to actively solicit other bidders for an agreed-upon period after signing. Another recent high-profile transaction, the buyout of Equity Office Properties Trust, was also entered into without the company conducting an auction or making a public announcement prior to entering into a merger agreement. Equity Office, however, proceeded on a slightly different basis than was the case in HCA and TXU by forsaking a go-shop provision and simply having a particularly low break-up fee apply throughout the signing-to-closing period. These types of transaction structures are meant to enhance the target company's ability to market-check an agreed-upon deal price following the signing by making it easier for the target to attract competing bids.

Background-testing the market before or after signing

There are a number of approaches available to US public companies that are considering a going-private transaction-transactions in which the public stockholders are cashed out in the context of a buyer taking the public company private. One principle underlying all approaches is that the public company board, as part of discharging its fiduciary obligations to the stockholders, should have an informed, reliable basis upon which to judge the company's value. In that regard, canvassing the market through a well-run, public auction prior to signing an acquisition agreement certainly is a dependable way for a public company board to get a gauge of the company's market value. Indeed, over the last couple of years a substantial number of large US buyouts led by private equity sponsors were entered into following a full-blown auction or, at least, a public announcement by the target company that it was exploring strategic alternatives (generally viewed as another way of publicly stating that the company is open to considering a sale). For example, in the pending buyouts of Biomet ($10.9 billion; announced in December 2006) and Univision ($13.5 billion; announced in June 2006), each company was publicly on the block for several months prior to entering into a definitive agreement. Similarly, some of the largest US sponsor-led buyouts completed in 2006 and 2005 were entered into after a meaningful pre-signing market check, including Michaels Stores ($6.0 billion; completed in October 2006), Albertsons ($17.1 billion; completed in June 2006), Neiman Marcus ($5.1 billion; completed in October 2005) and Toys "R" Us ($6.0 billion; completed in July 2005).

Conducting an auction or otherwise canvassing the market prior to agreeing to a going-private transaction, however, are not the only approaches available to a target company. A target company instead may elect to pursue a strategy of testing the market after agreeing to a buyout transaction that was negotiated without engaging in any meaningful market check activity before announcing the execution of a definitive acquisition agreement. Exploring a transaction without canvassing the market prior to signing permits a target company to determine whether an acceptable buyout transaction is feasible outside of the public spotlight. Preserving confidentiality may, for example, have considerable appeal to a company particularly worried about the lasting harm that could come to the company, including the disruption within the company and potential adverse impacts on employee and customer relationships, in the event it runs a public process but is ultimately unable to execute a satisfactory transaction. These advantages often are more pronounced when the transaction involves a management- or founder-led buyout, where there may not be, in the context of an auction, sufficient clarity as to a CEO's or founder's continuing role with the company following a sale. Other companies may face critical business issues that need to be addressed in short order, either through a sale of the company or some other means. A target company's directors may therefore conclude that putting a for sale sign on the company and potentially receiving no attractive bids (or no bids at all) is a less preferable alternative than developing an attractive bid for the company and then determining whether it can be topped during a post-signing market check process.

From a legal standpoint, Delaware law, which is the most influential US jurisdiction in corporate law matters, has recognized that a pre-signing auction is not the only means of discharging the obligations of directors to shareholders in a going-private transaction. In particular, an effective post-signing market check approach has been accepted as a legally suitable course of conduct in going-private transactions. The 1988 Delaware case In re Fort Howard Corp. Shareholders Litigation typically is viewed as a seminal decision in this regard and provides an illustrative example of how a post-signing market check strategy may be effective for purposes of satisfying judicial scrutiny. The transaction underlying the Ford Howard decision was the negotiated buyout of Fort Howard Corporation by affiliates of Morgan Stanley. Fort Howard elected not to conduct an auction of any kind before signing a merger agreement with Morgan Stanley. The merger agreement provided Fort Howard with a so called fiduciary out, meaning the company was permitted to terminate the merger agreement if a third party were to make a proposal that the board of directors determined was more favorable to the company's stockholders. In addition, Fort Howard negotiated the right to make it clear in the initial press release announcing the transaction that it had the right to entertain alternative proposals and would cooperate with any person in the development of a competing bid. Evaluating these provisions as well as the other deal protection provisions contained in the merger agreement, the Fort Howard court was satisfied with Fort Howard's deal structure, noting that the special committee formed to evaluate the Morgan Stanley proposal negotiated "provisions purportedly intended to permit an effective check of the market before the Morgan Stanley [transaction] could close [and] this approach was adopted in good faith and was effective to give the board an informed, dependable basis for the view that the Morgan Stanley offer is the best available transaction from the point of view of the Fort Howard shareholders."

Broadly speaking, therefore, in order for a post-signing market check structure to be effective it must designed to demonstrate that the board of directors selected a course of action that was in the best interests of the company's stockholders and ultimately provided reliable evidence with which to judge company value (which implies the post-signing market check should not be compromised by excessive deal protections). Notably, however, there is no single blueprint for an effective post-signing market check, and a go-shop provision is just one strategy available to a target company and its board of directors, albeit a strategy that has been used in a number of recent going-private transactions.

Table 1
Transaction (date of merger agreement) Equity value (total transaction value) Length of go-shop Termination fee payable by target if transaction abandoned due to competing bid Matching right during go-shop
TXU Corp.
(Feb. 26, 2007)
$32.1 billion ($45.0 billion) 50 days • $375 million if during go-shop
• $1 billion otherwise
Station Casinos, Inc.
(Feb. 23, 2007)
$5.4 billion ($8.8 billion) 45 days • $106 million if during go-shop
• $160 million otherwise
Harrah's Entertainment Inc.
(Dec. 19, 2006)
$17.2 billion ($27.8 billion) 25 days • 500 million Yes
Realogy Corporation
(Dec. 15, 2006)
$6.7 billion ($9.0 billion) 61 days • $99.3 million if during go-shop Yes
Clear Channel
Communications Inc.
(Nov. 16, 2006)
$18.7 billion ($26.7 billion) 21 days • $215.2 million otherwise
• $500 million
Freescale Semiconductor, Inc.
(Sept. 15, 2006)
$17.5 billion ($17.7 billion) 50 days • $150 million if inside first 10 days of go-shop
• $300 million otherwise
Not during first 10 days of go-shop
HCA Inc.
(July 24, 2006)
$21.3 billion ($32.9 billion) 50 days • $300 million if during go-shop
• $500 million otherwise

What is a go-shop?

A go-shop is a provision that grants the target company the right to actively solicit competing bids following the execution of a definitive acquisition agreement with a buyer. Put another way, a go-shop provision provides an exception to the general rule that prohibits a target company from soliciting third-party bids once the definitive acquisition agreement is executed (this general rule, commonly referred to as the no-shop provision, is contained in nearly all US going-private transactions and makes up part of the deal protection package negotiated between buyer and seller).

Outside of these broad parameters, there are a number of variations to the actual terms of the go-shop provision that are the product of negotiation. For example, the length of the go-shop period varies on transaction-by-transaction basis and is dependent on the particular facts and circumstances underlying the transaction, including the complexity of the target company and whether there have been public leaks prior to the transaction being announced. The duration of go-shop provisions in recent transactions has tended to range from 20 to 60 days. Another aspect of the go-shop often subject to negotiation is whether the termination fee payable to the buyer is reduced in the event that the transaction is abandoned as a result of a competing bid solicited during the go-shop period. In the buyout of HCA, for example, HCA generally was required to pay the sponsor group $500 million if the agreement was terminated under various circumstances, but that fee was reduced to $300 million in the event that the agreement was terminated as a result of a competing bid solicited during the go-shop period. One final and important example of the provisions that vary among go-shop transactions is whether during the go-shop period the original buyer has a contractual right to match any competing offer that the target company board determines is superior prior to the target having the ability to terminate its agreement with the buyer so as to accept the superior, third-party deal.

The chart above sets forth how the parties to several of the recent go-shop precedents addressed these go-shop variations:

Go-shop alternatives

As discussed above, a go-shop is merely one alternative available to a target company electing to do a deal on a post-signing market check basis. Although a go-shop provision may enhance the basic post-signing market check structure, it certainly is not legally required. Indeed, the transaction underlying the Fort Howard decision did not contain a go-shop provision. A company could, for example, stay within the four corners of Fort Howard by making an express statement in the initial press release announcing the transaction that the target is available to respond to unsolicited third-party bids.

Another alternative is to follow the strategy used in the recent Equity Office Properties Trust buyout. Equity Office did not conduct a public auction of the company prior to agreeing to a $36 billion buyout by affiliates of The Blackstone Group. The merger agreement in that transaction, however, contained a particularly modest termination fee equal to roughly 1% of the transaction's equity value. The agreed-upon termination fee, which applied throughout the post-signing period, was therefore considerably lower than the 2.5% to 3.5% norm seen in many recent going-private transactions executed following an auction. This structure ended up bearing fruit for Equity Office shareholders as it did not deter a subsequent unsolicited takeover proposal led by US real estate giant Vornado Realty Trust. Although Blackstone eventually prevailed, it twice increased the merger consideration in response to a series of Vornado-led proposals. Blackstone ultimately agreed to pay $55.50 per share as opposed to its original agreement to pay $48.50 per share, resulting in a transaction valued at approximately $39 billion by the time the deal closed in February 2007. Notably, of all of the transactions discussed in this article, Equity Office is the only one to date in which a competing bid surfaced after the signing.

Finally, traditional fiduciary out transactions, such as the approximately $11.0 billion buyout of Sungard Data Systems in 2005, are still legally permissible. For the reasons described below, however, this more traditional deal structure may be used less frequently in going-private transactions in the current environment.

The recent trend and its implications

As evidenced by the above discussion, a quick look at a sampling of recent sponsor-led buyouts of US target companies suggests a renewed focus by deal-makers on executing a post-signing market check strategy. Both sellers and buyers participating in a going-private transaction increasingly seem focused on and motivated by the reasons for exploring the possibility of effecting a deal without first publicly canvassing the market. In addition to the extraordinarily large buyouts such as TXU, Equity Office and HCA, consortia of private equity sponsors also have recently entered into a number of relatively smaller deals (less than $5 billion transaction value) outside of the auction context (for example, the buyouts of Laureate Education, OSI Restaurant Partners, Aleris International, West Corporation and Kerzner International). The trend seems to have reached the point where it cannot be viewed as an anomaly.

What remains to be seen is how the implementation of this approach will develop in the coming years. In particular, is the go-shop provision, which historically has been used quite sparingly, here to stay and has it supplanted the Fort Howard model? For the time being it is difficult to imagine that sellers who choose to rely on a post-signing market check to build a record of reliable evidence with which to judge company value will not attempt to install a go-shop provision or some other feature designed to enhance the likelihood of a topping bid surfacing. The body of recent precedent alone likely will lead to a number of additional deals following this recent roadmap. Once a target board of directors is advised of some of the recent precedents it often becomes difficult to move in a different direction, unless there are compelling distinguishing circumstances. In addition, the ubiquitous legal challenges posed by the plaintiff's bar in connection with buyouts appear to be causing some boards of directors to seek a go-shop and/or a particularly low break-up fee notwithstanding that such provisions are not legally required.

Given that this recent precedent is even more pronounced when it comes to especially large buyouts, it would not be surprising to see many going-private transactions of this nature wind up with a similar structure, at least in the near future. There are indications, however, that the trends discussed in this article may expand into broader categories of transactions. The go-shop trend already has moved beyond the management- or founder-led transactions, which were largely responsible for re-popularizing the go-shop as a post-signing market check alternative, into going-private transactions with no management involvement on the buy side prior to signing (TXU, for example). In addition, go-shop provisions have now been extended from transactions in which there was no pre-signing market check activity to transactions in which the target company in fact has run a limited pre-signing auction (Clear Channel) or received other indications of interest in advance of signing as a result of news of the potential deal leaking into the public marketplace before a definitive acquisition agreement was executed (Harrah's). In light of these developments, practitioners should consider whether the go-shop trend could expand into the realm of non-shopped cash acquisitions by strategic acquirors.

One development that could usher in a change in direction would be any modification to the underlying legal paradigm. To date, it appears that most litigation in connection with these recent US buyout transactions is either on-going or has been settled with no meaningful judicial gloss being added to the current legal framework for post-signing market check transactions. If the current pace of deals continues, however, it is not unreasonable to expect that there will be some noteworthy judicial development in this arena that could impact the future of post-signing market checks in general and go-shops and other enhancement features specifically.

Another area to watch closely in the coming years is whether there is any acceleration in the number of interloping bids to these types of deals. To date, the Equity Office transaction is the only one of the recent buyouts discussed in the article to be jumped following the signing. In the event more deals begin to get jumped it will at the very least change a potential buyer's calculus when it comes to deciding whether to agree to a go-shop provision or a particularly low break-up fee.

In the near term, however, the current factors at work suggest that the recent trends set by the large buyouts will continue to affect deal-making. Sellers and buyers opting to negotiate a transaction supported by a post-signing market check increasingly seem to be focused on the bells-and-whistles associated with a go-shop and the related size of the break-up fee rather than on whether any of these enhancements need to be present at all. To be sure, there undoubtedly will continue to be a substantial number of deals that are either conducted through an auction or that, alternatively, simply rely on the classic fiduciary out model even though there was no pre-signing canvassing of the market. In spite of the myriad options available to participants in a going-private transaction, the trends witnessed during the last twelve months of large, sponsor-led buyouts in the US undoubtedly will lead to a number of additional transactions that will draw on, and refine, this latest deal blueprint.

David Sorkin is a member of the firm of Simpson Thacher & Bartlett LLP, and Eric Swedenburg is a senior associate at Simpson Thacher & Bartlett LLP. All or part of this article may have been or may be used in other materials published by the authors or their colleagues.