Role of the Board in M&A Transactions · •If the Board’s performance of their Revlon duties is...

Role of the Board in M&A

TransactionsJuly 2017 | Privileged and Confidential

PRIVILEGED AND CONFIDENTIAL

Stout is a trade name for Stout Risius Ross, LLC and Stout Risius Ross Advisors, LLC, a FINRA registered broker-dealer and SIPC member firm.

Contact Information

This document has been prepared for the exclusive benefit and use of the Association for Corporate Counsel. For further information regarding this document please contact one of the following Stout representatives:

Christina E. Carroll

Managing Director

Valuation Advisory

+1.310.846.8897

[email protected]

Gregory P. Range

Managing Director

Investment Banking

+1.310.775.2510

[email protected]

Paul Gurrola

Director of Business Development

Valuation Advisory

+1.310.601.2566

[email protected]

Stout Risius Ross, LLC10100 Santa Monica Blvd., Suite 1050Los Angeles, CA 90067

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Delaware Cases


Delaware Cases

Early Landmark Cases

Historic Cases Establishing the Role of the Board in M&A Transactions

• Smith v. Van Gorkom (Delaware 1985)• Board held as grossly negligent in recommending a merger with 39-62% control premium• Board not protected by business judgment rule• Directors:

• did not adequately inform themselves of the role of the Chairman in the sale process• were uninformed of the intrinsic value of the Company, and • were grossly negligent in approving the sale of the Company with only 2 hours of consideration.

• Revlon Inc. v. MacAndrews & Forbes Holdings Inc. (Delaware 1986)• Established that if a combination is deemed a sale of the company or change of control, Revlon doctrine will govern• Fiduciary duties shift from long term considerations for target to short term goal of maximizing sale price “Revlon

duties”• If the Board’s performance of their Revlon duties is challenged, the Board will not be protected by the business

judgment rule• “Enhanced scrutiny” will be the standard of care

• procedure requires independent, disinterested directors prove:1) decision making process was performed with adequate care2) decision was reasonable under the circumstances

• Weinberger v. UOP (Delaware 1983)• Established “entire fairness” standard• Comprises the dual components of fair price and fair dealing

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Delaware Cases


What is a Fairness Opinion?

• An investment banker’s professional opinion as to the price an acquiring firm is offering in a take-over or merger (www.trading-glossary.com)

• Scope is clearly defined in engagement agreement between parties• Should not superimpose Board’s fiduciary duties on financial advisor• Financial advisor relies on information from Management • Not required by statute or regulation• Board should seek on all material transactions• Have become commonplace after several court case decisions

• Opinions typically written for:

• Public Company acquiring a Public Company (To Buyer or Seller) • Public Company Acquiring a Private Company (To Buyer)• Restructuring (To Board or Special Committee of Board)• Going Private Transactions (To Special Committee of Board)• Special Situations (Usually to Special Committee or Trustee)

• Spin-offs• Private Companies for Minority Shareholder Buyouts & Related Party Deals• Recaps• ESOP Transactions

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http://www.trading-glossary.com/


Delaware Cases

Legal Standards in Transactions


• Business judgment rule • Courts don’t second guess a business decision made by disinterested directors acting in good faith (duty of loyalty,

duty of loyalty) as long as the decision is based on a rational business purpose

• Entire fairness• Applies to transactions involving self-dealing by controlling shareholder• Before MFW, defendants could shift the burden of proof to the plaintiff if the transaction is approved by either:

• Well-functioning committee of independent directors or• Informed vote of majority of minority stockholders

• After MFW, defendants can also shift the standard of review to business judgment if both procedural safety mechanisms are used

• Enhanced scrutiny• Standard of care between business judgment rule and entire fairness• Duty is to maximize price in the short run (control transactions)• Directors must establish reasonableness of decision making process and that decision was reasonable under the

circumstances

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Delaware Cases

Background – Motion for Injunction to Enjoin the Transaction

El Paso Corporation (Strine, February 2012)

• Case involved $21 billion acquisition of El Paso by Kinder Morgan (after announcement El Paso was going to spin-off its E&P business)

• Non-public bid by Kinder Morgan• El Paso had announced intent to spin off its Exploration & Production (E&P) business• Kinder’s intent was to keep the Pipeline business and sell the E&P business to finance the deal• 30 day premium was 47.8%

• Goldman Sachs, El Paso Board’s advisor, had conflicts because it owned 19% of Kinder Morgan ($4 billion) and controlled two Kinder Board seats

• Morgan Stanley was hired to render a second fairness opinion due to Goldman Sachs conflict; however, Morgan Stanley’s engagement letter ensured that Morgan Stanley did not get paid unless the transaction consummated was a sale to Kinder Morgan ($35 mm vs. “zilch, zero, nada”)

• On top of everything, the Goldman Sachs banker did not disclose his own personal ownership in Kinder Morgan ($340,000)

• CEO of El Paso, Doug Foshee, wanted to buy the E&P assets from Kinder Morgan in MBO

• CEO never disclosed his motive to his Board and although he should have been maximizing the price for El Paso shareholders, he had an incentive not to

• Bid was reduced from $27.55 to $25.91 as the final price

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Delaware Cases

Board Failures


• There were numerous decisions that were considered questionable by the Court:• Failure of the Board to shop El Paso or its two key divisions separately to any other bidder after Kinder Morgan

made its overture.

• Failure of the Board to reject Kinder Morgan’s initial overtures and force it to go public and face market pressure.

• Having CEO handle all negotiations without independent director or legal oversight.

• Signing on to deal protection measures that would effectively preclude a post-signing market check for bids for separate divisions because of limited fiduciary out ($650 million termination fee and Kinder Morgan matching rights).

• Allowing Kinder Morgan to renege on its $27.55 bid based on its assertion that it based its bid on the most bullish analyst covering El Paso.

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Delaware Cases

Strine Quotes


• “At a time when Foshee’s and the Board’s duty was to squeeze the last drop of the lemon out for El Paso’s stockholders, Foshee had a motive to keep juice in the lemon that he could use to make a financial Collins for himself and his fellow managers interested in pursuing an MBO of the E&P business”

• “Now, I know we're going to have to deal with things like why, if someone is stepping out of a process, they're getting involved as an advisor on the other banker's compensation and tilting the other banker's compensation in a way where the other banker is supposed to objectively benchmark the two options, and they only get paid for the one option, and it's the option that the other bank has a conflict in. And I don't really understand how that's standing behind a Chinese Wall. And I really am anxious to hear about that role and about that. It didn't seem to be immediately a logical role for the conflicted banker to play.”

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Delaware Cases

Outcome


• Court ruled that undisclosed conflicts of interest by CEO of El Paso rendered the sale process flawed.

• Second investment bank was hired due to Goldman Sachs conflict and the Morgan Stanley engagement was flawed due to its soft market check and its incentive for one outcome.

• Undisclosed conflicts by Goldman Sachs banker added insult to injury.

• Injunction denied as deal had substantial benefits to El Paso shareholders.

Subsequent Event

• Subsequent shareholder litigation settled by Kinder Morgan for $110 million

• Goldman Sachs agreed to forego $20 million fee

• Plaintiffs counsel awarded $26 million in fees

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Delaware Cases

Background

Rural Metro Corporation (Laster, November 2015)

• Case involved Rural Metro, a Delaware corporation and public company, headquartered in Scottsdale, AZ• Rural Metro Board was one of two national ambulance and fire protection companies

• Rural Metro merged with an affiliate of Warburg Pincus, each publicly held share of Rural Metro received $17.25 in cash

• Plaintiffs contended: • Rural Metro Board breached their fiduciary duties approving the merger • Board failed to disclose material information in the proxy• Financial advisors aided and abetted the directors’ breach of fiduciary duty

• Special Committee originally formed to oversee acquisition of AMR (sub of EMS), Rural’s lone national competitor• RBC acted as buy-side advisor• EMS rejected price offered by Rural Metro as too low

• Special Committee re-engaged RBC and authorized an assignment with an investment bank to “explore strategic alternatives”

• Quickly developed into sale assignment for RBC without much exploration of alternatives (not authorized)

• AMR, lone national competitor, was concurrently being marketed for sale• RBC did not include strategic buyers on their buyer list, only private equity sponsors

• Other strategic buyers wanted to bid but were under NDA on AMR transaction and RBC bankers wouldn’t change timeline• Several buyers indicated they would pay more than Warburg’s bid once the AMR auction was over

• RBC didn’t disclose to Board they were pursuing a buy-side role with potential private equity buyers for stapled financing

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Delaware Cases

Valuation Issues


• First intrinsic valuation the Board received was 3 hours before the vote on the Transaction

• Inconsistencies between RBC’s pitchbook and the final fairness analysis:

• In December 2010 pitchbook, the investment bank disregarded the 7 year old acquisition of EMS by AMR in 2004 at a low 6.3x EBITDA

• In fairness analysis, gave full weight to the precedent transaction and its low multiple

• Two other precedent transactions valued Rural at $21+ per share (vs. $17 per share bid)

• In pitchbook, RBC adjusted EBITDA for one-time expenses (increasing EBITDA)• In fairness analysis, they did not make the adjustment (increasing the implied multiple)

• DCF exit multiple was inconsistent with the precedent transaction analysis

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Delaware Cases

Valuation and Special Committee Quotes


• Warburg Pincus was the only final bidder at $17.00 per share

• Chairman of the Special Committee (Shackleton of hedge fund, Coliseum) case analysis showed an intrinsic value of $18.86

• There were several interesting quotes by the Chairman of the Special Committee, Shackleton:• Noted this is a “great opportunity to get more out of the bidders”• “I think we’re nuts to take a price less than $18.00”• “I full heartedly believe that Warburg Pincus can get to $18.75”

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Delaware Cases

Key Points


• The investment bank began the sale process before they were authorized by the Special Committee

• The Board did not properly monitor the sale process• “Directors cannot be passive instrumentalities during merger proceedings”• Did not ask fundamental questions such as why they were moving to a sale without much exploration of strategic

alternatives, whether RBC had any conflicts, who should be on the Special Committee, etc.• Directors must maintain “an active and direct role in the context of a sale of a company from beginning to end”

• Investment bank’s conflict of interests were not known to the Special Committee

• M&A process was flawed, excluding many likely suitors and only focusing on private equity

• Updates on the M&A process were insufficient and did not include intrinsic valuation until the last meeting

• The valuation analysis was manipulated by the investment bank to show lower intrinsic value

• Advisors, legal and financial, can be held liable under the “gatekeeper” theory

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Delaware Cases

Outcome


• Directors settled for $6.6 million, Moelis (second opinion provider) settled for $5 million well before trial

• Resulted in a $76 million judgment against RBC for faulty advice in the sale of Rural Metro – aiding and abetting directors

• In November 2015, the Delaware Supreme Court upheld the ruling against RBC

• Chancellor Laster found that RBC acted in its own interest ahead of its client, Rural Metro

• Judge concluded that RBC’s actions had tainted the process and resulted in a lower sale price than should have been paid.

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Delaware Cases

Best Practices for M&A Process


• In the case of Rural Metro, Board was held responsible for a failure to oversee M&A process

• Court wants to see that the price achieved was developed within a range of reasonableness and that the price obtained in the process is appropriate.

• Judge wants to see a well-constructed process with legal and financial advisors who are conflict free• Correct formation of the Special Committee with no bias• Process includes field of appropriate buyers• If there is a conflict and Board wants to hire investment bank, it needs to be discussed and reasons why it is ok need

to be documented.

• Typically see a “football field” where the values fall within a range of fair market value• Consistent application of methodologies

• Is there a special interest that conflicts with the shareholders? Conflicts impair independent, objective judgment of the Special Committee

• Board has the responsibility to ask questions about potential conflicts and inconsistencies in process, valuation

• Court wants to understand how carefully the Board has considered and exercised their duties to get a fair price • the responsibility still rests with the Board, particularly if the financial advisor is conflicted

• It is incumbent on the financial advisor to disclose potential conflicts from past work, stock positions they hold, roles they are seeking

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Delaware Cases

MFW Background

MFW (Strine March 2013)

• MFW Shareholders Litigation (Delaware 2013)• Stockholder class action brought to challenge a going-private merger of M&F Worldwide Corp., a publicly traded

entity, with its controlling stockholder, MacAndrews & Forbes Holdings, Inc.• From the outset, MacAndrews & Forbes stated that it would not proceed with the transaction if it was not

approved by a special committee and by the majority of the unaffiliated minority stockholders

• Before MFW, well-settled law from the Delaware Supreme Court held that approval by either a special committee or a majority of the minority would shift the burden of proof from the defendants to the plaintiffs, but would not change the standard of review of an interested transaction with a controller (i.e., entire fairness)

• With the MFW decision, the court determined that if the defendants can prove that both protective devices are established:

• transaction replicates a third-party, arm’s length merger and, • actions of the directors will be reviewed under the business judgment rule rather than the entire fairness

standard

• However, under this framework, the business judgment standard of review will be applied in controller buyouts if and only if:

• The controller conditions the procession of the transaction on the approval of both a special committee and a majority of the minority stockholders;

• The special committee is independent;• The special committee is empowered to freely select its own advisors and to say no definitively;• The special committee meets its duty of care in negotiating a fair price;• The vote of the minority is informed; and• There is no coercion of the minority.

• According to the court, “the rule of equitable common law that best protects minority investors is one that encourages controlling stockholders to accord the minority this potent combination of procedural protections”

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Delaware Cases

Background

Dole Food (Laster, November 2015)

• Case involved Dole Food Company, a Delaware corporation and public company, headquartered in Westlake Village, CA

• David Murdock, CEO and Chairman, owned 40% of Dole and initiated a $1.6 billion going private transaction, which closed November 2013 ($13.50 per share).

• Dole sold its packaged foods and Asian fresh produce business in 2012

• Plaintiffs contended: • Murdock and Carter breached their fiduciary duties, including duty of loyalty• They committed fraud by manipulating information released to the public and canceling an open market stock

repurchase program

• Special Committee formed to reflect recent MFW Delaware finding• Special Committee of disinterested directors• Hired separate legal counsel and financial advisor• Vote of “majority of the minority” of disinterested shareholders

• Special Committee negotiated a higher price (20% premium over traded price)

• Carter restricted the Special Committee’s mandate to “specifically consider Murdock’s proposal and for no other purposes”

• Projections were not reliable because they were inconsistent with projections used for ITOUCHU six months prior

• Cost savings from the split of the Company were estimated at $50 million• Carter reduced the cost savings estimates, causing the stock price to drop• Banks were told a different story about cost savings

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Delaware Cases

Key Points

Dole Food (Laster, November 2015)

• Processes structured like MFW does not default to business judgment standard and protect the Board • Fraud and manipulation by management could not be overcome

• Lazard was praised for scrutinizing the projections and “Herculean” efforts in building their own

• Inconsistencies between public market communication on cost savings, projections and financing was considered fraudulent

• Cancelling the stock repurchase program two weeks after it was approved by the Board and not informing the Board also contributed to the findings of fraud

• Go-shop provision with a small break-up fee by industry standards not viewed as sufficient• Murdock refused to sell to any other buyer rendered the go-shop ineffective

• Transaction was held to the higher standard of entire fairness, fair price and fair process

• Given the Dole executives’ actions in driving down the stock price and manipulating information, Laster thought the Special Committee was prevented from achieving a “fairer” price

• Murdock and Carter were found jointly and severally liable for breaches of fiduciary duty• Since breach of fiduciary duty is not indemnifiable under Delaware law, Murdock and Carter were personally liable

for damages of $148 million.

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Delaware Cases

Background

Dell (Laster, May 2016)

• Appraisal action involving Dell Computer, a Delaware corporation and public company, which was sold for ~$24.5 billion in a going private transaction with its founder, Michael Dell and Silver Lake Partners.

• Chancellor Laster dismissed the transaction of $13.75/share price entirely as an indication of fair value.• A significant departure from the Court’s history of considering the transaction price as fair value in shopped M&A

deals• Laster determined fair value of $17.62/share, 28 percent more than deal price

• Dell’s M&A process seemingly followed best practice:• The Special Committee hired its own legal and financial advisors• Special Committee had merger discussions with multiple parties including KKR and TPG• Go-shop period of 45 days in which buyers could present a topping bid• 60 buyers were contacted during the go-shop period, resulting in two additional bids• Resulted in an upward adjustment to the purchase price (a 25% premium over the 4 week trading price)• Court’s view of the sale process was that it was well crafted and satisfied the directors fiduciary duties, but was

insufficient for appraisal purposes.

• The Court advanced 3 theories of why the transaction price did not reflect intrinsic value of Dell: • A lack of meaningful pre-signing competition among bidders (no strategic bidders)• Financial advisors focused on an LBO model (typically used to determine whether the investment meets the

financial investors’ return hurdles)• The market’s short term focus vs. a longer term focus for enhancing shareholder value under Silver Lake plan

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Delaware Cases

Key Points

Dell (Laster, May 2016)

• Chancellor Laster found that the merger consideration was inadequate in Dell by an additional $6 billion. Cost to compensate qualified plaintiffs, however, was only $37 million

• The Dell case suggests the following are not necessarily evidence of a fair M&A deal:• A large control premium (25%)• Engaging with a lot of buyers (over 60)• Negotiated increases in purchase price (2 additional bidders including KKR and TPG)• Go-shop provision with a break-up fee

• Laster used the petitioner’s DCF conclusion as the sole basis for determining fair value

• Case highlights significant departure from traditional fair value appraisal away from transaction price and away from market efficiency theory

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Select Professionals

Biographies

Christina E. Carroll

Managing Director

Valuation Advisory

Los Angeles

[email protected]

Office +1.310.846.8897

Mobile +1.310.562.7131

Christina E. Carroll is a Managing Director in the Valuation Advisory group where her responsibilities include providing valuation and transaction related advice. For more than 20 years, Ms. Carroll has been a Board and C-suite advisor on complex transactions and strategic issues with a focus on evaluating transactions and assisting her clients in enhancing shareholder value.

Ms. Carroll’s experience includes rendering fairness opinions, solvency and related transaction opinions to board of directors, special committees, financial institutions, pension funds and other fiduciaries in conjunction with mergers & acquisitions, going private transactions, spin-offs, recapitalizations and financing transactions. Ms. Carroll also performs independent valuations of businesses and securities for tax, financial reporting, estate and gift tax planning, Employee Stock Ownership Plans and other purposes.

Prior to joining Stout, Ms. Carroll was a Director in the Financial Advisory Services Group at Houlihan Lokey where she was responsible for business valuations, fairness opinions, co-investment advice, portfolio valuation and other strategic transaction advice to institutional investors and large private and public companies. Prior to Houlihan Lokey, Ms. Carroll was a partner at Ernst & Young in Los Angeles, Dublin, Ireland and Dallas, Texas. During her tenure at Ernst & Young, she advised CEOs, founders and management teams on their strategic transactions included mergers, acquisitions, capital raising, IPOs, ESOPs, spin-offs and going private transactions.

Education

M.B.A., The Anderson School at UCLA

B.A., Economics and Business, University of California at Los Angeles, Magna Cum Laude, Phi Beta Kappa Honors

Designations

Chartered Financial Analyst (CFA)

Practice Areas

Portfolio & Fund

Shareholder & Succession Planning

Transaction Support Services

Fairness Opinions

Solvency Opinions

Professional Memberships

• CFA Institute

Industry Focus

Consumer, Retail, Food & Beverage

Diversified Industrials

Energy & Utilities

Financials

Government Agencies

Healthcare & Life Sciences

Real Estate, Lodging & Leisure

Technology, Media, & Telecommunications

Community Engagement

• Los Angeles Regional Foodbank – Board of Directors

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mailto:[email protected]

Biographies

Gregory P. Range

Managing Director

Head of Los Angeles Office

Investment Banking

Los Angeles

[email protected]

Office +1.310.775.2510

Mobile +310.308.1930

Gregory P. Range is a Managing Director and head of the firm’s Los Angeles office. He has extensive experience in both valuation and investment banking with broad experience advising owners of middle market private companies, boards of directors of public companies, C-suite executives, private equity firms, charitable foundations, ERISA-covered trusts and Employee Stock Ownership Plans (ESOPs). His expertise includes mergers & acquisitions, fairness opinions, solvency opinions, divestitures, distressed transaction advisory and private market financing, estate and gift tax planning, business valuation, and obtaining liquidity for privately held business owners.

Mr. Range has advised on sell side transactions ranging from $10 million to $1 billion. He has also participated in private equity coverage efforts, primarily on the west coast, developing relationships and monitoring approximately 15 sponsors and their portfolios across industries. Additionally, he developed portfolio valuation projects with substantial US and foreign private equity groups.

Among the many industries Mr. Range has served are aerospace & defense, asset management, distribution, manufacturing, consumer products, construction, agriculture, and specialty chemicals. Mr. Range has published regular industry newsletters and is an accomplished public speaker to industry groups, attorneys, accountants on industry transaction trends, valuation, fairness opinions, and other topics.

Prior to joining Stout, Mr. Range led the Los Angeles office of Duff & Phelps, where he also served as the global head of theAerospace and Defense industry vertical. Previous to that, he was a Senior Vice President at Houlihan Lokey, Inc.

Mr. Range has served on Boards of Directors/Trustees of private companies, foundations, and not-for-profits. He is also a member of the National Association of Corporate Directors, the Association for Corporate Growth and the Los Angeles Venture Association. Mr. Range has been featured in LA Business Journal ‘s annual list of “Who’s Who in Banking.”

Education

M.B.A., University of California at Los Angeles

B.A., Stanford University

Practice Areas

Shareholder & Succession Planning

M&A Advisory

Private Placements of Debt & Equity

Strategic Alternative Assessments

Fairness Opinions

Solvency Opinions

Industry Focus

Aerospace, Defense, & Transportation

Consumer, Retail, Food & Beverage

Diversified Industrials

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Biographies

Paul M. Gurrola

Director

Valuation Advisory

Los Angeles

[email protected]

Office: +1.310.601.2566

Paul M. Gurrola is a Director of Business Development within the Valuation Advisory group. Mr. Gurrola is responsible for developing relationships with finance executives of public and private companies and private equity firms, managing client engagements, working with trusted advisors and continuing to build the Stout brand in the western United States.

Mr. Gurrola brings over 20 years of experience working with public and private companies on engagements that include merger and acquisition services, tax and consulting projects, and valuations for purposes of commercial and intellectual property disputes.

Prior to joining Stout, Mr. Gurrola was a Director at the national accounting firm of BDO USA where he was in charge of their Los Angeles business development efforts, including BDO’s West Coast private equity initiative.

Education

M.B.A., Finance,

University of Southern California

B.S., Finance & Marketing,

University of Southern California

Practice Areas

Intellectual Property Disputes

Intellectual Property/ Intangible Assets

Financial Reporting

M&A Advisory

Transaction Support Services

Fairness Opinions

Solvency Opinion

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Role of the Board in M&A Transactions · •If the Board’s performance of their Revlon duties is...

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