wheelIf you have not noticed, or if you had assumed the turtle or ostrich position recently in light of the macro market conditions, deals are cratering left, right and center.  If we were on the Chinese calendar this may have been the year of the “retrade” or “material adverse change” (MAC) out, though the later is a mouthful.  Some of the deals that are floundering are quite interesting.

Take the fate of the Chicago Cubs and Wrigley Field.  In September, we learned the that Tribune Co. and its owner Sam Zell had narrowed the field down to two potential buyers for the historic franchise, field and interest in their cable affiliate.  A deal was to come shortly after the World Series.  Mark Cuban was the leader in the club house after the first round, valuing the asset package at a cool $1.3 billion, though many believed that Major League Baseball would never welcome Cuban into the fraternity, so his only hope was to put an unbelievable price tag on the business.   Just two months later and the conversation has taken a remarkable u-turn.  Zell is talking about selling a minority stake, offering seller subordinated financing and pretty much saying he is open to anything at this point.  Zell has limited options as he needs asset sale proceeds to paydown debt at the Tribune, which is soon to come due without the prospects of a full refinancing.  Brings new meaning to the term “lovable losers”, the common Cubs moniker.

Then their is the case of the “American Idol” rights franchise owned by CKX, Inc.  Management had found backing to lead a buyout of the company at $13.75/share, valuing the franchise at $1.33 billion dollars.  The genesis of this deal dates back to November 2007, when 19X, backed by the Chairman and CEO of CKX and Simon Fuller, yes that Simon, made their first bid to buy the business that also owns the  image rights to Elvis Presley, Muhammad Ali and Victoria Beckham, among others.  A year later and after two definitive agreements in the round circular file, Credit Suisse Group and Deutsche Bank pulled their $650 million financing for the deal.  Deal over, at least for now.

Another handful of deals have ended in a much less becoming fashion  Take for example Cleveland Cliffs  Mining Corporation’s $10 billion acquisition of Alpha Natural Resources.  The deal values Alpha at $128.12,  just a slight premium to today’s $26.16 trading price.  The deal went south from the get-go when a major shareholder in Cleveland Cliffs went postal saying the company should be a seller not a buyer.   The fallout is Cleveland Cliffs, now traveling by the moniker Cliffs Natural Resources, has adopted a poison pill to repel the recalcitrant shareholder and Alpha is suing to force a shareholder vote from Cleveland.  Forgive me, but I can’t see how this ends happily ever after.

Then there was the curious JDA Software press release, asking that i2 Technologies, whom it had agreed to acquire for $346 million, to adjourn its shareholder meeting  without a vote so that is could negotiate a new deal due to the fact that its financing was “in jeopardy” and that closing the deal as contemplated would have “unacceptable risks and costs to the combined company”.  Wisely i2 ignored the request, met and approved the transaction as previously contemplated.  I’m sure the last chapter on this deal has yet to be written.  Who ever crafted JDA’s strategy should be given a leave of absence.

The deal demise with the greatest potential for permanently altering the deal landscape, by far, is the proposed acquisition of Huntsman Chemical Corporation by Hexion Specialty Chemicals.  This deal interests me in part because I grew up in Salt Lake City, attended high school with a Huntsman, attended graduate school with a different Huntsman (there are lots of them), enjoy a birdseye view of the Huntsman Center (home to the University of Utah Running Utes) from my childhood home and have family friends who work at the Huntsman Cancer Research Center.  I even once pitched to represent Huntsman Chemical in a debt restructuring.  Apparently they found out I was a little short on my tithing balance of payments.

Hexion/Huntsman established a healthy track record of turbulence during the year Apollo Management, owner of Hexion, tried to close the transaction.  In June 2008, Apollo asked the Delaware Court of Chancery to excuse Hexion from buying Huntsman for $6.5 billion, citing a material adverse change in Huntsman’s business as a means for not closing the deal (their only real avenue for breaking the deal, see below).  They argued that Huntsman was insolvent.

Mr. Huntsman responded as follows: “Huntsman Corporation is strong and profitable today.  Of course, our business has been considerably damaged during the nearly year long period that Apollo should have used to get this transaction closed.  Apollo’s recent action in filing this suit represents one of the most unethical contract breaches I have observed in fifty years of business.  Leon Black and Josh Harris should be disgraced.  Our company will fight Apollo vigorously on all fronts.  First and foremost, we shall protect the interests of our shareholders.”

The problem for Apollo, is that the Huntsman definitive agreement was well crafted, or at least highly favorable to the seller.  The agreement called for Hexion to use best efforts to enforce its debt and equity financing letters.  It also called for specific performance for Hexion to draw down on these financing commitments to close the deal.   The specific performance clause here only obligates Hexion to draw on its financing, but the agreement also gave Huntsman the ability to go after Hexion for economic damages for any willful breach of the agreement.  Huntsman could argue that under this clause, if Hexion breaches the merger agreement, due to its inability to enforce its financing commitments or its unwillingness to draw down on those commitments, it is required to pay the lost deal premium, and perhaps more, to Huntsman.

On the eve of closing Credit Suisse Group and Deutsche Bank (theme anyone?) said they would not fund into the deal.  Huntsman is suing for specific performance, and winning.  A solvency opinion for the combined company was rejected by the lending group.  An earlier court ruling rejected the MAC out.

Apollo now faces a daunting challenge to close the deal or find a loophole out.   An attempt to sue the banks to honor their commitments appears doomed based on Apollo/Hexcion’s assertion that Huntsman is insolvent.  This has Texeco/Pennzoil written all over it, and could all but scuttle Apollo’s planned public offering.  The more likely scenario, is Apollo will try and get Huntsman to agree to a reduced purchase price so it can close the deal as contemplated, only at a lower valuation.  After all Huntsman trades at a 70% discount to the contemplated deal price.

It must be hell being an arb trader right now.

So why is it that so many deals are going south today?  The primary reason is that many of the deals contemplated a transaction at a time where debt was abundant and the global economy was not considering cratering in on itself (does anyone remember DOW 11,000?).  Many of the deals that are now being retraded are no longer economically viable due to the forward prospects of the business that is being purchased.  The problem is when the deals were struck, either the buyer, lender or both agreed to terms and conditions which they now deemed to be unfavorable, but do not provide them real options to walk away.  As such parties are turning to the courts to attempt to enforce previously agreed to term sheets.  This is the problem with asset bubbles, the back sides can be mighty steep.

Another reason you are seeing deals repriced is for liability reasons.  When financing for a transaction is put in place, the borrower often makes a representation with respect to the forward financial performance of the business on a “conservative” case scenario.  Given the uncertainty associated with the forward economic climate, owners are uneasy about making this representation, even against “worst case” numbers.  The consequences of missing numbers could result in their credit becoming more costly, at the low end of the pain threshold, to being pulled all together, higher end of the pain continuum.  If debt continues to be difficult to garner for an extended period, a lost facility could materially harm the equity value of company that relies on such financing to operate its business.

Lastly, deals are dying due to acrimony between buyers and sellers.  Often times management is caught in t he middle between sellers trying to enforce obligations, whether real or otherwise, on buyers and buyers trying to bully sellers.  Management is like a wishbone, trying to support the interests of shareholders while trying to engender themselves to their new potential owners who will be determining their compensation going forward.  At times, things boil over and the best thing to do is move on.  However, when the bid to value ratio becomes so wide, and the buyer lacks true avenues for exit, expect the courts to be the true venue for settling differences — a reality that was, for the most part, previously unthinkable.

Then again, a lot has changed in a short time.


I’ve had the opportunity over the past week to spend a considerable amount of time with lenders, private equity investors and transaction lawyers in a variety of settings.  Notably, we appear to have rapidly arrived at a period of openness with respect to what we all are seeing in an effort to calibrate our own observations.  Historical experience has been characterized by a “I’m smarter than you” air.  Maybe self preservation has sobered us all up, made us willing to share.   Here are some of the key themes of my conversations.

Bank Bonanza

Opinions on the TARP program and direct bank investment plan are wildly divergent, but there is universal agreement that something had to be done to calm the markets.  Now that that has happened and a bucket of money has been set aside for the plan, a workable solution will be found.  Opinions on what will ultimately be successful show very little homogenization and do not exist at any level of granularity.  Said differently, lenders know they need to go to rehab, but no one can agree on the type of treatment, the duration and prospects for success.

People I spoke with vary in their belief as to how the injection of capital and the cleansing of  financial institutions balance sheets will ultimate manifest itself.  There are those who simply believe banks will horde the cash and take a very risk averse view towards the lending market.  Others believe the IRR in buying up senior loans in the secondary market at 70 cents/dollar is a better use of capital than making fresh forays into the corporate lending market.  Finally, there are those who believe that banks will simply use the capital to buyback their own stock.  I’m not sure I disagree with the later two assumptions.

At a panel discussion where bankers were to be talking about deal structuring, lenders who had agreed to be on the panel found themselves having an entirely different conversation — discussing the state of their loan portfolios.  Some unsuspecting folks were hit with a new question that not many people are talking about — fraud.  The question was “What percentage of your loan portfolio do you expect to find malfeasance in?”.  The question was met with silence, and then a soft “we don’t know”.  There are “Four Cs” in lending — collateral, cash flow, credit quality and character.  Much has been said about the first three, but not much about character.  It is quite conceivable that a considerable amount of fraud was spawned by the glut of cheap money and limited due diligence on behalf of lenders.

On the flip side, I’m seeing a lot of talk about de novo banks and lending institutions.  Hedge funds, individuals and new lending institutions are seeking to fill in the gaps in the lending landscape.  Who can blame them?  For smart lenders you can find fully collateralized obligations and pretty juicy interest rates.  I take this as a positive sign that there will be stop gap alternatives.

On the plus side, LIBOR has fallen for the past 4 sessions, indicating that people are moving out of treasury instruments and into equity or corporate securities.  With senior credit going for LIBOR + 650, and LIBOR previously hovering at 4.5%, you can see how the equation stopped the whole prospect in its tracks.  Pay 11% for a collateralized loan or pay 12% – 14% plus warrants for unsecured.  Relative to depressed equity prices,  that decision is still easy.

Let’s Make a Deal

On the transaction side, the world went dark for the past two weeks, but equity sources are starting to re-emerge and re-calibrate.  I’ve found equal parts who believe the earth has bent on its axis and those who think the world is just fine.   That said, I’ve seen a number of private equity parties with term sheets outstanding either pull those term sheets, renegotiate (or attempt to) on the basis that “the world has changed” or take a financing out (if they had one).  For those of you not familiar with the Hexion/Apollo Management/Huntsman Chemical situation, the concept that a down market does not make for a material adverse change (MAC) out, will have far reaching implications on the transaction landscape over the long haul.

On the private equity side, I’m also seeing a number of hung deals based on the lack of debt.  In most of these deals, we are seeing a counter of seller subordinated, and in some cases seller senior paper.  What will be interesting is whether sellers can consent to a pre-packaged bankruptcy as an impaired consenting class where they receive the lions share of the NewCo in a restructuring.  These are the things that keep me up at night.

However, where private equity buyers have pushed the pause button, strategic buyers have, thus far, stepped into the void.  Strategics are enjoying their moment in the spotlight, brought on by the absence of private equity alternatives.  That said, some of them are approaching the situation from a rather draconian perspective.  A public company buyer recently served us with a definitive agreement as a take it or leave it proposition.  I’m not sure indemnity in excess of the purchase price and 100% shareholder consent are realistic asks, yet, if ever.

Stay tuned.  I’m sure there will be chapter two in this saga.