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March 19, 2008
Bear Stearns - Is the World Coming to an End?
David Hoffman graciously invited me back to comment on the Bear Stearns meltdown. As I mentioned to him, I'm no expert in financial institutions, but I was a deal lawyer, and I spent a lot of time with boards of directors, so the dynamics of the deal process are very, very interesting to me. (I'm also an investor in the market generally, thankfully diversified, but probably reflect the mood of the country generally - even though it makes no difference in the short or long run, yesterday I deferred the purchase of a new Apple MacBook.)
The usual pundits are commenting - Steve Davidoff of M&A Prof Blog and the New York Times Dealbook did us all a service by posting the Bear Stearns - J.P. Morgan merger agreement, and got into a nice little debate with Larry Ribstein. I have posted a few observations in various spots around the blogosphere, and I thought I'd consolidate and update them here.
1. When the deal was first announced, I didn't realize from the newspaper accounts that it was not a cash deal at $2.00 a share. It's a stock-for-stock deal that pegged $2.00 to the J.P. Morgan stock on an exchange ratio of just over .054 shares of JPM for each share of Bear. The market, at least on Tuesday, was not persuaded that this was a done deal - indeed, the stock price for Bear tripled or quadrupled during the day on arbitrage activity. Once the deal is viewed as done, the Bear shareholders will continue to ride up or down depending on the markets' reactions generally, but tied to what JPM does.
2. The fairness opinion on the price will come from Lazard Freres. That should be an interesting read.
3. The hot issue among experts in Delaware law on takeover matters is the fact that the agreement locks out an alternative proposal for a year. Let me put this in context for non-corporate types. What the buyer in a friendly deal tries to do is lock up the deal to the limits permitted by Delaware case law with respect to the directors' obligation to obtain the highest price for the company once it is "in play." So the merger agreement, as here, always has a "fiduciary out" (although that may not be necessary if the agreement follows a full auction for the company). Indeed, the fiduciary out is a way of ameliorating the effect of a non-auction deal. The trick is in putting in as many roadblocks to an alternative proposal without crossing the line after which the Delaware Chancery Courts think that the board of the target company has breached its duty to get the best price. One such tactic is for the buyer to demand the ability to force a shareholder vote even over a "Change in Recommendation" if there is an "Alternative Proposal." Not surprisingly, a "force the vote" is a win for the acquiring company, as you'd expect here. This agreement takes one step further, giving JPM another bite at the apple, and gives JPM one year to complete a deal to the exclusion of other suitors who pop up. Gordon Smith at Conglomerate has commentary on this.
Obviously, the "asset option" to buy the headquarters, which would survive even an alternative deal is another way to lock down the deal.
4. The deal was reported as being "locked down" in terms of J.P. Morgan's ability to get out. That appears to be true. There is no MAC ("material adverse change") provision as a condition of closing. The representations and warranties are made only as of the date of signing and not as of the closing. The "bring down" certificate as to the continued accuracy of the representations and warranties in the closing conditions applies only to the bare minimum: that JPM is getting pretty much all of the stock, that the deal is authorized, that nobody other than Lazard Freres is a broker, and that Lazard Freres will issue a fairness opinion. It just goes to show how little you need to make a deal when you gotta make a deal!
5. One commentator mentioned to me in an e-mail that the purpose of doing this as a stock deal was to be able to eliminate dissenters' rights under Delaware corporation law (i.e. if you vote against the merger, you get to invoke an appraisal of the value of your shares). This is because there is an exception to the appraisal right provision if the consideration in the merger is the stock of a company traded on a national exchange. The comment ended sarcastically "nice guys!" I'm less cynical, I guess. The only significant closing condition here is getting all the Bear shares. If you do a deal for cash with appraisal rights, a buyer can reasonably ask for a condition of closing that it be able to get out of the deal if more than X% of the shares exercise their appraisal rights. I can't believe either the Fed or Bear wanted that to occur.
6. There has been some discussion of the impact on employees. The WSJ reports this morning that Bear senior management will get very little out of this deal because so much of their compensation was in stock, and they don't have much in the way of golden parachutes. My level of sympathy is inversely related to the employee's rank in the company, and Paul Secunda has already commented here about the problem of employee non-diversification.
There's two different issues, one evoking more sympathy than the other. I'm speculating on the facts here, so take this with a grain of salt. I don't know how it broke down at Bear, but there's usually a dividing line in most big companies between those employees who are incentive compensation eligible and those who are not. If you are granted stock options or restricted stock, moreover, it has a vesting schedule. Holding the stock once you have vested is an employee diversification issue.
One feels for the executives who may have lost the value in their restricted stock, although chances are the plan has a change in control provision so they'll end up with JPM stock at the exchange ration. I realize that's cold comfort, but they are executives and have, I think, less claim on our sympathy than the employees in the other category, which is those (assuming Bear did it) either got their 401(k) match in Bear stock, or worse, actually selected Bear stock as a place to put their own money, again a diversification error, and one I think employees make a lot.
7. The Bear directors have the standard continuation of D&O insurance. Again, I have to admit some sympathy for them. I'm convinced that great success is generally serendipitous, as is great disaster. You can always dissect it looking backwards, but predicting it is radically uncertain. I can only imagine what it was like for an outside director of Bear, operating in good faith and appropriate diligence over the last week (assuming they have been so operating up to this point, which I do). There is, in that light, something to be said for thinking this case lies somewhere between the deference given to boards by the business judgment rule and the more exacting standards of Revlon and progeny, in which the directors' action are held to a higher level of scrutiny.
Finally, as long as I'm here on a limited brief I'm going to use the opportunity to link up my observations on the art of the elevator speech and the oral arguments in District of Columbia v. Heller!
Posted by Jeff Lipshaw at March 19, 2008 12:05 PM
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Comments
Jeff,
But you didn't answer the question your title promised: is the world coming to an end?
Posted by: dave hoffman at March 19, 2008 09:14 PM
Nah.
Posted by: Jeff Lipshaw at March 19, 2008 09:48 PM
