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THE WALL STREET
JOURNAL. |
MARKETS
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Markets
Hedge Funds
Wield Risky Legal Ploy to Milk Buyouts
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By
Liz Hoffman
April 13, 2014 7:47
p.m. ET
When Dole
Food Co. sold itself last year to its founder for $1.2 billion, many
market watchers saw just another in a string of buyouts.
A few
investors saw an opportunity to squeeze the buyers for potentially
millions of dollars more, using an arcane—but increasingly
popular—legal process known as appraisal.
Merion Capital LP bought 7.5 million shares of the fruit company in
the days before Dole's October stockholder meeting. It rejected the
$13.50-a-share deal price and, alongside three other hedge funds, is
seeking more in court through appraisal.
Dole's
buyout highlights the rise of "appraisal arbitrage," in which hedge
funds buy shares of companies on the brink of a buyout and ask a judge
to award them a higher price. These lawsuits have risen sharply as a
growing group of investors looks to extract more money from corporate
takeovers.
Some have
won big, but risks lurk in the strategy's popularity, industry
participants say. As more investors chase appraisals, they risk
toppling the very deals on which they are trying to profit. That is
because appraisal-seekers must abstain or vote "no" on a deal. Dole's
buyout passed with just 50.9% of the vote after the four hedge funds,
holding 17 million shares, positioned themselves for an appraisal
claim. The litigation is pending.
"People are
waking up to the idea that there is a lot of money to be made," said
Kevin Abrams, a lawyer who has worked on both sides of these cases.
"But it's not for the faint of heart. There are risks at every step."
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Above, a picker for
Dole Foods, which was the subject of an appraisal.
Bloomberg News |
In
an appraisal case, dissenting stockholders ask a judge to determine
the fair value of their shares after a deal closes. The judge weighs
expert valuations and decides on a number, which is binding on the
company and shareholders.
Appraisal claims were brought on 17% of takeovers of Delaware
companies in 2013, the most since at least 2004, according to a coming
study from Brooklyn Law School and Case Western Reserve University.
Based on deal prices, those claims were valued at $1.5 billion, an
eightfold increase from 2012.
So
far this year, at least 20 appraisal claims have been filed in
Delaware court, compared with 28 in all of 2013, according to a Wall
Street Journal review of court filings.
About 81% of Delaware appraisals that went to trial since 1993 have
yielded higher prices, according to law firm Fish & Richardson PC,
which has represented shareholders in appraisals. In an extreme case,
a judge in 2004 awarded dissenting stockholders of Coleman Co. $32.35
a share, five years after the company was sold for $5.83 a share.
Shareholders also get backdated interest on their claims, whether they
win or not; the current rate is about 5.75% annually.
The
risk of a big payout prompts many companies to settle with the
shareholders seeking appraisal. "Having to come back and pay 10
million shares three times the deal price isn't a very attractive
option, especially for a company that's taken on debt in the deal,"
said Carl Sanchez of law firm Paul Hastings LLP.
Settlement amounts vary and are confidential, but lawyers and
investors say double-digit per-share price bumps are common.
Verition Fund Management LLC has averaged about 30% annualized returns
on its appraisal lawsuits, which include a settled case last year over
Carlyle Group LP-led buyout of
Duff & Phelps Corp., according to a person familiar with the fund's
performance.
Merion has averaged an 18.5% annualized return across five completed
appraisals, four of which settled, according to documents reviewed by
The Wall Street Journal.
Merion looks for deals that it feels are undervalued by at least 30%
and focuses on management-led buyouts, said founder Andrew Barroway.
Court filings show the five-year-old firm has nearly $700 million tied
up in four pending appraisals, including $352 million in BMC Software
Inc., which was sold last summer to private-equity firms Bain Capital
and Golden Gate Capital.
"The
vast majority of deals are fair. We're looking for the outliers," Mr.
Barroway said.
Another big player is Ohio-based Ancora Advisors LLC, which has filed
more than 30 appraisal claims since 2004, court filings show.
The
strategy has drawn newcomers.
Fortress Investment Group LLC,
a buyer of troubled corporate debt, is seeking appraisal on $40
million worth of Dole shares, according to people familiar with the
matter.
And
new money is flowing in. Ancora recently raised $50 million dedicated
to appraisals, Managing Director Brian Hopkins said. Verition last
month launched a fundraising effort targeting $250 million, a person
familiar with the matter said. New York-based Muirfield Capital
Management LLC is hoping to raise $100 million or more, according to a
person close to the fund.
"Word is getting out," said Matthew Giffuni, managing partner of
Quadre Investments, which has brought 11 appraisal lawsuits since
2010.
Still, the strategy can backfire. A judge can award less than the deal
price. In 2007, hedge fund Highfields Capital Management LP turned
down a $31-a-share bid for its stock in MONY Group Inc., only to have
a judge decide the shares were worth $24.97 apiece.
Even
successful appraisals can take years to resolve. The Technicolor case,
in which shareholders challenged Ronald Perelman's 1983 buyout of the
movie-production company, took 22 years. The strategy's growing
popularity may also be increasing its risk. In addition to Dole's
razor-thin margin, the sale of Cornerstone Therapeutics Inc., another
deal that has attracted arbitrageurs, got just 50.2% of relevant votes
in February. A failed vote would have wiped out the funds' appraisals
rights and likely caused the price of their shares to fall sharply.
"The
concern is that [the strategy] becomes a victim of its own success,"
Mr. Hopkins of Ancora said.
Write to Liz Hoffman
at
liz.hoffman@wsj.com
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