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![The Deal Professor By Steven M. Davidoff](http://graphics8.nytimes.com/images/blogs/dealbook/professor/deal_professor_davidoff_header.gif)
Anatomy of a Merger
April 13, 2008,
9:56 pm
On Friday, JPMorgan Chase filed
its registration statement on Form S-4 with the Securities and Exchange
Commission related to its acquisition of Bear Stearns. This
is the document JPMorgan is using to register the securities it is issuing
to the Bear Stearns shareholders and will also function as the proxy
statement for the Bear Stearns shareholder vote.
It is interesting reading, but it is quite clear that this deal has very
little to do with corporate law. Still, here are a couple of highlights from
the section on the background to the transaction:
1. It was over for Bear on the evening of Friday, March
14. That was when the New York Federal Reserve informed Bear that on Monday
morning it was pulling its secured lending facility agreed to earlier that
day. This was the stick for the carrot another “unnamed” government official
gave Bear – find a “stabilizing” transaction by the end of the weekend.
Without any liquidity on Monday morning, Bear had no choice but to take
the carrot. The question here is what led the Fed to do an about-face and
force Bear into a transaction – was it Treasury lobbying? Regardless,
someone in the federal government decided that Bear was no longer going to
go it alone. I haven’t read the congressional testimony so if it is
explained there please let me know in the comments below.
2. “Bidder A” never had a chance. It is being reported
in the media that the alternative bidder described in the filing is the
private equity group J.C. Flowers & Company. According to
the filing, a Bidder A (i.e., Flowers) gave a preliminary indication of
interest for a transaction involving a capital infusion of $3 billion for 90
percent of Bear’s equity. By mid-afternoon on Sunday, however, Flowers had
to withdraw, given the Fed’s refusal to support the proposal and the
consequent refusal of other financial institutions to provide financing for
Flowers’ bid. The filing discloses that Lazard was able to find other
interested bidders, but the required timeframe made things unworkable for
them.
3. The end of the affair. After Bidder A’s withdrawal
and with no other savior or bidder in sight, JPMorgan lowered its $10-to-$12
initial offer to $2, refusing Bear’s request for some form of contingent
consideration. The filing states that this move was done in consultation
with yet again “unnamed” government officials. I would have loved to hear
that conversation. Nonetheless, it appears clear that by this time with no
Fed lending facility, no other bidders, and the Japanese markets about to
open, Bear’s only other alternative to the JPMorgan transaction was
bankruptcy. JPMorgan lowered the price leveraging off this fact with some
level of government support/ “persuasion”?
4. Bankruptcy alternative. Here, Bear’s broker-dealer
subsidiary would have been required to file a Chapter 7 liquidation, but the
Bear holding company and non-broker-dealer entities could still file for
Chapter 11 reorganization selling operations along the way through the
bankruptcy process. This alternative is mentioned but the parties say that
it was not considered a realistic possibility because of the lack of cash at
the Bear holding company. Here, bankruptcy may have been harder since the
broker-dealer entities at this point were relying on collateralized
overnight borrowing, and the concern and the Bear holding company debtor
would not have the right to put a hold on collateral seizures and forced
liquidations or otherwise the assets to get debtor-in-possession financing.
5. There is a weird dynamic in the bankruptcy analysis.
The board of directors was advised by Lazard, their legal
advisors and management that it was their collective view that in bankruptcy
“the holders of Bear Stearns common stock likely would receive no value and
there likely would be losses incurred by certain creditors of Bear Stearns.”
But in their fairness opinion Lazard assumes that the stockholders will
receive nothing. Hard to see if there was any real financial valuation done
of the bankruptcy alternative other than the usual mantra of we’ll lose
everything, but likely such analysis was impossible given the timeline
imposed by the Fed.
6. The Lazard opinion is a waste of paper. The Lazard
opinion assumes a Chapter 7 filing (without a valuation thereof and based on
the stockholders receiving nothing) as the only alternative. The opinion
notes that the consideration was set with the participation of the
government, and unusually caveats the opinion as excluding anything with
respect to the deal protection mechanisms or any compensation agreements
with Bear employees. But Lazard shouldn’t be blamed here — no other
investment bank would have given an opinion on anything more. Lazard is
getting $20 million for their services, a large dollar fee relative to my
salary, but a relatively appropriate sum for their services in this deal
outside of the fairness opinion. Still – I’d be curious to see their fee
letter to see if it too was renegotiated to take into account the first
version of the deal and comparatively low consideration.
7. The deal renegotiation is the most interesting part.
The filing makes a case that Bear was continuing to face liquidity issues
and a possible bankruptcy despite the Fed loan and JPMorgan guaranty. More
importantly, the filing details a scenario where JPMorgan was getting
pressure from the New York Fed to further guarantee Bear’s loans from the
Fed and rework the transaction to in the filings word’s “achieve a greater
degree of stability at Bear Stearns.”
8. Here it is worth going through the disclosure a bit.
The filing states:
On Friday, March 21, 2008, discussions continued between Bear Stearns
and JPMorgan Chase regarding the revised transaction terms proposed by
JPMorgan Chase. Representatives of JPMorgan Chase informed Bear Stearns
that during the week the New York Fed had repeatedly requested that
JPMorgan Chase guaranty Bear Stearns’ borrowings from the New York Fed,
and that JPMorgan Chase was at this time unwilling to do so.
In addition to the New York Fed borrowings, representatives of JPMorgan
Chase also noted that they did not see how JPMorgan Chase would be able to
continue to extend credit to Bear Stearns or provide an enhanced guaranty
in the face of the market’s concerns regarding Bear Stearns’ viability and
the risk that the merger might not be completed. In light of these
factors, JPMorgan Chase expressed its view that the previously discussed
transaction revisions would not be sufficient to provide the stability to
Bear Stearns or certainty to JPMorgan Chase necessary for JPMorgan Chase
to continue its exposure to Bear Stearns.
This appears to be carefully choreographed language to put Bear back into
a bankruptcy scenario and justify the deal protections imposed. It may
indeed be true. But I just don’t understand this. Didn’t Bear just sign a
contract to be acquired at $2 a share with no outs (question – under the
deal would even bankruptcy have qualified)? And didn’t they have a guarantee
to provide them some operational coverage. Would the Fed at this point have
really just let JPMorgan walk? I interpret this last sentence in this
disclosure to mean that JPMorgan was threatening to terminate the merger
agreement and perhaps the guarantee and address this in litigation with a $2
a share cap on liability to Bear’s shareholders. The disclosure then
continues:
Bear Stearns senior management believed that, in light of the
deterioration in Bear Stearns’ liquidity and the absence of any other
source of additional funding, if the New York Fed and JPMorgan Chase were
unwilling to maintain their funding of Bear Stearns and JPMorgan Chase was
unwilling to assure Bear Stearns’ customers, counterparties and lenders by
clarifying and enhancing its guaranty of Bear Stearns’ obligations, Bear
Stearns would not be able to open for business on Monday, March 24, 2008
and would have no choice but to file for bankruptcy by that morning. Bear
Stearns’ bankruptcy advisors were instructed to be prepared for this
contingency by the end of the weekend.
Again, am I missing something about the original deal? I read the
original guarantee to provide a relatively broad guarantee of Bear’s
revolving credit and term facilities for a year. Was it really not enough?
The rest is history — over the weekend, JPMorgan recut the deal and
received the deal protection devices it wanted. These included a change in
the guaranty termination mechanism from effectively a one-year arrangement
to a guarantee which expired 120 days after a negative shareholder vote.
JPMorgan gave the Bear board a reason to support these changes: a four-fold
increase in the consideration and continued director indemnification
provisions possibly unavailable in a bankruptcy scenario.
JPMorgan and Bear paint this as necessary to again avert bankruptcy. But
I have more questions than answers about this:
• Why wasn’t JPM buying stock that week at $3.75 to $7 (and getting the
Fed and the Treasury to lean on the FTC for even earlier termination than
April 1 to go up above the $50 million threshold)? Who was to stop them
from buying for the next month? Would even the FTC have done so? I don’t
see any provision under the original merger agreement prohibiting them
from doing so. And what about all those creditors who were supposedly
buying Bear stock to vote the shares? Furthermore who was at risk if Bear
continued to face liquidity issues that week? Not Bear shareholders.
• Why a fourfold increase? Why not just two or three times? What gave
the Bear board leverage now if they were indeed facing bankruptcy? On
Friday, March 21, JPMorgan asked for 2/3 of the company vote to be locked
up through a stock purchase, and it would increase the merger
consideration to an undisclosed amount. On Saturday, Bear countered for
$12 and offered to sell 19.9 percent of its shares. On Sunday they came up
with an unexplained compromise of $10 a share, a 39.5 percent stock
issuance to JPMorgan, an apparent implicit understanding that JPMorgan
would purchase more shares up to 49.5 percent of Bear in the open market,
and a guaranty that got “clarified and enhanced.” The Fed also got its
direct guaranty from JPMorgan of Bear’s Fed borrowings.
• I’m still most troubled by the actions of the Bear board members who
subsequently sold their shares in the market after the deal recut. The
disclosure talks of Bear offering “to obtain the agreement of Bear
Stearns’ directors to vote their stock in favor of the merger.” This
turned into a commitment in the press release, and at least two sales so
far (James Cayne, Bear’s chairman, and director Paul A. Novelly). What
were the conversations that led to this? How did the Bear directors
justify refusing to give a contractual commitment.
So what explains all this? What explains the deal change from Saturday to
Sunday? Did the Bear board think they were again in a bankruptcy scenario?
The disclosure implies this if not out rightly states it.
But I am thinking JPMorgan was one month pregnant (after one week) and
the guaranty terms looked increasingly inappropriate. JPMorgan also got some
pressure from the Fed because the Fed was being criticized for a bailout.
For some reason they weren’t buying Bear stock in the market. And no doubt
it was impossible for JPMorgan to lock up the Bear human assets they wanted
during that week, particularly after Jamie Dimon’s
reception at Bear. And one week into the deal, they liked it more and
were willing to resolve the Fed’s guaranty issue. It gave the Bear board
some leverage, of approximately $8 a share.
And back to that corporate law. The document describes a situation where
the parties felt that they had no risk in stretching ordinary corporate
laws. And it is probably the correct assumption. JPMorgan and Bear have
already won a stay of the Delaware proceedings. They have a good chance of
winning in New York at least as to holding the shareholder vote and getting
a positive outcome and from there it’s any easy close – JPMorgan is still
buying stock in the market this past week. The New York Court will likely
refuse to enjoin and at best say monetary damages are sufficient – if so,
this will be quietly settled in a few years with the class action attorneys.
This may explain the negative spread right now (to the extent the class
period is stretched or people are derivatively hedging class period plays),
but it doesn’t explain Joseph C. Lewis’s continuing absence.
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