What is Driving M&A These Days?

There's an awful lot of merger-and-acquisition activity underway in the US these days. If you wanted to 'play' it in a relatively accessible way you could doso through a merger and arb oriented ETF, such as John Spence discusses in his "Fund Track" in today's Wall Street Journal.

(I'm not suggesting you do any such thing, by the way. The observation was purely hypothetical. My readers are clearly too smart to take market advice from blogs.)

Anyway: what is driving it? Are these directors, eager to build empires? CNBC says not, that it is shareholder driven.

It may simply be that there is too much cash out there. Nobody wants to sit on cash. One wants to put it to work. But over the last couple of years, the idea of putting cash to work has been scary. Buying another firm, one that has a track record or perhaps one with assets that create some synergy with one's own, may be one of the least scary ways to do so.

Sanofi and Genzyme: They'll do it the hard way

Negotiations for a friendly merger between Sanofi-Aventis and Genzyme, which I discussed here a month ago, now seem to have fallen apart.

Sanofi's CEO has written a "bear hug" letter in the first instance to the Genzyme CEO but in reality to the Genzyme shareholders. The idea is to get the shareholders ticked off that their management is standing between them and a nice pay-out.

Here's a discussion from two and a half years ago about the art of giving a bear hug.

A little history. Back in 2004, a company then called Sanofi-Synthélabo made a 47.8 bn euro for Aventis, a Strasbourg based concern. At first, Initially, Aventis spurned the bid, and a three-month battle resulted. The merger did in time come about, but the price increased, from the original 47.8 billion to 54.5 billion euros.

The French government played a big role in that imbroglio. The government was concerned that a Swiss company (Novartis) would step in as Aventis' white knight if Sanofi-Synthélabo didn't raise its bid. That would lead to Aventis falling under the control of foreigners. Indeed, non-EU foreigners! (The Swiss are only geographically part of Europe.)

The lesson: there is good reason, based on their fiduciary obligation to their shareholders, for the management of Genzyme to make this difficult for Sanofi. They shouldn't make it impossible, but they should make it difficult.

From Both Sides of the Chunnel

The Brits have fined the UK branch of Societe Generale 1.58 million pounds [US$2.44 million] for failure to file acciurate reports on transactions that occurred between November 2007 and February 2010.

Some of the transactions weren't reported on at all, others were treated inaccurately.

The FSA said the failure was branch was "a serious breach of our rules as it can have a damaging impact on our ability to detect and investigate suspected market abuse.”

This fine has nothing to do with Jerome Kerviel, but I thought I'd mention him, because no story abouyt SG is complete without some such mention.

By the way, Kerviel has a book out, L’engrenage: Mémoires d’un Trader (Gears: Memoires of a Trader). There seems as of yet to be no English language edition.

A Potash Auction?

The giant Anglo-Australian mining concern BHP Billeton (LSE: BLT) -- which has a stock symbol that reminds me of a sandwich -- has bid $38.6 billion for Potash Corp., of Canada, and has also put on something of a charm offensive, seeking to persuade Canadians that locals will continue to run the place.

Canadian regulators have taken a permissive attitude of late toward foreign companies who want to take over the mining concerns of the Great White North. Xstrata, of Switzerland, bought Falconbridge (a nickel miner) without a fuss, for example.

Anyway, the key question here is: how much will Potash go for? Can the incumbent board set off an auction? You need more than one bidder for a good auction. Potash is apparently in discussions with a couple of Chinese concerns: the Sinochem Group and Hopu Investment Management.

As you can see from the chart, the course of BHP's stock price has been pretty rocky since April. Nonetheless, the company has deep pockets, and analysts are convinced it can sweeten its offer if it has to.

Indeed, Marius Kloppers, the CEO of BHP, has referred to the bid -- which stands at US$130 per share, as "full and fair." If he had wanted to say "last and best," he would have done so.

Penn and Teller

The famous magicians -- the one who talks and the one who doesn't -- have their own program on Showtime called Bullshit! In which they seek to expose various forms of, yes, Bullshit.

Recently, they did an episode of that program on multi-level marketing. The above link will take you to a collection of clips from it. The next link will take you to a blog specifically devoted to expansive treatment of some of the issues that P&T could but raise.

I whole-heartedly agree with the gist of the Penn & Teller critique of the whole practice. I wrote about this in May specifically in the Medifast context, but it bears repeating.

The Amway case, and its 70/30 rule, have given a cloak of legitimacy to an industry. But, in my view and that it seems of most of those who have looked at the matter dispassionately, the distinction between lawful MLM and unlawful pyramids is itself something of a sham. MLM systems as defined above inevitably create a context in which the success stories are the sales people at the top of the chain, and those at the bottom are their suckers. The success stories are held up as role models, and this is used to generate more suckers.

Just to be fair to that company, here's the official site for Medifast.

And just to be fair to potential suckers thereof, here's a contribution to discussion of their business model by Barry Minkow.

Who is Barry Minkow? This may jog your memory.

Marketing Gases

The Airgas annual meeting is set for Wednesday, September 15.

Airgas, based in Radnor, Pennsylvania, sells gas to industrial and commercial users.

Air Products, another firm in that field, has offered to acquire it, but Airgas management is resisting.

But you've read that much before. What's new?

Just this: Air Products sent a fairly entertaining letter to its rival's shareholders on August 19 detailing what it calls the "numerous inconsistencies and misstatements regarding our bid.

Intel and McAfee

I don't get it. Where is the synergy here?

Here's an effort to explain it

But a company known for making chips is buying a company that offers protection from viruses. It is not at all obvious that the one provides any support for the other that has to be done "in house," that can not be accomplished just as well through arms-length bargaining between separate entities.

Dell: The Company and the Man

What is going on with Dell these days?

The owners of 378 million shares withheld their support from Michael Dell's re-election as chairman of the board of the company that bears his surname.

That reminds me of the brouhaha at Disney in the period 2003-2005.

But what is the "big picture" at Dell? My understanding is that its core business remains the sale of "the box," the physical computer you stick on top of your desk. It typically has Intel's chips, and MS software. Furthermore, since the selling of boxes is competitive, whereas both the software and the chip making markets have a single dominant firm each, most of the profit goes to Microtel. Dell's core business has a slim margin.

Accordingly, in recent years, Dell has tried to branch out into non-core areas where it might be less tightly squeezed. Last year, Dell bought Perot Systems, a provider of a wide range of IT services.

There's also this.

It seems to me that the missteps that led to investor dissatisfaction, and all those withheld votes, have to be understood in this context. Dell is changing course, and there will be some stumbling as a result of such a change. The right thing to do, nonetheless, is to persist.

CEOs and Debt

We have all become rather accustomed to the fact that executives of a company are often compensated for their services in part by equity in the corporation -- or, in the alternative, by options to buy equity.

Not only does this seem normal, there is a superficially plausible case to be made that it aligns incentives properly. A CEO with stock in the company has "skin in the game," as the saying goes.

There are two sides to that, though. As Roger Lowenstein wrote in ORIGINS OF THE CRASH (2004), "For an incentive to functiom properly, there must be a prospect of pain as well as gain" and the the 1990s dotcom bubble with which Lowenstein was concerned in that book, the very possibility of CEO pain was "trivialized."

Another common complaint about reimbursement through equity is that if executives see themselves as equity holders, they have an incentive to shift wealth away from debt holders, toward themselves and their fellow stockholders. How might they do this? By over-paying dividends, most obviously. If a company is in trouble (in the "zone of insolvency" as lawyers sometimes say, although not across that line yet) and it pays its shareholders a generous dividend anyway, then the company is essentially making sure the shareholders get cash while the 'gettin' is good.' That cash will never be available to pay off the bondholders should the company default and either voluntarily file bankruptcy or be pushed in that direction by debtor action.

So: if executives are compensated in stock, they may have a commonality of interests with their fellow shareholders, but this may express itself not in productive dcisions, but in beggaring other stakeholder groups.

What, then, about compensation in bonds? Perhaps a CEO who really wants to show us that he has skin in the game will load up on debt instruments issued by his company. Here is the recent discussion of that point that has gotten me thinking.

Barnes & Noble settlement talks

Settlement talks between the parties in the fight over the famous bookstore chain seemed promising early last week. Talks went late into the night on Wednesday. But by week's end, things had fallen apart.

In a brief statement B&N said that it and Yucaipa "were unable to conclude an agreement on mutually acceptable terms."

Yucaipa is an investment company alter ego for Ron Burkle. According to scuttlement, a tentative deal had emerged in which B&N would expand the size of its board of directors by three seats and let Burkle name directors to the new seats. In return, Burkle would support the candidates director nominees for this meeting and the next. He would also stop litigating to try to have B&N's poison pill plan invalidated, thereby allowing B&N to continue in effect to limit the size of his investment in their company.

On Thursday, that tentative agreement unravelled. The parties communicated that to the chancery court in Delaware, and that court issued its ruling on the pending motion to dismiss. Barnes & Noble won the litigation -- or at least this round of it -- in a ruling by Judge Leo Strine.

The "rights plan" a/k/a the poison pill, by the way, provides that if an outside acquires 20 percent or more of the company's stock, other investors get to buy common shares at a 50 percent discount. So Burkle can only pass the 20 percent threshold if he is willing to accept enormous dilution in stock value thereafter.

"The defendants have shown that their adoption and use of the rights plan was a good, fair, reasonable response to a threat to Barnes & Noble and its stockholders," Strine said, dismissing Burkle's lawsuit.

The name of the decision is: Yucaipa American Alliance Fund II LP v. Riggio, CA5465, Delaware Chancery Court.

Blackstone and Dynegy

The Blackstone Group and Dynegy Inc. have entered into a definitive merger agreement. Dynegy stockholders will receive $4.50 in cash for each of their shares. This is a 62% premium on the closing share price as of the Thursday, August 12.

Separately, but not-so-separately, Blackstone and NRG Energy have entered into an agreement through which NRG will buy four natural gas-fired assets currently owned by Dynegy for a total cash consideration of $1.36 billion. Three of the facilities involved are in California, the other is at Casco Bay, Maine.

The closing of the merger transaction between Dynegy and Blackstone is contingent upon the concurrent closing of the Blackstone and NRG deal.

News involving Dynegy always perks up my ears because Dynegy was involved in the big energy-markets story of 2001, the demise-of-Enron. Dynegy was the white knight who never quite arrived to save the damsel from the dragon of insolvency.

That's an episode that goes unmentioned in the company's official version of its own history. But there is a fine account, with some Dynegy background, in the Smith/Emshwiller book n Enron's fall.

Smith/Emshwiller tell us that the companies jointly announced a merger agreement at 5 PM Houston time, November 9, 2001. "Who would have imagined it? Enron officials had looked down on Dynegy as one of the little kids on the energy block, with assets of a 'mere' $25 billion compared with Enron's more than $60 billion. The planned merger was just one more example of the unintended consequences of the Enron debacle...."

WaMu bankruptcy

The Delaware bankruptcy court has authorized a study of the circumstances that led to the bankruptcy of Washington Mutual by Joshua Hochberg of the law firm McKenna Long & Aldridge.

This was part of those overly dramatic days of the fall of 2008. The FDIC seized the operating company, i.e. the actual bank, and unceremoniously sold it to JP Morgan Chase. This was all done hurriedly. As Sorkin wrote, "The FDIC typically conducts seizures of troubled banks on Friday evenings, to allow regulators time over the following weekend to readsy the institution to open under government oversight on Monday. But WaMu was deteriorating so rapidly -- nearly $17 billion had been withdrawn in ten days -- that the regulators had no choice," but to run the auction on Wednesday and effectuate the seizure on Thursday.

That didn't involve a bankruptcy court at all. But immediately thereafter its holding company (WMI) filed for bankruptcy protection. All this happened so quickly that no one had a chance to work out which assets belonged to WaMu and which to WMI, so they proceeded to argue that out in court. In a development that may have helped generate some changes in the law, JPMC sought full disclosure of all information called for by Bankruptcy Rule 2019(a), not just the names of the members of the WMI Noteholders Group and the aggregate value of their interests. Following the 2005 decision of the United States District Court for the Southern District of New York in In Re Northwest Airlines Corp., the court granted JPMC's motion and ordered full compliance back in December 2009.

It appears, though that the issue of disclosure in other forms is still bedevilling this particular bankruptcy proceeding.

Anyway, I look forward to an enlightening report from Hochberg.

Geoff Sorbello to Okapi

Sorbello, who has been with ISS/RiskMetrics, is the new hire at Okapi Partners.

In a statement yesterday, Sorbello said, "During my seven-plus years at ISS, I had the privilege of working with many of the world's best advisors on shareholder rights issues, proxy contests and [mergers & acquisitions]. I look forward to adding to Okapi Partner's existing expertise and stellar reputation."

Okapi is a proxy solicitation firm launched a little more than two years ago -- in February 2008 -- by Bruce H. Goldfarb and Patrick J. McHugh.

At that time, Goldfarb said: "Companies and their investors are increasingly recognizing the need for more proactive strategies and tactics to influence the outcome of shareholder votes. In this environment, Okapi Partners is well-positioned to provide senior-level attention and conflict- free advice to our clients."

I hate the word "proactive," but it seems to be unstoppable at this point anyway.

An urgent question: why do they call themselves Okapi? It's the name of a girafe-like animal. But with a shorter neck. What does that have to do with proxy solicitation. Damned if I know.

Black-Scholes and Monte Carlo

Aside from the lattice method discussed in yesterday's entry, the two most important methods of valuing the expense of stock options as compensation are: the Black-Scholes-Merton (BSM) formula, and a Monte Carlo simulation.

BSM is here.

This amounts to valuing an option to buy a share of stock by making certain simplifying assumptions. The devisers of the formula were explicit about these assumptions. One of the more important of them is that extreme price changes are very rare, because the movements in the value of the underlying stock follow lognormal distribution. Many scholars have quarrelled with this, but BSM does still offer a useful approximation of the value of such options.

Still: the "Monte Carlo" method has by far the cooler name, paying homage as it does to the city whose image I've uploaded with this entry.

Through the miracle known as a digital computer, modelers can run thousands of simulation paths covering possible price movements in the underlying asset -- the stock - and can assign a value to the option for each of these paths. The present value of the average of all those values is the Monte Carlo value of the option.

More on Stock-based Compensation

It was only a few flicks of the calender away, it was as recently as 2004, that one could say that generally accepted accounting principles (GAAP) in the United States didn't require employers to recognize in the books they showed the investing public that by issuing stock options to their employees they were incurring an expense.

The move of the FASB that year toward standards explicitly requiring this was caught up in the election-year debates. The FASB held its ground, although if I remember correctly it had backed down under political pressure on the same score a decade before. But the second time around it held its ground and made the expensing of stock options mandatory for all annual and interim reports, effective beginning June 15, 2005.

Over the last few years the nature of the debate has shifted. Now that we know companies are supposed to expense their stock options, the question is: how?

There are three dominant methods thus far. There's the Black-Scholes-Merton (MSN)formula, the Monte Carlo os 'simulation' methods, and the lattice model.

The lattice model is the most intriguing of the three in my eyes so I'll expound upon that a bit.

The modelers start by dividing the time between the issuance of an option and its expiration into a definite number of discrete time periods. These periods might be, for example, months or quarters.

Given input variables and assumptions that the company and its modelers must makle explicit, they can then assign a probability to an "up" and to a "down" move in each period. This yields two (or more, depending on how the particular lattice is constructed) end points, which are then starting points (nodes) for the next jump.

The model continues to generate nodes in an ever-widening pattern, looking a bit like a branching tree turned on its side (because the horizontal axis by convention represents the passage of time) until time runs out; that is, until option expiration.

Modelers then employ the whole lattice to decide what would be the value of an option in the final time segment. It helps that the ending is in a sense binary. Either the exercise price of the option is less than the current stock price or it is not, and that simplicity makes calculation straightforward. From there, one can work backward, step by step, until one comes eventually to a value for the option at time 0.

EBITDA and Stock-Based Compensation

The acronym "Ebitda" is in the news again.

For the record, this stands for "earnings before interest, taxation, depreciation and amortization," and is sometimes thought a useful statistic as an approximation of cash flow.

Over time, the significance once attributed to the P/E ratio has come to be relocated -- the value/EBITDA ratio is now the important one.

Value, for such purposes, is a modification of the simpler statistic of market cap, or price.

So: why do I bring it up today? Because it is in the news, of late. Two listed companies, Penson Worldwide (NASDAQ: PNSN) and Comtech Telecommunications (NASDAQ: CMTL) have been called out on fiddling with their EBITDA calculation.

Penson has added stock-based compensation into the EBITDA figure, while Comtech has addedf the amortizationof stock-based compensation. Well ... the A does stand for amortization, but not as it happens that amortization.

Of course, if the EBITDA figure itself can be jiggered with in this way, then any ratios of which EBITDA forms a part become less useful for any investors who might be relying on them. If an investor is diligently working out the value-to-EBIDTA ratio, he'll end up with a smaller ratio that he "should" for these firms. Smaller, that is, than he would if the rules were adhered to consistently. That smaller ratio might well lead him to include, "these stocks are at bargain prices."

Sam Antar has done good work bringing these shenanigans to public notice, and I congratulate him on that.

Another way of looking at this story, though is as a new episode in a continuing controversy over how to account for stock-based compensation. On that, I hope to have something to say next week.

Portugal Telecom

The European Court of Justice (ECJ) has ruled against the largest telecommunications provider in Portugal in a much-watched case that involves the legal significance of "golden shares" within the EU framework.

Portugal Telecom was a legal monopoly in that country until 1994, when the government began privatizing the company and liberalizing the market. But through that period of liberalization, the government wanted to ensure that it would retain a veto right to certain corporate decisions, so it created the "golden shares," -- 500 shares with extended voting rights, effectively allowing it to block a takeover of the company by outsiders.

Here's a link to a discussion, by Jaron van Bekkum, who professes himself baffled.

DWS Enhanced

On July 29 the board of directors of DWS Enhanced announced that at the annual meeting of shareholders July 22 three things happened:

a) the board's proposal to merge the fund into DWS Enhanced Commodity Strategy Fund received approval
b) none of the nominess for director "received a sufficient number of votes to be elected" despite the presence of a quorum.
c) a proposal presented by Western Investment LLC to end the IM agreement between DWS Enhanced and Deutsche Investment Management Americas failed.

See here for some background.

So, if nobody was elected to the board: who is running the show? According to the post-vote press release, "[T]he incumbent Class I Directors, Dawn-Marie Driscoll, John W. Ballantine and Henry P. Becton, Jr., and the incumbent Class III Directors, Rebecca W. Rimel, Paul K. Freeman, William McClayton, William N. Searcy, Jr. and Robert H. Wadsworth, will continue as Directors until such time as their respective successors are duly elected and qualify."

Not sure what that means.

Crown Crafts' CEO

The Crown Crafts annual meeting is set for August 10.

Crown Crafts is a Louisiana based marketer of products for babies and toddlers: nursery decor, burb cloths, bibs, and so forth.

The dissidents, led by the Wynnefield Group, have claimed that the CEO of Crown Craft, Randall Chestnut, has a "history of long non-publicly explained absences from the Company."

Even when Chestnut had heart bypass surgery, the company says, he was only out of the office for two weeks. As for the present, "he is in great health and remains totally immersed in running the business."

Wynnefeld has also expressed concern that "there is no publicly disclosed succession plan to address the possibility of the CEO being unable to carry out his duties or obligations."

Crown Crafts has rebuked them for that is well. They do have a plan, and there is good reason it has not been publicly disclosed. Nobody does that.

"[In]line with long-established corporate governance best practices, no public company board, to our knowledge, discloses its carefully constructed succession plan outside the board room."

Blah and counter-blah. I'm just passing it along today folks. Go hit the beach, if you live anywhere near one. Or a good pool, otherwise.