Delaware Chancellor Leo Strine has a bright future in blogging if chancelling doesn’t work out for him. Here’s how he describes Kinder Morgan’s negotiations to buy El Paso, specifically KMI CEO Rich Kinder’s price retrade with EP CEO Doug Foshee:
Kinder said “oops, we made a mistake. We relied on a bullish set of analyst projections in order to make our bid. Our bad. Although we were tough enough to threaten going hostile, we just can’t stand by our bid.”
Instead of telling Kinder where to put his drilling equipment, Foshee backed down.
I umm … I’m pretty sure that that quote from Kinder is approximate.
Anyway, this is from Strine’s opinion refusing to block the KMI-EP merger from proceeding even though he is pretty pissed about some of the apparent conflicts of interest in the deal, including that Goldman Sachs owns almost 20% of KMI while also advising EP, that the lead GS banker owned some KMI stock that he didn’t disclose, and that Foshee negotiated the merger single-handed while also maybe thinking about possibly LBOing EP’s E&P business for his own self.
Lucrative though my current pseudoprofession is, I suspect that if Strine ever leaves the chancelling racket he’d probably prefer to try his hand at merging and/or acquiring. Certainly he is fond of dispensing tactical advice:
On September 9, 2011, Kinder Morgan threatened to go public with its interest in buying El Paso. Rather than seeing this as a chance to force Kinder Morgan into an expensive public struggle, the Board entered into negotiations with Kinder Morgan. … Allowing Kinder to play the tough hostile bidder and then back off the $27.55 per share price can certainly be seen by a rational mind as oddly timid, especially because once El Paso stockholders realized that Kinder Morgan – a supposedly mature market player making an unsolicited bid – had agreed to pay that price, they would be reluctant to accept less.
And he is an ace at valuation*:
Rather than use a perpetual growth model to calculate the pipeline business’s terminal value, Morgan Stanley used a mid-point exit EV/EBITDA multiple of 10x, which implied a perpetual growth rather of only 0.7% [?? - ed.]. That is, Morgan Stanley calculated that the pipeline business would grow only 0.7% from 2016 into perpetuity – a rate less than half of the estimated rate of inflation (2%) – an implication which is inconsistent with Foshee’s testimony that the pipeline business had strong growth prospects …
I am somewhat constrained in writing about this because I do know (and like, and respect) a lot of the people involved from my former life. When Strine says that “Moreover, [El Paso] executives wanted to reward Goldman for its ‘eight [and a half] years of strategic advisory work for El Paso,’” let’s just say I know whereof he speaks.**
So I’ll mostly send you to two excellent posts from Steven Davidoff at the Times and Ronald Barusch at the Journal for a breakdown of what this means for the Future Of M&A. You can perhaps go beyond them in places; in particular, Strine’s scorn for Kinder’s retrading suggests that it might be harder for buyers to get away with retrading in the future, since he more or less says “EP should have just announced that KMI had bid $27.55 per share and then told its shareholders that if they’re offered a penny less they should just shake their heads and gesture rudely to their drilling equipment.” And he then basically measures the potential damages that EP might have to pay to shareholders as the difference between that $27.55 initial bid and the $26.87 final value that EP obtained – meaning that every penny saved by KMI retrading is part of the damages that directors and bankers are potentially liable for. Given that, what board in the future will be willing to accept a retrade on price? Now go think your thoughts about what that does to ex ante incentives to bid etc.
But the main message of this, plus the Barclays stapled financing case from a while back, is probably: it’s asymptotically approaching impossible to manage and disclose around investment bank conflicts in M&A. Goldman’s principal conflict here would seem, to a normal person (no, not really, to a Goldman alum), to have been managed in a textbook fashion: the banking team was walled off from the private equity arm that owned a Kinder Morgan stake the GS directors at Kinder recused themselves from merger discussions, everything was disclosed, and an independent advisor was hired to advise on the merger and give a fairness opinion.*** You could certainly come away from this opinion with the impression that a bank can’t really advise one party on a merger while owning a big stake in, or having any serious ties to, the other party.
One sort of subversive theory (not mine) suggests that concerning yourself with conflicts like this is pointless, since M&A prices are zero-sum, everyone’s basically an index investor, and pushing KMI to overpay serves no social good. On this theory, I guess, an advisor who has a stake in everybody and just wants to broker a mutually acceptable deal, rather than push for the last penny for one side or another, is probably fine – sort of like you see in the capital markets businesses of investment banks. But in M&A, Revlon duties blah blah blah, so let’s ignore that theory even though – kind of, right? Reading Strine’s opinion, I found myself utterly unable to shed tears for the plaintiffs and their lost 68 cents.
Anyway, though, leaving that aside, you can see Strine’s anti-conflict agenda as a second front in the Volcker Rule, anti-too-big-to-fail wars. Whereas lending and investing and financing have long been ways to get M&A business, they’re increasingly becoming ways to lose that business too. Too close a relationship with both sides of a deal could prevent you from working for either side. And while Strine scoffs at GS’s $20mm merger fee from EP in comparison to its $4bn investment in KMI – a risk-free $20 million is, y’know, better than not having $20 million. At the margin this, like Volcker, makes fee-based, non-capital/investment-intensive businesses more attractive to banks.
You could guess that this will help the M&A boutiques that are sprouting up everywhere these days, whose balance sheets, at least, won’t be causing conflicts. That said the news isn’t all good for them. One long-standing function of smaller boutiques is to provide second fairness opinions in exactly these situations where a big bank with a good relationship gets the M&A relationship but is too conflicted to be the sole advisor. That is increasingly seeming like not an option. Kick those big banks out of the process entirely and who will be left to recommend bringing in a harmless boutique to bless the deal?
Delaware Court Declines to Block Kinder Morgan’s El Paso Corp. Deal [DealBook]
Deal Professor: The Losers in the El Paso Corp. Opinion [DealBook]
Dealpolitik: Plenty of Warnings As El Paso Deal Squeaks By Judge [Deal Journal]
In re El Paso Corporation Shareholder Litigation
* Though, solid footnote to a different bit of armchair valuation in Strine’s opinion: “These are rough approximations and I have applied my own training as a humanities major to arrive at the results. Rely upon them with this caution in mind.” As a classics major, I approve.
** But: I at no point was involved in any discussions of or related to the merger or spin-off discussed in the opinion.
*** Strine makes much of the fact that Morgan Stanley only got paid if the merger happened. Welcome to all mergers! That, by the way, is actually a real conflict. But it’s hallowed by tradition so whatever.