Classically, the “Background of the Merger” section of a merger proxy is where you get the fun details of how the deal came to be, from which you can perhaps extract a sense of whether or not the deal is a good one for shareholders. But it’s written by lawyers so sometimes their idea of “fun details” differs from yours and mine. Here is a critical moment a week before Heinz agreed to be bought by 3G and Berkshire Hathaway, from Heinz’s merger proxy:
On February 8, 2013, representatives of Davis Polk and Kirkland & Ellis had a conference call to continue negotiations concerning the merger agreement. During the call, Kirkland & Ellis noted that the Investors were willing to accede to Heinz’s request that Heinz be permitted to pay regular quarterly dividends prior to closing of the Merger. Kirkland & Ellis noted that, while Heinz had reserved comment on the remedies for a debt financing failure proposed by Kirkland & Ellis in the initial draft of the merger agreement, the Investors’ willingness to enter into a transaction was conditioned on Heinz’s remedies in those circumstances being limited to receipt of a reverse termination fee. Kirkland & Ellis noted, however, that the Investors would withdraw their initial proposal that Heinz would not be entitled to any remedies if the merger were not consummated due to a failure of the debt financing that resulted from a bankruptcy of those financing sources. In addition, Kirkland & Ellis stated that they expected that the Investors would be willing by their guarantees to guarantee liabilities of Parent and Merger Sub under the merger agreement (including liabilities for breach of the merger agreement) up to a cap on liability equal to the reverse termination fee if it became payable (as the Investors had previously proposed). Kirkland & Ellis also reiterated that the Investors were unwilling to agree to a “go-shop” provision but confirmed that they were willing to accept a customary “no-shop” provision with a fiduciary out, which would allow the Heinz Board, subject to certain conditions, to accept a superior offer made following the announcement of the merger agreement. Davis Polk replied with a slanderous description of Kirkland’s mother’s sexual proclivities. Davis Polk suggested that, in lieu of a “go-shop” provision, Heinz might consider a two-tiered termination fee, with a lower fee payable by Heinz if it terminated the merger agreement to enter into an alternative transaction within a limited period of time post-signing. Kirkland & Ellis responded that, while the Investors might have some flexibility on the size of the termination fee, the Investors would not accept a two-tiered fee. Finally, Kirkland & Ellis noted that the standard for efforts to obtain antitrust approvals proposed in the most recent draft of the merger agreement was too onerous in light of the circumstances, but that the Investors would agree not to acquire other food manufacturers during the period prior to closing of the merger if doing so would interfere with obtaining antitrust approvals.
Oh so that’s what happened!1
We’ve talked before about some amusing research suggesting that these sorts of terms of merger agreements don’t actually matter, because deals basically always close so all the rigamarole about go-shops, no-shops, liability caps, breakup fees, and antitrust efforts quickly come to nothing. There are some important exceptions; with all the daggers out in the Dell buyout you can imagine that the lawyers are earning their keep there.
But here? Here everyone seems to think that Heinz is getting a pretty full price, the stock is placidly trading a few pennies below the deal price, and the lawyers may be overestimating the importance of their negotiations. I suspect people are reading the background more for folksy anecdotes about Warren Buffett’s involvement than they are for technical details about the go-shop negotiation. Those anecdotes are limited and dull, alas.2
Still if you’ve got the stomach for it there’s some interesting stuff in that passage. A hotly negotiated question in any leveraged buyout is: what happens if the debt markets shut in the buyer’s face? Is the buyer on the hook to close the deal by any means necessary, or can it get out by paying a fee? With Warren Buffett behind you, it’s tough to demand a financing out; he’s got all the money in the world, and if your bank balks on the financing he can just buy the bank. So the buyer group didn’t ask to be able to walk away if financing fell through, but it did ask for a sort of ridiculously tail-case financing out: they could get out of the deal if their banks went bankrupt. Their banks being JPMorgan, Wells Fargo, Barclays, and Citi. When the end times come, Warren Buffett doesn’t want to be buying any ketchup.
They ended up caving on this point, though, so I guess it’s back to plan B of he buys the banks if they go bankrupt. Though there is a novel provision that says that, if the financing falls through, the merger can be put on hold for up to four months to let the buyers sue the banks. So, some value add by the lawyers indeed.
Again, it’s Buffett, all the money in the world, so why all this nervousness about financing? Here is more from the Background section:
Heinz’s financial advisors advised the Heinz Board that they did not believe that any other financial sponsors possessed the financial capacity to finance an acquisition of Heinz with an equity component the size of that proposed by the Investors, that, in their views, the financing markets would not support a transaction with a smaller equity component at a financing cost that would allow competing financial sponsors to generate acceptable returns, and that, in their views, any acquisition with a larger debt financing component would introduce greater risk to Heinz that changes in the debt financing markets would interfere with consummation of an acquisition.
Indeed. This deal isn’t just richly valued; it’s very highly levered. The fairness opinion disclosure cites Heinz’s advisors at Centerview and Merrill as concluding that precedent transactions justified an enterprise value to LTM EBITDA multiple of 11-14x, and that trading comparables justified a 10-12x valuation. The financing section describes the deal as being financed with ~$12 billion of secured debt and $8 billion of Buffett’s preferred stock, meaning that fixed-income securities represent roughly 10x LTM EBITDA.3
So “financing sources,” construed broadly – the banks and Buffett’s preferred stock investment4 – are providing financing of around 10x EBITDA, and senior secured financing is 6x EBITDA (versus ~6x and ~4x, respectively, for the average 2012 LBO). Making this a pretty nosebleedy deal, and one where you could imagine the financing sources balking despite Warren Buffett’s involvement. It’s perhaps harder to imagine them going bankrupt because of it, though to be fair Moody’s has.
Dell’s buyout group has the somewhat unenviable task of trying to convince its shareholders that it’s paying a full value for the company, while simultaneously persuading debt investors that there’s some margin of safety. That’s true in every buyout, and it’s true here too, though Heinz, unlike Dell, doesn’t have fractious shareholders who are loudly complaining about being underpaid. So they can focus all their attention on convincing debt investors to provide financing. (And not to go bankrupt, I guess.) The fact that Heinz’s advisors thought that this buyer group – with Warren Buffett providing $8 billion in subordinated financing to make the debt investors more comfortable – is the only group in the world that can do that should be enough to persuade shareholders that this is the best deal they’re going to get.
1. One sentence there is my interpolation – see if you can spot it! In any case, I am more a fan of Wachtell’s stoic approach in the Kinder Morgan proxy: “On September 23, 2011, Weil delivered a draft merger agreement to Wachtell Lipton, and on September 24, 2011, Wachtell Lipton delivered a revised draft merger agreement to Weil.” Do your suffering in silence.
On February 11, 2013, Messrs. Buffett, Behring and Johnson met in Omaha, Nebraska. During the meeting, Messrs. Johnson, Buffett and Behring discussed the transaction generally and Mr. Buffett again confirmed the Investors’ commitment to maintaining Heinz’s presence and heritage in Pittsburgh, Pennsylvania, which commitment was important to the Heinz Board. There were no discussions during the meeting regarding the role, if any, of the Heinz management team following consummation of the merger.
3. Per Bloomberg I see $1,875.78mm of LTM EBITDA as of October 28, 2012 (Heinz’s Q2 quarter-end, and the date that Centerview and Merrill used), and $1,007mm of cash. So I see this deal – $12bn of debt, $8bn of pref, $8.24bn of common equity – as being $27.24bn of total enterprise value or about 14.5x EBITDA. Or about 5.9x through the senior debt and 10.1x through the preferred. The financial advisors’ numbers are different by about three quarters of a turn – BofA says a 14x multiple is a $74 share price, as opposed to the actual $72.50 in the deal, implying that the deal was done at 13.75x TEV/EBITDA – so, I dunno. I did similar math before using Q3 numbers.
Berkshire will also invest $8 billion in preferred shares that pay a 9% dividend. The preferred has two other features that materially increase its value: at some point it will be redeemed at a significant premium price and the preferred also comes with warrants permitting us to buy 5% of the holding company’s common stock for a nominal sum.”
If it pays a fixed coupon and has a maturity it’s debt. Very junior debt but still.