Another One Bites The Dust: KKR and Goldman Kill Harman Deal And Walk Away With Treasure Chest Of Convertible Notes

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As we noted in Opening Bell this morning, another big buyout has gone the way of all mortal things. Today’s entry into the deal graveyard is the $8 billion Kohlberg Kravis Roberts and Goldman Sachs buyout of Harman International. According to most news stories on the deal, Goldman and KKR are forking over $400 million in exchange for convertible notes, Harman’s using the money for a stock buy-back, and everyone’s amicable, honky-dory, smiles and handshakes about the new deal.
But when we squint at the fine text, we’re not sure that Harman should be smiling so widely. According to the acquisition agreement, the company was due to collect a $225 million break-up fee if KKR and Goldman walked. So what’s seems to be happening is that they are selling $400 million of notes to the balking buyers for $175 million. Let’s call that a 57% discount. So Harman will now owe $400 million of principal to KKR and Goldman in exchange for just $175 million beyond what they were arguably already due according to the agreement.
But Goldman and KKR are getting more than just the notes. They are getting an option to buy the stock. Typically, a convertible note is linked to a share price that places the option currently out of the money. But if we follow through on the idea that Goldman and KKR are buying the notes at a discount, we can see that these are actually currently in the money. The $104 a share translates into 3.8 million shares for $400 million of notes. Those shares are now trading at $85, which means that the buyers have entitled themselves to $326 million of shares for just $175 million dollars.
To put it even differently, after the discount, the deal prices the shares at $59. We’re not sure that’s exactly the “vote of confidence” in Harmon that its executives are touting. Harman may now have an additional $175 million for a buyback but this seems a steep price to pay for that money.
Of course, if you figure that break-up fees are not sunk costs for dead deals because the buyers aren’t ever going to pay them anyway—a growing trend from private equity buyers, to be sure—then we guess it does sound like great deal for Harman. It’s probably just our short-sighted stinginess that makes us think in terms of additional, incremental dollars in the deal rather than the complete $400 million package.
KKR and GS Capital Partners to Invest in Harman International [Press release via Market Watch]

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