Skip to main content

Delaware Judge To Goldman: Here, Let Me Re-Do That Fairness Opinion For You

  • Author:
  • Updated:

A thing I liked about being a banker, but that made me consistently terrible at managing my PA, was that in banking you don't really get paid to be right about things. Nobody made any money telling AOL and Time Warner that maybe they'd be better off on their own. Instead, your job is telling a persuasive story - a story that often ends with "so that's why you have to [buy this company][sell your company]." You tell that story with DCFs and PowerPoint and steak dinners, but ultimately all the numbers and charts are aimed not at objective reality but at persuasion. And the easiest way to make a story persuasive is to tell people what they want to hear.

It is, however, possible to take that concept too far. Fairness opinions are a troublesome example. Nobody in the real world believes all that much in fairness opinions, but banks actually take them pretty seriously because they represent in a vague and highly caveated way a bank's conclusion that the price paid in a merger is (within a wide range of) "right," or at least somehow connected to objective reality. This is a hard mindset to get into when your day job is basically persuasion, and you can expect some slips every now and then.

Here, for instance, is a useful tip for any junior analysts: this is not what a DCF looks like:

You can tell because it doesn't have any cash flows! Or values!

What is this beast? Well, it's the "DCF" output of a proxy summary of a Goldman fairness opinion to Southern Peru Copper in an acquisition it did in 2004. Basically they did a DCF of the acquirer and another DCF of the target and mashed them together into the unholy matrix above, carefully obliterating any trace of the actual values generated for either company.

This is news because a Delaware judge on Friday decided that it was deficient to the tune of about $1.26 billion. DealBook has the details, and the opinion, which I endorse as late-season beach reading. The short version is that Grupo Mexico controlled two companies, Southern Peru Copper (now Southern Copper), and Minera Mexico. Southern Copper was and is a public company (SCCO), and is now 80% owned by Grupo Mexico; Minera was private and 99% owned by Grupo Mexico. Grupo Mexico decided they wanted to get some liquidity so they offered to sell Minera to Southern Copper for $3 billion in SCCO stock, which Grupo Mexico could readily convert to cash. Problem is, Southern Copper's bankers at Goldman thought Minera was only worth $1.7 billion based on old-fashioned things like DCFs.

Southern Copper's independent directors seem to have really wanted to make the deal work, so they and Goldman put on their collective thinking caps and came up with the mish-mash above, which you could read to mean "sure, Minera isn't worth $3 billion of our shares, but then $3 billion of our shares aren't worth $3 billion either." The mish-mash supported a fairness opinion, the fairness opinion let the board agree to the merger, the shareholders approved, the merger went through, some SCCO shareholders sued, and the lawsuit sort of casually wended its way through the courts for six or seven years. And then last Friday the shareholders won and Grupo Mexico was told to return $1.26 billion of SCCO stock.

Delaware M&A opinions are always fun reading because the judges all seem to have grown up on Barbarians at the Gate, so they get into the drama and like telling stories with heroes and villains. Mostly villains. Here the story is a moral fable in which Grupo Mexico, which controlled Southern Copper, had beaten the supposedly independent SCCO directors so far into submission that it didn't even occur to them to ask for a lower price. Actually the judge had an even better idea for them: if your stock was so overvalued, why not demand that Grupo Mexico buy out SCCO at the inflated price rather than sell some other inflated asset to you?

You could read this story another way: Southern Copper's independent directors knew that Grupo Mexico wanted liquidity and was unlikely to double down and buy out SCCO; they knew that Grupo Mexico was asking a pretty rich price but also that they wouldn't be likely to give on it; and they really wanted to acquire more Latin American copper mining assets. (Which turned out to be kind of an okay idea what with copper up 300+% since 2004.) Their conclusion was not that SCCO was overvalued but that a DCF undervalued Minera, because it understated where copper prices were really likely to be headed. They did the deal that they could do, they felt in their gut that it was right, and they got a fairness opinion that said so. You could then go on to ask questions like "should a judge, seven years later, really be deciding not only the right price for Minera but also the right M&A strategy for Southern Copper?" Or "what would have worked out better for SCCO shareholders - this deal, or the judge's suggestion of selling out in 2004 with the stock (currently at $27.44) below $10?"

I'm kind of sympathetic to that view, but you can't stretch the point too much because that fairness opinion, at least with hindsight, looks pretty comical. And it's a good example of what happens when bankers get so excited by the chance to craft persuasive stories with numbers that they forget to check in with reality.

Grupo Mexico Is Hit With $1.26 Billion Judgment [DealBook]


Delaware Judge Driven To Possibly Obscene Energy Industry Euphemism By Kinder-El Paso Merger

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: