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Judge Decides LBO Boom Could Have Used A Few More Bidding Wars

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The antitrust lawsuit against all the big private equity firms, accusing them of colluding with each other to drive down prices on LBOs in the 2003-2007 boom, was always a bit of a puzzler. On the one hand, there were lots of emails between private equity firms that they'd probably like back, to the effect of "hey thanks for not bidding on my last deal, hope you enjoy my not bidding on your next deal!" On the other hand, the lawsuit was sort of a mess, full of hazy accusations, unsupported conspiracy claims, and the sort of unfalsifiable tin-hattery that sees occasional fierce bidding wars between private equity firms as just a cunning cover-up of their conspiracy not to bid against each other.

I blog for a living, such as it is, so sometimes I would complain about that confusion, but Edward F. Harrington is a federal judge for a living so he gets to just fix it:

Plaintiffs persistent hesitance to narrow their claim to something cognizable and supported by the evidence has made this matter unnecessarily complex and nearly warranted its dismissal. Nevertheless, the Court shall allow the Plaintiffs to proceed solely on this more narrowly defined overarching conspiracy because the Plaintiffs included allegations that Defendants did not “jump” each other’s proprietary deals in the Fifth Amended Complaint and argued in response to the present motions that the evidence supported these allegations. Furthermore, the Court concludes that a more limited overarching conspiracy to refrain from “jumping” each other’s proprietary deals constitutes “a continuing agreement, understanding, and conspiracy in restraint of trade to allocate the market for and artificially fix, maintain, or stabilize prices of securities in club LBOs” ....

And so he ruled today on a summary judgment motion, getting rid of most of the crackpottery but letting the plaintiffs go forward on the claim that the private equity firms had an agreement not to jump each others' deals after they'd already been signed. A further claim, that the private equity firms specifically had an agreement that no one would jump Bain's and KKR's (signed) deal for HCA, will also go forward.

In some ways this seems like the weakest claim in the case: of course you don't jump already-signed deals! I mean unless you're Carl Icahn or whatever. But in general: a company shouldn't agree to an LBO unless it's fairly confident that it got the best available deal. And in exchange for that confidence - in the form of a high price - the buyer expects, and normally gets, fairly significant deal protections, including a limited go-shop period, matching rights in the event of a topping bid, and a break-up fee if it ultimately loses to another bidder. So an interloper faces the prospect of a time-constrained diligence process and an auction where the incumbent buyer can always top the interloper by a penny, and where the incumbent is bidding with - sometimes - hundreds of millions of dollars in free money due to the breakup fee.1 Not a good place to be.

So if you want to buy a company, you should try to buy it before it signs a merger agreement with someone else. (Similarly if you want to buy a house you should buy it before it's in contract with someone else, etc.: this is not an unusual concept.) Sometimes this is easy: lots of companies - including many of those mentioned in the lawsuit - run auctions, and you bid in the auction, and if you win you win, and if you lose you don't try to bid again after the deal is signed, that's nuts. Sometimes it's harder, particularly when management is involved: HCA, for instance (like Dell), was a negotiated deal, and no private equity firm outside the consortium got to bid until the go-shop period.2 Still even there it could be quite sensible to just say "oh well, we'll get 'em next time."

But the evidence, like I said, is mixed. I take these to be good quotes for the defense:

On July 28, 2006, Joseph Baratta of Blackstone in Europe emailed Neil Simpkins of Blackstone asking about HCA. Mr. Simpkins responded that “the reason we didn’t go forward was basically a decision on not jumping someone elses deal and creating rjr 2 with us as kkr . . . .” ... In response to their decision not to pursue HCA, a Blackstone executive wrote that “Pags [Pagliuca of Bain] probably will be able to steal the company.” On July 27, 2006, another Blackstone executive wrote, “[a]fter some soul searching, we decided wisdom was better part of valour and passed on hca. . . . charlie was right; we are a bunch of p**s*es — I am on plane and will call you both with the rationale although it still drives me crazy.”

"We don't want to get into an RJR-style bidding war" and "we are pussies" are perfectly legitimate reasons not to get in a bidding war, though I would love if Steve Schwarzman had to get on the stand and testify "oh yeah we didn't bid on that deal because we're pussies." On the other hand this is not so hot:

In September, 2006, a consortium of Blackstone, Carlyle, TPG, and Permira were negotiating the buyout of Freescale. On September 10, 2006, KKR, Silver Lake, Bain, and Apax Partners Worldwide delivered to Freescale’s board an unsolicited written indication of interest to acquire Freescale.

The next day, Blackstone, in apparent retaliation, immediately contemplated a bid to buy HCA at $55 per share. The following day, September 12, 2006, a proposed buying consortium of Blackstone, TPG, Carlyle and Permira was considering HCA. The same day, Tony James of Blackstone called George Roberts of KKR to say Blackstone signed a confidentiality agreement on HCA.

On September 15, 2006, KKR immediately withdrew its interest in Freescale. ... [O]n September 16, 2006, Carlyle confirmed that Blackstone had already “dropped HCA.”

On September 16, 2006, after learning that KKR had decided to withdraw from Freescale, a Goldman Sachs executive observed “club etiquette prevails . . . .”

The judge cites the "club etiquette prevails" line in his decision to allow the no-deal-jumping claims to go forward; the tit-for-tat deal-jumping and deal-un-jumping is also pretty suspicious.

So will the plaintiffs win? Meh, they kind of have, no? Here's Reuters:

"From the plaintiffs' perspective, this was a good day," said Christopher Burke, a partner at Scott & Scott representing the shareholders, in a phone interview.

"This remains a multibillion dollar case, and that is going forward," Burke added. "What was written by some defendants in their papers, and by some of the press, that what we had was 'thin gruel' has been dispelled."

The key words here are "multibillion dollar case." The private equity firms each get one more shot at summary judgment on the bid-jumping claims - the judge today denied an "omnibus motion" for summary judgment for all of them, but now they can each ask to get out of the case. Still it seems increasingly unlikely that they'll get rid of this case without a trial - or a settlement. And it's a little scary to take a multibillion dollar case to trial, especially if it involves defending the practices of the private equity industry.

Dahl et al. v. Bain Capital Partners, LLC et al. [D. Mass.]
Judge narrows private equity collusion lawsuit [Reuters]
Judge: Private equity conspiracy case can (sort of) proceed [Fortune]
[Update:Dealpolitik: Time to Settle in Private Equity Clubbing Litigation? (Deal Journal)]

1.Because the incumbent pays 100% of whatever it bids for the company, while the interloper pays 97% for the company and 3% for the breakup fee, so it costs it more to bid the same amount. (This is not especially rigorous - the incumbent really should be thinking about the opportunity cost of losing the breakup fee too - but, still.)

2.One annoyance of this decision is that it rescues boards who didn't do auctions and relied too heavily on go-shops. You can't just sign the first deal you get, with a big breakup fee, and figure you'll do a market check during the go-shop period. That's dumb! It's dumb because of the breakup fee, and the matching rights, and the general annoyingness of coming into a deal during the go-shop, and also maybe because of private equity collusion I don't know. You should either run an auction, or else have a good reason to believe that the solo deal you negotiated is the best you can get. If you didn't do that, you shouldn't get a second bite at the apple in court a decade later.