Terra Firma Gets Second Chance To Prove It Only Bid For EMI Because It Thought Everyone Else Would Too

Author:
Publish date:
Updated on

Fundamentally if you're a sell-side M&A banker your job is to find a buyer and get them to overpay for the company you're selling. I mean, oh, you know, you're a repeat player and reputational concerns and continued business relationships and all that militate against getting them to overpay too much. But mostly, the more they overpay the better you've served your client. Also, though, those reputational things etc., plus lots of fraud laws, militate against getting buyers to overpay by deceiving them about stuff relating to the company you're selling. You can't, like, just go forge financial statements. That's cheating, and not in an admiring hahaha-you-got-me way. In a jail way.

So what's left? One thing you can do is gently deceive them about the competitive dynamic. This might seem a little silly - if you're buying a company, shouldn't you be carefully determining its fundamental value rather than just bidding a penny more than whoever else is in the auction? - but in fact a lot of the M&A function is pretty much exactly that. You set up an auction, you demand confidentiality, you forbid bidders from talking to each other, you don't tell them each others' bids, you don't announce to the world when a bidder has dropped out, all with the goal of creating the appearance of more competition than there is. When the bidders share too much information about their bidding plans with each other, you sue them. If a possibly viable but spivvy bidder comes along, you encourage them to stick around and throw out big numbers, just to keep the other bidders on their toes. "Yes, Carl Icahn, please, tell us more about your plans to buy our company," is a sentence you might find yourself saying. You don't outright lie, but you do your best to create the impression that your particular fertilizer-byproducts company is the prettiest girl at the dance or whatever the going metaphor is.

Or just do this:

Wormsley allegedly made numerous statements that caused Terra Firma to bid more than necessary in order to acquire it. Specifically, on May 18 and twice on May 20, 2007, Wormsley allegedly informed Hands that Cerberus was bidding 262 pence per share for EMI Group and that Terra Firma would have to exceed that bid to win the auction. Wormsley also allegedly knew that Cerberus had pulled out of the auction as of May 19.17

Allegedly! As alleged by Guy Hands, founder of Terra Firma Capital Partners, which agreed to buy EMI Group for 265 pence the next day, May 21, 2007, rushed into the deal by Cerberus's fictitious competition. On the other hand, David Wormsley, the Citi banker who arranged the financing for the LBO,1"testified that he didn’t remember the specifics of any of the conversations, [and] told jurors he never lied to Hands about the auction." Though one imagines that he didn't, like, call up Hands to let him know as soon as Cerberus dropped out, and that if Hands said "oh I'm worried about Cerberus outbidding me" Wormsley didn't exactly rush to reassure him. You gotta keep up the fiction. Speaking of which, here's how EMI announced the deal:

"The EMI board received a number of proposals from several different parties," EMI Chairman John Gildersleeve said in the statement. "Terra Firma's offer is the most attractive proposal received and delivers cash now, without regulatory uncertainty and with the minimum of operational risk to the company."

Terra Firma's offer was the most attractive in that, unlike the other proposals, it:

  • delivered cash now,
  • had no regulatory uncertainty,
  • created a minimum of operational risk, and
  • existed.2

Anyway Terra Firma sued over those disputed phone calls, and Citi won at trial two and a half years ago, presumably because the jury believed Wormsley over Hands. But Hands will get another go because today the Second Circuit reversed on honestly some staggeringly boring conflict of laws points. Mazel tov David Boies, who argued the case for Hands, but that's all we're going to say about that. The new trial, other than some slight changes in the jury instructions, should be the same as the old one; as the court of appeals put it "The basic conflict in this case is of the he-said-she-said variety," though I'm not sure which of Wormsley and Hands gets to be the "she" here.

But it'll still be sort of fun. This case reminds me a little of Jesse Litvak, my favorite former Jefferies bond trader, who made some incremental, possibly criminal, innovations in bond dealing like so:

  • Old method: moan to your customer and imply that you can't afford to sell at these levels, he's getting a great deal, you're losing money on the trade, your trader will kill you, your manager will fire you, your wife will divorce you, etc., without actually lying about the price you paid for the bonds you're selling.
  • New method: same, but with the actual lying.

Similarly, the proper method of conducting an M&A auction with one bidder is to create the sense - through secrecy, indirection, body language, tone of voice, procedures, hints, knowing looks, but not actual lies - that there are a bunch of other highly competitive bidders.3 The improper method is to be like "oh Cerberus is bidding 262 and you need to beat that." I dunno, those things are pretty close. You can understand why Hands might remember it one way and Wormsley another.

Terra Firma Investments (GP) 2 Limited v. Citigroup Inc. [2d Cir.]
Terra Firma Gets New Trial in Citi Suit Over EMI Deal [WSJ / Moneybeat]

1.Oh, yeah: Citi both advised EMI and "provided $4.8 billion in loans to finance the EMI acquisition." People often criticize "stapled" financing like this for any number of reasons, mostly conflicts-related - it gives the seller's advisors incentives to favor a private equity bidder, and even more than just regular deal fees it incentivizes them to get a deal done even if it's not great for the seller so they can earn the financing fees. (You could paint both pictures here: "Warner Music offered 260 pence a share in March, a bid EMI said at the time was 'inadequate,'" only to accept a 2% higher offer from a private equity firm two months later.) On the other hand! By overpaying and over-borrowing, Hand lost control of EMI to Citi. Which possibility maybe gave them some price-maximizing incentives.

2.Gildersleeve seems to have been very artfully referring to a previous offer from Warner Music, as well as to sniffs of interest from One Equity Partners, Permira and Cerberus. But there were no other live bids when EMI accepted Terra Firma's.

3.Btw the other proper thing to do, at least in American deals, is to have an "integration clause" in the merger agreement saying "never mind what we said on the phone, the only stuff you can sue us over is what's in this agreement." Since the merger agreement will never contain a rep like "a bunch of other people wanted to buy this company," that should absolve you of any half-truths you may have dropped during the auction process.

Related

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: