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MA Update

• Bowne/PLI Securities Law Update
• December 11, 2006
• Nicole E. Clark

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• This presentation is for general informational
  purposes and does not constitute legal advice.

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MA Update

• Hedge fund activism
• Private equity club deals
• Go-shop provisions
• Tender offer best-price rules

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Hedge fund activism

• Now, instead of being called a corporate raider,
  Im an activist.
• Carl Icahn

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Hedge fund activism

• From Raiders to Activists
• 1980s
• Takeover boom
• Emergence of junk bond market for MA finance
• Corporate America mobilizes to repel corporate
  raiders
• Creation of poison pill and rise of takeover
  defenses
• Late 80s market bust
• 1990s
• Demise of cash bids and hostile deals
• Era of all-stock deals, synergy claims and MOEs
• Emergence of corporate governance activism
• Anti poison pill resolutions
• Antagonism to takeover defenses spreads among
  institutional holders

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Hedge fund activism

• From Raiders to Activists
• Today
• Continued corporate governance activism
• Continued success of anti-poison pill and board
  declassification proposals
• Majority voting proposals
• Hedge Funds emerge as the new MA sharks
• Marty Lipton, renowned adviser to corporate
  boards and veteran of the takeover wars of the
  1980s, lists attacks by hedge funds as the
  number one key issue for directors

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Hedge fund activism

• The Hedge Fund Market
• Over 8,000 hedge funds manage in excess of 1.2
  trillion in assets
• In 1990, approximately 500 hedge funds managed
  less than 40 billion in assets
• More money, but fewer opportunities for outsized
  returns
• Intrigued by MA and activism opportunities
• Hedge funds are largely unregulated
• Recent attempts by the SEC to increase regulation
  have been thwarted (See Goldstein v. SEC, 2006 WL
  1715766 (D.C. Cir. June 23, 2006))
• Future of hedge fund regulation uncertain (SEC
  currently mulling its options)

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Hedge fund activism

• General objective is to increase share value
  quickly
• Primary focuses of hedge fund activism
• Changes in governance or financial policy
• Change in business strategy
• Stock buyback or payment of dividends
• Force divestitures
• Changes in Board/management
• Opposition of overvalued MA deals on the
  acquiror side
• Push for better terms in MA deals on the target
  side
• Takeovers (convergence with private equity)

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Hedge fund activism Tactics
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Hedge fund activism Success

• In 2005, the Altman Group tracked 20 instances of
  shareholder activism involving hedge funds and in
  15 of those cases the target company conceded or
  was forced to accept to some degree the demands
  of the dissident shareholder.
• Hedge funds often enjoy support from ISS and
  institutional stockholders.
• Whether this success has generated long-term
  economic improvement is debatable.
• Excluding activism surrounding the successful
  sale of a company, it is not clear that hedge
  fund activism has resulted in significant
  long-term value creation for other stockholders.

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Hedge fund activism Concerns for the target and
its stockholders

• Conflicts of interest
• The hedge fund may face conflicts if it is
  bidding to acquire the company
• The hedge fund may face conflicts as a result of
  its ownership interest in multiple parties to a
  proposed transaction, particularly as a result of
  the derivative nature of interests held
• Short-term focus
• Performance fees and other management incentives
• Use of derivatives (e.g., vote buying)

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Hedge fund activism Characteristics of
potential hedge fund targets

• Small to mid-cap company
• Median market cap of targeted companies in
  2004-2005 was approximately 780 million
  according to 9/05 Citigroup study
• Substantial pool of cash
• Debt capacity
• Undervalued assets, such as real estate
• Underperformance relative to peers

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Hedge fund activism Preventing and defending
against attacks

• Investor Relations
• Monitor Investor Base

• Be proactive
• Maintain regular contact with institutional
  investors (but be wary of Reg FD concerns)
• Monitor analyst and media reports
• Anticipate and respond to questions about
  performance and other concerns
• Review shareholder list and trading activity
• Review Schedule 13D/G filings and Section 16
  filings
• Monitor HSR filings

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Hedge fund activism Preventing and defending
against attacks (cont.)

• Inform the Board
• Company Defenses

• Regular updates on company strategy and
  operations and on the industry
• Review dividend policy and capital structure
• Review defensive mechanisms
• Staggered board
• Poison pill
• State business combination statutes
• Written consent thresholds
• Special meeting provisions (e.g., advance notice
  provisions in by-laws)
• Special voting stock

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Hedge fund activism Preventing and defending
against attacks (cont.)

• Company responses to hedge fund approach
• No duty to discuss, though the company may want
  to listen
• No duty to disclose (unless leak from within),
  though disclosure may be advisable
• If no confidentiality agreement is signed (which
  likely will be the case), do not share material
  non-public information
• Keep the Board informed
• Consider litigation
• 13D/G filing requirements
• Section 16 filing and profit disgorgement
  requirements
• Group status considerations
• HSR filing requirements for investments in excess
  of 56 million if the purpose is for control

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MA Update

• Hedge fund activism
• Private equity club deals
• Go-shop provisions
• Tender offer best-price rules

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Private equity club deals

• 2006 is Year of the Deal according to Forbes
• Biggest year ever for global MA, with deal
  volume soaring to 3.4 trillion (beats previous
  record of 3.3 trillion set in 2000)
• This years biggest theme is the leveraged buyout
• Nine LBOs topping the 10 billion mark(compared
  to three in 2005 and none in 2000)
• Two Biggest LBO deals to date (eclipsing KKRs
  LBO of RJR Nabisco)
• 11/06 33 billion LBO of HCA by Bain, KKR and
  Merrill Lynch
• 11/06 announced 36 billion LBO of Equity Office
  by Blackstone

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Private equity club deals Dramatic growth in
U.S. private equity funds
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Private equity club deals

• Two or more private equity funds join together to
  purchase a company
• Club deals have become increasingly prevalent in
  the MA market

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Private equity club deals 2006 private equity
club deals over 10 billion
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Private equity club deals Reasons underlying
growth in club deals

• Deal Size
• Company sizes are increasing
• Average SP 500 market cap grew from 9 billion
  in 1995 to 21 billion in 2005
• Increase in competition for mid-size deals has
  driven increased interest for large deals
• Sharing of risks and burdens
• Private equity funds generally have internal
  limits on investments in any single transaction
• Share costs of due diligence and failed deals
• Access to Financing
• Pool relationships with financing resources
• Pooling Expertise
• Industry expertise
• Knowledge of local or foreign market

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Private equity club deals Sell-side issues in
club deals

• Balancing a need for consortiums to form in order
  to achieve necessary scale against a diminution
  in the number of bidders and increased deal
  uncertainty
• Use of confidentiality agreement to manage the
  process
• Standstill
• Restrictions on equity partnering without target
  consent
• Restrictions on debt financing lock-up
• Buyer group may seek several (and not joint and
  several) liability amongst buyer group for
  breaches

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Private equity club deals Buy-side issues in
club deals

• Policing entry and exit of consortium members
  before a deal is signed
• Governance
• Need to balance consensus against hold up value
• Allocation of board seats
• Exit strategies
• Club deals have not yet weathered a high-profile
  failure

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Private equity club deals Financing outs and
reverse termination fees

• Background
• Large private equity deals historically had
  financing outs
• Merger agreement and shell company acquisition
  sub designed to insulate buy-out group from
  liability
• Sponsors sought to have buyers rely on their
  track record
• Over time, use of equity commitment letters
  increased

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Private equity club deals Financing outs and
reverse termination fees (cont.)

• Standard financing condition vs. reverse
  termination fee approach
• There have been limited (SunGard) or no (Neiman
  Marcus, Hertz) financing conditions in certain
  large club deals
• Transaction agreement provides for an agreed upon
  marketing period for obtaining financing
• If financing not obtained, a reverse termination
  fee (often equal to the break-up fee) is payable
  by the buyer and guaranteed by the private equity
  funds (on a several basis). In certain
  transactions, a higher fee is payable if the
  buyer is otherwise in breach.
• Reverse termination fee serves as a cap on
  damages well below the amount of the sponsors
  equity commitment

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Private equity club deals Financing outs and
reverse termination fees (cont.)
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Private equity club deals Financing outs and
reverse termination fees (cont.)

• Issues
• Cannot divorce the willingness of private equity
  firms to contemplate limitations on financing
  conditions from the availability of very tight
  financing commitments
• If financing commitments fully cover all debt
  financing (including a bridge for the high yield)
  and have no incremental conditionality, is the
  removal of the financing condition in tandem with
  a liability cap more favorable to sellers or
  buyers?

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MA Update

• Hedge fund activism
• Private equity club deals
• Go-shop provisions
• Tender offer best-price rules

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Go-shop provisions

• What is a Go-Shop provision?
• A Go-Shop is a provision in a merger agreement
  involving a change of control that permits a
  target to solicit competing bids for a specified
  period of time following the signing of the
  merger agreement.
• A go-shop provision is typically negotiated
  between the parties as protection for a target
  board subject to Revlon duties when the target
  has not engaged in a pre-signing auction.

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Go-shop provisions

• A no-shop provision, in contrast, typically
  permits a target to receive only unsolicited
  competing offers. A traditional no-shop
  prohibits the target from providing confidential
  information to another bidder or negotiating with
  another bidder unless the competing bidder has
  made a proposal likely to lead to a superior
  deal.
• Typically, though not always, a no-shop provision
  is negotiated following at least some form (even
  limited) of market check.

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Go-shop provisions
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Go-shop provisions
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Go-shop provisions

• Recent Examples of Go-Shop Provisions
• HCA (21.2 billion)
• Freescale Semiconductor (17.6 billion)
• Kerzner International (3.6 billion)
• Maytag (1.1 billion)
• Despite the recent attention they have received,
  go-shop deals remain rare.

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Go-shop provisions

• Maytag
• In May 2005, Maytag announced a 1.13 billion
  definitive merger agreement with Ripplewood, a
  private equity fund.
• Agreement provided for a 30-day go-shop
  provision. During this period, Maytag approached
  more than 100 potential acquirors and received a
  bid from a consortium that included a Chinese
  appliance maker and leading private funds.
  Whirlpool then lobbed in a 1.36 billion offer,
  which ultimately reached 1.7 billion. The
  Whirlpool agreement included a 120 million
  reverse breakup fee payable to Maytag if the deal
  did not receive antitrust clearance on terms
  satisfactory to Whirlpool.

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Go-shop provisions

• Kerzner (Atlantis)
• On March 20, Kerzner International, the owner of
  the Atlantis resort in the Bahamas, announced an
  agreement to be acquired by an investor group for
  3.6 billion. The merger agreement provided for
  a 45-day window-shop period. On May 1, the
  investor group raised its bid from 76.00 to
  81.00 Bahamian dollars in cash, and Kerzner
  agreed to cease the shopping process.

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Go-shop provisions

• Pros
• Accelerated timing (most agreements require that
  the proxy be filed as promptly as practicable)
• Avoidance of potentially disruptive pre-signing
  auction
• Avoidance of leaks
• Increased certainty of deal
• Cons
• The breakup fee may be a deterrent to competing
  bids
• The go-shop period may not be sufficiently long
  enough to allow competing bidders to perform
  adequate diligence and present their highest bid
• Management allegiances
• Open questions remain
• Do go-shop provisions result in increased
  shareholder value?
• Do go-shop provisions deter litigation?

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MA Update

• Hedge fund activism
• Private equity club deals
• Go-shop provisions
• Tender offer best-price rules

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Tender offer best price rules

• SEC adopted amendments to the best price rules
  to clarify that the rules apply only to
  consideration offered and paid for securities
  tendered.
• Effective Date December 8, 2006
• Amendments include
• Change in language of rules
• Exemptions for employment compensation, severance
  or other employee benefit arrangements
• Safe harbor that permits the compensation
  committee or other independent committee to
  approve such arrangements
• Result acquiring companies are more likely to
  consider using tender offers instead of statutory
  mergers that also involve such arrangements

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Tender offer best price rules ?Background

• Before these amendments, the best price rules
  required that the consideration paid to any
  security holder pursuant to the tender offer is
  the highest consideration paid to any other
  security holder during such tender offer
  (emphasis added).
• Source of significant litigation
• Plaintiffs have alleged violations when bidders
  have implemented or assumed employee
  compensation, severance or other employee benefit
  plans in connection with tender offer
  acquisitions
• Additional risk and uncertainty
• Courts have been split between bright line and
  integral part tests

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Tender offer best price rules ?Amendments to the
rules

• Amended language (emphasis added)
• The consideration paid to any security holder
  for securities tendered in the tender offer is
  the highest consideration paid to any other
  security holder for securities tendered in the
  tender offer.
• The SEC believes that the replacement of the
  phrases pursuant to the tender offer and
  during such tender offer with the phrase for
  securities tendered in the tender offer will
  clarify that other arrangements that are not
  payments for tendered securities should not be
  considered.

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Tender offer best price rules ?Exemptions for
compensatory arrangements

• Specific exemption for consideration offered and
  paid pursuant to employment compensation,
  severance and other employee benefit arrangements
  that are entered into with the security holders
  of the subject company.
• Not limited to employees and directors
• Two-part test
• paid or granted as compensation for past services
  performed, future services to be performed, or
  future services to be refrained from performing,
  by the security holder (and matters incidental
  thereto) and
• is not calculated based on the number of
  securities tendered or to be tendered in the
  tender offer.

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Tender offer best price rules ?Safe harbor

• An arrangement will be deemed to be subject to
  the exemption if approved by certain independent
  directors of the subject companys or, in certain
  circumstances, the bidders board of directors.
• Third-party tender offers ?arrangements should
  be approved by
• Compensation committee (or a committee performing
  similar functions) of the subject company or
• If the bidder is a party to the arrangment, the
  compensation committee (or a committee performing
  similar functions) of the bidder.

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Tender offer best price rules ?Safe harbor

• Issuer tender offers ?arrangements should be
  approved by
• Issuers compensation committee (or a committee
  performing similar functions).
• If no compensation (or similar) committee or if
  none of the members are independent, the safe
  harbor allows establishment of a special
  committee of independent directors.

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Tender offer best price rules ?Provisions not
adopted

• Other types of commercial arrangements
• No express exemption
• SEC stated that this does not raise any inference
  that payment under any such other arrangement
  constitutes consideration paid for securities in
  a tender offer

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