Glossary of Hostile Takeover Terms with Discussion

General Thoughts on the Courtrooms Dramas

Hi everyone:

Since I have a handful of questions regarding the various courtroom decisions -- none thus far on any merits, just on timing issues -- and the sense, in the media and CafePharma, that momentum is with Valeant; I thought I'd try to bring in some perspective.

The first thing to keep in mind is that the courtroom matters are the side show -- in my earlier posts, I referred to these and other side shows as a "soft power" (important, in that they keep the other side distracted, but won't win by themselves). The courts won't stop a deal that the shareholders want. And, even if they stopped this deal cold, what about the next guy who will come along and offer to buy Allergan for more than it's trading share price -- to be likewise financed through the wholesale liquidation of R&D? That next guy will be smarter than to have the shady financial statements of Valeant and possible Insider Trading of PS.

This battle will be won or lost through Hard Powers -- the ability to leverage the balance sheet to the benefit of shareholders. Allergan has a huge advantage over Valeant: The Valeant offer will give Allergan shareholders about $0.44 out of every $1.00 of value creation (since Allergan shareholders will own 44% of the combined company). If Allergan creates as little as half the value Valeant is promising, it will have a better value proposition (the recent restructuring is already about halfway to that target). There are many ways to get there without killing the best R&D: Acquisitions, spin-offs, further restructuring, sale of the company, management buyouts, special dividends, shares buybacks, and so on (some of these only work in combinations with others). My favorite, that no one has yet said a word about, is management buyout; but from the media it would seem that acquisition is the path being most explored.


But, since the courtroom dramas are currently in the headlines, here is my play-by-play take:

The DE Chancery Court: This court is being asked to adjudicate a dispute between shareholders (not all shareholders, or even a majority, to be sure; but 31% is too many to be dismissed) and the board of directors. Ultimately, they have to rule in favor of the shareholders -- the shareholders are, after all, the owners of the company and the Board is the servant of the shareholders. The main argument that the Board can use in this court is that some shareholders (those who do not want the deal), whether they are a majority or a sizable minority, are at risk of being disenfranchised by those who do, by having the deal railroaded upon them before the Board had a chance to find a potentially superior alternative to the Valeant offer. This argument is the justification as to why Poison Pills (see glossary entry) are legal in the first place. The counter argument is that 6-8 months (the time between when the Valeant offer was first publicized and the special meeting), should already enough time for the Board to find alternatives, and any further delay, with no such superior option identified, is for it's own sake and not to the benefit of any shareholder.
I expect that the court will take the view that there is no reasonable justification to keep the shareholders from holding a special meeting -- and let the chips (in such meeting) fall where they may. They might even accept PS argument that the meeting should be hurried (to keep the Board from placing the Valeant offer at risk in the absence of a superior alternative). The court might also rule that any deal (such as an acquisition) that has the effect of pushing Valeant away, should also be voted on by the shareholders (heck, if it's such a great deal, even better than the Valeant offer, the court will agree with PS, the Board shouldn't be afraid to put it to the shareholders to vote). One thing the Chancery Court won't consider is the matter of Insider Trading. That question is in the Federal Court, and until there is a ruling in that matter to the contrary, the DE court will consider all of Ackman's shares kosher. (However, any decision by the Federal Court to neutralize Ackman's shares will be respected by the DE Chancery Court -- likely shifting the balance of power drastically).

The Federal Court: This is where Allergan will get a friendlier audience. By agreeing to take the case and by using language such as "serious allegation," the court is implying that they see some meat to the Insider Trading claim. As this is unexplored legal territory, I won't handicap their merit decision; just mechanics. This court will try, for as long as possible, to find excuses not to make any decision (or even work on an expedited basis), because it would not want to set precedents (what you inevitably do when working in uncharted legal territory) and risk being overruled on appeal. The Federal court, with each expedition denial, will re-invite Allergan to come back if further steps are taken toward PS gaining control of the company. As far as the Federal Court, if it really wants to max out the temporizing game, is concerned; scheduling, and even holding, the Special Meeting are all reversible steps (they can, even retroactively, declare PS shares not to count in any vote -- even after the vote is held). The eventuality that would most motivate it to rule, would be the possibility that PS will gain control of the Board and moot justice to the victims (by stopping the suit) without having first been cleared. If the Federal court hits PS with any sort of injunctions at any prior step, then that would be an indication that they are leaning in the direction of ruling for Allergan on the merits.

The bottom line: I think Allergan Board and management need to make their Hard Power move now. Time is beginning to run short!

Dan.

 

Valeant shares are doomed, but the company will still have a smidgen of life.

The acquisitions they made can not pay for themselves. Too much value was destroyed in the process. While there is enough value left in the acquired companies to pay off the debt holders (the lenders have been very careful to lend no more than Valeant can pay off), the shareholders will be left with pennies on the dollar for their investment.

If Valeant stopped acquiring now, and simply started paying off their debt from existing business profits, they will, just barely, be able to pay their debt down slightly faster than the rate of decline in the business. But with no financial resources available to making any investments (in either R&D or market development), by the time Valeant finishes paying the debt down, what will be left of their book of business will be a shadow of it's current self, and, correspondingly, their share value will be a fraction of today's valuation.

The original offer for Allergan (with $48 cash) had the opportunity to give Valeant a bit of breathing room. With the deal, Valeant would have been a bit more credit worthy than it is now (since it would be adding more revenues than debt load). Under the hypothetical scenario where Allergan accepted the initial Valeant offer and then Valeant stopped acquiring any further; the same debt pay down process would have left Valeant in a financially better shape than the no-more-acquisitions scenario described above. The post-debt-pay-down Valeant share would still be worth a fraction of today's stratospheric valuation (relative to earnings and debt load), but a bigger fraction.

Under the current offer for Allergan (with $72 cash), Valeant is essentially back in the same boat it is currently: With both earnings and debt load higher, but maintaining their present edge-of-the-abyss ratio.

As it is hard to see how Valeant can make another acquisition that will dwarf this one (like this one dwarfs B+L, B+L dwarfed Medici, and Medici dwarfed all the prior ones) -- there just aren't that many companies that dwarf Allergan -- it is fair to assume that this would be the last material acquisition. Whether MP likes it or not, after Allergan (or, for that matter, after failing to acquire Allergan and realizing that there are no easy $50B targets available), the future of Valeant is to start unwinding it's debt. This will either be through methodical pay down, controlled spin outs, or chaotic bankruptcy proceedings.

Dan.

 

The DE court has near total authority with regards to corporate governance. It generally chooses to exercise this power sparingly, but if the judge feels that a board is entrenched and is disregarding the shareholders, it may choose to be more proactive. Forcing the meeting sooner is a distinct possibility -- but by no means a forgone conclusion. Valeant is hoping for anything that will speed things up, every day that passes their case weakens and Allergan's options grow.

Dan.

 

Valeant, no; it has no standing to dictate anything to Allergan -- making a bid for someone doesn't give you a right to tell them how to run their business and have the courts enforce it.

PS, is another matter -- it's a major shareholder. Ackman stated that if Allergan tries to make a major acquisition he'll sue. However, this was before he was himself sued (and SEC-investigated) for Insider Trading, where his defense is that he is a co-bidder. If he is a co-bidder, he is in the same boat as Valeant. Maybe he can find some creative legal gymnastics that somehow makes him both (we are in uncharted legal territory, as I do not tire of saying), but the courts would want to clear that before giving him any rights to interfere with Allergan's business.

While a judge can block a defensive transaction, it's a high barrier. Unless proven to the contrary, Boards operating within the Bylaws are presumed to act in the best interest of shareholders, and a judge would loath to substitute their own judgement for that of the Board. Whether Ackman can prove to the DE courts that this Board is no longer acting in the interest of the shareholders remains to be seen. So far, twice, he was able to convince the court that there was need for expediting; but there has yet to be any rulings on the merits of any issue.

Dan.

 

The date of record is not particularly meaningful. It's just bookkeeping mechanics. In practice, except for very unusual transactions, whenever someone sells a share, the right to vote the share is sold along with the share. Ownership at the time of the vote (which is the date of special meeting) is what counts. The proxy mechanisms, deep in the back offices of the brokerage firms, assure that the contemporaneous owners are the ones actually voting.

I think Allergan needs to make their hard power move now. The closer we get to the Special Meeting, the more likely a judge will rule that the move, whatever it is, should not be used to prejudge the outcome of the meeting without a shareholder vote.

The Special Meeting can only remove, not appoint, directors. The remaining directors, if they wish, can go ahead and immediately re-appoint the removed directors (sounds silly, I know). Only the Chancery Court can, and may well do, force the Board to appoint the Ackman slate. Normally, I would have said that there is a bit of a delay tactic opportunity at that point; but this judge seems to be very quick to approve expedite requests from Ackman, so I don't think there is much delay available here.

Dan.