A rise in corporate bankruptcies, as well as the pressure felt by companies not in bankruptcy to rid themselves of non-core assets, are expected to result in an increase in private equity opportunities for investment in bankruptcy sales and corporate divestitures. Because management and operational problems typically accompany the financial difficulties experienced by such companies, investments in these companies are difficult to analyze. Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. A bankrupt company, the “debtor,” might use Chapter 11 of the Bankruptcy Code to reorganize its business and try to become profitable again. Management continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court. Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to liquidate (sell) the company’s assets and the money is used to pay off the debt, which may include debts to creditors and investors. The investors who take the least risk are paid first. For example, secured creditors take less risk because the credit that they extend is usually backed by collateral, such as a mortgage or other assets of the company. They know they will get paid first if the company declares bankruptcy. Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment. The bankruptcy court may determine that stockholders don’t get anything because the debtor is insolvent – debtor’s solvency is determined by the difference between the value of its assets and its liabilities. Most publicly-held companies will file under Chapter 11 rather than Chapter 7 because they can still run their business and control the bankruptcy process. Chapter 11 provides a process for rehabilitating the company’s faltering business. Sometimes the company successfully works out a plan to return to profitability; sometimes, in the end, it liquidates. Under Chapter 11 reorganization, a company usually keeps doing business and its stock and bonds may continue to trade in securities markets. The U.S. Trustee, the bankruptcy arm of the Justice Department, will appoint one or more committees to represent the interests of creditors and stockholders in working with the company to develop a plan of reorganization to get out of debt. The plan must be accepted by the creditors, bondholders, and stockholders, and confirmed by the court. However, even if creditors or stockholders vote to reject the plan, the court can disregard the vote and still confirm the plan if it finds that the plan treats creditors and stockholders fairly.
ActiveAllocator Research- An excellent Forbes article points out that the M&A environment has radically altered in the coronacrisis. Among other things, pandemic induced uncertainty increases negotiation period, surfaces newer due diligence issues as well as increases effort to obtain third-party consents. It also delays antitrust and regulatory approvals, makes buyers and their boards of directors much more cautious, shifts more closing risk and indemnity risk to sellers, brings added risks of “buyer’s remorse” and above all raises valuations concerns.
We recommend a collar to hedge the time to closing risk and point out the advantages and disadvantages of fixed vs. floating ratio hedges.
As coronacrisis progresses expect companies to separate portions of business. Such actions will be typically driven by strategic decisions to divest businesses and/or valuation creation opportunities. Often there is a valuation drag on due to ownership of lower valuation businesses. Spin-offs often have potential for shareholder value creation when investors have higher valuation expectations of the new separate public company.
I illustrate a variant of the M&A collar through a floating exchange ratio. This is rather atypical but I have encountered it in the past. Here, issues differ from a fixed exchange ratio giving rise to multiple possible events at end points. There are many ways one can prepare for this including : (i) Terminate / Walk Away (ii) Renegotiate Exchange Ratio (iii) Pre-signing Agreement to Accept Fixed Exchange Ratio (iv) Possible Cash Top-Up
Given heightened market uncertainty, volatility in share prices, a cloudy outlook it is now important to hedge time period to closing risk in M&A deals. We recommend that a collar around announced deals is especially useful.
If acquiror share prices fall or rise beyond a certain point, the transaction switches to a floating exchange ratio. Collar establishes the minimum and maximum prices that will be paid per target share. Above the maximum target price level, increases in the acquiror share price will result in a decreasing exchange ratio (fewer acquiror shares issued). Below the minimum target price level, decreases in the acquiror share price will result in an increasing exchange ratio (more acquiror shares issued).
Proposed Uber Grubhub M&A lends itself to be a game theory case where the acquiror (Uber) and target (Grubhub) share holders have opposite interests in pricing – i.e. how to get the acquiror and the target to agree on a price at which the acquirer can purchase the target. Locking in a floor and cap brings benefits to both parties.
ActiveAllocator Opinion – I profoundly disagree with U.S. Rep. David Cicilline, D-R.I., who chairs the House’s antitrust subcommittee, and has come out in opposition of the Uber Grubhub deal. In a statement, he described it as ” marks a new low in pandemic profiteering”. I compare the pros and cons of fixed price (number of shares issued varies depending on acquiror’s stock price changes) and fixed exchange ratio (constant number of shares issued, value delivered changes). The Uber offer is a fixed exchange ratio and show in this visual that in my opinion Grubhub investors interests are well served. This is not pandemic profiteering!
Uber recently approached Grubhub with a potential all-stock takeover bid. Apparently it is structured as a Fixed Exchange Ratio (Floating Price)offer. This suggests Uber does not expect stock price to rise during the time it takes to consummate the merger. In public market M&A transactions, where at least part of the consideration is stock of the acquiror public company, the value offered is subject to market risk as the acquiror’s stock price changes. A visual illustrates.
We build on our M&A series by drawing attention to changes in US regulatory environment for foreign deals in the Trump presidency. The national security landscape has shifted in recent years, and so has the nature of the investments that pose the greatest potential risk to national security. Recent amendments to the Committee on Foreign Investment in the United States (CFIUS) process now brings significant hurdles to foreign investment in ‘sensitive’ sectors. The Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) was signed into law after receiving broad bipartisan support in Congress and new regulations are expected. We provide historical context, highlight recent evolution and provide color on consummating such transactions.
COVID-19 stimulus proposals has revived the stock buyback debate. A week later Congress continues to remain locked ( as of 3/23/2020, 8 AM EST) in acrimonious debate on details of a proposed trillion-dollar stimulus package; meanwhile these funds are critical and urgently needed. The contentious issues being prohibiting excess executive compensation and restricting corporate bailout capital injection from being used for shares buyback. While the former is intuitively obvious, the effects of the latter less so.
I support the push for a ban on share buybacks as a condition of any financial assistance. To bring clarity, we explain how share repurchases will be an egregious transfer of economic rents from the US tax payer to corporate shareholders without benefiting the economy in this visual.
As the coronavirus pandemic continues to mercilessly unfold, I recommend that large companies recognize and immediately act on significant business risks and stifled growth prospects in the months ahead. To not do so would be willful blindness. Top management in all publicly listed firms now needs to pay special attention to funding and capital structure issues, to ensure adequate liquidity, to manage cash properly and improve capital productivity. Firms should creatively avail of the spectrum of available financing options. To catalyze creative thought, I present these along with their pros and cons in a visual here.
ActiveAllocator, aside from organic growth, seeks to have a dialog with established firms ready for M&A. We intend to spin off a portion of our business in 2021. My co-founder and me have done around $40 billion M&A, allocated to activist and private investments and share attached our thoughts on a potential carve out of our business to socialize a prelim conversation. Please get in touch if you see this as something you can bring value to or have friends who may want to work with us. Contact me for our deck on spin-offs
ActiveAllocator is unique in that it saddles the public policy , private investments and investing banking space. We have advised international Governments and are pleased to share our views on privatization; here we explain why governments privatize assets, suggest best practices, opine on key considerations for successful sale, present the larger institutional framework, highlight global privatization trends, PPP/PFI and sale structure alternatives. We applaud the Modi Govt’s courageous decision today to divest Air India, India’s national carrier lock stock and barrel! Hopefully the first of many more privatizations to come!
ActiveAllocator is pleased to share with you our research piece on “Management Compensation, Retention, Severance in Private Equity Leveraged BuyOut “. Gleaned from our own experience across over $40 billion in M&A, poring over scores of SEC filings, and our private investment diligence credentials we bring visibility to a topic long shrouded in secrecy. Our deck sheds light on why the average CEO pay is 271 times the nearly annual average pay of the typical American worker, why select normal senior executives become extra ordinarily wealthy during certain corporate events, and other subjects of conversation. We describe the main components of compensation, the general features of equity retention and severance arrangements and employment contracts, and conclude with a few case studies to illustrate calculations.
Institutional investors running deep pools of capital moving to in-house management, now increasingly do club and direct deals outside allocating to traditional private equity fund sponsors. They compete and win and also outperform co-investments. The ones who do, usually have excellent in house talent, access to deals etc. But what exactly is a deal? How do you buy a company? The actual process has long been shrouded in secrecy and practitioner jargon. Having done +$40 billion in M&A, seen and evaluated hundreds of buy offers, having sold portfolios of assets and companies, we bring sunlight to the ‘investment banking’ buy space.
#ActiveAllocator is pleased to share with you our latest research piece ” Event Driven Hedge Funds – Share Buyback”. Event Driven hedge funds exploit pricing inefficiency before, during or after corporate events. Episodes of shares buyback or around dividends announcement are a potential source of alpha. We explain the capital redistribution framework and illustrate the mechanism of a tender offer to provide color.
ActiveAllocator summarizes the imminent Aramco IPO- soon to become the world’s most valuable company. We touch upon the offering, the firm’s vision, status, synergies between its upstream-downstream business, competitive strengths, risks to investing and general prospects.
Disclosure: Inputs sourced from internet searches, offering docs, conversations. Shares are not offered in the USA and some other countries. This is not an offer to sell or a solicitation of any offer to sell any securities.