Harry Campbell
The private equity firm Blackstone Group has exited the stage for Dell, abruptly bringing down the curtain on a budding takeover contest. It has the elements of a farce, and Dell’s board has no one to blame but itself.
The fizzled bidding for Dell is a result of the board’s extreme reliance on a process known as a go-shop and how it ran the initial sale. If this episode does not change the way companies sell themselves, perhaps it should.
A go-shop is a device that companies started using about a decade ago. The go-shop typically provides that after a deal is announced, the target company shops like Paris Hilton, as a Delaware judge once put it, looking to see if another bidder is willing to compete.
Why would the first bidder allow this?
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The answer lies in its origins. Go-shops were first used in private equity buyouts. The private equity firm would often team with management to make a bid, demanding exclusive negotiations. Boards would agree to this exclusivity but in exchange demand a period of time when alternative bids could be solicited. This way they could be assured that the company was being sold for the highest possible price.
Yet there is also plenty of skepticism about this process. The conventional wisdom is that go-shops are a hollow ritual. The feel-good perception that the company is being actively shopped covers up the fact that the initial bidder has a perhaps unbeatable head start. Once a deal is announced, others don’t have time to catch up, nor do they want to get in a bidding war. A go-shop becomes just a cover-up for a pre-chosen deal.
There is truth to this. At least one study has found that go-shops don’t generally attract higher-valued bids when management and private equity firms are involved. This makes sense. After all, if the original bidding group has management locked up, how is a subsequent bidder going to run the company?
Despite such concerns, the Dell board used both exclusivity and a go-shop in structuring the sale process, although it did add some frills to try to protect shareholders further.
Instead of running an open auction contest at the very beginning, the Dell board negotiated with the private equity firms Silver Lake Partners and Kohlberg Kravis Roberts Company. When K.K.R. dropped out, the board asked TPG to join the process.
But the board focused on only two bidders at a time and didn’t reach out to others. Instead, when Blackstone called about a deal in January, it was left to bid only in the go-shop after it was announced that Michael S. Dell and Silver Lake were offering $13.65 a share to take Dell private.
It is curious that the Dell board adopted the go-shop process so wholeheartedly. Even in the best of circumstances, they are seldom successful. Since 2004 there have been 196 transactions with go-shops in them, according to the research provider FactSet MergerMetrics. In only 6.6 percent of these did another bidder compete during the go-shop period. More than 93 percent of deals with go-shops do not attract competing bids.
You can slot Dell into the overwhelming majority. The Dell board hired Evercore to run the go-shop, and the investment bank contacted 71 parties. Now Dell appears left with only Carl C. Icahn.
It might have turned out differently, if the board had pulled Blackstone fully into the sale process before the announcement of an agreement to sell the company to Silver Lake and Mr. Dell. By failing to include Blackstone — with its growing technology practice that includes a former executive of Dell — from the get-go, it allowed the go-shop process to unfold in the harsh glare of the media.
And when your business is something like a melting ice cube, time matters. A recent International Data Corporation report showed the PC business in a free fall, with United States shipments down 12.7 percent in the first quarter of this year compared with the previous year, and Dell falling behind its competitors. The deterioration in the business was one of the reasons Blackstone decided not to bid.
Hindsight is 20-20, of course. Still, Dell’s board should have known that how it ran the sale would come under harsh scrutiny. Dell’s biggest shareholder outside of Mr. Dell, Southeastern Asset Management, had told the Dell board before the proposed buyout was announced that it would not support a transaction where it could not roll over its shares and that was not in the range of $14 to $15 a share, according to a securities filing. That Southeastern is now heavily protesting this deal is no surprise.
People close to Dell vigorously defend the sale process, calling the go-shop a “success” since it brought Blackstone even this close to bidding.
But Dell’s use of the go-shop now leaves its shareholders with a hollow choice. Silver Lake and Mr. Dell will most likely wait it out, possibly raising their offer a quarter or two at the last minute to win over shareholder holdouts. They certainly have no incentive to do anything before then or to do much more, if even that. And then shareholders will be forced to vote between this deal and taking the risk with a still publicly traded company that Blackstone has now so publicly spurned. It’s really not much of a choice.
Moreover, there will now be furious lobbying by Southeastern and Mr. Icahn to have equity stakes in a newly private Dell rather than take the buyout offer. Southeastern wants to salvage its investment in Dell — its cost basis in the stock is above the current offer price. But it appears the fund has little leverage unless it can persuade these now doubly cowed public shareholders to play a game of chicken with Mr. Dell.
At this point, it is simply speculation whether there could have been a healthy bidding war for Dell. Yet there are lessons here for companies that use go-shops in the future.
The risk that the process leaves shareholders with no real choice is particularly keen when management is involved. Dell’s board went admirably out of its way to secure the cooperation of Mr. Dell with any winning bidder, but even then it appears that he was not so willing to cooperate with Blackstone, as Andrew Ross Sorkin of The New York Times noted in his column.
Running a full auction of a company beforehand when there is leverage to fully secure management’s cooperation appears to be the better course.
In other words, the next time a company says that the price being paid to shareholders will be a good one because they have a go-shop, be wary. And as for directors, when executives from a private equity firm with $51 billion in assets under management comes knocking on your door, you might not want to turn them away.
Article source: http://dealbook.nytimes.com/2013/04/23/a-flawed-bidding-process-leaves-dell-at-a-loss/?partner=rss&emc=rss
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