Harry Campbell

Instead of awarding F’s for the worst deals and deal-making of the year, I am going to focus on two of the year’s biggest buyouts. The first: J.Crew’s $3 billion buyout by its chief executive, Millard S. Drexler, and the private equity firms TPG Capital and Leonard Green Partners. The second: Del Monte Foods’ $5.3 billion acquisition by Kohlberg Kravis Roberts Company, Vestar Capital Partners and Centerview Capital.

Both acquisitions showed that sometimes being bad pays very well.

In the J.Crew deal, Mr. Drexler spent seven weeks planning a management buyout of the retailer with TPG and Leonard Green before he informed the J.Crew board of his intentions. At the last minute the buyout group lowered the price it was offering, making a “take it or leave it” offer that appeared to cow the J.Crew board into a lower-price deal. The Delaware judge overseeing the litigation that was later brought over the matter observed that the conduct of Mr. Drexler and his friends was “icky.”

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In the case of Del Monte, the investment bank Barclays Capital, which was representing Del Monte, was accused of bringing together Del Monte’s eventual private equity buyers, K.K.R., Vestar Capital Partners and Centerview, turning possible competing bidders into allies. Barclays subsequently moved from representing Del Monte to providing financing for the buyers. Another Delaware judge wrote a scathing opinion in which he questioned the conduct of both Barclays and the Del Monte board for allowing Barclays to arrange and finance this bidding consortium.

In both deals, litigation was brought before the takeovers could be completed. As a remedy, both deals were reopened and new bidders invited to ensure that there was full and open bidding for the companies.

No new bidder emerged for either company.

This was no surprise.

In J.Crew’s case, Mr. Drexler is the creative force behind the preppy clothing company. But Mr. Drexler repeatedly expressed his desire to work only with TPG and Leonard Green while sometimes saying halfheartedly that he might work with others. Without his cooperation, no other bidder was likely to appear.

Del Monte lacked a “secret sauce” executive, but there were few natural bidders for the company, leaving only private equity firms. Unfortunately, there was slight chance of a private equity firm bidding against K.K.R. and its partners. One reason is financing. It is quite difficult to put together a multibillion-dollar financing package for a bidding war. The financing banks just don’t want to write a blank check.

Reopening the bidding was thus a hollow penalty.

There were also monetary penalties, to be sure. In the J.Crew case, there was a $16 million litigation settlement for shareholders. The settlement in Del Monte was higher, at $89.4 million. About half of the Del Monte settlement money came from Barclays.

But it was also small change. Even the bigger Del Monte settlement was only about 1.7 percent of the transaction value. J.Crew was about 0.5 percent. And much of the money will be paid by insurance.

Being bad has largely paid off for these buyers.

This is not to say there were no repercussions. Both cases have changed Wall Street practice. Boards of target companies facing management buyouts have strived to run cleaner sale processes to prevent another J.Crew-like situation. Boards have also become more wary of their investment bankers. In the wake of the Del Monte case, boards are less willing to allow “staple financing,” where the target’s bankers offer a financing package to potential buyers.

As for the buyers of J.Crew, at the judicial hearing to approve the litigation settlement, Martin Vogel, an objecting former shareholder, complained that this settlement was “nominal.” It would not make a future executive think twice before engaging in the same conduct. Mr. Vogel is right.

But the problem is what to do about the penalty. Depriving shareholders of a buyout, even at a bad price, would punish them.

Perhaps the answer is to establish meaningful penalties paid out of the pockets of the bad actors. In the case of Del Monte, this appeared to have happened. Barclays was deprived of its fee, and that is why bankers on Wall Street have all had to slog through classes on the Del Monte case. The worst nightmare of a banker is to lose a $45 million fee. With real money at stake, the bankers have an incentive to change their conduct.

Nothing of the sort happened in J.Crew. The small settlement was apparently structured to be paid by insurers, and even then a quarter of it went to lawyers’ fees. Mr. Drexler and his buying consortium are getting off almost scot-free.

The difference between the two cases reflects in part a quirk in the law.

In the Del Monte case, Barclays was party to the litigation while not being one of the principals in the deal. But in J.Crew, the lawsuit was aimed squarely at the J.Crew board and its chief executive. Without delving into the intricacies of Delaware law, establishing a case against the J.Crew board and Mr. Drexler would have been difficult. In the case of Del Monte, the same rules applied to the Del Monte board, but the law on Barclays’ liability was different and uncertain.

But the law should not depend upon such distinctions. Delaware wants to protect directors and officers from liability to ensure that they operate the business without undue fear of personal liability. There are good reasons for these rules, at least in some measure. It is only when you examine the differences between J.Crew and Del Monte that you realize that sometimes these laws act to protect conduct that is, to say the least, “icky.”

The J.Crew case rewards a chief executive for his poor conduct, letting him keep the company without real penalties except reputational damage. But reputation is fleeting on Wall Street, and Mr. Drexler, TPG and Leonard Green do not seem too bothered by the controversy. Why should they? They now own J.Crew.

Perhaps in the new year, it will be time to get serious about penalizing, rather than rewarding, deal makers for their bad conduct.

Article source: http://feeds.nytimes.com/click.phdo?i=025e7e7356f61a53a4eaedd8d2c2a645