Do Financial Buyers Pay Fair Value?

Part Three: Disclosures re: Board Deliberations

Posted by George Hickey on October 27, 2017

I was recently reading through the Schedule 14A filed with the SEC in connection with Amazon’s acquisition of Whole Foods (that is what I do for fun) and I came across this disclosure in the Background of the Merger section:

The board of directors discussed these contacts and reaffirmed its previous consensus to not solicit proposals from the private equity firms, given concerns of the Company’s board of directors about leaks and the views of management and the perspective of Evercore that the price proposed by likely exceeded the price level that a private equity buyer could reasonably be expected to pay while achieving customary expected returns from such an investment.

I’ve never seen this disclosure spelled out so clearly and so I wondered if there were other proxies with a similar disclosure. As it turns out, there are only a couple of others (that I could locate). This one related to the acquisition of Monogram Residential Trust, Inc. in September 2017:

The Evaluation Committee also discussed the perspective of the representatives of Morgan Stanley that the $12.00 price proposed by Greystar likely exceeded the price level that any competing financial buyer could reasonably be expected to pay while achieving customary expected returns from such an investment.

And this one related to the acquisition of Advent Software in July 2015, which interestingly (a) was only included in a proxy addendum (DEFA14A) filed about a month after the Definitive Proxy Statement and (b) goes a few steps further by both defining a range of "customary rates of return" and acknowledging some of the constraints on achieving them (debt sources, interest rates, and assumed exit):

As part of these discussions, the Board also discussed with representatives of Qatalyst Partners the price a private equity firm would reasonably be expected to pay to acquire Advent and still obtain a sufficient rate of return. For example, the Board noted in this discussion that to achieve customary rates of returns ranging from 15% to 25% per year, based on assumptions deemed to be appropriate with respect to certain matters, including debt sources, interest rates, and exit valuations, a private equity firm would be very unlikely to acquire the Company at a valuation higher than the SS&C proposal unless such firm expected future financial performance of the Company to be substantially better than the Management Projections.

These deliberations and disclosures make a lot of sense to me - why jeopardize the bird-in-hand to reach out to a group of bidders that you know are constrained by having to achieve "expected" and "customary" returns? This is exactly why bankers put the LBO analysis in the deck - to give the Board an idea of where the bids from potential financial buyers will likely come in.

From a fiduciary duty perspective, I don’t think this taints the process in any way and actually evidences more thoughtful and complete deliberations by the Board. However, from a "fair value" perspective, if you buy the DE Supreme Court’s argument in DFC,then these customary rates of 15 to 25% merely reflect the risks and costs associated with buying the business. And if that is true, why is the range of "customary rates" more or less uniform across different deals and financial buyers?

Note: All emphasis in this post is my own.