Dispatches from the front
What the Harman Deal Means
This time we’ll skip the usual hand-wringing over heavily-leveraged mega-acquisitions by private equity groups.
Sure, the $8 billion that KKR and Goldman Sachs have agreed to pay for audio electronics manufacturer Harman is awfully rich: it represents a PE of about 30x. But on giant deals, that’s almost par for the course these days.
What’s news is how PE buyers are increasingly being forced to make concessions beyond just offering record-breaking prices. Now they’re allowing the target to continue shopping the company after the terms of a purchase agreement have been hammered out, and they’re cutting sellers into a piece of the equity pie in the surviving entity.
So-called “Go-Shop” provisions allow the seller a limited amount of time to find a superior offer. While actually doing so is problematic under the time constraints typically imposed, the option at least offers some protection for the target’s board of directors and management. With Go-Shop, they're less likely to get sued on the theory that they sold off the business at below-market rates in order to pocket personal goodies like generous employment contracts, consulting fees, and the opportunity to invest in the foregoing business at an inside price. Yes, Virginia, such things have happened.
The use of Go-Shop is in stark contrast to traditional M&A practice which calls for the opposite, a “Stand-Still” provision that prohibits the target from entering into any dialog with competing buyers until the deal is closed. Stand-Still agreements are still the norm for mid-market deals and they exist for a good reason: they protect the buyer’s investment in time and money.
So buyers don’t like abandoning Stand-Stills for the opposite extreme. But big-deal competition is forcing the concession on them and it doesn’t hurt that target boards, especially those at public companies, also have a legitimate concern over inside-deal legal liabilities.
The second form of concession embodied in the Harman deal is the opportunity for equity holders to either accept cash or exchange their stock for up to 27% of the successor company. While these new shares won’t be as liquid as Harman’s current Nasdaq-traded securities (they’ll be listed on the so-called Pink Sheets), the new company will thereby escape many of the usual public company regulatory costs and legal risks (e.g., Sarbanes-Oxley), and current shareholders will have the opportunity to enjoy the sort of upside that good private equity firms generate.
In sum, the Harman deal nicely demonstrates how PE firms are reacting to today’s rising competition for diminishing numbers of big targets.