FEBRUARY 15, 2013, 2:25 PM
Nicholas Kamm/Agence France-Presse — Getty Images
It is by now almost trite to say that there are deals and then there are Warren Buffett deals. And the $23 billion acquisition of H.J. Heinz is certainly a Warren Buffett deal.
Warren E. Buffett is known for picking public targets, setting his price and the targets agreeing without much bargaining to be acquired. If you need examples, look at Berkshire’s big acquisitions of Burlington Northern, Lubrizoil and Wrigley’s. In those deals, once Mr. Buffett showed up, the companies appeared to lose interest in finding any other bidders.
We don’t know the full story of what Heinz, a legendary consumer products company, did to find other suitors or to make sure shareholders were getting a full price. We will learn more once the proxy statement for the deal is filed. But this is an unusual deal already even at the beginning. For evidence, you need look no further than the agreement for the deal filed on Friday morning.
The reason is that there is no “go-shop” provision, which allows the company to search for other bidders after the deal is announced. Go-shop provisions are common in private equitydeals, and even some strategic ones, because they allow a target to negotiate with only one bidder before announcing a deal. After the deal is announced, the target will do a market check and see whether if there are any other bidders. If a bidder comes along, the termination fee that it would pay to acquire the company would be lower than if there were no go-shop provision.
There are good reasons for this type of mechanism. First, it allows the board to feel comfortable that it is getting the best price reasonably available. Second, while a go-shop provision is not mandated under Delaware law, companies feel that it helps them satisfy their so-called Revlon duties, which require a board to get the highest price reasonably available in a sale of the company.
As you might have gathered, the Heinz deal doesn’t have a go-shop provision. Instead, the company has negotiated only with Mr. Buffett and 3G Capital, according to reports. If another bidder comes along, it would have to pay a $750 million termination fee, plus $25 million in expenses. That’s about 3 percent of the transaction value and standard for a deal but about three times what would be paid if there had been a typical go-shop provision. Any way you slice it, it is a very large sum.
And this deal is structured more as a private equity deal than a strategic one. Mr. Buffett and 3G are financial buyers, and this deal depends on financing. They negotiated a common right in private equity deals that if the financing fails, Heinz can sue to force them to obtain it. But if it is still unavailable, the two buyers can walk from the deal by paying Heinz the hefty sum of $1.5 billion.
I stop here to note to merger agreement aficionados that 3G (represented by Kirkland & Ellis) and Berkshire (represented by Munger Tolles) also negotiated a unique financing extension provision that defers the ability for Heinz to force payment of this fee right away in the event of a financing failure. It allows the buyers to delay such termination to force the banks to finance the deal. We’ll call this new requirement, the ketchup provision.
But back to my main point: Heinz appears to have consciously limited its options. Why would it do this? One reason is simple market dynamics – Mr. Buffett and 3G wouldn’t allow a go-shop provision it. But mergers are market driven, and the common use of go-shop provisions in these situations would have given Heinz good grounds to draw a line in the sand. After all, it would satisfy shareholders that this really is the best deal out there.
But here another reason comes into play: the peculiarities of Heinz. The company is not incorporated in Delaware, as most American corporations are, but in Pennsylvania.
And the state’s law is intended to give complete latitude to boards in deciding whether to accept or reject a takeover. Accordingly, under Pennsylvania statute, a board does not have to consider the interests of shareholders as dominant in deciding to sell the company. Instead, the directors can base their decision on the interests of “employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.”
The net effect of this statute is to repudiate Delaware’s Revlon rule. A Pennsylvania company like Heinz is under no obligation to get the highest price available for shareholders, and its courts have specifically rejected this doctrine. Instead, other interests like the community can come into play. (Section 7.15 of the agreement requires Mr. Buffett and 3G to, among other things, keep Heinz’s headquarters in Pittsburgh, keep the company named Heinz, preserve the company’s heritage and charitable commitments and, of course, honor the naming rights on Heinz Stadium).
So on the advice of its lawyers (Wachtell, Lipton for the special committee and Davis Polk for the company), Heinz probably told the board that although best practices weren’t required, this wasn’t Delaware and it could basically look at other interests to justify selling to Mr. Buffett and 3G.
This has been done before to great criticism. In 2009, Bankrate sold itself to Apax Partners. Because it was a Florida corporation, it didn’t adopt the safeguards you also normally see in a private equity deal, primarily because this was Florida and the law didn’t require it. Bankrate’s board, also advised by Wachtell, decided to go with the letter of the law rather than best practices.
Ultimately, this also means that if there is another bidder who wants to put in an offer even without a go-shop provision, the Heinz board is within its rights to turn it down, even if it is a higher bid. The reason is that the board can justify the rejection as being better for Heinz’s long-term interests in the community.
In other words, Mr. Buffett’s magic here was handed an assist by the State of Pennsylvania itself.
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