Dow Shenanigans

Dow Chemical, rumored to be the latest giant company to be swallowed up in a PE deal (for some $50B), fired two of its executives today over the rumors. The interesting part is that they weren’t canned for the pedestrian offense of leaking the potential deal to the media, but rather for having unauthorized discussions with potential buyers. What’s more, at least one of these guys - Romeo Kreinberg, a 30-year company veteran who currently heads Dow’s Sales & Marketing functions and its Performance Plastics division – is vehemently denying doing anything untoward.

Were Kreinberg and the other "traitor" (Pedro Reinhard, a member of Dow’s Board) really going behind the board’s back and talking to suitors, or were they thrown under the bus? While dealmakers in most organizations have (or at least should have) wide latitude to talk to potential targets and partners, there’s no question that things need to get tightly constrained when you’re talking with potential buyers. There are just too many sensitivities around relations with employees, customers and investors to let such discussions take place without the direction and oversight of the board. I’m guessing we’re going to get a good glimpse at how this works – or should have worked – at Dow as this little drama gets played out.

Sometimes you've got to stop . . .

Brilliant article in the Sunday Washington Post – what happens when you take one of the world’s pre-eminent violinists, set him up in a Metro station with his $3.5M violin, and have him busk away, open case at his feet, for rush hour commuters? No, nothing related to M&A – but terrific musings nonetheless on our need to make time for beauty in our over-scheduled lives.

Wither Private Equity?

Some readers have asked why I don’t have much to say about private equity, as PE seems to be the hot topic in just about any current financial forum. For starters, there’s not much that I could say, opinion-wise, about PE that isn’t already being more than adequately addressed by Equity Private and others in the PE field. Secondly, my focus always has been on corporate – strategic – dealmaking rather than that of the PE, or strictly financial, type.

For this reason, folks need to understand that my posts on topics such as the limitations of financial analysis are to be viewed through the lens of the corporate acquirer, who may be blending in non-financial (or at least difficult-to-quantify) factors relating to competition, speed to market, organic growth alternatives, etc. Obviously, financial analysis should take a far more prominent role in a PE setting.

CVS-Caremark

I haven't posted on this in a while, largely because it finally has become the competitive process it should have been from the beginning. Caremark's management had to be dragged into this, but the net result is likely to be a much better deal - with the same suitor, CVS - than the company would have gotten had management had its way. Sometimes you win in spite of yourself.

More Fun with (Financial) Models

Analysts I’ve worked with in the past have accused me of taking an overly-skeptical view toward financial analysis/valuation of potential deals. Guilty as charged, I suppose, although I’d quibble with the “overly” part.

As I’ve noted before, one of the inherent limitation of financial modeling is that its reliability as a predictive tool decreases with the level of uncertainty involved. Stable, slow-growing businesses are easy to model reliably; new or fast-growing ones, not so much. It’s a matter of “garbage-in, garbage-out”: if you’re guessing at future input levels (which you have to be doing for something new), your output will not necessarily conform with reality. That’s OK – often a best guess is fine – but decision-makers need to be able to differentiate between these two scenarios and discount the value of the model accordingly. I don’t see that done often enough.

Also on the subject of models: I am always amused that, more times than not, the bankers or brokers peddling distressed or declining businesses feel compelled to include a page showing three or five years of historical financials along with the corresponding period of projections. Imagine the revenue graph – the historical numbers trend downward, reaching their nadir at the time the business is being sold. Miraculously, at that point the trend reverses and heads upward from there in the projections. Sometimes there is an explanation for how this bit of magic is supposed to come about, more often not. I haven’t come up with a good name for this little bit of modeling desperation, but I’m partial to the “golden horseshoe.” Any other thoughts?

XM-Sirius

I've been a happy customer of XM Radio for two years, and I'll be even happier when I can access the full suite of channels offered by XM and Sirius on their merger. Many don't think the merger will get through. The FCC has an explicit rule prohibiting joint ownership of the spectrum. A narrow definition of the relevant market for antitrust combination analysis would yield an HHI score off the charts (i.e., if the relevant market is satellite radio, the merger yields a monopoly). Despite all that, my prediction is that the merger gets through.

XM and Sirius face competition from all sorts of fronts, from traditional (free) radio to iPod link-up. While some of these might not be considered "substitutes" for antitrust analysis purposes, there's no question that terrestrial radio - and nascent high-definition radio in particular - will be considered. Layered on this competitive analysis will be the fact that two satellite competitors, with their astronomical cost structures, are probably not viable long-term anyway. This will take care of the DOJ's concerns. The FCC will do a similar analysis, and reach the same conclusion and eliminate the spectrum cross-ownership rule, although it will likely be a more tortured path getting there than that of DOJ.

Is many respects, the current FCC prohibition is akin to the cellular cross-ownership rule, which prohibited the same entity from owning both cellular licenses in any given geographic market. That rule was eliminated about four years ago as the availability of PCS spectrum made it largely moot. Circumstances demand a similar result here.

Proxy Advisor: NO to CVS-Caremark

In the continuing tussle between CVS and Express Scripts over Caremark, independent proxy advisor Glass Lewis has weighed in, advising Caremark shareholders to vote "no" on the CVS link-up. I can't recall ever seeing a deal of this size (well north of $20B) run afoul of the proxy guys, much less for the target conducting a "flawed negotiating process." Glass Lewis, like many others, has latched onto the fact that Caremark has shown a strangely unyielding commitment to seeing the CVS deal through, despite ardent interest from others.

I've pointed out in previous posts some of the speculation surrounding the motivations of Caremark management. Suffice it to say is highly unusual for the managers of a multi-billion dollar public company to act as Caremark's has in handling this sale process.

Negotiating Tactics

Besides the stuff on building a corporate development department, this last issue of Corporate Dealmaker also has a piece on negotiations that stresses the importance of preparing for big negotiating sessions and focusing on structural/relationship issues rather than tactics. The acticle includes a great paraphrased quote from Marty Lipton (long-term readers will know I've spent my share of late evenings at his firm): "You can get the price up 2% by at-the-table tactics; by bringing in other credible buyers you can bring the price up by 50%."

I've got little use for negotiating tactics, and I'd take this one further: That 2% opportunity is offset by an increased risk that you'll crater the deal with juvenile, offensive or misdirected tactics. Spend the time figuring out what the other side needs to get. Make sure your own objectives aren't muddled. Then go to the negotiating table as yourself - you won't need to play any games.

Google Blogger Issue

Google continues to be unable to move me to the new blogger application, and it seems for the last few weeks my posts haven't actually been published. As I don't pay a lot of attention to what my blog looks like, I didn't notice until now. In any event, check back through the last few posts if there's something you've missed.

M&A Departments

The latest issue of Corporate Dealmaker is a particularly good one, with a number of first-hand views from corporate dealmakers on how they've structured their departments and improved the results their companies have gotten from M&A. It's also got my now-regular back page article; this month is a look at the fun and games of corporate annual review time.

Ben Stein on Caremark

Curmudgeon Ben Stein has weighed in on Caremark, and while he gives short shrift to the timing and regulatory advantages of the CVS deal, he rightly points out the lack of regard Caremark management has shown for the (financially) superior ESRX bid, and explores some of the reasons this may be the case.

Caremark - ESRX Developments

Express Scripts (ESRX) continues to battle away for Caremark. Along with the proxy fight, ESRX also filed a lawsuit last week aimed at the breakup fee in the CVS-Caremark deal. I suppose they have to try everything, but the lawsuit isn't going to work; aside from the merits there's a decent chance they don't even have standing to sue.

As predicted, CVS has upped the stakes a bit in an attempt to push things over the top, announcing a $2 special dividend for Caremark shareholders. This isn't quite as good as it appears, since shareholders essentially pay themselves for the post-merger portion of the company attributable to Caremark, making the dividend closer to $1 than $2. However, between that and recent stock price increases, the ESRX bid is now less than 5% better than the CVS proposal. There's no question CVS is now the superior proposal, given the timing benefit and the fact that regulatory clearance has already been obtained.

The next move belongs to ESRX - while they will continue to slog forward on the desperation measures of the proxy fight and lawsuit, expect to see a sweetened bid in the days to come.

Proxy Fight!

Express Scripts is not skulking away from Caremark's summary rejection, opting instead to raise the volume by nominating four directors of its choosing for the Caremark board. This tactic, an old standby of hostile takeovers, allows the successful hostile to get a friendly board which will, in turn, approve the hostile's takeover proposal. CVS, whose friendly proposal has been embraced by Caremark, labeled the ESRX move a "publicity stunt." It's not, unless CVS means that ESRX is using any means necessary to plead its case to Caremark shareholders.

This isn't a move you'd usually see in a deal this big, but Caremark didn't give ESRX many options. What remains to be seen is whether Caremark shareholders will be swayed. While there has been some grumbling, it doesn't seem loud enough yet. Will shareholders decide that the 50% cash component and 13% premium in the ESRX deal outweighs the better timing and increased chance of closing the CVS deal? I'd say no, unless ESRX ups its bid.

Caremark - CVS

New year, new deals to watch. Some time ago, pharmaceutical services provider Caremark (NYSE: CMX) announced a "merger of equals" with CVS (NYSE: CVS) in a transaction valued at $21B. That deal had toddled along for a few months until competitor Express Scripts (NDAQ: ESRX) hurtled in with a $26B cash-and-stock offer. Today brings Caremark's rejection of the Express Script proposal, and the unusually detailed statement from Caremark is well worth a read.

After the expected litany of reasons why Caremark thinks a combination with CVS offers better strategic benefits, growth opportunities, etc., we get to three of the real reasons Caremark prefers CVS: Less integration risk, quicker timing and greater closing certainty (the CVS deal has already passed antitrust review). These are valid concerns and would certainly justify taking a lower price, particularly considering the concentration in the industry and the considerable (9+ months) timing benefit. Still, with a 20% pricing gap between the proposals you've got to wonder if Caremark has really taken the time to review the merits of a deal with Express Scripts, or at least play it out to leverage CVS to a better price or terms.

There's also a lot of drama in the backstory here, relating to options backdating, indemnity and officer compensation that I won't get into here but which may make the issue of closing certainty that much more important for Caremark management. How that works for shareholders is another matter. I suspect this one won't move quietly to closing.

Windstorm Woes

My neighborhood in Redmond looked like a bomb had gone off last Friday morning, with trees down everywhere and power lines draped on the ground. While the trees have been largely chopped up (including the one that landed on my roof), we're now on Day 6 of no power. We're coping, but it doesn't inspire a lot of confidence about what will happen if we ever face a real disaster here in the Northwest . . .

Yahoo - Facebook Leaked Docs

Techcrunch posted purported internal Yahoo documents supporting an acquisition of Facebook for up to $1.6B. $1.6B? Are you kidding me? As I've posted before, the child prodigies running Facebook should take the money and run - even if it's "only" $1B.

Anyway, the Techcrunch Yahoo docs include some high level model readouts. All I can say is that I don't think I'd want to explain to senior management that my business case for a $1.6B price depends on believing that a service like Facebook can:

- Be regularly used by 60% of high school and young adult internet users and
- Reach sustainable 58% profit margins (up a tad from today's -33%)

At least they're using a 19% discount rate. I know things are tough at Yahoo, but overpaying for a MySpace also-ran like Facebook isn't the answer.

3rd Place Winners

In a recent New Yorker article titled "In Praise of Third Place", oft-praised-in-this-blog writer James Surowiecki profiles the financial success of Nintendo compared to the higher-selling but less profitable games units of Microsoft and Sony. By focusing on units that are really good at playing games - as opposed to the be-all-end-all XBox and Playstation units - Nintendo has made a great business out of third place. Meanwhile, its competitors slug it out for market share leadership, losing money on every unit sold (and no, you don't make that up in volume).

In thinking about mergers, there is often a bias for scale. While it's a fair assumption within certain parameters, there is a point beyond which scale doesn't offer meaningful cost structure reductions - and which can lead you into a bottom-line-punishing race for to preserve a market-leading position. This is why the synergies assumed in large merger financial analysis need to be carefully evaluated, and the strategic questions of whether a larger scope is truly desirable fully vetted.

Back to Nintendo vs. XBox/Playstation: A lot of my Redmond neighbors work at Microsoft, including several in the Xbox group. They ALL want the Nintendo Wii.

"Corporate TiVO"

Fascinating article in BusinessWeek Online about Best Buy's approach to working hours at corporate HQ. Trying to embrace what they call "ROWE" ("results only work environment"), Best Buy employees are to eschew "face time" and regular hours in favor of focusing solely on results. As one employee gushes, the ability to work where and when one likes is akin to "corporate TiVO."

I've railed on the topic of face time a bit in the past, and as I noted recently, technology changes over the last ten years have radically reduced the need for many corporate workers to log regular hours in an office. Unfortunately, those outdated notions still hold great currency. It says a lot that the grass roots founders of Best Buy's program had to sharply point out the need to focus on results. Nothing else about one's time in the office matters, of course, but how many of our corporate policies, procedures, rules and attitudes are directed at controlling or measuring things unrelated to results?

New Corporate Dealmaker Column

I've been writing a regular back page column in Corporate Dealmaker magazine, looking at some of the details and idiosyncrasies of doing deals. I neglected to post the first article before now, so here it is, along with the latest. It's a fun outlet; feel free to e-mail me with any comments or topics you think I should write about.

The Evils of Private Equity?

Excellent analysis from Going Private in response to the increasing spate of journalistic attacks against LBO transactions - she does a nice job dispensing with the muliple "shareholder protection" arguments that are popping up against PE deals.

I would add that there's nothing inherent in LBOs that makes them any less favorable to shareholders than strategic M&A transactions. At root, all of the objections to PE are based on a common presumption of board ineptitude and managerial duplicity. The assumption that evil managers will run their companies into the ground so they can pursue LBOs is comedic (as we've seen, such types prefer the easier work of book-cooking and options back-dating). In any event, there are just as many opportunties for corrupt management to profit via strategic M&A as there are in LBO deals, so why are our PE friends being singled out?