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?

Due Diligence - Sellers

While diligence is ostensibly the buyer’s process, it typically is a bigger deal to the seller, who should take pains to manage the process closely. This is because wide-open diligence poses any number of problems to sellers:

- Disclosing sensitive information (often to a bitter competitor)
- Consuming management time
- Dragging on without end

As a seller, you’re highly motivated to limit the scope of review and the time buyers have to review the information. You don’t want to waste time and resources turning everything over, particularly if you know the documents are of marginal utility to the other side. It helps to try to think like the buyer and anticipate which of your information would be most useful to them, even if it’s not exactly what they’ve asked for.

You also don’t want to make your executives available for endless meetings and diligence sessions with buyers. Savvy buyers know that such meetings are not typically very helpful, particularly with public companies, and will be fine with keeping them brief. With others, you will need to set limits on availability, and be sure that the questions are appropriate for the senior exec involved. There’s nothing like seeing a slack-jawed head of marketing getting grilled about the intricacies of last year’s advertising budget . . .

And then, of course, there is the sensitive stuff. What’s important here is to keep things in perspective. Yes, it can get the hackles up to see your competitor rifling through your secrets. On the other hand, not everything marked “confidential” is worthy of considering thusly. Use this simple test: If your competitor doesn’t buy you, and violates the NDA and tries to use the info against you, what’s the worst they can do? For the vast majority of so-called "confidential" info the answer is: Precious little. Share freely if it’s painless to do so. For the truly sensitive stuff, consider providing it later in the diligence process once things have turned serious. You can even redact or simply tell the buyer it’s too sensitive to share (this last move is best used with care, as it can easily blow trivial documents far out of proportion to their meaning in the context of the deal).

Finally, while buyers would be content doing diligence 'till the cows come home, sellers are wise to put time limits on the process. The amount of time will depend on number of bidders and deal leverage, but setting boundaries is key. Naturally, you will not want to let diligence push on past signing unless it is limited to specific integration matters (and isn't set up as a closing condition).

There are far more intricies to how sellers handle the diligence process, from document copying to using multi-party diligence to further an auction process. I'll try to cover some of those in later posts.

Due Diligence - Buyers

Questions percolate in about the diligence process, so I thought I'd post some thoughts on various aspects of the process from the differing perspective of buyers and sellers. Today, the buyers:

As a buyer, your primary goal in diligence is simple:

Verify that the asset you are buying is essentially what you think it is.

However, buyers often run their diligence in ways that, at best, cost them money and time, and at worst ruin their deals. The two primary mistakes are using a cookie- cutter approach to diligence and over-reliance on outside help.

If an acquiror applies a standard diligence approach to all deals, it will inevitably be overdoing its diligence on many deals. A screaming deal - either due to price or strategic need - demands a very different level of diligence than a deal that is in the margins financially and for which there are strategic alternatives.

In the latter case, you'll want to go through everything at some level of detail, because even small hiccups could push your marginal deal into the red. In the former case, you should just be doing what I like to call "nuclear" due diligence - take a high level pass and make sure there is no radioactive waste: Subsidiary asbestos mining companies, crooked accounting - you get the idea. Subjecting such a deal to a rigorous diligence process is simply a waste of time and resources. Worse, since it is such a great deal, the delay inherent in doing such detailed work - and the annoyance it causes your target - may open a window for an interloping buyer to push you out of the way. If you went shopping for a new TV or computer last Friday, you would have seen this principle at work at Best Buy and Circuit City stores across the land: Not a lot of consultive selling; just a mad scramble to get the limited-quantity deals.

Relying over-much on outside accountants, consultants and lawyers complicates problem number 1. Diligence is in many ways an ass-covering exercise for those involved. In the absence of very clear guidance, even internal people will overdo diligence out of concern for missing something. External professionals will be even worse. Their incentives - financially, professionally and with respect to potential liability - are all aligned on the side of doing exhaustive diligence. As a buyer, you need to make sure they understand very clearly what your goals are for diligence in each case. Are you looking only for unexploded bombs, or for any accumulation of small liabilities? As is the case in many strategic deals, time to deal execution is often far more important than doing a complete diligence work-up.

As a buyer, it is important that you have a senior person running the diligence process so that the personalities can be controlled and the process tailored to the needs of the specific deal.

One final thought for buyers is the difference between valuation and integration diligence. In strategic deals involving significant integration issues, you need to do some high-level diligence on the integration process: Verify software platform versions, people issues, etc. However, the specifics of the integration process are unlikely to matter in verifying value or deciding whether the deal is go/no go. The tricky part is that your operating people will want to get into the specifics right away, because they are responsible for delivering the post-merger results. And of course, it's critical that integration happen quickly and smoothly so deal synergies can be fully realized. One approach that often works - particularly if you've been reasonable with valuation diligence up front - is to negotiate in the definitive docs a process for integration-related diligence between signing and closing. Such diligence won't be a closing condition, and it will be limited to integration-related information, but it can meet your need for speed in the stage up to signing while still getting the detail your ops folks need to start integration as quickly as possible.

More on Mining Deals

Check out The Deal for an in-depth look at the mining company M&A saga I've been posting about all year. The article, which obviously went to print more than a week ago, ends by speculating that Phelps Dodge might be an acquisition target. Indeed.

Google AdSense

With Google shares cresting the $500 mark, I thought I'd help out and add AdSense to my blog. I'm interested in seeing howly closely the AdSense program can hew to the target audience. This is a narrowly-focused blog - will it elicit ads for diligence and financial services or garden tools?

A Classic Rediscovered

I recently read Sloan Wilson's The Man in the Gray Flannel Suit. The book has often been described simply as a critique of corporate conformity, but that's far from apt. While it is in ways a period piece, its themes of balancing corporate ambition and family responsibilities should resonate with any of us corporate tools.

Our hero, Tom Rath, has even more than that to contend with: As the book opens, poor Tom strives to answer the following inane question on a job application: "The most significant fact about me is . . ."

It's a shock, then, when he considers the following response:

"It was the unreal sounding, probably irrelevant but quite accurate fact that he had killed seventeen men."

So Tom's got to climb the corporate ladder, find time for family and come to terms with his wartime experiences. Five years ago that would have seemed difficult to relate to; not so much now as our Iraq veterans return to the workplace