Case Study: Kinder Morgan Buyout Raises Ethical Questions
SEC proxy filings following the announcement of the management buyout at the time revealed potentially questionable behavior by top management of Kinder Morgan Inc. The filings revealed that they waited 2 months before informing the firm's board of their desire to take the company private. The delay is particularly troublesome since it is the board that has the overarching fiduciary responsibility to protect shareholders interests. It is customary for boards governing firms whose managements were interested in buying out public shareholders to create a committee within the board consisting of independent board members (i.e., nonmanagement) to solicit other bids. While the Kinder Morgan board did eventually create such a committee, the board's lack of awareness of the pending management proposal gave management an important lead over potential bidders in structuring their proposal. The delay in telling the board also precluded the board from overseeing the process, which is generally considered the proper role of the board in such matters. By being involved early on in the process, a board has more time to negotiate terms more favorable to shareholders. The transaction also raises questions about the potential conflicts of interest of investment bankers who are hired to advise management and the board on the "fairness" of the offer price but who also are potential investors in the buyout.
Kinder Morgan's management hired Goldman Sachs in February 2006 to explore "strategic" options for the firm to enhance shareholder value. The leveraged buyout option was proposed by Goldman Sachs on March 7 and was later followed by their proposal to become the primary investor in the LBO on April 5, according to the proxy materials. Subsequently, the management buyout group hired a number of law firms and other investment banks as advisors and discussed the proposed buyout with credit-rating firms to assess how much debt the firm could support without experiencing a significant downgrade of its credit rating. On May 13, 2006, the full board was finally made aware of the proposal. The board immediately demanded that a standstill agreement that had been signed by Richard Kinder, CEO and leader of the buyout group, not to talk to any alternative bidders for a period of 90 days be terminated. While investment banks and buyout groups often propose such an agreement to ensure that they can perform adequate due diligence, this extended period is not necessarily in the interests of the firm's shareholders because it puts alternative suitors coming in later at a distinct disadvantage. Later bidders simply will not have sufficient time to make an adequate assessment of the true value of the target and to structure their own proposals.
In this way, the standstill agreement could discourage alternative bids for the business. The special committee of the board set up to negotiate with the management buyout group was ultimately able to secure a $107.50 per share price for the firm, significantly higher than the initial offer. The discussions were rumored to have been very contentious due to the board's annoyance with the delay in informing them (Berman and Sender, 2006). The deal between the management group and the board was hammered out in about 2 weeks. In contrast to the Kinder Morgan deal, a management group within HCA, a large U.S. hospital operator, took less than 1 month to inform its board of their interest in an LBO. The special committee of the board took 3 months to negotiate a deal with the firm's buyout group.
Discuss the following:
1. What are the potential conflicts of interest that could arise in a management buyout in which the investment bank is also likely to be an investor? Be specific.
2. Comment on the following statement: It is desirable for firms interested in undertaking an LBO to receive strategic advice from investment bankers who also are willing to invest in the transaction.
3. Do you believe standstill agreements in which the potential LBO firm agrees not to shop for alternative bidders for a specific period of time are reasonable? Explain your answer.
Case Study: Private Equity Firms Acquire Yellow Pages Business
Qwest Communications agreed to sell its yellow pages business, QwestDex, to a consortium led by the Carlyle Group and Welsh, Carson, Anderson and Stowe for $7.1 billion. In a two-stage transaction, Qwest sold the eastern half of the yellow pages business for $2.75 billion in late 2002. This portion of the business included directories in Colorado, Iowa, Minnesota, Nebraska, New Mexico, South Dakota, and North Dakota. The remainder of the business, Arizona, Idaho, Montana, Oregon, Utah, Washington, and Wyoming, was sold for $4.35 billion in late 2003. Caryle and Welsh Carson each put in $775 million in equity (about 21% of the total purchase price).
Qwest was in a precarious financial position at the time of the negotiation. The telecom was trying to avoid bankruptcy and needed the first-stage financing to meet impending debt repayments due in late 2002. Qwest is a local phone company in 14 western states and one of the nation's largest long-distance carriers. It had amassed $26.5 billion in debt following a series of acquisitions during the 1990s.
The Carlyle Group has invested globally, mainly in defense and aerospace businesses, but it has also invested in companies in real estate, health care, bottling, and information technology. Welsh Carson focuses primarily on the communications and health care industries. While the yellow pages business is quite different from their normal areas of investment, both firms were attracted by its steady cash flow. Such cash flow could be used to trim debt over time and generate a solid return. The business' existing management team will continue to run the operation under the new ownership. Financing for the deal will come from JP Morgan Chase, Bank of America, Lehman Brothers, Wachovia Securities, and Deutsche Bank. The investment groups agreed to a two-stage transaction to facilitate borrowing the large amounts required and to reduce the amount of equity each buyout firm had to invest. By staging the purchase, the lenders could see how well the operations acquired during the first stage could manage their debt load.
The new company will be the exclusive directory publisher for Qwest yellow page needs at the local level and will provide all of Qwest's publishing requirements under a 50-year contract. Under the arrangement, Qwest will continue to provide certain services to its former yellow pages unit, such as billing and information technology, under a variety of commercial services and transitional services agreements (Qwest, 2002).
Discuss the following:
Why did the buyout firms want a 50-year contract in order to be the exclusive provider of publishing services to Qwest Communications?
Case Study: IBM Partners with China's Lenovo Group
IBM was able to satisfy two objectives in selling its ailing PC business to China's Lenovo Group for $1.75 billion in cash, stock, and assumed liabilities in late 2004. First, the firm is able to eliminate the business' ongoing operating losses from its books. Second, IBM could sharply enhance its position in information technology in China, which is rapidly emerging as one of the world's largest information technology markets.
Under the terms of the transaction, Lenovo will relocate its world headquarters from Beijing to Armonk, New York, near IBM's headquarters. Lenovo will be managed by senior IBM executives. IBM owns an 18.9% stake in the new company, which will sell PCs under the IBM brand name. IBM gets to continue selling PCs, which helps it sell other products and services to corporations as packages. IBM hopes to exploit Lenovo's influence in China to sell additional information technology products. As China's number one PC maker, Lenovo has a 27% overall market share and strong positions in both the government and education markets. The firm's presence in these markets is expected to strengthen, because the Chinese government owns 46% of the new company. Lenovo hopes to benefit by obtaining a global PC operation and to expand its sales under the widely recognized and respected IBM brand.
The challenges of implementing the new business are daunting. Enormous geographic and cultural differences will make communication difficult. While former IBM employees will be among the product designers, some corporate customers may not trust Lenovo to deliver the quality and innovation they have come to expect from IBM.
Discuss the following:
What other challenges to making this relationship work would you anticipate? Be specific.
Case Study: Johnson and Johnson Sues Amgen
In 1999, Johnson and Johnson (J&J) sued Amgen over their 14-year alliance to sell a blood-enhancing treatment called erythropoietin. The disagreement began when unforeseen competitive changes in the marketplace and mistrust between the partners began to strain the relationship. The relationship had begun in the mid-1980s with J&J helping to commercialize Amgen's blood-enhancing treatment, but the partners ended up squabbling over sales rights and a spin-off drug.
J&J booked most of the sales of its version of the $3.7 billion medicine by selling it for chemotherapy and other broader uses, whereas Amgen was left with the relatively smaller dialysis market. Moreover, the companies could not agree on future products for the JV. Amgen won the right in arbitration to sell a chemically similar medicine that can be taken weekly rather than daily. Arbitrators ruled that the new formulation was different enough to fall outside the licensing pact between Amgen and J&J.
Discuss the following:
What types of mechanisms could be used other than litigation to resolve such differences once they arise?