When presented with an attractive acquisition offer by the buyer most likely to place the highest value on a company, boards of directors face an unenviable predicament. On the one hand, the directors want to ensure the premium provided by the buyer's offer is available to stockholders. On the other hand, the directors must satisfy their fiduciary duty to take efforts to ensure they obtain the best price for stockholders while negotiating with a buyer insisting on strong deal protections and with no obvious alternative for a better offer.
The Delaware Court of Chancery's opinion in Koehler v. NetSpend Holdings Inc. earlier this year offers insights for directors in this situation. In the decision, Vice Chancellor Glasscock found a reasonable likelihood that NetSpend's directors failed to satisfy their fiduciary duties when negotiating the terms for selling the company, despite negotiating several price increases and obtaining a healthy premium compared to the company's historic stock price. However, because an injunction likely would have prevented stockholders from receiving this premium, Vice Chancellor Glasscock declined to enjoin the transaction.
Between 2007 and 2009, NetSpend, then a private company, embarked on several failed sales attempts, all of which involved lengthy and disruptive negotiations. NetSpend remained independent and conducted an initial public offering in October 2010 at $11 per share. By 2011, however, the company's stock price fell significantly, reaching $3.90 per share.
Throughout 2011 and 2012, several companies contacted NetSpend regarding a possible acquisition of the company, including four potential strategic acquirers. In late 2012, NetSpend's largest stockholder, which owned more than 30 percent of the company's shares, advised NetSpend's board of directors of its interest in selling most or all of its position in the company. The board decided to assist the stockholder with liquidating its position to avoid the drop in the company's stock price likely to result from an unorchestrated sale of such a large stake. These efforts resulted in two private equity firms executing standstill agreements with "don't ask, don't waive" provisions that did not terminate in connection with the public announcement of another transaction.
Contemporaneous with its efforts to assist its largest stockholder with liquidating the stockholder's position, NetSpend began exploring a possible sale to Total Systems Services, Inc. (TSYS). In light of the prior failed attempts to sell the company, NetSpend's directors were hesitant to engage in a full sale process.
Near the end of 2012, one of the two private equity firms that had entered into a standstill agreement with NetSpend indicated an interest in acquiring a 20 percent interest in NetSpend from the company's largest stockholder for $12 per share. A few days later, TSYS indicated an interest in acquiring all NetSpend shares for $14.50 per share. NetSpend terminated discussions with the two private equity firms and hired legal counsel and a bulge bracket investment bank to advise the company on a potential transaction.
NetSpend's investment banker prepared a list of nine potential purchasers, but the company's board did not authorize contact with anyone on the list because NetSpend was "not for sale." The investment bank also advised the company that a private equity bidder was unlikely to match TSYS' offer. The board's position was that it would only depart from its position that the company was not for sale if TSYS offered a substantial improvement to its $14.50 per share initial proposal. NetSpend did contact one other party about a possible sale to comply with its obligations under a commercial contract, but that counter party never expressed interest in an acquisition even though it was a potential strategic acquirer of NetSpend.
During the course of negotiating the terms of TSYS' offer, NetSpend's board attempted and failed to obtain a "go-shop" provision in the merger agreement. NetSpend negotiated three increases to TSYS' initial offer, resulting in a final offer price of $16 per share, a 69 percent premium over the company's 52-week average price. However, that final price fell below the bottom end of the $19.22 to $25.52 range of the discounted cash flows analysis in the fairness opinion from the company's investment bank.
The final deal terms included a no-shop provision, a termination fee of 3.9 percent of the transaction value, a provision prohibiting the waiver of any standstill agreements then in existence, and voting agreements covering approximately 40 percent of the company's outstanding stock. During the three months between entering into the merger agreement and the court's decision, no competing offers emerged for NetSpend.
Guidance for Directors
- Single bids may be acceptable. As Delaware courts have previously stated, a board's duties under Revlon do not require it to run a perfect process, but to find the highest price reasonably attainable. A board could reasonably decide that the best way to do that is through negotiations with a single bidder instead of through an auction process. The court noted the NetSpend's board legitimate concerns about the possible negative effects an auction process could have on the company's business in light of the company's prior experience. However, the NetSpend case shows that courts may look more carefully at other aspects of a transaction, such as deal protection devices or the analysis underlying a fairness opinion, if the board has decided to pursue a single bidder approach.
- Fairness opinions should be carefully reviewed. The court noted that the price obtained from NetSpend's purchaser was less than the low end of the range produced by the discount cash flow analysis performed by NetSpend's financial advisor. In addition, the comparable companies and selected transactions used for other analysis were dissimilar to NetSpend and the proposed transaction. These facts led the court to determine that the fairness opinion was "weak" and to discount its utility as a proxy for conducting a market check when considering the price offered in the proposed transaction.
Directors should carefully review fairness opinions and the analysis proposed by financial advisors. If the analysis suggest that the price offered may not be supported, the directors should consider whether the fairness opinion provides a reliable measurement of the target company's value. Conducting a market check becomes even more important when the fairness opinion analysis indicate that the price offered in the proposed transaction is less than the ranges of values derived from the financial analysis conducted by a financial advisor in connection with its fairness opinion.
- Deal protection devices may receive enhanced scrutiny if there is no market check. Upon reviewing the deal protection devices contained in the merger agreement, the court determined that while most were within the accepted range as decided by prior courts, they were nevertheless too onerous in the NetSpend transaction given the lack of a market check. The court focused particular attention on the failure of the NetSpend board to negotiate a waiver of the standstill provisions agreed to by the two private equity firms approached to buy a minority position in the company, even though those firms were unlikely to buy the entire company at a price higher than TSYS' offer. Without a pre- or post-signing market check, a court may find that the acceptance of even "normal" deal protection devices could be a breach of the board's fiduciary duties.
- Courts are unlikely to enjoin transactions. A final point to note is that even when finding it reasonably likely that a board breached its fiduciary duties, courts are reluctant to enjoin transactions if there is a possibility that the injunction may cause stockholders to lose an opportunity to receive a significant premium for their shares. The directors may still be liable for breach of fiduciary duty after the transaction is closed, but the transaction is unlikely to be delayed.