Friday, April 3, 2009

One Goldman Sachs Lawyer Makes A Startling Disclosure at Tulane. . . .

Apparently there was a deplorable excess of testosterone flowing -- at a panel-discussion during Thursday's corporate law seminar at Tulane University, to wit:

A senior writer for Corporate Control Alert is quoted on The as having heard the Goldman lawyer (an adviser on the contemplated deal) describe one proposed (but not prevailing) structure for the Merck Schering-Plough reverse merger as including a direct borrowing, by the target (Schering), from the acquiror's (Merck's) banks. That borrowing was to be used to fund a pre-closing cash payment to Schering-Plough shareholders. Astonishing. He recounts it, thus:

. . . .To address the funding uncertainties posed by the $41 billion deal, Schering considered borrowing money directly from Merck's banks and paying it to Schering shareholders before the deal's close. The scheme would have given Schering a direct claim against the banks funding the deal, rather than have the buyer be in contractual privity with the banks. . . .

[Emphasis supplied.]

[To be sure we all follow what was proposed, here, let me re-cast this, in a more familiar setting, as an illustrative (if not perfectly-analogous) example: if this structure were employed as you went to sell your home, it would give you -- the seller, the right to get half of the cash, for your house, well before the closing, and then to sue the buyers' bank -- if that bank didn't give you the cash, before the closing -- while the title-report was still being prepared, and the prior real estate tax payments were still being confirmed. Doesn't that seem rather extraordinary?]

Okay -- now, I have at least three reactions: (1) Such a pre-closing payment, in cash, of $10.50 per share, would smell quite a bit like a "settlement" payment -- to the institutional shareholders. Collectively, institutions hold something north of 70 percent of all outstanding Schering-Plough shares -- the proposed "settlement payment" would arguably be offered to take care of all the matters I have blogged about these past 14 months. Why do I say so? Because payments in cash, so far in advance of a merger are almost unheard of, in public company transactional practice -- especially in any deal near this size. That leads me to my next reaction:

(2) Such a pre-closing payment would essentially "gut" the deal of half of its value -- making it nearly impossible to break it up, with a higher offer. It would effectively eviscerate the synergy value of the deal, pre-close -- by paying over $17 billion out to the "old" Schering-Plough shareholders, and leaving only the "husks" for closing day -- in the form of the actual share exchange values (the .5767 shares of Merck). And that leads to my third reaction:

(3) This proposed structure -- paying so much out, in cash, so significantly in advance of closing -- would have almost certainly been a breach of the Schering-Plough officers' and directors' fiduciary duties (among them the duty to determine that this was the highest, best offer available). Consider that such a mechanism would effectively (a) line the Schering officers' pockets with brand new cash, pre-close, and (b) preclude any other bid, by obligating Schering to repay the banks some $17.33 billion ($10.50, times 1.65 billion Schering-Plough shares) -- even if Schering didn't nominally end up acquiring Merck (via the reverse merger -- which is, in substance, the wipe-out of Schering). And that structure -- if endorsed by Merck's officers and directors -- would arguably be a breach of the fiduciary duties owed by Merck's directors and officers, to the "old" Merck shareholders, as well. Wild.

To be fair, though, the Goldman lawyer plainly offered it as anecdotal evidence of the choppiness of the deal-funding credit markets, at present. I do think he "said the soft part a little too loudly", in so doing. That is, his statement has all the earmarks of a very-rushed, or not very-well-vetted, "do the deal, at all costs" feel to it.

Now -- is it possible that the Goldman Sachs lawyer was simply "selling wolf tickets" -- at Tulane, yesterday? Sure. It's possible. It seems unlikely, though. It seems like just the kind of soup CEO Hassan, and his Top Six would cook up. [Note that it would have given each of them a very-nice, pre-closing, gift of cash (for over half of the then-NYSE-price of their shares!), to boot. Can you say "self-interested"? Yep. You certainly can.]

Finally, this is -- if true -- a detail that we likely would not have learned from the publicly-filed merger proxy filings (when they are filed, in a few weeks' time). So, this is a selective piece of disclosure, at least arguably. And it is, to my eye, at least arguably material -- given the insight it offers -- to the extremely-motivated approach Schering's CEO and team seemed to be taking, to get this deal "cashed-out" early.


Anonymous said...

Hey rain guy. I have followed you and frank argue for a long time,I was fortunate to sale most of my Claritin stock options in $55range 10 years ago. I still have 1,000 shares and wonder what you think the value of the shares will be when the Schering-Merck deal is final.

Condor said...

I honestly have no idea.

There are too many unknowns -- most importantly, will J&J reclaim the Remicade and Simponi rights?

I'd be surprised if it all came off without a hitch. . . .

But beyond that, I can't really guess.

Sorry, but thanks for the comment!


Anonymous said...

Hey Rain guy. Thanks for getting back to me. I asked Frank but he didn't answer me,I mentioned I still have 1000 shares of Schering left from when I worked for them and feel I should hold on to them because when all the dust is cleared the stock price will be higher.Do you think Schering will just trade in the 20s range? Should I take my profir now?

Condor said...

The only thing I'd personally be certain about -- is that I wouldn't take Frank's advice -- at least as to how this stock will trade during the pendency of the proposed reverse-merger transaction. [He has almost no experience trading these scenarios -- as his latest posts make manifestly clear.]

It should be range-bound in the $20s -- unless (on the downside) JNJ gets a solid shot in on reclaiming Simponi and Remicade rights -- that would hurt merger values; and unless (on the upside) someone decided to pay the $1.25 billion deal-breaker fee -- to make a significantly higher bid for all of Schering-Plough.

If one of the above two scenarios come to pass, I think SGP might well fall below $20 (in the former), or rise slightly above $30 (in the latter).

As to when, or whether, JNJ surfaces, who knows? But I think a JNJ challenge is far more likely than a third-party "topping offer", for all of Schering, outright.

That said, I do think if you think about the values in this way (see linked post),
you might be able to mitigate the risk of getting surprised on your downside exposure.