Stereo Firm's Prospects re Said to Be Worse; Legal Battle May Erupt
By DANA CIMILLUCA and DENNIS K. BERMAN
September 22, 2007 (WSJ)
Kohlberg Kravis Roberts & Co. and Goldman Sachs Group Inc. walked away from their $8 billion leveraged buyout of stereo maker Harman International Industries Inc. late Friday, setting up a potentially nasty legal squabble between two sides that months ago had heralded a new long-term partnership.
Coming from two of the most respected buyout firms on Wall Street, the move represents a severe setback for the overall deal market as it tries to close upward of $350 billion of leveraged buyouts amid tightening credit conditions. KKR and Goldman said they found financial conditions inside Harman to be unacceptable, triggering a material adverse change that would allow them to walk from the transaction. In deal parlance, this is often known as "calling a MAC."
Harman shares plummeted by $27.25 each, or 24%, after The Wall Street Journal reported the deal was in jeopardy. They closed at $85 apiece, or 29% less than the original buyout price of $120 a share. The shares dropped an additional 2.8% in after-hours trading Friday to $82.65 each.
The Harman deal was originally billed as a groundbreaking transaction because it allowed sellers to keep a piece of the company's shares in addition to receiving a large cash payout. This step was designed to minimize shareholder griping about low prices paid by private-equity firms for public companies.
But the addition of the "stub equity" component, as it is called, may have slowed the regulatory-approval process and therefore created more time for the deal to spoil.
In particular, the buyers said the future prospects of Harman, which builds audio components for home stereos and automobiles, were worsening, according to one person familiar with the matter. The buyers also said that Harman may have tripped certain covenants in the parties' merger agreement related to capital spending, this person added. The buyers contend the overspending invalidated the merger agreement, this person said.
The deal also required a large portion of equity investment -- some $3.5 billion of the total $8 billion -- that might have also discouraged the buyers from proceeding.
Harman said that it disagrees with the buyers' interpretation that the merger agreement has been breached.
While the announcement appears tied directly to Harman's financial performance, it raises some broader questions for the pipeline of deals outstanding: whether the pullback shows that buyout firms are becoming comfortable with the risks associated with scuttling a deal and whether KKR and Goldman's actions give cover to other firms contemplating similar moves.
The deal also brings to the fore the issue of the Material Adverse Effect clause, which is used in merger agreements to guide how and why buyers can walk away from a transaction.
In the Harman agreement, the language is written in a way that would appear to give KKR and Goldman little room for backing away. It states, in part, that the buyers can't walk for issues "generally affecting the consumer or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or financial, credit or securities markets in the United States or any other country."
Company filings note, however, that Harman's operations would be materially affected if it lost sales to some of its core customers, including DaimlerChrysler AG, BMW AG, Volkswagen AG or Toyota Motor Corp.
"It's a dangerous game," said Gerald Nowak, a partner at Kirkland & Ellis LLP in Chicago. "The standard for proving a MAC has occurred is very high." A previous case, involving agriculture firms IBP and Tyson showed "you have to prove there's been an endemic and sustained decline in the business. Short-term blips don't do it."
Private-equity firms walk a tightrope in situations like this; if they fail in their effort to call a MAC, they would have to do the deal. But the bank that is financing them could use the fact that KKR called a MAC to get out of that commitment.
"The conventional wisdom is the standard for a MAC is extremely high. KKR are very savvy deal guys and aren't likely to do anything foolish," said Mr. Nowak.
Write to Dana Cimilluca at firstname.lastname@example.org and Dennis K. Berman at email@example.com