Submitted by Thomas Kirchner, CFA & Paul Hoffmeister of Camelot Portfolios
- Merger canceled for Material Adverse Change and breach of contract
- Merger agreement favors Taubman, which will likely to sue
- Most likely outcome is a large monetary settlement
The latest casualty of the Covid crash in the M&A world is the $3.6 billion acquisition of mall owner Taubman by Simon Property Group. 88 mergers with a total equity value of $60 billion have been terminated in North America, including the $35 billion HP/Xerox and the $7.5 billion Hexcel/Woodward deals [i]. Unlike these two deal terminations, which were consensual, the Taubman/Simon merger will end up in court, an outcome that many arbitrageurs would have discounted as unlikely due to the strong language in the merger agreement.
On February 9, the two companies executed a merger agreement under which Simon would purchase 80% of Taubman’s shares for $52.50 per shares; the Taubman family would not sell its 20% stake but would remain a minority shareholder. On June 10 Simon announced the termination of the merger, citing the impact of the crisis on Taubman and breach of contractual obligations by Taubman.
Can Simon Back Out?
Merger agreements have been tightened since before the financial crisis to make it harder for companies to back out. Other than outright fraud, which is a completely different story, a company needs to show that a target has suffered a Material Adverse Change (MAC). The devil is in the details: Delaware Courts, the gold standard for corporate law in the U.S., have held that just a bad quarter is not enough to call a MAC. A decline in sales needs to be sustained and expected to last over an extended time. Moreover, the decline has to impact the target company disproportionately compared to its industry. If the judge finds that no MAC occurred, then the buyer can be forced to execute the purchase. This is called Specific Performance.
In the case of Taubman, that would mean that in order to claim a Material Adverse Change, Simon Property Group will have to show that Taubman’s malls are impacted more severely than malls in general. Considering that mall operators, in general, were already under stress when the merger agreement was signed on February 10, making a convincing argument that Taubman has suffered even more than everyone else in recent months is going to be a challenge; in particular when you consider that this crisis is turning into the worst commercial real estate market since 1986 and it is too early to know where in the industry the winners and losers will be.
Working in Taubman’s favor, however, is the merger agreement which is not governed by Delaware but by Michigan law. And Michigan is Taubman’s home turf. In 2002 the two companies sued each other – in the exact opposite constellation. Simon wanted to purchase Taubman through a hostile takeover but Taubman resisted. It ended up winning the battle against Simon by lobbying Michigan legislators to change M&A State laws. While investors may be tempted to extrapolate this past experience to the Material Adverse Change debate it is unlikely to work now – any legislation would have to be made retroactive, which would be an uphill battle.
Interestingly, Simon Property Group claims not only Material Adverse Change but makes a second claim, which is contractual: Taubman “has failed to take steps to mitigate the impact of the pandemic as others in the industry have, including by not making essential cuts in operating expnses and capital expenditures.” [ii] This argument appears to be even more difficult to prove – what are “essential cuts” in the context of Taubman’s business? This is likely to be an area expert witnesses will have diametrically opposed opinions, depending on who pays their fees.
Remember Genesco/Finish Line?
Investors who have been in the merger arbitrage market for some time may recall the big M&A victim of the 2008 crisis, the acquisition of Genesco by its rival Finish Line. This highly leveraged transaction was canceled when financing conditions deteriorated during the crisis to the point that the bank would have had to take massive writedowns on the loans had they actually provided funding. To get out of its funding obligations, UBS sued Genesco for fraud, a claim that the court threw out as unfounded, but only after a few months. In the end, the two companies and UBS settled their disagreements with UBS paying $175 million in damages to Genesco, and Finish Line issuing 12% of its stock to Genesco as a termination fee[iii].
“Taubman believes that Simon’s purported termination of the merger agreement is invalid and without merit, and that Simon continues to be bound to the transaction in all respects […] including, among other things, the right to specific performance and the right to monetary damages, including damages based on the deal price.” [v] In other words: Taubman will very likely sue Simon Property Group. Under the merger agreement, a termination fee of $111,851,783 [iv] would be payable. However, by basing damages on the value of the transaction Taubman could receive an even higher amount.
For now, Taubman will likely go ahead with all actions necessary to complete the called-off merger. The shareholder meeting to approve the transactions continues to be scheduled for June 25. If shareholders approve the transaction, which is likely too, then Taubman can demand specific performance. Here is what the merger agreement says about specific performance:
“The Parties acknowledge and agree that irreparable damage would occur in the event that any of the provisions of this Agreement were not performed in accordance with their specific terms or were otherwise breached, and that monetary damages, even if available, would not be an adequate remedy therefor. It is accordingly agreed that the Parties shall be entitled to an injunction or injunctions to prevent breaches or threatened breaches of this Agreement and to enforce specifically the performance of the terms and provisions of this Agreement, including the right of a Party to cause the other Parties to consummate the Transactions. It is agreed that the Parties are entitled to enforce specifically the performance of terms and provisions of this Agreement, without proof of actual damages (and each such Party hereby waives any requirement for the securing or posting of any bond in connection with such remedy), this being in addition to any other remedy to which they are entitled at law or in equity. The Parties further agree not to assert that a remedy of specific enforcement is unenforceable, invalid, contrary to Applicable Law or inequitable for any reason, nor to assert that a remedy of monetary damages would provide an adequate remedy for any such breach.”[iv]
While specific performance is definitely a potential outcome, we believe it is more likely that the companies will settle for substantial monetary damages. The key here is, are the 20% of shares held by the Taubman family, which would not be cashed out in a merger.
If we were the Taubmans, we would be hesitant to be minority shareholders in a Simon-controlled company whose merger we just forced through in the courts against the wishes of the future majority shareholder. Therefore, we do not believe that the merger will be completed or recast at a lower price. Instead, Taubman will likely litigate for substantial damages. It is worth noting that litigation finance is a well-developed financing niche today so that Taubman could probably get some financing for its claim, should it need liquidity in the near term.
[i] Source: Bloomberg North American M&A database.
[ii] Form 8-K filed by Simon Property Group with the Securities and Exchange Commission on June 11, 2020.
[iii] Chad Bray: “Finish Line, Genesco Settlement Terminates $1.5 Billion Merger.” The Wall Street Journal, March 3, 2008.
[iv] Merger Agreement filed by Simon Property Trust with the Securities and Exchange Commission as Exhibit 99.1 to Form 8-K on February 9, 2020.
[v] Form 8-K filed by Taubman Centers with the Securities and Exchange Commission on June 10, 2020
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