NYT: Parsing the Mystery Foundry Press Release
October 27, 2008, 8:27 am
Foundry Networks announced on Friday that it had adjourned its shareholder meeting from that day until Oct. 29 because of “recent developments related to” its proposed merger with Brocade Communications. This stunning and ominous disclosure, coupled with no clarifying statement, promptly resulted in a 25.7 percent drop in Foundry’s stock price.
I nominate Foundry’s as the worst in a string of badly worded press releases by a number of companies in recent weeks.
It is at these times that I wish we had a market regulator, similar to England’s Financial Services Authority or its Takeover Panel, which ask Foundry why this disclosure is so vague. This regulator would, if necessary, force something substantive out of the company.
If the development was non-material, why adjourn? And if the development was material and the company still want to adjourn, why spook the market this way? This is a subject for another writing, but clearly Foundry felt unconstrained by the federal securities laws on disclosure.
Instead, we are forced to guess. No doubt everyone is thinking a financing failure.
The Foundry-Brocade deal is a new one in a string of strategic deals with limitations on specific performance in the case of a failure of financing. Others include the Hercules-Ashland merger. These deals are based on private equity transactions and limit the target’s ability to force the buyer to close if financing fails. In such a case, the target can only get a reverse termination fee.
A “financing failure” in the Foundry acquisition agreement is defined as:
[A] refusal or other failure, for any reason, on the part of any Person that has executed the Debt Commitment Letter or any definitive financing document relating to the Debt Financing, or on the part of any other Person obligated or expected at any time to provide a portion of the Debt Financing, to provide a portion of such Debt Financing; provided, however, that any such refusal or other failure shall not be deemed to be a “Financing Failure” for purposes of the Agreement if such refusal or other failure results directly from a Willful Breach of any of the Parent Financing Covenants.
If there is an uncured “financing failure,” Brocade cannot be forced to complete the deal – there’s a bar on specific performance. (But upon Foundry’s termination of the agreement, Brocade must pay an $85 million reverse termination fee.) Moreover, this prohibition on specific performance includes some unusual language, which states that Brocade is not required to pursue its banks for reneging on their lending commitments. And if there is a financing failure, Foundry cannot even sue for a breach of Brocade’s representations and warranties on adequate financing.
Brocade has already placed its needed $1.225 billion senior loan into escrow. There could still be some failure on this loan, but there are likely slim grounds at this point. Brocade has syndicated bank debt and was in the market with an offering for $400 million in senior notes to replace a $500 million bridge loan from its banks. That offering may also be an issue – but the bridge loan is still there. Perhaps the bridge is the financing failure?
But in that case, the agreement requires Brocade to use its reasonable best efforts to obtain alternative financing on terms not materially less favorable. If the bridge has failed, surely Foundry’s shareholders can cough up the extra $500 million as alternative financing. After all, they stand to lose much more if the deal collapses.
And I think there is a good argument under the merger agreement that Brocade cannot refuse such financing if it isn’t materially less favorable, lest it risk being in willful breach of the agreement and triggering a damages suit beyond the reverse termination fee.
So my guess – a big one – is that there isn’t a financing failure. Maybe Brocade is seeking an extension of the closing date. That of course would be good news, and therefore really bad disclosure on Foundry’s part, so I doubt that would be it. (It remains possible.)
Rather, in light of this and the status of the financing, Brocade may be looking for a different out. Maybe there is something related to accounting for the quarter. Or maybe Brocade wants to review its closing conditions in search of an out.
In any case, Brocade can’t just come to the table and demand a price concession, threatening to not close the deal. They need an out, or one of their lenders to refuse extending the bridge loan. Brocade can’t overtly orchestrate this, or else its out for a financing failure will disappear. It also still faces the alternative financing problem.
The deal also has a cash condition, which does not appear to be a problem. Foundry has $1 billion in cash, more than the $800 million needed under the condition, and the company’s latest quarter appeared to be fine. Perhaps there are issues of revenue recognition, but who knows?
Moreover, this cash condition refers to the satisfaction of “the dollar amount necessary to enable the condition set forth in clause (xi) (relating to consolidated unrestrctived cash and cash equivalents) of Annex III to the Debt Commitment Letter to be satisfied.” Of course, the debt commitment letter isn’t disclosed, so no one in the public knows what this means.
Absent any undisclosed facts, I don’t think this is a matter of a material adverse effect. The agreement is governed by Delaware law, and the forum is Delaware. As recently as in the Huntsman case, the Delaware courts have reinforced the principle that an MAE is hard to prove and must be of a long-term durational quality. There doesn’t seem to be anything here to support that.
At this point, I could even guess some type of breach by Foundry of one of the covenants, as in the Harman Industries transaction. But again, there is no evidence of this.
While we’re at it, let’s look at Brocade. The company’s fiscal year ends on Sunday. Has something come to light? Again, we have to say for now, “Who knows?” But Brocade had an analyst day on Sept. 17, and nothing came up to my knowledge.
So we’re left with a bit of a mystery, one created by Foundry itself. I suspect we will learn it before the Oct. 29 meeting. In the meantime, I can make only an educated guess about what it may be.
Given the shorthand nature of this disclosure, however, I am betting it is not good news. though, I am betting it is not good news. –Steven M. Davidoff |
