NYT: Brocade’s Financing Problems in Foundry Deal
November 17, 2008, 4:55 pm
Foundry Networks filed the proxy statement on Friday for its renegotiated agreement to be acquired by Brocade Communications Systems.
From a review of the history of the transaction section, it appears that there was indeed a financing failure and that it was related to a difference of interpretation between Bank of America and Morgan Stanley, the banks that agreed to finance this transaction, and Brocade on the interest rate provisions (probably the flex terms) of the $400 million in bridge financing. Since the reason is not specifically disclosed in the history as to what it actually was, I am drawing the inference that it was related to the $400 million financing as the $1.25 billion in senior credit facilities had already been funded.
Nonetheless, my inference is supported by another statement in the proxy that Foundry rationally concluded that its shareholders might bear the costs of the interest rate difference problem on a present value basis (35 cents to 45 cents a share), which again appears related to filling the gap on the $400 million bridge financing. Brocade, however, came to the table saying that if it could not get the financing it bargained for, it had a $400 million financing failure and an out if no alternative financing was available.
I don’t know why Foundry did not say its holders would take back paper as alternative financing and threaten a lawsuit. They may well have — but the acquisition agreement was ambiguous and, given the risks, Foundry may have rationally concluded to just take the haircut and take a complete deal. Here I think of the words of the Blackstone Group in the Alliance Data Services litigation, “a merger agreement is not a suicide pact.” I only wish Foundry had done a better job of managing their disclosure.
According to the proxy statement, the Foundry board clearly knew when it postponed the shareholder meeting that Brocade was talking about a financing failure. Yet, they only announced the specifics the week after their postponement.
The proxy makes it pretty clear that Foundry was backed against the wall with bad choices all around. Once again, j’accuse — it appears that the financing banks here (perhaps with some level of complicity with Brocade) arranged a refinancing on deal documents previously agreed upon. The banks appeared to do this by leveraging the ambiguity inherent in any debt commitment letter which is, after all, simply a more detailed letter of intent.
I think this deal shows the weakness of this version of the new strategic model that incorporates a reverse termination fee private-equity-type provision in the cases of financing failure. A simple cost of capital issue allowed Brocade to engineer the removal of its equity component in the deal and an additional $250 million cash price adjustment. A strategic acquirer is not in the market for future acquisitions the way a private equity firm is — it has a greater hit to its reputation if there is no closing and perhaps gives more leverage with the banks. Here, I note that Blackstone completed its acquisition of Apria during this same time. I don’t think this would have happened over such small beer had it been a private equity firm, but who knows?
The kicker is that Foundry agreed to a reduced deal price and has no additional deal protection devices. The agreement is the same option model that allows for financing failure with a $40 million higher reverse termination fee payable if there is another uncured financing failure. There is a two-week go-shop period that allows Foundry to shop itself for a higher bid, but Foundry was always a bit of a desperate seller to begin with (hence its predicament and a weak agreement that allowed for all of this to happen), and so this is cosmetics.
Finally, why was the stock consideration in the deal eliminated? The explanation in the proxy is that Brocade said the decline of its stock might make a shareholder vote on its side might be necessary. But how could that happen? The exchange ratio for the stock was fixed — there is no way the stock price affects whether there is a vote. If anyone has any idea what the real reason is, please post below. I suspect it somehow it relates to the conversion of Foundry’s equity awards, but I am not sure.
Final note — almost as sad is the fact that Foundry had to switch counsel in the midst of this renegotiation to White & Lee as its legal counsel at Heller Ehrman, Steven Tonsfeldt, left that firm upon Heller’s dissolution. Reportedly, he was to go to Cooley Godward, but did not do so because of a conflict – mainly Cooley is representing Brocade. Meanwhile, Foundry was forced to pay an extra undisclosed fee to Houlihan Lokey because its financial adviser, Merrill Lynch, was being acquired by one of the balking banks here, Bank of America, and so was deemed conflicted. Sigh.
Go to S.E.C. Proxy Filing from Foundry Networks »
Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the legal aspects of mergers, private equity and corporate governance. A former corporate attorney at Shearman & Sterling, he is a professor at the University of Connecticut School of Law. His columns are available at The Deal Professor blog.
3 comments so far...
1.November 17th,
2008
6:56 pm a few quick points
The issue about the banks and BRCD having a difference of opinion regarding certain terms of the financing CL was known on or before Oct 9, fifteen days before the announcement of the meeting adjournment. That’s a long time to leave the matter undisclosed.
That this merger agreement allowed BRCD to exploit what appears to be some technical or pricing ambiguities in the CL to get a substantial pricing discount should be a very important indicator that seller deal counsels have to come up with some better innovations than this model. Of particular concern is the best efforts covenant in this contract which explicitly denies FDRY the right to force BRCD to litigate against the banks and elsewhere in the contract eliminates BRCD’s liability for misrepresentations on its “financing”.
Finally I think in several of your blogs you hinted that strategic buyers have reduced “reputational” inhibitions on bad deal termination behavior relative to PE buyers. I honestly don’t think the data regarding DMA terminations or repricings would support that view. But whatever reduced reputational inhibitions on that behavior may be industry specific and depend on whether the contracting parties have relationships other than that of buyer and seller. I note that HPC-ASH and WWY-MARS closed on time without a hitch and these contracts were basically the same as FDRY-BRCD’s. When I think of the weird ballets of terminated hostile offers from MSFT for YHOO and ERTS for TTWO, I wonder if it’s a new economy old economy or east coast west coast thing. Maybe these new fangled guys play by a different set of rules.
— Posted by north fork investor
2.November 17th,
2008
9:33 pm Bobby Johnson liked the fit with Brocade or they would have walked. He sees the combined company as a very legitimate competitor to CSCO, and he will be a big part of that. He may not have wanted to put the new merged company in a precariously bad financing arrangement on the bridge loan. Moving forward was the best option given the circumstances. As a long time holder of FDRY, I was disappointed in the haircut. But I trust BJ’s knowledge of the industry and that this is a strategically correct move for the company. He will be using the ‘go-shop’ clause to make sure there are no far superior offers and to protect the BOD. But ultimately, this has been about two companies and CEO’s, Johnson and Klayko, who have been committed to the vision of the combined entity.
— Posted by Neil LaGrange
3.November 17th,
2008
10:19 pm Another unfortunate (unfortunate for the target shareholders) example of the lack of integrity among the bankers involved in funding deals. They are truly the scum of the earth, justifying their existence only to the extent they can tilt the playing field to their advantage time and again.
Brocade isn’t without fault here too, as they misrepresented themselves to Foundry’s board and shareholders with regards to their ability to fund this transaction. And finally, how sad that Foundry’s Board (with poor advice from their scumbag advisors) didn’t strike a more secure deal that afforded better protections to their shareholders.
How can we restore honor to deal making?
— Posted by giacometti |
