It’s almost crazy to mention that you have regular deals, and then you have Warren buffet style deals. And when looking at a Warren buffet style deal, the acquisition of H.J. Heinz for $23 billion certainly fits the bill.
Warren Buffett is known specifically for choosing a target that he like to buy, letting them know his price and then ultimately acquiring that target without doing too much bargaining in the process. Would you like to take a look at a few examples? Then check out the Berkshire Hathaway acquisitions of Wrigley’s, Burlington Northern Santa Fe railroad and Lubrizol. In every instance, once Warren Buffett came to the table, each company lost interest in looking for any other bidders. That’s a powerful position to be in.
As of this time, it’s difficult to know the full story around the Heinz acquisition, and we have no clue how they looked at other suitors when trying to make sure that their shareholders will get the best deal. Once the proxy statement for the deal is filed, we will certainly learn more information. But as I’m sure you can imagine, this is already a very unusual deal from the beginning. If you’d like to see further evidence, then you can take a look at the last Friday morning agreement filed in regards to this deal.
One occurrence you need to be aware of is that there is no “go shop” provision that will allow Heinz to search for other bidders once the deal was announced. This type of provision is very common when a private equity deal takes place, and it also happens in some strategic deals as well, since it prevents the target from negotiating with any other bidders prior to announcing the deal.
But once the deal is announced, the target company can do a market check and look to see if there are any other bidders. If another bidder does come along, then the termination fee they would have to pay in order to acquire the company is actually lower than when there is no go shop provision in place.
There are some very good reasons for this particular type of mechanism. For starters, it will let the board of directors feel comfortable that it is actually receiving the best reasonable price that is available. Secondly, even though a ghost out provision is not mandated under the laws of Delaware, companies feel like it helps them satisfy their Revlon duties, which basically requires that a board of directors receive the highest price that is reasonably available when they sell a company.
You may have already gathered this, but there is no go shop provision in place during the Heinz deal. The company has only negotiated with 3G Capital and Berkshire Hathaway, according to all reports that are circulating. If there were another bidder to possibly come along, they would have to pay a $750 million termination fee, and there would also be another $25 million worth of expenses. That estimates to roughly 3% of the total transaction value, and this is a standard for a deal like this. But if a go shop provision were in place, it would typically be about three times less than this amount. No matter what way you look at it, we are still talking about a very large sum of money.
The deal is ultimately structured a lot more as a private equity deal than a strategic deal. 3G and Warren Buffett are financial buyers, and this deal specifically depends on the financing. They have jointly negotiated a common right in the private equity deals that if there is a failure and financing, Heinz will be able to sue them and they will be forced to obtain the financing. But if it is still not available, both buyers will be able to walk away from this deal, even though they would have to pay Heinz a whopping $1.5 billion.
I’d like to make a note that both Berkshire Hathaway and 3G capital also negotiated a very unique financing extension provision that will actually be for Heinz from forcing the payment of this see immediately if there is an event that financing failure takes place. This will allow the buyers to delay the termination and force the banks to finance this deal. We are going to officially call this new requirement The Ketchup Provision.
Getting back to the main story, it appears that Heinz has purposely gone out of its way to limit their options. Do you have any idea why they would do this?
One potential reason is simply the market dynamics, meaning that 3G and Warren Buffett didn’t allow a go shop provision with the deal. Since mergers are often driven by the market, the very common go shop provision use in situations like this would have provided Heinz a good reason to draw a line in the sand. All in all, it would show the shareholders that this truly is the best deal available to them.
There is also another potential reason that may come into play – the Heinz peculiarities. The company is actually incorporated in Pennsylvania, unlike most major American corporations that incorporated in Delaware.
The law of that state is created to provide total latitude to boards when it comes to deciding whether or not they should reject or accept the takeover offer. Under the Pennsylvania statute, the board is not required to take the shareholders into consideration as their main deciding factor when they choose to sell the company. The directors are able to base their decision on the interests of the “employees, suppliers, customers and creditors of the Corporation, and upon communities in which offices or other establishments of the Corporation are located.”
The overall effect of this particular statute is there to repudiate the Revlon rule in Delaware. Heinz, which is a Pennsylvania company, has no obligation whatsoever to take the highest price possible for their shareholders, and the courts in Pennsylvania have rejected this doctrine specifically. Instead, there are other interests such as community that come into play. (Mister Buffett and 3G must agree to section 7.15 that states that Heinz headquarters must stay in Pittsburgh, the company has to continue to retain the name Heinz, and they have to preserve the charitable commitments and heritage of this business. They also have to honor the naming rights of Heinz Stadium.)
Based on the advice of Heinz lawyer – Wachtell Lipton for special committee and Davis Polk for the company – they are told that the board doesn’t have to make shareholders their main requirement, and since this isn’t the state of Delaware, they can take other interests into consideration and still justify the sale to 3G and Warren Buffett.
Deals like this have been made before under great criticism. During the year 2009, Apax Partners purchased the Bankrate under similar circumstances. Since the Corporation was based out of Florida, they did not have to adopt the same safeguards you would normally come across during a private equity deal, mainly because the Florida laws did not require it. The board of Bankrate chose to go with the letter of the law instead, and they were also advised by Wachtell.
So what it all boils down to is this… If there is another bidder interested in purchasing Heinz, since there is no go shop provision in place, the Board of Directors can legally turned down this bid even if it is higher. The board can easily justify this rejection as the better move for Heinz if it feels the original deal upholds the interests of the community.
In reality, the state of Pennsylvania truly assisted Warren Buffett in his latest blockbuster deal.