Elon Musk’s escape hatch | Global finance magazine

Elon Musk is aiming to be the second buyer in history to exit a merger due to significant negative effects, but it won’t be easy.



Fresenius Kabi AG, a Germany-based pharmaceutical company, wanted in a $4.3 billion deal to buy US drugmaker Akorn for $4.3 billion.


That’s no small feat in Delaware courts, where sellers generally have the upper hand. Fresenius, however, argued that his target suppressed information that would have a “material adverse effect” (MAE) on the stock price. Whistleblowers revealed that Akorn submitted falsified data to the Food and Drug Administration, and Akorn’s stock price plummeted. In 2018, the court ruled for Fresenius, making it the first buyer to successfully emerge from a merger due to an EAW.


Elon Musk hopes to be the second.


“Sellers aren’t particularly interested in giving an easy fix to buyers who are unsure,” notes Bryan Cummings, senior financial sponsor banker at Cannacord Genuity. Those with cold feet usually have to pay a “break fee” of 1% to 3% of the transaction. An EAW allows buyers to exit without penalty.


As a result, of course, sell-side negotiators are looking to limit them to the “truly extraordinary,” Cummings says, so buyers “have no particular incentive to deploy the MAE catapult,” either.


Chancellor Kathaleen McCormick, currently Chief Justice of the Delaware Court of Chancery, ordered Musk and Twitter to begin a trial in mid-October, to determine whether Musk, with a net worth hovering between $250 billion and $273 billion, can rightfully pull out its $44 billion deal to buy Twitter, with the social media giant boasting more than 220 million daily active users.


Too many of these users, Musk says, are “fake accounts” or so-called “bots.” This means that Twitter is “likely to suffer a material adverse effect on society,” its legal counsel wrote to Twitter’s chief legal officer. Spam accounts make up less than 5% of daily users, Twitter responded, and filed a lawsuit to ensure Musk makes the purchase or pays a $1 billion break fee.


M&A professionals and legal experts have since participated in this drama, a revealing retrospective on how MAE was used to nullify a deal. “Musk has nothing here,” said Accelerate CEO Julian Klymochko. Global finance. “The bot problem is, quite frankly, dishonest.”


In previous MAE cases, such as Akorn’s, the target company’s finances have fallen off a cliff. Twitter remained stable. “It is basically impossible here to claim an EAW,” says Klymochko. “It’s kind of laughable how much they can come up with.”


Burden of proof


While EAWs are typically used in relation to the time between signing and closing, giving the buyer a way out if the business suffers a sudden downturn, it is often less a matter of what may be claimed, and more of a matter of what the courts might accept, Cummings says.


“The accepted opinion is that an EAW should be specific to a company, quantitatively significant – the material part – and durably significant. The material doesn’t mean a quarter of the poor performance,” says Cummings. “If a target experiences a change in a payout rate, it doesn’t necessarily qualify, as that risk is an integral part of the industry.”


Such was the case in July 2021 when Bardy Diagnostics Inc. went to court with Hill-Rom. The Delaware Court of Chancery found that there was no EAW within the meaning of the agreement between the two medical device companies. As a result, Chicago-based Hill-Rom had to pay $375 million.


EAWs can also be external factors, such as a lawsuit, weather-related losses (an act of God) or something as simple as a key customer terminating a contract. And even then, “it’s a very high threshold,” says Don Ritucci, head of healthcare mergers and acquisitions at investment bank Oppenheimer & Co.


As part of a $50 million healthcare services deal, Ritucci recently announced that one of Target’s clients will not be renewing their contract. “In the end, it was negotiated and the buyer closed the deal, but at a lower price,” says Ritucci. From a seller’s perspective, it’s a wise move, he adds. Why? Because if a deal with your number one buyer is canceled, second and third choice buyers will feel “blood in the water”, and their bids will either be much smaller or disappear altogether. “Think of BATNA, or the ‘better alternative to a negotiated settlement’,” says Ritucci. “Once you’re hitched, you have to really try to see it through.”


In 2020, the pandemic was cited by negotiators as a potential EAW. But in April, as Covid-19 infections and deaths devastated the UK, London-based insurance broker Aon notably ruled out the pandemic as a potential EAW trigger in its £30bn deal. dollars on all shares for Willis Towers Watson – ultimately the biggest M&A deal. that year and the largest ever recorded in the insurance industry. Had the deal failed, Aon would have had to pay Willis Towers $1 billion.


An EAW can also serve as a negotiating lever. That same year, Simon Property Group wanted to leave the Taubman centers at the altar. Taubman sued, and the deal was done — just before the trial began — at a discounted price of 18%. Settling for a discounted price is the most likely scenario, Klymochko says. Musk may also be able to convince a judge that Twitter simply did not provide him with adequate information as promised. This would make the spam account problem useless.


Musk could also broker a deal where he rescinds his actions instead of the hefty financial penalty, though that’s highly unlikely, Klymochko adds. “Currently, Elon Musk owns 9.5% of Twitter shares outstanding, or 73 million shares. These shares have a redemption value of $4 billion at $54.20 per share, or nearly $3 billion. at current market value,” Klymochko said. “If Musk doesn’t directly buy Twitter, he would want to spin off the company. An amicable solution would be for him to give up his shares for no consideration, which would result in a penalty of $3 billion to $4 billion, depending on how it is calculated. As a result, each remaining share would be made up of a larger portion of the company.


The surprise factor


EAWs are also linked to new events and circumstances that were previously unknown or unexpected. If Musk is looking to paint Twitter as fraudulent based on the number of bots and spam accounts, that’s a tough hill to climb.


“Musk couldn’t get comfortable with the number of real accounts [versus] bot accounts, but I don’t see how this is a “significant adverse event” because it would be a condition that already existed, not a new “event” that happened. product and caused the business to deteriorate after it signed its agreement or completed its due diligence,” said James Caruso, chief financial officer of J. Knipper and Company.


Caruso is right. After all, Musk has been an active Twitter user since 2009. Today, he has more than 102 million followers, who have grown accustomed to his penchant for memes, trolling and lewd comments. Musk also mentioned the robots when the deal was first announced in April. He pledged to make Twitter “better than ever by improving the product with new features, making algorithms open source to increase trust, defeating spambots, and authenticating all humans.”


Musk also has fuel in the form of a whistleblower complaint, recently filed with regulators. Former Twitter security chief Peiter Zatko, who was fired in January, says the company misled regulators and its own board about certain security practices and spam controls.


Plus, Musk can afford the best legal advice. The entrepreneur retained Skadden Arps Slate Meagher & Flom, a leading M&A law firm, and Los Angeles-based Quinn Emanuel Urquhart & Sullivan as legal counsel. Whether they can effectively wield what Cummings calls the “but canon” remains to be seen. “Think of EAW as the ‘but…’ canon: I had planned to buy this company, ‘but’ this company is no longer the one I signed up for,” Cummings says. “I really want to close the deal, ‘but’ the seller was totally fraudulent in their representations and I can’t be expected to close.”


Except that firing a shot doesn’t cause the castle walls to collapse, he adds: “Exactly the opposite. A world where MAE disputes frequently nullify deals is a world in which mergers and acquisitions – an uncertain business at the best of times – becomes a game of roulette.


Twitter also has legal heavyweights in its corner. Wachtell Lipton Rosen & Katz and Simpson Thacher & Bartlett are both advising the San Francisco-based company to ensure the Musk deal stays intact or bears fruit. Twitter even sought advice from Wilson Sonsini, whose partner William Chandler III is a former Chancellor of the Delaware Chancery Court.


“Merger contracts are meticulously negotiated and agreed upon, and a free trade clause throws all that to the wind, creates uncertainty in the market that would reduce deal activity and, over time, discourage deals that would benefit shareholders,” Cummings said. “Delaware knows that, which is why, both in language and in practice, proving the DEA is an extremely high bar to achieve.”

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