Tuesday, July 22, 2008

With Friends Like This ...

... who needs enemas?

Okay, okay. Being the self-appointed expert on investment banking compensation on the worldwide web, I guess I have a professional obligation to comment on Evan Newmark's recent cherry bomb post on M&A fees over at the WSJ Deal Journal.

Summary: He wrote a doozy.

I have to say, I kinda like Evan. He's brash, opinionated, and unafraid to publish his smirking picture in a town and a time when the average investment banker hides his Wall Street Journal under a Daily News on his subway commute to work and carries a bounty on his head. He's got cojones, that guy, I'll give him that. And he usually does a respectable job pitching his commentary and explanations of Wall Street to the cheap seats.

But this time I think he forgot he wasn't regaling a bunch of industry buddies at the Bull & Bear. Judging by the tone and content of the majority of comments left on his post, I think he really stepped in it. He might want to hide out a little in the Hamptons for a few weeks or so for this to blow over. Either that, or take to wearing a mustache, wig, and sunglasses at his regular day-trading venue.

Now his argument—that M&A bankers occasionally really do earn their mouthwatering fees—happens to be one that I agree with. If memory serves, I have written as much one or two times in the past.

But illustrating his contention with anecdotes like this falls short—in my opinion—of driving the point home:
Almost a decade ago, as a Goldman Sachs banker, I advised a European client on buying a U.S. publicly traded company for a couple of billion dollars. We had worked for months on the deal, and in a few days of negotiations, hammered out the terms with the board of the U.S. company.

Our client was overjoyed. We had negotiated hard for a purchase price that was 6% above where the shares were then trading.

Effectively, a no premium deal. An M&A banker’s dream. Or nightmare.

It turned out that none of the U.S. company’s large institutional shareholders tendered their shares. They didn’t like the price. We had an agreement to buy the company, but no company.

So now we had to go back to the U.S. shareholders with another price. But how much to offer?

We talked to about a dozen large shareholders. Forget the 6% premium. Now, it was highway robbery. The shareholders demanded takeover premiums of 50% to 75%. That meant another $500 million straight out of my client’s pocket.

That was unacceptable. So my client asked me at what price we could get the deal done. A tough judgment. The team talked it over. We consulted colleagues. In the end, the call was based on gut instinct. Another 25%. No more. No less.

At the close of the tender, we gathered about 55% of the shares, just barely above the 50% needed to close the acquisition.

The good call saved our client several hundred million dollars.

Now, as an M&A practitioner myself, I appreciate that every deal is different, and it is practically impossible to critique a banker's advisory performance from the outside, since one never has access to all the pertinent facts. This generic problem is exacerbated, in this instance, by Mr. Newmark's playing rather fast and loose with the numbers in his illustration, creating the unfortunate effect of generating more fog and confusion that true understanding. But I have to agree with some of his interlocutors that he does not appear to have covered himself in glory in this transaction.

For one thing, it is a rather elemental error in M&A negotiation to fail to consider the motivations and likely behavior of parties which have an important say, or vote, in a deal but which, usually for regulatory or legal reasons, do not have a seat at the bargaining table. As I said, I do not know the complete set of facts, but it does appear to me a rather significant blunder not to have better anticipated the likely reaction of the target company's large institutional shareholders to the 6% takeover premium agreed with the target's Board. (One also might wonder whether the target Board was so easily persuaded to accept this unusually low premium because they knew full well that their shareholders might very well create the conditions for another, much larger, bite at the apple. Hmm. If so, so much for Mr. Newmark's "hard" negotiating.)

For another, in my deal experience one of the most important services a buy-side M&A advisor renders his or her client is a carefully judged, thoughtfully rendered opinion as to the likely "clearing price," or ultimate sale value, of the target company (in the form of a range). It is this type of information, for example, which should be completely understood by the client before it ever undertakes an approach to a potential target. The client should have carefully weighed the likely transaction price, the potential value it could achieve by purchasing the target, and its own ability to pay before its CEO ever picks up the phone to call his counterpart at the target company. It should not be, as Mr. Newmark's narrative implies, an ad hoc add-on or "bonus" service provided to the client under pressure when the original negotiating plan goes off the rails.

Next, while I think I understand what Mr. Newmark was trying to convey by asserting that the final offered premium of "another 25%" (31% in aggregate?) was determined by "gut instinct," I fear he does his firm and his industry colleagues a disservice by saying as much in the pages of the Deal Journal.

There is no "right" number in merger negotiations, just as there is no one, right number in valuing any for-profit enterprise. Valuation, whether in the market or in a deal, is well and truly—and ineluctably, now and forever—an art, not a science. But such gut instincts—rather more accurately described as carefully considered judgments—on the part of M&A advisors are or should be based on a mountain of careful, well-judged analysis, comparison, and argument. You never go to your counterparty in an M&A deal and say your offer of $100 million for his pissant company is based on gut instinct; you give him reasons. You show him where his company's peers are trading in the marketplace, you show him the levels at which other companies in his industry have been bought and sold, and you share your assumptions of the future value of his business enterprise with exhaustively analyzed and justified discounted financial projections. He, if he is not an idiot, will counter with his own exhaustive analysis showing why his gem of a company is really worth $500 million. And you're off to the races.

I would expect no less from Mr. Newmark when he went back to the target company's shareholders with an improved offer, and I am sure they did, too.

Lastly, I find Mr. Newmark's implicit argument that Goldman Sachs earned its fee by saving his client "several hundred million dollars" disturbingly similar—and just as unconvincing—as Mrs. Dealmaker's occasional attempts to justify her splurge on a $10,000 cocktail dress by crowing that it was marked down 40%: "But Honey, look how much money I saved!" Sorry, Evan, no cigar.

Anyway, Mr. Newmark seems to have convinced himself he came out a hero in this transaction, smelling like a rose. (Interestingly enough, Goldman Sachs as a firm seems to have a preternatural ability to convince its clients they have received the best investment banking advice available, no matter how badly their bankers have fucked up. Perhaps Mr. Newmark is still drinking the 85 Broad Street kool aid.) To me, based upon what he has told us, he looks more like one of the Keystone Cops.

M&A bankers do earn their transaction fees, by and large, Dear Readers, but not by acting like this.

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