Why is Debenhams paying its bidders just to look?
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When is an auction not an auction? When Deben-hams is selling itself, of course.
Splashed all over the national press last week was the bizarre arrangement that Debenhams had dreamt up to offload itself to either CVC and Texas Pacific Group, or the consortium consisting of Permira, Blackstone Group and Goldman Sachs PIA.
First, Debenhams has agreed to pay Permira a £8.5m break fee should
its £4.25 per share offer, valuing the retailer at £1.5bn, be trumped by a higher offer. So far, so good.
CVC and Texas Pacific Group, on the other hand, will be paid £1m per week to conduct due diligence on Debenhams. With estimates that this process will last around six weeks, CVC and Texas Pacific could earn £6m just for looking at the books.
There has been no indication so far that these two private equity houses have already or indeed are ever required to make an indicative offer. In normal circumstances, a break fee is negotiated when a bidder makes an indicative offer. However, the Debenhams deal is not your run-of-the-mill transaction.
At first glance, Debenhams' decision to pay this fee makes the company look a bit desperate. Isn't the retailer an attractive enough business to persuade a whole host of equity houses or corporates to make a bid for it? It seems to be a hopeless cause if Debenhams has to pay bidders to even look at it. It's like giving someone a tenner to be your boyfriend.
As always, City lawyers are torn on this. Some say the idea of paying a bidder to investigate a potential target is becoming the norm, specifically where private equity houses are concerned and especially in public-to-private deals. Lawyers say that this is because private equity houses are investing other people's money and it is not plausible to spend thousands on both financial advisers and, of course, lawyers doing due diligence when it may not result in a bid. Do me a favour.
Private equity houses are businesses and therefore, you would think, have cash reserves that would finance the cost behind assessing a potential purchase. And anyway, whose cash are companies spending when they invest in sizing up a deal? The shareholders', that's who. But as a target,
Debenhams' shareholders must be simply jumping for joy at the prospect of shelling out £6m willy-nilly.
It is unclear whether CVC and Texas Pacific would receive a more traditional break fee on top of this initial inducement fee. One lawyer spoke of two deals he has been involved with this year where both an inducement fee and a break fee were discussed. And on the contested bid for PizzaExpress both Venice Bidder, the initial interested party, and Gondola Express negotiated termination fees. These two examples show that the traditional break fee that the UK has become used to is evolving.
By now, lawyers are well used to the inclusion of break fees on deals. According to Financial News, over the past 18 months, 80 per cent of deals valued at more than £250m have included a break fee. As a practice that migrated from the US to the UK, break fees, or termination fees as they are poetically known on the other side of the Atlantic, started to
become a feature of UK corporate life at the back end of the 1990s. It was BT that really raised awareness when, in 1997, it was paid $465m (£287m) when its merger with MCI went belly-up. A couple of years later, LucasVarity agreed to stump up £30m to TRW after Federal-Mogul stepped forward as a hostile bidder.
In 1999, the Takeover Panel introduced a rule which said that break fees should be capped at 1 per cent of the value of the deal, which has so far worked quite well in the UK. The only slight wobble on this was the merger agreement between P&O and Royal Caribbean, containing a 2 per cent break fee, which was allowed as the Takeover Code did not include a rule on dual-listed companies. The panel has since amended its standing on this.
In fairness, while Debenhams' decision is unusual, its directors do have fiduciary duty to make sure that they are securing the very best deal for the company's shareholders. If a higher price is paid for the company because another bidder is brought in, then in the end, that is something that will benefit the shareholders.
Although it is a very different situation, in the ongoing bun fight for Safeway, WM Morrison, the first company to make an offer, secured a £29.5m break fee if its offer lapsed or was withdrawn. Following Morrison's offer, five other interested parties stepped into the fray (although the US private equity house KKR has since walked away from the deal). This fight for the business - presuming that the four remaining bidders all pass muster with the Competition Commission - could result in a premium on Morrison's original £2.9bn bid. This is, of course, what Debenhams is trying to achieve. What a shame its directors have gone about things in such a peculiar way.