Question
To:Mike Verne
FederalTrade Commission
From: (redacted)
Date:September 20, 2006
I would appreciate your review of our HSR analysis onthe following hypothetical:
Facts: Four investment companies intend to form a newcorporation ("Newco") for the purpose of acquiring interests in alimited partnership ("Cogeneration LP") that operates a cogenerationproject (the "Project"). Collectively, the investment companies (invarying amounts) will contribute approximately $53.3 million in cash to Newcoand also lend money (or borrow it from third party lenders) in the sum of $110million. In exchange, they will receive voting securities in Newco. None of theinvestment companies will own 50% or more of the voting securities in Newco,although the investment advisor to three of the investment companies, pursuantto contract and in light of its stock ownership in the three investmentcompanies, will have the ability to vote 87.5% of the shares and appoint themajority of the directors of Newco. The acquisition will take place in twotransactions.
In the first transaction, Newco will acquire 100% ofthe membership interests in an LLC ("LLC A") for $13 million. LLC Aowns approximately 43% of the economic interests and 51% of the voting interestin Cogeneration LP.
Newco will also form a wholly owned subsidiary, NewcoII. In the second transaction, Newco II will purchase 100% of the stock ofCorporation B for $60.5 million. This purchase will occur after Newco purchases100% of LLC A. Corporation B owns two assets: (1) 100% of the membershipinterests in an LLC ("LLC B"), which, in turn, owns an approximate49% economic and voting interest in Cogeneration LP1 and (2) anapproximate 46% interest in a limited partnership ("Project LP") thatowns a beneficial interest in a trust that owns an approximate 75% undividedinterest in the Project and has leased its undivided interest to CogenerationLP pursuant to a 25 year lease. The remaining approximate 25% undividedinterest in the Project is owned in varying amounts by four other trusts, whichalso lease their undivided interests to Cogeneration LP under separate 25 yearleases. Cogeneration LP has no ownership interest in the Project, but only acontractual right to lease the Project from the five trusts. Cogeneration LPhas the option of purchasing the Project under certain circumstances, includingat the end of the lease. In addition, Newco II will provide an $85 millionletter of credit to support the pre-existing obligation of the UPE ofCorporation B to pay money if Cogeneration LP telutinates a contract to supplysteam from the facility to a third party.
Here is how we analyze thetransactions:
1.Formation of Newco. This is notreportable because all of the assets of Newco consist of cash or debt. Sections 802.4 and 801.21.
2.Newco's acquisition of 100% of themembership interests in LLC A. This is not reportable because LLC A's onlyasset is a minority interest in a limited partnership. Section 801.2(f)(1)(i).
3.Formation of Newco II. This is notreportable because it is an intraperson transfer. Section 802.30.
4. Newco II's acquisition of 100% of the voting stock of Corporation B.This is not reportable because Corporation B does not own non-exempt assetswith an aggregate fair market value of more than $56.7 million. Corporation Bowns 100% of the membership interests in LLC B, which owns approximately 49% ofthe economic interests in Cogeneration LP (the same limited partnership inwhich Newco will have previously purchased certain interests), which togetherwith Newco's acquisition of 43% of the economic interests in Cogeneration LP inthe acquisition described above in #2, results in Newco controllingCogeneration LP. As a result of the acquisition of control of Cogeneration LP,the purchase of the interests in LLC B (whose only asset consists of interestsin Cogeneration LP) is not exempt. To determine the value of these non-exemptinterests, we apply the test set out in Section 801.10(d). We add the fairmarket value of the Cogeneration LP interests previously acquired(approximately $13 million)2 to the allocated purchase price ofCorporation B's ownership of approximately 49% of the interests in CogenerationLP (approximately $5 million out of the overall $60.5 million purchase pricefor the stock of Corporation B)3 For purposes of this analysis, youmay assume that, at the time of the second transaction, the sum of theacquisition price of the interests in Cogeneration LP to be acquired and thefair market value of the interests in Cogeneration LP held by the acquiringperson prior to the acquisition is approximately $18 million. Corporation B alsoowns an approximate 46% economic interest in a limited partnership that owns anapproximate 75% undivided interest in the Project, which it leases toCogeneration LP pursuant to a long term lease. The allocated portion of the$60.5 million price for the stock of Corporation B attributable to the 46%economic interest in the limited partnership is approximately $55.5 million.4The acquisition of a minority interest in Project LP is exempt because it isthe acquisition of a minority interest in an unincorporated entity. Section802.1(f)(1)(i). Without consideration of the letter of credit (discussedbelow), Newco II's acquisition of 100% of the voting securities of CorporationB is not reportable because it does not hold non-exempt assets with anaggregate fair market value of more than $56.7 million as established bySection 802.4.
5. The UPE of Corporation B has a back up agreement thatsupports an obligation of Cogeneration LP to pay money if Cogeneration LPterminates a steam contract with a third party. As part of the transaction inwhich Newco II acquires 100% of the stock of Corporation B, Newco II will agreeto provide a letter of credit in favor of the UPE of Corporation B that the UPEmay draw down if, among other circumstances, the steam contract is terminatedand Cogeneration LP does not discharge the obligation or if a defense topayment by Cogeneration LP for the termination is not honored. The purchaseprice for the letter of credit is $85 million. Whether this sum (or a partthereof) may be drawn down by the UPE of Corporation B depends on thecircumstances. Without characterizing the likelihood of whether the letter ofcredit will be drawn down, it is clearly possible, based on its own terms, thatthe letter of credit may not be drawn down (or only a part thereof will be),and the balance will be returned to Newco II. We do not believe that theobligation to purchase and collateralize the letter of credit in favor of theUPE of Corporation B should be valued and added to the consideration whichNewco II pays to acquire 100% of the voting securities of Corporation B forpurposes of calculating the size of the transaction because the purchase priceof Corporation B's voting securities should already reflect any suchuncertainties. Also, Newco II would not make the acquisition of the votingsecurities of Corporation B, subject to the letter of credit, but for the valueattributable to the 46% interest in the limited pay Inership. For that reason,any assumed value of the letter of credit would be consideration for the 46%interest in the limited partnership, which is exempt. Any such value would notcount toward the $56.7 million threshold. If the amount should be added,however, it would be incumbent upon the board of directors of the acquiring personto value the contingent liability and add it to the value of the interests inCogeneration LP which the acquiring person shall hold as a result of theacquisition of the voting securities of Corporation B (approximately $18million) to determine whether the size of the transaction threshold is met forreportability. To make that determination, the likelihood that the contingentliability would be realized and the amount of its realization would have to beestimated.
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1 LLC B's only asset is this minorityinterest in Cogeneration LP.
2 To determine the fair market value of the interests previously acquired,we should apply the test of Section 801.10(c)(3) for defining fair marketvalue. This test requires that the board of directors of the UPE of Newco IIdetermine the fair market value in good faith as of any day within 60 calendardays prior to the consummation of the second acquisition
3The purchase agreement will not allocate the overall $60.5 millionpurchase price for the voting securities of Corporation B between theacquisition of interests in Cogeneration LP and Project LP. However, in makingthe acquisition, Newco II will have internally calculated that $5 million ofthe overall purchase price should be allocated to the acquisition ofCorporation B's 49% interests in Cogeneration LP. Since the buyer so allocatesthe acquisition price, the acquisition price of the interests in CogenerationLP is considered "determined" within Section 801.10(d).
4 In making the acquisition of the voting securities of Corporation B,Newco II will have internally calculated that $55.5 million of the overallpurchase price should be allocated to the acquisition of Corporation B's 46%economic interests in Project LP. The acquisition price for these interests is thus "determined." See footnote3.