Question
VIA ELECTRONIC MAIL
September 28, 2009
Mr. B. MichaelVerne
Premerger Notification Office
Bureau of Competition
Federal Trade Commission
7th & Pennsylvania Avenue, NW
Washington, DC 20580
Dear Mike:
Iam writing to confirm our discussion of September 15, 2009 regarding thenonreportability under the Hart-Scott-Rodino Antitrust Improvements Act of1976, as amended ("HSR Act") of the proposed transaction discussedbelow.
Proposed Transaction
Buyercurrently owns approximately 22% of the voting securities of Target. TheProposed Transaction involves the acquisition by Buyer of all of the remainingissued and outstanding voting securities of Target that it does not currentlyhold.
Thepurchase price payable at closing is $ I 5 million in cash and promissory noteswith an aggregate principal amount of$29 million. The promissory notes willbear interest at a 5% annual rate. There are two formulas based on growth inprofits under which additional purchase price consideration could be paid outpost-closing. Under the first formula, the selling shareholders and optionholders can receive additional consideration based on a formula focused on 2011profitability. Participation in receiving possible additional payment under thesecond formula is optional. Each selling shareholder and option holder canelect by a certain date post-closing if he or she wants to participate in theoptional additional payment opportunity under the second formula and must payto Buyer a percent of his or her previously received transaction considerationto participate in this option. Under the second formula, the additionalconsideration is focused on 2013 profitability.
Underthe two formulas, the additional payments may be zero and are subject to anaggregate transaction consideration ceiling of approximately $81 million.Accordingly, the minimum the selling shareholders and option holders willreceive is $44 million, the payment at closing, and the maximum they canreceive is $81 million. You should assume that the amount of the transaction considerationthat will be paid to the option holders will be less than $1 million -theoutstanding options at issue do not have any current voting rights with regardto the election of directors and will be terminated at closing.
Buyerbelieves that there is a reasonable basis for estimating the contingent portionof the acquisition price -Buyer has made its estimate after conductingcalculations with assumptions including what it regards as the likely growth inprofits of the Target. You should assume that Buyer's calculation will beadopted in good faith by the board of Buyer's ultimate parent or a delegee ofthat board within 60 days prior to closing as a reasonable estimate of theacquisition price.
Assumingit is an acceptable fair market valuation methodology for HSR purposes to valuethe voting securities already owned by Buyer at the same price per share as theshares to be acquired are valued under Buyer's acquisition price estimate, youshould assume that this fair market valuation of the already held shares alsowould be adopted in good faith by the board of Buyer's ultimate parent or adelegee of that board within 60 days prior to closing.
Thecombination of (1) Buyer's estimate of the acquisition price ($44 million plusits estimate of any additional purchase price payments it anticipates makingunder the two formulas); and (2) the value of the shares of Target already heldby Buyer (determined under the fair market valuation methodology describedabove) results in an aggregate value of less than $65.2 million.
Buyerunderstands that the controlling selling shareholders believe they will receivecontingent payments such that the Buyer would hold in excess of$65.2 million invoting securities as a result of the Proposed Transaction. However, Buyer believesthat the assumptions those shareholders are operating under are unrealisticallyoptimistic as to the future profitability and that factors are not likely to beachieved under which any contingent pay-out amounts would result in Buyerholding $65.2 million or more in voting securities combining the value of theshares to be acquired with those already held.
Asa condition of the Proposed Transaction, Buyer is making a capital infusioninto Target in the amount of $25 million prior to closing of the ProposedTransaction and immediately following the signing of the purchase agreement forthe Proposed Transaction. The capital infusion is structured in the form of theacquisition by Buyer of $25 million worth of a class of preferred stock ofTarget. The preferred stock carries no current voting rights with regard to theelection of directors. The preferred stock is only entitled to vote fordirectors in situations involving the non-payment of dividends for multipledividend payment periods.
Asa condition of the Proposed Transaction, there also are various ancillaryagreements being entered into as described below. First, a subsidiary of Buyerhas existing reinsurance agreements with a subsidiary of Target. On or beforethe date of the capital infusion described above, those existing reinsuranceagreements will be amended resulting in Buyer's subsidiary increasing theamount it reinsures for Target's subsidiary, an insurance company. Thereinsurance agreement amendments will be negotiated at arm's length and atmarket rates. Second, there are various agreements between Target andaffiliates of the selling shareholders that will be amended before closing. Youshould assume that these existing agreements originally were on terms favorableto the affiliates of the selling shareholders. To the extent that Buyer has notbeen able to get all of these agreements renegotiated at a market rate, theterms that Target will be subject to post-closing will be closer to market rateterms than they were before. Third, prior to closing, the Target will form anew entity and shall cause the ownership interests in that entity to transferto the selling shareholders. The Target will then enter into a quota sharereinsurance agreement with this entity. However, the terms of the quota sharereinsurance agreement are based on arm's length negotiations and market rates.Fourth, Buyer will enter into a non-compete and non-solicitation agreement withthe major selling shareholders. However, there will not be additionalconsideration paid to these shareholders for entering into such agreement.Fifth, Buyer will enter into employment agreements with certain employees ofTarget. Payments under the employment agreements will be for rendering futureservices.
Analysis and Conclusions
You confirmed thatthe Proposed Transaction as described above is not reportable under the HSRAct. Specifically you agreed:
(1) Theparties can treat the acquisition price for the shares to be acquired asdetermined under 16 C.F.R. 801.10. See ABA Section of Antitrust Law,Premerger Notification Practice Manual (4th Ed. 2007),Interpretation #94.
(2) Thevalue of the voting securities of Target already held by Buyer is the fairmarket value of those shares. It is acceptable to value the fair market value ofthose shares for HSR purposes by attributing to them the same per share valueas the voting securities to be acquired are valued under Buyer's acquisitionprice estimate.
(3) The overall valueof the shares of Target to be held by the acquiring person as a result of theProposed Transaction (the estimate of the acquisition price plus the fairmarket value of the voting securities of Target already held by Buyer) would bean amount below the $65.2 million HSR Size of the Transaction Test. Thisvaluation controls for HSR purposes regardless of whether post-closing it turnsout that payments made to the selling shareholders are greater than wereestimated by the acquiring person. (Based on your confirmation regarding thepreceding sentence, my understanding is that the acquired person in theProposed Transaction, like the acquiring person, is entitled to rely upon thevaluations done by the acquiring person's board or its delegee in not filingunder the HSR Act -please let me know if this conclusion is not correct.)
(4) Thecapital infusion payment is not part of the acquisition price for HSR purposes.The acquisition of the preferred stock as a part of the capital infusion is anHSR exempt acquisition of non-voting securities under 15 U.S.C. 18a(c)(2)given that the holder only has voting rights with regard to the election ofdirectors upon the occurrence of certain events (i.e., the non-payment ofdividends for multiple dividend payment periods). See ABA Section of AntitrustLaw, Premerger Notification Practice Manual (4th Ed. 2007),Interpretation #65.
(5) Thecancellation of the options (which do not entitle the holders to current votingrights with regard to the election of directors) is an exempt event for HSRpurposes. Specifically, the options are exempt convertible voting securitiesunder 16 C.F.R. 802.31, and consideration paid for the options is notincluded in the acquisition price or transaction valuation for HSR purposes.
(6)Interest paid under the promissory notes discussed above does not constitutepart of the acquisition price for the Proposed Transaction. See ABA Section of Antitrust Law, Premerger Notification Practice Manual (4th Ed.2007), Interpretation #112.
(7) Noneof the ancillary agreements described above would impact or change theacquisition price for the Proposed Transaction or otherwise be viewed asconstituting additional transaction consideration for HSR valuation purposes.