Money Stuff: You Can’t Change Your Mind About Mergers

The way that public company mergers work is mostly that the executives of one company (the buyer) negotiate a deal with the executives of another company (the target), and then the board of directors of the buyer and the board of directors of the seller both approve the deal, and then the merger agreement is signed and the deal is publicly announced, and then the shareholders of the target get to vote on whether to take the deal. The shareholders of the buyer, though, usually don’t get to vote. The target is going to disappear, and its shareholders will be cashed out; they get some say in the matter. The buyer is just doing a business deal, which its executives and directors are generally allowed to do; nothing fundamental is changing for its shareholders, so they don’t get a say. [1]

But a big acquisition can be pretty fundamental for the buyer, and its shareholders might have some complaints. If they’re really mad, what can they do about it? Well, the theoretical answer is something like:

1. The buyer’s shareholders can launch a proxy fight to replace the board of directors of the buyer.
2. If they win the proxy fight, the shareholders’ newly elected directors can replace the executives who approved the deal with new executives who want out.
3. Uh … then what? There is a signed merger agreement. The target can get out of the merger if its shareholders vote it down, but there is no similar out for the buyer. If the buyer’s new executives show up at the weekly integration meeting and say “actually sorry the deal’s off,” the target’s executives will say “no it isn’t.” The buyer doesn’t get to change its mind just because its shareholders don’t like the deal.

Here’s a case:

Desktop Metal, Inc. (NYSE: DM) (“Desktop Metal”) [yesterday] announced that the Delaware Court of Chancery has ruled in favor of Desktop Metal in its pending litigation against Nano Dimension Ltd. and Nano US I, Inc. (together, “Nano”) regarding the merger agreement between Desktop Metal and Nano dated July 2, 2024 (the “Merger Agreement”). In its March 24 post-trial opinion and order, the Court found that Nano materially breached the Merger Agreement, rejected Nano’s counterclaims, and granted Desktop Metal specific performance. The Court ordered that, within 48 hours of its order, Nano must agree to and execute a national security agreement with the Committee on Foreign Investment in the United States, which is the sole remaining condition to closing the merger. 

Here is the ruling, by Delaware Chancellor Kathaleen McCormick. The situation is basically what I described. Nano Dimension and Desktop Metal are 3D printing companies; Desktop Metal is a US public company, while Nano is an Israeli public company with a US listing. “Nano approached Desktop about a possible acquisition in 2022,” did some due diligence, realized that Desktop was in bad financial shape, but ultimately agreed to buy Desktop for $5.50 per share (about $183 million) in July 2024. [2]

But Nano’s “second-largest stockholder, Murchinson, a Canadian hedge fund founded by Marc Bistricer,” opposed the deal, sending a letter to Nano management in March 2024 saying:

Given our sizeable investment in Nano and our ongoing attempt to seek independent board representation, please be advised that we do not intend to sit idly by and watch [Nano Chief Executive Officer Yoav] Stern waste shareholders’ money on dubious and illmotivated acquisitions. We have every intention to challenge any such improper deal.

Murchinson’s view was that Desktop was in such bad financial shape that Nano should just “let it run out of cash completely and buy the parts of it that are useful to Nano” out of bankruptcy, rather than paying a premium to buy the whole company.

Nano’s management did the deal anyway. Murchinson did not drop the issue. “After Nano’s Board approved the Merger Agreement, Murchinson launched a proxy contest premised primarily on Nano’s opposition to the Desktop merger,” arguing that the Desktop deal was “overpriced” and “misguided” and destroyed (Nano) shareholder value.

Murchinson won the proxy fight and got a total of four directors on the board. “By December 16, following the threat of personal legal exposure from claims by Murchinson, the six legacy directors resigned,” leaving Murchinson’s nominees in control of the board. “The new board started terminating Nano executives, seeming to focus on those who supported the Merger.” Nano was now looking to do what Murchinson had argued for all along: Wait for Desktop to go bankrupt and buy its assets more cheaply.

But Chancellor McCormick points out:

The problem with Murchinson’s plan for Nano to purchase Desktop out of bankruptcy was that Nano had already agreed to purchase Desktop pursuant to the Merger Agreement. Murchinson needed a way out of that agreement.

The answer was apparently regulatory foot-dragging. Nano is a foreign company, Desktop “makes industrial-use 3D printers that create specialized parts for missile defense and nuclear capabilities,” and the deal required approval from the Committee on Foreign Investment in the United States. The right nudge to CFIUS might blow up the deal. “An internal Murchinson document dated November 6 contained allegations
connecting Nano’s management and Russian oligarchs, a potential concern for CFIUS,” allegations that later appeared in the press. Still CFIUS was ready to sign a national security agreement with Nano that would allow the deal, and the agreement was acceptable to Nano’s previous management. But, says the chancellor, Nano “delayed responding to CFIUS’s December 10 draft NSA by 38 days” and “dribbled out objections to the draft NSAs as the litigation unfolded.”

Chancellor McCormick doesn’t like it:

Desktop prevailed, proving that Nano breached its obligations to take all actions necessary to obtain CFIUS approval and use reasonable best efforts to close as soon as reasonably possible. Nano, meanwhile, failed to prove a failure of any covenant or condition. 

And so:

Chalking up yet another victory for deal certainty, this post-trial decision awards Desktop specific performance.

She ordered Nano to sign the national security agreement and close the deal. “While we are disappointed with the decision of The Delaware Court of Chancery and are considering all of our options,” says Nano, “we recognize that the transaction may close.” It may!

This all seems right and not even controversial: If a buyer signs a merger agreement, and the closing conditions are satisfied, the buyer can’t get out of the deal just because it changed its mind. You might remember that Chancellor McCormick was involved in another deal certainty case a few years ago; the buyer changed his mind, but he still had to close the deal.

But there is something a bit interesting about how a public company changes its mind. Here, Nano changed its mind not because its CEO was fickle, but because the CEO signed a deal that shareholders didn’t like, so the shareholders fired him and put in a new CEO. The old CEO was in some sense wrong about the company’s desires; the deal that he signed was not the deal that shareholders wanted, the shareholders were ultimately in control of the company, and they fired him for it as soon as they could. But he was the CEO when he signed the deal, and he — not the shareholders — got to decide. 

One way to tell the story of private equity is that, half a century ago, a few smart people had one essential, surprising, and wildly lucrative insight: “Companies should be more levered.” In the 1970s and 1980s, there were lots of sleepy inefficient companies whose capital structures had too much equity and not enough debt; they had lazy managers who didn’t care much about increasing value; they had steady reliable cash flows that their managers wasted on vanity projects.

A few people noticed — two of the most famous were Henry Kravis and George Roberts [3]  — and figured they could do better. They could run more efficient capital structures, they could give managers bigger equity stakes to align incentives, they could sell off underperforming divisions, they could pay the cash flows out to shareholders. But to do this — and profit from its success — they would need to buy the companies themselves. This was hard because they were just some guys. They didn’t have billions of dollars.

But their essential insight about leverage suggested the solution to this problem: They could borrow the money to buy the companies. This is called a “leveraged buyout,” or LBO. The companies were sleepy and inefficient, but they had good businesses and steady cash flows and not much debt; banks would lend them a lot of money. So the Kravises and Roberts of the world could buy the companies with money they borrowed from banks, secured by the companies they were buying, just like buying a house with a mortgage. They didn’t need much money of their own. And the world was rich with targets — lots of inefficient companies — and there was not a lot of competition, because it was all new and risky and surprising.

So they could raise funds from investors, borrow money, buy companies, sell the bad bits, align incentives, spruce them up, pay down the debt, sell the companies (or take them public) and return tons of cash to the investors. This is called “private equity.”

It is traditionally not exactly a short-term business, but not exactly a long-term one either. The job is not to find good companies and own them forever, but to buy cheap companies, fix them up and flip them. The goal is to earn a spread, to buy inefficient companies cheaply, make them efficient quickly, and then sell them at a higher price.

This worked extremely well, with the following consequences:

1. Kravis and Roberts and many of their contemporaries now have lots of money, both in the sense that they are personally very wealthy and in the sense that they now run firms with hundreds of billions of dollars of assets under management. Kravis and Roberts are founders of KKR & Co., which has about $195 billion of private equity assets under management.
2. There is now huge competition to do leveraged buyouts, both in the sense that there are a number of big firms that compete to do deals, and in the sense that every young person in finance is competing to get hired by those firms, which are now the default ideal financial employers.
3. Most of the sleepy, inefficient, under-levered companies with steady cash flows are gone, some because private equity firms took them private and spruced them up, and others because they responded to the private-equity zeitgeist by sprucing themselves up, borrowing money and aligning incentives and generally becoming more like private equity companies.

Then what? The original private equity founders were in a scrappy business of picking low-hanging fruit; now they run huge institutions and a lot of that low-hanging fruit is gone. [4]  Every top business school graduate wants to work for them, and every institutional allocator wants to give them money, because of the generational profits they made with the essential insight of “companies could be much more levered,” but that insight is not as lucrative now as it was when they made all that money.

On the other hand, they do run huge institutions. They parlayed their essential insight into giant piles of money and lots of smart ambitious employees. If have all that money and smarts, there has to be something useful you can do with them. What? “Private credit” is an important answer: If you’re a big successful asset manager, you can manage lots of assets and expand into credit. But there are other answers. You can … just … do a good job of managing normal companies? Just, like, be an industrial conglomerate, but with really smart mid-level executives and really rich senior ones? Bloomberg’s Allison McNeely reports:

KKR & Co.’s plan to break from the traditional buyout model and hold some bets on its own books for decades is being directed by a tight-knit group, including co-founders Henry Kravis and George Roberts.

The alternative asset manager’s Strategic Holdings unit, launched a little over a year ago, is a key part of KKR’s plan to more than quadruple earnings per share over the next decade. The firm sees a chance to build a portfolio that kicks off more than $1 billion a year in dividends.

What the firm is trying to create “is in some ways a mini Berkshire Hathaway,” Co-Chief Executive Officer Joe Bae said at the Bloomberg Invest conference in New York earlier this month. …

The unit currently holds stakes in 18 long-term investments that are expected to compound over time instead of being flipped for a quick profit. Bae said this month that the firm intends to add infrastructure and real assets to the mix.

KKR says the upside for patient investors could be massive. The firm has pointed out that Berkshire is worth almost as much as all the publicly traded asset managers in the world combined. But it’s a long-term bet that will require capital now. KKR cut its share buybacks to zero last year and paid out a lower portion of its earnings as dividends than any of its major competitors.

Yes, right, the opportunity to buy underperforming companies and flip them for huge profits in five years has decreased, but KKR’s pile of cash has increased, so there are other things it can do.

Most of the time, if a company borrows money against some collateral, the collateral is worth more to the borrower than it is to the lender. That’s sort of the point of lending. It’s a division of labor: I am good at producing widgets in my factory, so I use the factory to do that; the bank has no particular widget-production skills, but it has money, so it lends me money. If I mess up and go bankrupt, the bank will seize my factory, but it doesn’t want the factory, and will probably sell it off as quickly as it can. Seizing the factory is a distinctly second-best outcome for the bank. Similarly: If I take out a mortgage to buy a house, I want the house, but the bank would rather just get my monthly checks than have to deal with foreclosure. Or: If Elon Musk borrows $13 billion to buy Twitter Inc., he wants to operate Twitter, but his lenders definitely do not. 

There are exceptions, “loan-to-own” cases where a distressed-debt investor decides it really wants to own some troubled business, so it buys up the business’s debt, hoping for the opportunity to foreclose and take over the business. But normally lenders are looking to get paid back, not to seize their collateral, so they don’t build up any particular expertise in operating the collateral.

Here’s a weird idea:

As the co-founder and former chief executive of facial-recognition startup Clearview AI, Hoan Ton-That pushed the technological and legal boundaries of artificial intelligence and privacy. For his next act, he is jumping into the hurtling world of private credit.

After resigning from Clearview earlier this year, Ton-That said in an interview that he has joined Architect Capital as head of technology to help the San Francisco-based investment firm develop a financial strategy that will allow it to increase leverage in lending to tech startups.

The firm issues loans, largely to tech startups, against customer contracts they hold, rather than against the business as a whole. If one of those software companies folds, Ton-That’s team will take over the contracts and build in-house the necessary tech and support team to continue meeting the contracts’ obligation with customers, allowing Architect to get the revenue stream. Architect will collect on the contract until the firm is made whole on the loan.

The assurance of being able to assume a contract’s revenue in the event a company goes under will allow Architect to take on more risk, Ton-That said. Architect will be able to offer companies larger loans with more lenient covenants and be able to lend to companies at up to five times their annual recurring revenue—more than could be done via a standard corporate loan, he added. 

“We have to do this in order to convince our investors that we can take on this much credit risk,” Ton-That said. “My job is to be able to, in these downside scenarios, service a lot of different types of software to build. I have that background building tech companies, running servers and building databases.”

Fun! I feel like, if I were really good at building tech companies, I would try to build the tech companies I wanted to build, rather than trying to rebuild the tech companies that went under? Like, surely the product that you build for your own vision will be better than the product you build to rescue a defunct company that promised it but couldn’t deliver? Surely the customers you win with your own vision will be happier than the customers you service because their original supplier went bankrupt? This whole idea feels very not tech, not in keeping with Silicon Valley idealism and ambition. People do like private credit, though, and I suppose private credit firms need workout capabilities. 

The two most straightforward dumb ways for a US public company to get a high stock price in the 2020s are:

1. Announce that you will buy a lot of Bitcoin: Retail investors love Bitcoin and will sometimes, for some reason, pay a premium for a company with a stash of Bitcoin.
2. Be GameStop.

It is puzzling that no one ever thought to combine these strategies. I mean, I guess only GameStop could have combined them. Now it has:

GameStop Corp., the struggling video-game retailer that became a favorite of retail traders during the meme stock frenzy in 2021, said its board has approved a plan to add Bitcoin as a treasury reserve asset.

The Grapevine, Texas-based firm is joining a growing list of public companies experimenting with using corporate cash or borrowed money to buy the digital asset in a bid to capitalize on the surge in Bitcoin. The gambit was pioneered by Michael Saylor’s Strategy, the enterprise software company formally known as MicroStrategy that has acquired more than $40 billion in Bitcoin and seen its share price soar.

Last month, GameStop Chief Executive Officer Ryan Cohen teased at the idea, posting a picture of himself and Saylor on the X social media platform. Shares of GameStop rose as much as 14% on Wednesday. 

Sure!

One possibility is that shareholders will pay a premium for every public company that owns Bitcoins, so every company can boost its valuation by putting out a one-sentence press release about Bitcoin. Another possibility is that “public company that owns a lot of Bitcoin” is a more or less winner-take-all category, where retail investors will pay up a lot for the one most salient meme-iest public company that owns Bitcoin but will have no interest in imitators. On that theory, Strategy has a huge head start and it’s probably not worth trying for most other companies. But GameStop is GameStop! It has its own powerful memetic first-mover advantage; maybe it can apply that to owning a pile of Bitcoin.

When I was an investment banker, I kept a folder of terrible pitchbook pages, which I lovingly passed on to a colleague when I left the bank. So I admire this guy:

For more than a decade, [Ford Motor Co. sales executive Mike] O’Brien kept a meticulous log of mixed metaphors and malaprops uttered in Ford meetings, from companywide gatherings to side conversations. It documents 2,229 linguistic breaches, including the exact quote, context, name of the perpetrator and color commentary. 

After one colleague declared: “It’s a huge task, but we’re trying to get our arms and legs around it,” O’Brien quipped: “Adding ‘legs’ into the mix makes it sound kinda kinky.”

Others include “we need to make sure dealers have some skin in the teeth,” “we need to keep running in our swim lanes” and “we need to talk about the elephant in the closet.” He retired last month and emailed the spreadsheet to “a few hundred colleagues.”

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