More on Sears Holdings "Going Private"

Ever since the first post on this issue I have been looking into this further. Today’s Autozone (AZO) filing with ESL (Sears Holdings (SHLD) largest shareholder) gave me the information I needed.

From the Findlaw Legal site

“Delaware’s Analysis

Fiduciary principles have long been established to protect minority shareholders in interested transactions. This protection is embodied in the “entire fairness” standard, a reasonably stringent review. Under a fairly recent line of cases, controlling shareholders can avoid the entire fairness review by structuring their going-private transaction as a tender offer. As described in the Delaware Chancery’s decision In re Pure Resources, Inc. Shareholders Litigation, Delaware courts now apply two distinct fiduciary standards to boards evaluating a controlling shareholder’s acquisition of the remaining shares of a company.7 On the one hand, as detailed in Kahn v. Lynch Communications Systems, Inc., Delaware courts apply the “entire fairness” standard to long-form merger transactions involving a controlling shareholder:

“The concept of fairness has two basic aspects: fair dealing and fair price. The former embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and stockholders were obtained. The latter aspect of fairness relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock. However, the test for fairness is not a bifurcated one as between fair dealing and price. All aspects of this issue must be examined as a whole since the question is one of entire fairness.” 8

Moreover, in Lynch “[t]he Court held that the stringent entire fairness form of review governed . . . [even though]: i) the target board was comprised of a majority of independent directors; ii) a special committee of the target’s independent directors was empowered to negotiate and veto the merger; and iii) the merger was made subject to approval by a majority of the disinterested target stockholders.”9 Even with these additional protective mechanisms, the Kahn Court determined that merger transactions involving a controlling shareholder contain an “inherent coercion” of the interests of minority shareholders, thereby requiring the more stringent “entire fairness” standard.

On the other hand, as demonstrated in Solomon v. Pathe Communications Corp., Delaware courts do not apply the “entire fairness” standard to tender-offer transactions involving a controlling shareholder if the tender offer is not coercive.10 Specifically, the Solomon Court found that “in the absence of coercion or disclosure violations, the adequacy of price in a voluntary tender offer cannot be an issue.”11 Recent decisions in In re Aquila12 and In re Siliconix Inc. Shareholders Litigation have followed this doctrine and found that “unless coercion or disclosure violations can be shown, no defendant has the duty to demonstrate the entire fairness of . . . [a] proposed tender offer.”13 The tender offers in Siliconix and Aquila contained a majority of the minority tender conditions and agreements to consummate DGCL §253 mergers at the same price as the tender offers. While the Chancery Court in those cases determined that the tender offers were not coercive, they did not specify factors for determining whether a tender offer is coercive.

In Pure Resources, while the Chancery Court “remain[ed] less than satisfied that there is a justifiable basis for the distinction between the Lynch and Solomon lines of cases,”14 it was unwilling to apply the Lynch “entire fairness” standard to tender offers involving a controlling shareholder. The Court found “the preferable policy is to continue to adhere to the . . . Solomon approach, while giving some greater recognition to the inherent coercion and structural basis concerns that motivate the Lynch line of cases.”15 In an effort to blend both lines of thought and expand upon the decisions in Siliconix and Aquila, the Court determined that a tender offer by a controlling shareholder would be noncoercive only when “1) it is subject to a nonwaivable majority of the minority tender condition; 2) the controlling stockholder promises to consummate a prompt [DGCL]§253 merger at the same price if it obtains more than 90% of the shares; and 3) the controlling stockholder has made no retributive threats.” Accordingly, although the distinction between a noncoercive tender offer and a long-form merger appears to rest on form over substance and has been questioned by commentators (e.g., Franklin Balotti), Delaware courts continue to honor the distinction.16

Conclusion

As seen by the Delaware Chancery’s decision in Next Level Communications, Inc. v. Motorola, Inc.17, target boards evaluating going-private transactions involving a controlling shareholder should continue to use the framework provided in Pure Resources. Whether a going-private transaction involving a controlling shareholder is structured as a merger or a tender offer, additional protective mechanisms should be employed to insulate target boards from breaching their fiduciary duties. For long-form mergers, “an approval of the transaction by an independent committee of the directors or an informed majority of minority shareholders shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder-plaintiff.”18 Alternatively, tender offers can avoid a coercive taint by including (i) a nonwaivable majority of the minority tender requirement, (ii) a back end short-form merger at the same price as the tender offer, and (iii) the absence of any retributive threats.19 Given the Chancery’s internal struggle with this issue, the Delaware courts appear likely to revisit the matter.”

Sears Holdings is a Delaware Corp. and would fall under its jurisdiction should this come up.

Any attempt by ESL to take Sears private would fail the “fairness” tests.

Price. Lampert has publicly said repeatedly that the market is undervaluing Sears shares and its prospects. Those statements alone would require him to offer a massive premium to the current price in order to satisfy the “fairness in price” requirement.

“Majority of minority”. In order to be free of a “coercive” offer claim, a majority of the minority shareholders would have to vote for the transaction. Does anyone really think Legg Mason, Pershing and Bill Ackman and Bruce Berkowitz, who all own shares in the $100 plus range would vote for a deal for anything less that what they bought shares at? Do we think they would demand a nice premium to even consider saying ok? Me too..

Those three hold 22% of the outstanding shares or, a virtual “majority of the minority”. Here is the kicker. As Lampert uses Sears cash to buy up shares to increase his ownership, he also increases theirs, giving them even more power in any deal.

Special deal for the big three to sell? Nope. This is what killed the Sears Canada deal. Pershing argued that Lampert achieved his “majority of the minority” by offering the banks that gave him their shares a higher price that the rest of the shareholders. The courts ruled that this is “unfair” to the remaining shareholders and ruled the “majority” Lampert had invalid. Without the bank shares being counted, Lampert lost his “majority”. The same scenario would hold here. Any deal the big three get, we would also.

The oft said “if Lampert owns 60% of the shares he can do whatever he wants” claims are patently false. As a shareholder, no matter how small, you do have rights…

Disclosure (“none” means no position):Long SHLD, none

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