Why is a Lawsuit Filed for Every Deal? See below.

February 11, 2011

Recently, the Wall Street Journal published a story “First, the Merger; Then the Lawsuit” criticizing shareholder suits that are inevitably filed after a public company get acquired.   Shareholders often challenge a deal without knowing many details, and, most of the time, it is the shareholder’s attorneys who do the legwork on the case.  The Journal was critical of this practice, blaming lawyers for perceived inefficiencies in the law and benefiting at the expense of the shareholders involved.  The Journal’s article, however, is short sighted, because the benefit (a “second opinion of the deal”) of these suits far outweighs any potential or perceived harm.

Steven Davidoff of the NY Times Dealbook recently provided two compelling examples of why shareholders need to probe every deal.   Davidoff does a quick analysis of two deals, both of which involved management led buyouts from the last five years that are now set to go public once again.   First, Kinder Morgan:

The $22 billion Kinder Morgan buyout was completed in 2007. Richard Kinder, the chief executive, teamed up with four private equity firms and orchestrated a buyout to his advantage. Mr. Kinder planned the buyout for more than two months before presenting a proposal to the board. His group eventually bought the company with Mr. Kinder receiving a 31 percent stake. Shareholder litigation over the buyout was eventually settled for $200 million, one of the largest-ever such sums. With the I.P.O. this week, it appears that Mr. Kinder and his private equity partners have almost tripled their money in four years during a terrible market.

So, even with highly successful shareholder litigation, Kinder Morgan’s management took the company private, made a buch of money, and are now ready to cash out into by selling the company to the public once again.  Davidoff also shows the same “fortune” for HCA:

In the deal, Thomas F. Frist Jr., a founder of HCA and a director, and his son Thomas F. Frist III raised their ownership of HCA to 18.8 percent of the now private company from 6.8 percent.

The senior Frist also received a payout of more than $134 million in the acquisition. This type of simultaneous cash-out while actually raising an ownership stake is a tactic of management-led buyouts that is commonly criticized. And this was the second time the Frists had taken the company private. The buyers are also looking to triple their money in an I.P.O., which is expected to occur in the coming months.

If these companies stay public, shareholders recognize these gains rather than management, that is why management is taking the company private.  The insiders see the potential, and decide that the shareholders (who financed that growth) don’t deserve to share in the spoils.

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