Tuesday, November 24, 2009

A Look at Xerox’s Big Concessions in Its A.C.S. Deal

The following appeared on NYT's DealBook yesterday. I don't think a competitive bidder would come in at this valuation level and pay a $194M break-up fee. Besides, Xerox shareholders have no hope but to approve the merger to at least retain some hope to catch up with HP in services rather than trying to do it in house via Xerox Global Services, too little too late!


A stipulation of settlement in a shareholder lawsuit over Affiliated Computer Services’ deal with Xerox was filed Friday evening in Dallas County court in Texas.

The lawsuit, brought by A.C.S. shareholders, is as unusual as the deal itself and may signal more bumps in the road for investors of both companies.

In the settlement (available after the jump), Xerox agreed to two things:

· It agreed not to enforce the voting agreement it entered with A.C.S.’s chairman, Darwin Deason. Mr. Deason controls a 43.6 percent voting interest in A.C.S. and previously agreed to vote in favor of the Xerox deal. Even if A.C.S.’s board recommended a competing transaction as a superior proposal, Mr. Deason was still locked in to vote half of his shares, or 21.8 percent of A.C.S.’s outstanding stock, in favor of the Xerox deal. (I discussed the terms of the merger here.) A result of this part of the settlement is to remove any obstacles to Mr. Deason’s endorsing a higher bid if A.C.S.’s board deems it superior.

· It also agreed not to enforce the force-the-vote provision in the merger agreement. Before, not only did Xerox have 21.8 percent of A.C.S. votes locked up, but it also could force the target to hold the meeting for the shareholder vote. Commonly called a force-the-vote provision, this feature is allowed under the laws of Delaware, where A.C.S. is incorporated. Xerox now has agreed to end the merger agreement if A.C.S.’s board recommends another bid as a superior proposal.

The vital part of accepting a higher third-party bid is now defining what is a “superior proposal.” The A.C.S. board can recommend such a bid only if it deems that offer to meet those terms. Such a proposal is defined as any that the board determines to be:

(i) more favorable to the stockholders of [A.C.S.] from a financial point of view than the transactions contemplated by this agreement (after giving effect to any changes to the financial terms of this agreement proposed by [Xerox] in response to such offer or otherwise) and (ii) reasonably capable of being completed on the terms set forth in the proposal.

This settlement follows an earlier agreement in the Texas lawsuit to effectively amend the merger agreement to permit A.C.S. to provide confidential information to a third-party bidder. A.C.S. can do so for any offer that its board “determines in good faith to be reasonably likely to lead to a proposal that provides greater consideration to the A.C.S. Class A stockholders than provided in the merger agreement, which offer may be made expressly contingent on due diligence and obtaining financing commitments and may be subsequently modified or withdrawn.”

A result of these two agreements is that the door is now open for a third-party bidder to step in – provided it is willing to pay the $194 million termination fee and tolerate Xerox’s matching rights. The rights afford Xerox three business days to match any new superior proposal and require that A.C.S. negotiate with all parties in good faith during that time.

Why did Xerox agree to this far-reaching settlement, which to my knowledge is unprecedented? The first explanation is that the lawyers representing the shareholder plaintiffs have done a good job of convincing the judge that the lockups are inappropriate. Xerox saw the writing on the wall and agreed to waive them.

(Even though A.C.S. is a Delaware company, it is headquartered in Texas, letting its shareholders sue in that state. I doubt that a Delaware judge would have ruled on the lockups the same way, even post-Omnicare. For those who don’t understand that reference, see a previous post here.)

The second possible explanation is realpolitik. Xerox is still struggling to convince its shareholders to approve the deal. A competing bid may kill two birds with one stone by giving the company an easier exit with a $194 million payment, instead of Xerox owing A.C.S. $65 million. The $65 million is the fee Xerox must pay if its shareholders vote down the merger. This may help explain why Xerox did not fight this issue through to trial.

I suspect the true answer is a mix of both.

In any event, the litigation isn’t over. As part of the settlement, the Texas plaintiffs are joining a separate, pending shareholder lawsuit in Delaware’s Court of Chancery. That suit’s focus will turn to Mr. Deason’s $300 million premium and the propriety of the actions of A.C.S.’s special committee in approving a deal with this special, unusual premium.

I hope that the depositions of the special committee are made public, because I suspect they will show a carefully scripted process with Cravath, Swaine & Moore(sometime counsel to Mr. Deason, sometime counsel to A.C.S.) as the author. The question is how independent the committee was in this scripted process, given that it was selected and signed off on only a few years ago by Mr. Deason himself, likely advised by Cravath.

This lawsuit likely won’t stop the deal, but the Texas settlement once again shows there is nothing ordinary about this transaction. I suspect that we may continue to see collateral effects from this litigation — and that Friday’s settlement won’t be the last interesting event in this merger’s lifespan.

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