This Is What Happens When You Screw Up An Acquisition And Piss Off Your Shareholders


JCrew executives may have their fingers on the hip and happening pulse of fashion-forward America, but in the corporate governance world, no one would ever consider them to be trendsetters. The retailer became the object of investor anger in December when it filed an SEC proxy statement detailing how CEO Millard Drexler had negotiated the recent sale of the company for $2.86 billion.

J Crew’s shareholders have filed a lawsuit claiming Drexler didn’t get a fair price for the firm. While such suits are fairly common at companies that have undergone takeovers, experts agree the facts surrounding the retailer’s recent deal are particularly noteworthy.

The J Crew buyout serves ‘as a great business school case study on how not to govern a company,’ says Bruce Foerster, president of South Beach Capital Markets Advisory, a corporate finance and governance advisory firm. Perhaps the most controversial aspect of the J Crew takeover is that Drexler knew it was a possibility for seven weeks before he notified the board.

SEC documents reveal that he first began discussing a possible offer with Leonard Green & Partners, one of the two acquirers, on August 23, 2010, but most board members didn’t learn of the overture until the first or second week of October.

‘The chief executive has an obligation to tell the board the nano-second after he receives the offer,’ says Foerster.

He notes that Drexler, who owns nearly a 12 per cent stake in the company, should have let the board help negotiate the deal, given that the board represents all shareholders equally.

‘The question is, whose interests is Drexler looking out for – the hundred-lot shareholders’, or his own?’ asks Foerster. Cutting the board out of takeover discussions not only indicates poor governance but is also likely to backfire, observes Stacy Ingram, senior counsel for corporate and securities at Home Depot. Ingram says that while her company’s size makes it an unlikely takeover target, questions like these do shine a light on the management/board relationship.

‘You can’t enter into that type of transaction without board authority,’ she says.

‘If you go too far down the line without getting the proper authority, are you risking the possibility that the board might not grant that authority, or that the board will lose its trust in you going forward?’

‘Being the last one to the party is not a good thing for a board member,’ agrees Brian Quinn, assistant professor of law at Boston College Law School.

No firm rules

That said, there’s no official, clearly established point at which an executive must convey news of takeover interest to the board. Dannette Smith, secretary to the board at UnitedHealth Group, acknowledges that when to divulge an acquisition overture can be a judgment call.

‘If it’s a passing comment that seems like it will never go anywhere, no one would mention that,’ she says.

‘But if it’s an early-stage discussion, even if you don’t think it will lead to anything, more often than not the CEO should advise the board members. We routinely tell the board about all kinds of transactions that may never go anywhere.’

According to Quinn, counsel might want to formally discuss any possible responses to an offer with the board, even if the possibility of an offer is only theoretical. ‘It’s always easier to set out the rules when the CEO, or whoever will benefit most from a transaction, doesn’t have the transaction lined up,’ he explains.

Other facts surrounding the J Crew takeover have raised the specter of impropriety, or at least dismayingly lax governance practices. Before the overture was disclosed to the whole board, J Crew’s chief financial officer James Scully spoke frequently to officials at TPG Capital, the private equity firm that acquired J Crew along with Leonard Green. During these conversations, management revealed non-public information, including earnings expectations for the remainder of the year.

Once the board began discussing the offer, Drexler told a committee of J Crew directors that he had ‘significant reservations’ about working for anyone other than TPG should the company end up being sold. Such an announcement naturally gave TPG/ Leonard Green a distinct edge because Drexler is a large shareholder and his retail prowess makes him a valuable asset.

When Leonard Green and TPG temporarily called off the deal on November 22, however, Drexler made a sudden about-face, telling J Crew director Josh Weston that he would consider continuing his employment with an acquirer other than TPG.

In another eyebrow-raising detail, Goldman Sachs met with J Crew executives in September to advise on a potential recapitalization of the company prior to any buyout being formally announced. Goldman Sachs had already been advising TPG and Leonard Green on the deal, and Goldman Sachs (along with Bank of America Merrill Lynch) had agreed to provide debt financing.

If the same investment bank is on both sides of the deal, it’s definitely a red flag, although not necessarily fatal to a transaction, maintains Quinn. He notes that the universe of investment banks is quite small.

Green light for ‘go-shop’ period

One aspect of how the J Crew board handled the takeover offer has garnered praise: the company’s directors fought for a lengthy ‘go-shop’ period, or a window of time for entertaining rival offers. In this instance, J Crew’s go-shop period extended to January 15, 2011, allowing potential suitors a modicum of time to gauge how the retailer had performed during the critical holiday shopping season.

‘It’s only in the last few years that companies have regularly pressed for go-shop periods, and usually in the context of private equity deals,’ explains Quinn. This is because private equity buyers often want management to stay on, which brings up the possibility of an insider conflict of interest.

A sufficiently long go-shop window, however, dispels the idea that a particular party is getting preferential treatment.


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