For a while, appraisal arbitrage was a great little trade. Delaware — where most US public companies are incorporated — has a law that says that, if a company sells itself in a merger for cash, shareholders who object to the deal can sue for the fair value of their shares. If a company agrees to merge for $10 a share, but you are a shareholder and think it’s worth $15, you can vote no on the deal, but if a majority of shareholders vote yes then the deal will close anyway. You can then go to court and demand $15, and if the judge agrees with you then you’ll get your $15. What made it a great trade was interest. If you sought appraisal, you rejected the deal price and took your chances in court instead. The acquirer would cash out everyone else’s shares at $10, but you wouldn’t get the $10; you’d go to court. You’d argue your case, and then, months or years later, there would be a result. Either you would win (the judge would agree with you that the company was worth $15) and you’d get your $15, or you’d lose (the judge would agree with the acquirer that the company was worth $10) and you’d get $10, or something in between (you’d get $12 or whatever). But in any case, the Delaware law provides that you get interest on the money, from the time the deal closed (and everyone else got their $10) to the time you get your money ($10 or $12 or $15 or whatever you get). And the interest is set at the Federal Reserve’s discount rate plus 5%, compounded quarterly. [1] And so you could do this trade: - Buy stock in the company after the deal is announced but before it closes, paying $9.95 or whatever per share (because it’s about to be cashed out at $10).
- Demand appraisal.
- Wait two years and get back at least $10 plus interest at 5% over the discount rate, which is pretty good, particularly in a low-interest-rate environment and with fairly low credit risk.
- And maybe you’ll get $15!
If you lost, you got a nice return on your money; if you won, you got more. It was a good steady fixed-income strategy with some big equity upside. Good trade. Too good. It became a big business, shareholders sued for appraisal in lots of deals, and eventually Delaware decided it had gone too far. Appraisal was intended to allow courts to correct egregiously bad insider deals, or private-company mergers with no market prices; getting appraisal on every public-company merger with an auction process, a big premium and an unbiased shareholder vote seemed silly. And so there was a crackdown that made appraisal arbitrage much less attractive. There were two elements of this: - One attraction of appraisal, historically, was that you could get an above-market interest rate on your money. That changed. Not entirely: The statutory appraisal interest rate is still the discount rate plus 5%. But in 2016, the law was amended to allow acquirers to prepay some or all of the deal price to shareholders seeking appraisal, to avoid interest. If the deal price is $10 and you sue for appraisal, the acquirer could give you $10 right away, and you’d only get interest if you won. If the court agreed with the acquirer that the company was worth $10, you’d get nothing extra.
- Another attraction of appraisal, historically, was that there wasn’t much downside. Either you got the deal price, or you got more; you tended not to get less. You’d argue the company was worth $15, the acquirer would argue it was worth $10, and the judge would choose between those arguments or pick something in the middle. But acquirers and courts realized that the deal price is not really a floor on valuation. If a company is acquired for $10 a share, that might mean that it was worth $8 a share as a standalone company: The acquirer is paying an extra $2 for (1) synergies (value that is created by combining the target and the acquirer, but that does not belong to the target shareholders and can’t be awarded in appraisal [2] ) and/or (2) mistake, hubris, winner’s curse, etc. The acquirer could go to court and say “oops we overpaid,” and the court would, increasingly, agree. (In particular courts sometimes found that the unaffected trading price of the stock, without the deal premium, was the right reference point for valuation.) And then the shareholders who sought appraisal would get $8, instead of the $10 that they would have gotten in the merger.
So appraisal stopped being risk-free and stopped being a juicy fixed-income trade. It still exists. But now, if you want appraisal, you have to be sure that you’re right. If the deal price is $10 and you’re pretty sure you can convince a judge that the market was wrong and the deal was mispriced, go ahead and sue for $15. But if you’re wrong, you’ll be worse off than if you just took the deal price. We have talked a couple of times about Silver Lake’s buyout of Endeavor Group Holdings Inc. Endeavor was a public company, but 74% of its voting stock was owned by Silver Lake, the private equity firm. Endeavor also owned about 54% of another public company, TKO Group Holdings Inc. Silver Lake decided to buy out the minority shareholders of Endeavor, negotiated with a special committee of Endeavor’s board, and struck a deal at $27.50 per share. The minority shareholders had no say in the deal — as controlling shareholder, Silver Lake voted it through — and they thought the deal price was too low. In particular, between signing and closing of the deal, TKO’s stock went up, so that by the time of closing, [3] Endeavor’s stake in TKO alone was worth more than $27.50 per share. And so Endeavor is an unusually attractive appraisal case: - The deal is procedurally hairy. Many public-company mergers involve an auction, a sale to the highest bidder, and an informed vote of independent shareholders. Here there was only one possible buyer — the majority shareholder — and, unlike in many such deals, there was no “majority of the minority” condition requiring approval of the minority shareholders. The minority shareholders had no say in the deal.
- There is objective market evidence that the deal is underpriced. Even if a judge looks only to public trading prices of stock, ignoring all subjective arguments about valuation, the market price of TKO implies a value for Endeavor that is significantly higher than the deal price.
So it led to a huge revival of the appraisal arbitrage trade. Bloomberg’s Mike Leonard reports: The number of appraisal petitions—by funds holding 150 million shares worth $4 billion at the deal price—guarantees the dispute will be among the largest ever of its kind in Delaware’s Chancery Court, the leading US forum for corporate cases. (There are also other possible lawsuits; just before the deal closed, Carl Icahn bought a big chunk of shares that are presumably ineligible for appraisal, and one assumes he will eventually sue for more money.) There is one other interesting feature of Endeavor. Silver Lake could just pay the appraisal funds $27.50 per share now, to avoid paying interest — of almost 10% per year — on the deal price between now and the end of the appraisal proceedings. That would probably save it some money: It will definitely have to pay something for appraisal, eventually, and 10% financing is expensive. But it has said that it won’t pay the funds a cent until the bitter end: “Silver Lake hereby advises all dissenters that it does not intend to pay them any merger consideration at closing,” it said in March. The popular assumption is that this is an attempt to smoke out weak hands: It might not be easy for funds to finance holding their Endeavor appraisal claims for years until they are fully resolved in court. Not paying anything now makes the appraisal trade harder, but also more rewarding: Not only do you have a good chance of getting much more than the deal price (and very little chance of getting less), you’ll also get 10% interest on the whole payment. It’s just like the good old days! Leonard’s story is not about that, though. It’s about the law firms fighting to lead the deal. In particular it is about how they want to get paid: Two firms that moved to take charge of the litigation right after it was consolidated are now drawing fire from funds over their fee structure and allegedly aggressive client engagement tactics. ... That June 4 filing targets the firms representing the biggest bloc of shares, Rolnick Kramer Sadighi LLP and Heyman Enerio Gattuso & Hirzel LLP, which are handling the case on contingency. The arrangement means they’ll get a percentage of any winnings but nothing if they lose—apart from the same cut of any interest that accumulates. The interest is the catch, according to funds that signed with Abrams & Bayliss LLP, which wants a share of the lead counsel assignment. Abrams & Bayliss is billing hourly, backstopped by two funds pledging to foot the whole fee unless the damages are enough to cover it. Those billings could reach $50 million—still a steal compared to a percentage-based windfall, the June 4 filing said. ... The interest already comes to $77 million, and the litigation is barely underway, that person said. That is, the potential lead law firms on the case want to get paid a percentage of their winnings. But their winnings won’t just come from winning: “By including the potentially huge pool of accumulated interest within their percentage-based fee, attorneys involved in the case could earn hundreds of millions even if they lose.” If, two years from now, a judge concludes that the $27.50 deal price was fair, the shareholders who sued for appraisal on their $4 billion of stock will only get $4 billion — plus $800 million of interest. [4] If that happens, it will look like a loss for the shareholders — I mean, it’ll be fine, but not great given the TKO valuation — and not a great performance by their lawyers. But if the lawyers get 25% of the recovery (above the deal price), that’s $200 million, even for losing. [5] I can see why some funds would object to that: It’s not the best incentive for the lawyers to pay them $200 million even if they lose. On the other hand … that’s the trade that the funds are in? That’s the appraisal arbitrage trade? There is something kind of fitting about the lawyers getting paid in the form of a nice fixed-income trade with equity upside. It’s a little strange that modern artificial intelligence companies are simultaneously: - Incredibly capital-intensive: If you want to compete in AI, you need to spend billions of dollars on chips and data centers and nuclear power plants; and
- Incredible examples of companies where “the assets take the elevator down every night”: AI researchers are in hot demand, “Meta has offered seven- to nine-figure compensation packages to dozens of researchers from leading A.I. companies,” and famous AI researchers can start their own companies and instantly get multibillion-dollar valuations without chips, data centers or nuclear power plants.
It is a real corporate financing puzzle. If you are a top AI researcher, you can start an AI company with a few of your top-AI-researcher friends, but you will need tons of money. So you go out to investors and say “I need $2 billion for electricity and stuff,” and they say “oh sure of course here you go” because you are a top AI researcher, and they give you $2 billion, and you spend $1.7 billion of it on electricity and another $300 million on paying yourself and your dozen researchers eight-figure salaries. And then a few weeks later, before you have even done any research, Meta comes to you and says “hey we need more researchers, we’ll pay you and your team nine-figure salaries, plus we already have nuclear power plants,” and you say “hmm that’s one more figure than we’re making now, we’re in.” And you all quit and your investors, who paid $2 billion, are now left with $1.7 billion of electricity that they have no particular use for. That is a bad dynamic; the investors won’t give you the $2 billion if that’s what will happen. If they are going to give you money, they will want, not just an equity stake in your AI company, but an equity stake in you. If you decamp for a better job at Meta, they will want to get paid. And so the norm seems to be that they get paid. We have talked about a few previous AI quasi-acqui-hires, where big tech firms hire the founders and top employees of AI startups by paying big piles of money, not just to the founders and employees, but also to the shareholders of their startups. Here’s the latest, from The Information: Meta has agreed to take a 49% stake in data labeling firm Scale AI for $14.8 billion, two people familiar with the matter said. The unusual deal will be structured so Meta will send the cash to Scale’s existing shareholders and place the startup’s CEO, Alexandr Wang, in a top position inside Meta, the people said. The deal, which hasn’t yet been finalized, appears to be a rich one for Scale’s shareholders, with big paydays for some of Scale’s biggest investors such as Accel, Index Ventures, Founders Fund and Greenoaks, as well as current and former employees. Scale shareholders also would maintain their existing holdings in Scale, which will now be valued at $28 billion, including the cash invested, up from $13.8 billion last year. Basically Scale was a $13.8 billion company and now Meta will pay $14.8 billion for 49% of it, while also more or less hiring away its chief executive officer. And then, instead of spending Meta’s $14.8 billion on chips and nuclear power plants, Scale will dividend it out to the existing shareholders. The shareholders will get cashed out for pretty much the full previous value of Scale, and they’ll keep Scale (or at least 51% of it). In some ways it would be cleaner for Meta to just buy Scale — $14.8 billion is a premium to its valuation last year, and “there have been some signs of the company struggling to meet expectations” — but in most ways not: Meta, with abundant cashflow, could have bought Scale. But the company is coming off a painful trial in which regulators sought to show the company’s acquisitions of Instagram and WhatsApp were anticompetitive. The unusual structure of the deal, and the fact Meta will own just 49% of Scale, could be an effort to avoid more regulatory scrutiny. One possible reading is that Meta doesn’t want to own Scale; it wants to hire Wang for its own “superintelligence group.” If there was a clean way for Meta to pay $14.8 billion to Scale’s shareholders for (1) Wang and (2) zero percent of the stock, that would probably have been fine. But this is close enough. We talked on Monday about how no one likes private equity recruiting. There is a prisoner’s-dilemma situation in which private equity firms recruit a little earlier each year, so that this year private equity firms interviewed some candidates in May (before they graduated college and started at investment banks) for jobs that will start in summer 2027 (after they finish their two-year investment banking analyst programs). Private equity firms don’t like this, banks don’t like it, and candidates don’t like it, but it happens anyway because everyone can get an advantage by moving first. And, as we discussed on Monday, Jamie Dimon really doesn’t like it, and because he’s Jamie Dimon he can do something about it. Specifically he told JPMorgan Chase & Co.’s incoming analysts that they’d get fired for accepting a private equity job too early. I wrote: This is all very reasonable on its own terms and I assume they will quietly forget about it in six months, which is probably when on-cycle recruiting for 2028 will start. But maybe not! Maybe JPMorgan will be an outlier, and will attract good analysts who don’t want to go into private equity. Maybe JPMorgan will be an outlier in a different way, and private equity firms will reserve some spots for JPMorgan analysts and just wait longer to fill them. Or maybe everyone else will see this move and say “yes obviously this is better,” and everyone will hold off on recruiting until the analyst programs end. Well! Today Bloomberg’s Laura Benitez reports: Apollo Global Management told prospective investment-banking candidates that it won’t interview or extend offers to the class of 2027 this year, following backlash among Wall Street firms over young recruits accepting future-dated offers. In a letter sent to candidates on Wednesday, Apollo explained its decision by saying it believes graduates should take time early in their careers and deepen their understanding of business. Apollo’s Chief Executive Officer Marc Rowan said he agreed with recent criticisms that the process for hiring young recruits had started too early. It just … worked? That’s it? Jamie Dimon was like “stop recruiting so early” and everyone is like “oh yeah good idea”? Seems too easy. Is hosting TikTok securities fraud? | Two themes we have talked about around here are: - The Trump administration tends to deregulate by suspending laws rather than changing them. President Donald Trump doesn’t like the Foreign Corrupt Practices Act, but instead of asking Congress to revise it, he announced that it wouldn’t be enforced for a while. Now it will be, but a bit less. Does this mean it was legal to do bribes over the last few months? Not really, but maybe a little bit. Similarly Congress passed a law forbidding US companies from hosting TikTok on their servers or in their app stores, but Trump doesn’t like it, so he announced that he would not enforce it for a while. Does this mean it is legal for US companies to host TikTok? No, but also yes. The US Department of Justice has told Apple and Google — which run the big app stores that distribute TikTok — that they can keep distributing TikTok, and one gets the impression that Trump would prefer it if they did. So they do.
- Every bad thing that a US public company does is also securities fraud, and in our politically charged times, most things that US public companies do will look bad to someone.
You can combine those two themes and get “if a US public company distributes TikTok, it is breaking the law, which is bad, and so it is also securities fraud.” (Also, though, “if a US public company stops distributing TikTok, it is misinterpreting the legal situation and giving up revenue, which is bad, and so it is securities fraud.”) And in fact we talked about this last month, because Adam Conner wrote a piece laying out the theory for the Center for American Progress. (“Ideally, the public companies should disclose, in their quarterly filings to the SEC, the risk of massive fines for violating the TikTok ban,” etc.) Well here’s a case: Alphabet Inc.'s leaders may have exposed it to significant legal risk by continuing to distribute TikTok through its Google Play app store, according to a lawsuit filed Tuesday. An investor sued the tech giant for documents, saying it was unwise to restore TikTok based solely on President Donald Trump’s executive order pledging not to enforce a ban on the Chinese-owned social media app. Google delisted TikTok in January, after the US Supreme Court upheld the federal law banning it, but restored it in February, about three weeks after Trump issued the order on the first day of his second term. The move appears to put Alphabet at the mercy of a mercurial president, according to the filing in Delaware’s Chancery Court. “The first five months of the current administration’s term is already replete with examples of President Trump changing his mind,” the suit says. Here is the complaint. It’s not technically a securities fraud case; it’s a Delaware fiduciary duty case, or rather, it’s a request for books and records as a preliminary to a potential fiduciary duty case. But same basic idea: (1) Google is violating the law, (2) that’s bad, (3) specifically it is bad for shareholders: Plaintiff’s investigative purpose for requesting access to the Company’s books and records is proper and reasonably related to his interest as a stockholder of the Company. There is a credible basis from which to suspect corporate mismanagement and wrongdoing, including breaches of fiduciary duty by directors and officers, and positive and knowing violation of the law sufficient to allow Plaintiff inspection of books and records. Therefore, Plaintiff has a credible basis as a stockholder to investigate corporate governance. Sure why not. If you are unhappy that Donald Trump is not enforcing the law, I suppose you can sue Donald Trump, but there are various problems with that. It’s probably easier to sue Alphabet. I wrote last week about two classic financial ideas that people keep reinventing: “People should be able to sell stock in themselves” and “people should be able to sell stock in their houses.” Over the years, many companies have been formed to address the first idea, and at least a few have been formed to address the second. One of them is Point, which we discussed in 2016. Last week I said that Point “as far as I can tell still exists.” Well, uh, it still exists. In fact, just last week “Point and Funds Managed by Blue Owl Capital Close Oversubscribed $248 Million Home Equity Investment Rated Securitization”: Over the past 18 months, the rated securitization space for HEIs [home equity investments] has entered a new phase of maturation. With multiple HEI-backed deals successfully rated, the asset class is seeing increased institutional recognition and investor confidence, with issuance volume doubling and the number of transactions tripling in 2024 alone. According to Finsight, HEI-backed deals totaled $936 million across five transactions last year—up significantly from prior years. These transactions have helped set important benchmarks for credit quality, structure, and performance, signaling a shift from emerging to established within the alternative housing finance landscape. There you go. You can sell stock in your house, and someone will securitize it. And obviously you can sell stock in yourself, and someone will securitize it; we talked about those securitizations back in 2020. Markets are complete now. Moelis’ New CEO Pledges to Push ‘Hazing’ Out of Banking Culture. Private market funds lag US stocks over short and long term. European banks spend €1.1bn axing senior staff. US Regulators Seek Rollback of 1-Minute Bond Trade Reporting. X’s Sales Pitch: Give Us Your Ad Business or We’ll Sue. Elon Musk says he ‘regrets some’ of his attacks on Donald Trump. Disney, Universal Sue Midjourney Over AI-Generated Princesses and Minions. US charities plan for cuts as Trump budget targets investment returns. GameStop Swings to Profit, Sales of Collectibles Up 54%. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! |