$8 Billion Buyout of D.C. Firm Collapses
Saturday, September 22, 2007
The $8 billion buyout of audio-equipment maker Harman International Industries collapsed yesterday, the first major private-equity deal to unravel since the current credit turmoil began and a sobering sign for other big takeovers in the works.
Harman, of the District, said its would-be buyers, Kohlberg Kravis Roberts and Goldman Sachs, accused it of breaching a clause in the contract, allowing them to walk away after paying a $225 million termination fee. Harman denied the accusation, but it did not describe the nature of the alleged breach. The company and the bidders declined to comment further.
If Harman chooses to fight, the battle would almost certainly end up in the courts, pitting Sidney Harman, an 88-year-old philanthropist who is married to Rep. Jane Harman (D-Calif.), against two of the most powerful titans on Wall Street.
The disintegration of the deal, rumored for much of the day before it became public, helped send Harman shares plunging 24 percent in regular trading. After hours, the stock dropped another 3 percent.
It also left analysts and others wondering what effect the collapse would have on buyout king Henry Kravis and on Goldman Sachs, the world's largest investment bank. Any time a company reneges on an agreement, it puts its reputation at risk. It may find companies reluctant to do deals in the future, said several analysts who follow mergers and acquisitions.
The breakup could set a precedent for other private-equity firms to get out of acquisitions that have become less profitable because of the rising cost of financing big buyouts, the analysts said.
Harman built his company over the last half-century into a multibillion-dollar manufacturer of high-end audio nameplates like JBL, Harman Kardon and Infinity. He negotiated a deal that allowed Harman shareholders to roll over their stakes into a KKR private-equity fund; usually, such investors are bought out.
In an interview in May, shortly after the deal was negotiated, Harman said he was looking for "a secure harbor" for his "beautiful company." He believed he had found it by agreeing to a private takeover.
Since then, private equity has been looking less safe as a haven.
Private-equity firms typically use vast pools of investor money to buy struggling companies, turn them around and sell them at a profit. They make even more off the fees they charge for their services. Business was so good for so many years that private-equity firms started paying ever higher premiums to buy companies. Even the rumor of a private takeover would send a firm's stock soaring.
The Harman deal was negotiated in April, when the credit markets were booming and financing big deals was easy. But a credit crunch in August shook confidence in the financial system, making money far more expensive to borrow.
That has left many private buyers feeling remorse for agreeing to pay high prices for companies. Several private-equity firms are fighting to get out of major deals or renegotiate the price. Carlyle Group of the District and two other private-equity firms, for instance, recently got the struggling retailer Home Depot to reduce the price of its wholesale business by $1.8 billion.
Harman's business, too, has had its troubles in recent months. In August, the company reported a lackluster quarter, posting revenue of $911.1 million. That was about $30 million less than the consensus analyst expectation.
To get out of their deal, KKR and Goldman Sachs are citing a "material adverse change" clause, which is included in virtually every buyout agreement but is rarely invoked. It defines what changes would significantly alter the value of a company that would allow its buyers to back out.
Such provisions often are written with very specific language and greatly limit a buyer's options. In Harman's case, KKR and Goldman cannot walk away for events "generally affecting the consumer, or professional audio, automotive audio, information, entertainment or infotainment industries, or the economy or the financial, credit or securities markets."
"These clauses are very tightly written," said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College. "Something just short of fraud is the only way [KKR and Goldman] could walk away."
Invoking this clause is often used as a negotiating tactic by buyers seeking a lower price. Since 2003, no deal has been canceled because of a material adverse change clause, according to the research firm FactSet MergerMetrics.
KKR and Goldman told Harman that the turmoil in the credit markets was not the reason why they are walking away, said a source close to the matter who spoke on condition of anonymity because he was not authorized to talk publicly about the deal.
A legal battle over the Harman deal could effect other buyouts, such as the $25 billion acquisition of student loan giant Sallie Mae. Its private-equity buyer, J.C. Flowers, has talked about using the material change clause to force the company to consider a lower price. On Thursday, Sallie Mae released a statement saying it disagreed with J.C. Flowers on the matter.