"Valuing Asset Acquisitions Under the Hart-Scott-Rodino Act Where Liabilities Are Assumed Some Anomalies Explored"
the antitrust source www.antitrustsource.com May 2006 1 Valuing Asset Acquisitions Under the Hart-Scott-Rodino Act Where Liabilities Are Assumed: Some Anomalies Explored Malcolm R. Pfunder O One of the most confusing problems under the Hart-Scott-Rodino (HSR) Act arises when an acquiror assumes outstanding liabilities of the target or pays off some or all of its existing debt. Current rules lead to different conclusions concerning the reportability of transactions that are eco- nomically similar but structured differently. Consider the following examples. Five Similar Offers Target corporation has assets with an aggregate unencumbered fair market value of $60 mil- lion. Target has $50 million in debt, owed to third party lenders. (Target’s shareholders therefore have an “equity interest” of $10 million.) Five buyers approach target and make the following offers: A will acquire all of Target’s stock for $10 million. As a result of the transaction and a current expenditure of $10 million, A would automatically hold all of Target’s assets and assume all of its liabilities. B will acquire all of Target’s stock for $10 million, but at closing will pay off all of Target’s out- standing debt. For a current expenditure of $60 million, B would hold all of Target’s assets, and the company would be debt free. C will buy all of Target’s assets for $10 million and agree to assume all of its liabilities. For a cur- rent expenditure of $10 million, C would hold $60 million worth of assets and owe $50 million worth of liabilities. D will buy all of Target’s assets for $10 million and pay off the Target’s liabilities at closing. For a current expenditure of $60 million, D would hold $60 million worth of assets and owe nothing. E will buy all of Target’s assets for $60 million and specifically declines to assume or pay off any existing debt. The owners of Target would transfer its assets free of debt or encumbrance. For a Malcolm R. Pfunder is current expenditure of $60 million, E would hold $60 million worth of assets and have no liabilities. Of Counsel at Gibson, Dunn & Crutcher HSR Analysis Under Current Rules and Informal Interpretations LLP in the firm’s Assuming that the buyers’ and the Target’s ultimate parents satisfy the statutory size-of-person Washington, D.C. office. tests,1 HSR Act reportability turns on the value of these transactions—that is, on the value of the The invaluable advice, voting securities or assets that will be held by the buyers as a result of the transactions. The HSR commentary, and rules specify that an acquisition of voting securities that are not publicly traded is valued at the criticism of B. Michael “acquisition price” 2—i.e., the consideration that the parties agree will be paid by the buyer to the Verne of the Federal Trade Commission’s Premerger Notification 1 15 U.S.C. § 18a(a)(2)(B). These tests do not apply to transactions valued in excess of $226.8 million (i.e., the statutory $200 million figure Office is gratefully adjusted for indexing). 15 U.S.C. § 18a(a)(2)(A). acknowledged. 2 16 C.F.R. § 801.10(a)(2)(i). the antitrust source www.antitrustsource.com May 2006 2 sellers.3 If, for some reason, the acquisition price cannot be “determined,” the fair market value of the stock governs.4 An acquisition of assets is valued at the greater of acquisition price or fair market value.5 Informal interpretations issued by the Federal Trade Commission’s Premerger Noti- fication Office make clear that the fair market value of assets must be determined without regard to potentially offsetting liabilities.6 That is, the assets must be valued as though they were being acquired free and clear. Different Results for Similar Transactions These rules have some anomalous results. Take the five cases outlined above. A would acquire Target’s stock for $10 million, well below the HSR Act’s minimum filing thresh- old of $50 million “as adjusted” for annual indexing7 (currently $56.7 million). There is no doubt that These [current] rules the acquisition price is $10 million, because that is the value of the consideration to be paid to Target’s shareholders to acquire their stock. have some anomalous B would acquire Target’s stock for $10 million, and the result is the same because the consid- eration being paid to Target’s shareholders is $10 million. Again, the transaction is not reportable, results. for the same reason. The fact that B chooses to pay off (or acquire) existing debt for an addition- al $50 million does not affect the amount of consideration being paid for the stock8 (even if the debt happens to be owed to the selling shareholders, rather than to unrelated third parties 9). By investing an additional $50 million in the Target, B has made the Target enterprise more valu- able, but not by increasing the consideration paid to the Target’s shareholders. (It does not mat- ter if the debt repayment is structured as an “acquisition” of outstanding debt instruments, since the acquisition of debt is exempt 10 and for HSR Act purposes debt securities or instruments being acquired are not “assets”.11) C would acquire all of Target’s assets for a payment of $10 million, but would agree to assume Target’s outstanding liabilities of $50 million. Under the HSR rules, the acquisition price would be $60 million, because the assumption of liabilities is viewed as additional consideration “paid” to the owners of Target’s assets12 (regardless of whether the creditors technically retain recourse against the owners in the event that C does not ultimately pay the liabilities). Here, the acquisition price exceeds the HSR Act filing threshold, and the transaction is reportable. Moreover, the fair market value of the Target’s assets, ignoring the liabilities, would also be $60 million and would also satisfy the HSR Act filing threshold. D would acquire the Target’s assets for $10 million and simultaneously pay off the existing lia- bilities. In this case, even though the acquisition price would be only $10 million, D would be 3 16 C.F.R. § 801.10(c)(2). 4 16 C.F.R. § 801.10(a)(2)(ii). 5 16 C.F.R. § 801.10(b). 6 See ABA S ECTION OF A NTITRUST L AW, P REMERGER N OTIFICATION P RACTICE M ANUAL 153 (3d ed. 2003). 7 15 U.S.C. § 18a(a)(2)(B)(i). 8 See P REMERGER N OTIFICATION P RACTICE M ANUAL , supra note 6, at 116. 9 Id. at 122. 10 15 U.S.C. § 18a(c)(2). 11 16 C.F.R. § 801.21(b). 12 P REMERGER N OTIFICATION P RACTICE M ANUAL , supra note 6, at 153. the antitrust source www.antitrustsource.com May 2006 3 viewed as acquiring assets with fair market value of $60 million (regardless of whether the liabil- ities are ignored or are zero), and the transaction would be reportable. E would acquire Target’s assets for $60 million and neither assume nor pay off any liabilities. The transaction would be reportable because the acquisition price paid to the owners of the assets (and presumably also the fair market value of the assets) exceeds the HSR Act filing threshold. So, in these five cases the voting securities acquisitions are both non-reportable and the asset acquisitions are all reportable. While the transactions differ somewhat in their up-front costs, they are economically similar, in that each of the buyers obtains control of $60 million worth of assets and (where any existing debt is assumed) the ability to pay, pre-pay, or refinance the debt. Resolving the Inconsistencies An important first step in considering ways of resolving these inconsistencies is deciding upon the best public policy outcome that is consistent with the goals of the HSR Act. Are these best viewed as $10 million transactions or $60 million transactions? At least where control of an existing entity is being acquired, the answer to that question seems relatively easy. The value of the entity should approximate the value of its stock or the value of the owners’ “equity” interest, which in turn should at least approximate the value of its total assets minus the liabilities to which the assets or the entity is subject. Just as the amount of the Target’s liabilities affects the value of its stock, those liabilities also affect its enterprise value and should be similarly reflected in a similar transaction in which all or substantially all of the Target’s assets, rather than its voting securities, are acquired. The buyer is not acquiring $60 million worth of assets; it is acquiring $60 million worth of assets with a bill for $50 million. And the sellers are not receiving $60 million cash consideration; they are receiving $10 million cash consideration. They are also (assuming no recourse) being relieved of $50 million of debt obligations, just as they would if the transaction were structured as an acquisition of all of the Target’s stock. Where control or substantially all the assets of an entity are being acquired, it is artificial and distorting to add the $50 million back into the acquisition price in an asset acquisition but not in a voting securities acquisition. One obvious possible solution would be simply not to include the assumption of liabilities in the asset acquisition. The corollary is that, in determining the fair mar- ket value of assets being acquired, the value determination should reflect (rather than ignore) the liabilities that the buyer will assume as a result of the asset acquisition. Thus, when C buys all of Target’s assets for $10 million and assumes all of its debt, the trans- action should be valued at $10 million, both because the consideration being paid by C to the sell- ers is $10 million and because C is acquiring an enterprise with a fair market value, net of relat- ed liabilities, of $10 million. The result should be the same for D, who buys all the assets for $10 million and pays off all the debt. The assets, when acquired, were worth $10 million. The fact that D chooses to pay off the debt to third parties and enhance the value of the enterprise by $50 mil- lion does not affect the value of the assets when acquired and does not enhance the considera- tion received by the sellers. Just as in B’s stock purchase, the decision to pay off the debt should not affect reportability. Acquiring a Debt-Free Enterprise Reconsider the last case, in which E acquires all of Target’s assets for $60 million but does not assume or pay off any liabilities. This is actually a different case economically, because the busi- ness that is being acquired from the sellers has no debt. The consideration paid to the sellers for the antitrust source www.antitrustsource.com May 2006 4 acquisition of their assets is $60 million cash. The fair market value of the acquired assets is also $60 million (since there are no liabilities). Whether the sellers ultimately use all or any part of $50 million of their proceeds to discharge the retained liabilities seems unrelated. This case is distinguishable from the other four because here the buyer acquires a debt-free business and pays a premium to do so. The result would be the same if the buyer had agreed to buy all the stock of a debt-free Target, and its owners agreed to pay off its debts prior to closing. Possible Changes in HSR Rules and Informal Interpretations These observations suggest possible changes in the existing HSR rules and related informal inter- pretations where all or substantially all the assets of an existing entity are being acquired. To treat such cases like an acquisition of control of a corporation or an unincorporated entity, the “acqui- [T]he “fair market sition price” of such transactions should not include the value of any liabilities of the entity that are being assumed by the buyer,13 and the “fair market value” of the assets being acquired in such value” of the assets transactions should reflect rather than ignore any liabilities related to those assets that are being assumed.14 being acquired . . . Acquisitions of less than all or substantially all the assets of an entity would continue to be val- ued under existing rules and interpretations. That is, the amounts of any liabilities assumed would should reflect rather continue to be included in (i.e., if necessary added back into) the amounts of any other consid- eration being paid to sellers, and the fair market value of the assets being acquired would be than ignore any determined without regard to any related liabilities (whether or not they were being assumed). Thus, if a buyer makes an offer to cherry-pick assets from an entity for a cash price, without liabilities related to assuming any liabilities, that looks just like E’s acquisition above, and the outcome should be the same. those assets that are One might consider expanding this approach to acquisitions of all or substantially all the assets of any ongoing business and the assumption of any liabilities relating to that ongoing busi- being assumed. ness. This would more closely approximate the treatment of acquisitions of controlling interests in corporations or unincorporated entities, although it would introduce some uncertainty as to the appropriate definition of an “ongoing business” and perhaps also as to what liabilities are “relat- ed to” that business. What the approach suggested here would not fix is a buyer’s offer to acquire certain (but not all or substantially all) assets of an entity in return for a cash payment and the assumption of lia- bilities that relate specifically to the assets being acquired. Here it is assumed that, because the buyer is not acquiring control, any assumption of liabilities is volitional and reflects a deliberate intention to structure a portion of the consideration in this manner. In the absence of explicit agreement, no liabilities would automatically pass to the buyer or necessarily be reflected in the purchase price, as they typically would with an acquisition of control. The parties’ apparent inten- tion to include the assumption of liabilities in the consideration would require that they be reflect- ed in (i.e., if necessary added back into) the acquisition price. 13 This could be accomplished by inserting the following language at the end of existing rule 801.10(c)(2): Provided, however, that if all or substantially all the assets of an entity are being acquired, the acquisition price for such assets shall not include the acquiring person’s assumption of any liabilities to which such assets may be subject. 14 The following language could be added at the end of existing rule 801.10(c)(3): In an acquisition of all or substantially all the assets of an entity, the fair market value of such assets shall reflect the amounts of any liabilities to which such assets may be subject, even if the acquiring person will assume some or all of such liabilities.