Do the "stub equity" components of the recent Harman and Clear Channel buyouts in the U.S. herald a new era in North American private equity transactions?
In recent weeks, two U.S. buy-out offers made by KKR/Goldman Sachs and Bain Capital/Thomas H. Lee Partners, respectively, have contained an innovative offer structure that may herald a new era in North American private equity transactions. In each, the transaction was structured as an all-cash offer, but with the target shareholders being offered the chance to take a minority interest in the acquiring company, and thus an opportunity to share in any profit on a subsequent sale or IPO of the target company. Under the terms of the offers, the current public shareholders could end up holding as much as 27% and 30%, respectively, of the new companies. In each case, the share portion of the transaction is optional and current shareholders can elect to receive only cash, a combination of cash and shares, or all shares (with the share portion pro-rated if over-subscribed). The new shares will be registered with the SEC, but not listed for trading on any exchange (although there has been some speculation that trading may develop on the "pink sheets" centralized quotation service in the United States for over-the-counter securities).
The first transaction was the U.S. $8 billion offer by KKR and Goldman Sachs for Harman International Industries, the maker of JBL speakers and Harman Kardon home theatre systems. Harman was founded in 1953 by Dr. Sidney Harman, the now 88-year-old chairman, who will remain as executive chairman following the transaction. Interestingly, Harman had previously been sold by Dr. Harman in 1977 to the Beatrice Company, under whose ownership it performed poorly. Dr. Harman bought the company back in 1980 for U.S. $55 million.
The second transaction was the protracted U.S. $19.5 billion bid by Bain Capital and Thomas H. Lee Partners for Clear Channel Communications, the radio, television and outdoor advertising firm. The final bid was the bidders’ third offer, the first two having been rejected by Clear Channel’s board and resisted by activist hedge funds and other institutional investors.
The innovative structure, known colloquially as a "stub" (as in a ticket stub), apparently has not previously been employed in the United States in the current buy-out wave, although it has been reported in the Financial Times that several buy-out groups had been flirting with the concept for several months. It represents a concession to public shareholders, who, in the U.S. market, have recently voiced concerns about tendering their shares to private equity groups, only to watch the buyers profit handsomely upon a sale or IPO of the company several years, or even months, later. The recent use of this structure may well convince shareholders to press for stub provisions in future similar transactions (in order to help quell criticism that they are currently leaving "too much cash on the table" in such transactions), and make private equity firms more willing to offer stubs. In this respect, stubs may well serve as a palatable middle-ground for target shareholders and private equity buyers.
However, wider use of stubs is not assured, and indeed in some respects each transaction can be viewed as somewhat of an anomaly: in Harman, given the founder’s historical close association and involvement with the company and the history of the prior buyout; and in Clear Channel, in light of the protracted process (during which the shareholder vote was postponed four times) and need to offer a sweetener sufficient to secure approval of the Board and certain large shareholders. In addition, Clear Channel is incorporated under the laws of Texas, under which approval of the transaction is required by shareholders holding at least two-thirds of all outstanding shares (in comparison with Delaware law, for example, which requires only a simple majority shareholder approval), which gives even small institutional shareholders an out-sized role in the bid process. Further, stubs are not without their drawbacks, as a profitable outcome may never occur or may take many years to realize, during which period there could be little liquidity for the stub equity and little opportunity for the public shareholders to influence the controlling group.
Only time will tell whether these transactions become landmarks, with such stub provisions becoming common or even customary. If stub equity becomes sufficiently prevalent, it has been suggested that it may even give rise to "stub equity funds" existing to invest in stub equity to attempt to duplicate private equity returns.
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