The public faith in the private(4)

The sight of public shareholders scrambling for the stub equity in Thomas H Lee and Bain Capital Partners’ take-private bid for Clear Channel Communications shows the asset class still holds its allure despite the credit market upheaval, writes Toby Lewis.

The two times over-subscription for the stub equity in media company Clear Channel Communications is a demonstration of the faith public investors place in buyout firms’ magic. The deal sweetener of an optional 30 percent stake, or stub, in the outstanding shares in the company provided by the buyout firms Thomas H Lee and Bain Capital Partners was agreed at the height of private equity’s dealmaking boom in May.

This helped push through the $27.5 billion (€19.5 billion) deal including $8.5 billion of debt as the bid needed 65 percent acceptance from shareholders, which was not forthcoming at the offered price.

Some shareholders may have been forgiven for ignoring the stub, given the recent turbulence in the credit markets threatens financial sponsors’ abilities to make spectacular returns and in such a scenario a full cash offer may look more attractive.

Yet the owners of more than 67 million shares opted to receive the stock once the Clear Channel merger completes, more than double the 30.6 million share limit, or 30 percent of the outstanding shares.

The result is slightly surprising given some of the disadvantages incurred. The investors will have little liquidity for their stock, which can only be traded on banks’ so-called “pink sheets “or private exchanges. Otherwise they will need to wait until the buyout firms choose to exit or recapitalise.

The investors are also threatened by a possible limited visibility of their investments, if there are fewer than 300 shareholders two years after completion. According to SEC regulation, if the number falls below that level buyout firms are no longer obliged to file public reports. Hardly elements attractive to funds more accustomed to trading shares regularly and with the need to provide regular reports to their investors.

Asset managers like Highfields Capital Management and Fidelity originally led the pressure for the stub, but eyebrows had been raised among market sources about their and other public shareholders’ willingness to sit out typical five year private equity waiting periods as the financial markets look to be entering a more volatile phase of their development. A $39.2 per share cash offer may have begun to look more attractive than it did four months ago. However, such scepticism perhaps seems churlish, after the evident leap of faith taken by owners of 67 million shares convinced taking a backseat ride in a buyout will reap returns.

The shareholder uptake of the stub is also likely to be eyed with interest by buyout firms attempting to pull off large public to private deals in the United States.

The other much-vaunted example of the structure being used to help push through a take-private bid in the US recently failed. Buyout firms Goldman Sachs Capital Partners and Kohlberg Kravis Roberts’ attempt to buy Harman International ended as the financial sponsors walked away from the deal. They claimed a material adverse change had occurred in the business, meaning Harman had breached its original sale agreement.

This makes the Clear Channel deal the only recent test case for the concept in mega deals to convince shareholders to accept an offer. Previously the practice had been used on a much smaller scale in the late 1990’s to aid recapitalisation accounting.

The success of the Clear Channel sale has been so strong, it is perhaps likely more buyout firms will follow Bain and TH Lee’s lead. Meanwhile, the public markets will be watching out to see how Fidelity, Highfields and other shareholders fare allowing the buyout firms to take the reins for them.