That question is front and center in light of the announcement this week that the Parallel Petroleum Corporation had agreed to be acquired by an affiliate of Apollo Management in a deal valued at $483 million, including the assumption or repayment of $351 million in debt.
The New York Times has an interesting article on this - summarized here:
Apollo has been painted as one of the chief private equity villains of the financial crisis. The firm earned this reputation by orchestrating an attempt by Hexion Specialty Chemicals, which Apollo controls, to escape its obligation to acquire Huntsman. Apollo succeeded in this attempt, but its reputation suffered both externally and possibly internally as its investors sweated the possibility of a big damages award. Parallel’s announcement clearly is a signal to the market that Apollo is not permanently exiled.
But this does not mean that targets will blindly trust private equity. Prior to the financial crisis, the private equity acquisition agreement typically included a reverse termination fee that allowed a suitor to walk for any reason by paying this amount. Targets granted this right because they relied on private equity’s reputation for completing deals. Parallel filed its own acquisition agreement on Tuesday with the Securities and Exchange Commission. Parallel is willing to deal with Apollo, but the agreement itself shows that there is little trust. Instead of relying on reputation, Parallel reverted back to contract terms to ensure that Apollo lived up to its promise. While some of this may be attributable to Parallel’s state and need for certainty, the Parallel deal is yet another sign that a new private equity deal model is developing.
First, the acquisition agreement in the Apollo/Parallel deal does not have a financing condition. This is normal. However, this deal is all equity-financed by Apollo, which is injecting $283.2 million. This means that in order to do the deal, Apollo is taking the credit risk for any new financing as well as refinancing Parallel’s $150 million senior notes. This is a sign of a return to normalcy in the markets, but it also reflects the lengths Apollo had to go to secure this deal.
Second, the equity commitment letter was not disclosed on Tuesday. It will be disclosed with the tender offer documents. (An aside: When is the S.E.C. going to force the disclosure of these documents with acquisition agreements?) But the merger agreement appears to state that Parallel has a right to specifically enforce it. That is, Parallel can sue to force Apollo to specifically perform its obligations under the equity commitment letter instead of paying monetary damages. This is also a sea change. Before the financial crisis, a target only had a right to sue the shell subsidiary acquiring it. The only exception I remember was in the Fortress/Penn National Gaming deal.
In such a scenario, if there was even a right of specific performance, a judgment was required first against the subsidiary, forcing it to sue the buyout firm to perform on the equity commitment letter. Then the subsidiary would somehow have to pursue a lawsuit against its owner. This was a high hurdle. But the private equity firms wanted to keep their liability remote and insisted on it. The Parallel deal and its different approach is another marker that the practice is not likely to continue.
Third, this is the second significant private equity deal in recent months (the Bankrate deal is the other one) in which there is not a reverse termination fee. In other words, the buyer cannot terminate the deal by simply paying a preset fee. Instead, the Parallel merger agreement requires specific performance. Parallel can sue to force the Apollo subsidiaries to perform their obligations, and since these are shells, Parallel can also bypass these subsidiaries to sue on the equity commitment letter to force the money to be provided.
As in other recent private equity agreements, including the Sum Total/KKR Accel agreement, this deal requires that Parallel first seek specific performance as a remedy. Only if specific performance is unavailable can Parallel seek monetary damages and specifically the benefit of the share premium, and only then after giving Apollo two more weeks to perform its obligations.
This is a nice benefit to Apollo. It essentially provides them a free pass on litigation — with a maximum cap of having to close the deal. Because of this, future targets may want to rethink this provision.
Because the Parallel deal is all equity-financed, it can be a tender offer, which means it can close 20 business days after the tender offer commences, as opposed to the two to three months necessary for a proxy contest.
Previously, the margin rules and need to market the debt financing had made it difficult to structure deals as tender offers instead of mergers. The margin rules, Regulations U and X, limit a lender’s ability to lend money on margin stock. “Margin stock” includes any publicly traded security (e.g., Parallel stock). A private equity firm that wants to do a debt-financed tender offer can get around this problem by structuring the deal to comply with these margin rules and limit the amount of its borrowing to 50 percent of the value of the collateral pledged to secure the loan (i.e., Parallel).
Historically, this was lower than a private equity firm is willing to go.
And the tender offer has tight conditions. If you look at Annex A to the acquisition agreement, these are the bare minimum conditions you see in a tender offer — no material adverse change, requirement of regulatory approvals, etc. There is nothing like the minimum cash or Ebitda conditions you often would see in private equity deals.
The Parallel and Bankrate deals show that a new private equity model is developing. Private equity is focusing on the low side range of middle-market deals and negotiating tight contracts with no financing out, specific performance, all equity financing and a guarantee enforceable by targets.
Vice Chancellor Stephen P. Lamb's opinion in Huntsman/Hexion and the private equity implosion appear to be having lasting impacts. Nonetheless, this all-equity model is not portable to larger deals, so it remains to be seen if the historical structure of private equity will shift if and when private equity ventures deeper into the deal pool.
Still, the fact that anyone is still willing to deal with Apollo means a lot for private equity generally and perhaps the short memory of Wall Street. It would also be interesting to know if Apollo had to pay a slight premium for its reputation risk. But that is hard if not impossible to determine. If true, though, it would show that markets are much more efficient than the day’s conventional wisdom.