Antitrust Inquiry Probes Club Deals: PE firms might argue that their megadeal consortia generate greater value for shareholders

Leveraged dealmakers joke that they call their field private equity because they like to keep their business dealings private. But the veil of privacy was pierced in October when the Justice Department sent letters, initially to four of the largest private equity firms, asking for information on recent deals, apparently in an effort to determine whether any of this year’s spate of club deals was anticompetitive. Specifically, the government is looking for evidence of collusion, bid rigging, or other antitrust violations. In the wake of monster deals like the $33 billion HCA buyout and the $17.6 billion buyout of Freescale Semiconductor by PE consortia, regulators have deviated from their traditional hands-off treatment of the buyout business. The firms that have received the letters are Kohlberg Kravis Roberts, Carlyle Group, Silver Lake Partners, and Clayton, Dubilier & Rice. In November, the DOJ added the private equity arm of Merrill Lynch to the list. “The way the DOJ works is that it identifies the economic incentive of the participants and inventories the communications among them. Then the economic staff tries to reverse-engineer what happened,” says Thane Scott, a Partner at Edwards Angell Palmer & Dodge. He points out that the government will look at why PE funds have formed clubs. If regulators find that bidding teams were put together to reduce price competition and eliminate rivals, it will be a big problem for the private equity firms. “They’ll be looking for things like a payoff from a winning bidder to a loser,” Scott says. Club bids enhance value? Buyout firms could argue that the consortia are pro-competitive. For example, an unidentified buyout expert noted that the threat of a rival bid by KKR and Silver Lake Partners for Freescale Semiconductor forced the winning bidder, a club led by Blackstone Group, to raise its offer. Another defense is that in an age of shareholder lawsuits, the seller’s board must prove that it got the highest price. Without club bids, the reasoning goes, many larger targets could not attract value-maximizing overtures from financial buyers. Scott suspects that once the DOJ investigates possible collusion, it may find more communication among the PE firms than they would like to admit. Even if the DOJ doesn’t follow up on its initial probe, it will have raised consciousness among the private equity community, Scott notes. Antitrust lawyer Steve Newborn, a Partner at Weil, Gotshal & Manges in Washington, D.C., says that unless the DOJ finds a smoking gun, it’s hard to imagine that the investigation will go beyond a preliminary stage. With scores of funds chasing targets, he adds, there are many defenses for forming clubs. He points to a number of situations in which the prices of assets have been driven higher by clubs competing for companies. Speculation about the probe’s effects has held that it will make PE groups more reluctant to team up because clubbing could lead to regulatory scrutiny of their acquisitions. If fear of regulators poking around their deals chills future clubbing, it also would have the effect of placing companies with market caps of $10 billion or more out of the reach of buyers for the time being. By the same token, if clubs aren’t being formed to go after large targets, it could make the playing field even more competitive in the middle market. (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com