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Make lemonade

20 June 2012 By Robert Cyran

Quest Software’s directors have come up with a canny plan to squeeze more money out of a buyout offer backed by Chief Executive Vincent Smith. They were put on the defensive in March when Smith, who owns a third of the enterprise software company, teamed up with private equity shop Insight Venture Partners for a lowball bid. But independent board members managed to level the playing field by offering Dell an option to acquire a 19.9 percent stake in the firm if Smith didn’t support its superior bid. That bagged shareholders a 12 percent bump in the purchase price.

Management buyouts don’t always work out so well for investors. Take the case of retailer J Crew two years ago. Its boss, Millard “Mickey” Drexler, talked to private equity firms for weeks without informing his board, who approved the resulting sweetheart offer from TPG and Leonard Green Partners without conducting an auction. And the subsequent go-shop provision suffered a big flaw – Drexler was a big shareholder and appeared reluctant to work with other potential bidders.

Quest Software’s Smith acted more admirably, informing the board when first approached. Still, the private equity shop’s $23-a-share offer had the inside track. Smith’s stake meant he could swing a vote. Moreover, his interests aren’t necessarily the same as other holders. A strategic bidder wants to run the company, while Smith could keep his job if the firm were bought by private equity.

Granting Dell the option to acquire a 19.9 percent chunk of stock – the most allowed without a shareholder vote – effectively neutralized Smith’s ability to sway the outcome. This encouraged the computer company to lob in a higher bid of $25.50 a share. Insight and new partner Vector Capital quickly trumped this with a $25.75 offer.

There’s still a chance that Dell could put in a higher bid – or that another firm could enter the frame. But even if the gavel comes down at the current price, the directors’ clever wheeze has already squeezed out 12 percent more for investors. Granted, threatening to dilute shareholders should never be done lightly. Nonetheless, members of other boards, who have a legal obligation to achieve the best outcome for shareholders in a takeover, should take note.


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