J.Crew's Buyout Leaves Some Questions

With J.Crew's deal to go private almost complete, there are still some lingering questions. "Thanks!" to many of you, including WellFedFred, who shared the following news. The article below is from the Wall Street Journal (click here to read in its entirety):

The Lesson of J. Crew: To Err is Human. To be Forgiven…Doesn’t Cost Much
By Ronald Barusch
January 21, 2011

The J.Crew board process was, as I have said before, a disaster. So it is not surprising that in the settlement with the plaintiffs’ lawyers, of whom I am equally skeptical, the buy-out group of CEO Mickey Drexler, TPG, and Leonard Green actually had to give a bit up…just not too much. And of course, ... the outside directors who also made mistakes didn’t have to pay anything.

To briefly recap, the deal was hatched by two directors behind closed doors. They waited weeks to tell their fellow directors They got a huge head start by sharing corporate secrets with no confidentiality agreement. Even when the outside directors engaged, they seemed to panic and pushed to sign the deal up quickly—before the all-important holiday sales season. And that allowed the buyout group to threaten to walk away and reduce its bid, blaming the company for disclosing bad news at the last minute.

This week, J.Crew announced that although holiday season revenue was higher, same store sales were down more than 6%. Apparently the board was pushed into the deal because it was nervous about whether Drexler could tackle that problem.

J.Crew tried to fix everything with a “go-shop”—but that was flawed as well... The management group discouraged other bidders by, among other things, insisting on matching rights. This meant even if a new party came up with a better deal it would probably lose when the management group matched. So not surprisingly the go-shop expired last weekend with no one coming to the party.

Meantime those plaintiffs’ lawyers were likely developing an unusually good case. Why? Because under Delaware law the TPG deal would probably have been scrutinized under an “entire fairness” standard. And that means not only did the price have to be fair, but the process had to be “fair dealing” as well. Maybe with enough expert witnesses J.Crew could argue the price was okay, but, as I have said, J.Crew and TPG were vulnerable in trying to establish fair dealing.

Other terms [in the settlement] included a $7 million reduction in the breakup fee, an extension of the go-shop period, a non-compete from Drexler if he chooses not to go with a new bidder, some expenses for a competing bid to the extent the matching rights remain, a majority of the disinterested shareholders vote requirement (it may sound good, but the insiders don’t own much stock in this deal) and a whole lot more of relatively inconsequential stuff.

But don’t get your hopes up that the extended go-shop is going to have any different outcome. The company is now shop-worn and a buyer still has no assurance of getting Drexler.

One more meager victory that settlement wins for shareholders: J.Crew (or its insurers) is going to pay its shareholders $10 million at the closing of the deal. Don’t spend it all in one place. It works out to about 15 cents a share. My guess is that is included just to assure a plump legal fee to the plaintiffs’ lawyers. They will be paid separately, but the lawyers can argue they are entitled to at least 30% of this additional value they created for shareholders. I suspect they will ask for more than $3 million though given all those monetary concessions.

But here is the bottom line: The many mistakes which were made cannot be undone. What really were the options here for moving forward? J.Crew shareholders have a deal on the table for $43.50 per share in cash–plus that extra 15 cents. And that for a stock that was trading at $37.65 prior to the deal with the company about to announce it was missing its numbers. Was it ever realistic to expect a court to enjoin such a transaction and leave shareholders without the option of a deal?

Sometimes, even when there are mistakes, there are no good or fair solutions. And the shareholders still have a choice: Once the go-shop is over it will be up to the shareholders to decide if they want the $43.50 deal or if they would prefer to send the directors back to the drawing board.

And speaking of the shareholders’ decision, the excitement may not be over. Mason Capital, an investment fund, filed a Schedule 13D on Tuesday saying it owned 6.5% of J.Crew. Mason Capital says its purpose is investment, but it bought all of its shares at prices above the $43.50 deal price—some of them as recently as two weeks ago. TPG and Leonard Green could have a fight on their hands even if they thought they had cleared away their obstacles with this settlement.

This article sums up the history behind the deal and all the hurdles (to put in nicely) along the way. A couple of things stuck out for me: (1) It's amazing that Mickey Drexler has so much pull with J.Crew that they (the board and investing firm) are worried about losing him. (2) J.Crew shareholders are really the getting the short-end-of-the-stick here. They are basically going to get less per share than its worth–plus that extra 15 cents from the settlement.

Honestly, I think we will still be hearing more about this deal.

What are your thoughts on this latest news? Do you think there will be anymore hiccups now that J.Crew is on the path to privatization? Do you think going private is still the right move for J.Crew?