Palm Reading: HP Extends the Life Line
On April 28, HP announced the $1.2 billion acquisition of Palm for $5.70 per share.
The acquisition will provide discussion fodder for months if not years to come, and we will see if HP can turn Palm into a serious competitor for the iPhones, Androids and Blackberries of the world.
In this post, I will stay clear of any strategic speculation, but rather focus on the process of the transaction.
The proxy statement recently sent out to the shareholders provides some interesting turn-by-turn insights into the transaction. A number of lessons can be learned that are equally applicable to smaller transactions.
How events unfolded
The story starts with a meeting of the Palm Board of Directors on February 17, 2010, where they reviewed operational results. Anticipated revenues for the quarter ending 2/26/2010 were 25% below plan. Anticipated revenues for the quarter ending 5/28/2010 were 63% below plan.
That has to hurt.
The Board channeled its pain into an “assessment of strategic alternatives”, also known as “raise money, license the IP, or sell the Company”. Bring in the investment bankers – in this case Goldman Sachs and Frank Quattrone’s Qatalyst Partners.
At this point, the share price hovers around $9.62 – down but not out from its recent high of $17.46 in September 2009.
On February 25 the Company officially revised its revenue guidance downwards for the current quarter and the current fiscal year. The stock closes at $6.53 the following day and erodes further in the coming weeks to $3.85 on April 6, the day before takeover rumors start.
The bankers and management draw up a list of 24 strategic partners. Between the end of February and beginning of April a total of 16 companies are contacted of which 6 sign a nondisclosure agreement to take a look under the hood. Three of them (“Company A”, “Company B”, and the ultimate acquirer, HP) are invited at the end of March to submit preliminary proposals for a transaction. Two more hover about the fringes (“Company C” and “Company D”).
HP submits its first offer at $4.75 per share on April 13, below the public market share price of $5.16.
Company A came in with a cash offer of $600 million which after preferences would have returned little or nothing to the common shareholders; Company B delivered an unspecified, drawn-out stock deal ; while Company C proposed a cash offer in the range of $6.00 – $7.00 per share with the promise of a fast close. But after taking a closer look, Company C later revised its offer down to $5.50 per share.
Bird in hand, Palm’s CEO and advisors communicate on April 24 to HP and its advisors that, “to remain in the process, HP must improve its offer significantly and immediately”, which they promptly did, increasing their offer to $5.70 per share on the same day.
In the end, Company C did not match that offer, but proposed an alternative transaction under which it would acquire certain patents and take a nonexclusive license to Palm webOS in exchange for a one-time cash payment of $800 million. The Board eventually dismissed the licensing agreement as too dilutive to the value of the overall Company.
The deal with HP at $5.70 per share was announced on April 28. Prior to the announcement, the shares were trading at $4.63. The $1.2B offer represents a 23% premium over the price on the previous trading day, and a premium of almost 50% over the price before any rumors of a transaction started to circle.
Unfortunately it also represents a discount of 41% from the time the M&A process was initiated and before the devastating results were announced; and a discount of 67% from the last high in September 2009.
Several lessons can be learned from the process:
1. Start your M&A process early
There are a number of reasons to start the process early, especially in a situation where the company is strategically stalled, as in Palm’s case. Usually the runway is limited, and any delay also restricts strategic options. For Palm, the option to license out webOS turned out to be an inadequate non-starter. Once the bad news is out, share prices fall quickly and any transaction is perceived as a “fire-sale”. Missing the revenue target by over 60% one quarter out qualifies as VERY bad news. So bring in the bankers before you run out of options.
2. The more the merrier
Not all bidders may be the ideal candidate, and any auction in such an environment will inevitably attract bottom-feeders. But a healthy number of participants will keep the auction competitive, make the ideal candidate pay up, and generally force a transaction in a timely manner on the best available terms.
3. Keep key employees motivated
Once a company is on the auction block, employees will consider their options too. It is important to retain key employees to effectuate a transaction as well as maintain the value of the company. This is especially true for technology companies, where most of the value is intellectual property that is embedded in the workforce. Palm’s Board recognized this early on and approved a Retention Bonus Plan for certain employees on April 1.
4. Cash is king
Somewhat obvious, but in a situation such as Palm’s it is hard for any Board to accept and consider the complexity and value of a stock deal. Not surprisingly, Company B’s proposal was not pursued further, in part because of the ambiguity and uncertainty of a stock deal.
5. Keep the options open
A straight sale is not always the best option, and Palm’s Board considered a range of different strategic options. Although the ultimate transaction was a sale of the whole Company, this open option approach helped to attract more and diverse potential interested parties. In this case, a straight sale was the easiest to evaluate for the seller, and – as indicated above – as the game moved to later innings, the less viable options were retired.
6. Elephants can dance
This one is probably less obvious. The deal was pulled off on a very abbreviated time line. This is exceptional from the seller’s perspective, but even more from the buyer’s. Palm certainly was motivated by a dwindling cash balance, deteriorating fundamentals, and the inability to double-down on its webOS roll-out in light of the weak initial market success. HP had its strategic reasons to buy into the deal, but the speed of execution was forced by the competitive nature of the auction that did not leave much room for delay.
Now, if only HP and Palm do their post-merger integration at the same speed as they did the transaction, we should see some new and exciting products in the marketplace fairly soon.
Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and is an Accredited Valuation Analyst (NACVA). Gunther is Treasurer and a Member of the Board of Directors of the the German American Business Association (GABA)
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