Sunday, December 30, 2007

Judge pushes credit crunch case over the Finish Line

Easy credit, just a few months ago it seems, was behind the buying binge of private equity and other grabby acquisitors that has now given way to the credit crunch heaves -- barf follows binge for these financial fashionistas.

When money was easy deals were being done in wild west mode: buy first and ask questions later. Lawyers, who, like doctors, usually get blamed when the patient's antics end disastrously, have tried to put these deals together as best they could at their clients' behest, but when clients boldly go where no lawyer has yet gone, the cart sometimes gets there without the horse.

How's that for a grab bag of mixed nuts and other metaphors!

Giving context if not clarity to that prelude is the story of a couple of companies, Genesco and Finish Line, a couple of shoe stores. Finish Line, it seems, wanted to put the boot into Genesco by way of a takeover offer, that was contested by another shoe company, Foot Locker, but Finish Line got there the fastest with the mostest and won the bid. It doesn't appear that Genesco was real happy with the loss of its independence, initially, but eventually gave it up as an offer too good for its shareholders to pass up.

Now, Guambat recalls an old economic geography notion that suggests that, counter-intuitively, two competing shoe stores will actually generate more profits for each of them than one standing alone. It has something to do with market creation and generation of more traffic/demand. This case may actually support that theory because, if they are bound to be bound together as Finish Line at first insisted, the combined whole may go bankrupt.

The story has interest to Guambat because Finish Line and its financial backer, UBS, having won the bid on a shoe-in began to drag their feet as the credit crunch barf began to replace the easy credit binge. Seemingly they just didn't see the party coming to an end and that the consumer would soon be feeling the pinch of tight credit, which would affect the sales of products like shoes.

Blogging Stocks recently highlighted the plight of the poor shoe salesman:

Back in August, I wrote about all the beaten-down shoe stocks currently on the market: companies like Rocky Brands (NASDAQ: RCKY), Finish Line (NASDAQ: FINL), Phoenix Footwear Group (AMEX: PXG), and Shoe Pavilion (NASDAQ: SHOE).

Basically, selling shoes without a strong brand name is a tough business. Companies like Phoenix and Rocky are seeing their margins crushed by competitive forces, and retailers like Finish Line, Shoe Pavilion, and Genesco (NYSE: GCO), owner of stores like Journeys, are having a hard time making any money.

There are a lot of cheap shoe stocks out there. But the companies that are selling commodities and providing customers with a commodity-like experience are unlikely to see a turnaround. Before investing in shares of a shoe retailer like Finish Line, Foot Locker, or Genesco, ask yourself whether that company provides an experience that is unique. If all they're selling are shoes, they'll be extremely vulnerable to price competition.
Rather than put the blame on the consumers' reluctance to continue to spend, they based their own reluctance to buy Genesco on a claim that Genesco misrepresented the company's financials. Finish Line and, indirectly, UBS have brought suit to try to hoof it out of the Genesco purchase.

As a "hometown" report noted, Genesco
finds itself in a legal wrestling match with a reluctant suitor and its bank, both of which have accused the Nashville-based retailer of fraud, a charge that if proved would tarnish Genesco's well-polished image.

The dispute started when Genesco agreed to a $1.5 billion buyout bid from Indianapolis-based athletic shoe retailer Finish Line Inc. in June. Now, Genesco is suing Finish Line, accusing the company of trying to get out of the merger because it can't get financing from UBS, its Swiss bank.

Genesco's lawsuit against Finish Line "is one of the more high-profile cases of a deal falling through with the credit crisis,'' said Morningstar stock analyst Brady Lemos.

Lemos and others are watching the case. They say it illustrates what can go wrong when credit becomes too easy to get on Wall Street.

Counterclaims of fraud by Finish Line and UBS also have piqued the interest of the U.S. attorney's office in New York, which has issued subpoenas to look at Genesco's financial records.

Some analysts see the fraud allegations as a delaying tactic by Genesco's opponents, and they don't expect investigators to uncover corporate wrongdoing.

On top of it all, Genesco and Finish Line have each seen profits decline in recent months as consumers spend less on clothes, shoes and other goods. Legal costs tied to the case have added to Genesco's losses.

Finish Line originally planned to finance the deal with $11 million in cash and $1.5 billion from UBS [can you spell leverage? Is this corporate subprime lending?]. Since the first of the year, though, sales at Finish Line stores open at least a year have fallen 4 percent, and it has warned shareholders to expect a loss of $14.5 million to $15.3 million when it releases its third-quarter results in January.

UBS is suing both companies in a New York federal court, saying that Finish Line can't afford the deal and that if a merger were to go through, the combined company would go broke.

Finish Line's plan to borrow so much money from UBS concerned some analysts from the start. And today most doubt that anything can be done to salvage the deal.

Given Finish Line's financial condition, it's no wonder UBS wants out of the deal, added Steven Davidoff, an assistant law professor at Wayne State University in Detroit.

Finish Line's plan to borrow $1.5 billion makes it "a very highly leveraged buyout deal that probably shouldn't have been financed and only happened because markets were buoyant at the time," he said.

Today's rancor is a far cry from the environment earlier in 2007, when consumer spending was stronger and Genesco stock was in demand. Wall Street credit markets were soaring and suitors came calling.

In fact, athletic shoe retailer Foot Locker CEO Matthew Serra, representing another of Genesco's competitors, called Pen nington in January and offered to buy Genesco for $48 to $50 a share, a 20 percent premium over its stock price at the time. Genesco said it had no interest in selling.

Serra, though, was insistent. He called again in February to say his company was putting together a formal offer. By mid-March, rumors of a hostile takeover by Foot Locker were reported in the media, and Genesco's stock price started to climb.

Genesco ultimately rejected Foot Locker's final bid of $51 a share, saying it wasn't in the best interest of shareholders, but it did open the door to other companies to make offers. Several private equity firms were interested, but only Finish Line, with about half the annual sales of Genesco, made a bid.

On June 13, Genesco's board accepted that offer, worth $54.50 a share.

Soon, though, Genesco says, Finish Line developed "buyer's remorse."

On Aug. 30, Genesco released its second-quarter results, saying it had lost 19 cents a share, or about $4 million, in the period, surprising Wall Street and leading to accusations from Finish Line and UBS that Genesco hid the extent of problems at the company. Genesco says that it opened its books to Finish Line before their deal and that the buyer shouldn't have been surprised by the losses.

On Sept. 11, UBS said in a letter to Finish Line that it also was concerned about Genesco's results. In November, UBS filed a separate lawsuit in the U.S. District Court in southern New York, saying it should be let out of its commitment to fund the deal.

One key issue to watch as the Genesco trial plays out this week is how the original merger agreement was written, analysts say.

Page, the Indiana University law professor, said the contract was drawn up without a clause letting Finish Line escape if it couldn't get financing. The wording may have been a sign of exuberant times on Wall Street before the current credit crunch kicked in, he said.

"The market became so confident that these conditions were being dropped," Page said. Finish Line and UBS seem most at fault, he said, because they failed to see "the (financing) party was maybe coming to an end."
Suing Genesco on a claim of nondisclosure, especially after Enron and the like, seemed such a shoe-in that many other law firms joined in class actions against Genesco, on behalf of its own shareholders, e.g., this and this.

The accusations and responses in the case are, for a Guambat burrowed well away from the sidelines, quite entertaining.
Genesco: E-mails indicate UBS feared financial risk

Shoe and hat retailer Genesco presented e-mails in court Thursday that showed UBS employees thought the Swiss bank's financing of Indianapolis-based Finish Line's $1.5 billion acquisition of Genesco was one of its biggest financial risks.

The e-mails suggested the risk was high because of the downturn in the credit market, bolstering Genesco's argument that Finish Line and UBS wanted out of the deal simply because they thought it no longer would be profitable.

"What seemed like a good deal in June turned out to be a disastrous deal in July," testified Anthony Saunders, chairman of the department of finance at New York University's Stern School of Business.

UBS, which has almost $2 trillion in assets, projected in August it would have a $132.1 million net loss if the deal were to go through.
In his cross-examination, UBS attorney Joe Frank said the credit markets have improved slightly since August, changing the bank's projections of a net loss to $65 million.

Meanwhile, UBS has filed a lawsuit in New York seeking to escape its commitment to finance the deal, contending the combined company of Genesco and Finish Line would be unable to pay off its debt.

The meat of the story for Guambat, though, lies in what the judge in the case said, as reported in MarketWatch, in holding Finish Line's feet to its own fire:
Tennessee Chancery Court judge Ellen Hobbs Lyle ruled that Finish Line has breached the parties' merger agreement and dismissed Finish Line's claims that Genesco withheld key financial information....

"The merger in this case was a highly negotiated transaction, with teams of lawyers, advisors and handlers being paid enormous sums to orchestrate the procedure for obtaining information, the product of information, and the use and reliability of information," the judge wrote.

"The court finds it doesn't offend the conscience to enforce the performance of the merger agreement, Finish Line and UBS have failed to prove that Genesco fraudulently induced Finish Line to enter into the contract or that Genesco committed securities fraud."

Meanwhile, S&P rates Finish Line as far from finished:
The Chancery Court in Nashville (Tenn.) has ruled that Finish Line cannot back out of its merger agreement with Genesco (GCO). That said, a suit by UBS AG (UBS), which had committed financing to Finish Line, seeking to halt the merger is still pending in the U.S. District Court for the Southern District of New York. The merger would be halted if the New York Court determines that a combined Finish Line-Genesco would go bankrupt. We believe completion of the merger has been priced into Finish Line shares, which are trading at forward P/E and price-to-sales multiples well below peers.

And this legal tiff may be just the beginning of a long string of such cases as the euphoria of buy-ins and buy-outs floated with easy money fades and is replaced by the cold judgment of old-fashioned banking.

As the WSJ noted
In the latest private-equity buyout agreement to dissolve into acrimony, Platinum Equity LLC is suing PPG Industries Inc. to end or renegotiate its $500 million deal for the company's troubled auto-glass business.

In a complaint filed in New York State Supreme Court, Platinum alleged that PPG misrepresented the health of the business, which makes sunroofs and windshields, as a way to squeeze a higher price from a buyer. In the lawsuit, Platinum said PPG's behavior was "repugnant, wanton, and involved a high degree of moral turpitude."

Jack Maurer, a PPG spokesman, says that the company believes Platinum's claims are without merit and will defend itself against the suit. "Platinum Equity is a sophisticated financial buyer," Mr. Maurer said. "They looked into this; we had a signed sales agreement."

Buyout firms are loath to pull out of signed contracts because of the risk to their reputations and an aversion to lawsuits. But that aversion has subsided amid weak credit markets and a stumbling economy. A host of players, from KKR to Goldman Sachs to J.C. Flowers & Co., have recently walked away from deals.

The Leagles are busy discussing the rarely invoked specific performance remedy (instead of damages) and the so-called "MAC/MAE" clauses and its effect, or lack of same, in this case; see, e.g. the WSJ lawblog, which has obtained and made available a copy of the judge's decision here (which Guambat has some difficulty downloading but got there in the end). This clause is suggested to give the buyer a "get out of jail free" card in the event of "material adverse" events affecting the value of the deal. See this and this for more explanation.

These legal issues make for fun Monday morning quarterbacking and other games, but Guambat considers the real moral of the story to be the morals of the easy money, get rich quick crowd who ran with the bulls in the subprime/easy credit melt up.


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