THE END OF THE AFFAIR

The value of cancelled deals globally broke the $200 billion (€136 billion) mark in 2007, far surpassing the previous year's total of $127.1 billion, according to data provider Dealogic.

US deals gone bad accounted for $63.4 billion of the total, among them Silver Lake's and ValueAct's planned $3 billion buyout of data company Acxiom and the $8 billion buyout of stereo maker Harman International Industries by KKR and Goldman Sachs. A JC Flowers-led consortium's $25 billion buyout of US student lender Sallie Mae may join them if a Delaware court decides the buyers can walk away.

Breaking up a deal can be as bitter and acrimonious as any soured love affair. There are two ways out of a deal: pay a break-up fee or attempt to skirt that by invoking a “Material Adverse Change” (MAC) clause. Break-up fees hurt the overall return of a fund, and also present a significant downside for co-investors, who are hit with the fee twice.

From a seller's perspective, break-up fees might not be seen as punitive enough. For a multi-billion dollar mega-fund, a break-up fee of several hundred million dollars is hardly a critical blow. In some instances the fee may be viewed less as a punitive measure, more as the price of an option to buy the company, says Dechert partner Craig Godshall.

The MAC clause gives buyers a way out of a deal without having to pay the break-up fee, if some metric of the financial health of the target has declined beneath a previously agreed level. But proving a MAC is notoriously difficult, and buyout targets rarely give up without a fight.

They are aided by the fact that there is very little legal precedent. The legal process is also greatly complicated if the sellers have negotiated any MAC exemptions beforehand. For example, buyers and sellers might agree that if a drop in performance is caused by a general market decline, a MAC clause cannot be invoked.

“There's so much legal uncertainty as to what is a material adverse effect and whether the exceptions kick in, and whether the exceptions to the exceptions kick in, that on balance sellers still have an advantage in this area,” says Dechert attorney Bill Lawlor.

The burden of proof in a MAC case rests on the party seeking to get out of the deal, which is almost always the buyer. The buyer also has to consider the potential damage to its reputation if it tries to renege on a deal agreement, and is then forced by a court to close the deal.

“If a buyout firm with a relatively weak argument walks away from a deal and then loses [the legal battle], if it wants to do another deal with a public company board, it will be going uphill,” says Godshall. “The board is going to either not do a deal with them, or exact a much more punitive deal protection measure than they would from other buyers.”

As a result, many contested battles are settled out of court. When Lone Star tried to walk away from its acquisition of Accredited Home Lenders, the subprime mortgage company sued the buyout firm. Months of negotiations and several vitriolic letters followed, but ultimately the two parties inked a new agreement that slashed the deal price from $400 million to $311 million, rather than wait for a verdict on whether Accredited's financial woes triggered a MAC clause. KKR and Goldman Sachs, too, decided to invest $400 million in Harman rather than wait for a lawsuit or pay a $225 million break-up fee.

Given the sheer volume of contested buyouts this year, driven largely by worsening credit market conditions, buyers and sellers would both benefit from more clarity in break-up provisions. But they can rarely agree on what measure should trigger the dissolution of a deal, Godshall says.

“It's an extraordinarily complex negotiation that oftentimes just doesn't work out,” Godshall said. “The parties wring their hands and say ‘Okay, we'll just both live with the uncertainty’.”

CARLYLE COMMITS $199M TO EDUCATION VENTURE
The Carlyle Group is expanding its education services exposure by committing $199 million (€139 million) to Apollo Global, a $1 billion joint venture with US education provider Apollo Group. Carlyle will own approximately 20 percent of the joint venture, which will target investments and partnerships in education services primarily outside the US. Carlyle's Asia Growth Partners Group made such an investment in September with a $20 million commitment to NeWorld Education Group, a Japanese language institute expanding in China. The Apollo Group offers high school, college and graduate educational programs and services in 259 locations worldwide.

SPECTRUM INVESTS IN GENEALOGY WEBSITE
Spectrum Equity Investors has agreed to acquire a majority stake in The Generations Network, the parent company of popular subscription-based genealogy website Ancestry.com, after leading a $300 million (€211 million) round of financing for the company. Spectrum declined to name the other investors in the transaction. In conjunction with the deal, Spectrum partners Vic Parker and Ben Spero will join The Generations Network's board of directors. Spectrum anticipates that a number of areas will represent growth opportunities for the company, Spero said, including a new DNA-based ancestry testing product, self-publishing tools for users and improved search technology.

SILVER LAKE SUMERU COMPLETES DEBUT DEAL
Silver Lake's mid-market technology fund, currently reported to be raising $1 billion (€691 million), did its first deal with the acquisition of mobile phone marketing company Mobile Messenger. The firm paid an undisclosed amount for the privately held mobile phone marketing company, which was founded in 1999 and has operations in the US, Canada, Australia, New Zealand and the UK. Sumeru was brought under Silver Lake's umbrella last December, when the Silicon Valley buyout firm absorbed Shah Capital, a tech-focussed private equity firm founded in 2004 by California entrepreneur Ajay Shah.

HELLMAN & FRIEDMAN BUYS STAKE IN GROSVENOR
The private equity firm is the latest to invest in the growing fund of hedge funds industry, with the acquisition of a minority stake in Chicago fund of hedge funds manager Grosvenor Capital Management. The size of the stake, which Hellman & Friedman acquired from Value Asset Management, is undisclosed. “We believe that alternative investments will continue to gain global balance sheet share as investors further appreciate the high quality risk reward profile of the space,” Hellman & Friedman managing director Jeffrey Goldstein said in a statement. The fund of hedge funds sector is expanding rapidly. Since 2000, the global fund of hedge funds industry has grown its assets under management from $112 billion (€78 billion) to $1.2 trillion, according to data from Barclay Research Group.

HALYARD TO NET 12X RETURN ON DEAL WITH VSS
Veronis Suhler Stevenson has agreed to pay $185 million (€128 million) for direct marketing company TRANZACT, generating for its owner, Halyard Capital, a return of 12 times cash and an 85 percent IRR. TRANZACT serves the financial services and communications industries. Halyard created the company out of assets it acquired from bankrupt marketing firm Mosaic Group in May 2003. The division, originally called Mosaic Performance Solutions, USA focussed on the wireless communications, satellite and credit card markets.

MACQUARIE CONSORTIUM IN $7.4BN US UTILITY DEAL
Puget Sound Energy, Washington State's largest utility company, will be taken private in a $7.4 billion (€5.2 billion) transaction by a consortium including Macquarie Infrastructure Partners, the Canada Pension Plan Investment Board and the British Columbia Investment Management Corporation. Expected to complete in the second half of 2008, the deal is comprised of $3.2 billion of equity, $1.6 billion of newly issued debt and $2.6 billion of existing debt. Alberta Investment Management, Macquarie-FSS Infrastructure Trust and Macquarie Bank are also members of the investor consortium, which has promised to invest $5 billion in Puget Sound Energy over the next five years to support infrastructure needs and continue the utility's commitments to developing renewable energy, such as its hydropower project at Baker River.