I’ll summarize the LVMH claims as I understand them:
- Financial mismanagement by Tiffany during the pandemic
- There’s no carve-out for pandemics under the definition of a so-called material adverse effect. Tiffany assumed the risk of a virus outbreak per LVMH.
- Tiffany breached its agreement to operate as usual by paying out the highest possible dividend.
- LVMH argues the letter is a mandatory directive to take part in France’s efforts to defend its national interests in a trade dispute with the United States.
- Tiffany stands to profit “far more” if the deal proceeds than as a stand-alone company
- Tiffany’s top five executives are in line to receive at least $100 million in total compensation if the deal moves forward
At the Special Situations Report, I’ve gone over all these points in-depth as they conform to what was expected. In the case of Tiffany, I’ve covered a lot of it on the broader Seeking Alpha site as well.
Take note that I’m not a lawyer but merely motivated and curious to look into the legal aspects of this deal.
The major problem I still have is that it isn’t clear to me how LVMH is going to show a material adverse effect.
The material adverse effect also needs to have taken place by the “outside date” which we’re rapidly approaching.
Delaware courts have been most strict with material adverse effects. It has been considered breached only on one occasion. On the other hand, the stronger cases usually get settled. There’s simply not that much data that constitutes a material adverse effect.
Outside of Delaware two quarters of a deep drawdown in cash flows could probably be enough. It’s my understanding that in Delaware a Material Adverse Effect means that the value of the business has been materially impaired. This would likely be tested by looking at EBITDA development.
One thing Tiffany could argue, although to my knowledge it has never been done before, is that cash flows or EBITDA may have gone down. Yet, the value of the business may well have increased because the decreases in interest rates have boosted the valuation multiples of long-duration assets like luxury houses. An example of this is the share price development of LVMH itself:
If the court decides there’s been a material adverse effect the six arguments brought forward by LVMH become more important. Because then it gets interesting whether LVMH can terminate. Here’s what I think about these six points:
1. Financial mismanagement
Financial mismanagement is not something over which LVMH can walk away from this merger.
If LVMH wants to argue there’s no carve-out for pandemics it first needs to establish there’s been a material adverse effect. That’s the first hurdle and it’s not a given at all that LVMH can overcome that.
There are two problems with this argument. 1) There’s no carve-out for pandemic but there’s one for natural disasters. It’s not a certainty, but it seems likely to me that this will be interpreted in Tiffany’s favor.
Even if LVMH benefits from a pandemic not being considered a natural disaster in this court, it would still face the problem that there are carve-outs for “the outbreak or escalation of hostilities” and “any change in law applicable to the company’s business,” and with riots in the U.S. and government-mandated business shutdowns and lockdowns all over the globe, Tiffany will have a field day arguing these contributed to any perceived Material Adverse Effect.
3. Operate as usual
There’s a clause about how to manage the business while the transaction is underway. There’s one bit that sounds like there’s a sliver of daylight for LVMH:
…the Company has agreed that it will, and that it will cause each of its subsidiaries to, conduct its business in all material respects in the ordinary course of business and, to the extent consistent with the ordinary course of business, will and will cause each of its subsidiaries to, use commercially reasonable efforts to preserve its and its subsidiaries’ business organizations substantially intact…
If you read that, it sounds like LVMH could make stand there, but “conducting business in all material respects in the ordinary course of business” has been interpreted in prior cases.
There’s some room for new interpretation but my understanding is that LVMH has to show that Tiffany managed its operations in a worse fashion than its peers that are active in the same geographies. Because the pandemic is often very different from location to location I think this is going to be even more difficult of an argument than it would be under normal circumstances.
But even if LVMH can show this, notified Tiffany, and gave it a chance to remedy things, it still needs to show the impact also constitutes a material adverse effect.
The merger agreement says “the company’s regular quarterly dividends not to exceed $0.58 per share of common stock;” and it has not:
4. LVMH says the letter is mandatory
The French minister who wrote the letter has said the opposite in front of his parliament. At the same time Reuters has multiple sources claiming instructions to write the letter came from Macron.
The two sources, who spoke on condition of anonymity, said the Elysee Palace, President Emmanuel Macron’s office, had asked Le Drian to produce the letter.
Embarrassing revelations especially as Huffington Post France contends Macron is known as the friend of the rich, Louis Vuitton dresses the first lady with no apparent commercial benefit and Bernard Arnault supported Macron’s election.
It seems to me the judge is trying to sidestep the entire letter by setting the court date in such a way it’s no longer relevant.
The French version is still not available but the English version of the letter says:
In order to support the steps taken vis-a-vis the American government, you should defer the closing of the pending Tiffany transaction until January 6, 2021.
I am sure that you will understand the need to take part in our country’s efforts to defend its national interests.
I’m still curious to the French version but “should” means something is desirable but not mandatory.
5 + 6 – these points seem completely irrelevant.
Finally, even if LVMH succeeds proving a material adverse effect and it isn’t attributed to a carve-out then there’s a third problem – that its ability to terminate the merger is conditional under certain circumstances:
Provided, however, that such right to terminate the merger agreement will not be available to Parent if Parent, Holding or Merger Sub is then in material breach of the merger agreement
If it’s in breach of the merger agreement itself, it can’t terminate. Tiffany sued LVMH and is alleging that LVMH did just that. Tiffany contends that LVMH did not obtain regulatory approvals in a timely manner and it could also argue LVMH broke the merger agreement if it can prove that LVMH Chairman Bernard Arnauld approached the French government regarding the deal without consulting with Tiffany. According to Reuters, Tiffany’s Chairman Roger Farah learned from LVMH Managing Director Antonio Belloni that Arnault had met with the French foreign ministry to discuss the aforementioned letter, but too late. There also appear to be two sources that claim Arnault talked to President Macron. There are interesting rabbit holes Tiffany could go down to chase this deal over the finish line.
The merger still trades at about a 10.5% gross spread. I don’t think the likelihood of LVMH getting away from this deal is very high. Their claims have a high “let’s throw spaghetti at the wall” element to them. The whole letter sage is only becoming more embarrassing and likely counterproductive.
There’s a chance there could be a small discount but I’d think Arnauld is under a lot of pressure, especially if he doesn’t want to pay out another dividend in December or go through a potentially embarrassing trial process. Consequently, I still think this is a very attractive M&A situation.
Check out the Special Situation Investing report if you are interested in uncorrelated returns. We look at special situations like spin-offs, share repurchases, rights offerings and M&A events like this Tiffany’s deal or Alphabet’s acquisition of Fitbit. Ideas like this are especially interesting in the current late stages of the economic cycle.
Disclosure: I am/we are long TIF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.