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    Case Study 13-1
    Kinder Morgan Buyout Raises Ethical Questions
    SEC proxy filings following the announcement of the management buyout at the time
    revealed potentially questionable behavior by top management of Kinder Morgan Inc. The
    filings revealed that they waited 2 months before informing the firm's board of their desire
    to take the company private. The delay is particularly troublesome since it is the board that
    has the overarching fiduciary responsibility to protect shareholders interests. It is customary
    for boards governing firms whose managements were interested in buying out public shareholders
    to create a committee within the board consisting of independent board members
    (i.e., nonmanagement) to solicit other bids. While the Kinder Morgan board did eventually
    create such a committee, the board's lack of awareness of the pending management proposal
    gave management an important lead over potential bidders in structuring their proposal. The
    delay in telling the board also precluded the board from overseeing the process, which is
    generally considered the proper role of the board in such matters. By being involved early
    on in the process, a board has more time to negotiate terms more favorable to shareholders.
    The transaction also raises questions about the potential conflicts of interest of investment
    bankers who are hired to advise management and the board on the "fairness" of the offer
    price but who also are potential investors in the buyout.
    Kinder Morgan's management hired Goldman Sachs in February 2006 to explore "strategic"
    options for the firm to enhance shareholder value. The leveraged buyout option was
    proposed by Goldman Sachs on March 7 and was later followed by their proposal to become
    the primary investor in the LBO on April 5, according to the proxy materials. Subsequently,
    the management buyout group hired a number of law firms and other investment banks as
    advisors and discussed the proposed buyout with credit-rating firms to assess how much
    debt the firm could support without experiencing a significant downgrade of its credit rating.
    On May 13, 2006, the full board was finally made aware of the proposal. The board immediately
    demanded that a standstill agreement that had been signed by Richard Kinder, CEO
    and leader of the buyout group, not to talk to any alternative bidders for a period of 90 days
    be terminated. While investment banks and buyout groups often propose such an agreement
    to ensure that they can perform adequate due diligence, this extended period is not necessarily
    in the interests of the firm's shareholders because it puts alternative suitors coming in
    later at a distinct disadvantage. Later bidders simply will not have sufficient time to make
    an adequate assessment of the true value of the target and to structure their own proposals.
    In this way, the standstill agreement could discourage alternative bids for the business.
    The special committee of the board set up to negotiate with the management buyout
    group was ultimately able to secure a $107.50 per share price for the firm, significantly
    higher than the initial offer. The discussions were rumored to have been very contentious
    due to the board's annoyance with the delay in informing them (Berman and Sender, 2006).
    The deal between the management group and the board was hammered out in about 2 weeks.
    In contrast to the Kinder Morgan deal, a management group within HCA, a large U.S. hospital
    operator, took less than 1 month to inform its board of their interest in an LBO. The special
    committee of the board took 3 months to negotiate a deal with the firm's buyout group.

    1. What are the potential conflicts of interest that could arise in a management
    buyout in which the investment bank is also likely to be an investor? Be specific.
    2. Comment on the following statement: It is desirable for firms interested in
    undertaking an LBO to receive strategic advice from investment bankers who also
    are willing to invest in the transaction.
    3. Do you believe standstill agreements in which the potential LBO firm agrees not to
    shop for alternative bidders for a specific period of time are reasonable? Explain
    your answer.

    Case Study 13-2
    Private Equity Firms Acquire Yellow Pages Business
    Qwest Communications agreed to sell its yellow pages business, QwestDex, to a consortium
    led by the Carlyle Group and Welsh, Carson, Anderson and Stowe for $7.1 billion. In a
    two-stage transaction, Qwest sold the eastern half of the yellow pages business for $2.75
    billion in late 2002. This portion of the business included directories in Colorado, Iowa,
    Minnesota, Nebraska, New Mexico, South Dakota, and North Dakota. The remainder of the
    business, Arizona, Idaho, Montana, Oregon, Utah, Washington, and Wyoming, was sold for
    $4.35 billion in late 2003. Caryle and Welsh Carson each put in $775 million in equity
    (about 21% of the total purchase price).
    Qwest was in a precarious financial position at the time of the negotiation. The telecom
    was trying to avoid bankruptcy and needed the first-stage financing to meet impending debt
    repayments due in late 2002. Qwest is a local phone company in 14 western states and one
    of the nation's largest long-distance carriers. It had amassed $26.5 billion in debt following
    a series of acquisitions during the 1990s.
    The Carlyle Group has invested globally, mainly in defense and aerospace businesses,
    but it has also invested in companies in real estate, health care, bottling, and information
    technology. Welsh Carson focuses primarily on the communications and health care
    industries. While the yellow pages business is quite different from their normal areas of
    investment, both firms were attracted by its steady cash flow. Such cash flow could be used
    to trim debt over time and generate a solid return. The business' existing management team
    will continue to run the operation under the new ownership. Financing for the deal will
    come from JP Morgan Chase, Bank of America, Lehman Brothers, Wachovia Securities,
    and Deutsche Bank. The investment groups agreed to a two-stage transaction to facilitate
    borrowing the large amounts required and to reduce the amount of equity each buyout
    firm had to invest. By staging the purchase, the lenders could see how well the operations
    acquired during the first stage could manage their debt load.
    The new company will be the exclusive directory publisher for Qwest yellow page
    needs at the local level and will provide all of Qwest's publishing requirements under a
    50-year contract. Under the arrangement, Qwest will continue to provide certain services to
    its former yellow pages unit, such as billing and information technology, under a variety of
    commercial services and transitional services agreements (Qwest, 2002).

    Why did the buyout firms want a 50-year contract in order to be the exclusive
    provider of publishing services to Qwest Communications?

    Case Study 14-1
    IBM Partners with China's Lenovo Group
    IBM was able to satisfy two objectives in selling its ailing PC business to China's Lenovo
    Group for $1.75 billion in cash, stock, and assumed liabilities in late 2004. First, the firm is
    able to eliminate the business' ongoing operating losses from its books. Second, IBM could
    sharply enhance its position in information technology in China, which is rapidly emerging
    as one of the world's largest information technology markets.
    Under the terms of the transaction, Lenovo will relocate its world headquarters from
    Beijing to Armonk, New York, near IBM's headquarters. Lenovo will be managed by senior
    IBM executives. IBM owns an 18.9% stake in the new company, which will sell PCs under
    the IBM brand name. IBM gets to continue selling PCs, which helps it sell other products and
    services to corporations as packages. IBM hopes to exploit Lenovo's influence in China to
    sell additional information technology products. As China's number one PC maker, Lenovo
    has a 27% overall market share and strong positions in both the government and education
    markets. The firm's presence in these markets is expected to strengthen, because the Chinese
    government owns 46% of the new company. Lenovo hopes to benefit by obtaining a
    global PC operation and to expand its sales under the widely recognized and respected
    IBM brand.
    The challenges of implementing the new business are daunting. Enormous geographic
    and cultural differences will make communication difficult. While former IBM employees
    will be among the product designers, some corporate customers may not trust Lenovo to
    deliver the quality and innovation they have come to expect from IBM.

    What other challenges to making this relationship work would you anticipate? Be

    Case Study 14-3
    Johnson and Johnson Sues Amgen
    In 1999, Johnson and Johnson (J&J) sued Amgen over their 14-year alliance to sell a
    blood-enhancing treatment called erythropoietin. The disagreement began when unforeseen
    competitive changes in the marketplace and mistrust between the partners began to strain the
    relationship. The relationship had begun in the mid-1980s with J&J helping to commercialize
    Amgen's blood-enhancing treatment, but the partners ended up squabbling over sales rights
    and a spin-off drug.
    J&J booked most of the sales of its version of the $3.7 billion medicine by selling it for
    chemotherapy and other broader uses, whereas Amgen was left with the relatively smaller
    dialysis market. Moreover, the companies could not agree on future products for the JV.
    Amgen won the right in arbitration to sell a chemically similar medicine that can be taken
    weekly rather than daily. Arbitrators ruled that the new formulation was different enough
    to fall outside the licensing pact between Amgen and J&J.

    What types of mechanisms could be used other than litigation to resolve such
    differences once they arise?

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    Solution Preview

    Case Study Discussion Questions
    1. What are the potential conflicts of interest that could arise in a management?
    Buyout in which the investment bank is also likely to be an investor? Be specific.
    The conflict of interest is that if the investment bank is a part of the buyout group then the investment bank is likely to advise the management/board of a buyout price that is less than the worth of the business. This would be to the detriment of the business. The conflict of interest is that how can an investment bank advise on a buyout where the bank itself is a potential buyer(investor).
    2. Comment on the following statement: It is desirable for firms interested in
    undertaking an LBO to receive strategic advice from investment bankers who also
    are willing to invest in the transaction.
    No, it is not desirable for firm interested in undertaking an LBO to receive strategic advice from investment bankers who are willing to invest in the transaction. The reason is that their advice is ...

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