Playing too Many Sides of a Deal Badly: RBC
This past Friday the Delaware Chancery issued a decision in a case involving the investment banking services rendered by RBC to Rural/Metro (“Rural”). Rural was a publicly held ambulance service that was acquired by Warburg Pincus, a private equity firm. In simple terms, the court ruled that the former shareholders are entitled to unspecified damages because the board agreed to sell for too low a price due to bad and conflicted advice it received from RBC. Moreover, the court ruled that investors received inaccurate information about the value of Rural in the proxy based on RBC’s improper analysis. The board of directors had previously settled with investors concerning their actions in the sale of Rural.
While corporate lawyers will scrutinize this case to better understand the requirements for proper analysis and disclosure by investment bankers advising clients, I’m more interested in the story behind this case because it highlights the myriad of conflicts endemic on Wall Street and corporate board rooms. While this deal only involves about $550 million in financing, it has all the elements of deeply conflicted behavior.
From the beginning, Rural was a company divided. Its new CEO, Michael DiMino, had been hired to execute a growth strategy, including potential acquisitions. The company also had two directors with rather short-term interests in Rural. Christopher Shackelton managed the Coliseum Fund, a hedge fund with a 12% position in Rural. In addition, Mr. Shackelton was getting ready to launch a new fund and thus had an interest in liquidating his large position in Rural. Eugene Davis was another activist board member. Mr. Davis was under pressure from shareholder services groups to reduce the number of his board memberships. However, the only way he could step off the Rural board and receive value for his Rural shares was to sell the company. While Mr. DiMino eventually acceded to the idea of selling, the board appears to have been rife with conflict over the future of the company.
While RBC was ultimately hired by a special committee of the board of directors to advise on the sale of the company, RBC had its own larger business plan. RBC figured it could get paid several times over by becoming the financier of choice in the emergency services business. RBC wanted to provide the debt financing for the EMS deal no matter who won it. They figured that if they also represented Rural, potential buyers, mainly PE firms, would want to ensure that they had a relationship with RBC, since Rural would be a likely future target. In addition, RBC wanted to offer the eventual acquirer of Rural a type of financing known as “staple financing.” According to the judge, RBC stood to earn about $5 million for advising Rural. However, financing the EMS deal could earn them another $14-$35 million, and the staple financing was worth $14-$20 million in fees.
Like all banks, RBC had separate merger and acquisition (M&A) and leveraged finance teams. However, senior bankers coordinated RBC’s business activities. As M&A advisor, RBC was supposed to provide advice that was in the best interest of the Rural shareholders. That advice might well have included the recommendation to remain independent. In fact, RBC’s preliminary analysis suggested that Rural was worth more executing its business plan rather than selling. However, under pressure from Mr. Shackleton, who’d become chairman of the board, RBC pushed for an ill-advised rapid sale of the company.
While RBC succeeded in getting all the private equity bidders to use its financing for the EMS transaction, the sales process for Rural went relatively poorly. Almost all the PE bidders involved in the EMS transactions were unwilling to simultaneously entertain a bid for Rural. When Warburg emerged as the only viable acquirer for Rural, RBC made a series of bad decisions. First, it fudged the valuation of Rural in order to make the Warburg proposal look attractive. Second, it delayed giving the Rural board the valuation information until the very last hours before the board needed to decide. Third, it lobbied hard to get Warburg to use their financing package even as they were advising the board. Executives at Warburg testified that those negotiations provided them with great information about the inner workings of the Rural board. In the end, Warburg used a different finance package, but the damage had been done.
While RBC’s M&A team had some incentive to get the highest possible price for the sale of Rural, they’d have gotten nothing if they’d recommended the company remain independent. Moreover, RBC stood to earn multiples of the M&A fee if they could become participants in the financing of Rural and/or EMS.
There’s a huge irony in this story. Although Warburg paid too little for Rural, they put too much leverage into the deal. As a result, Rural filed for bankruptcy in August of last year. The company re-emerged in December. For the public shareholders, RBC has proven to be a potential deep pocket for recovery.
These types of conflict are common in investment banking, especially given the extreme concentration among the major banks. Wall Street uses extensive procedures and disclosures to permit firms to play all sides of a deal. Nothing in the judge’s decision prevents the game from continuing. RBC’s sin wasn’t engaging in a conflict of interest. They did a poor job of managing the conflict.