According to a report on NY Post citing several anonymous sources, Verizon (NYSE:VZ) is asking for a $1 billion discount on its $4.8 billion deal to buy most of Yahoo (NASDAQ:YHOO). The reason? The allegedly state-sponsored hacking of over 500 million Yahoo accounts, an event that occurred 18 months ago but came to light only last month. Verizon says this constitutes a material adverse event, or MAE in legalspeak, and that therefore Verizon is entitled to renegotiating or even entirely canceling the deal. The deal has a standard MAE clause that gives Verizon the right to withdraw from the deal if a new event "reasonably can be expected to have a material adverse effect on the business, assets, properties, results of operation or financial condition of the business."
From Verizon's standpoint, first, it is naturally worried of the legal and business fallout of this data breach, and is rumored to be setting aside $1 billion just to address the liabilities. This is the same amount it is seeking as a discount.
It may also be true that Verizon-owned AOL's Tim Armstrong, himself no stranger to security breaches, is leveraging this incident to get a better deal out of Yahoo. It may even be true that Verizon is rethinking its entire Yahoo strategy and wants out, not because of the hack but simply by using it as an excuse. But that sort of Buyer Regret would be immature business dealing; less than 6 months after you offer to pay $5 billion for a sagging giant of yesteryear, in a deal which some consider a giveaway price, if you think you made a bad business offer, nobody is going to take you seriously ever again.
So, considering all this, it seems to this layman that what Verizon is trying to do is what buyers have been trying to do to sellers for thousands of years - renegotiating an already negotiated deal by using a piece of negative information as leverage.
What are Yahoo's options?
First, Yahoo can recognize Verizon's fears as valid, and give in to the discount. But Marissa Mayer claims she is trying to unlock shareholder value with this Verizon deal. It would hardly be unlocking shareholder value if she gives in; although that might be conducive towards her long-term future at the post-deal Yahoo - but again, that might be a major conflict of interest to do something like that.
Second, Yahoo could woo other bidders - there are reports that there were quite a few other bidders. Yahoo maybe down - I believe it is suffering from age-related ailments - but it isn't out. It still has a huge subscriber base, and perhaps, under new management, things can change. So there's still a lot of value in this dino, and other bidders might be interested. On the other hand, those bidders will be shark-like in their negotiations now. Yahoo probably won't be able to get $4.8 billion, or anywhere near, if it comes with a begging bowl.
Third, Yahoo could hunker down and refuse to bulge.
What the courts say
If Yahoo acts obstinate, refusing to negotiate, or to accept a low-priced cancel-the-deal bone (the reverse-break fee) thrown at it by Verizon, then either or both parties may go to court. Thus, it becomes important to see what happened in court to cases similar to this - or, as lawyers say, is there caselaw showing precedence?
In a similar lawsuit in Delaware 8 years ago, the Chancery Court said that "a buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close," and that, ipso facto, "Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement ... is not a coincidence."
This lawsuit pertained to a deal between Hexion Specialty Chemicals and Huntsman Corp., where the former agreed to acquire the latter in a $6.5 billion buyout. But Huntsman reported disappointing financial results after the deal was signed. Hexion, and its 92% owner Apollo Global Management, LLC went to court to avoid the deal closure.
In the Huntsman case, the court basically set a very high standard to determine what constitutes an MAE. Short term earnings problems, it declared, do not constitute an MAE, and do not give the buyer a cause to walk out of the deal. Also, the burden of proof rests with the buyer not only to show that the breach is material and adverse, but also to prove that the seller did not make "reasonable best efforts" to avoid the adverse event.
Applied to Yahoo's case, this will be very difficult for Verizon to prove that Yahoo did not do its best to avoid getting hacked by a state-sponsored act of what amounts to digital war. It will be easier for Yahoo to say that it was a victim, and that even AOL, which is now part of Verizon, has numerous times been hacked, and that hacking making the hacked party a victim, not an accomplice.
Yahoo will also be able to show, reasonably well I believe, that this adverse event constitutes a short term problem, not a long term one, and that efforts are already underway to minimize the fallout. So, on both standards as determined by the Delaware court, "short or long term" and "reasonable best efforts," Yahoo will be able to show support to its case.
8 years before this, the same Delaware Chancery Court, which is a special sort of "equity court" Delaware has because of the high volume of corporate registrations that take place there, ruled similarly in re IBP, Inc. v. Tyson Foods. It said Tyson (NYSE:TSN) breached its covenant to close a deal to acquire IBP after Tyson claimed that IBP misled it about its earnings potential. In this case, a Chicago law professor demonstrated that IBP's failure to disclose certain accountings problems at one IBP unit did not constitute material breach. The Court agreed, and Tyson was forced to honor its deal. As a legal analyst says of this case, "To an acquirer who has purchased a business as part of a long term strategy, the important thing is whether the company has suffered a MAC in its business or results of operations that is consequential to the company's earnings power over a commercially reasonable period, which one would think would be measured in years, not months."
Again applying the same standards to Yahoo's email hack, one can reasonably conclude that neither did Yahoo mislead Verizon on anything because it only came to know about the hacking recently, nor does this impact Yahoo's long term business prospect. Therefore, Verizon is obliged to close the deal at the agreed upon price, and honor its commitment.
More about the deal
If you compare what I just discussed above with what spokespersons from Verizon say, it will be apparent that they are not well-schooled in the law, or think their opponents aren't.
"I think we have a reasonable basis to believe right now that the impact is material and we're looking to Yahoo to demonstrate to us the full impact," Craig Silliman, Verizon's top lawyer, said, according to Reuters. "If they believe that it's not then they'll need to show us that."
Unfortunately for Mr Silliman, Yahoo does not need to 'demonstrate" anything. They do not need to believe anything or show anything to Verizon. The burden of proof, according to the Delaware Court, clearly lies with Verizon to prove that there's material breach.
One angle here will be for Verizon to show how many users cancel their yahoo accounts as a result of the breach. But the concomitant relation between breach and cancellation will be hard, if not impossible, to prove. Moreover, not all user accounts, it could be reasonably argued, are equally important. Further, if the breach has been effectively controlled, that gives Yahoo yet another reason to demonstrate the short-term nature of the problem. Overall, MAE is a huge burden, and it is a huge burden mainly for the buyer.
Bottom line, this deal seems likely to go through, and if Yahoo agrees to any discount, it can face a lawsuit from its own shareholders. On the other hand, Yahoo stock has been very robust YTD, and the news surrounding this issue may pull it down for a period of time. Such a dip would be a buying opportunity if you believe, as I do, that the deal will go through and the market has already factored it into the stock price.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in YHOO over the next 72 hours.
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.