“For 40 days, the Topps board could shop like Paris Hilton.” ~ Vice Chancellor Leo Strine, Delaware Chancery Court, on Topps’ go-shop provision (prior to Hilton’s incarceration)
Michael Eisner’s attempted Mickey Mouse buyout of playing card and Bazooka bubble maker Topps (TOPP) has been relegated to the history channel after a Delaware court enjoined the deal and allowed Upper Deck to launch a tender offer for Topps’ shares at a premium to Eisner’s proposed price. Topps’ management frustrated all attempts by Upper Deck to buy Topps in a classic example of a principal-agent conflict, where management prefers a financial buyer over the purchase by a competitor in order to keep their jobs, although shareholders would get a bigger payout from a strategic buyer.
Topps is run by CEO Arthur T. Shorin and his son-in-law, COO Scott Silverstein. It was the subject of a proxy fight by Pembridge Capital and Crescendo Partners last year and settled by expanding the board with three dissident nominees. The point of contention was Topps’ management’s repeated failure to turn the struggling company around. Topps tried and failed to sell its Bazooka bubble business. This year, it fights a second front against its competitor Upper Deck, which wants to buy Topps.
Both Shorin and Silverstein are at risk of losing their jobs if Topps is bought by Upper Deck. Michael Eisner, however, made clear in his buyout proposal that he will only take a financial interest in Topps and leave management in place. So management’s preference for Eisner is clear, and it shows in repeated misrepresentations to shareholders.
Details of attempts to prevent Upper Deck from buying Topps became public during a trial in Delaware’s Chancery Court, where Upper Deck sued Topps, which with it had signed a confidentiality agreement, as part of which it had agreed not to make a tender offer for Topps shares without Topps’ management approval. Given management’s conflicted incentives, they had little reason to help Upper Deck make a proposal and worked actively to prevent it.
For example, Topps misrepresented Upper Deck’s proposal, claiming that there was a financing contingency. In fact, Upper Deck had already arranged financing through CIBC, subject to certain conditions. These conditions, however, all related to information about Topps, and exactly the information that Topps had refused to provide to Upper Deck under the confidentiality excuse.
Similarly, Topps overestimates the anti-trust aspect of a combination of the two firms. Upper Deck’s own lawyers estimate that there is little anti-trust risk in a buyout, and it is difficult to see why Upper Deck would want to buy Topps just to be rebuffed by regulators. Baseball trading cards are not a competitive market, where consolidation would pose a risk to consumers. Major League Baseball is a monopolist that licenses the cards, and with $20 million annual guaranteed minimum license fees (actual Topps royalties are $30 million or roughly 20% of card sales) the licensees have little room to compete with each other on price. Instead, they “compete” through market segmentation, seeking to extract monopolistic prices from nostalgic baby boomers whose demand curves are inelastic.
Some have noted the high 669% inflation of trading card prices over the last 15 years - this price shows rent-seeking by a Baseball League monopolist rather than competition. Major League Baseball has the monopoly, while Topps and Upper Deck act merely as printers and distributors. If regulators were concerned about competition in the trading card market, they would have blocked the 2004 purchase of Fleer Corporation by Upper Deck. The anti-trust risk in Upper Deck’s tender offer is therefore negligible.
Yet again, an investment bank played an unsavory role in a buyout. Lehman provides us with another example of how an investment bank doctors its financial opinion to please the managers that hired them (another recent example that we wrote about is William Blair’s opinion in Netsmart’s buyout). Lehman’s first opinion used management’s five year projection, exit multiples between 9-10 and a cost of capital of 11-12% (actual: 11.6%) and found range of values for the stock of $9.67-$12.99 per share. In a subsequent opinion, Lehman eliminated the last two years of management projections, reduced exit multiples to between 8.5-10 and increased the cost of capital to 11.5%-13.5%. These changes had the effect of reducing the theoretical value of TOPP shares to $8.76-$12.57. Eisner’s then proposal of $9.75 was no longer near the low end of the range and made the price look somewhat less undervalued.
Topps directors included a go-shop provision in the merger agreement, which led Judge Strine to make the above-mentioned comparison with Paris Hilton. It appears to us that they never really intended to consider a buyer other than Eisner.
But now that Upper Deck won the upper hand in court and can make a tender offer, it looks to us that there is nothing to prevent them from gaining control of Topps - unless Michael Eisner gets Uncle Scrooge to lend him a few extra dollars, so that he can raise his price above Upper Deck’s $10.75.
Disclosure: The author manages the Pennsylvania Avenue Event-Driven Fund [PAEDX], which owns shares of TOPP.