In today's newsletter we talk about Mergers & Acquisitions and explain why Private equity firm Sycamore walked out of a deal to buy a controlling stake in Victoria’s Secret.


The Story

For the uninitiated, Victoria’s Secret is a chain of high-end lingerie stores. The brand is owned by its parent company — L Brand and until about 5 years ago, it made up around two-thirds of its parent company’s revenue.

And truth be told, Victoria’s Secret was more than a brand- it was a cultural phenomenon. Both men and women were made to feel comfortable shopping in their plush stores. Their annual fashion show attracted millions of viewers every year and the brand was deeply enshrined in pop culture.

But over the years, this carefully cultivated brand image turned toxic. The fashion shows were criticized for promoting unrealistic beauty standards. Shoppers started complaining about the poor quality of their products. And the brand owner Les Wexner’s ties with noted sex offender Jeffrey Epstein garnered a lot of bad press. According to a study by Coresight Research, their market share dropped from 31.7% in 2013 to 24% in 2018.


But then, in February 2020, private equity firm Sycamore agreed to pay $525 million to buy out 55% of Victoria’s Secret. The agreement was signed when investors were still downplaying the risks of the coronavirus (back in February) and the deal was supposed to go through without a hitch. But within a month, Victoria’s Secret was forced to close all their stores and take down its online operations.

So in April, Sycamore tried to get L Brands to adjust the purchase price considering the situation at hand. L Brands flat-out refused to discuss it. And Sycamore said, “Screw this, the deal is over.”

L Brands sued them right back.

To wriggle out of the agreement, Sycamore planned on using a clause that is usually included in most merger agreements: Material Adverse Change (MAC). According to MAC, buyers can walk away from an agreement if something unexpected causes a sharp decline in business conditions. Well, a pandemic certainly fits the definition of ‘unexpected’, and Victoria’s Secret’s business certainly was declining. But enforcing the clause was a bit more complicated than that.

You see, the definition of MAC is very long and complicated, and is usually subject to interpretation. It also contains exceptions- a list of events that cannot trigger the clause. In this contract’s case, it contained “national, international, foreign, domestic or regional social or political conditions (including changes therein) or events in general” and much, much more. And highly unusually, it also contained an exception which would directly prevent Sycamore from using it to walk out: pandemics.

And that was it. Couldn’t be plainer. This exception ensured that Sycamore could not use coronavirus as an excuse to invoke MAC and weasel out of the deal. And so, Sycamore took a different tack.

They said that L Brands had breached the agreement themselves, by failing to “conduct the business in the ordinary course consistent with past practice.” They alluded to the fact that Victoria’s Secret laid off most employees, failed to pay rent, and let merchandise go out of style- all of which was inconsistent with past behaviour and was damaging to the brand. They refused to take coronavirus as an excuse.

Well, L brands argued that they were simply responding to an unprecedented crisis and pointed out that Sycamore, too, was taking similar steps with its other retail brands. They were prepared to fight the lawsuit.

But they didn’t. On May 4th, Victoria’s Secret announced that they would be avoiding “costly and distracting litigation to force a partnership with Sycamore”- They had reached an agreement to terminate the deal. Neither party would be required to pay a termination fee, and would mutually release all claims.

And that was that.

But this case study points to a broader pattern emerging in the Mergers & Acquisitions (M&A) industry. On the one hand, you have a host of companies reeling from an unprecedented cash flow crisis, looking to merge or sell off parts of their business to other more financially sound institutions.

On the other hand, you see Xerox dropping its $34 Billion offer for HP, Softbank refusing to buy WeWork shares, Sycamore threatening to litigate unless they are allowed to walk away from the contract. And desperate M&A professionals struggling to put together deals remotely without having the luxury of negotiating in person.

Timelines are being extended. People are being furloughed. Courts and regulatory agencies responsible for vetting the deals and settling disputes are running with bare minimum staff and the multi-billion-dollar M&A industry is effectively on its knees. Now you know why.

Until next time…

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