Transcript: When M&A goes wrong

This is an audio transcript of the Behind the Money podcast episode: ‘When M&A goes wrong’

Michela Tindera
Today I want to talk about M&A. That’s mergers and acquisitions. Now to do this, I’m gonna dive into a bit of a hypothetical situation here where I’ve spent years not covering financial news, but rather making and selling the best pizza in New York. Now I called in the FT’s Wall Street editor Sujeet Indap to help me with the next part here.

So, Sujeet, let’s picture this. I have this pizza restaurant that I’ve built up and I’ve run it for years. Everyone loves my pizza. I’m really proud of it. But now I’m done with that. I want to sell it and I’m looking for a buyer. So how does this process work with a typical M&A deal? 

Sujeet Indap
Sure. Imagine I had another pizza chain, or I was just an investor, and I liked your restaurant and the location, and I came to you and said, I’d like to buy it for $1000 or . . .  

Michela Tindera
$1000?!? My pizza restaurant is worth more than that. 

Sujeet Indap
Sorry, let’s say . . . OK, let’s say I want to buy it for $1mn. 

Michela Tindera
Perfect. Sold.

Sujeet Indap
And yeah, no, well, but you’re not going back and forth. There’s a, maybe it’s 1mn and maybe it’s 975,000, but we settle ultimately on $1mn. And so we sign a contract. And the contract says, I’m going to buy your restaurant for $1mn, and I’d write you a cheque. You’d get the money, I get the restaurant, and we would go on our separate ways. 

Michela Tindera
Sounds simple enough, right? That’s how M&A tends to work. You need a buyer. You need a seller. They agree to a price and then handshakes. Money is exchanged for a business. But Sujeet says that’s not what happened with the deal he recently came across. This particular case involved a private equity firm that wanted to buy a grocery store chain called Save Mart, and the deal looked normal. That is until the very end. 

Sujeet Indap
So the money changed hands. But since this was a private company, all hell can still break loose afterwards. And it did. 

Michela Tindera
That hell turned into a court battle that’s had a surprising outcome. 

Sujeet Indap
A court has ordered a seller to pay the buyer $109mn, which is not how this normally works. 

Michela Tindera
Meaning that the family that owns the grocery store chain might actually end up paying this firm to take the business off their hands. And what’s even more surprising is that this $109mn dispute was only brought up after the deal had already closed. 

Sujeet Indap
That, I think, is actually the most important and most interesting aspect of this whole fight. Why is this dispute? Why are we talking about it after the money has changed hands? 

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Michela Tindera
I’m Michela Tindera from the Financial Times.

Mergers and acquisitions tend to follow a set order of operations. But that wasn’t the case for the owners of the grocery store chain Save Mart. Today on Behind the Money, we’re peering inside the mechanics of the private dealmaking process that in this specific case went very south.

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Hey, Sujeet. Welcome to the show. 

Sujeet Indap
Thanks for having me. Good to be here. 

Michela Tindera
So for our listeners who live in California’s Central Valley — places like Sacramento or Modesto — they’ve probably heard of Save Mart. It’s a grocery store chain like Kroger or Sainsbury’s. 

Sujeet Indap
It goes back several decades, and like any other grocery chain, it’s really well-known and just part of the fabric of this central California community. 

Michela Tindera
For many years, the chain is owned by this one family: the Piccininis. But in 2015, the long-standing patriarch of the family, Bob Piccinini, dies. 

News clip
Sad news out of Modesto. Bob Piccinini, the man who started this family grocery store as a box boy at the age of 12 and rose to become the owner of a 240-store chain on the Save Mart and a number of other brand names worth 2.3bn, according to Forbes in the latest survey, he has passed away at the age of 73. 

Michela Tindera
The family continues to own Save Mart for the next few years, but then in 2021, they decide, like I did with my hypothetical restaurant, that it’s time to sell. 

Sujeet Indap
If you’re selling any asset, whether it’s your house or a company, you obviously want the highest price you can get. But there’s these other kind of social factors that will come into play, where you ideally want the buyer to take care of your asset, feel like it’s gonna be a good steward of it. 

Michela Tindera
So a potential buyer pops up — a private equity firm called Kingswood Capital Management. 

Sujeet Indap
The founder of Kingswood is a gentleman named Alexander Wolf, and he has a distinguished career in private equity. He had years ago been in a firm called Cerberus Capital Management. And then just prior to forming Kingswood, he was at another firm called Ares Management. Cerberus, famously in Greek mythology, is a three-headed dog that roams or guards the gates of hell. And then Ares is the Greek god of war. So Ares and Cerberus have a reputation as being very shrewd, very sharp and not afraid to play rough when necessary to win. 

Michela Tindera
But Kingswood’s efforts assure the Piccininis that they’ll take care of the Save Mart business, and they win the family over towards the end of 2021. 

Sujeet Indap
There definitely was the sense between Kingswood and Save Mart and the family that Kingswood was going to be a responsible owner of this business. They had great plans that were gonna grow it, and that Save Mart could actually not only get a good price, but they could feel good about the party that was gonna take over this institution. 

Michela Tindera
For a few months, Save Mart and Kingswood go through the typical sale process, the due diligence, reviewing the books, valuing the business, deciding what shape it should be in when Kingswood takes it over. And finally, in March 2022, the deal closes. 

Sujeet Indap
Typically, these private company deals are structured in a way that is described as debt-free, cash-free. 

Michela Tindera
Remember that phrase: debt-free, cash-free. 

Sujeet Indap
What that means is the buyer essentially just wants to buy the business itself and does not want to get stuck with either the existing debt on the business or the cash. The cash in the company’s balance sheet will typically just get swept up by the owners. And so truly, they’re just buying, like, the operations. 

Michela Tindera
So in this particular debt-free, cash-free acquisition, it shakes out that Kingswood gets the business and the Piccinini family gets about $30mn. And this is typically where the story ends. The buyer gets the business and the seller gets the cheque. That’s not what happened here. And that’s because this deal involves a privately owned company. 

Sujeet Indap
The big difference is when a public deal closes where there’s shareholders and they get $50 a share and they’re paid out at closing, that is the end of the story. That is not quite true in private company deals. And the difference is private companies typically have only one or two or a handful of shareholders who are all known and easy to find, whereas a public company has thousands of shareholders, if not millions. For that reason, there is the idea of post-closing adjustments in a private company deal where a buyer can say, hey, we agreed to there being $75 of eggs on the balance sheet. But in fact, there’s 73 or 77, and we just need to resolve these differences, typically very small, just so we get what it is we each bargained for. It’s a very typical process, and usually it leads to some very, very small minor adjustments. 

Michela Tindera
OK. That’s what you typically see in this scenario. But in this case it ended up being a nine-figure number that they need to settle out with the seller. 

Sujeet Indap
Right. Yeah. And so in this instance there’s actually is a dispute about the balance sheet at closing. And it’s not minor. It is $109mn. Yes. So it is a very big number, and almost unprecedented. 

Michela Tindera
So where did Kingswood get this $109mn figure? 

Sujeet Indap
So the key thing to understand about the transaction is that when Kingswood buys Save Mart, they’re actually buying two businesses. One is the grocery store, which we’ve been talking about. But also Save Mart owned a stake in another company, which was a food wholesaler or distributor, which basically means it just delivers groceries to various grocery stores to sell. That business was called SSI, and Save Mart owned 50 per cent of it. 

Michela Tindera
Now, remember, this deal was debt-free, cash-free. So that meant that when they sold to Kingswood, the family owners, well, they were responsible for any outstanding debt. 

Sujeet Indap
So on SSI, which is the distributor’s balance sheet, it had its own debt of $109mn. And so that was just its own debt from its own operations. And so the dispute is this: SSI had its own debt, and Save Mart said, we’ve already accounted for that, on our own financial statements. And that is what you Kingswood have bought, and there’s no reason to independently say it’s something that we have to account for. And Kingswood says no, in fact, the way this contract is written is that any debt at any Save Mart company or subsidiary counts as a liability, which you need to pay for. And you need to come up with the $109mn. 

Michela Tindera
Let’s break this down even more, because there’s an accounting part to this story and a legal part to this story. So let’s take the accounting part first. Essentially, Save Mart says that based on the accounting method that they use to keep their books, the debt of the distributor they partially own, SSI, is already baked into a single line item on their balance sheet. 

Sujeet Indap
And that single line represented the net value of that subsidiary. Basically, it was the assets minus liabilities. Pretty straightforward stuff. Nothing unusual about that. 

Michela Tindera
Now here comes the legal part of this. Kingswood takes a close read of their merger agreement, their contract with Save Mart, and says, wait a second here. 

Sujeet Indap
Kingswood, after closing, ended up calling this technicality when it said, hey, look at SSI’s books. It has 109mn total debt on the SSI books. And in fact, the merger contract says you, the family, have to pay off all the Save Mart group debt for this deal to close on correct terms. And maybe it’s double counting, maybe it’s not, but it doesn’t matter because it’s not clearly written. And therefore we’re gonna call this technicality and you’re gonna pay it all off. 

Michela Tindera
OK, so the Piccininis essentially receive a $109mn bill from Kingswood. How do they react to that? 

Sujeet Indap
I think that, from my various conversations with various people involved, they were obviously shocked to see this. They would not have signed an agreement that had them writing a cheque to the buyer. That doesn’t make sense. You wouldn’t pay someone to buy your house, typically, right? 

Michela Tindera
Not surprisingly, the two sides, Kingswood and Save Mart, can’t agree on an outcome on their own. So they take this dispute to an arbitrator. So, Sujeet, how does the arbitrator rule on this? 

Sujeet Indap
So the arbitrator, who is a former Delaware judge, an expert in corporate law, in fact sides with Kingswood, and agrees . . .

Michela Tindera
What?!? How?!?

Sujeet Indap
He does, yes. How does he do that? Exactly. And so there’s, like, these two competing schools of thought that collide in this case, which is, what does the actual contract say? The words, and what does it literally say? And then what did the parties actually want to do? What is the spirit of this agreement? And in a perfect world, those would be perfectly aligned. The words in the contract would say exactly what the deal that they want. When they don’t, a judge has to say which one actually prevails. Is it the words on the page, or is it like what they were like, really trying to solve for? And in this instance, the judge, the arbitrator says, in fact, the words on the page lead me to believe the $109mn falls into this formal definition of indebtedness. It needs to be brought into the transaction, and therefore, the family needs to send back $109mn to the private equity firm. 

Michela Tindera
So the Piccininis seem backed into a corner over this contract technicality. But the battle isn’t over yet.

Coming up: Sujeet lays out what’s next and what other companies can learn from this fiasco. 

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Michela Tindera
Before the break, we heard the arbitrator’s decision. They ultimately sided with Kingswood. The PE firm then got that decision blessed as binding by a Delaware court. That was the second nail in the coffin for the Piccininis. But the family isn’t done fighting this dispute yet. Their next stop is the Delaware Supreme Court.

So, Sujeet, what happens if this arbitration decision is upheld by that court? Does that mean that the Piccininis have to pay Kingswood to take their business essentially? 

Sujeet Indap
They have to do that and they will pay interest as well on 109mn, because the transfer of money is taking more time than at the time of the decision. So they are bearing the costs of obviously not just their lawyers, but the interest as well from delaying the payment. 

Michela Tindera
And in a high interest rate environment, that number is probably just taking off. 

Sujeet Indap
That’s exactly right. Yes. 

Michela Tindera
Yeah, yeah. What, in your opinion, would have solved or stopped this dispute from happening? Just better contract writing? Better contract reading?

Sujeet Indap
Yeah. I mean, it sounds like there should have just been a more explicit conversation before the closing on saying, hey, SSI has this debt. It’s actually incorporated already in the Save Mart balance sheet in this one equity line. Therefore, it doesn’t need to be accounted for somewhere else or brought on to the balance sheet for the purposes of the purchase price calculation. Save Mart and the family say, in fact, we had all these discussions and there was no controversy, and it was all out there, and there’s emails and financial statements flying back and forth where everyone agreed on this treatment. But obviously Kingswood felt differently. 

Michela Tindera
So why did Kingswood wait until after the deal closed to say anything? 

Sujeet Indap
So Save Mart lawyers asked the Kingswood executives in depositions, why or how did this $109mn come up after the deal closed? And they both said that, in fact, Kingswood knew all along before the deal closed that the $109mn was going to be an issue. But they decided to stay quiet because they thought it was something that was better handled after closing, and the negotiations were already tense, and this would just raise the temperature. And it was within their rights to stay quiet because there was this post-closing mechanism. So that is all interesting and theoretically correct. But their answers, again, go back to the social aspect of dealmaking. If it was contentious before closing already, then it, certainly bringing this up after closing was not going to lower the temperature. 

Michela Tindera
So in some ways, it sounds like Kingswood has made a great deal here. They’re gonna get this windfall from this $109mn. But I’m curious, what do you think this does for Kingswood’s business in the long term? Do you think that this is showing other people what savvy dealmakers they are or what exactly? 

Sujeet Indap
Obviously, having an extra $109mn coming in is going to be a huge victory and seems like a great trade for them with their canny lawyering and accounting. But they want to be in business for the next several years and raise new funds and buy new companies. And when they go out and enter auction processes, sellers are choosing between a bunch of private equity firms who all look the same. So there very much could be some kind of reputational blowback as Kingswood, oh, is that firm that called that accounting technicality and made off for $109mn against that grocery store family in California? Do we really want to sign a contract with them? And that is something Kingswood, I think, is going to have to confront and think about. And it will be really interesting to see how it is they respond to this going forward. 

Michela Tindera
The Piccininis, as you said, there was a lot of due diligence that went into this on both sides. The family patriarch at one time was on the Forbes billionaires list. These are not totally naive people. 

Sujeet Indap
They did not fall off the turnip truck. Yes, that’s right. 

Michela Tindera
Yeah. So . . . and even they ended up kind of getting duped in this situation. So I’m curious, what can other business owners with less experience learn from this story? 

Sujeet Indap
Typically, in an M&A transaction, the buyer and seller are both, like, ultimately aligned. And even if the negotiation is tough, at the closing, they’re both happy, right. Because the seller is getting money, which they want, and the buyer is getting a business that they want. So for that reason, sometimes I think maybe then the parties are not as careful or as fastidious as they should be, because they just don’t envision a scenario where they’re going to be potentially exploited. And again, this whole reputational point, if you’re like a person that’s known for exploiting counterparties, you’re potentially gonna pay for that down the road. So I think there’s real question marks for both sides about how they should feel about how this all went down. 

Michela Tindera
Sujeet, thanks for being here. 

Sujeet Indap
Thanks for having me. 

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Michela Tindera
Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week. 

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