Wednesday, December 08, 2010

J Crew Goes Private: More Self-Dealing & Unethical Corporate Governance

The story emerging around J. Crew Group's sale of itself to private equity groups TPG Capital and Leonard Green & Partners, and CEO Mickey Drexler, is distinctly unpleasant. How it portrays corporate governance and unethical behavior of certain parties is another black eye for corporate America.

According to the latest Wall Street Journal piece on the subject,

"The details of the J. Crew deal show how top management kept a number of key details from the company's board, while a TPG executive serving on that board eventually engaged in direct purchase negotiations with the company.

TPG, Leonard Green and J. Crew declined to comment."

As if this wasn't bad enough, Goldman Sachs, which originally advised J. Crew on,

"management's review of strategic alternatives other than a sale....had switched sides, working as a financial adviser for the TPG group that included Mr. Drexler. Goldeman declined to comment."

The private equity groups and Drexler discussed a buyout "for about seven weeks" before notifying J. Crew's board. During that time, the Journal article states that senior managers were brought in to make board presentations about the company's condition. This means the private equity bidders for the company were essentially being given all of the company's confidential information, unbeknownst to the directors not involved in the buyout.

Upon reading, in the Journal, and hearing, on CNBC, these various details, I immediately thought of the similar case of Kinder Morgan's buyout a few years ago. And at least one other pundit made the same connection.

The Journal article provided further details of how Drexler wouldn't work with any other buyer, and the buyout group's intimate knowledge of J. Crew's situation allowed it to make an offer calculated to satisfy the board, meaning, that the offer wouldn't be unnecessarily high.

Obviously, the big losers in this situation are the shareholders.

The nearby chart shows J. Crew's recent performance versus that of the S&P500 Index. The retailer has done better than the index over the period. It isn't completely clear why the firm's management or board would consider it to be so in need of a private equity rescue.

But what is pretty clear is that the private equity groups who ultimately agreed on a $43.50/share deal felt they were getting a bargain. So shareholders were implicitly being roughly handled.

Why? It seems that, with Drexler unwilling to work for other buyers, and having allied himself with the TPG-Green  bid, he was acting against the interests of the shareholders in whose interest he allegedly served as CEO and a board member of J. Crew. Depriving shareholders of his services, after having been compensated for learning the details of the firm, seems unethical. If Drexler did such a bad job that the firm had to be sold to a private buyout group, why was he necessary if the firm wished to remain public? If he was so key and successful, why was it being sold to a private group?

The logic is neither clear, nor sensible. Instead, about the only way it seems plausible is because Drexler and the TPG representative on J. Crew's board gained sufficient knowledge of the firm's operation and prospects, coupled with Drexler's alliance with that buyout group, to give them leverage over future prospects of the firm as a publicly-held entity.

Like the Kinder Morgan deal, it smacks of insider, self-interested dealing at the expense of shareholders. This undermines long term faith by investors in the publicly-held firm model. Perhaps investors would be wise to note whether private equity firms have representatives on boards.

One also wonders why and how the board of J. Crew let itself be put in this position? And if there were not other remedies available, such as removing the TPG-affiliated board member, and Drexler. Instead, they were evidently rewarded for their questionable ethics and behavior by being awarded a buyout price based on insider knowledge and unique leverage over the firm.

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