The dramatic story involving Japan's Fujifilm, its long-standing U.S. partner Xerox and American investor Carl Icahn is already the stuff of a corporate blockbuster. But this tale of money, trust and alleged betrayal still has a long way to run.
After successfully blocking a no-cash bid by Fujifilm to buy 50.1 % of Xerox with shares, Icahn is now in a position to press Fuji for what he has said he wanted from the beginning. That is a cash offer for 100% of Xerox at a substantial premium over Xerox's current market capitalization of $6.9 billion.
The high-stakes decision for Fujifilm is whether to engage with Icahn on these terms -- or shut down further negotiations until Icahn changes his mind.
In a column published here in March I argued that Icahn was laying a "beautiful trap" for Fujifilm. The trap, as I saw it, was a deal structure that suckered Fuji into initially acquiring 50.1% of Xerox (for as high a price as Icahn could induce Fuji to offer) but kept Icahn and other Xerox shareholders in the picture still owning 49.9% of Xerox.
I suggested that in Act 2, Icahn would leverage his legal rights as a minority shareholder of Xerox to pressure Fuji to buy him out for an even higher price and that Fuji was underestimating the risks of buying into Xerox while leaving 49.9% of Xerox in the hands of public shareholders that include wily operators like Icahn as well as opportunistic hedge funds.
The unexpected event that derailed the original plot was a highly unusual injunction issued by a New York state judge in late April. The judge ordered Fujifilm and Xerox not to consummate the original non-cash transaction under which Fujifilm would have acquired 50.1% of Xerox. The injunction was unusual because the transaction had been unanimously approved by the Xerox board, including its independent outside directors. Normally, under the "business judgment" rule, a court will not second guess the merits of a transaction approved by a majority of outside directors.
The judge broke with the normal presumption, however, primarily on the basis of an exchange of damaging e-mails between Xerox's (now-dismissed) CEO Jacob Jacobson and senior Fujifilm executives. The emails show Jacobson offering Fujifilm its desired non-cash deal, seemingly in exchange for assurances about his continued employment as CEO after the deal is closed. This betrayal of Xerox shareholders by its "massively conflicted" CEO (with Fuji's collusion) was disturbing enough to cause the judge to suspend the deal until its fairness to Xerox shareholders could be established through a more transparent and objective process. Xerox not only denied wrongdoing on Jacobson's part but also, in court papers, insisted the question was irrelevant, saying: "Even if Jacobson's conduct could be shown to be improper (and it was not), Xerox shareholders are fully capable of making their own independent judgment about the Transaction".
That senior Fujifilm executives were naive and clumsy enough to engage with Jacobson in this incriminating manner and get caught was not only embarrassing -- it fundamentally calls into question Fujifilm's ability to acquire and manage a large-scale acquisition like Xerox in a foreign legal environment very different from the forgiving legal landscape of Japan. At the very least, being insufficiently aware of the sensitivity of U.S. corporate law to conflicts of interest, or the reach of the discovery process in civil litigation, ended up sinking the non-cash deal Fujifilm originally thought it had secured.
In the wake of the injunction, Icahn and co-shareholder Darwin Deason moved quickly, using the threat of a proxy fight to oust Jacobson as CEO, take control of the Xerox board and terminate the transaction agreement under which Fuji would have acquired 50.1% of Xerox. So we are now back to Square One, the only difference being that Fujifilm must now directly deal with the dreaded Icahn rather than the more malleable Jacobson.
Fujifilm now confronts anew the existential questions, do we need to do this deal, and if so at what price? Paradoxically, the keys to answering these questions depend largely on legal variables that Fujifilm and other Japanese companies have in the past poorly understood and been ill-equipped to manipulate to advantage.
The key questions of necessity and valuation depend on legal variables because Fujifilm and Xerox, through their joint venture Fuji Xerox, are indelibly joined at the hip through a welter of contracts that date back to 1962. The contracts cover not only the parties' rights as shareholders of Fuji Xerox, but reciprocal patent and other technology rights, and reciprocal supply obligations. The contracts contain geographical restrictions that carve the global copier market into an Asian sphere served exclusively by Fuji Xerox and the rest of the world served by Xerox. After a half century of patent cross-licensing between the two companies, it is simply not realistic now to try to disentangle who owns which technology -- it is all one big stew. Trying to separate Fuji Xerox from Xerox would be like surgically separating Siamese twins.
But it has now become clear that Icahn and Deason are employing a strategy of legal brinksmanship focused on the Fuji Xerox web of contracts, either to force Fuji to pay a steep premium for Xerox as if Xerox were a stand-alone, contract-free entity, or to threaten chaos and destruction by blowing up the Fuji Xerox contracts.
The main, but by no means only, target of Icahn's legal strategy is a so-called "crown jewel" lock-up provision, that in essence repeals or severely dilutes Xerox's economic, management and technology rights in Fuji Xerox if a "competitor" (e.g. Hewlett-Packard) acquires more than 30% of Xerox. So long as the "crown jewel" provision is left standing, no strategic buyer of Xerox would pay top dollar to acquire it, for that would entail automatic scuttling of the value of Xerox's ownership in Fuji Xerox. No doubt, Fujifilm negotiated its cash-free deal with Jacobson assuming, in light of the "crown jewel" provisions, no competing bids would be forthcoming to raise the ante.
Normally, a "crown jewel" provision of this kind is viewed as legitimate and enforceable, in which case Fujifilm's calm and rational stance toward Icahn would be, "Go ahead and try to sell Xerox to HP and see how far you get. Good luck, you are never going to get more than what we already offered." But Icahn and Deason's success in winning an injunction by painting a picture of sinister collusion between Jacobson and Fuji has shifted the legal calculus. One can easily anticipate legal action down the road by Xerox (now under Icahn and Deason's control) to challenge the validity of the "crown jewel" provisions and to terminate some or all of FX contracts. High on Fujifilm's priority list should be to get the best legal advice possible on the enforceability of its "crown jewel" rights.
But even without the legal complexities, deciding whether to spend hard cash for Xerox in a mature global market for copiers should be a tough call for Fuji management. Xerox's revenues today are one-half of what they were four years ago. Fuji Xerox's Japanese competitors in copiers are under pressure, brought about by low margins, oversupply and irreversible changes in office technology that have reduced the role of paper. Legal complexities layered on top of fundamental business decisions only compound the difficulty for Fujifilm management.
As Japanese companies confront the challenges of cross-border change-in-control transactions, both as acquirer and target, they will need to factor in legal strategy and risks much more carefully, and with greater sophistication, than in the past. Toshiba's lurching efforts to sell its memory business last year, in the face of contractual restrictions that arguably gave Western Digital, its American technology partner, the right to veto the transaction, are another recent example of the way legal variables that depend on persuading judges and juries in courts thousands of miles removed from Japan, can decisively change the calculus. In Toshiba's case, Western Digital's threat to run out the clock in prolonged litigation forced the company to raise cash to survive by issuing a controlling tranche of equity to a consortium of foreign hedge funds: a leap from the pan into the fire.
It is no accident that many "event-driven" hedge funds (which try to profit from corporate events such as a takeover battle), are headed by former lawyers. Elliott Management of the U.S., for example.
To avoid unintended disaster in today's global business world, Japanese companies can no longer assume that legal risks are as simple or benign as they generally are within Japan itself. The rest of the world is, at least in legal terms, a much less forgiving place.
Stephen Givens is a practicing corporate lawyer based in Tokyo. He is concurrently a professor in the Law Faculty of Sophia University.