J Crew Shareholders Turn Up Heat on Private Equity Buyers

With its extended go-shop period having expired and with no other bidders showing up, shares of J Crew are still hovering at or above the price of $43.50 that its private equity buyers have agreed to pay.

A J. Crew logo is seen on a glass door of one of its retail clothing stores in Chicago, Illinois.
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A J. Crew logo is seen on a glass door of one of its retail clothing stores in Chicago, Illinois.

The reason is that while no other buyers ever showed up here, a deeply flawed sales process has given many large shareholders a cudgel they plan to use to beat more money out of TPG Group and the other partners it has enlisted in this go-private deal.

And they may have a shot. While J Crew reached a so-called settlement with shareholders to rectify the mess it made of its sale, that settlement fell apart in mid January.

Since then, each side has asked Delaware Chancery Court Vice Chancellor Leo Strine for relief, but he is not expected to rule on anything here until after J Crew holds its shareholder vote on the deal on March 1.

Between now and then, large shareholders such as Mason Capital, which owns 6.5 percent of J Crew and sent the board a nasty letter a few days ago, and even larger shareholders such as Paulson and Co., which owns 9.4 percent of the company's shares, are expected to turn up the heat.

It's not just the threat that shareholders could potentially vote this deal down—while somewhat unlikely, it is a possibility. It is also the threat of damages being sought after such a vote and the use of appraisal rights by these shareholders to try and get a price they believe is fair, that could bring J Crew to increase the price.

As Mason writes in its letter "they cannot repair a process that has been intentionally botched. If the parties continue to try and complete this deal at the current price, we will oppose the transaction and will review our statutory appraisal rights under Delaware law."

Given it's only an additional $64 million for each dollar-a-share increase in price, and the fact that debt markets are even cheaper then they were when the deal was announced, shareholders are hopeful they can get a couple of bucks more out of J Crew.

As for the sale process itself, it continues to be a subject for consternation among many in the M&A community.

It wasn't just the inherent conflict of the key person at this company, CEO Millard Drexler, choosing his own deal. It was also that the the special committee of the board, hired Perella Weinberg to give it a fairness opinion for a fee of $3.25 million, with the promise of being paid $16.5 million if the deal closed.

How do you not hire another bank when your first advisor is clearly incented to say yes to any price?

The bottom line: go-shops are a waste of time. Fairness opinions are barely worth the paper they are written on when there's bigger fee on the line and management led buyouts are a very tricky thing to get right.

Follow David on Twitter: @DavidFaberCNBC

*This post has been updated.

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