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Background: RBC Capital Markets LLC, the investment banking arm of Royal Bank of Canada, was representing Rural/Metro Corp. in the sale of their business. Another team at the bank was trying to get the financing work from one of the buyers, Warburg Pincus LLC, a private equity firm. According to a recent article in the Wall St. Journal, a senior banker at RBC was in touch with both teams, and didn’t tell Rural/Metro that the bank was trying to get that business from Warburg. Essentially, RBC was trying to get paid from both sides of the deal. The former shareholders of Rural/Metro took RBC to court, claiming that they didn’t receive fair value for their shares. On Friday, March 9th, Vice Chancellor J. Travis Laster ruled in their favor.
So what can you learn from this?
First, pay attention to valuation metrics. In late 2010, when RBC was pushing to grow their investment banking business, and they initially pitched the company to serve as their advisor, they “relied on two recent deals, signed at 9.5 times and 9.4 times the targets’ earnings before interest, taxes, depreciation and amortization (“EBITDA”), to show what Rural/Metro might be worth.” But on the final weekend before the deal was to close, the RBC team presented a revised valuation range to the company’s Board of $8.19 and $16.71, which made Warburg’s offer of $17.25 per share look like a great offer. But the new valuation was lower than the valuation RBC used to pitch the deal, because now it included a deal from 2004 that was at struck at a much lower multiple – about 6.3 times EBITDA.
When an investment banker is pitching you to get your sell-side M&A business, pay careful attention to how they calculated the valuation range they present to you. Are the transactions relevant? Are they recent? Which transactions did they exclude from their analysis and why? RBC is not the first investment bank to pitch a company using only the most favorable valuation metrics. It’s critical that as the business owner, you be aware that valuation is an art, not a science, and that your results may be different. Don’t select an investment bank just because their anticipated valuation is the highest. Getting the highest price for your company is the result of a competitive process, not dependent on historical multiples.
Second, look for conflicts of interest. In this situation, the judge determined that RBC “failed to disclose the relevant information to further its own opportunity to close a deal, get paid its contingent fee, and receive additional and far greater fees for buy-side financing work.” In this situation, lawsuits were filed against three parties: RBC for failing to disclose its conflict of interest adequately; Moelis & Co., a second advisor to Rural/Metro to settle allegations related to its fairness opinion; and Rural/Metro’s Board, which was accused of selling the company for too low a price.
A question for the readers: do you believe that an investment banker can be free of a conflict of interest if they are getting fees from both sides of transaction? What if they’re helping both sides get the deal financed and closed, but only get fees from one side? Share your opinion in the comments.