A French white knight, a court in Amsterdam, ESOPs fables

The 30-Month Fight for Gucci

A EUROPEAN TAKEOVER UNLIKE ANY OTHER

"It's very simple. If those guys don't pay, I'll cut their balls off and sue them for specific performance." So said Domenico de Sole, chief executive of Gucci. And that's after all sides reached a settlement. It took thirty months for Gucci to hand itself over to its white knight and for its attacker to fold its tents and give up the siege. It will take until the year 2004 for the peace treaty to take its full effect, and, if Gucci's stock price remains high, Pinault-Printempts-Redoute would never have to acquire an additional share to maintain control.. Over the two-and-a-half years of this fight between Pinault-Printemps-Redoute and LVMH Mot Hennessy Louis Vuitton, Gucci defended itself with an inventiveness that drew much interest, as well as some controversy and judicial disapproval of both sides. The conduct of the battle and the rulings from the courts in the Netherlands could well change the way takeovers are conducted, both in that country and across the continent. The rules of individual countries remain as important as ever, given the recent defeat at the hands of the German delegation of the European Union's proposal for a standard set of M&A regulations covering unsolicited transactions. Says Paul Storm, a senior M&A partner in the Rotterdam office of NautaDutilh, who advised LVMH: "This is one of the first times that a takeover battle has been taken to the Dutch courts and the very first time that the inquiry procedure before the Enterprise Chamber has been tried for such a case. For centuries, hostile battles have been frowned upon in the Netherlands. But now the climate for takeovers will never be the same. Already this summer, the Enterprise Chamber refused to allow a white-knight construction. There will be many other cases that will go to the courts." On September 24, the Securities Board of the Netherlands approved the agreement but insisted that, in addition to the strong contractual protections already in place, Gucci post a letter to support a small portion of the offer PPR is required to make in 2004. U.S. antitrust authorities at press time had not yet spoken but were not expected to raise objections. Says Wachtell's David Katz, counsel to PPR, Gucci's white knight: "It will be one of the most interesting deals of the year. I do not think that Europe has ever seen anything quite like this transaction." Quirky This fight involved a Dutch company founded by an Italian family fending off a French conglomerate by turning to a French white knight, with the contest ultimately adjudicated in the Netherlands. Gucci Group

NV is incorporated in that country but has almost no employees. It is a holding company that for tax reasons owns all the operating companies of the Gucci group, each of which has headquarters and operations around the world. As a Dutch company, Gucci could have arrayed itself with a number of daunting defenses. The Amsterdam Stock Exchange, which saw a market turnover in 1999 of some EUR 1.5 billion, is a sophisticated market. Shares in companies have been traded in the capital for four hundred years. Battles for corporate control have always been frowned upon. Says Paul Storm of Amsterdam's NautaDutilh: "Since the beginning of the twentieth century, Dutch companies, including Royal Dutch and Unilever, have invented a wide range of corporate devices to keep power essentially in the hands of management. In listed companies, these devices are in fact protective devices against hostile takeovers. Some of them have even been regulated in the Civil Code." A Dutch company can create a class of priority shareholders, for example, a group that can virtually dictate the direction of the company and assure its independence. This group can select members of both the supervisory and management boards, decisions that require steep majority votes of the general shareholders to overturn. Board members can themselves own priority shares, although directors cannot own more than half of this class of stock, under the rules of the Amsterdam Stock Exchange. Similarly, if it is a legal entity such as a foundation that is the owner of the priority shares, not more than half of the foundation's directors can be members of the listed company's management board. Priority shareholders can also be in charge of crucial corporate resolutions. The company's articles of incorporation can require that this class be the only one that can propose certain actions, or it can decree that priority shareholders have a veto over those resolutions, or both. "Such resolutions may include all the important ones--to amend the articles, to issue shares, or to distribute dividends," explains Mr. Storm. A particularly popular defensive weapon is the so-called "receiptization" of shares, which can mean that an acquiror buys all the receipts and gets voting rights equivalent to as little as one percent of the stock. A company issues shares to a legal entity, typically a foundation, which then issues a depository receipt for each share. The foundation, known as an "administratiekantoor" or AK, exercises the voting rights of the stock and the owner of the receipt gets all the economic benefits. Receipts may or may not be convertible into company stock, although as prerequisites to listing receipts, the Amsterdam Stock Exchange requires that they can in fact be converted into stock without undue restrictions, and that the majority of voting rights on the AK's board be held by independents. Says Mr. Storm: "Some thirty percent of all quoted Dutch companies other than investment companies have in fact depository receipts quoted rather than their shares." Protective preference shares, known as "prefs," can be fired from a company's cannons as soon as a hostile bidder appears on the horizon. These shares yield a dividend at a fixed percentage and only 25 percent of the nominal value must be paid up immediately, but they carry the same voting rights as ordinary shares. Again, a foundation is usually the entity to which such shares are issued, and it must conform to stock exchange rules for the company to remain listed. But this is a potent weapon: "When there is a threat of a hostile bid, the competent body will issue such number of prefs as may be needed to prevent the predator from acquiring a majority of the shares," explains Mr. Storm. The exchange does not allow a company to have more than two of these three defenses. When it decided to apply for a listing on the New York Stock Exchange, the company decided not to arm itself with any of these three defenses available to Dutch companies, fearful that U.S. investors would not find it as attractive if it did so, despite the fact that there are companies on the NYSE incorporated in the

Netherlands that do have the traditional arsenal of defenses available in their corporate homeland. Before the battle was joined, Gucci had sought shareholder approval to strengthen its takeover defenses but its efforts were narrowly defeated. Gucci had no defensive weapons whatsoever, except two. Battle Is Joined On January 6, 1999, LVMH made its move. Advised among others by Marius Josephus Jitta of Amsterdam's Stibbe, and Paul Kingsley of Davis Polk & Wardwell, LVMH executives called Gucci to say that they had just crossed the five percent disclosure threshold that triggered filing requirements in both the U.S. and the Netherlands. Gucci CEO Domenico de Sole remembers this first contact as a friendly call from a passive investor enamored with the company. He got a second call from LVMH executive Pierre God: "I asked him how much they owned and he said, 'I don't remember.'" A week later, LVMH had 9.6 percent of Gucci stock, having snapped up the stake that Prada, another Italian house, had bought in the summer of 1998. When it filed its first 13D ten days after the calls to Gucci, LVMH held a 26.6 percent stake, with purchases of ever-larger tranches at ever-increasing prices. They ranged from 100,000 shares purchased on January 5 at $55.84, to 631,000 shares bought on January 12 at $68.87 per share. By January 25, LVMH stood looming over its target with a total of 34.4 percent. Not only did Gucci have no defenses--save the two it would use later on--but also the Netherlands does not require a full tender offer for all shares of acquirors who cross a given threshold, as is required in Britain, Italy, and France. LVMH said publicly and privately that there would be no changes to management, and that it had no desire to take over Gucci, but it did demand three seats on Gucci's eight-person supervisory board. Gucci, alarmed at the prospect of a competitor owning so much of its stock and worried for its minority shareholders, urged LVMH to make an offer for all Gucci shares. LVMH refused. Gucci asked for a standstill agreement. By February 16 advised by Martin van Olffen of Amsterdam's De Brauw Blackstone Westbroek and Scott Simpson of Skadden's Canary Wharf office, Gucci sent over a term sheet for LVMH's approval, released the next day, which guaranteed Gucci's independence and limited LVMH's ownership stake. A letter from LVMH CEO Franois Arnault stated that his company would agree "to preserve the independence of Gucci's management" and that "all commercial proposals by LVMH Group companies to Gucci . . . would be accepted or rejected by Gucci on the basis of its best interest." The very next day, Gucci issued a press release stating that it had granted an option to a foundation under its control, the Stichting Belangen Werknemers, to purchase 37 million newly issued shares. As part of this employee stock-option plan, or ESOP, Gucci said it had just--at company expense--issued to the foundation a total of 20,154,985 shares. That was the exact number of shares now owned by LVMH. At a stroke, LVMH found its 34.4 percent stake diluted to 25 percent of the company. Moreover, should LVMH increase its stake, Gucci said it would issue more stock to the ESOP on a share-per-share basis. Because it had none of the other traditional Dutch defenses in place, this was one of the two defenses it had left to it under Dutch law. In 1995, the general meeting of shareholders had granted to the supervisory board a five-year right to issue more of its own stock to a separate legal entity under its control. The target had made a no-interest loan to the ESOP to finance the share purchase. The ESOP would get dividends on the stock but would use that money to pay down the principal, so that the ESOP would not reduce earnings per share or affect Gucci's balance sheet. They were not additional capital, but additional voting rights. Says Mr. Storm: "The stated intention of the ESOP shares was to neutralize the voting rights of LVMH's shares in Gucci."

Gucci had a rationale for its move. Its management insisted that it was always amenable to a tender offer for all shares, and was only trying to prevent an acquiror from taking it over without making such an offer. Gucci could quickly shut down the ESOP, paying a small premium to employees. Scott Simpson of Skadden's London office, advisor to the target, explained that all of the defenses would collapse in the face of a bid for all the stock. That was very important to the board of Gucci, he said, because the company wanted such a bid to remain feasible. Gucci did not think of the ESOP or Stichting over a few days in the winter of 1999. It had in fact been examining the possibility of such a defense since the previous summer, when it suspected that Prada might be on the prowl. Gucci general counsel Alan Tuttle--who, along with Gucci CEO de Sole, had been a partner at Washington, D.C.'s Patton Boggs before joining the company--asked Skadden's Scott Simpson for advice. Simpson suggested using an ESOP. Gucci's Dutch counsel De Brauw Blackstone Westbroek examined the plan, pointing out that Dutch corporate law generally prohibits a company from financing the purchase of its own shares. However, the Netherlands firm noted, this rule did not apply to ESOPs. LVMH Goes To Court LVMH was not happy. It had spent $1.4 billion for its stake in Gucci, which had been knocked down from a third to a quarter of target stock. It could not buy any more shares, and its votes were unusable--all this after responding favorably to the standstill proposal. LVMH said Gucci was using "legal trickery as a substitute for sound business practice and shareholder democracy" and called the Stichting "an outrageous mechanism which would allow management to deprive any shareholder of voting rights any time a shareholder opposes management." The French conglomerate asked the Enterprise Chamber of the Amsterdam Court of Appeals, a five-judge panel that oversees complex commercial cases, to conduct an official inquiry into Gucci's actions. Under Dutch law, the holder of a minimum of ten percent of a company's stock has the right to ask the court to appoint one or more experts to conduct such an investigation. If the results show mismanagement--that is, if the company has not followed "proper policy" that takes into account the interests of all stakeholders including employees--the court can set aside provisions of the articles, or vitiate resolutions of the board or the general meeting, and even suspend or dismiss directors. LVMH also asked the court to enjoin in the meantime the voting rights of the Stichting shares. On March 3, 1999, the court criticized the actions of both sides. LVMH had a broad duty of good faith, as the acquiror of so much stock in another company. A company in its position "must...consult to a reasonable degree with the [target] company...and act in accordance not only with [the acquiror's] own interests but also with those of the company...and with those of the persons involved with the company." This was the first time such a duty had been articulated in the Netherlands: an acquiror must show its credentials at the door, instead of trying to break it down. Gucci, on the other hand, may well have violated the intent of Dutch corporate laws if it set up the Stichting only to frustrate a potential acquiror. The court said it needed to look into this matter. In the meantime, the court put a pox on both houses, freezing the voting rights of both LVMH and the Gucci Stichting. The president of the Enterprise Chamber urged both sides to continue to negotiate the proposed standstill and independence agreement. Gucci suggested that the two sides meet on March 19 to go over the term sheet it had submitted to LVMH on February 16. LVMH agreed.Before the March 19 meeting, the two sides continued to spar. LVMH reiterated its position that it had no intention to make an offer for all of the outstanding shares of Gucci, much less one at a premium. In hindsight, this stance turned out to be a crucial error.

Another Bombshell Two hours before the combatants were to sit down at the negotiating table on March 19, Gucci made a surprise public announcement. It had signed an agreement with a white knight. The meeting with LVMH went ahead, but it was brief. Gucci refused to discuss its moves and referred LVMH to the press release. It seemed that Gucci had actually been taken over. Again, much had gone on behind closed doors. In what must have brought back memories of good old-fashioned American hostile takeovers, Skadden and Wachtell lawyers put together an agreement with a white knight brought into the fray by Michael Zaoui and Joseph Perella of Morgan Stanley Dean Witter: Franois Pinault, CEO of Pinault-Printemps-Redoute, a French retailing chain. Pinault asked to meet Gucci, during the time of frozen votes after the March 3 ruling, and by March 15, Skadden's Simpson and Wachtell's David Katz, PPR's outside counsel, had put together the mainframe of an agreement. "It was like the days before the Williams Act in the United States," recalls Katz. "The Dutch legal system together with the NYSE listing requirements allowed for some creative solutions. Skadden's use of the ESOP was bold and gave Gucci time to find a full solution." Gucci sought to leave the path always clear for a full tender offer to all its stockholders. PPR had to be provided with enough power to enable it to step in front of a determined opponent that had already captured much of the territory at significant cost. Using its other defense, the ability to issue new stock to third parties unrelated to the company, Gucci sold PPR 39 million new shares, virtually double the LVMH stake, that placed 40 percent of the target in PPR's hands at a price of $75 per share (significantly higher than any price paid by LVMH) or $2.9 billion, diluting LVMH's interest in Gucci to 20 percent. In its initial proceeding before the Enterprise Chamber, LVMH had asked the court to remove Gucci's right to issue stock to third parties. But even when it froze the Gucci Stichting, the court refused to remove from Gucci's arsenal the right to issue shares to an unrelated third party. PPR was permitted to increase its stake to 42 percent of the outstanding shares on a fully-diluted basis, but was otherwise generally prohibited from acquiring additional Gucci shares for a five-year period. Under the strategic investment agreement between Gucci and PPR, the latter did get an option to acquire additional shares, at a maximum of 10.1 percent tranches, to match any increases by LVMH. If LVMH made a bid for all of Gucci's stock, PPR could sell its shares or make its own bid for all the stock. PPR got the right to nominate four of the nine members of the target's supervisory board and was granted veto power over the appointment of the chairman. A new "strategic and finance committee" of Gucci's supervisory board was to be established. PPR would appoint three of the five members of this new body, and a number of significant corporate and financial decisions would have to be submitted to the committee for its approval before they could be sent on to the supervisory board. In connection with its investment in Gucci, Pinault also agreed to sell Gucci the Yves Saint Laurent business together with a line of perfumes that were to be acquired from Sanofi S.A., another French company, for $1 billion. This was the first step to implementing Gucci's multi-brand strategy. Hours after all this was revealed, LVMH announced an offer for all of Gucci's stock, which it had so far refused to do, to protect its investment now that PPR was ensconced. Under Dutch law, a bidder has to give seven days' notice of a formal bid. Although never made public, LVMH was offering $81 for all shares, or $85 if the issuance of stock to PPR was nullified. Gucci turned down this offer. At an impasse once again, LVMH looked again to the court that same afternoon. LVMH made several offers to buy Gucci stock. Its final bid formally submitted on April 7 was $85 per share for all shares except those held by the Stichting, or $91 per share if Gucci abandoned its white knight. Also, LVMH demanded that Gucci dilute PPR's stake if after such an offer LVMH won 50 percent of the independently held shares but less than 50 percent of the total tradable stock. LVMH cited

the court's declaration that the PPR arrangement should not be allowed to deter shareholders from joining in an LVMH offer for all stock lest independent shareholders get short shrift. The Gucci board met on April 8, the next day, and turned down LVMH because, the target said, of conflicts with its PPR agreement. That pact, Gucci pointed out, released PPR from its standstill if another bidder got over 25 percent of the stock. LVMH came back with an alternative: Make sure that PPR tenders its shares and get a top Gucci designer to agree to stay on for two years after an LVMH tender offer. Gucci again tossed this aside. On April 19, Gucci said it would support an offer of $88 per share--as if to say, "So come and get us." LVMH did not raise its bid from $85. To strike back, LVMH considered turning to the New York Stock Exchange. If Gucci faced the possibility of being delisted for having broken NYSE's rules, it might rescind the PPR transaction. Gucci had quite clearly run afoul of the rule that bars companies from issuing more than 20 percent additional capital without shareholder approval, But, as PPR had been telling LVMH, NYSE rules permit foreign issuers to use the rules of their home country in lieu of shareholder approval requirements set forth in the listing standards. And it was back to court. After three interim decisions, the Enterprise Chamber issued its final ruling on May 27, 1999. First, the panel struck down the Gucci Stichting. By setting up the ESOP as it had, Gucci had violated basic standards of conduct and was therefore guilty of mismanagement. So far, for LVMH, so good, if so moot, since after PPR got its tranche of target stock, the Stichting's stake was largely irrelevant. The court then found that Gucci had also acted improperly by granting PPR a large percentage of company stock. Gucci, the court ruled, had run afoul of Article 2:8 of the Civil Code, which requires corporations to act in accordance with "the requirements of reasonableness and fairness." Even better news for LVMH. Then came the bad news. The PPR transaction would not be unwound. Although Gucci had not acted fairly at a time when the court had strongly suggested that the two sides return to the negotiating table, there had been no absolute decree that talks had to continue. LVMH was a competitor and Gucci was entitled to keep it at bay. PPR, on the other hand, had agreed to maintain Gucci's independence and to enter into a standstill agreement for five years. LVMH had repeatedly refused to make an offer for all its target's shares and should have been aware that Gucci could rightfully defend itself by issuing more of its stock. LVMH appealed to the Dutch Supreme Court. The Dutch Association of Securities Owners and the French Association for the Defence of Minority Shareholders, both of which had joined LVMH in the action, saw their arguments dismissed as well. These two entities had asked the court to agree that the share issuances to both the Stichting and the PPR should have been put to the general meeting of shareholders for approval. Not so, said the Enterprise Chamber. Gucci had been given the power by its shareholders to issue shares back in 1995. Gucci was also under no obligation to demand a full offer from any recipient of a large percentage of stock. Says NautaDutilh's Paul Storm: "It was a very odd decision. I think they just didn't dare do anything." John Finley of Simpson Thacher, who was not involved in the deal, also found the decision a bit peculiar at first glance: "Although the Enterprise Chamber refused to unwind the transaction, it reached a seemingly inconsistent result by opining that by issuing a significant block of shares to PPR, Gucci had violated elementary principles of proper business conduct which qualified as mismanagement. This holding, however, related to Gucci's decision to enter into the PPR transaction while the entire matter was

subject to court review and the Enterprise Chamber had recommended that Gucci and LVMH meet to try to resolve their differences. The mismanagement related to the timing of the transaction rather than the substance of the transaction itself. Accordingly, the Enterprise Chamber upheld the substantive action and refused to rescind the issuance of shares to PPR because this action could have been taken in the future, provided that due deference was given to Gucci's duty to negotiate with LVMH." In October of 2000, the supreme court held that the Enterprise Chamber had been wrong to make any conclusions without an official inquiry. Says Paul Storm of the latest decision of the Enterprise Chamber: "This opinion is a long and well-reasoned one. The court found indications of mismanagement with respect to many actions by Gucci, including the substance of the transaction between Gucci and PPR--the issuance of shares to a single shareholder that gave it virtual control with no premium paid to all shareholders." LVMH went back to the Enterprise Chamber, seeking an order for an inquiry. On March 8, 2001, the court granted the request, and appointed two prominent Dutch lawyers and a former CEO of a large financial institution as the official investigators. In September 2001, the panel was about to issue findings, which, Mr. Storm believes, were likely to be critical of Gucci. Katz disagrees, saying that the investigators had spent a significant amount of time focusing on the extensive record put together by Gucci that he says strongly supported the actions taken by the Gucci board. Storm says that the imminent publication of the report spurred Gucci to reach a settlement with its white knight and its attacker, but advisors to PPR say that had nothing to do with it. It is clear that none of the parties particularly wanted the investigators to have to issue their report. The Final Answer It was perhaps to be expected that the peace negotiations were as hard fought as the three-year war-with constant leaks to the press. Recalls Wachtell's David Katz: "It was a long negotiation, with lots of fits and starts in a changing market environment, with each side vigorously defending the interests of its own shareholders." The final settlement negotiations occurred at the offices of Darrois Villey in Paris (PPR's French counsel), the week after the Labor Day holiday in the U.S. After a dinner of Lebanese food (ordered in at the last minute for a large group on a Sunday night), executives from all three companies gathered to hammer out the final details of the settlement, to review the documents and to agree to the terms of a short joint press release that would precede each company's longer public statements. Strangely, it was the only instance during the entire deal that executives from all three sides found themselves in the same place at the same time. The final clink of glasses, filled with some of LVMH's finest, came late into the night after all the documents were signed, and, in the European tradition, initialed by all sides on every page. Here is how all the strands of this complicated knot are to be disentangled. LVMH has agreed to cede Gucci to PPR. In the first step, PPR will buy about one-third of LVMH's stake in Gucci for $94 per share, giving PPR more than 50 percent of Gucci. Then, in December, Gucci will pay a special dividend of $7 per share to all non-PPR shareholders, including the shares retained by LVMH. In the final step, PPR has agreed to make an offer in 2004 at a price of $101.50 per share for all shares of Gucci that it does not

own, in effect placing a floor price on Gucci's stock. The $101.50 price is roughly the value today of $94 per share, taking into account the payment of the $7 dividend. The settlement agreement and the revised strategic investment agreement has strong contractual protections to ensure that PPR makes the promised offer. For example, if PPR does not make its offer, Gucci will have the right to issue new shares to all its stockholders, diluting the French company's stake back to 42 percent and rescinding PPR's additional rights. PPR can acquire up to 7 percent of Gucci's outstanding shares, which will make sure that there continues to be a strong public float. PPR is clearly betting that Gucci's share price will equal or exceed $101.50 in April 2004, in which case it will not have to buy any additional shares. PPR also gets control of 50 percent of Gucci's supervisory board immediately, and has the right to a majority of the board and to designate the chairman after it completes its offer in 2004. Next came a discussion over the role of regulators. Advisors to PPR did not think the Dutch securities board had jurisdiction over the arrangement, arguing that PPR's commitment to make its all-shares tender offer in 2004 did not constitute a present offer to buy stock. "The new Dutch Securities Board just wanted a seat at the table," says one advisor. In the end, however, the regulators successfully insisted on an additional guarantee that PPR would indeed come through with its offer so many years from now--although, oddly, they turned to Gucci to supply this guarantee. Gucci is to set up a $230million letter of credit to benefit minority shareholders (other than LVMH) should PPR fail to make its offer of $101.50 per share. Minority shareholders would then receive a payment of $6.47 per share, the difference between the $87.53 closing price on September 10, when the deal was struck, and $94, the price PPR will now pay for part of LVMH's stake. All's well that ends well, says Paul Storm: "LVMH will see a profit of 760 million euros; Gucci is no longer under attack; and PPR is certain of full control by 2004." David Katz sees the deal as one that meets the needs of all three parties, with tangible benefits for Gucci's public shareholders. What's more, he says the battle could become a case study for M&A experts throughout corporate Europe. "With the derailment of Europe's takeover directive, there may be a unique opportunity for companies that are potentially vulnerable to attack or that come under attack, to adopt real defensive measures that protect the rights of all shareholders." And if it all falls apart? Mr. de Sole certainly made clear his dedication to ensuring that all goes according to plan, with his colorful assertion as to what would happen to PPR executives--and their anatomies-should promises not be kept. PPR's response was sympathetic amusement and a renewed pledge to fulfill its part of the bargain. Said Serge Weinberg, the chairman of the French white knight: "Domenico is a very sanguine character, but we have a good relationship on the major business issues. There has been a lot of pressure on him on this question of the bid and there is absolutely no question that we will respect our commitments." And, Mr. Weinberg insisted: "I would like just to reassure everyone that I'm still intact." "For centuries, hostile battles have been frowned upon in the Netherlands. But now the climate for takeovers will never be the same," says NautaDutilh's Paul Storm, advisor to LVMH.

LVMH had spent $1.4b for its Gucci stake, which had been knocked down from a third to a quarter of target stock. It could not buy any more shares, and its votes were unusable. Gucci did not think of the ESOP over a few days in the winter of 1999. It had in fact been examining the possibility of such a defense since the previous summer.