Sony abandons its merger with Zee and wants to get paid for it

Billionaires also get ghosted sometimes

A failed merger can lead to some sad faces.

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It’s long but I have to start by summarising the drama. Zee Entertainment and Sony Pictures are both large media companies in India. Zee is run by Subhash Chandra & family while Sony is owned by the eponymous multinational in Japan.

In 2021, Zee and Sony decided to merge. Combined, they would become the largest media company in India valued at $10 billion. It was mostly a deal of equals. Sony would have a controlling stake at 50.86% of the merged company while the remaining 49.14% would be with Zee.

Even so, Zee always seemed to want the deal slightly more than Sony. The company’s share price was at around ₹170 before the deal was announced and nearly doubled to ₹318 after. Subhash Chandra & family’s authority was also being challenged in the company, they owned just 4% stake because of being forced to sell their shares to pay off debt not long before the deal. The Sony merger was their redemption. Shareholders clearly liked it and hey even the family was going to get some money in the process.

At any given point in time, Subhash Chandra & family have multiple lenders chasing them for money. For the lenders, this was the one chance they had to get some of their money back. Zee initially tried to resist but then finally repaid some of its lenders and in August 2023, a good year-and-half after the deal was signed, Zee got the final approval it needed from the NCLT.

While all this approval stuff was happening, SEBI announced that it had been investigating the Subhash Chandra family for fraud. It found evidence of the family stealing funds from banks (I wrote about it here) as well as from Zee itself .¹ SEBI decided that Punit Goenka, Zee’s CEO and Subhash Chandra’s son, could no longer be the director of a listed company. This included both pre- and post-merger Zee.

This was a problem! Zee’s merger agreement with Sony which had by now received all approvals said that Punit Goenka was to be the CEO. So Goenka contested SEBI’s decision in the SAT and the latter ended up staying this part of SEBI’s decision. So Goenka could again become the CEO of the new merged company as was always the plan.

Late last month, Sony—which had been sitting quiet waiting for the merger to be completed—decided that it had had enough and terminated the merger. It also asked Zee for $90 million as termination fee! The two companies have now taken each other to court in India and Singapore. Zee is asking the NCLT to force Sony to close the deal. Sony is asking the Singapore International Arbitration Centre to ask Zee to pay it the $90 mil.

The egregious bit here (apart from the casual fraud) is that Sony is the party that’s terminating the deal but is also the party that’s asking for the termination fee. That’s not how it works! The point of the termination fee is to discourage parties from breaking a deal that’s decided. If the party that terminates the deal gets paid $90 million, it wouldn’t be a lot of discouragement.

But can Sony terminate the deal?

Once a merger deal is agreed upon and the agreement signed, it is legally binding. The participants can’t just back out! The termination fee isn’t a price to get out of a deal because someone changed their mind. It’s what the terminating party must pay because they were unable to close the deal for a valid reason, because of being unable to get approvals, for instance.²

So how exactly does Sony think it can get out of this deal and also get paid for it? Unfortunately, neither Sony nor Zee has made the merger agreement or Sony’s termination notice public yet, so we’ll have to pick up bits and pieces from the media and the few disclosures the two have made.

Here’s some stuff from Sony’s termination press release:

1. Zee and Sony had 24 months to close the deal. If the deal didn’t close in that timeline, the two could spend 30 days discussing in “good faith” and decide on an extension.

2. If they could not decide on an extension, either party could terminate the merger.

3. Sony and Zee couldn’t agree on an extension, because, as Sony claims, some of the merger conditions weren’t met. Apparently, by Zee. So Sony decided to terminate.

If Sony terminated the deal because Zee goofed up somehow, that’s one way for Sony to both terminate the deal and ask for a termination fee. “I wanted the merger to happen but you made it impossible for me to do so,” is basically what Sony is saying. “Now pay me!”

Zee was (is) desperate for the merger to close, whatever could these merger conditions be which Zee didn’t fulfil?

Here’s Reuters with its hands on some leaked emails:

Emails show there was a face-off between Sony and Zee about four Russian subsidiaries that dealt in content creation and distribution, as the merger agreement had stipulated no dealings with entities based in countries under U.S. sanctions. Russia is under Western sanctions for the Ukraine war.

In a Jan. 5 email, Erik Moreno, executive vice president for corporate development and M&A at Sony Pictures Entertainment said Zee had not ended ties with the Russian entities even though it was "absolutely critical", and the merged entity "would under no circumstances inherit the Russian entities".

And,

The emails show another key sticking point was Zee's 2022 decision to enter into a $1.4 billion deal with Disney to purchase certain TV cricket rights for India.

Sony said Zee had decided to furnish a bank guarantee and a deposit totaling $406 million for that deal. And Zee's bid to take debt for the deal, which was "without prior written consent" of Sony, took the Indian firm's total debt to more than $451 million - above the merger agreement threshold.

Moreno wrote said in the Jan. 5 email that Sony had several times "raised our concerns and reservations in relation to the (Disney) alliance agreement ... including, in respect of the consideration agreed to be paid".

If Zee is in breach of the merger agreement, I’d like to know its one major breach. One is enough! If there is an argument to be made and if instead of the main argument I hear three mini arguments, the sense I get is that it’s just stuff being thrown at the wall hoping something will stick.

Is Russia the reason Sony wants to back out? I can’t imagine Zee’s Russian revenue being more than a blip. Zee says that it has already shut down its Russia business³ but getting rid of the companies is taking time because of Russian regulations. Shutting down a company is generally time consuming, and the Russian government is intentionally making it difficult for companies to leave. Can Sony use this as a reason to get out of the merger? If the Russia stuff was in the agreement, sure. But Zee seems serious about getting rid of its Russia subsidiary so there’s probably not a lot of ground to ask for that $90 million.

The other thing is the purchase of TV cricket rights. If you’re a company that’s going through a merger, there is this uncomfortable period between the time of signing the merger agreement and the merger actually happening. You’re technically still on your own, you still have to make your everyday business decisions, but you also have to ensure that the company that finally merges is still the same company that your counterparty had initially agreed to merge with.

If you sign a merger agreement and then the next day sell off all your assets and lay off all your employees, the lawyers would call this “material adverse effect” which means that your company is no longer the company the other party originally agreed to buy. When you sign the merger agreement, you would also agree to “carry out business in the ordinary course”—essentially, Zee had to ensure that it remained Zee and didn’t do anything drastic, at least without first checking with Sony.

Zee owns a bunch of television channels, and it bought television rights from Disney. Is this “business in the ordinary course”?

It depends! Did Zee check with Sony if it would be fine with this big purchase? Sony says that Zee did not and that it “raised their concerns” when it found out. But Zee says that Sony’s concerns were raised too late and by then the deal was already finalised.

I don’t understand this. If I was in the middle of a crucial merger, I’d make sure my counterparty was on board before I signed yet another agreement with someone else. I’d send them an email, then call them up and ask them to check their email, then call them up again and annoy them to give me an answer. I would not sign a billion dollar deal! Apparently, Zee did.

So could this be grounds for abandoning the merger? It could be! $1.4 billion is a lot of money and Zee did not even have this money. It took on debt and was hoping that Sony would pay the bill after the merger.⁴ Does not look good!

The problem for Sony here is that this Disney deal took place in August 2022, a good year and half back. If Sony figured that Zee breached its contract by doing business outside the ordinary course, why did it wait? It should have abandoned the merger much sooner if this was important for them.

Sony’s third reason is probably the easiest to evaluate if only the merger agreement was public. Sony says that Zee took on too much debt to fund the Disney deal and it now has $451 million in debt. Apparently the merger agreement defines a maximum debt threshold and this is above that.

Could this be sufficient grounds? I would think so. But I doubt the merger agreement mentions a definitive figure the way Sony is implying. If there was, Zee would have been more careful. A precise figure can be matched with your financials and is too black-and-white to ignore!

Unsaid reasons

If you’re a company that’s signed a merger agreement and you want to terminate this merger, you’re going to get your lawyers to come up with whatever reasons they can. You’re fine with whatever sticks. That does seem like what Sony is doing here. Its reasons to end the merger may be valid, and the company might even win in court, but what could be the real reasons that it wants to ditch the deal?

The classic reason for an acquisition or merger to not happen is buyer’s remorse. The company that is doing the spending feels in hindsight that it got a raw deal and wants to get out.

Could that be what’s happening here? Here are some facts:

1. Sony was going to invest about $1 billion into the post-merger company, and also pay $100 million separately to Subhash Chandra & family.⁵

2. Zee’s financial performance has fallen. From a post-tax profit of ₹800 crore ($96 mn) in 2021 to ₹250 crore ($30 mn) in 2023.

3. Both Zee and the Subhash Chandra family are desperate!

Earlier in this piece I mentioned that this was mostly a merger of equals. That was before the merger agreement was signed. After the agreement, in terms of profit, Sony is at least 5X ahead. And Sony had clearly been generous to start with—it was going to invest $1.1 billion for a narrow majority (50.86%) in the new company!

Maybe Sony does still want to do the merger but it just wants a better deal.⁶ It would’ve been awkward to ask for one two years after signing the legally-binding agreement.

This is, of course, the classic self-serving reason for why someone usually wants to get out of a merger. Another reason could be that it just doesn’t want the headache of dealing with someone who has been accused of stealing from both lenders and the company itself.

Would Sony have been fine with the merger if Punit Goenka, Zee and the post-merger CEO stepped down? Here’s Subhash Chandra in an interview with Mint last week:

Some shareholders may think that if Punit stepped aside, Sony would agree to the merger. But that is not true. This was already offered to Sony. As the founding family, we wrote to them and we had decided that even if Sony is demanding Punit’s separation, we will agree to it but let us at least meet once. But they even refused to give me time for a meeting to close this discussion.

Funny! Subhash Chandra says that they were fine with having Punit Goenka step down but Sony ghosted them. The fraud stuff could very well be the reason Sony doesn’t want to merge, but come on, the Subhash Chandra family has been (accused of) stealing from lenders since much before the deal. It’s almost like a hobby.⁷

Did Sony expect different this time? Maybe fraud doesn’t hit home until it’s too close for comfort.

1. I’d have loved to write about this but seems like I missed it back then. In brief what Subhash Chandra & family did was they took a loan via a subsidiary of Zee while keeping a fixed deposit of Zee as collateral. Then when the subsidiary didn’t repay, the bank took away the fixed deposit.

2. The logic here is that no matter the approvals, the counterparty would’ve spent money to comply with the merger agreement. Adobe wanted to acquire Figma and Amazon wanted to acquire iRobot but both ended up abandoning the deals because of being unable to get approvals and still paid the termination fee.

3. Zee’s Russian website is dead but ironically Sony’s website is still on. Just how important is this for Sony again?

4. Now that the merger with Sony is probably not happening, Zee had to itself cancel its cricket rights deal with Disney.

5. The $1 billion is an estimate. The post-merger company is to have $1.5 billion cash on hand so news reports have worked backwards to arrive at this figure.

6. By itself, falling financial performance is almost never a material adverse change. The challenge is that you’d have to prove that there is materially adverse change within the company and it’s not just going through general economic conditions. Matt Levine, as always, has a great piece on this.

7. My favourite financial story that I haven’t written about yet is probably the Yes Bank-Dish TV episode. Dish TV is yet another Subhash Chandra & family company that a bank chased to get its money back. BTW if you or someone you know knows anything more about this episode than what’s in the news, please get in touch!