The Battle for Data Domain; A Critique of Data Domain's Negotiations With NetApp

On May 20, 2009, Data Domain (NasdaqGS: DDUP) announced an agreement to merge with NetApp (NasdaqGS: NTAP) pursuant to which NetApp would acquire Data Domain’s outstanding common stock for $25 per share in cash and stock. EMC Corporation (“EMC”) (NYSE: EMC), which had been put off from participating in the negotiations for the sale of Data Domain, promptly reacted by announcing, on June 1, 2009, an all-shares, all-cash tender offer at $30 per share.

In response, NetApp, which had declared during its negotiations with Data Domain that it “would not engage in a bidding contest” for Data Domain if EMC or any other party were invited into the bidding process, promptly upped its bid to $30 per share, consisting of $16.45 in cash and from 0.7783 to 0.6370 shares of NetApp common stock, designed to deliver to the Data Domain shareholders an additional $13.55 in value (within a 10% collar ranging from $17.41 to $21.27 for NetApp’s common shares) (NetApp closed at $19.17 on June 10, 2009).

We are awaiting Data Domain’s response to the EMC tender offer, which is due by no later than June 16, 2009.

Given the way that the board of directors of Data Domain conducted the negotiations with NetApp, the board may be fortunate that EMC has now launched its tender offer for the outstanding shares of Data Domain. Defending the board’s actions in the face of any Revlon challenge might have been problematic.

A. Dancing with Only One Suitor

As is made clear in the background discussion of the merger in the proxy statement/prospectus filed by Data Domain and NetApp under cover of a Form S-4 filed with the SEC on June 4, 2009 (the “S-4”), Data Domain discussed a deal only with NetApp prior to entering into the merger agreement with NetApp on May 20, 2009. Discussions over a deal were held from time to time since 2006 between Data Domain’s President and CEO, Frank Slootman, and his counterpart at NetApp, Daniel J. Warmenhoven. Discussions turned serious in March of this year. Notwithstanding that it had served as a co-managing underwriter in Data Domain’s IPO in June 2007, Goldman Sachs represented NetApp in the negotiations, and sat in on the early discussions between NetApp and Data Domain, and before Data Domain had hired its financial advisor, Qatalyst Partners, on March 26, 2009, after at least two face-to-face meetings had been held between senior officers of NetApp and senior officers of Data Domain.

Undoubtedly with a view to its possible Revlon duties, Data Domain in its background discussion of the merger articulates early on its board’s justification for discussing a deal only with NetApp:

“The Data Domain board of directors expressed concerns regarding the potential harm to Data Domain’s business relating to any uncertainty perceived by its current or future customers should they learn of discussions regarding a potential business combination involving Data Domain and the ability of Data Domain’s competition to take advantage of any such perceived uncertainty. At the conclusion of the meeting [held March 26, 2009], the Data Domain board of directors confirmed that it had not been seeking a sale of Data Domain, however should NetApp elect to proceed with an offer it would merit further consideration.”

S-4 at 49.

Elegant prose this is not.

Both Data Domain and NetApp are Delaware corporations. As a Delaware corporation, Data Domain is subject to Revlon duties with respect to any change-in-control transaction (Revlon v. McAndrews & Forbes Holdings, Inc., 506 A. 2d 173 (Del. 1986)) requiring it to seek the best price reasonably obtainable on any sale of the company. As the Delaware Supreme Court made clear in its recent decision in Lyondell Chemical Co. v. Ryan, 2009 WL 1024764 (March 25, 2009, revised April 16, 2009), “[t]he duty to seek the best available price applies only when a company embarks on a transaction — on its own initiative or in response to an unsolicited offer — that will result in a change of control.” 2009 WL 1024764 at *6.

So it is in this context that one can appreciate the dance engaged in by the Data Domain board in pursuing a deal with NetApp while, at the same time, declining to conduct any pre-signing market check. While concern about discussing a deal with one’s competitors is legitimate, relying upon this justification for declining to conduct any market check with strategic buyers is tricky, as the justification could justify virtually any board refusal to conduct a pre-signing market check.

Data Domain (or it least its advisors) were clearly cognizant of this balancing act in drafting the justification for the deal, as the concern over potential competitive harm from shopping Data Domain to other strategic partners pre-signing is repeated ad nauseam throughout the background discussion of the S-4.

B. EMC is Put Off While Negotiations with NetApp Continue

What raises the question of whether the Data Domain board’s concern over competitive harm in conducting a market check was pretense is its treatment of EMC. EMC did not jump into the fray with its June 1 announcement of its proposal to acquire Data Domain. On May 7, 2009, in the midst of negotiations between Data Domain and NetApp, an EMC director contacted Slootman, Data Domain’s CEO, to arrange a meeting between Slootman and EMC’s CEO, Joe Tucci, for the stated purpose of sharing with Slootman “EMC’s vision for the future.” S-4 at 52. That very day, at a meeting to discuss the negotiations between Data Domain and NetApp, the Data Domain board reviewed the EMC request. What was the board’s response?

“The Data Domain board of directors was concerned that initiating a market check at this time could jeopardize securing a firm agreement from NetApp and could disrupt Data Domain’s relationships with its current and future customers during the process. The Data Domain board of directors determined that Data Domain should move forward with the potential business combination with NetApp without contacting other companies that might be candidates for a strategic transaction with Data Domain, but that the Data Domain board of directors would continue to evaluate this strategy and consider the matter further based upon the progress and terms of the potential business combination with NetApp.”

S-4 at 53.

This is a windy way of saying “no” to EMC. Nevertheless, Tucci persisted, requesting a meeting with Slootman on Tucci’s next trip to the Bay Area. Slootman agreed to meet Tucci on May 27, 2009.

C. No Apparent Consideration of a Go Shop

Throughout its extended discussion of the negotiations with NetApp leading to the announcement of a deal on May 20, and its repeated statement of the board’s justification for not conducting a market check, there is no discussion whatsoever of why the Data Domain board did not insist on a post-signing go shop. Indeed, the initial draft of the merger agreement prepared by NetApp’s counsel, Wilson Sonsini, preposterously excluded even a fiduciary out for the Data Domain if a superior proposal were presented to Data Domain after it entered into a deal with NetApp. After Omnicare (Omnicare v. NCS HealthCare, Inc., 818 A. 2d 914 (Del. 2003)), even suggesting such a lockup is a joke, and, of course, the ultimate Data Domain/NetApp deal includes a fiduciary out and the ability to terminate the agreement if the Data Domain board receives and accepts an unsolicited superior proposal (and pays a $57 million breakup fee to NetApp). But the background discussion omits entirely any reference to negotiations over a go shop, which one would think would have been an obvious (and acceptable, if properly structured) market check mechanism if, indeed, the board’s concerns over competitive harm in conducting a pre-signing market check were legitimate.

D. Were Slootman and Bhusri Compromised?

The negotiations with NetApp on behalf of Data Domain were, as made apparent in the discussion of the background of the merger in the S-4, conducted primarily by Slootman and Aneel Bhusri, Chairman of the Data Domain board of directors. Showing less than a deft hand, Warmenhoven, NetApp’s CEO, at an early meeting, in which, apparently, only the executive officers of the two parties were present, “informed Mr. Bhusri of the potential for a role on the NetApp board of directors for Mr. Bhusri and a role in the management of NetApp for Mr. Slootman.” S-4 at 50.

While such ham-handedness might not by itself support a finding of lack of independence on behalf of Slootman or Bhusri, the potential for divided loyalty presented by such a proposal would lead some boards to either replace Bhusri as lead negotiator for the board or insist that he and Slootman be “babysat” by Data Domain’s financial advisor in all substantive negotiations between the parties. When the Data Domain board was informed of the overture, it apparently took no such action, as the description of the Data Domain/NetApp negotiations in the background discussion of the merger contains numerous examples of negotiations occurring apparently only between the principals.

E. What Might Have Been

Had EMC’s tender offer not mooted the question, it would have been interesting to see how the Delaware Chancery Court would have treated the Data Domain board of directors on any challenge to their conduct of the negotiations and approval of a merger with NetApp in the face of a Revlon challenge. As a board’s Revlon duties are explained by the Delaware Supreme Court in its recent Lyondell decision:

“There is only one Revlon duty — to ‘[get] the best price for the stockholders at a sale of the company.’ No court can tell directors exactly how to accomplish that goal, because they will be facing a unique combination of circumstances, many of which will be outside their control. As we noted in Barkan v. Amsted Industries, Inc., ‘there is no single blueprint that a board must follow to fulfill its duties.’ That said, our courts have highlighted both the positive and negative aspects of various boards’ conduct under Revlon. The trial court drew several principles from those cases: directors must ‘engage actively in the sale process,’ and they must confirm that they have obtained the best available price either by conducting an auction, by conducting a market check, or by demonstrating ‘an impeccable knowledge of the market.’”

Lyondell Chemical Co. v. Ryan, 2009 WL 1024764 at *6 (footnotes omitted).

Under this articulation, since the Data Domain board did not conduct an auction or a market check (pre- or post-signing), they would have been left to establishing “an impeccable knowledge of the market.”

That is a defense that now need not be made, given EMC’s all-shares, all-cash tender of $30 per share. Attention will now focus on how the Data Domain board and NetApp respond to the offer.