(Reuters) - I’m a sucker for a good story, and Bartlit Beck sure tells one in a new complaint accusing the private equity investors KKR and Shamrock Capital of squeezing FanDuel’s founders, early employees and startup funders out of any interest in the sports gaming site’s 2018 merger with Paddy Power Betfair.
According to the lawsuit, filed in Manhattan state supreme court, FanDuel was poised for explosive growth in May 2018, after the U.S. Supreme Court cleared the way for states to legalize sports gambling in Murphy v. NCAA (138 S.Ct. 1461). FanDuel’s board had valued the company at $1.2 billion in early 2017, in connection with FanDuel’s prospective merger with DraftKings, which ultimately fell through after the Federal Trade Commission raised antitrust objections. But FanDuel had found a new merger partner, the European sports betting firm Paddy Power Betfair, and thanks in part to the Supreme Court’s Murphy ruling, the combined company promised to be a blockbuster. The market certainly thought so: Paddy Power Betfair gained more than $2.2 billion in market capitalization when news broke about the FanDuel merger, according to the complaint. And under the stock-for-stock merger agreement, FanDuel investors were slated to receive 40 percent of the shares of the combined company.
For more than 100 plaintiffs - FanDuel’s founders, longtime employees and early investors - that stake turned out to be worth precisely nothing, according to the lawsuit.
All of the shares in the combined company went instead to a cadre of preferred investors, led by KKR and Shamrock. The private equity investors had taken control of FanDuel’s board after a $275 million financing in 2015 and a restructuring after the failure of the DraftKings merger in 2017.
The new lawsuit claims that the board – which allegedly included only one independent director and six directors tied to KKR and Shamrock – priced the value of FanDuel’s stake in the merged company at about $559 million. That number, the suit alleges, was no coincidence. Under FanDuel’s operative bylaws, preferred shareholders were due to receive all of the first $559 million from any merger. Common shareholders, including FanDuel’s founders, employees and early investors, were only entitled to a pro rata share of proceeds above $559 million.
By pricing FanDuel’s stake in the merged company at $559 million, the suit alleged, the private equity-controlled board assured that KKR, Shamrock and their allies would keep their hands on all of the future value of the merged company – a stake worth billions of dollars, according to the complaint. Common shareholders, the suit alleged, didn’t even get to vote on the deal because KKR and Shamrock used their “drag along” rights as controlling shareholders to accept the merger on behalf of all FanDuel investors.
It’s important to remember that the suit does not contend the Paddy Power Betfair merger was bad for minority shareholders. To the contrary: The plaintiffs agree that the deal created a company with spectacular potential. Their allegation is that KKR, Shamrock and former FanDuel board members breached their duties to minority shareholders by refusing to cede any shares in the merged company. The suit seeks a constructive trust for the post-merger shares plaintiffs allege they would have received if the FanDuel board had properly evaluated investors’ 40 percent stake in the merged company.
KKR and Shamrock issued a joint statement responding to the complaint. “”KKR and Shamrock stood by and supported the company during difficult times,” the statement said. “We are confident that the facts will demonstrate that the allegations in this lawsuit are completely baseless.”
But there’s more to their side of the story, based on a filing by FanDuel in a proceeding in Scottish Court of Session in Edinburgh.
FanDuel was actually incorporated in Scotland, even though most of its founders are American and the company’s base of operations has been in Manhattan since 2011. In 2018, days before the company’s merger with Paddy Power Betfair was to be completed, FanDuel’s founders filed a suit in Scotland to block the deal from going through. The suit went nowhere. In 2019, long after the merger was consummated, FanDuel founders dropped the suit. (The November 2019 dismissal order even requires FanDuel’s founders to pay defendants’ fees and costs.)
The company did file an answer before the Scottish case ended, though. And its portrayal of FanDuel’s prospects leading up to the Paddy Power Betfair deal is considerably less rosy than the version in the new suit by FanDuel’s minority investors. According to the Scottish filing, FanDuel was on the verge of collapse in 2018 as its investment bank, Moelis & Company, shopped for a merger partner. It had negative working capital and was encumbered by $60 million in debt. Moelis approached more than 150 potential buyers and investors, the filing said. And even with the prospect of a favorable ruling from the Supreme Court in the sports betting case, FanDuel only managed to obtain a bridge loan to keep the company up and running after reaching a tentative deal with Paddy Power Betfair.
The implication of the Scottish filing is that minority shareholders’ stake in FanDuel was basically worthless at the time of the 2018 merger. I’d expect KKR and Shamrock to argue that FanDuel’s founders received exactly what they deserved from the Paddy Power Betfair merger: nothing.
I’d also expect a challenge to the jurisdiction of New York courts to hear the new suit. After all, FanDuel’s founders incorporated the company in Scotland – and filed a suit to block the 2018 merger in Scottish court. The minority investors’ lawyers at Bartlit Beck seem to anticipate a jurisdictional fight in the complaint, which highlighted the company’s ties to New York and emphasized that the board decisions underlying the suit’s allegations were made in New York.
Bartlit Beck partner Sean Gallagher said in an email statement that FanDuel’s minority shareholders are braced for KKR and Shamrock defenses. “We expect the venture capitalists who engineered this deal to claim that FanDuel was worthless,” the statement said. “But the fact is the merger with PaddyPower created enormous value that the late investors captured entirely for themselves through deceptive and unlawful practices.”