A Seriously Appalling Merger

There are sweetheart deals, and then there are sweetheart deals. For construction mogul Ron Tutor, the imminent merger of construction giant Perini (NYSE:PCR) and his own closely held Tutor-Saliba is one heck of a sweetheart deal for him.

It is not, however, a sweetheart deal for Perini shareholders, who have watched their company's stock plummet from a high of more than $70 per share in July 2007 to just $27 and change today. And while most public companies' boards of directors might be wary of vastly overpaying for an acquisition with undervalued stock, Perini's board has no such concerns. That's one of the reasons why Perini's stock has continued its free fall since the merger was announced April 2, despite impressive first-quarter results and a $1.2 billion contract win.

If you've guessed that Ron Tutor, the construction mogul who is CEO of Tutor-Saliba and stands to benefit enormously from the merger, is also the CEO of Perini, then you know exactly how Wall Street works.

But before I imply any wrongdoing ...
While there are some eye-popping clauses involved in this deal, Tutor has not done anything illegal, nor violated any kind of conflict of interest statutes during negotiations. According to what I've read in the merger proxy and elsewhere, Tutor recused himself from all relevant discussions by Perini's board.

That said, this deal is pretty unbelievable. Here's how it all reportedly went down ...

Flash back to ...
The year is 1997, and the once-strong, 103-year-old Massachusetts-based Perini is staring down bankruptcy. It's burdened by a number of failed real estate deals and a growing, onerous debt load. Enter Ron Tutor of California's Tutor-Saliba, who helps recapitalize the company and refocus operations as a member of the company's board of directors. In 2000, he is named CEO.

To his credit, Perini has thrived under Tutor's leadership. The company today is nearly debt-free, with more than $460 million in cash and investments. It generated more than $250 million of free cash flow in 2007, and has grown revenue at more than 35% annually over the past five years. Perini has won high-profile work in Atlantic City, Phoenix, Las Vegas, and Washington, D.C., with big-name customers such as MGM (NYSE:MGM) and Wynn Resorts (NASDAQ:WYNN).

Yet it appears that Tutor was not content with his salary and ownership stake at Perini. The construction mogul, who has been portrayed by one foe as "arrogant and cunning, a master manipulator" in the San Francisco Chronicle, told the Perini board last November that Tutor-Saliba was selling its Perini shares in advance of going public in 2008. At that point, Tutor would resign from Perini in order to focus his time on Tutor-Saliba.

Now is the time to panic
This move makes a lot of sense for Tutor. He owns 96% of Tutor-Saliba, and he's obviously looking to maximize his skills, connections, and gains within the company where he has the largest ownership stake. But what doesn't make a lot of sense is the magnitude to which the Perini board of directors panicked over the next few weeks at the prospect of losing Tutor.

Michael Klein is the vice chairman of Perini's board; he joined the company as part of the 1997 bailout orchestrated by Tutor. According to the merger proxy, Klein met with Tutor a month after the announcement to tell him that Perini would like to merge with Tutor-Saliba, and that such a plan would help Tutor-Salibara shareholders (including Tutor, who holds the biggest individual stake) "monetize their interests...at public market values...[and] be faster, less expensive and less risky" than the proposed IPO.

While I'm no master negotiator, I would think such an offer told Tutor that Perini:

1. Had no contingency plan in case he left.
2. Was willing to make it worth his while to stick around.

Put it all together, and now Tutor had all of the leverage.

As a result ...
Tutor told the Perini board in January that he was open to a merger, and that based on his valuation work, Tutor-Saliba shareholders were entitled to own 55% of the combined company. Specifically, this company:

*Using the Q1 2008 run rate.

According to Tutor, though Tutor-Saliba would contribute 24% of the revenue and 15% of the backlog to a combined company, its shareholders were entitled to own 55% of it. And while Tutor could point out that Tutor-Saliba is growing faster than Perini, and has higher operating margins, even folks who aren't financial wizards can see that offer is absurd.

In the end
The parties finally agreed on a deal that would give Tutor-Saliba shareholders a 45% stake in the combined company. It would also allow Tutor-Saliba to pay out the $120 million in cash on its balance sheet as dividends to Tutor-Saliba shareholders, and divest to those shareholders non-core assets such as a $3.5 million property near Sun Valley, Idaho, and an office building in San Pedro, Calif., worth another $21.3 million.

That's an enormous payday for Tutor-Saliba shareholders (particularly 96% owner Tutor). And while the good people at UBS Securities signed off on the deal using financial projections generated by the Perini board (which seemed keenly interested in keeping Tutor with the company), my own calculations have Perini shareholders handing over between $100 million and $200 million of their company's intrinsic value to Tutor-Saliba shareholders.

What to do now
If I were a Perini shareholder who bought the stock at any price greater than today's, I'd be infuriated ... and I'd express my anger by voting against the deal. That said, the price may also turn out to be worth it.

Tutor's expertise and connections have been a crucial part of Perini's resurgence. Had the company allowed Tutor to walk, it may have quickly found out that projects it wanted for itself were being won by fast-growing competitor Tutor-Saliba. So while a merger likely is in the best interest of shareholders, the Perini board should be ashamed of the terms of the deal they cut. That, of course, is the nature of "key man" risk, and the danger of a board that answers to its company's CEO.

It's also better than the alternative. Though Perini shareholders are paying an enormous price to hold on to Tutor, they're at least getting something in return. Shareholders at Pfizer (NYSE:PFE), Home Depot (NYSE:HD), and Merrill Lynch (NYSE:MER) paid former CEOs Hank McKinnell, Bob Nardelli, and Stan O'Neal, respectively, enormous sums of money just to go away.

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