When faced with a takeover bid, the directors of the target company must make a crucial decision: If they believe the bid undervalues the shares of the company, what information should they disclose to shareholders?
The decision of the Australian Takeovers Panel ("Panel") on 11 March 2016 in Metro Mining Limited and Gulf Alumina Limited ("Metro") has left target company directors with doubts about what they need to do, when commenting on valuation matters, to satisfy their obligation under sections 638(1) and 638(1A) of the Corporations Act 2001 (Cth) ("Act") to disclose all information that will enable shareholders to make a proper assessment of the takeover offer.
In Metro, the directors of the target company (Gulf Alumina Limited) advised shareholders in response to an off-market scrip takeover offer from Metro Mining Limited:
- In a letter prior to the issue of the target's statement, that the offer "materially undervalued" certain mining projects and tenements of Gulf Alumina Limited; and
- In the target's statement, that the valuation methodology used by Metro Mining Limited "may not reflect a true value of Metro's shares".
In response to those statements, Metro Mining Limited applied to the Panel for a declaration of unacceptable circumstances under section 657A of the Act.
In satisfying their disclosure obligations when commenting on valuation matters to shareholders, target company directors will be eager to avoid obtaining an independent expert's report because a report effectively places a price on the target company and its shares, presenting a strategic advantage to the bidder.
Section 640(1) of the Act requires an expert's report to be obtained only when the bidder's voting power in the target is 30 per cent or more or the bidder and the target have common directors. The Panel has consistently said that the only other circumstance in which it expects directors to obtain an expert's report is where the target is "too beholden" to the bidder to be able to provide a fair assessment to shareholders about the merits of a takeover bid: see, for example, the Panel's decision in Sirtex Medical Ltd.
In reliance on the Panel's 2009 decision in Tully Sugar Limited ("Tully Sugar"), directors have understood that, where they inform shareholders that a takeover bid undervalues the shares of the target company and an expert's report is not required, they do not need to state what they believe to be the value of the shares and are only obliged to provide shareholders with some degree of practical guidance about the target's value.
For example, where the takeover is a scrip bid (under which shareholders of the target receive new shares in the bidder in return for the sale of their existing shares), directors usually provide shareholders with, among other things, a comparison of the businesses of the target and the bidder, a forecast of the target's earnings and a comparison of the target's historical and forecast earnings with the pro forma combined earnings of the merged entity, assuming the takeover is successful.
In Metro, while the Panel did not extend the need for directors to obtain an expert's report to any new circumstances, it nevertheless stated that directors who comment on the valuation of a target company's shares and do not obtain an expert's report should provide shareholders with valuation information "in a manner consistent with ASIC's Regulatory Guide 111" ("RG 111"). RG 111 is a policy statement specifically designed to regulate the content of expert's reports, creating significant ambiguity for directors.
It is not clear whether the Panel intends that directors of a target company that is the subject of a scrip bid need only ensure they provide information to shareholders on "the assets and liabilities of the target and the dilution effect of the acquisition on the target's earnings, asset backing and dividends" as well as the "bases for calculating the dilutions" (RG 111.34), or whether directors should also comply with other key requirements in RG 111. These include comparing values using different valuation methodologies (RG 111.65), referring to matters that an expert might consider in assessing whether an offer is fair and reasonable (RG 111.13) and providing specific valuation ranges (RG 111.78). The latter requirement is inconsistent with the Panel's current view (stated in Tully Sugar) that directors do not need to nominate a specific price for the target's shares in making a recommendation to shareholders in the target's statement.
If directors are expected to comply in all material respects with the requirements of RG 111, the regulatory landscape for directors during a takeover will be significantly altered, and bidders will benefit from crucial tactical advantages in future transactions.
It is hoped that further clarity will be provided by the Panel when it releases its reasons for the decision in Metro in coming months.
In the meantime, if directors comment on valuation matters in a target's statement in the context of a scrip bid (or a mixed cash-scrip bid) and do not wish to obtain an independent expert's report, they should, at a minimum:
- Include a forecast of the target's earnings and a comparison of the target's historical and forecast earnings with the pro forma combined earnings of the notionally merged entity (along with an analysis of key line items);
- Clearly compare the businesses of the target and the bidder (including earnings comparisons and an analysis of material contracts);
- Analyse the liquidity of the market in the target's shares; and
- Specify the net asset backing of the target's shares as well as earnings per share.