Summary

  • Yancoal (market cap A$220 million) undertook a US$2.3 billion discounted pro rata renounceable rights issue.
  • The Panel ordered that Yancoal’s 78% shareholder could not increase its percentage shareholding without shareholder approval.
  • The Panel’s decision meant that minority shareholders did not have to participate in the rights issue to avoid being diluted.
  • If the decision is followed, it could have significant (adverse) ramifications for financially distressed ASX-listed companies whose only funder of last resort is its major shareholder. Major shareholders may be reluctant to participate in rescue fundraisings on such a basis.

Background

On 10 November 2014, Yancoal announced a pro rata, renounceable rights offer of subordinated convertible notes (SCNs) to raise up to US$2.3 billion. Prior to the announcement, Yancoal’s market capitalisation was approximately A$220 million.

Yancoal’s 78% shareholder – Yanzhou Coal Mining Company Limited (Yanzhou) (a company listed on the Hong Stock Exchange that is 56.52% owned by a Chinese SOE) – committed to subscribe for its full entitlement of SCNs. The only other substantial holder in Yancoal was Noble Group Limited with voting power of 13.2% (Noble).

Yancoal’s outstanding debt facilities at the time included:

  • approximately US$2.6 billion owed to the Bank of China, and
  • approximately US$1.9 billion owned to Yanzhou (this debt ranked pari passu with the Bank of China debt).

Absent the rights offer, on 31 December 2014 Yancoal would have failed the consolidated net worth and gearing ratio covenants in its Bank of China facilities. Yancoal had a total of A$4.9 billion of senior debt falling due before 2020 and its prospectus disclosed that its operations were not expected to generate sufficient cash to repay this debt within that timeframe. Its financial adviser had indicated, in October 2014, that Yancoal’s projected cash flow shortfall for 2014-2018 was A$2.1 billion.

As part of the arrangements established in conjunction with the rights offer:

  • Yanzhou would subscribe for its pro rata allocation of SCNs and, out of the proceeds, Yancoal would repay US$1.8 billion of the senior debt owed to Yanzhou,
  • Yanzhou would also provide to Yancoal a new subordinated funding facility of A$1.4 billion which ranked behind the SCNs and the Bank of China debt,
  • Yanzhou would also provide to Yancoal an additional funding facility of up to US$807 million, ranking equally with the SCNs, for the purpose of paying distributions on the SCNs for a period of 5 years, and
  • Bank of China agreed to extend its US$2.6 billion facility for 3 years.

Yanzhou was essentially giving up its senior lender status and becoming a subordinated lender at the same time as extending significant additional (subordinated) debt funding to Yancoal.

To address its Bank of China covenant issues, Yancoal needed to ensure that the new capital being raised would be treated as equity for accounting purposes. Ordinary shares were effectively  not a viable alternative as Yancoal would not have been able to pay a dividend for an extended period given its accumulated losses.

An independent board committee (IBC), which received independent financial and legal advice, had considered 11 funding options and concluded that a rights issue of SCNs was the best option available to meet Yancoal’s objectives.

The features of the SCNs included that:

  • they were convertible into Yancoal ordinary shares at a conversion price of A$0.12 (US$0.10) per share,
  • they carried at 7% coupon – this was the most that Yancoal could afford (the coupons were deferrable and at the discretion of the Yancoal board – this was a requirement for the SCNs to be classified as accounting equity – but, if coupons have been deferred, there are provisions that restrict Yancoal’s ability to pay dividends on ordinary shares and prevent interest payments on Yanzhou’s other subordinated debt),
  • the SCNs had priority over Yancoal’s ordinary shares, but were otherwise unsecured, and
  • although an underwriter could not be found for the rights offer, despite efforts to do so, there was a shortfall facility, in which Yanzhou had agreed not to participate.

If no shareholder other than Yanzhou took up their rights, Yanzhou could have reached the 90% general compulsory acquisition threshold within 19 months by converting SCNs in reliance on the 3% creep exception to the 20% rule in item 9 of s611 of the Corporations Act 2001 (Cth). In this regard, it ought to be noted that if the rights offer had, instead, been structured as a (vanilla) rights offer of ordinary shares and no other shareholder had taken up their rights, Yanzhou would have immediately been placed in a position to exercise compulsory acquisition rights as a result of the rights offer exception to the 20% rule in item 10 of s611 of the Corporations Act 2001 (Cth). Yanzhou had made it evident to the IBC, however, that Yanzhou did not want to privatise Yancoal.

The application

Certain minority shareholders (including Noble) objected to the rights offer on a number of grounds, including submitting that:

  • the rights offer was part of a strategy to avoid the need to obtain shareholder approval and enable Yanzhou to compulsorily acquire minorities cheaply,
  • the rights offer was not necessary given Yancoal’s debt was not yet due for repayment and Yanzhou had undertaken to support Yancoal financially, and
  • the SCNs were ‘complex’.

The Panel’s decision

The Takeovers Panel stated that it accepted that Yancoal needed further capital, but that the need for funds is not a safe harbour. The Panel made a declaration of unacceptable circumstances, stating that it considered:

  • the rights offer was highly dilutive,
  • the Bank of China had not yet conclusively refused to waive the impending breach of covenant,
  • some shareholders were excluded from participation by reason of their investment mandates,
  • the SCNs were a complex security which require a significant capital contribution and were unattractive to Yancoal shareholders other than Yanzhou,
  • the steps taken to minimise the control effect of the rights offer were not sufficient, including the discount conversion price which exacerbated the potential control effect, and
  • compulsory acquisition may occur at a cheaper price than would be the case through ordinary acquisitions of shares.

The Panel ordered that, if a conversion by Yanzhou of SCNs would have increased its voting power above its existing 78% level, the conversion could only proceed with the approval of Yancoal’s shareholders (excluding Yanzhou and its associates).

Commentary

The Panel’s decision was a surprising one and raises significant new issues for those contemplating, and those proposing to commit to participating in, rescue-like fundraisings.

By denying Yanzhou conversion rights (except to maintain its current percentage holding) without shareholder approval, the Panel’s orders effectively removed any incentive for the minority shareholders to participate in the rights offer as they would not be diluted if they did not participate (given their ability to vote against any dilutive conversion). In a sense, the Panel’s orders gave minority shareholders a 'free ride' – that is not how rights issues generally work.

In light of its financial situation, it is difficult to know what more Yancoal (or another ASX-listed company in its position) could have done to make the rights offer more acceptable.  In this regard, it is noteworthy that:

  • in many classic recapitalisation situations, private equity, hedge funds and other investors have only been willing to invest under instruments which both rank ahead of ordinary equity, and carry equity upside (they do not want ordinary shares on which a dividend cannot be paid). The structure of the Yancoal rights offer accorded those benefits to all Yancoal shareholders. Examples of recapitalisations involving securities with analogous commercial features to the SCNs include Mirabela Nickel, GPT Group, Boart Longyear, Billabong and Southern Cross Goldfields – yet, in none of those transactions were ordinary shareholders given the same opportunity to participate in the benefits accruing to the 'rescuer' and to avoid dilution,
  • although an underwriter could not be found for Yancoal’s rights offer, efforts were made to do so, the offer was discounted, renounceable and pro rata, and Yanzhou had agreed not to participate in the shortfall facility,
  • given Yancoal (a) needed to raise a minimum equity amount of US1.8 billion and (b) had a market capitalisation of just $220 million, it was inevitable that if minority shareholders did not participate in the rights offer they would be heavily diluted,
  • the only real alternative to a rights offer of SCNs was a rights offer of ordinary shares. However, as the Panel noted, this would have been less desirable to minority shareholders than a rights offer of SCNs (noting Yancoal’s inability to pay dividends on ordinary shares). Assuming Yanzhou was happy to accept ordinary shares and that minority shareholders chose not to participate, it would have placed Yanzhou in a position to exercise compulsory acquisition rights immediately (rather than after a minimum of 19 months under the rights offer of SCNs), and
  • the conversion price of the SCNs was reduced from a 10% premium to a 50% discount to the pre-announcement Yancoal share price at the request of the arranger of the rights offer to make the SCNs more marketable. However, to put the relevance of the conversion price into context, given Yancoal’s pre-announcement share price was A$0.22, the conversion price would have to have been increased to an untenable level of A$1.50 to keep Yanzhou under 90% on a fully diluted basis.

As demonstrated by the following table, the Panel’s decision is difficult to reconcile with two other decisions relating to rights offers (being those put forward by Wollongong Coal Limited and Celamin Holdings NL) which were decided around the same time as the Yancoal matter.

Click here to view table.

Situations will inevitably arise again in the future where the major shareholder of an ASX-listed company is the only person willing to contribute further equity funding to that company. The Takeovers Panel’s decision raises a number of important questions in that context.

For example: the Panel appears to have established a principle that if an equity contribution by a major shareholder could result in it crossing the 90% compulsory acquisition threshold either immediately (as a result of an issue of ordinary shares) or over time (as a result of the conversion of convertible notes), that equity contribution can only proceed if the other minority shareholders are shielded from dilution and compulsory acquisition, and accordingly can benefit from the recapitalisation without making any contribution to it. If so, that would be a disturbing development for a financially distressed ASX-listed company whose only funder of last resort is its major shareholder. Major shareholders may (quite reasonably) be unwilling to participate in rescue fundraisings on such a basis.

This article was written by George Durbridge, Consultant, Melbourne.