M&A activity and acquisition financing transactions were lower in 2012. However, some significant debt-funded transactions did occur, including DuluxGroup’s successful unsolicited takeover of Alesco, in which we advised DuluxGroup. The acquisition financing for this transaction demonstrated both continuing liquidity in debt markets and an ability of banks to work in constructive (and occasionally novel) ways to support strategic acquisitions.
Partners Alexander Danne and Neil Pathak provide an overview of some key aspects of the acquisition financing of the Alesco takeover.
The 90% threshold
One of the key risks in using debt to fund an unsolicited takeover of a public company is that the bidder may be unable to obtain sufficient acceptances to reach the threshold of a relevant interest in 90% of the target’s shares. Beyond this threshold a bidder can compulsorily acquire the remaining outstanding shares to achieve 100% ownership. Typically, the bidder’s debt financiers will prefer not to be financing the acquisition unless certainty of 100% ownership can first be achieved. This is usually dealt with by:
- inclusion of a condition to the takeover bid that the bidder receives sufficient acceptances to have a relevant interest in more than 90% of the target’s shares. The waiver of this condition would usually be regulated under the financing agreements; and
- through a corresponding condition precedent in the financing agreement to the provision of the debt finance itself.
The difficulty for bidders in takeover bids with the 90% condition is that often the bidder needs to waive such condition to the takeover offer to create momentum and encourage shareholders to accept the bid. This is because some shareholders are reluctant to accept until they know the bid is unconditional and payment for the acceptance will soon be made and also because the mandates of some institutional shareholders (eg. index funds) who can only accept unconditional bids. The need to waive the condition is exacerbated in unsolicited or hostile takeover bids where the target board generally recommends (at least initially) that shareholders reject the offer – it is very difficult if not impossible to reach 90% with a conditional bid not being recommended by the target board.
This can give rise to a “chicken and egg” scenario: a bidder needs to waive the 90% condition to get shareholders to accept, yet once the condition is waived, bidders have the risk of not obtaining enough acceptances to reach the 90% threshold.
Therefore it is critical to obtain appropriate bank consents before the 90% condition is waived. In these circumstances, assuming at least 50% ownership can be achieved, the bidder’s debt financiers would still (happily) be lending to a bidder that:
- can ensure ordinary resolutions of the target’s shareholders will be approved (and most likely special resolutions as well (given not all shareholders in public companies vote));
- has the ability to appoint nominee directors to the target board; and
- receives (through its shareholding) the majority of dividends and other distributions from the target group. That is, the target’s profits and cash flow can be used to service the acquisition finance.
Despite this, debt financiers will generally still be cautious in providing takeover financing where the bidder owns less than 100%, for reasons including:
- disputes with minority shareholders can affect the management of the target’s business operations, for example a controlling shareholder may not be able to reorganise the business as it wishes without the approval of minority shareholders if such reorganisation involves a related party transaction; and
- financial assistance issues aside, in most cases it’s not possible for a partly owned target or its subsidiaries to guarantee (or provide security for) holding company debt used to acquire target shares. Accordingly, financiers lending to a bidder that only partly owns its target would not have the benefit of target level guarantees or security.
These factors create an inevitable point of discussion between debt financiers and bidders.
On the one hand the bidder (which obviously needed certainty of funding to bid in the first place) needs actual funds to make its offer unconditional and pay accepting shareholders, but its debt financiers will prefer that the bidder has a relevant interest in 90% of the target’s shares before that occurs. Ensuring debt financiers are able to lend into a sub-90% scenario can therefore be critical to the success of a bidder’s takeover.
In this respect, keeping lenders regularly up to date with the progress of a takeover and the dynamics of discussions with the target shareholder base can be important. Separately, giving the lenders the comfort they need to lend into a sub-90% scenario can be vital.
Lender protections in a sub-90% scenario
Notwithstanding the difficulties for debt financiers providing acquisition financing for takeovers in a sub-90% scenario, lenders may be able to do so in the right circumstances.
Such circumstances will inevitably involve putting in place additional protections for the debt financiers. These protections could be reflected in either:
- a separate ‘contingency’ sub 90% funding package, in place from commencement of the bid (alongside the 100% ownership funding package); or
- a subsequently negotiated conditional waiver of the 90% ownership funding condition precedent.
Key financier protections might include:
- ensuring the bidder has adequate asset/cashflow base to service its debt in the event the 90% condition is not achieved;
- ensuring at least 50% (or a higher agreed threshold) ownership has been achieved and the bidder’s nominee directors are promptly appointed to the target board and the boards of its subsidiaries (to achieve effective control of target management and operations);
- ensuring the usual debt covenants will continue to apply (in some cases with specific adjustments) in relation to target group indebtedness and/or further acquisitions by the bidder. In particular, specific controls on the amount, tenor, purpose and repayment of any permitted loans into target subsidiaries may be implemented (possibly in contemplation of a potential need to repay target-level indebtedness following a change in control trigger in the target’s facilities);
- the bidder being obliged to use all reasonable endeavours to obtain a relevant interest of 90% in the target either in the takeover bid or via other means post takeover (eg. using the 3% creep exception to acquire a further 3% in the target each 6 months); and
- providing for flexibility to renegotiate a commercially acceptable outcome for the lenders and the bidder in the event 90% ownership is not achieved within an agreed period of say 12 months - without imposing a pre-ordained finance default.
While these protections will not be sufficient in all circumstances for lenders to provide finance to a bidder in a sub-90% scenario, for companies with steady cash flow and appropriate gearing they can often provide a solution.
Conditional waivers, considered flexibility in finance documentation and regular commercial updates to financiers on the takeover status, are all key elements of a bidder productively and prudently managing its financing arrangements for a debt-funded takeover bid.
The DuluxGroup-Alesco takeover was a prime example of how constructive engagement between debt financiers and bidder can assist in achieving a successful outcome.