The approach recently taken by the independent board committee (IBC) of Engenco Limited (Engenco) in relation to the takeover bid by Elph Pty Ltd (Elph) is a timely reminder that the recommendation options available to target directors extend beyond the standard yay or nay.
In December 2012, Engenco entered into an implementation agreement with Elph under which it agreed to facilitate Elph’s bid. Engenco did not, however, give any commitment with respect to the IBC’s recommendation, which is highly unusual in the context of an agreed control transaction (an implementation agreement will usually require target directors to recommend a bid in the absence of a superior proposal).
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The IBC ultimately decided to split their recommendation into two parts:
a recommendation that shareholders with a medium to longer term investment horizon reject the offer. Reasons for this recommendation included that:
- the independent expert engaged by the IBC concluded that Elph’s bid is neither fair nor reasonable, with the offer price of 18 cents per share being 14% below the bottom end of the expert’s valuation range for Engenco shares on a control basis; and
- in the opinion of the IBC, Elph is not offering value for Engenco shares having regard to the long term potential of Engenco’s business; and
- a recommendation that shareholders with a short term investment horizon consider accepting the offer. Reasons for this recommendation included that the IBC cannot be confident there will be an opportunity to realise a higher price in the foreseeable future or reasonable trading liquidity, making the offer a lower risk option for shareholders.
The approach of the IBC is not without precedent; for example, a similar approach was adopted by the independent directors of National Hire Group Limited in the 2011 bid by Seven Group Holdings Limited.
It will be interesting to see whether this approach becomes more common, particularly in the current climate where there are increasing cases of a target board being put under pressure by investors to facilitate a takeover approach which the board considers to be “opportunistic”, “inadequate”, etc. A prime example of this is last year’s takeover of Spotless Group Limited (Spotless) by Pacific Equity Partners, which was strongly resisted by the Spotless board for a number of months before a recommended deal was finally agreed following intense public pressure from Spotless institutional investors. In this case, the Spotless board recommended an offer that was priced below their publicly stated view of the fundamental value of the company, on the basis that it provided “the most certain near term return” for Spotless shareholders.
Often where a takeover approach is rejected, there will be calls for the target board to “let shareholders decide”. The difficulty arises where a bidder’s position is that it will only be prepared to proceed on the basis of a recommended deal, meaning that the only way the decision can be placed in the hands of shareholders is if the target board gives a positive recommendation.
The approach taken by the IBC in Elph’s bid for Engenco struck a middle ground between a rejection and a positive recommendation. It allowed the IBC to “let shareholders decide” whilst still preserving flexibility for the IBC to give whatever recommendation they considered appropriate in the circumstances.
No doubt the simplicity of a yay or nay recommendation is attractive (especially for retail shareholders), but in a time where the interests of investors can vary dramatically, the path taken by the IBC is one which other target boards may wish to consider, both in a friendly and hostile context. It should be noted, however, that in a friendly scenario, most bidders will strongly resist a target board having the same level of discretion as the IBC, as the potential for a negative (or split) recommendation will likely be viewed as creating significant/unacceptable deal risk.