In uncertain markets, it is no surprise that the number and size of takeover offers in 2009 has shrunk significantly. As well as having an impact on the size and number of deals, the uncertainty of the markets has also influenced deal tactics and structuring. The possible or “virtual” bid remains prevalent as bidders look to test target company and shareholder appetite without committing to a full, formal bid. Minimising execution risk through the deal protection package has also been key. Unsurprisingly, schemes of arrangement continue to be the deal structure of choice for recommended transactions, but 2009 has also seen the emergence of the non-recommended scheme as a potential deal mechanism. This briefing reflects on what the deal statistics tell us and discernible trends in public M&A in 2009, as well as the outlook for 2010. In terms of private company M&A, there is no doubt that the current environment is different to that of a few years ago, where sellers were very much in the driving seat. In recent times, we have seen some forced disposals but many more deals with a restructuring focus, although, perhaps surprisingly, there have been fewer disposals driven by target company insolvency. There have been a number of significant strategic deals, including the merger of the mobile phone operators Orange and T-Mobile, on which Norton Rose advised France Telecom. Certainly, as a reflection of the economic climate, buyers are more cautious, with a renewed focus on the due diligence investigation of the target. The risk-averse approach of buyers has affected the structure of acquisitions and the standard clauses contained in share purchase agreements. This is one of the deal trends in private M&A in 2009 which we will also consider in this briefing.
Public company M&A in 2009
So, what do the public M&A deal statistics tell us?
Less deals, smaller deals
It is not surprising, in the current economic climate, that the number and size of public company takeovers in the UK has reduced significantly. In 2009, there were only seven offers above £250 million and only three above £1 billion. Contrast this with 2007 and 2008 when the numbers were 36:21, and 16:10 respectively. In addition, in 2007-2008, there were over 15 public M&A deals greater than £2 billion, with only one in 2009. The lack of available credit has obviously had a significant impact, particularly for financial sponsors at the higher end of the market, with the aborted CVC/Cosmen bid for National Express at £765 million being the largest private equity driven public M&A deal in 2009. Contrast this, for instance, with much larger bids, such as the KKR/Alliance Boots bid (£10.6 billion) and the Terra Firma/EMI bid (£2.4 billion), in 2007 and the £1.4 billion competitive bid battle for Expro International Group Plc in 2008. Credit is, however, still available for the stronger corporate transactions as was the case, in 2008, in the Carlsberg/Heineken bid for Scottish & Newcastle (where Norton Rose acted for Carlsberg) which was financed entirely with debt finance on the back of an equity bridge rights issue.
Is cash still king?
With less cash available, you may have expected to see an increase in the number of share-for-share deals, but this has not materialised. Cash has been the preferred currency with no obvious trend towards all-paper bids. 2009 saw 13 public M&A deals over £100 million, nine of which were all cash offers. This may no doubt be due in part to the difficulty of valuing and pricing bidder and target shares and structuring the share-exchange ratio in more volatile, uncertain stock markets. As share prices recover and markets become more stable, however, we may see a trend for share driven consolidation re-emerge in 2010. Indeed, significant activity continues to be driven by strategic or sector consolidation; most recently in the case of Kraft’s bid for Cadbury and, earlier in 2009, for instance, with Peter Hambro’s merger with Aricom. The economic climate has also produced interesting financial institution deals, with significant divestments agreed following the injection of government aid.
The Takeover Panel bid list – does it reflect market activity?
The average number of target companies appearing on the Takeover Panel’s disclosure or bid list in 2009 is relatively high compared to the figures for 2007 (58 per month in 2007 against 49 per month in 2009). For various reasons, however, it is arguable that this is not a true reflection of market activity. First, the Takeover Panel’s adoption of a “zero tolerance” regime in terms of Rule 2 of the Takeover Code (circumstances where an announcement of possible M&A activity might be required) over the last 18 months or so since the release of Practice Statement 20 has led to the increased likelihood of transactions being notified to the market by way of talks announcements. Secondly, although a possible or virtual bid might become public, it is often common for no formal bid to materialise, leaving the target on the Takeover Panel’s bid list for a long period of time. Thirdly, there has been a considerable rise in the number of strategic reviews with target companies putting themselves “in play”, which perhaps adds to the inflated number of target companies on the bid list. Finally, while the number of companies on the bid list might be relatively high, the deal statistics tell us that many of these companies are in the smaller cap sectors of the market with larger deals fewer and far between. Conversely, 2009 has also seen a number of acquisitions of strategic stakes and rights issues/refinancings requiring a whitewash of the requirement to make a mandatory bid under the Takeover Code. Additionally, shareholders unable to raise the cash to formulate a takeover bid have instead looked at using procedures to instigate the removal of an incumbent board. Neither types of transaction are reflected in the Takeover Panel’s bid list.
Schemes of arrangement – still the preferred structure?
Between 2007 and 2009, the scheme of arrangement continued to be the deal structure of choice and there is no obvious reason that this is likely to change. Of 36 offers over £250 million announced in 2007, only six proceeded by way of contractual offer. A similar trend continued in 2008 to 2009, albeit against lesser deal flow. Mostly, the decision to proceed by way of scheme is fuelled by the considerable stamp duty saving (0.5 per cent. of the equity consideration) and the ability to achieve 100 per cent. control quicker than pursuant to a contractual takeover offer. However, one disadvantage in the current climate, perhaps not fully appreciated by the market, is the fact that it is more difficult for a bidder to withdraw a scheme. Using a takeover offer structure, a bidder can generally lapse its offer on the first closing date if it has not reached the requisite threshold, usually 90 per cent, even if the underlying rationale might be a change in the financial condition of the target or the market generally. In the scheme context, the Takeover Panel will not permit the withdrawal of a scheme without its consent, which can be particularly difficult for a first bidder who might need the certainty of 100 per cent. control to effect a break up bid or on-sale of target company assets. These circumstances, for insurance, might make switching to a contractual offer less attractive or viable.
What does the future hold for the scheme?
It is clear that the market has also become increasingly comfortable with using a scheme in a competitive environment. Schemes are no longer perceived as inflexible. This has been demonstrated over the last few years by the competitive bid battles involving Expro International Group and Resolution/Friends Provident/Standard Life/Pearl.The emergence of the non-recommended or hostile scheme in the 2009 competitive bids for IPC Holdings Ltd in Bermuda and Goldshield Group in the UK (even though, for differing reasons, neither transaction was actually implemented as a non-recommended scheme) also serves as a reminder that the scheme is a potential mechanism for implementing a transaction even where there is no target board support. For information on how a hostile scheme works, the legal and procedural issues involved and the implications under the Takeover Code, see the separate Norton Rose LLP briefing on Hostile Schemes.
Increasing trend towards virtual bids?
In the current economic climate, together with the costs and risks associated with committing to a formal takeover offer, it is not surprising that bidders have increasingly chosen to make announcements that they are considering making a bid to test the water (the so-called Rule 2.4 possible offer announcement or ‘virtual’ bid). The attractions of the virtual bid are obvious - it can enable a bidder to assess where the tipping point is for shareholders as to a fair/recommendable price and whether this is different to that of the target board and can lead to shareholders exerting pressure on a target to participate in the process and grant a bidder access to the target’s books. The prevalence of the virtual bid has attracted criticism in that, together with the related press coverage which is generated, the bid battle is usually fought ahead of any eventual (and then recommended) Rule 2.5 announcement and formal commitment to bid. For a target company, some argue it is sometimes almost like being subject to a hostile offer without the certainty of an actual offer, but with all the destabilising consequences. The inevitable upheaval in the target company’s share register, with the potential shift from longer term investors to investors with a more short term outlook on a company’s performance, can be all the more unsatisfactory when no bid materialises.The Carlsberg bid for Scottish & Newcastle was one of the clearest examples of almost the entire/virtual bid being played out before a Rule 2.5 announcement with the target making it publicly clear what the recommendable price would be. The case was equally extreme in the possible bid for Lonmin launched by Xstrata in 2008, where Lonmin published a full defence document before Xstrata had even produced a formal bid. More recently there was considerable coverage of Kraft’s offer for Cadbury and its proposed terms before any formal offer was tabled.
Virtual bids, the PUSU regime and time for more regulation?
The “put up” or “shut up” (or PUSU) regime was formalised by the Takeover Panel to force the bidder in a virtual bid scenario to present a firm offer to shareholders (or otherwise walk away) and therefore, to set a limit on the amount of time a target company is under siege. In 2009, the Takeover Panel continued to set PUSU deadlines regularly, with nine over the year, which is not far removed from those set in previous years. This number might be considered disproportionately high, given lower deal activity, perhaps reflecting the continued vogue in 2009 for possible offers. A timetable for a PUSU deadline requested early in the process continues to be set generally at six to eight weeks, with the target likely to require compelling reasons for the Takeover Panel to reduce this period (as illustrated in Kraft’s bid for Cadbury where the period was eight weeks and one day from the commencement of the offer period). In more difficult financing markets, bidders might be inclined to push for a longer period to enable them to put together financing packages but it is unlikely the Takeover Panel will increase the timetable drastically. Conversely, the Takeover Panel is unlikely to accede to a target’s request for a short or “bullet” PUSU deadline of, say, two to three weeks, as the Takeover Panel will always be concerned to ensure that a bidder has sufficient time to formulate a proposal and that target shareholders are not deprived of an offer. Commentators have queried whether the PUSU deadline effectively achieves the end to the siege faced by the target, as, in some cases, the deadline is often extended and diligence access granted following a proposal from the bidder without any formal bid. This occurred in the case of National Express in 2009 where the PUSU deadline was extended three times without any bid materialising. The problems for a target facing a virtual bid can be compounded by the extent of press coverage possible offers receive. The role of the press has been increasingly influential in the virtual bid process in recent times, such that it can be difficult to alter or correct the market’s perception once statements in the press have been made, whether those statements have any substance or not. This has been evident in the bid by Kraft for Cadbury where the “take-out” price for Cadbury or the price at which a recommendation might be forthcoming has been the source of much media debate since early September. The question has often been asked whether the Takeover Panel should do more to control the press in the virtual bid context. While clarificatory announcements obviously have a significant role, correcting perceptions created by the press can still be difficult and certain commentators have argued the Takeover Panel needs to take more stringent measures.
With the focus of the Takeover Code being very much on the bid process involving a Rule 2.5 announcement and related offer documentation, questions are often posed as to whether that is still a reflection of how public bids are conducted. In terms of the Takeover Panel intervening more readily in virtual bids, some commentators argue this is something which should be on the Takeover Panel’s agenda. It is unlikely, however, that the Takeover Panel will adopt a prescriptive regime in the possible offer period and prevent the making of possible offer announcements. There may be a case, however, for looking at whether some of the existing rules should apply more specifically during the virtual bid period.
Execution risk and protecting a bid
In more difficult times, bidders are increasingly wary of committing to substantial transactions which may take months to complete and, as a result, there has been an increased focus on minimising execution risk and the ability of a competing bidder to disrupt a first bidder’s process. The deal protection packages that target companies are being requested to sign up to by bidders have become increasingly sophisticated. While, historically, implementation agreements emerged to compel a target to drive forward the target-led scheme process, they have recently started to appear in contractual offers. For instance, as ENRC’s offer for CAMEC in mid 2009 shows (where ENRC obtained matching rights, non-solicit and information restrictions in connection with its offer) there is no reason why an implementation agreement cannot serve an equally effective purpose in a contractual offer.As deal protection packages have got more sophisticated over recent years, the deal protection “shopping list” has got longer and to some extent, increasingly ”market standard” without the provisions being as negotiated as might previously have been the case. Examples of the more offensive provisions include those that require bidder consent to deviate from an agreed timetable, that restrict the supply of information to a second bidder to that which is required to be supplied under Rule 20.2 of the Takeover Code and that prohibit a target from giving a break fee to a second bidder. The deal protection provisions can significantly restrict the target’s ability to negotiate with a competing bidder and considerably impede the second bidder. Whilst the target directors may be able to rely on a fiduciary duty carve-out in the case of their commitment to continue to recommend a bid, the carve out may not be available in respect of the taking of procedural steps to implement a scheme. Of itself, the deal protection package will not guarantee success for an original bidder but, coupled with a stakebuilding strategy, the package can effectively lock out a second bidder and put the first bidder in prime position. This has led to questions being raised as to whether (a) precluding a second bidder in this way is consistent with the general principle under the Takeover Code that shareholders should not be denied the merits of an offer; and (b) the Takeover Panel should intervene more than it does currently. While the Takeover Panel imposes a cap on break fees and the amount of damages that can be recovered from breach of offer-related agreements under the Takeover Code, there are often far more significant hurdles in the deal protection package facing a second bidder’s attempt to intervene in an offer.
It is yet to be seen whether the Takeover Panel will take a closer look at these provisions, particularly where a properly advised target has agreed to such provisions in order to elicit a formal offer from a bidder. However, there must be a case that the increased difficulties faced for competing bidders to enter the fray with its own offer is not entirely consistent with the basic principles set out in the Takeover Code. For further information on deal protection packages, see the separate Norton Rose LLP briefing on Deal protection in the UK for public company M&A.
Outlook for 2010
There has been considerable speculation that the Kraft/Cadbury bid would lead to an upsurge in sector consolidation and “big ticket” M&A activity. This has not yet transpired but it will be interesting to see how M&A activity develops in 2010.It does seem that 2010 will afford opportunities in a recovering market for companies to increase scale through acquisition at relatively good value, based on companies’ historic valuations. Market confidence will no doubt remain key to executing a deal. Whilst, in 2009, cash has been king in terms of deal currency, more bidders may well consider offering their paper. If shareholders believe in recovering markets and the increased opportunities for an enlarged group, critical mass derived from sector consolidation must lead to potential upside for target shareholders and make share-for-share offers more attractive. Indeed, given that share prices are still some way short of where they were over recent years, in the context of cash offers, fairly healthy premiums might otherwise need to be offered to persuade shareholders to take the cash to ensure they are not left feeling short changed. Finally, there has certainly been a trend to more hostile bids in 2009 - there is obviously Kraft’s bid for Cadbury and, towards the end of 2009, there were three or four target companies on the bid list fending off hostile offers. 2010 may indeed be the time for dusting down takeover defences - and we may even see the sanction of the first hostile scheme.
Private company M&A in 2009
In the context of private company M&A, 2009 has also seen a shift away from a more seller-friendly market. Buyers have become increasingly risk averse, which has been reflected in both the way deals are structured and the content of sale and purchase agreements. In particular, there has been an increase in the use of:
- earn-outs (where part of the purchase price is linked to the future performance of the target company) and deferred consideration — in each case buyers are wanting to protect themselves from overpaying;
- adjustments to the consideration through completion accounts mechanisms (rather than the ‘locked box’ mechanism which was popular in the more seller-friendly market); and
- material adverse change (or MAC) clauses, perhaps reflecting uncertainty about the financial position of the target
Whilst liability caps have also generally increased (reflecting buyer insecurity), the time periods for bringing claims has remained stable.
Focus on warranty protection – restricting claims
Historically, the cap on liability claims for breach of warranty was usually equivalent to the consideration paid to the seller. In a strong seller market, the caps became a percentage of the consideration paid. This also reflected the practice in the US and Europe in relation to caps. However, these per centages (usually between 10 and 100 per cent) have been creeping upwards in recent transactions, reflecting the increased deal risk being perceived by buyers. Title to shares continues to remain subject to the highest cap (usually 100 per cent of consideration received). The concerns as to deal risk have also seen buyers reducing the level at which small claims can be brought (so called “de minimis claims”) as well as the aggregate thresholds for bringing claims (the so called “basket”). In terms of amounts, and depending on the size of the consideration, the basket threshold is often anywhere from one to five per cent, with the de minimis threshold often being in the thousands or tens of thousands of pounds. Tax deeds are now making a re-appearance on most transactions (having been specifically excluded on some auctions). In terms of warranties, the relevant time period is usually between one and two years from completion, with the trend towards longer periods again reflecting greater perceived deal risk. The practice of the so-called “boxing” of warranties (for instance, only allowing a buyer to claim specifically for an environmental claim under a specific warranty) did not become universal even during the headier seller-friendly times and are now often resisted.
Adjusting or deferring the payment of the purchase price
In terms of the methods for adjusting the consideration paid for a target company post-completion, buyers are generally requiring the preparation of completion accounts rather than agreeing to the more seller-friendly locked box mechanism (which is described below). There has also been a rise in the use of retention or escrow accounts for safeguarding money in case of a claim under the warranties, reflecting buyers’ concerns over the financial status of their selling counterparties. For the seller, the retention account route has brought new disadvantages, these being that the escrow money will usually only attract very low interest rates and the risk of bank default became a real possibility rather than a theoretical risk.
In the current market where there are fewer buyers with available credit, sellers are faced with receiving lower, more realistic prices for their investments from buyers who are more risk averse and concerned to avoid paying “over the odds”. Using a deferred or contingent element in the calculation of the purchase price is a means for the seller to seek to achieve as high a price as possible, whilst giving the buyer comfort that it is getting “value for money”. In the recent acquisition of Gatwick Airport from BAA Airports Limited, Global Infrastructure Partners agreed to pay an additional amount of up to £55 million in the event of certain targets relating to passenger volume and future capital structure being achieved. The number was significantly higher (up to US$800 million) for CVC Capital Partners in its acquisition of the central European business of Anheuser-Busch InBev but was based on the same contingency format, allowing the seller to benefit from the additional upside as a type of anti-embarrassment clause.
Is the locked box a mechanism of choice?
The locked box is a mechanism through which the parties agree a price payable for the target company (generally based on a balance sheet drawn up and settled between the parties on an agreed date) in advance of signing. To the extent that there is any extraction of value (other than permitted leakage) between signing and completion, the seller undertakes to pay on a pound-for-pound basis a corresponding amount to the buyer. The advantage for the seller of this mechanism is that it gives certainty as to the determination of the consideration, with little ability for the buyer to question the deal that has been struck, as well as leading to a quicker process, with no external accountants being required to agree completion accounts. By its nature, it is also less precise, and therefore seller-friendly, putting the onus on the buyer to conduct detailed financial due diligence in advance of signing. As referred to above, the use of purchase price adjustments in the form of completion accounts has increased over the period. This does not mean to say we have seen the last of the locked box. Indeed, it continues to make an appearance in a number of private company deals, and was the mechanic of choice on two very large transactions on which Norton Rose has acted recently. However, the reason for the use of the locked box now tends to be transaction-specific, rather than simply because sellers are used to requiring it as part of an auction process.
Is the auction route still a popular choice?
The seller-driven auction sale process evolved in a market where there was a proliferation of buyers and no liquidity problems. That market has changed significantly and, as a result, whilst auctions are still being used, sellers are expected to be more generous with the documentation and the process is becoming more buyer-friendly. For a seller contemplating using this process, it must expect to be realistic and flexible in terms of the timetable; it must test the ‘deliverability’ of the buyer carefully, particularly on financing aspects, and expect that the documentation will end up reflecting a more level playing field.
What are the alternatives to an auction sale?
In 2009, the “go shop” clause (a US private equity invention) came to the UK market’s notice by virtue of the press coverage surrounding the sale by Barclays Bank of iShares. The Barclays “go shop” model followed that used in the high-profile sale of La Salle Bank Corporation by ABN Amro to Bank of America in 2007. A “go shop” clause effectively permits a seller, once it has broadly reached agreement with a buyer, to try and identify, within a prescribed time frame, any other parties who might be prepared to enter into a transaction on similar or preferred terms.In the iShares deal, once a binding £3 billion bid by CVC had been agreed, Barclays had a further 45 day period in which to find another bidder who would offer more than CVC. For CVC, the advantage was the negotiation of a deal on its own terms, with the relative “luxury” of following a competitive auction from the sidelines. For Barclays, it had the opportunity to clarify whether the price struck with CVC was the maximum it could achieve for shareholders. It remains to be seen whether “go-shop” provisions will continue being used in acquisitions in 2010. Other features of public company takeovers, such as matching or topping rights (where the target notifies the preferred bidder of any third party proposal received during the offer process and gives the preferred bidder a right to match or top the proposal) may also become more widely used in private company acquisitions as an alternative to the auction sale.
What are the trends in relation to data rooms?
Electronic data rooms are now usually used in large transactions, although there is still a consistent use of physical data rooms (particularly where a seller wants to make sure it has more control over the printing and downloading of the documentation). Buyers are generally permitted to print documents from the virtual dealroom but this will very much depend on the circumstances, including the stage at which negotiations have reached, the sensitivity of the information in question and whether any competitors are involved in the bidding process. There is also the question as to whether the entire contents of the data room are disclosed against the warranties (probably more UK practice) or whether only those specific matters referred to in the disclosure letter are disclosed (probably more US practice). It remains to be seen whether the US style will become more popular as the buyer gains more negotiating strength in the market place.
What is the position in respect of warranty insurance?
Faced with a risk averse buyer, one might assume that sellers would be turning to their insurance brokers for cover specifically designed to deal with warranty claims, and this does appear to be the case. The market for specialised insurance has seen an increase in enquiries and of insurance being put in place, particularly in respect of transactions where non-core assets are being disposed of or in distressed sales. Buyers are also looking to obtain cover against less financially reliable sellers. This upward trend in the use of insurance is likely to result from buyers being concerned with the quality of the warrantors’ financial covenants rather than any concern as to the scope of the warranties being obtained. In particular, it may also result from buyers seeking to cover their exposure in these uncertain economic times, particularly where the protection is being sought over a reasonably long term, e.g. in relation to tax or environmental indemnities.
Finally – ability to walk away?
In this uncertain market, it is more likely that buyers will continue to seek widely drafted material adverse change clauses to encompass market disruptions rather than specifically targeted events, a trend in 2009 which has been reflected in the termination rights used in acquisitions in the financial institutions sector. In addition, to the extent that any external financing is obtained in relation to an acquisition, the lending banks will usually expect to see these MAC style clauses as conditions precedent to drawdown in the loan documentation, with the buyer therefore seeking similar provisions in the share purchase agreement.