The Takeovers Panel’s (Panel) decision in Yancoal Australia Limited  ATP 24 (Yancoal Decision) is a novel case which related to a rights issue which would have, in the circumstances, allowed the ASX-listed Yancoal Australia Limited’s (Yancoal) majority shareholder (Yanzhou) to use the creep exception and eventually compulsorily acquire Yancoal without having to seek shareholder approval. The Yancoal Decision, while unlikely to be of direct relevance to future rights issues, is nevertheless indicative of the Panel’s approach to considering the control implications of a transaction in the entire circumstances (in particular, the likely commercial outcomes) of the transaction.
On 10 November 2014, Yancoal announced a pro-rata, renounceable rights offer (to be made by its subsidiary) of“Subordinated Perpetual Convertible Unsecured Capital Notes” (SCNs). The rights offer was intended to raise approximately US$2.3 billion. SCNs are complex instruments, treated as equity for balance sheet purposes and having the following features:
- An issue price of US$100.
- Convertible into Yancoal shares at a conversion price of US$0.10 per share (a 50% discount to the prevailing Yancoal share price). Therefore, each SCN is initially convertible into 1,000 Yancoal shares.
- Perpetual; no fixed maturity date and no requirement for redemption except on winding up.
- Distributions (initially 7% per annum) are perpetually deferrable, non-compounding and within the control of the Yancoal board.
Yanzhou held 78% of Yancoal’s ordinary shares and had loaned to Yancoal approximately US$1.916 billion (Yanzhou Loan). The funds raised by the rights issue were intended to pay off the Yanzhou Loan and the remainder was intended to fund part of Yancoal’s existing coal operations and future growth. Yancoal’s other major source of debt funding was a US$2.6 billion loan from the Bank of China under a number of facilities (BOC Facilities). SCNs were subordinated to both major sources of debt funding but had priority to Yancoal’s ordinary shares.
The Panel accepted that it was commercially unattractive for any shareholder, other than Yanzhou, to take up the offer. By employing the creep exception, Yanzhou would have been able, by converting SCNs to ordinary shares, to increase its shareholding by 3% every 6 months without seeking shareholder approval or making a takeover bid. The evidence indicated that if no other shareholder took up the offer, in approximately 19 months, Yanzhou could hold 90% of the ordinary shares in Yancoal, at which time it could then compulsorily acquire Yancoal.
Listing Rule 7.1 and the Creep Exception
LR 7.1 relevantly prevents a company from issuing equity securities which exceed 15% of the company’s issued capital in the 12 months before the issue date, unless the company obtains shareholder approval. Exception 1 to LR 7.1 allows a pro rata issue to the holders of all equity securities to the extent that the terms of the issue of the equity securities permits participation in the pro rata issue.
The rights issue in the Yancoal Decision would have violated LR 7.1 as the capital raising was far in excess of 15% of the capital currently on issue. However, exception 1 to LR 7.1 applied as the rights issue was pro rata.
Section 606 of the Corporations Act 2001 (the Act) broadly prevents an acquisition:
- which results in any person’s voting power in a listed company increasing from below 20% to above 20%; or
- which results in any person’s voting power in the company increasing where that person has a voting interest in the listed company above 20% but below 90%.
Section 611 of the Act outlines several exceptions to the section 606 rule. One exception is the “creep” (item 9) which allows an acquisition which would otherwise contravene section 606 if, by that acquisition, a person increases their voting power in a company by no more than 3% over the previous 6 months.
Following the rights issue, any increase in Yanzhou’s voting power on conversion of the SCNs would have violated section 606 of the Act. However, the structure of the offer was such that it was possible to use the creep exception to acquire 90% of the shares in Yancoal in a relatively short period of time without having to use another section 611 exception (eg. making a takeover offer or seeking shareholder approval).
Despite the rights offer’s compliance with these provisions, the Panel found that the transaction constituted unacceptable circumstances having regard to the effect the transaction would have, or likely to have on the control, or potential control, of Yancoal. Central to this finding was that the rights issue was, in substance, highly dilutive, despite some efforts to mitigate the control impact. The result of the transaction would be that Yanzhou would have the opportunity to use a ‘bank’ of convertible securities to creep above the 90% compulsory acquisition threshold and thereby privatise Yancoal without having to make a takeover offer or seek shareholder approval.
Guidance Note 17 (GN 17) states that a company’s financial situation, the amount sought to be raised and the suitability of raising capital by the rights issue will be considered in whether a rights issue gives rise to unacceptable circumstances.
The Panel acknowledged that Yancoal was highly geared and accepted that it was in need of further capital in light of the debt covenants contained in the BOC Facilities. However, the Panel referred to GN 17, which states that the need for funds is not a safe harbour. The Panel also stated that the circumstances of Yancoal’s situation were less urgent than in other circumstances where the Panel had allowed a highly dilutive rights issue with a control effect to proceed. In particular:
- Yanzhou provided a letter to Yancoal on 14 February 2014 stating that it would provide A$300 million for the 2014 calendar year and ongoing financial support to Yancoal to enable it to pay its debts as and when they fell due unless removed by giving not less than 12 months’ notice; and
- it was not clear that the Bank of China had ruled out a waiver of covenant breaches in relation to the BOC Facilities should the rights offer not proceed.
Structure of the rights offer
GN 17 provides:
Structural matters (such as price, number of shares offered, renounceability, underwriting) cannot be considered in isolation from each other and the market conditions at the time of the rights issue. The Panel will look at the structure of the rights issue as a whole, and the market, in deciding whether the rights issue gives rise to unacceptable circumstances. In practice, if the rights issue is underwritten, the underwriter will usually influence the structure (and may in some cases decide on it).
The Panel found that there were some elements of the rights offer which were designed to mitigate any potential control effect, including:
- the offer was renounceable;
- shareholders (other than Yanzhou) could apply for any shortfall; and
- any remaining shortfall would have been offered to external investors, with Deutsche Bank being appointed as an arranger to find external investors.
However, the Panel concluded that the offer was not attractive to investors other than Yanzhou. In particular, the 7% distribution was low and perpetually deferrable at the issuer’s discretion. Further, while some terms of the SCNs were in form, attractive, they were not so in substance. These features included financial support which Yanzhou had committed to provide under the offer (amounting up to US$807 million over 5 years) and a clause which prevented distributions on ordinary shares so long as SCN distributions had not been paid. ASIC submitted, and the Panel accepted, that these did not make the offer attractive because SCNs were subordinated to the BOC Facilities and it was not expected that distributions would be paid on ordinary shares.
In light of this, the Panel found that the offer would, in practice, be highly dilutive given that:
- the offer was similar in effect to a 23 for 1 rights issue of ordinary shares; and
- minority shareholders would have had to pay over 19.3 times the current value of their investment in Yancoal to take up their full pro-rata entitlement under the rights offer to avoid dilution.
As a result, the Panel found that the structure of the offer was not sufficient to mitigate the potential control effect of the transaction.
Equality of benefits
The Panel concluded that the likely outcome of the transaction was such that the benefits accruing to Yanzhou would not be available to Yancoal’s minority shareholders, with the benefit of particular concern to the Panel being Yancoal’s ability, through the acquisition and conversion of SCNs, to acquire an interest in more than 90% of the shares of Yancoal at a conversion price which represented a significant discount to the price of Yancoal shares prior to the announcement of the proposed issuance of SDNs. In this regard, by employing the creep exception, Yanzhou would have been able obtain 100% of Yancoal’s shares in a relatively short period of time.
The applicants and another holder of Yancoal shares further submitted that Yanzhou’s ability to effectively set-off its funding commitment in respect of the SDNs against the Yanzhou Loan, also made the offer comparatively more attractive to Yanzhou. The Panel stated that, in isolation, this aspect of the offer would not be of concern to it, but that there may be features of debt to equity conversion that makes a particular proposal unacceptable.
Orders and comment
The Panel ordered that any conversion of the SCNs by Yanzhou and its associates may only proceed with the approval of Yancoal shareholders, excluding Yanzhou and its associates.
The Yancoal Decision involves a unique transaction which is unlikely to be of direct relevance to future rights issues. Nevertheless, it is indicative of the whole-of-transaction approach that the Panel will adopt in such cases. Further, it is a novel example of the potential use of the creep exception in a manner determined by the Panel to be contrary to the takeover regime’s underlying policy goals. This may prompt further discussion on the possible modification or abolition of this exception.