Discontent over the proposed Roc Oil merger with Horizon Oil – which was subject to the approval of (target) Horizon shareholders, but not (bidder) Roc shareholders – has raised the question of whether a bidder’s shareholders should have a direct say over major acquisitions that could significantly dilute their shareholdings.
While many major stock exchanges require shareholders to approve significant transactions, ASX’s rules allow listed companies to undertake large public transactions without the approval of their own shareholders.
Investors in listed companies understandably want a greater voice on transformative acquisitions. However, listed companies are likely to oppose any proposed rule change that would give shareholders more power to potentially disrupt M&A deals.
ROC OIL RENEGADES
Fund manager Allan Gray recently attempted to amend Roc Oil’s constitution so that Roc shareholders would need to vote on Roc’s planned “merger of equals” with Horizon Oil. While the resolution failed, it ignited the issue of whether bidder shareholders should be able to vote on major acquisitions that could dilute their shareholdings or otherwise substantially change the nature or scale of the bidder’s business.
Although the proposed amendment to Roc’s constitution missed the required 75% threshold, the resolution was supported by more than 50% of shareholders that voted. A number of proxy advisers also supported the proposal, with some pointing out that “current Australian standards are an anomaly when compared to other developed markets”, echoing Allan Gray MD Simon Marais’ claim that there is “a deficiency in ASX regulation which allows this loophole”.
Even Roc’s MD conceded that “[t]here's clearly a desire with shareholders to have more of a say” and suggested ASX should review the rules that apply to shareholder approval of major transactions.
ASX’s Listing Rules only require bidder shareholder approval for non-public acquisitions (ie, acquisitions not made by way of takeover bid or scheme of arrangement) that involve a listed company increasing its issued capital by 15% or more.
The rationale, presumably, is that because public deals are accompanied by both extensive disclosure and regulatory supervision, it is unnecessary to require bidder shareholder approval – bidder shareholders should already be fully informed about the transaction that their company is undertaking. If they disagree with the company’s strategic direction they can vote with their feet by selling their shares.
ASX can also require a bidder to seek shareholder approval if it is undertaking a transaction that would result in a “significant change” in “the nature or scale of its activities”, but typically only exercises its discretion to do so when small-cap companies make dramatic changes to their business plans – for example, if a junior mining explorer announces plans to become a biotech investor.
The result is that, in practice, the decision on whether to undertake a major listed-entity acquisition rests solely in the hands of the directors of the bidder.
IS ASX OUT OF STEP?
ASX does, on this point, differ from many major foreign exchanges including NYSE, NASDAQ, LSE, HKEx, and Canada’s TSX. Companies listed on these exchanges must obtain shareholder approval for any transaction over a particular relative size (in terms of assets, profit or consideration), or any dilutive scrip transaction that results in a significant issue of new shares in the bidder to target shareholders.
For example, NYSE requires shareholder approval for transactions that would result in the issue of common stock (or convertible securities) in excess of 20% of a company’s outstanding shares (similar rules apply on NASDAQ).
Similarly, companies with a “premium listing” on the LSE (which includes most major listed commercial companies) must obtain shareholder approval for transactions that exceed certain relative thresholds by reference to assets, profit or consideration – including any deal that involves paying or issuing consideration that is worth 25% or more of the acquirer’s market cap.
Click here to see a table that compares ASX’s rules on bidder shareholder approval of scrip acquisitions to those of some other major exchanges.
THE CANADIAN STORY
There is a strong parallel between the issues being raised by Australian shareholders now and the events that drove TSX in 2009 to introduce a requirement that shareholders approve acquisitions resulting in the issuance of more than 25% of the current issued and outstanding shares of the acquirer.
Prior to the introduction of the rule, a TSX-listed company making a scrip bid would only be required to hold a shareholder vote if TSX considered that the deal would “materially affect” control of the acquirer.
The catalyst for change arose in late 2008, when mining company HudBay Minerals’ proposed a ‘merger of equals’ with Lundin. Despite the fact the deal would result in HudBay essentially doubling its shares on issue, TSX declined to require that HudBay shareholders approve the deal.
A number of major shareholders sought a review by the Ontario Securities Commission, which overturned TSX’s decision and made HudBay shareholder approval a condition of the transaction. As a consequence, the deal was abandoned, and in November 2009 TSX’s rules were amended.
Contrary to some predictions that the rule would negatively affect the M&A market in Canada, there has arguably been little change in deal structures or practices as a result of the new rule. In particular, scrip deals (driven by financial factors) remain popular in mining sector mergers – though some companies do structure bids with a mix of cash and scrip to avoid triggering the shareholder approval requirement.
SHOULD ASX CHANGE THE RULES?
Giving shareholders a greater say over proposed transactions that could substantially change the company in which they have invested or significantly dilute their shareholdings is the main argument for a new rule requiring shareholder approval of major public acquisitions. It would also bring ASX in line with its major overseas peers on this issue.
Although the proposed Roc-Horizon merger has drawn attention to the issue, it has not generated the same momentum for listing rule reform that the HudBay case did in Canada.
We expect that listed companies are unlikely to support any rule change that would give shareholders the opportunity to disrupt M&A deals, particularly in light of the very public dispute between Roc Oil’s board and its major shareholder and the recent rise in “shareholder activism”.
Opponents to a rule change could also argue that a requirement to obtain shareholder approval will make it more difficult for scrip bidders to compete with other offers, or that bidders will shift to making cash offers (funded, where required, by capital raisings) to avoid needing shareholder approval for a scrip bid.
However, the Canadian example shows that the introduction of such a rule may in fact have little, if any, substantive impact on the M&A landscape.
As shown in our M&A Review: 2014 mid-year update, foreign bidders subject to similar rules are able to compete successfully in the Australian market – of the six proposed scrip acquisitions announced by foreign bidders so far this year, four are subject to approval by their shareholders, and none have yet failed to obtain that approval.
In any case, scrip bidders already typically find it difficult to compete with cash bids, which offer more certain value and can be increased without exerting downward pressure on the bidder’s share price – any added conditionality to a scrip bid will not change this dynamic.
WHERE DOES THIS LEAVE BIDDERS AND THEIR SHAREHOLDERS?
For the time being, bidders are still able to undertake sizeable scrip bids without needing approval by their shareholders. Other than pushing for a constitutional amendment, which involves a lengthy (and costly) process with a low prospect of success, even large bidder shareholders will find it difficult to disrupt a deal that has already been announced.
A board spill, for example, might remove the decision-makers responsible for initiating a controversial merger but would still leave the company contractually committed to completing the deal (and likely facing payment of break fees or damages if it fails to do so). Nor is a challenge based on directors’ duties likely to succeed – Australian courts have been pointedly reluctant to second-guess directors’ commercial judgments on merger proposals.
That said, bidders and targets alike may need to tailor transaction strategies and agreements for the possibility that major shareholders may pursue their own independent agendas. In particular, parties should prepare for, and include provisions in implementation agreements to deal with, not only the possibility of a rival bidder emerging (for the bidder or the target) but also the prospect of the transaction being disrupted by significant shareholders who either oppose the announced deal or (as in the case of Mr Solomon Lew’s emergence on the register of David Jones) seek to use it to advance their own interests.