- On-going market uncertainty and volatility since the onset of the credit crisis in late 2008 has generated divergent views between buyers and sellers on asset valuations.
- In the UK public M&A market, purchasers have seen some success using contingent value rights (CVRs) to bridge the value gap.
- We have also provided a snapshot of the use of CVRs in the US.
We have written previously about contingent consideration in public M&A deals on various occasions in the last two years1.
While these arrangements remain rare in Australian M&A practice, they have been used in a number of UK public M&A transactions.
What are CVRs?
Contingent value rights (CVRs) can take the form of a contractual right embedded in a takeover document or a separate, potentially transferable, security, but in either case they give rise to a right to receive further consideration either via a ‘single contingency’ CVR, where a one-off payment (whether in cash or additional securities) may be made, depending on whether or not the contingency is met, or a ‘tracker’ CVR where a series of payments may be made to holders over a period of time.
CVRs were pioneered in the United States and initially adopted in Europe (mainly in France) as a means to provide a collar on the value (that is, set a minimum value) of the bidder's share offer. However, history has shown that CVRs tend to attract adverse trading behaviour of the very type they seek to provide protection against (ie because speculators seek to push down the share price of the bidder in order to secure the additional payment) and their use for this original purpose has declined in recent years.
As a result, in the UK, CVRs have increasingly been used to give shareholders additional consideration on the outcome of a certain contingency affecting the value of the target business in the bidder's hands, for example the successful completion of a substantial piece of litigation or the sale of a particular asset.
A third potential use for CVRs has emerged, which is in some respects akin to stub equity, as in the case of the 2008 acquisition by Electricité de France (EdF) of British Energy plc (where Herbert Smith Freehills advised EdF). As with stub equity, this form of CVR allows a continued economic exposure to the target's general performance rather than a specified contingent event, but unlike classic stub equity structures it avoids the need to provide the holders with certain other features associated with an equity investment such as voting or control rights.
Typically, CVRs do not give holders voting rights in respect of the target and target directors do not owe duties to CVR holders as shareholders, although some duties will be owed to CVR holders in their capacity as creditors if the target becomes insolvent or is on the verge of insolvency.
Where CVRs take the form of a transferable instrument, given eligibility issues arising from their hybrid nature and depending on the bidder's appetite to prepare a prospectus, there is usually little appetite to list CVRs on a regulated market in the UK. This is consistent with the Australian experience, where difficulties can arise in relation to meeting ASX’s requirements for quotation. However, in order to give investors some prospect of liquidity in the instrument, bidders in UK transactions have considered obtaining a listing for CVRs on a specialist market such as the Professional Securities Market or one of the ISDX markets.
In practice, given the costs of implementation, the specialised nature of the security and likely lack of liquidity, CVRs have tended to be employed in the UK in relation to large-volume (£1bn+) public M&A transactions in situations where there is a strong desire from a particular key shareholder or group of shareholders to be offered some ongoing economic exposure to the target's value.
US CVR snapshot
The use of CVRs in US transactions continues to outstrip UK and Australian examples.
Over past three months, the following deals have involved CVRs:
- Atlas Copco / Edwards Group – future revenues and EBITDA results.
- AllianceBernstein / WP Stewart & Co. – value of assets managed at a future date.
- Community Health Systems / Health Management Associates – outcome of litigation.
- Cubist Pharmaceuticals / Optimer Pharmaceuticals – future drug sales.
- Cubist Pharmaceuticals / Trius Therapeutics – also future drug sales.
- AT&T / Leap Wireless – value of wireless spectrum to be sold.
We believe greater market familiarity (particularly in the healthcare and biotech industries) along with a greater ability to list and subsequently publicly trade CVRs in the US is driving the greater use of these exotic securities in US public M&A.
Examples of single contingency CVRs in practice
Since their first appearance in the UK in 2000, single contingency CVRs have been used to achieve a range of objectives:
- Acquisition of Saatchi & Saatchi plc by Publicis S.A. (2000) – target investors were offered a CVR listed on the Paris Bourse designed to offer target shareholders a price adjustment to protect against movements in the share price of the bidder and the €/GB£ exchange rate. Publicis's share price dropped and Publicis ended up paying out an additional €195 million in cash consideration under the CVR.
- Acquisition of ENIC plc by Kondar Limited (2003) – target investors were offered an unlisted instrument providing for an additional cash payment based on a specified formula in the event that there was a post-completion disposal of ENIC's stake in Tottenham Hotspur FC within 18 months of the date of the offer document.
- Acquisition of GB Railways Group plc by First Group plc (2003) – target investors were offered a contractual right to receive further cash consideration in the event of a successful outcome for the target in two live tender processes for railway franchises (an additional £2 per share for one tender and £0.50 for the second tender). Both tenders were unsuccessful and no additional payment was ever made.
- Acquisition of CD Bramall plc by Pendragon plc (2004) – target investors were offered a contractual right to receive further cash consideration in the event that the target group was successful in a claim for recovery of overpayment of VAT.
- Acquisition of QXL ricardo plc by Tiger Acquisitions Corporation plc (2005) – target investors were offered an unlisted ‘litigation entitlement unit’ providing for the holder of the LEU to be issued a loan note on recovery of litigation proceeds above a specified threshold following final determination or settlement of a litigation.
- Acquisition of WHAM Energy plc by Venture Production plc (2007) – target investors were offered ‘deferred consideration notes’ giving a right to receive new shares in the bidder (in addition to the cash consideration in the offer) in the event of receipt of regulatory approval and success of identified petroleum exploration prospects before a longstop date.
- Acquisition of Biocompatibles International plc by BTG plc (2010) – target investors were offered an unlisted instrument giving them the right to receive further cash consideration in the event that certain milestone events relating to the development of a pharmaceutical drug by Biocompatibles and AstraZeneca occurred within a specified timeframe.
Examples of Tracker CVRs in practice
Tracker CVRs are designed to provide for periodic payments over a finite period, contingent on specific criteria being met. Typically, a Tracker CVR will be used to address a future uncertainty which will have a material impact on the profitability of the business and which neither buyer nor seller are able to get objective comfort on. Examples of the use of Tracker CVRs in the UK include:
- Acquisition of British Energy plc by Electricité de France (2008) – target investors were offered a listed instrument giving exposure to British Energy's nuclear production capacity for 10 years post-takeover in the form of a right to an annual payment which is contingent on nuclear power output and UK power prices, based on a pre-determined formula. Investors were offered the ability to ‘mix and match’, electing to receive all cash (at £7.74 per share), a basic mix of CVRs and cash (£7.00 and one CVR per share) or an enhanced mix of CVRs and cash (£5.52 and three CVRs per share).
- Acquisition of Proximagen Group plc by USL Pharma International UK Limited (2012) – target investors were offered an unlisted instrument conditional on the revenue performance of two existing Proximagen drug development programmes, neither of which were commercialised at the time of the acquisition, subject to an overall cap of £1.92 per CVR.