The first half of 2013 has seen an unprecedented decline in the level of M&A activity in the Australian market. Despite that, we have identified a number of trends and developments which are taking place in the market which we believe will continue to impact on M&A during the remainder of 2013.
2013 TRENDS SO FAR
1. M&A IS MIA - DECLINE IN PUBLIC M&A ACTIVITY
“2013 has seen the lowest levels of M&A activity for many years.”
This time last year, we wrote of “relatively subdued” M&A activity levels as there had been only 22 deals with a transaction value over $50 million in the first half of 2012. This year, activity can only be described as “extremely subdued” or perhaps even “missing in action”.
Click here to see graph.
In the first half of 2013, just 9 deals over $50 million have been announced1, less than half of the number announced in the first half of 2012 and less than a third of the number announced in the first half of 2011. Average deal value remains low, sitting around 2012 levels, helped in large part by ADM’s multi-billion dollar bid for Graincorp (the only deal announced worth more than $300 million). The average value of deals announced so far this year is $446 million. ADM’s bid for Graincorp is the outlier, with a deal value of approximately $2.8 billion. The other 8 deals have an average deal value of $155 million.
2. EQUITY PRICES ON THE RISE - MORE BAD NEWS FOR M&A
“Rising equity prices remove much of the recent impetus for M&A activity.”
While the M&A market has been in decline in the first half of 2013, following a slow finish to 2012, equity prices have experienced strong gains through most of the last 12 months, with prices coming under pressure again from mid-May. The ASX All Ordinaries Index increased by 25% from 1 June 2012 to the middle of May 2013. This positive news from the stock market was not however matched with positive news in respect of other economic indicators and, as a result, it appears that the increase in equity prices has dampened M&A activity. There are a number of reasons for this.
LESS ROOM FOR OPPORTUNISTIC BIDS
Strong share price performance significantly reduces the scope for opportunistic bids. Target boards are better placed to reject takeover bids and bear hug approaches where the company’s share price has had improved performance in recent times.
LESS NEED FOR M&A ACTIVITY TO SATISFY PERFORMANCE HURDLES OF INVESTORS
In an environment of rising equity prices, institutional investors whose performance is measured based on the mark to market value of their portfolio can meet their performance hurdles without needing to rely on control premiums from M&A deals to do so. In these circumstances, such investors are more likely to be content with backing the incumbent board and management to achieve their stated objectives rather than agitating for or supporting an M&A deal for the company.
LESS OPPORTUNITY FOR PRIVATE EQUITY BIDS
A typical model for private equity bidders in the public M&A market involves identifying companies whose recent share price performance has not been strong, where there is an opportunity for the private equity bidder to take a longer term view of the prospects of the company than many institutional investors whose performance is measured over much more shortterm time horizons of 3 to 6 months. Companies embarking on strategic transformations or change projects which are expected to deliver value over the medium- to long-term are also common targets for private equity bidders. For the reasons discussed above, shareholders in these companies who are deriving some growth through increasing equity prices may be more content to wait out the process to see if these benefits actually materialise. As a result, increasing equity prices make it more difficult for private equity to find institutional shareholders willing to support a private equity bid.
BEAR HUG STRATEGY MUCH LESS EFFECTIVE
Each of the reasons described above mean that in an environment of rising equity prices, bear hug approaches will be much less effective in causing a target board to co-operate with the bidder. Bear hug approaches have been most successful in causing the target board to deal with the bidder where there has been sustained underperformance in the company’s share price, where growth prospects are based on long-term plans, and where a significant body of institutional shareholders of the target are willing to support the proposed deal. The absence of these factors will allow target boards to feel more comfortable about rebuffing bear hug approaches and instead focus on delivering the promised longer term growth for which that company has been positioned.
While most of the past 12 months has seen fairly consistent growth in equity prices, the 6 weeks leading up to 30 June brought an end to this trend with significant volatility returning to equity markets. Volatility is also a significant deterrent to M&A activity. In an environment where there is a generally conservative approach to M&A, volatility in the target’s share price can cause the bidder to question its valuation of the target. It also means bidders are less willing to make a binding commitment to a deal at a fixed price and then be exposed to volatile market pricing over what are increasingly long deal timetables.
3. SCRIP BIDS MAKE SENSE BUT ARE NOT WITHOUT CHALLENGES
“With the increase in equity prices in 2013, scrip mergers can be more attractive for strategic mergers.”
Given the strength of equity markets relative to general economic conditions, scrip bids make a lot of sense for domestic strategic buyers. When equity prices are low, bidders can be reluctant to use their scrip for a bid if they feel it is undervalued.
So far this year, out of the 9 listed deals over $50 million, 3 are scrip offers: Equity Trustees’ and Perpetual’s respective proposals for The Trust Company, and Troy Resources’ bid for Azimuth Resources. Over half of the deals under $50 million are also offering scrip consideration. The scrip bids we have seen this year are all in the energy/mining and metals, and financial services sectors and continue the recent wave of consolidation in those sectors among smaller players.
However, scrip deals are not without their challenges. There is the susceptibility of the bidder’s scrip to volatile stock market movements, whilst the target share price may remain relatively stable underpinned by the control proposal. For example, as at the time of writing, recent share price movements have diminished the face value of Perpetual’s and Equity Trustees’ respective scrip bids for The Trust Company’s shares to below the independent expert’s valuation range from being comfortably within that range just a month earlier.
There is also a question as to the expert’s valuation methodology to be applied in assessing fairness and reasonableness of the merger. Where a “merger of equals” transaction is proposed as opposed to a “takeover” the fairness assessment would typically compare the relative value contribution of each party on a minority basis (i.e. there is no assumption of full control required as is the case under typical takeover transactions).
As such, whether the transaction is a “merger of equals” as opposed to a “takeover” can have a significant bearing on a target board recommendation and shareholder support. Relevant considerations in assessing whether this applies include the nature of the businesses, the relative size of the businesses and management and board composition posttransaction; all areas which are often subject to lengthy debate between parties.
Finally, for a hostile bidder without access to due diligence, the ability to analyse the synergy value it can extract from the merger for the benefit of its current shareholders and future shareholders, and the impact on who gets what in a merger, is somewhat diminished.
4. MAJOR SHAREHOLDERS - WHAT ARE YOUR OPTIONS?
“Major shareholders need to carefully consider all of their options in a market where M&A deals are becoming more difficult to execute.”
Major shareholders played an increasingly active role in stimulating M&A during 2012 and are continuing to do so in 2013. Having sat through prolonged periods of uncertainty following the GFC, a number of major shareholders have become tired of waiting patiently and leaving their fortunes in the hands of the markets and are now wanting to actively consider their options.
CapitaLand has, for example, announced this year that it is considering its options in respect of its 59% stake in Australand.*
However, rising equity prices and increased volatility have meant that fund managers are less inclined to support opportunistic bids, and M&A deals have also become more difficult to execute. While we still saw that major shareholders helped initiate 5 out of the 9 M&A deals announced over $50 million, there are a range of different strategic options available to major shareholders. These include block trades and other equity capital market alternatives which can often have lower execution risk for the shareholder; and have been very popular during the first half of 2013.
SELL INTO THIRD PARTY BID
The most common way for a major shareholder to be involved in an M&A deal is for it to sell into a bid made by a third party. This allows the shareholder to exit all of its holding while realising an attractive control premium on their holding. Shareholders have a range of options for supporting such a transaction including giving an outright pre-bid stake, entering into a call option or making a binding public statement of intention. The key issue for the shareholder will be balancing the objectives of maximising the certainty of a transaction as compared with retaining the maximum level of flexibility to deal with its stake and also participate in any upside associated with higher potential offers.
An example this year was the agreement by GPG to sell a 19.9% stake in Peet to CIC Australia which had made a takeover offer for Peet and its announcement of its commitment to accept CIC’s offer in respect of the remaining part of its 53% stake.
Where a major shareholder takes the view that a company represents an attractive investment opportunity from a strategic or value perspective, and there are no other bidders to which the shareholder can sell, it may want to increase its exposure through a take private transaction. An example of a take private proposal this year is Ironbridge’s approach to acquire the minorities in Bravura Solutions in which it has a 67% stake.* A takeover, particularly an onmarket bid, is also a useful means of increasing a stake where the shareholder does not need to acquire 100% and may not be offering a full premium, as was the case with Jindal’s on-market bid for Gujarat NRE Coking Coal earlier this year in which it had an existing 19% stake.
JOINT BID/ACQUISITION OF ASSETS
As a variation of the above options, the shareholder may combine with a third party to make a joint bid for the company. This option is often attractive to major shareholders because it can allow the shareholder to retain an interest in the company once it is taken private or acquire particular assets of the company and in effect exchange its shareholding for those assets. The key issues include carefully considering the effect of the joint bidding arrangements in the context of takeovers policy to ensure there is no unacceptable lock-up or collateral benefit and determining the fair value of any assets which are acquired.
Recent examples include AXA SA’s joint bid with AMP for AXA Asia Pacific Holdings whereby AXA SA effectively sold its shareholding into the transaction and acquired the Asian assets of AXA Asia Pacific Holdings*, as well as the joint bid from Rio Tinto and Mitsubishi for Coal & Allied where the two shareholders shared control of the target once taken private.
SALE TO STRATEGIC INVESTOR
If the shareholder is not able to sell into an M&A deal and realise a control premium for its stake, it is likely that a sale of the stake as a single parcel to a strategic investor will be the next best option in terms of maximising its sale proceeds. These types of transactions will generally be relatively straightforward although takeovers issues will arise where the stake is of more than 20% and the shareholder is likely to need to obtain either tender offer relief from ASIC or shareholder approval in relation to the sale.
An example this year was the sale by GPG of a 19.6% stake in Ridley to AGR Partners.*
Block trades, where a shareholder disposes of a significant stake to a number of buyers typically through an off-market accelerated sale to institutional and sophisticated investors, have become very popular this year. These transactions have accounted for almost half of all ECM activity to date in 2013. The key issues include the structure of the sale, timing, the pricing of the transaction (which may be fixed or determined by a bookbuild) and whether or not the sale will be underwritten.
There have been 8 block trades of around 10% or more since March this year. The largest examples include the $806 million Aurizon sell-down this year and the $1.5 billion QR National (now Aurizon) sell-down via block trade and selective buy-back in October last year.*
Finally, a selective buy-back conducted by the company could be used to dispose of the shareholding. The key issues will be getting the cooperation of the company, the approval by shareholders by special resolution (75%), the required IER, as well as whether the company has sufficient cash to buy-back the shares. While a buy-back may be used in isolation, it is often combined with a block trade, as in the case of the QR National sell-down last year.*
5. ASSOCIATES - ARE THEY OR AREN’T THEY?
“The need for legislative reform to assist the Panel in dealing with associations remains an open question.”
For some time now, the Takeovers Panel has been wrestling with the difficulty in proving whether an association exists between shareholders where the evidence of such association is merely circumstantial.
So far this year, the Panel has received a number of applications from target shareholders arguing that a particular group of shareholders acquired shares in the target in breach of the 20% prohibition because the persons or entities within that group are associates.2 It can be very difficult for the applicant in these kinds of cases to prove an association exists - it is up to the applicant to demonstrate a sufficient body of evidence of association although the Panel recognises that proper inferences may be drawn.
The Panel has given some useful guidance in cases this year on what it considers to be a “sufficient body of evidence”, including the following guidelines:
- basic structural links, such as common directorships and investments, are unlikely to provide sufficient evidence of association - the Panel needs to see more evidence such as a shared goal or purpose in relation to the target or some prior collaborative conduct; and
- clauses in agreements which expressly state that the parties are not associates will not preclude a finding of association where the substance of the agreement in fact makes the parties associates.
However, the fact remains that in most cases, any evidence of an association will be circumstantial in nature. The Panel is also generally reluctant to compel the giving of evidence in its proceedings.
ASIC raised with Treasury last year its concern is that, because of the difficulty in proving associations, shareholders who individually hold less than 20% of a company may be able to improperly act together to exert control over the company in breach of the takeover laws.
ASIC’s updated RG 5 Relevant interests and substantial holding notices, released in June this year, provides some greater detail on the circumstances that may be relevant in determining whether an association exists but this largely draws together existing court and Panel decisions rather than providing any new guidance on this point. Given that Treasury is also considering this issue as part of their scoping paper on takeovers issues, it may well be that ASIC is reluctant to intervene with existing policy while Treasury continues with its consideration of the need for reform in this area.
Treasury doesn’t have a fixed timeline for reporting on this issue, but given the powers that the Panel has and the confidence it has shown in outlining what it does and does not consider to be evidence of an association, we think it unlikely that Treasury will see the need for legislative reform in this area. Given that the definition of associates in the Corporations Act is broadly cast, any reform in this area has the potential to be more heavy-handed than is appropriate.