As we know, Australia has come through the global financial crisis better than most and we are in the midst of another resources boom. These happy coincidences have resulted in some instances where a key asset of a foreign company has been its controlling or substantial shareholding in an Australian listed company. The bid by ACS for Hochtief, which has a majority shareholding in Leighton Holdings, and more recently the proposed bid by CGNPC Uranium Resources for Kalahari Minerals plc, which has a controlling shareholding in Extract Resources, are two high profile examples of such an occurrence. These bids have brought a focus on the so-called downstream acquisitions exception to the 20% takeover prohibition. This note considers some of the key issues which arise in connection with the practical operation of that exception.
The 20% takeover prohibition
The 20% rule in the Corporations Act can present a potential obstacle to the execution of a foreign takeover. This may be so if the target ("upstream company") has a relevant interest in more than 20% of the issued voting shares in an Australian listed company or an Australian company with more than 50 members ("downstream company"). In such a case, the takeover of the upstream company would give the bidder a relevant interest in more than 20% of the issued voting shares in the downstream company, which is prohibited under the Corporations Act other than in certain circumstances.
The downstream acquisitions exception
There is an exception to the 20% rule for downstream acquisitions, which was introduced to facilitate acquisitions of relevant interests in voting shares that are merely incidental to a bona fide, lawful takeover. Initially applicable only in the context of a takeover for an ASX-listed company, the exception now extends to companies listed on certain foreign markets approved by ASIC. Moreover, the exception now covers acquisitions of relevant interests in voting shares generally, not just those made under a takeover.
The scope of the exception makes it potentially applicable to acquisitions beyond those which the legislature sought to accommodate. For instance, the exception can technically apply where an upstream acquisition is an artifice to gain control of a downstream company without complying with Australian law.
ASIC is concerned to protect Australian investors in such circumstances, where shareholders of the upstream company would receive the premium paid for control of the downstream company. If shares in the downstream company comprise a substantial part of the upstream company's assets, or if control of the downstream company is a significant purpose of the takeover of the upstream company, a bidder seeking to rely on the exception risks a declaration of unacceptable circumstances by the Takeovers Panel.
Leighton Holdings: a Spaniard bidding for a German to get an Australian?
In late 2010, both Leighton Holdings and its majority shareholder, Hochtief, made applications to the Takeovers Panel seeking a declaration of unacceptable circumstances in connection with the announcement by ACS, then a 29% shareholder in Hochtief, of an intention to increase its stake to 50%.
Hochtief is listed on the Frankfurt Stock Exchange, being an approved foreign market for the purposes of the downstream acquisitions exception.
Various orders were sought from the Panel in these proceedings, including orders requiring ACS to make a downstream bid for the minority shares in Leighton. The applicants faced the fundamental hurdle that ACS acquired more than 20% of Hochtief in 2007, and no action was taken at that time with respect to ACS' reliance on the downstream acquisitions exception. Since then, ACS has had a relevant interest in more than 50% of Leighton's voting shares, and that interest would not be changed by further acquisitions of Hochtief shares.
In declining to make a declaration of unacceptable circumstances, the Panel commented that there was no real evidence supporting the argument that ACS' bid for Hochtief was an artifice to acquire control of Leighton, notwithstanding that, at the time, Hochtief's holding in Leighton had a greater value than its own market capitalisation. The Panel did not consider that a significant purpose of the bid was to acquire control of Leighton, thinking it more likely that the bid was designed to facilitate financial consolidation and business diversification.
ACS' holding in Hochtief is now above 40%. In the event that ACS seizes control of Hochtief and seeks to increase Hochtief's practical influence on the conduct of Leighton's affairs (for example, by increasing the number of Hochtief representatives on Leighton's board), it will be interesting to see whether someone tries to persuade the Panel that ACS has indirectly acquired control of Leighton – and has done so without paying a premium for the privilege.
What if the downstream acquisitions exception does not apply?
In circumstances where the downstream acquisitions exception does not apply (for example, because the upstream company is not listed or is listed on a market not covered by the exception), a bidder will need to obtain ASIC relief before proceeding with an upstream acquisition that would result in it acquiring more than 20% of the issued voting shares in a downstream company.
In its regulatory guide on downstream acquisitions, ASIC states that there are two main categories of relief that it may grant in connection with such acquisitions: unrestricted or restricted.
Unrestricted relief permits a bidder to proceed with an upstream acquisition free of any restrictions or requirements with respect to the downstream company or any shareholding acquired in that company. Such relief is difficult to obtain.
ASIC will only grant unrestricted relief if:
- the upstream acquisition is a takeover or merger governed by laws and regulations which afford investors a comparable level of protection as afforded by Australian law; and
- the shares in the downstream company do not comprise a substantial part (ie. more than 50%) of the assets of the upstream company and acquiring control of the downstream company is not one of the main purposes of the takeover / merger of the upstream company.
Restricted relief allows a bidder to make an upstream acquisition subject to certain conditions. According to ASIC's regulatory guide, those conditions will usually require a bidder to either:
- for a specified period following the upstream acquisition, not acquire any more shares in the downstream company and not exercise voting power attached to shares acquired through the upstream acquisition ("standstill relief"); or
- make a bid for the downstream company ("bid relief").
There are very few market examples of where standstill relief has been granted. This is likely because the length of a standstill will, in many cases, be unsatisfactory to a bidder from a commercial standpoint. That is, depending on the size of the upstream company's interest in the downstream company, a standstill could theoretically run for several years.
ASIC will require a downstream bid to be made where an upstream acquisition will give a bidder absolute or effective control of a downstream company. Absolute control is evidenced by a shareholding of more than 50%. Whether someone has effective control of a company will depend on a variety of factors, in particular the composition of the company's share register. ASIC has previously held that a shareholding of 34% was enough to give someone effective control of an ASX-listed company.
A difficult issue that can arise in connection with bid relief is the price at which a downstream bid is made, especially where the consideration offered to upstream shareholders includes scrip and/or where the upstream company has significant assets other than its interest in the downstream company. To provide downstream shareholders with some comfort with regard to the pricing of a downstream bid, ASIC requires that they are provided with a report by an independent valuer on whether the price is fair.
Bidders who agree to the terms of bid relief will need to accept two (potentially harsh) realities: first, the consideration offered to downstream shareholders must be cash or include a cash alternative, and second, ASIC may require them to alter the pricing of their bid so that it reflects the price effectively being offered to upstream shareholders for control of the downstream company.
Extract Resources: the Chinese bidding for an English company with an African name to get an Australian?
On 7 March 2011, CGNPC-URC and Kalahari made a joint announcement regarding a possible recommended cash takeover of Kalahari by CGNPC-URC.
CGNPC-URC is a state owned enterprise in the People's Republic of China. Kalahari is listed on the Alternative Investment Market of the London Stock Exchange ("AIM") and on the Namibian Stock Exchange. Kalahari's key asset is its 43% holding in Extract Resources Limited, a company listed on ASX and the Namibian and Toronto exchanges.
Neither of the exchanges on which Kalahari is listed has been approved by ASIC for the purposes of the downstream acquisitions exception. Accordingly, the acquisition of a relevant interest in 43% of the voting shares in Extract that would result from the takeover of Kalahari would, in the absence of ASIC relief, breach the 20% rule.
In the joint announcement regarding the deal, CGNPC-URC said that it would seek ASIC relief and foreshadowed that such relief may require it to make a downstream bid for Extract. The announcement also lists certain pre-conditions that would be attached to any bid by CGNPC-URC offer for Kalahari, a number of which relate to the operation of Extract's business. This suggests that acquiring control of Extract (which ASIC would likely consider to be delivered by a 43% shareholding) would be the main (or at least significant) purpose of a bid for Kalahari.
As at the date of this article, no public announcement has been made as to whether ASIC has granted CGNPC-URC relief from the 20% rule. However, guidance can be taken from ASIC's position on the various control transactions proposed in 2007/2008 in respect of Anzon Energy (then listed on AIM) and its 53% owned subsidiary, Anzon Australia (then listed on ASX). From these examples it can be expected that ASIC will require CGNPC-URC to make a downstream bid for Extract under which Extract shareholders are offered cash consideration for their shares of equivalent value to that offered to Kalahari shareholders. The question is – will this be acceptable to CGNPC-URC? This will likely fall on whether CGNPC-URC is prepared to risk ending up as a controlling shareholder of an ASX-listed company. That is, ASIC is unlikely to allow the downstream bid for Extract to be subject to a minimum acceptance condition, as ASIC is of the view that there should be a reasonably high level of certainty that a downstream bid will become unconditional if the upstream bid is successful.
Accordingly, any restricted relief granted to CGNPC-URC by ASIC will likely require that, if all necessary regulatory approvals for the downstream bid for Extract are obtained and the upstream bid for Kalahari becomes unconditional, CGNPC-URC must declare the downstream bid unconditional, subject only to Extract having done something to trigger a prescribed occurrence (eg issuing securities or disposing of a material asset).
A final comment
As noted by the Takeovers Panel in Cape Lambert MinSec Pty Ltd  ATP 12, ASIC's regulatory guide on downstream acquisitions addresses the law as it stood at July 1996 and as such would benefit from updating. One way it could be updated is to provide restricted relief which, instead of requiring a downstream bid, allows the upstream bid to proceed on the condition that the bidder sells down its stake in the downstream company to less than 20% within a set timeframe (and to not vote shares in excess of 20% in the meantime).