As Covid-19 decimates deal activity through 2020, we size up the H1 trends and developments in Australian takeovers.
State of the M&A market
Overall, M&A activity worldwide and in Australia has been significantly affected by COVID-19. This has seen fewer transactions and, generally speaking, lower deal values than in recent years. This will, of course, come as no surprise given the enormous uncertainty for the global economy.
According to Refinitiv (formerly Thomson Reuters), worldwide M&A activity totalled US$1.2 trillion during the first half of 2020, a decrease of 41% compared to a year ago and the slowest opening six-month period since 2013. The second quarter was weaker than the first quarter, lower by 25%. It was the slowest quarter since 2012.
Private Equity-backed buyouts accounted for 17% of global M&A activity during the first half of 2020. This was the highest percentage of deals since the heady days of 2007. Despite that, consistent with other measures, the overall value of PE deals still fell by 24% compared to a year ago.
Interestingly, M&A activity overseas seems to have rebounded to some degree since the end of June, presumably as economies have started to reopen. The Financial Times reported earlier this month that, since the end of June, 8 deals each worth more than US$10 billion have been announced.
In Australia, M&A activity for the first half was subdued. Announced deals in Australia and New Zealand fell by 51% in value terms and, although we do not have precise figures, no doubt there was a similar fall by number of transactions. The largest public company transactions in the period were:
- Iberdrola’s bid for Infigen at $1.5 billion (topping an earlier bid by UAC Energy, a joint venture between AC Energy and UPC Renewables);
- Uniti Group’s proposed merger with OptiComm, valued at $540m; and
- Shandong Gold Mining’s bid for Cardinal Resources, valued at $335m.
All other deals announced in that period had a lower value, though this excludes a number of significant transactions including:
- Bain Capital’s acquisition of Virgin Australia (in administration), agreed in June, but not strictly a public company transaction, given the nature of the transaction;
- TPG’s $15 billion merger with Vodafone which completed in July, as that was announced in 2018; and
- BGH’s $542m recommended bid for Village Roadshow as it was agreed in August.
For the first half of 2020, we are pleased to say that Herbert Smith Freehills was ranked as follows:
- 1st by deal count and 1st by value in Australasia announced deals (Mergermarket);
- 1st by deal count and 1st by value in Australia and New Zealand announced deals (Bloomberg);
- 1st by deal count and 2nd by value in Australia and New Zealand announced deals (Refinitiv); and
- 1st by deal count and 6th by value in Australia and New Zealand completed deals (Refinitiv).
We are proud of this record. It underlines the depth and scope of our practice. We see a large slice of what goes on in this market. We had a role in the 4 largest Australian deals mentioned above.
There have been a number of interesting developments in M&A so far in 2020. Here is a brief overview.
Revised foreign investment rules
In response to the economic implications of the spread of the COVID-19 pandemic, the Australian Government announced important temporary changes to Australia’s foreign investment review framework on 29 March 2020.
- reduced the monetary screening thresholds for all foreign investments regulated under Australia’s foreign investment legislation to $0 (and therefore increased the number of foreign investment proposals that require approval); and
- extended the processing time for non-urgent applications from 30 days to up to 6 months.
The Government was concerned that, without these changes, it was possible many normally viable Australian businesses could be sold to foreign interests without any government oversight, presenting risks to Australia’s national interest.
While the changes are expressed as temporary, they will remain in place for the duration of the current COVID-19 crisis.
In practice, we have seen varying approaches to the approval of foreign acquisitions. On the whole, where the acquisition will lead to greater investment in Australia and the promotion of jobs, we have seen that FIRB approval has been given relatively quickly (say, four to five weeks). On the other hand, where those factors are absent, or the transaction raises issues about defence, security, data or personal information, FIRB approval is taking several months to be resolved and in many cases FIRB is seeking to impose operational conditions.
Further changes are proposed from 1 January 2021. These are permanent and are primarily focused on ‘national security businesses’, largely in the telecommunications, energy, infrastructure and defence manufacturing sectors.
The tightening of FIRB rules is consistent with the approach in other jurisdictions around the world where there is a heightened scrutiny of foreign transactions, largely to protect local ownership and sovereignty.
Renegotiation and reneging
The impact of COVID-19 on business valuations has led to many, if not all, buyers trying to extricate themselves from transactions agreed before the pandemic. Examples include Scottish Pacific’s proposed acquisition of CML, Carlyle’s proposed acquisition of Pioneer Credit and EQT’s proposed acquisition of Metlifecare in NZ, which led to litigation as the target attempted to hold the bidder to the deal (which has since been renegotiated at a lower price).
These transactions highlighted several points that had not been appreciated by everyone in the market:
- While a bidder under a formal takeover bid is required by law to proceed, there is no equivalent for a proposed scheme of arrangement. A scheme is governed by a private agreement between the bidder and the target. Not only is each agreement different, but frequently there is room for argument how the agreement operates.
- Arguments have arisen about whether the business impact of COVID-19 is covered by a MAC condition and whether steps taken in response to lockdown rules have breached the standard requirement for the business to be carried on ‘in the ordinary course’. Any dispute may take a long time to be resolved, especially if court proceedings are commenced, and that can lead to a deal being timed out.
- While there can be disputes about a MAC clause in a takeover bid, it is unlikely to be as devastating for the transaction given the Takeovers Panel would have jurisdiction to step in, most likely to assist shareholders.
- In addition, shareholders are not party to the scheme implementation agreement, so cannot enforce it in court. In any event, it is untested whether a court would order specific performance when the bidder does not want to proceed. Damages may be an adequate remedy for the target, even if that would not compensate shareholders for any loss suffered.
- These issues may be complicated further if the bidder is a special purpose vehicle with no assets in the jurisdiction.
Similar issues have arisen in the US and the UK. This has caused lawyers to go back to the drafting of agreements to try to improve the position of their clients should such a dispute arise.
The valuation issues caused by economic uncertainty is a major problem when parties seek to reach a deal. One potential solution is to provide for part of the price to be dependent on the future performance of the target company or the success of the merger. There are two recent examples in our market where this has been used.
The first is in BGH’s proposal to acquire Village Roadshow Limited. This is a complex transaction, but, for present purposes, the important point is that selling shareholders will receive $2.20 per share plus up to a further $0.25 per share depending whether or not the Village Roadshow theme parks and cinemas reopen and the Queensland borders reopen to people from Victoria and NSW in the period leading up to shareholders voting on the transaction.
The other example is Downer’s bid to mop up the remaining shares in Spotless. The consideration is cash plus an option to acquire shares in Downer in the future if the Downer share price reaches $6.50, $7.00 or $7.50 over the next 4 years. Downer’s share price is around $4.30, so the option only becomes valuable if Downer’s share price improves significantly.
Another technique is to exclude an asset from the transaction if the parties cannot agree on its value. An example is OZ Minerals’ bid for Cassini Resources announced in June, where some assets of Cassini are to be distributed to shareholders under a demerger before the company is acquired by OZ Minerals. Two schemes of arrangement, with a lot of complexity, are proposed to achieve this outcome.
Disclosure of equity derivatives
The Takeovers Panel consulted last year on possible changes to the rules for the disclosure of equity derivatives. This consultation was concluded in May and the Panel announced that it would adopt a new policy so that all equity derivatives which, together with any physical position, represent 5% or more of voting shares would need to be disclosed, whether or not there was a control transaction on foot. This should promote greater transparency in the market and also bring Australia’s approach in line with the approach in other jurisdictions around the world.
However, cognisant of the fact that there have been a lot of changes and a somewhat volatile M&A market, the Panel has announced that this new rule will not be imposed immediately. Instead, the Panel intends to give three months’ notice of when the rule may be introduced. It is hard to know when this will be, a start date early in 2021 seems likely.