Following a decade of dominance for scheme of arrangements, a new frontier is emerging in Australian take privates
In this article, we will examine the recent examples of takeover offers being used by private equity instead of a scheme when a target Board refuses to engage. Private equity firms should develop their playbook on takeover offers. Target Boards and bidders should be aware of the effectiveness of the technique.
- Historically, it has been considered difficult for private equity to use a takeover offer because of the preference for due diligence and the risks associated with being left with a minority public shareholding.
- In two recent examples private equity has put their offer directly to shareholders using a takeover to overcome a target’s unwilling to grant due diligence access and rival bidders.
- The takeover option is allowing private equity to be more dynamic to changes in circumstances and gain momentum for their offer.
- Private equity firms should understand the challenges with an offer, gauge their willingness to accept these and develop their public-to-private playbook accordingly.
- Target Boards and bidders should be alive to the effectiveness of the new tool in the private equity kit.
Historically, if a target refused to engage, a private equity bidder’s options have broadly been to raise price, walk away or force the target into a ‘bear hug’ by disclosing the offer publicly; the latter dramatically increasing the threat of a rival bidder.
Partly due to the ‘bid-ask’ spread opening up last year (ie, price expectations diverging) and partly due to the increased competition among private equity firms, a new tactic has emerged when a target refuses to engage. A takeover offer made directly to shareholders which bypasses the target Board.
While this route does not give the bidder the benefits of a recommended proposal, it does:
- Apply pressure on unwilling targets by putting the offer directly to shareholders.
- Allow the bidder to gain momentum by gathering acceptances as the bidder can efficiently adjust the offer as developments arise and acceptances can continue even if the Board solicits proposals.
- Force the target to respond formally in a target statement with detailed reasons and often an independent expert’s valuation.
- Allow the bidder to increase their blocking stake above the 20% limit.
In this article we consider two recent examples and the considerations involved in using the tactic. It is important for private equity firms to understand the challenges with using a takeover and for target Boards and rival bidders to understand the threat that they present.
RECENT EXAMPLES OF TAKEOVERS BY PRIVATE EQUITY
Takeover offers as an alternative to scheme of arrangement proposals have gathered momentum since the Brookfield-Healthscope transaction, which we advised on. There, twin proposals were put to shareholders: a scheme proposal at a higher price and a takeover offer at a lower price. This overcame a 15% blocking stake held by a rival bidder, by encouraging them to vote for the scheme or risk having a minority position.
The BGH-Virtus and Potentia-Nitro situations have taken things a step further, using a takeover offer made directly to shareholders to circumvent, or apply pressure on, the target Board. A summary of each follows:
- BGH (holding 19.99%) made a $7.10 a share scheme proposal for Virtus.
- CapVest proposed a scheme and takeover at $7.60 and $7.50, respectively, and was granted exclusivity and due diligence.
- BGH, without due diligence access, made a takeover offer at $8.00 a share.
- CapVest increased its scheme and takeover to $8.13 and 7.98, respectively.
- BGH’s takeover was only subject to a ‘no prescribed occurrence’ condition. Because of this, BGH could acquire shares on market during the bid, including at a higher price of $8.15 (which automatically increased the offer price for the bid).
- CapVest did not respond and the Virtus Board recommended the BGH offer. BGH almost immediately achieved 50%, then 75% and, within 2 weeks, 90%.
- Potentia (holding 19%) made a $1.58 a share proposal, rejected by Nitro.
- A month or so later, Nitro announced it had received multiple rival offers.
- Potentia, without due diligence access, launched a takeover at $1.80 a share. The bid was conditional only on: (i) Board recommendation; and (ii) no prescribed occurrences. The offer price is final, subject to any competing offer or Potentia getting due diligence.
- Nitro granted a KKR portfolio company, Alludo, 3 weeks exclusivity and due diligence.
- An agreed deal with Alludo was announced on 15 November at $2.00 a share. Potentia matched the offer price under its takeover offer.
- Alludo increased its proposal to $2.15 best and final, but the scheme was voted down, mostly because of Potentia’s 19% shareholding.
- Alludo still has its takeover offer at $2.15 best and final and Potentia has its takeover offer at $2.00. However, Potentia has said that it may increase to $2.20 to $2.30 depending on due diligence, which has now been granted.
CONSIDERATIONS IN PRIVATE EQUITY USING A TAKEOVER
There are a number of key considerations when private equity uses a takeover.
The tactic assumes the private equity bidder is willing to proceed without due diligence, which had historically been considered unlikely to be palatable for private equity bidders.
One variation is to communicate a willingness to increase the offer price if due diligence is granted and is favourable, which is what Potentia did in the Nitro situation. This applies considerable pressure on the Board to grant access and unlock value for shareholders. This has been effective in the Nitro situation, where Potentia has been granted access to due diligence on the possibility of an improved offer.
If due diligence is not conducted, then debt financing may be challenging. The Potentia bidder’s statement for Nitro states that the source of funding the cash consideration is Potentia and co-investor funds (that is, no acquisition debt financing). BGH’s bidder’s statement for Virtus is similar, with the option to add acquisition debt financing later, if available. The bidder could use equity or a fund facility as a bridge to acquisition financing.
Typically, a takeover offer in this context would be set with either a 50.1% acceptance condition or no such condition at all to apply maximum pressure on the Board and any rival bidders who may have, or seek, a blocking stake.
Achieving less than 100% of the target gives rise to the following considerations:
The decision to lever the target is for the Board (post-takeover). While the bidder may obtain control of the Board, the bidder’s nominee directors will need to consider their directors duties, including if this is in the best interests of shareholders as a whole. Minorities may object if they disagree (including with the benefit of hindsight).
Unless the target can use the additional leverage to generate returns, then the funds raised from financing will need to be returned to shareholders. A tax efficient way to do this is by capital return, which requires (i) sufficient share capital; and (ii) an ordinary resolution (>50%) of shareholders (on which the bidder can vote).
b) De-listing and listing rules
The bidder may de-list the target in certain circumstances. ASX policy is to generally allow delisting:
1) without a shareholder vote if the bidder acquires ≥75% and there are <150 shareholders with <$500 worth of shares; or
2) if a special resolution (>75%) of shareholders is obtained, with the bidder generally only able to vote its shares if the resolution is put 12 months after the takeover ends and the ASX agrees.
ASX listing rules would continue to apply for so long as the target remains listed. Most notably the following would apply:
3) continuous disclosure and reporting obligations would continue;
4) equity raising restrictions under the listing and takeover rules; and
5) transactions with the sponsor will be subject to the listing rules and Corporations Act rules in respect of transactions with related parties.
c) Exit requirements
Private equity will want certainty of achieving an exit, including by being able to require minority shareholders to sell. If a minority of public shareholders remain at the end of a takeover, an exit becomes more challenging. In particular, it is likely that the private equity investor will be unable to guarantee an exit and deliver 100% of the target to an acquirer. Chapter 6 takeover rules will also likely govern the exit. However, the PE funds substantial shareholding will be powerful in a takeover or scheme (or resolution to pass control) on an eventual exit.
The examples listed above have not resulted in a sponsor bidder being left with less than 100% of the target. However, we have identified one example where this occurred.
In 2009, Pacific Equity Partners engaged with Energy Developments and was given due diligence based on a $2.80 per share offer. Following diligence, PEP revised its scheme proposal to $2.65 per share, which was not recommended by directors. However, PEP was released from its standstill obligations to allow it to make a takeover offer if it wished, on the basis that the company had run a thorough auction prior to the PEP offers.
PEP made a takeover offer at $2.75 with a 50.1% minimum acceptance condition. The Target Board did not recommend the offer at any stage. PEP waived all conditions to the bid when it reached 49% and eventually reached ~80% at offer close (~3 months later). In particular, two major shareholders refused to accept the offer and remained invested.
Energy Developments remained listed for the entire PEP holding period, until DUET acquired 100% in 2015 for $8.00 per share. The listing created additional reporting and compliance obligations, including injecting equity by way of pro rata offer to comply with listing rules. However, PEP used the listing to achieve a partial sell down (15%) in 2014. From a distance, PEP looks to have made a reasonable return on the investment, proving that having minority public shareholders is not necessarily an obstacle to achieving returns.
For a decade, schemes of arrangements have dominated the private equity public-to-private transaction landscape. The use of takeover offers is the new frontier in take privates, as private equity puts their offer direct to shareholders and seek to overcome competition from rivals. The challenges above will need to be considered carefully by each PE bidder, but it appears in the right circumstances these challenges are not necessarily a complete bar.