We explore the important role merger arbitrage can play in the success or failure of a deal. Targets and bidders should be aware of this role and consider the approaches that may be taken in response to arbitrage funds seeking short-term profits from an announced deal.
- The acquisition of a pre-bid stake is one strategy that bidders consider closely as part of the overall transaction strategy. In many cases, it has proven to be successful.
- However, in the case of a scheme, one of the drawbacks is that the pre-bid stake cannot be voted, increasing the ability for one or more shareholders to block the scheme.
- In the recent Pushpay scheme and earlier proposed Australian Unity Office Fund scheme, bidders have sought to increase their chances of deal success by taking different approaches in response to arbitrage funds seeking short-term profits from an announced deal.
- Merger arbitrage activity will continue to be a prominent feature of control transactions in the Australian market.
- Targets and bidders should be alive to merger arbitrage activity following the announcement of a deal, and should consider the approaches that may be taken to increase the chances of deal success.
Merger arbitrage is by no means a novel investment strategy. It involves placing a bet on the probability of a deal completing based on the spread between the target’s share price and the consideration offered under an announced deal.
Where the likelihood of a bidding war is low, there are a number of reasons why target shareholders may be keen to sell their shares prior to completion of the deal.
- Shareholders are paid immediately – they do not need to wait for the deal to complete (noting that the average time period to complete a takeover or scheme is around four months, and in some cases, can be considerably longer)1.
- All risk of the deal not completing is avoided.
- The value realised by shareholders is usually only at a small discount to the consideration offered under the deal (and is usually higher than the undisturbed share price prior to the announcement of the deal).
When placing an arbitrage bet, arbitrage funds look at a number of factors. These include the timetable, deal conditionality (most notably, regulatory approvals (e.g. ACCC clearance or FIRB approval), shareholder support and any material adverse change condition) and the parties’ right to terminate and walk away. Greater deal risk and uncertainty usually means a bigger spread (and potential profit).
The high-profile Twitter take-private by Elon Musk is a recent example of arbitrage funds successfully riding the arbitrage rollercoaster. This transaction was littered with deal uncertainty and risk – most notably Musk’s (very public) desire to terminate the deal for alleged breaches by Twitter. This uncertainty and risk, coupled with already sceptical investors and a sentiment that Musk was never going to complete the deal, meant that the Twitter share price regularly traded below the US$54.20 per share offered under the deal – dropping to as low as US$32.52 at one point (a ~40% discount to the offer amount). Arbitrage funds took advantage of this spread and on completion made hundreds of millions of dollars.
While there have been other examples where arbitrage funds have had to sell at a loss due to a failed transaction, it is clear that merger arbitrage activity will continue to be a prominent feature of control transactions in the Australian market.
In the proposed acquisition of the ASX and NZX-listed Pushpay by the BGH Capital-Sixth Street consortium, the consortium agreed to acquire all the shares in Pushpay for NZ$1.34 per share by way of a New Zealand scheme. The scheme was recommended by the Pushpay Board and the offer amount was in the range of the independent adviser’s valuation. Notwithstanding this, with the ~20% pre-bid stake held by the consortium not being able to be voted on the scheme, and faced with resistance from a number of substantial shareholders, the scheme was voted down at the shareholder meeting.
After extending the period that the parties may terminate the scheme on two occasions, the parties agreed a new deal at NZ$1.42 per share. However, interestingly, under the new deal, certain ‘specified shareholders’ holding 10.3% of Pushpay shares agreed to receive the original offer of NZ$1.34 per share. These ‘specified shareholders’ comprised a ‘small number of sophisticated, professional offshore event driven fund shareholders’ – i.e. arbitrage funds. 7 of Pushpay’s largest shareholders agreed to support the new deal (6 of which did not support the previous deal), with the expectation being that the shareholder vote on the new deal will be successful.
Similar to Pushpay, in the proposed acquisition of Australian Unity Office Fund (AOF) by the Charter Hall Group-Abacus Property Group consortium back in 2019, the consortium had a ~20% pre-bid stake when the scheme was announced. In the lead up to the vote and with at least one substantial shareholder reportedly against the scheme, the consortium divested its entire pre-bid stake via its broker to certain institutional shareholders for an amount less than the consideration offered under the scheme. The consortium stated at the time that the decision to divest its stake ‘will provide the market the best opportunity to determine the outcome of the scheme’.
ASIC took issue with the divestment and made an application to the Takeovers Panel. ASIC submitted that ‘[the consortium] has intervened in the market for securities in AOF during the course of its proposed takeover of AOF in a way that undermines the integrity of the trust scheme mechanism and the basis for the compulsory expropriation of interests in AOF that will result if the trust scheme is approved’ – i.e. because the pre-bid stake was divested to certain investors who would likely support the scheme, noting that two of the substantial investors to emerge on the Australian Unity Office Fund register were arbitrage funds. Most notably, ASIC sought orders that the vote should be assessed after subtracting 19.9% of all votes cast in favour of the deal – effectively seeking to maintain the status quo that the pre-bid stake could not be voted.
Ultimately, despite the sell-down, the scheme vote was not successful and the Takeovers Panel application was withdrawn.
There have been a number of previous transactions where different groups of shareholders have been offered different consideration. Most commonly, this has been in transactions where management or founders receive scrip in the unlisted bid vehicle. It is, however, very unusual for a group of shareholders to simply receive a lesser cash amount than all other target shareholders.
The differential amounts offered by the bidder in Pushpay shows a creative approach in response to merger arbitrage that may be taken by a bidder to meet the demands of longer-term investors but at the same time not overpaying for the target. The revised deal in Pushpay meant that certain arbitrage funds would be paid less than other shareholders. The arbitrage funds would obviously want to maximise their spread in Pushpay, however, presumably when faced with a deal that would otherwise have been terminated following the failed vote, they were happy to receive the spread that they had initially bet on.
From the target’s perspective, the new deal allows Pushpay shareholders on the register before the deal was announced to benefit from the improved offer (sharing in a further ~NZ$80 million for their shares).
More generally, the Pushpay example highlights the importance of monitoring the target’s share register after the deal has been announced to identify the level of merger arbitrage activity and considering what levers are able to be pulled by bidders and targets to garner sufficient shareholder support to enable the deal to proceed.
A divestment of a pre-bid stake after the announcement of a scheme can have two key consequences:
- the bidder can no longer potentially block a competing proposal; and
- the divested shares may be freed up to be voted on the scheme, which can be important where the vote is finely balanced.
As the Charter Hall-Abacus consortium bid for Australian Unity Office Fund illustrates, any divestment by a bidder of its pre-bid stake will need to be carefully navigated, including:
- ensuring the buyers of the shares are at arm’s length and the sale process is not ‘selective’ (for example, the bidder is not specifically placing the shares in the hands of an arbitrage fund knowing it will vote in favour of the deal); and
- ensuring there is no agreement, arrangement or understanding as to how the buyers of the shares will vote on the scheme2.
- In FY22, the median time from announcement of a scheme through to implementation was 122 days and the median time from announcement of a takeover bid until completion of compulsory acquisition was 101 days – see our 2022 Public M&A Report for further information.
- These issues were considered in the Amcom-Vocus scheme – see our article here.