The increased use of schemes of arrangement to effect takeovers has been a dominant feature of the
No longer regarded as protracted court processes, the usefulness of schemes is now widely accepted. Indeed, they are now often thought of as the default position on many larger deals or on deals with a leveraged element. So, as the size of highly-leveraged deals in the market has grown, the schemes have followed suit. Recently, however, the market has been reminded that schemes’ structural limitations have by no means disappeared. With the takeover panel proposing to consult in the autumn on how the rules apply to takeovers by way of schemes, M&A professionals are beginning to query whether the glory days are numbered.
The fashion for take-privates and schemes has run in parallel, with cost and certainty being the two key drivers. On almost all schemes, stamp duty at 0.5% of the deal value is saved. On larger transactions, this will be a significant saving and will outweigh any concerns about the extra cost of producing scheme documentation. But equally important is the comfort that a scheme gives to the bidder and, particularly, the lenders. Lending banks can be sure that by the time they are required to lend, the bidder will definitely own 100% of the target’s equity. There are no circumstances in a successful scheme in which the bidder can end up owning anything less than the entire equity of the target company.
This has meant that lenders need not concern themselves with the difficult decisions which are sometimes put upon them in deals using a normal takeover structure, such as when the bidder has to decide whether or not to allow a bid to go unconditional at something less than 90% acceptances (as it is only with 90% that the bidder can be sure of getting to 100% by means of a Companies Act compulsory acquisition process). The loan documentation usually requires bank consent to waive the acceptance condition in this way.
This has on occasion been a challenging decision for lenders because the normal dynamic of a takeover bid is such that the bidder cannot usually wait until it gets to 90% before declaring the offer unconditional. Many shareholders will not accept an offer unless it is already unconditional and there is always a tail of small shareholders who never accept anything. Compulsory acquisition procedures are there to deal with the latter category. Moreover, a bidder sometimes needs the tactical flexibility to go unconditional well below 90%, at a level between 50%-75%. Yet only with the latter figure can the bidder be assured of tax consolidation and the banks be sure of the target company being able to be turned private after the deal and therefore being able to give lenders security for their loans over its assets. Against this background, one can easily see why lenders prefer schemes.
However, the inflexibility of schemes compared to offers always needs to be kept in mind. The key difference between a scheme and an offer is that whereas an offer acceptance condition can be flexed between 50%-100%, the requirements for a vote at a court-convened scheme shareholders’ meeting are fixed. To be successful, 75% by value of those voting in person or by proxy, together with 50% in number, must vote in favour of the scheme, which otherwise fails. Therefore, if one is a shareholder seeking, for whatever reason, to block a deal or put pressure on a bidder by making it think it might be blocked, there is a fixed number of shares one needs to muster, which will always be less than 25% (because the numbers actually voting will usually be between 50%-75% of the total). By comparison, to block an offer, one would need 50% of the target to stop it completely or just over 10% to block the compulsory acquisition process being completed via a squeeze-out.
The recent experience of one target company may, with hindsight, come to seem significant in this respect. The independent directors agreed a transaction with its management team, backed by a private equity house, in which the bidder was to acquire the target by means of a standard scheme of arrangement. However, for what seems to have been a variety of reasons, the target shareholders who were on the register at the time of the shareholders’ meeting voted against the scheme, which duly failed. This is an incredibly rare turn of events. We have not been able to establish any major deals of this type which have failed on the shareholder vote
in the absence of a higher bidder. In this case, once shareholder opposition became apparent, the bidder decided not to switch to an offer structure. A bidder in this position that is able to convert to an offer structure and to go unconditional at a level between 50%-90% gives itself the possibility of leaving opposing shareholders in the awkward position of deciding whether they are prepared to hold shares as minority shareholders in a structure controlled by the bidco. Traditionally, institutional investors have not relished finding themselves in this position, particularly as their dividend income may dry up and retention of their stake may become uneconomic.
Those planning deals that would recently have been done by a scheme should now pause to consider how confident they are that the shareholders voting on the scheme will support it. If the bidder is not prepared to flip to an offer its inflexible nature will encourage shareholders who wish to seek to block it. Since 100% of the target register do not turn out to vote at a shareholders’ meeting, shareholders seeking to vote down a scheme do not need to hold as much as 25% of the target’s stock. Moreover, it has been a well-observed feature of a number of larger deals that the target’s shareholder register can change significantly following the announcement of a bid, with many of the traditional ‘long’ holders promptly moving out and the less predictable hedge funds coming in. Their aspirations for the outcome of the bid may well differ from the expectations set by traditional bid analysis.
The position will change further when the provisions in the Companies Act 2006 abolishing financial assistance come into force. When that happens the dynamics should change, making it much easier for leveraged deals done by way of offers to go unconditional at 75%. That allows a special resolution to be passed to take the company private and achieve tax consolidation. In the meantime, while lenders will no doubt continue to prefer the clear outcome that a scheme always offers, bidders should be wondering whether the extra flexibility of an offer structure is, after all, worth retaining.
The author is head of corporate at Ashurst.