Key Points:
It appears that the bear hug approach is replacing the hostile takeover bid, and regulators will no doubt take notice.
2011 saw a continuation of a recent trend for public M&A deals to be announced with an initial target recommendation and 2012 is likely to follow this same path. Seventy-five percent of all public M&A deals (including 59% of off-market takeovers) in 2011 were recommended by the target when announced.1
What is responsible for this trend? A target recommendation has always been highly sought after: they provide greater deal certainty, a headstart over any potential competitors, facilitate access to due diligence and are very persuasive to retail shareholders. A target recommendation also has a significant impact on the likelihood of success of a deal: in 2011, 86% of recommended deals completed successfully, whereas only 50% of deals which did not receive a recommendation completed successfully.
However, none of that explains the increasing incidence of target recommendations from the time of initial announcement. Rather, that is explained by the rise of the bear hug approach or virtual bid proposal. A bear hug or virtual bid proposal starts with an unsolicited proposal being made to the target. That unsolicited proposal is subsequently made public (either by the bidder or the target) before any transaction is actually announced.
Twenty-nine percent of all deals in 2011, including some of the largest deals for the year, commenced with a bear hug approach which was made public. In addition to these deals, there were a number of bear hug proposals announced which did not result in a deal. However, for those bear hug proposals which did lead to an announced transaction, 75% of those which had completed by the end of 2011 were successful.
Bear hugs are driven by the bidder's desire for target co-operation – particularly those bidders who wish to use a scheme of arrangement or who need to gain access to due diligence before committing to a deal. Forty-five percent of the scheme transactions in 2011 started with a bear hug proposal. This tactic is also commonly used where a bidder suspects it will not be welcomed with open arms by the target, requiring the bidder to use other strategies to put pressure on the target to let it in the door. In particular, the bear hug is used to bring the proposal to the attention of target shareholders in the hope that shareholders will pressure the board to negotiate with the bidder.
With the number of hostile takeover bids in decline in recent years, it appears that the bear hug approach is replacing the hostile takeover bid. Bidders that in the past would have made a hostile bid are now preferring to use a bear hug proposal to force a recommendation at the outset rather than commencing straight off the bat with a hostile takeover bid.
Of course, a bear hug approach will not always remove the need for a hostile bid. There are a number of examples where the bear hug was not sufficient to bring the target board to the table, with the bidder needing to resort to a hostile takeover bid in order to achieve that outcome. SABMiller's bid for Foster's Group was a good example. There the target board withstood the pressure from the bear hug proposal and the public and private agitation from some of its shareholders, forcing SABMiller to take its proposal directly to shareholders by way of a hostile takeover bid. The making of the hostile bid finally brought both the bidder and the target to the table, and the bidder was able to negotiate a recommendation from the target as well as implementation of the deal by a scheme of arrangement rather than a takeover bid, albeit for a 13% increase in its offer price.
While the increasing prevalence of such tactics has seen some in this market advocate the need for a "put up or shut up rule" (such as exists in the UK), the general sentiment in the market has generally supported the view of the Australian Takeovers Panel that there is no pressing need for such a rule in Australia. This is despite the fact that the UK Takeovers Panel in 2011 tightened its rules further to reduce the period of time that a target can be exposed to a virtual bid without any actual bid eventuating.
While there does appear to be an increasing propensity for shareholder activism where a target board rejects a bear hug proposal and there is board and management distraction in dealing with that, there does not seem to be any evidence that boards of Australian targets are constrained in running the business of the company in its usual course or are otherwise being held hostage by the existence of a rejected virtual bid. The Takeovers Panel's "Frustrating Action" policy allows targets to press ahead with initiatives which might otherwise appear to frustrate a virtual bid. Complying with this policy enables the boards of Australian targets to carry on business as usual as well as implement important strategic objectives, thus obviating the need for any new rules.
The increasing use of bear hug approaches by private equity may however cause the regulators to think twice about this position. As we saw in the case of the SABMiller bid for Foster's and Peabody/Arcelor Mittal's bid for Macarthur Coal, most bidders have available to them the means of bringing the matter to a head if the bear hug approach does not result in engagement from the target. For most bidders, if the bear hug approach fails, the next step is the hostile takeover bid which effectively bypasses the target board and takes the proposal directly to target shareholders. Private equity bidders generally don't have the ability to do this, because they need the target to provide access to due diligence before they, or their financiers, can commit to a deal.
The result can often be a stalemate – the target refuses to grant due diligence at the price being offered, some target shareholders agitate for the board to do all that is necessary to allow the bidder to put a binding proposal on the table, the target board and management faces an indefinite period of uncertainty and instability while it tries to continue implementing the company's strategy in the face of the pressure from the would be bidder, target shareholders, and often the media. Throughout this period, which can run for some months, the company's share price trades at prices which reflect the possibility of a deal happening at the price the bidder has put on the table, although usually with a discount for the risk that no deal will eventuate. Yet the would-be bidder has no means of breaking the stalemate, short of walking away or increasing its offer to a value the target board finds acceptable. And the absence of a put up or shut up rule means the target has no means of resolving the situation.
If enough target shareholders support the virtual bid, a potential option is for those shareholders to call an EGM and replace some or all of the target board with directors who will facilitate a transaction. This option is however fraught with difficulty, including finding willing and acceptable candidates for election to the board, the damage that will inevitably be caused to the target's business by the distraction and publicity a hostile EGM process would involve. Given these risks and the fact that the only outcome of such a process is to allow a bidder who at that point has very little skin in the game decide whether they wish to proceed with their highly conditional, indicative and non-binding virtual bid proposal with no certainty of any outcome, the contested EGM option is ultimately unlikely to be a particularly attractive alternative for shareholders.
There have been a number of bear hug proposals made by private equity in late 2011 and early 2012. As yet, none of these proposals has manifested in a binding proposal which shareholders are able to accept. Market integrity is a paramount concern for regulators these days. One suspects the regulators will be closely watching the outcome of these virtual bid proposals and the consequent impact on market integrity. Depending on those outcomes, we just might find that the movement for regulatory change in Australia regains momentum.
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Footnote
1 Clayton Utz has recently launched THE REAL DEAL: M&A Trends and Developments 2012 edition, a report which contains an unparalleled depth of insight and analysis into public M&A deal structures, tactics adopted by targets and acquirers, and developments shaping the future of the Australian M&A market. The statistics in this article are taken from The Real Deal and Clayton Utz's survey of all Australian public M&A deals announced in 2011 with deal value over $50 million. If you would like to request a copy of THE REAL DEAL 2012, please email Luke Wilson on lukwilson@claytonutz.com
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.
