Article by Derek Van Der Plaat, Veracap M&A International Inc. and Kathleen Skerrett, Gardiner Roberts LLP
From time to time, public companies announce they have hired an investment bank to explore strategic alternatives. This is generally a euphemism to say they feel they are under-valued and are open to selling parts of the company or the company as a whole. Is an announcement required, or even in a company's best interest, when a TSX-V public company makes the decision to seek or encourage buyer interest?
A number of factors should be considered when the board of directors is making the decision regarding when to announce, including:
- Will the M&A process benefit from awareness?
- How likely is a transaction (i.e. are there buyers and is management committed to the decision)?
- How liquid/illiquid are the shares?
- Will the information allow investors to assess the impact of the anticipated transaction?
The following addresses some of the M&A and legal issues for a TSX-V company to consider when contemplating an M&A strategy.
Share Price Considerations
For larger established entities, announcing the hiring of an investment bank to explore strategic alternatives generally results in an upward move in a company's share price. This is to be expected as public shares trade at a minority discount and a 100% sale of a business typically occurs at a control premium. Not to mention, given that the decision to seek a buyer has been made, the company in question is probably viewed to be undervalued by management and the board of directors and, therefore, an even higher than average premium might be expected.
However, a TSX-V company making an announcement that it is exploring strategic alternatives can be a double edged sword. While initially, announcing may result in interest in a company's shares, the downside is that the process of closing a sale can take an extended period of time and eventually shareholder patience wears thin and the share price can slide on the disappointment of no news. A declining share price trend during due diligence may become an issue and a factor in the buyer potentially wanting to renegotiate terms or abandoning the transaction all together.
Share liquidity is another important consideration that has a substantial impact on equity value. To state the obvious, a TSX-V company is not like GE or Ford. If either of those companies announced they hired an investment bank, the share price would rise immediately to a level where the probable course of action would be valued and the transaction would happen because there is strong liquidity for these types of assets. The same cannot be said for a TSX-V company. Many TSX-V companies are early-stage companies, that may not be profitable and some are even pre-revenue. Therefore, if the company in question is a "trade by appointment" type of company, it will be very hard to predict what impact buyer interest will have on the share price and, even if it moves up, the board's view on the intrinsic value of the company may still vary greatly from the traded equity value.
For TSX-V listed companies, share price can vary dramatically from intrinsic value. If this is the case, the impact of an M&A announcement is far more uncertain and can ultimately interfere with actually completing a transaction.
M&A Process Considerations
Announcing that a company is open to strategic alternatives certainly makes the M&A process easier – management is dealing with public information and potential buyers will surface. There is less potential for confidential information leaks, senior management and board members can communicate strategy more freely and there is the potential for immediate interest from suitors.
If a company engages an M&A firm and decides not to make an announcement, management has to follow a process that safeguards the company information being communicated. The first item to be addressed after a banker is engaged is decide who is an insider and implement trading restrictions on those insiders. Management must ensure that their internal black-out policies are being complied with to ensure no improper trading occurs.
Once the marketing starts your banker will approach possible buyers with a no-names description (a teaser) of the opportunity - this should be signed off by counsel. The teaser should be written in such a way that the average investor would not be able to tell if the banker represents its client or a competitor (i.e. it would describe the general business characteristics yet not give away who it is - this also needs to be judged in the context of who is being approached. A tier one competitor in the same city would receive a different teaser than a foreign company in a complementary sector). If parties are interested they would have to sign an NDA and this NDA would, in addition to more common clauses like a non-solicit clause, include a standstill clause not allowing these parties to acquire the potential seller's shares for an appropriate period of time. Once a well-constructed NDA is signed, communications can flow freely.
The relevant legal considerations in deciding whether to announce a company's M&A activity, allow a board of directors to exercise their discretion. Both the TSX-V and the securities regulatory authorities have requirements on when material non-public ("MNPI"), or inside information, must be disclosed. These rules provide scope for directors and, in fact, require them to exercise judgment. For example, the definition of a "material change" in the Ontario Securities Act (the "OSA") defines it as an event "that would reasonably be expected to have a significant effect on the market price or value of the securities of the issuer". Similarly, the TSX-V defines "Material Information" as information "that results in or would reasonably be expected to result in a significant change in the market price or value" of the TSX-V company's listed securities. When considering whether the decision to seek a potential M&A transaction is disclosable, the board should assess whether it meets these criteria.
In applying the tests set out above, a board should assess whether (i) there is enough certainty that a transaction will follow, and (ii) that it would be reasonable for the market to react if full information is available. It is fair for a board to argue that in many circumstances the variables surrounding the type of transaction that may develop and the price at which such transaction could be undertaken are so broad that a reasonable investor could not assess the impact on the value of the company's shares. If that is the conclusion, no announcement needs to be made but the board should regularly reassesses the progression of events and make the announcement once enough facts are known to allow investors to assess the impact of an actual transaction.
A 2008 decision of the Ontario Securities Commission (the "OSC"), highlights how advanced a transaction may get before an announcement is required. In AIT Advanced Information Technologies Corp. (Re) (2008), 31 O.S.C.B. 712, the OSC held that the decision by the target board to execute a non-binding letter of intent to be acquired did not constitute a material change as the transaction still required approval by the AIT board which was not certain to be obtained. The OSC stressed that the determination of whether a material change has occurred is very fact specific and boards of directors should carefully assess their situation. The OSC also indicated that an intention to do something was not necessarily sufficient to trigger an obligation to disclose if there are factors that are beyond the control of the company that prevent completion of the intention.
The TSX-V is a unique, small company market. It is a market where, in certain cases, a lack of trading liquidity can result in share values more influenced by demand and supply than by underlying intrinsic value. Due to the generally early stage nature and potentially large divergence between traded share price and board expectations, a decision to seek a buyer for a TSX-V company may not necessarily result in a transaction. Typically, a considerable amount of uncertainty remains about the outcome of the M&A process and it would be misleading to suggest that the board is committed to a particular direction that may not pay off. In fact, it may actually do more harm than good to announce an intention to be in play when there is no proposed buyer at the table. Such information could be seen as misleading and if it did result in a change in the share price when there are no potential buyers on the horizon there could be a risk of future shareholder action.
The AIT decision supports the position that the mere decision to seek an M&A transaction does not necessarily constitute disclosable MNPI where factors beyond the control of the TSX-V company, such as actually locating an interested buyer and coming to an agreement on acceptable terms, are unresolved.
If there is uncertainty about whether acceptable offers will be found, then proceed in stealth mode. Ultimately, an announcement will have to made, but only when there is enough information available to allow a reasonable investor to assess the impact on the value of the company's shares.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.