Uncertainty is said to be the enemy of deal making. Yet, the number of takeovers and schemes of arrangement that were announced in Australia between April and September this year was almost the same as for the equivalent period in 20191. This surprising result suggests that parties in public M&A transactions are finding ways to deal with the uncertainty created by COVID-19.
We reviewed every takeover and scheme of arrangement announced in Australia since 30 April 2020 (until 1 September), to see how the parties dealt with the risk that the target business might be subject to a material adverse change after announcement. Our assessment showed that in almost 90% of cases, that risk was substantially borne by the bidder. This suggests that bidders are becoming increasingly confident that they can accurately assess COVID-19 risk and price that risk into their bid.
Protecting against material adverse change
Bidders in public markets transactions generally seek to protect themselves against negative events that arise after the bid is announced, by including a ‘no material adverse change' condition in their offer terms (a MAC condition). A MAC condition allows the bidder to terminate the bid where events that constitute a ‘material adverse change', as that term is defined in the bid documents, occur after announcement.
While every deal is different, the bidder's right to terminate for a material adverse change is not often absolute. The market expects that a bidder will take on known or generalised risks without reserving a right to terminate. Accordingly, it is a common construct that circumstances which have an adverse impact across the entire economy, or that are broadly felt in the industry in which the target operates, are carved out from the MAC condition, so that the bidder would not have a right to terminate for those reasons alone.
Closely aligned to the MAC condition is the conduct of business clause. The conduct of business clause typically requires the target to continue to operate the target business according to its ordinary course during the bid period. Often, the clause also expressly restricts the target from taking certain actions that the bidder considers would have an adverse impact on the value of the target, such as assuming more debt or discontinuing key operations. The conduct of business clause generally allows a bidder to terminate the bid if the target takes actions that are in breach of the clause. To the extent that a target takes any such action as a response to a downturn in surrounding trading conditions, the clause can therefore have a similar outcome to a MAC condition.
How is MAC risk being allocated under COVID-19?
In almost 90% of the bids that we reviewed, the bidder could be required to proceed with the offer, irrespective of whether trading conditions deteriorate after announcement as a result of COVID-19. Only two bids included a broad MAC condition that would provide a clear exit for the bidder in those circumstances. In contrast:
- 25% of the bids announced in the sample period did not include a MAC condition at all;
- where a MAC condition did appear, in a further 60% of bids, it was subject to a carve out that would mean that the bidder could not terminate if the material adverse change was caused by:
- COVID-19 or pandemic; or
- a change in general economic conditions2.
Of note, in just under half of the cases where one of these carve outs applied, the bidder did retain the right to walk away from the bid if the effects of COVID-19 or a downturn in general economic conditions were felt disproportionately by the target business relative to its industry peers).
Further, there was:
- One case3 where the bidder could not terminate for circumstances that were known to the bidder at the time of announcement. Arguably this would prevent the bidder terminating for the foreseeable effects of COVID-19.
- Another case4, in which the COVID-19 risk was shared. In that instance the bidder could only terminate if the target's operations were closed by government order for a given time during the bid period. The bidder could not otherwise terminate for a material adverse change caused by COVID-19.
It is harder to assess whether the conduct of business clauses in the deals we reviewed might push some risk back to target shareholders. Whether a particular target might be forced to take one of the prohibited actions in response to COVID-19, and thereby enliven a termination right, will be specific to the circumstances of the company and to the geography and industry in which it operates. Separate analysis undertaken by Corrs and to be released shortly, suggests that a breach of the conduct of business clause was an important factor in those few bids that were in fact terminated because of COVID-19.
It is evident from our analysis that the complex business conditions brought about by COVID-19 have not proven to be a significant obstacle to public markets deal-making in Australia. Bidders have shown that they are up to the task of assessing the risk and pricing it into their bids.
One interesting recent development has been the emergence of variable bid pricing, under which shareholders receive a higher bid price if the target business escapes the worst of the COVID-19 downsides. While these structures do push some value risk back onto target shareholders, they can equally be seen as an attempt to maximise the offer price by not baking in an overly conservative discount for what is becoming an increasingly understood business risk. It will be interesting to see whether that trend continues.
1 Based on a survey conducted by Corrs of all announced takeover bids and schemes between 30 April and 1 September 2020. Does not include indicative proposals that were made public but did not proceed to a transaction.
2 Whether the effects of COVID-19 represent a change in general economic conditions for the purposes of this carve out will depend on the wording of the particular clause. For current purposes it is sufficient to note that these bidders did not feel the need to expressly protect themselves against COVID-19 risk.
3 Euroz Limited bid for Hartleys Limited
4 See BGH bid for Village Roadshow Limited.
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