Company directors in Australia are more likely to find themselves contemplating a takeover offer than at any other time in the past decade, as the markets monitor the superheated mergers and acquisitions sector.
In exercising their duties when presented with a merger and acquisition (M&A) deal, there is a range of considerations for directors beyond the offer price, when they decide whether or not to firstly engage with the bidder and then to accept or reject the offer. That Friday afternoon phone call from an acquirer can place enormous pressures on company directors, who may face close media scrutiny as they assess the bid and decide whether or not to engage. They have to be prepared to publicly justify their view of the company if they turn down the approach.
Last year was a record year for mergers and acquisitions in Australia, despite COVID-19 disruptions, closed borders, supply chain challenges, climate change concerns and a spotlight on ESG. Some 62 deals valued at over $50m were announced in 2021, up from 42 in 2020 and 41 in 2019, according to figures collated in law firm Gilbert + Tobin’s Takeovers + Schemes Review 2022. Even more striking is the total deal value — $130.5b, compared to $23b in 2020.
Boards need to start preparing for a possible takeover well before any offer is received, says Pat O’Sullivan MAICD, a director of Afterpay when it accepted Block’s (then called Square) takeover bid in February 2021. The board and management need to undertake a regular valuation exercise on the company’s worth so they are well prepared if the chair receives an approach. Once the bid arrives, the real work begins. “You then need to really knuckle down and make sure you’re comfortable that the model is actually now up to date and truly reflects your best view on a good day, and your best view on a bad day as to what the value as a going concern in its current structure truly is,” says O’Sullivan.
While price isn’t the only consideration for target company directors, it is central to their deliberations, but even then it isn’t just the number. If the price is above directors’ and their advisers’ valuation, then a decision is more straightforward. However, often it can be below the board valuation, but above the price the share market is assigning to the stock. “The benchmark is always if we reject this offer at this price, do I truly believe the company will trade at that price in the not too distant future?” says O’Sullivan, who is chair of Carsales.com, TechnologyOne and Siteminder, and a director of Calvary Health, which acquired aged care provider Japara Healthcare last year in a public takeover.
Sometimes the board will need to explain the valuation gap by releasing more information to the market that might convince investors their shares are worth more in the long term by not selling now. Cash offers can also be more straightforward than scrip offers, because in the scrip scenario, target company directors also have to assess the valuation of the acquirer and consider how the two companies will fit together culturally, among other things, because the value of the scrip will finally be determined by the value of the combined businesses.
If a board decides to engage with a bidder, this will ultimately involve opening up the company books for due diligence. But directors need to be careful about revealing too much, particularly when they are in discussions with a competitor.
O’Sullivan faced this issue in 2015 as an iiNet director when the company received a takeover offer from David Teoh’s TPG. While the price was good, O’Sullivan says the board wasn’t sure how serious its competitor was with the initial offer. “Are we going to give away some competitive advantage if they walked away that would ultimately hurt us?” The board engaged with TPG, but granted limited access to the CEO and restricted the topics that could be discussed. Ultimately, the deal was successful.
Companies typically have a takeover defence manual and have advisers on standby for when they receive a bid, including corporate, legal and communications. They need to be prepared to communicate with shareholders, staff and customers, and the timing might not be of their choosing. “Although it’s confidential to start off with, it could very well be leaked by the target,” says Duncan Hogg, Oceania head of M&A at EY.
The initial offer from an acquirer usually isn’t their best possible price. Boards can sometimes make a condition of due diligence that a bidder raises their price. Target company directors can introduce competitive tension into the process by making an announcement to the market to draw out other bidders. Once a bidding war emerges, price will be a major factor, but boards will also have to weigh up the completion risk associated with each of the parties.
And there is always the risk that the bidder will walk away after doing due diligence, as happened to data company Appen after Canadian suitor Telus International ditched its $1.2b bid in May. “That can create issues for the director in explaining to the market why the suitor has walked,” says Hogg.
The heat is on
The $39b acquisition of Afterpay by Block was last year’s standout transaction, but not the only large one. There was also the $23.6b acquisition of Sydney Airport by a consortium led by IFM and Global Infrastructure Partners, and the $10.2b acquisition of AusNet Services by a consortium led by Canada’s Brookfield Asset Management.
“In our view, the strong M&A conditions in Australia were driven by low interest rates, strong capital markets, the continuing growth of superannuation funds, increased vaccination rates and a sense that the COVID-19 threat was diminishing, which all supported a growth in confidence,” says the Gilbert + Tobin report. “At the same time, technology trends, digitisation, decarbonisation, energy transition and other ESG matters created a need for portfolio management and acquisitions or divestments.”
Many of these elements have continued into 2022 with a strong environment for the first half of the year. The strength of the second half will depend on interest rates, inflation and capital markets, says Gilbert + Tobin. “Ultimately, while 2022 may fall short of 2021’s heights, we expect a year that will be stronger than most before 2021.”
While the bid price is the major consideration for target companies, there are others.
Rob Goudswaard FAICD — a non-executive director of Cashrewards, which was taken over by ANZ last year, and chair of Cornerstone Healthcare Property Fund —also considers the terms and conditions the bidders might put around an offer along with the terms of the final deal. Bidders will sometimes make a high initial offer, but whittle away its attractiveness with terms and conditions — such as paying part of the consideration now and part in a year. Or they may indicate that they want the business, but without any of its current staff.
Another factor is certainty. For instance, does the bidder have finance or will the bid need approval from the Foreign Investment Review Board (FIRB) or the Australian Competition and Consumer Commission (ACCC)?
Target company directors should take control of the bidding and due diligence process rather than always responding to the bidder and doing as the bidder asks, says Goudswaard. “Some very aggressive buyers will try to take control by making or trying to give the impression that time is of the essence and you have to make a decision now. You get pushed into making decisions quickly because you’re chasing some perceived tight timeline, but I don’t know that you’d actually make the best decision.”
Another red flag in a takeover bid is inconsistencies in what the bidder says verbally and then in writing. “You’re talking to the CEO, for argument’s sake, then the writing comes from the head of strategy. What’s going on here? Something’s not right,” says Goudswaard.
After receiving a takeover bid, directors need to be carful to avoid conflicts of interest. Bids can often come from an existing major shareholder, or other major shareholders might be in the same industry and have their own reasons for supporting the takeover — or not.
Joshua Lowcock MAICD, a director of Prime Media Group when it was acquired by Seven West Media last year, suggests the board sets up a subcommittee to evaluate the bid and commission an independent expert’s report, which then makes a recommendation to the board. It will give all shareholders confidence that the recommendation is unbiased.
Lowcock adds that a takeover offer is an enormous drain of management time and attention and the board has a role in ensuring that management is set up in a way that this doesn’t become a distraction to operating the core part of the business. The company needs to run two paths when it is under takeover offer — one working towards getting the deal completed and the other, business as usual.
“So if anything comes up during the due diligence process or the independent expert’s report and we end up pulling the pin, I haven’t just derailed the business and hurt shareholder value in the process,” says Lowcock.
“From a board perspective, it requires staying a little bit closer to the day-to-day parts of the business to ensure business as usual is kept on the track.”
In the scheme of things
In 2021, the M&A market also returned to the status quo of schemes of arrangement outnumbering takeovers, with four out of five transactions using the structure. Under a scheme of arrangement, the target company board agrees to the takeover and puts it to shareholders. If 75 per cent vote in favour, then the acquisition becomes binding on all shareholders.
Target companies wanting to complete a scheme of arrangement deal need to consider how their share registry will vote — whether there is a major shareholder likely to vote against the deal or a long tail of mum-and-dad shareholders who it will be difficult to reach, warns Lowcock. The process is a lot easier where the share registry is highly concentrated with a large number of institutional shareholders.
Once the takeover has been approved, the board still has a responsibility to set the target company up for success, adds Lowcock. This includes ensuring the acquirer gets the management team they expected, which can involve mentoring and counselling existing management on how to manage the transition. Directors might be asked to continue on the board after acquisition if it is to be run as a standalone entity.
A Treasury review of schemes of arrangements and takeover bids is considering whether courts should still have a role to play in approving schemes of arrangements under M&A deals.
Corporate control transactions in Australia, the review initiated by former Treasurer Josh Frydenberg just before the election, carries the subtitle: Consultation on options to improve schemes of arrangement, takeover bids, and the role of the Takeovers Panel.
The consultation paper consists mostly of broad, open-ended questions and contemplates only one reform proposal — whether the Takeovers Panel should also approve schemes of arrangements instead of the courts. Under the current regime, courts examine the scheme booklet and other supporting materials, and then make an order for the target company to convene a meeting. After the meeting, the target company returns to court with affidavits to show they have sent out the scheme booklet, the vote was passed and they have met other regulatory arrangements. “Going to court for a scheme is a very expensive process and ultimately all those costs are borne by investors,” says Rodd Levy, an M&A partner at law firm Herbert Smith Freehills. “It’s questionable whether or not those costs of going to court add any value in the vast majority of cases where there’s no dispute.”
The consultation paper suggests the Takeovers Panel should add scrutiny of schemes to its existing mandate to regulate takeover bids. But Levy argues the Takeovers Panel — whose 45 part-time members consist of a mix of lawyers, investment bankers and company directors — is ill-equipped to take on this role. He says such close scrutiny of schemes is unnecessary where there is no dispute.
Levy and colleague Robert Nicholson wrote a proposal last year that envisaged a new mechanism that would involve a 75 per cent vote of shareholders and would proceed with no need to go to court or the Takeovers Panel. However, if there was a dispute, that dispute would then be decided by the Takeovers Panel.
The consultation paper is silent on other potential reforms for change-of- control transactions. “Mainly lawyers would say there are lots of areas where the rules for takeovers and schemes could be reformed for the better,” says Levy.
One such reform, he says, could be reconsidering the three per cent creep rule, which allows an acquirer who already owns 20 per cent or more of a company to buy a further three per cent every six months. However, some shareholders believe that if there is to be a change of control, they should receive the benefit of a takeover offer and have the choice of selling into that offer.
There is another debate about whether bids should be subject to a minimum acceptance condition of 50 per cent, as they are in the UK. Currently, bidders can make a takeover offer without a minimum acceptance condition and might end up with 30–35 per cent of the company, which doesn’t leave the directors and remaining shareholders in a very strong position, says Levy.
Private equity/superannuation funds
Last year was notable for the increasing involvement of private equity and superannuation funds in M&A. Private equity (PE) involvement in public M&As hit $44.8b and accounted for 35 per cent of deals by value, and it was a player in many of the largest deals, including Sydney Airport, AusNet Services and Spark Infrastructure.
G+T said 2021 also highlighted the increasing direct involvement of superannuation funds in public M+As. Prominent deals included Aware Super playing a role in the successful $3.5b acquisition of Vocus Group, and the Future Fund and QIC teaming with AGL and Mercury NZ to take over Tilt Renewables for almost $2.7b.
The trend of increasing private equity and superfund involvement in M&A will continue as PE firms raise more funds, which will need to be deployed, and superannuation assets continue to grow, says Gilbert + Tobin. In fact, Australian superannuation assets now total more than $3.5 trillion, significantly exceeding the total market capitalisation of all companies on the ASX.
Private equity firms have long been active in M&A markets and superannuation funds have taken part by way of their holdings in PE funds. The larger super funds are now joining PE in making direct bids as they increase in size and internalise more of their investment capacity, furnishing them with the cash and the capability.
“There is an interest for real asset-style transactions that you can take large stakes in and if the opportunity is there, you can participate in taking them private,” says Damien Webb, deputy chief investment officer and head of real assets at Aware Super.
Direct investment provides super funds with better control of their portfolio, such as when to sell as opposed to leaving the decision to a fund they might be invested in. Secondly, it can reduce fees as some of the real asset investment funds can be “quite expensive”. In most cases, Aware Super is supportive of existing management in a takeover and wants to provide capital to help grow the business, says Webb.
When they receive a takeover approach, target companies are best to have an open mind, provide feedback on the bid and be transparent about how they are making decisions, he says. “Ultimately, it’s up to us to present an offer that is compelling for their shareholders. [Directors] have to act in the best interest of their company and we’ve got to make a case that it’s really worthwhile.”
Like Webb, Andrew Jennings, director of infrastructure investments at global private equity giant KKR, also wants open dialogue with target companies on where they stand with the bid. “If they’re seeing something in their business that we don’t have access to, we are happy to work with them to do some due diligence to better understand their business which may result in the price going up,” he says. “Just dismissing it outright may not necessarily get the best outcome for shareholders.”
Funds often make their private approaches on a Friday afternoon to allow directors to deliberate over the weekend without the pressure of needing to make a market announcement if one is required.
By the time KKR engages a company, it has done as much of the outside-in analysis as possible. “Once that engagement starts to happen with a board, boards can be comfortable that we will be able to follow through,” says Jennings.
Boards can also be more confident the bidders have financing in place when they are PE firms and super funds. In general, Jennings says that working with a super fund tends to be a less complex process than pulling together a consortium, which also comes with the risk of leaks to the media. Like many other acquirers, KKR prefers the all-or-nothing outcomes of schemes of arrangement so it doesn’t get stuck with a shareholding of 50–90 per cent of a target.
Jennings expects continued interest from local and foreign private equity and super funds in infrastructure assets. But as more traditional infrastructure assets are being taken private, investors’ definition of infrastructure is expanding to include assets such as telecommunications infrastructure and waste management.
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