A look at proposed change to the Takeover Code.

With the recent takeover bid for Cadbury plc (LON:CBRY) in the front pages of every national paper, hostile takeovers have been receiving a great deal of attention in the UK this year.

Stake-building

For an offer to succeed, the “acceptance condition” must be satisfied. A bidder must obtain control (through a combination of acceptances of the offer and any market purchases) of at least 50% of the voting rights.

Typically, a higher acceptance threshold will be specified in order that the bidder can be sure of obtaining sufficient voting rights to achieve its goals. For instance, it may want to de-list the target from the stock exchange (75% of voting shares) or to use the statutory compulsory acquisition procedures to gain complete ownership (90% of shares to which the offer relates).

If the acceptance condition is not satisfied, the bidder can walk away and will not be obliged to acquire any shares for which acceptances have been tendered, though the bidder will usually reserve the right to reduce the acceptance condition to 50% if it so chooses.

On the other hand, where the bidder is willing to run the risk of buying shares outright (and ending up with a stake in the target even if the bid fails), it is common to make on- or off-market purchases of shares in the run-up to or during the currency of the bid. This may cut the costs of the bid (where shares can be bought in the market at less than the offer price) and increase the likelihood of success by locking out competing bidders and generally building momentum.

What is the Panel proposing?

The Code aims to prevent the bidder (together with persons acting in concert with it) from acquiring effective control of the target (30% of the voting rights) before the board has had a chance to advise shareholders on the merits of the bid. In non-recommended bids, it is normally only possible to make purchases beyond the 30% threshold where:

1.    the first closing date of the offer (or of any competing offer) has passed (i.e. at least 21 days after the offer document is published); and

2.    it has been announced/established that the offer (or any competing offer) will not be subject to an investigation by the UK or EU merger control authorities or does not come within the statutory provisions for possible investigation (the “competition condition”)
The Panel is now proposing to delete the competition condition, so that it will be possible for a hostile bidder to make additional share purchases following the first closing date.

Historically, the competition condition was thought necessary because uncertainty about whether there will be a competition investigation could artificially depress share prices, since offers normally lapse in the event of such investigation. It was thought that the bidder might be unfairly assisted by the resulting uncertainty in increasing its holding to strategically significant levels.

In practice, the Panel have taken the view that the only way to establish no competition issue is to get clearance from the merger control authorities, even if on a common sense view there is no real issue.

From the bidder’s perspective the competition condition has always created a Catch 22 situation. It would need to approach regulators formally (and publicly) in advance before the publication of its offer document in order to obtain merger-control clearance by the first closing date. It is easy to see the tactical disadvantages of this approach – the target would be alerted to the bidder’s intentions and could begin fighting the takeover in the regulatory arena.

The timescales could be even longer for EU merger-control clearance. Pre-clearance would clearly also have cost and timing implications.

What kind of hostile takeovers will be affected?

On the basis of the information in the public domain about the dynamics of the Cadbury offer, we do not expect that the proposed rule change would have made any difference to the outcome of that bid.  Moreover, the change is unlikely to affect bids where there is a real potential for merger control issues, as the bidder will likely already have taken steps to seek pre-clearance. However, we think that certain types of takeover would gain greater prospects of success.

We expect that the change will affect cash bids where the bidder (together with persons acting in concert with it) is willing to accept an outcome of any shareholding in the target above 50%.

This is mainly because exceeding the 30% threshold triggers an obligation on the bidder to make a “mandatory offer”. This is a cash (or cash alternative) offer for which the only permitted condition is obtaining in excess of 50% (acceptances and shares purchased).

This is a high-risk strategy, however, because the bidder could end up with a stake of 30-50% but still not succeed in taking formal control. Unless it is able to exit the holding at a reasonable price, it could end up being a major investor of a company with a hostile board.

Conclusion

Given that the target board will have had adequate opportunity by the first closing date to explain any potential market uncertainty which might exist in relation to competition clearance, we think that it is unnecessary and heavy-handed for the Code to prevent shareholders from deciding whether to sell their shares to the bidder.

Equally, where a bidder has decided not to make a merger notification (for instance where competition concerns clearly do not, or are highly unlikely to, arise), we think that it is disproportionate to impose the costs of an unnecessary notification on the bidder purely to “settle the market”. It seems to us that it is a greater distortion of the workings of the market to enable the target board to use the “competition uncertainty” to frustrate a successful bid by a unilateral bidder which is being made by a combination of an open offer and a purchasing program. We therefore support the Panel’s proposed change.

Because the proposed change (if implemented) will only affect a relatively narrow group of hostile takeovers, we do not expect to see any significant rise in takeover activity as a result. However, where a bidder hopes to be able to gain control of the strategic direction of the investment company and is willing to run the risk of a sizeable investment without gaining overall control, bidders may be more willing to go hostile. We may therefore see more listed companies led by very powerful investors.



Bruce McGinn is an associate in the corporate department at Fox Williams LLP, specialising in public and private M&A.
Fox Williams LLP is an independent business law firm based in the City of London. The firm has a strong reputation for both contentious and non-contentious work in its core practice areas of corporate, employment, partnership, immigration, commerce and technology and property. For further information please contact Bruce McGinn on +44 020 7614 2661, email This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or visit www.foxwilliams.com