Drivers of share-for-share offers
M&A is an important tool for growth, although in the last few years the reaction to major M&A from corporate bidders’ own shareholders has been mixed, with many investors favouring returns of excess cash rather than reinvestment in M&A. In addition, with higher cost of debt there is an increasing desire to deleverage or not take on high levels of additional debt in order to finance growth.
However, where a combination offers the prospect of cost synergies, this can present a compelling value-creation proposition for shareholders, often with a relatively high degree of certainty and speed of delivery. This is particularly the case in the current environment where many businesses are grappling with a higher cost base which they do not necessarily have the scale or growth trajectory to absorb on their own without impacting their equity value. In a share-for-share offer, the opportunity for target shareholders to realise and share in those cost synergies is often an essential part of the rationale for the deal. This future upside can be used by bidders to execute a deal with a lower premium than might be required in an all-cash deal.
In addition, a clear equity story on the future growth potential of the combined company (“better together”) is an essential part of getting a deal done and demonstrating value creation beyond the day one premium and cost synergies. This piece often needs time to be developed through engagement between the management teams of the two companies in order to build confidence in the industrial logic of the deal.
In addition, in the light of the relative performance of the US equity market compared to other markets in recent years, we are seeing US bidders point to the valuation uplift that target shareholders can achieve by exchanging shares in a non-US listed target for shares in a US listed bidder. If the new shares are valued by the market on the same multiple as the bidder’s existing shares, in some cases this will present significant further value creation for target shareholders. This point always needs to be assessed carefully as market valuations are driven by a number of factors.
Tactical considerations
Initial engagement between the parties
Executing share-for-share deals usually requires a high degree of positive engagement between the parties.
Given the focus on synergies and the ‘equity story’ for the enlarged group, share-for-share deals typically necessitate a more collaborative approach than may be necessary on an all cash offer. The early-stage engagements between bidder and target are critical to establish trust at a senior level and agree a clear rationale for the combination. This often leads to longer negotiating period on the terms of the combination and the merger benefits than would be expected on a pure cash offer.
Keeping these discussions secret is key. Early leaks can lead to untoward share price movements for both parties which can significantly diminish any premium. Keeping the circle small for as long as possible is a sensible approach.
Some of the tactics which might be used to force target engagement such as a ‘bear hug’ possible offer announcement (where the aim is to involve shareholders in the debate on the rationale for the deal) are usually less effective where share consideration is involved, given shareholders are not necessarily well placed to fully assess the synergy benefit and other potential upside until further details are published (which requires accountants reports in the case of quantified synergy statements). This can mean that, compared to an all-cash deal, a bidder’s options are more limited if it struggles to gain traction with target management.
Launching a hostile offer with listed equity consideration is likely to run into similar difficulties. Due diligence and a high degree of collaboration between the parties is normally essential in developing a convincing equity story, quantifying synergies and selling the transaction to both sets of shareholders.
The target board perspective
For a target board, as with any bid approach, the initial focus will be on assessing the value of the share for share proposal against the stand-alone value of the company. To fully understand the potential future upside in the proposal, more information will be required from a bidder than on a cash bid. In particular, the target board will need to understand the deliverability and timing of the synergies and the costs of achieving them, as well as getting comfortable with the industrial logic of the combination and growth potential of the combined group.
The governance of the combined group is also important, particularly where target shareholders will hold a substantial part of the equity of the combined group. The target board will need to be comfortable that the right leadership team will be in place in order to deliver the merger benefits for the benefit of their shareholders, with the target management having appropriate representation in the combined management team where that expertise is considered necessary.
If these pieces fall into place, the future upside opportunity can make a share for share offer compelling compared with the standalone strategy of the target, and may be favourable in comparison to a cash offer which may crystallize an exit at a lower value than might be achieved through the combination.
In negotiating the deal, the target board needs to consider how hard to push a bidder on key terms, particularly the split of equity and share of synergies between the two sets of shareholders, as well as the level of any cash component (which is likely to have a consequential impact on the leverage position of the combined group). If the parties do not strike the right balance, the bidder’s share price may suffer after the deal is announced. Support for the deal from the bidder’s own shareholders is essential in supporting the bidder’s share price and therefore the value of the offer through to completion.
Addressing interloper risk
Minimising the risk of losing a deal to a rival bidder is a key consideration on any takeover. This is relevant in the context of share for share exchange offers, which the value of the offer will fluctuate in line with the bidder’s share price.
The UK public M&A regime provides an open field for competition between bidders, with the target board free to withdraw or switch its recommendation at any time before closing. A bidder for a UK company is only able to obtain, deal protection in the form of:
- deal terms (price/exchange ratio , synergies and conditionality) which cause a potential competitor to think twice about getting involved;
- any advance shareholder support it is able to obtain in the form of irrevocable undertakings; and
- the advantage of timing and momentum (first mover advantage).
Whilst a cash bid offers immediate and certain value, the value of the synergy benefits of a share-for-share offer may raise the bar to a level which would make it difficult for a private equity or other cash bidder to compete. However, maintaining the offer value through a positive reaction in the bidder’s own stock is essential to remaining in a robust position to defend against interlopers up to closing.
Key issues to consider
Synergy statements
Quantified financial benefits (i.e. synergy) statements must be accompanied by reports from the bidder’s accountants and financial adviser. The preparation of these statements and reports, using data provided by both bidder and target, takes time which needs to be built into the transaction timetable. This work is often undertaken whilst the potential transaction remains secret but where there is the ever-present risk of leak. Thought needs to be given as to what public statements can be made in the event of a leak in relation to the benefits and rationale of the merger in order to build support for the combination in the absence of quantified statements, if not ready at the time of any leak.
Profit forecasts
Similar requirements apply in relation to profit forecasts, including forecasts required to be published under any securities laws applicable to the bidder. For example, in the US it is often the case that the fairness opinion provided by the bidder’s financial adviser in the bidder’s proxy statement (if one is required) will include forecasts for the combined group. These are likely to constitute profit forecasts for Code purposes and therefore require preparation and reporting in accordance with the Code, in addition to the applicable US requirements.
Deal protection
The merger control environment is increasingly challenging to navigate, with more deals than ever being prohibited or abandoned on antitrust grounds, and authorities showing very limited appetite to accept remedies (e.g. divestments of overlapping businesses) to resolve perceived competition concerns. On a share-for-share deal, the parties’ interests are largely aligned in ensuring that the deal is approved without adverse impact on the combined group. However, the allocation of execution risk (e.g. in the form of commitments to take steps to secure clearances and/or a reverse break fee) is a matter of negotiation. In the UK, targets are prohibited from entering into any form of deal protection in favour of the bidder (e.g. break fees and ‘no shop’ commitments), whilst there is no such prohibition on the bidder granting any protections to the target (e.g. a reverse break fee). These provisions need careful consideration and will be driven by the substantive execution risk in the deal and, on a “merger of equals” (or similar), potentially a desire for a balanced position on risk as between each set of shareholders.
Secondary listing
A traditional concern on share-for-share offers is “flowback” risk, namely the risk of target shareholders being unwilling or unable to hold the bidder’s stock and exiting their positions in the combined group quickly after closing, causing downward pressure on the bidder’s share price and impacting the value of the combination for both sets of shareholders. Given the international reach of many investors, this concern is considered to be less acute than it once was. However, the target’s shareholder register needs to be assessed in order to form a view on the percentage of shareholders able and willing to hold shares listed on the bidder’s home market. A secondary listing for the bidder’s shares on the home market of the target company may be considered to mitigate flowback risk if needed, although many investors prefer to hold securities listed on the primary market of the bidder where there may be greater liquidity. If a UK secondary listing is required, a prospectus may be needed which needs to be factored into the deal timeline.
Intention statements
A bidder is required to state its intentions for the target’s business, locations, management, employees (amongst other areas) in the offer documentation, and the target’s board is required to set out its views on those intentions. These statements must be accurate and made on reasonable grounds, and compliance with the stated intentions must be publicly confirmed 12 months after completion. Where synergy statements are included, there is often greater scrutiny of the intention statements to ensure they accurately set out how and where those synergies will be achieved (e.g. any expected headcount reductions or location closures). Time should be allowed for the Takeover Panel to review the draft intention statements before publication of the firm offer announcement.
Due diligence
Reciprocal due diligence should be expected on a share-for-share offer. The target will be conscious of its obligation under the Code to provide the same due diligence information to any other bidder that may emerge, which often operates as a constraint on the extent of detailed due diligence information made available. A mutual NDA will be required at the outset, often including “standstill” obligations on the bidder not to acquire target shares or make an offer announcement without consent; the Code prohibits the target from agreeing a reciprocal standstill in favour of the bidder. Commercially sensitive information required for regulatory and antitrust analyses will usually to be provided through a “clean team” arrangement.
Advantages and considerations of using listed equity as consideration
