Monthly Archives: November 2015

An unsolicited approach: Let battle commence

Boudicca soloMy earlier article talked about how a board should respond to an unsolicited approach for the company. This looked at a straight-forward offer that the board has to review and accept or reject. However it’s not always so easy, as much depends on the attitude and tactics of the offeror.

The chairman of one of my competitors, calling out of the blue, explained that they were about to offer for my company. They had already spoken to my two biggest shareholders, who had signed irrevocable commitments to vote their shares in favour of the offer. Since their combined shareholding was pretty much 50%, the chairman explained, it was just a matter of us handing over the due diligence they required, and the deal would be done. This is what is known in polite terms as a ‘bear hug’, and would be classed as an unfriendly approach.

Friendly or unfriendly?

The tone for an offer will inevitably be set by the offeror’s first contact with the target. That initial approach could be direct to your chairman or indirectly via your advisers. It can be made on an exploratory, friendly basis; such as, “We think that this is a good idea. Would you be interested in exploring it further?” It could be on a firm, but friendly basis; as in “Here is an offer at X pence per share. Would you consider it and perhaps we can talk about it further?” Or it can be delivered as an unfriendly ultimatum. A ‘bear hug’ is where either the initial price is a knock-out one or sufficient target company shareholder support has already been secured behind the board’s back. In either case, the offeror aims to position the target board so that it has no option but just to accept the offer.

So why do some offerors start off unfriendly? There are a number of possible reasons;

  1. The offeror believes that the target board will not act rationally in the interests of its shareholders. There is therefore no point in trying to be friendly.
  2. The offeror believes itself to be in such a strong position, through a high price or shareholder support, that it does not need to be friendly.
  3. Either the offeror or its adviser is innately aggressive and believe that being unfriendly is a good tactic.

In my experience, none of these reasons are very good ones. Most boards will, in the end be rational, and will be urged to be so by their advisers, acting in their own view of shareholder interests. A powerful offer is not weaker for being friendly. In this example, I think that the competitor believed it was in an unassailable position, and it was counselled by poor quality advisers to deliver the offer as an ultimatum.

What are irrevocable commitments?

To the man in the street, an irrevocable commitment is one that you cannot get out of. However, in the streets of the City, nothing is ever that simple. It is imperative therefore, that the target board gets hold of either the actual irrevocable document or an impartial summary. From my experience, you cannot rely on a summary produced by the offeror or its advisers.

The key point is that an irrevocable commitment can have conditions attached to it, ie actually be revocable.   The UK Takeover Panel, which tends to take a legalistic approach, will even allow a revocable agreement to be called ‘irrevocable’ in public announcements. However it can take a tougher line if an announcement adds more detail to the ‘irrevocable’ without also giving any explanation of material conditionality.

In my example, one of the ‘irrevocables’ was conditional on my board actually recommending the offer. This was not therefore a true ultimatum, as the board duly rejected the offer and the irrevocable fell away. The stranglehold that the offeror thought it had was dependent upon not revealing the true nature of the shareholder commitment.

Cash and shares

A cash offer has a value, which should be unchanging and clear. However, if the offer is in shares, neither of those may be true;

  1. The offeror’s share price may move on the announcement, either up or down, depending upon shareholders’ views of the attractiveness of the bid.
  2. The offeror’s share price may move during the process as a result of market moves or new developments.
  3. If the offeror’s shares are trading at a premium, the target board will need to consider what the ‘true’ value of their shares is.

A share offer is therefore inherently uncertain. Furthermore, if the nominal share offer is increased, it may not result in a higher effective price. For example, if an offer in stock is increased, but the offeror’s shareholders think that this is too high, then the offeror’s share price may fall. This then reduces the value of the offer.

The relative share-price premia need to be considered. Take a property company offering for another very similar one. The offeror is likely to feel strong enough to make the offer because it has a healthy premium to its net asset value. Let’s say that it has a 20% premium, whereas the target trades at NAV. The offeror may offer a 10% premium for the target’s shares, but in practice the target shareholders would still be left owning a lower NAV per share than before. The same could be true of earnings per share, but synergies may soften this.

Advisers

A board should ensure that it has good advisers. There is no substitute for good, experienced advice, and preferably from more than one source. The best chance of getting a deal done is also for the other side to have good advisers too. I have known situations where one side even recommended particular advisers to the other party. The worst situations are always when the other party (offeror or target) has inexperienced, out of their depth or macho advisers.

Summary

  1. If an offer comes in on an unfriendly basis, there is a good chance that it will end up hostile.
  2. Keeping the process ‘friendly’, at least initially, should be in everyone’s interests.
  3. ‘Irrevocable’ commitments can be anything but. Make sure that you know the full facts.
  4. Be especially careful of offers in shares and what they really mean for value.
  5. Employ good advisers, preferably more than one, and hope that the others do too.
  6. Whatever happens, stay rational and do what’s right for your shareholders.

My next article will run through what tends to happen next following the receipt of an offer.

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What if you get an unsolicited approach for the company?

Dangerous gamesI was having a good day, sitting in my office sorting a few things out. Then, late afternoon, the phone rang. It was the Chairman of one of our competitors. I hadn’t spoken to him before, but this was no comfort, as he revealed that they were about to make an offer for my company.

As a non-executive, the first you may hear of an approach like this is when an urgent board meeting is called. There will probably be bankers, possibly lawyers too, at this meeting advising the board on its responsibilities, but this article will cover the basics so that you know what to expect and what questions to ask. It is a practical guide for non-execs, not a legal one, and based on the UK system.

An unsolicited approach

This is exactly what it says. An approach to the board, to make an offer for the company, that was not requested by that board. It may be out of the blue, as in my case, or there may have been some suspicions that it would happen. Some commentators describe every such approach as ‘hostile’, but this is not right.

An unsolicited approach may not be unwelcome, you just didn’t ask for it.

The first task is to assess whether the approach is genuine. This may seem strange, but fake takeover bids have been made. In 2015 a small unheard of company launched a takeover offer for cosmetic giant, Avon, but this subsequently appeared to have been merely an attempt to manipulate the share price. Assuming that the approach is genuine, the next step is to consult your advisers.

The “Rule 3” advisers

The board will need to get advice from its independent advisers (“Rule 3 advisers”). They should give you independent advice on how to proceed. Importantly they will give you a view on the ‘value’ of your company and therefore if any offer is worth serious consideration (“recommendable”).

It is worth at this point making sure that you know the fee structure for your advisers. This should be reviewed and approved by the Audit Committee, but if this offer is a surprise this may not yet have happened. One of the oddities in this process is that the Rule 3 adviser is often heavily incentivised to get a deal done, typically at a higher price than the initial offer. They may get a fee only if a deal happens, or if not, almost certainly an extra fee if a deal actually completes. Against that, a successful takeover may mean that they lose a client. The adviser is usually, on balance in the short-term, financially better off from getting a deal done.

How do they value your company?

The advisers will bring a pack full of numbers. There are two basic ways of measuring; comparables and absolute. The comparables will be using measures such as PE ratios, EV (value of shares plus net debt)/Ebitda, and market cap/net asset value. These may be based on trading multiples in the market or comparable takeover or merger offers. All of these are useful.

Absolute measures will include net present value (NPV) or net asset value (NAV). The NAV will be most useful if the company is a property company, where an acquirer is most interested in just getting its hands on the assets. The NPV is pretty useless. This is because it will tend to be based on management’s forecasts of profit and cash, discounted at an estimate of the company’s weighted cost of capital (WACC). However it generally takes no account of risk, so it’s the value if everything goes to plan (and show me a company in which everything goes to plan). Some will like the NPV valuation as, not surprisingly, it tends to show a value much higher than other forms.

The control premium

You expect an acquirer to offer a price above the current share price. The question the board will face is how much higher should it be to be recommendable? This is the ‘control premium’; the extra an acquirer should be expected to pay to get control of the company, as opposed to just buying some shares. The starting point is generally a premium of 30% above the current share price. This is just a custom and practice benchmark, but nevertheless an important one.

In some sectors, such as property, 30% may be rather high as the bidder may be looking largely just to acquire assets. The comparables of similar deal premia will be helpful as context.

The current share price is usually taken as the price at the close on the day before the Offer is received or announced. However this can be very misleading if the short-term share price has been volatile. It may be better to look at the 3 month average in that case. However, like it or not, markets get very focussed on the spot price.

The Board decision

“Advisers advise, but directors decide.” This is one of the most important aphorisms for corporate governance. The advisers are likely to say, if pushed, whether an Offer is “capable of being recommended”, largely based on the above comparison ratios. The board will then have to decide whether it will recommend. It will want to discuss its own private views of the company’s prospects. Some directors may not believe management’s forecasts are achievable or others may think them too conservative. Some may believe that the company is still undervalued because they see strategic developments that could increase value in the future, while others may believe that there will be trends that will put pressure on value in the future.

The board should always be putting the interests of their shareholders as a whole at the forefront. There may be some shareholders however, who would prefer a deal for other reasons, such as their desire to be bought out. The board should be aware of these individual interests, but keep referring back to the overwhelming interests of all shareholders.

No director would be human if they didn’t think about their own position. An acquired board would be likely to be dismantled and both executives and non-executives may become redundant. Directors should try to ignore their personal interests, however difficult this may be.

The board will also want to consider whether the Offer is really likely to be deliverable. Is the offeror credible? The Offer letter should have details of how they intend to finance the bid; by new equity issued for cash or swapped for the target company’s shares, loan facilities (that should already be lined up) or some combination. What shareholder approval do they need from their side and have they already got support from major shareholders? Are their anti-trust issues, if the offeror is a competitor, supplier or customer to the target?

Do not assume that just because an Offer is being made that the other side can actually deliver on it.

Recommended or hostile?

If the first you hear about an Offer is when it is an RNS or leaked in the media, then it will be difficult to avoid it being hostile. The board will be on the back foot and, unless it is at a knockout price, the board will want at the very least to get the price up.

However, most Offers will come, as mine did, in a private approach. This gives the board time to consult with advisers and consider the matter out of the glare of publicity. The Offeror may apply certain constraints, for example. They may give a deadline for a response, with the threat of going public or withdrawing the Offer if not accepted in time. The former is a very aggressive tactic applied by a party that thinks this will go hostile. The latter is only likely to work if the price offered is a very full one.

In general, however the initial offer will probably not come with threats, so the board is not required to make an immediate response. However, the board may be advised to have a response ready within a week or so to avoid the impression that it is not taking it seriously.

The board’s response can be to;

  1. Accept the first offer, perhaps with conditions. This is only likely if the price is a knock-out one. Conditions could be that subsequent due diligence is completed quickly, cash facilities are verified and that no leaks occur.
  2. Reject, indicating that the price is unacceptable. This is opening the door to further negotiations with the offeror, but only at a higher price.
  3. Reject the offer, saying that the time is not right. This is more of a brushoff, perhaps because the starting share price is unusually low or new management is only just coming on board.

The offeror must now decide whether to give up, to negotiate further on price or conditionality or to go hostile. Unless they do go away, battle will commence. My next article will take you through how the battle lines are drawn and what to expect from there.

Summary;

  1. An unsolicited offer is not necessarily hostile. It becomes hostile when the offeror persists against the target board’s wishes.
  2. Confirm that the offer is genuine and the offeror has the resources to carry it through.
  3. Place great reliance on your Rule 3 Advisers, but don’t take everything they say as gospel. Advisers advise but directors decide.
  4. Use comparables, both relative and absolute, plus the board’s private view of its prospects to decide what value you put on the company.
  5. Expect a control premium to be paid by an offeror.
  6. Try not to let the personal situations of either yourself or other directors influence your position.
  7. The initial offer is very likely to be rejected as too low. The offeror will expect this.
  8. The big decision initially is whether to reject but leave the door open to a higher offer, or whether to try to make the offeror go away.