Cleary Gottlieb | How Target Shareholders are Attacking Bids on Valuation Grounds

In the current environment, there is a perception from some sections of the UK market that targets are being sold on the cheap.

In addition, target shareholders are more regularly publicly objecting even to recommended bids, where the target board has come to a view that the bid price is fair having received financial advice from the rule 3 advisor. In relation to the bid by Clayton Dubilier & Rice for UDG Healthcare, the recent public statements from Allianz – that the bid is opportunistic and significantly undervalues the target – and M&G – that the bid does not offer fair value to ordinary shareholders – are illustrative of this phenomenon. These sorts of public statements from the ‘long only’ community have been relatively rare historically.

How Bids Implemented by Scheme of Arrangement are Being Attacked on Valuation Grounds

Most public bids in the UK market are implemented by scheme of arrangement. The other method of implementing a UK bid is a contractual takeover offer, which is used most often in hostile and competitive transactions.

The scheme of arrangement does have significant advantages for bidders vis a vis a contractual takeover offer¹. However there are certain features of a scheme which potentially make it more susceptible to intervention by disgruntled shareholders and activists when disagreements on valuation arise.

Given that a scheme compulsorily binds all of the target shareholders when it becomes effective, the scheme has certain inbuilt features which are designed to ensure fairness. These features include the fact that a scheme must be approved by:

Target shareholders at a target shareholders meeting²; and
The court³.

One of the tactics undertaken by shareholder activists in UK bids implemented by scheme of arrangement is to seek to exploit the minority protections in schemes in an attempt to force the bidder into increasing its bid price. One of the primary methods of doing this is to make submissions to the court at the court hearing to try to convince the court that the scheme should not be approved.

There have been two interesting recent examples – the bids for Inmarsat and William Hill – of shareholder activists attacking bids implemented by scheme of arrangement on valuation grounds by making precisely these sort of arguments.

In each of these examples, the shareholder activists appeared to have been concerned that the board of the target did not negotiate a sufficient premium. These concerns manifested themselves in objections at the court hearing to try to convince the court not to approve the scheme. The objections were broadly that:

The scheme documentation sent to target shareholders was misleading; and
The scheme was otherwise unfair.

More specifically, the crux of the arguments made by the shareholder activists was that the bid undervalued the target – or to put it another way, a better bid might have been possible – which made the scheme unfair, and, as a related argument, the target failed to disclose in the scheme documentation sent to target shareholders some contingency or other fact which demonstrated to shareholders that some other better bid might have been possible.

How Bids Implemented by Scheme of Arrangement are Being Attacked on Valuation Grounds

Target shareholders at a target shareholders meeting²; and
The court³.

The scheme documentation sent to target shareholders was misleading; and
The scheme was otherwise unfair.

In each of these bids, the court rejected these objections made by the shareholder activists. At a high level, the court found that:

What You Need to Know

Fundamental disagreements between bidders, and targets and their shareholders, as to valuation continue to subsist in the UK bid market.
Target shareholders, including the traditional ‘long only’ investors, are more frequently speaking out, and engaging in active resistance, if they perceive the bid to be too low, even in recommended bids.
Bidders and targets should be prepared to manage active dissent from the target shareholder base. This dissent could include disgruntled target shareholders seeking to garner support from other target shareholders to oppose the bid. One interesting way bidders have sought to deal with perceived threats from disgruntled shareholders and activists is to make a binding ‘no increase’ statement under the Takeover Code. One recent example of a bidder using this tactic was in the bid by Berry Group for RPC. After Elliott acquired an interest in RPC, Berry Group made a ‘no increase’ statement. This communicates to the market and to target shareholders that the bidder will not be able to increase its bid price (except where the bidder has reserved the right to do so), thereby potentially neutralizing the threat.

Most bids in the UK market are implemented by scheme of arrangement. Bids implemented by scheme are subject to potential additional threats from disgruntled shareholders and activists.
In lieu of, or in conjunction with, threatening to cause the scheme to be rejected at the target shareholder meetings, disgruntled shareholder activists frequently attack bids implemented by scheme at the court hearing on the basis that the bid undervalues the target – more specifically, this manifests itself in claims that the disclosure given to target shareholders was inadequate and the scheme unfairly undervalued the target.
Particular care does therefore need to be taken to ensure that the disclosure in scheme documentation does not open the door to criticism by shareholder activists. This is especially the case in relation to the description of the rationale for the transaction and the description of the bid process in the ‘background to and reasons for’ section of the scheme documentation.