While historically rare in the UK marketplace, discussion of “rollover” opportunities for target shareholders has risen up the agenda for bidders in UK public M&A deals over the last 12 months.
In this context, a “rollover” usually refers to an arrangement in which a target shareholder is offered the opportunity to exchange (“roll”) all or part of its shareholding in the target for a shareholding in the bid vehicle. This involves the target shareholder forgoing some or all of the cash consideration to which they would otherwise be entitled in return for retaining an ongoing interest in the target.
As we have reported in “How Target Shareholders are Attacking Bids on Valuation Grounds”, there have been a significant number of disagreements between bidders and major target shareholders on the appropriate valuations of target companies.
Offering target shareholders a rollover opportunity is an attractive solution to this valuation gap and offers a creative alternative to a simple price increase.
But structuring rollovers in UK public M&A transactions is easier said than done. A fundamental principle of the Takeover Code2 is that all target shareholders of the same class must be treated equally.
Rule 16 of the Code extends this principle by adding that bidders must not make special deals with selected shareholders unless these are offered to all shareholders. This generally means that bidders in UK public M&A transactions cannot offer a major target shareholder a selective rollover opportunity where that is not being made available to all target shareholders.
To add to this, most bids in the past few years have involved private equity bidders which, unlike listed corporate bidders, are not able to offer conventional listed securities3 as consideration.
There are two main options for structuring rollovers in UK public M&A deals4:
Joint Offeror Status
The first is where a target shareholder is regarded by the Takeover Panel as a genuine “joint offeror”. Where the Takeover Panel grants this status, the target shareholder in question is permitted to roll over its stake (and make other special arrangements with the other bidder) even if other target shareholders are only offered cash consideration.
Because joint offeror arrangements appear to contravene the Code’s General Principle on equal treatment of shareholders, the Panel subjects applications for joint offeror status to intense scrutiny.
The Panel’s criteria for assessing joint offeror status were originally set out during the bidding war for Canary Wharf in 20035. The general test is that a joint offeror is:
“A person who, alone or with others, seeks to obtain control of a company and who, following the acquisition of control, can expect to exert a dominant or at least significant influence over the company, to participate in distributions of profits and surplus capital and to benefit from any increase in the value of the company, while at the same time bearing the risk of a fall in its value resulting from the poor performance of the company’s business or adverse market conditions.”
In assessing this, the Panel will ask a series of probing questions about the purported joint offeror, the most important of which are:
What proportion of the equity share capital of the bid vehicle will the person own after completion of the bid? Where there are only two bidders, the rule of thumb is that each will usually need to hold at least 30% to achieve joint offeror status.
Will the person be able to exert a significant influence over the future management and direction of the bid vehicle? Board representation, shareholder voting rights and veto/minority protection rights are all important.
What contribution is the person making to the consortium, be it in the form of new equity financing, management input, the contributions of assets or political influence?
Will the person be able to exercise decisive influence over the conduct of the bid? When did the person’s involvement in the bid begin, and is their approval required for setting the terms of, and revising, the bid; and/or waiving material conditions to the bid?
Are there arrangements in place to enable the person to exit from its investment in the bid vehicle within a short period, or at a time when other equity investors cannot? If so, the Panel is unlikely to regard the person as a joint offeror.
None of these individual factors are determinative, but their combined impact means that the barrier for joint offeror eligibility is set at a high level. The result is that there have only been around 10 completed joint offeror deals over the last five years.
While the barrier to joint offeror status may be elevated, it is far from insurmountable. A notable recent example of a major target shareholder being granted joint offeror status by the Takeover Panel is Cascade Investment’s joint bid for Signature Aviation PLC earlier this year.
Under the bid, Signature shareholders were offered $5.62 per share in cash. Cascade was the largest shareholder in Signature prior to the bid with a ~17% shareholding. Cascade was granted joint offeror status by the Takeover Panel, which allowed it to join the bidding consortium. Cascade rolled over its shareholding into the bid vehicle and also provided equity financing to part-finance the bid, such that it owned 30% of Brown Bidco Limited following the bid.
Cleary Gottlieb advised Cascade on its joint bid.
Stub Equity Alternatives
The second involves the use of “stub equity” arrangements, also known as an “unlisted securities alternatives”. This involves a private equity bidder offering target shareholders the opportunity to roll over all or part of their stake into the bid vehicle instead of receiving cash consideration.
Electing target shareholders receive illiquid securities in the bid vehicle and, in practice, this tends to form only a small part of the overall consideration, hence the name “stub equity”.
Stub equity alternatives must be open to all target shareholders to comply with the equal treatment principle. In practice, only a small number of shareholders will be able and/or interested in receiving illiquid securities instead of cash.
The precise terms of the stub equity can vary significantly depending on both bidder and target shareholder preferences, including in terms of transferability, voting, and other governance rights. But as a general matter, stub equity will be structured in a way that avoids electing shareholders interfering in the private equity sponsor’s ability to manage the target business as it sees fit post-closing.
Recent examples of the use of stub equity in the UK public M&A market include TDR Capital’s bid for Arrow Global, Tosca Penta’s bid for TalkTalk and TowerBrook and Warburg Pincus’s bid for AA PLC.