Atakeover bid is generally good news if you hold shares in the target company but is usually not particularly welcome for shareholders in the predator company.
That is because takeovers are normally pitched at a higher level than the stock market price of the target company. This is known as the bid premium. There is no obligation to pay a bid premium, but if a bidder is keen to buy then it is usually willing to up the ante in order to succeed.
Bidders prefer to get the backing of the target company’s board. If they do, then it is an agreed or recommended bid.
An agreed bid has a greater chance of success, since the target company’s board is urging its own shareholders to accept. The offer has to be sufficiently generous to win this recommendation.
If the target company rejects the approach, the bidder may still go ahead and launch a hostile bid. The terms still have to be attractive enough to tempt the target company’s shareholders to accept. After all, you could sell on the stock market if you wanted to get out.
Hence shares in the target company will usually go up when a bid is announced.
Just occasionally a bid may be pitched below the stock market price. This can happen when a company finds itself in dire financial trouble and a rescuer emerges, but only at a lower price than the stock market was hoping for.
Irrevocable acceptances
In an agreed bid, the directors of the target company will be accepting the offer for any shares that they own and it is possible that other large shareholders will agree to accept also.
It is quite usual in these circumstances for such acceptances to be binding. The backing of a sizeable number of shares, possibly even a majority of them, may be a crucial factor in persuading a predator to launch a bid.
The directors, and any other shareholders who have been privy to the negotiations, may make an irrevocable promise to accept the bid even if a better offer comes along. Alternatively, they may reserve the right to switch sides if a higher offer is made.
Hostile bids
A bid can still be made even if it is rejected by the board of the target company. A spurned suitor can appeal directly to the target company’s shareholders who, after all, own the company. This is known as going hostile.
A hostile bidder is entitled to obtain a copy of the target company’s share register and to communicate with all the people who are on it.
The bidder will send documents setting out its arguments for taking over the company and urging the shareholders to accept. The target company will also write to its shareholders setting out the reasons for rejecting the offer.
If you own shares in a company that is the subject of a takeover offer it is in your interests to read these documents and to weigh up the arguments before deciding whether to accept or reject the offer.
The offeror
Now let us consider bids from the point of view of investors in the offeror. Benefits are distinctly less obvious. Indeed, a bidding company may see its share price fall as investors worry about whether it is overpaying for the proposed acquisition.
Assuming that the bid succeeds, there will be immediate costs to pay over and above the price of buying the target company. If cash has been borrowed from the bank to fund the bid, the interest bill will go up. Redundancies to remove duplication in the workforce will have to be paid for.
Management time will have to be spent in integrating the target company into its new owner and there may be additional costs in making the computer systems compatible or meshing the distribution networks.
The benefits, in contrast, take time to come through.
The bidding company will say when it announces its bid whether it expects the acquisition to be earnings neutral in the first year – that is, when earnings per share for the group would be roughly the same with or without the acquisition.
If the bidder has struck a good bargain, the acquisition could be earnings enhancing from the start, in other words any costs will be immediately more than offset by the gains.
More likely than not, it will take some months, possibly even a couple of years, before the acquisition starts to show its full potential, in which case the takeover will initially be earnings dilutive, that is earnings per share will be reduced at first before rising in subsequent years.
Bid terms
Any company making a firm bid must state the price per share that it is offering and must be certain that it has sufficient financial backing if it is offering cash.
The bidder can offer cash, some of its own shares or a combination of both in return for the target company’s shares. It must clearly state its terms.
Individual shareholders in the target company are not obliged to accept an offer even if it is recommended by the company’s own board. As we shall see when we discuss the bid timetable, it can be good tactics to hold off for a while. Do not be bullied into taking the offer immediately by the tone of the offer document that is sent out to the target company’s shareholders.
Bids may be subject to conditions set by the bidder. If the acquisition is a large one, the bidder may need to seek the permission of its own shareholders to proceed. Where the takeover is between two similar companies it is usual for the bid to be conditional on not being referred to the Competition Commission, which could block it as being against the public interest. If the companies have substantial operations abroad the bid may also be subject to approval by competition regulators in, say, Europe or the United States.
The bid will certainly be conditional on a minimum number of acceptances. This will normally be set at 50% plus one share, which gives a majority stake, but it can be higher, even as high as 90%.
Bidders often stipulate 90% acceptances as a condition when they launch the bid but reduce the level to 50% subsequently. They always have the right to waive – that is, to drop – conditions but not to introduce new ones.
If and when all the conditions have been met or have been waived by the bidder, the bid will be declared unconditional, which means the takeover has succeeded. If all conditions are not met or waived then the bid fails and the bidder cannot make a new approach for at least 12 months.
Compulsory share purchases
Where a company makes a bid and gains acceptances for at least 90% of the target company’s shares, it is entitled to force the tiny remaining minority to accept the bid.
The bidder normally wants full control of the target company and having a few errant shareholders left is a real nuisance. If that happens, separate accounts have to be drawn up for the target company and sent to the remaining shareholders.
At the same time, it is really not in your interests to be trapped into a company with just a handful of other tiny investors. You will be at the mercy of a massive shareholder who doesn’t want you hanging around and you will not be able to sell your shares because they will have been delisted from the stock exchange.
On the other hand, if a sizeable minority of shareholders totalling more than 10% refuse to accept, it may be because the bid price was too low and in that case they are entitled to hang on and hope that they will be offered more at some time in the future.
So again, the 90% threshold may be an arbitrary figure but it is a reasonable level and it is there to balance the interests of all parties.
Loan notes
Many bids come with a loan note alternative, that is, you can accept loan notes rather than cash to the value of your shareholdings.
A loan note is an IOU. You are letting the successful bidder hang on to the cash it owes you rather than taking the money for your shares immediately.
The reason for this alternative is that accepting a bid will usually create a capital gain and investors who have used up their capital gains allowance for the year will face a tax liability.
There is no capital gain on the loan note until you cash it in, so you can spread your gain over more than one tax year.
A set rate of interest will be paid on the loan notes, usually payable every six months. The issuer of the notes will let you cash them in on certain specified dates each year.
Reverse takeovers
In most takeovers a large company takes over a smaller one. This is because the smaller company comes at a lower price and the larger company will either have enough cash to pay outright or it will be able to issue new shares without swamping its own existing shareholders.
The outcome of a reverse takeover may not be straightforward. If the takeover is paid for in shares in the bidding company rather than cash, the shareholders in the target company may actually end up with more than half the shares in the enlarged group.
The most common reason for a reverse takeover is a technical device to give a large unquoted company a stock market listing. So instead of the big company buying the little one and losing the listing, the quoted company bids for the larger unquoted company, paying in its own quoted shares rather than in cash. In such cases management of the larger company usually takes charge of the enlarged group.
Scheme of arrangement
Instead of making a normal takeover offer, a predator may attempt to take control of a target company through what is known as a scheme of arrangement. These have been increasingly popular to the point where they are becoming the norm rather than the exception.
The biggest advantage for the bidder is that it is simpler and cheaper than an ordinary takeover. For one thing, it does not attract stamp duty and it can be a considerably faster process than a formal takeover.
Under a conventional bid, the predator is setting out to buy the shares of each shareholder individually. With a scheme of arrangement, the bidder is asking for permission to buy the entire company in one fell swoop.
Shareholders in the target company must vote on the deal and:
· votes for at least 50% of the shares must be cast
· at least 75% of the votes cast must be in favour.
Shares already owned by the bidding company are not counted.
A 51% acceptance is not good enough, as it is with an ordinary bid. The 75% rule is to protect the rights of small shareholders in the target company so they are not steamrollered into accepting.
Success means that any dissenters are overridden automatically and they must take the offer. It is not necessary to gain the support of 90% of the target company in order to force out the minority.
One disadvantage for the predator is that a scheme of arrangement is more vulnerable to a competing offer from another bidder. There is no point in the predator buying shares in the target company because these cannot be counted in the vote, so it is possible for a rival to buy enough shares in the target company on the stock market to block the arrangement.
A scheme of arrangement requires the support and cooperation of the board of the target company. This is because it is the target company, not the bidder, that actually puts the arrangements in place by calling an extraordinary general meeting of all its shareholders. It is also why this arrangement is often used when two companies are merging rather than one taking over the other.
Since the target company is supporting the offer, it is usual for the 75% hurdle to be cleared but that does not always happen if a concerted campaign can be waged against the deal.
Partial offers and tender offers
It is possible for a predator to ask the Takeover Panel for permission to make a partial bid in which it will end up with a sizeable stake but less than 100% of the target company, and possibly less than the 30% level at which control is deemed to have been secured.
The partial offer can be in cash or in the bidder’s own shares.
At least 50% of shareholders not connected with the bidder need to give their approval for a partial bid to go ahead.
These safeguards are to protect ordinary shareholders, who are at risk of getting locked into a company that has effectively been taken over without the bidder paying a premium for the privilege.
There are other restrictions. For instance, partial offers where the suitor ends up with more than 30% of the shares – the level at which it would normally be required to make a full bid – will not normally get the go-ahead from the Panel if the bidder has bought shares in the target company during the previous 12 months.
Also, if the predator intends to end up with between 30% and 50% of the target company it must declare the precise number of shares it intends to buy and it cannot declare the partial offer unconditional unless it secures that amount.
Shareholders should be wary of the possibility that the predator will make a full bid some time in the near future. If a full bid is made at a higher price than the partial offer, the shareholders who accepted the partial offer miss out on the difference.
The bidder may state that it does not intend to make a full bid. In that case it cannot bid for at least six months. Nor can it buy any more shares in the market for 12 months if the partial offer is successful.
Tender offers are cash only and the bidder must not end up with more than 30% of the target company.
The offer may be at a price fixed by the bidder. If the offer is oversubscribed – that is, acceptances for more than the required number of shares are received – the acceptances are scaled down. For example, if a tender offer was made for 10% of a target company and shareholders accepted for 20% of the shares, each accepting shareholder would keep half their shares and sell the other half to the bidder.
The alternative is for the bidder to set the maximum price it is prepared to pay and for accepting shareholders to state the minimum price they are prepared to accept at or below that level.
If the tender offer is not fully taken up, then all accepting shareholders will get the maximum price stipulated by the bidder. If the offer is oversubscribed, then the strike price is set at the lowest level that fills the tender. All shareholders accepting at or below the strike price will receive the strike price for all the shares they tendered.
Bidders can stipulate a minimum acceptance level for the tender, so if very few shareholders accept the offer can be dropped. The minimum level is, though, quite low, usually 1% of the target company and in any case no more than 5%. This is to prevent a potential bidder from testing how the land lies without making a serious commitment.
Stub equity
On rare occasions shareholders in a target company may be offered the opportunity of taking cash for most of their holdings while retaining a small stake in either the bidder or the target company, remaining as minority shareholders.
They are left with the ‘stub’ of their holdings, hence the name stub equity. The theory is that these shareholders get the best of both worlds. They receive a nice dollop of cash for most of their holdings but they still get some benefit if the target company does really well under its new owners.
The big advantage for the bidder is that less cash has to be found to fund the bid, since it is not buying all the shares.
Stub equity fell into disrepute donkey’s years ago when a supermarket chain called Gateway (later resurrected as Somerfield) was the subject of a bid battle. A private equity firm by the fanciful name of Isosceles won by grossly overpaying. To cut the cost of its pyrrhic victory as best it could, Isosceles offered stub equity in the now debt-laden group.
The stub fell in value to the point where you couldn’t give it away and nothing more was heard on the subject in this country for about 20 years until the notion was dragged up again in the takeover of property company Canary Wharf.
Offering stub equity may prove to be a sop to critics who argue that predators, particularly private equity companies, generate huge returns by taking companies private, loading them up with debt so they get their cash back, then refloating them on the stock market.
However, that raises the conclusion that they have underpaid in the first place. Shareholders accepting stub equity are locked in as minority shareholders in a company that is taken private so it may be very difficult to get the rest of their investment out until the company is refloated, possibly several years down the line.
Competition regulators
However much you may welcome a takeover bid as an investor, there are regulators in the UK, Europe, the US and elsewhere who see things from a different angle. Their job is to ensure that putting two companies together does not leave too much power concentrated in too few hands.
In the UK, regulation has been strengthened by merging the Office of Fair Trading (which used to screen mergers and takeovers) with the the Competition Commission (which investigated them), to form the Competition and Markets Authority (CMA).
The CMA is an independent government body within the Department of Business, Energy and Industrial Strategy. This department has undergone three name changes since 2007 and is likely to continue to evolve.
The main purpose of the CMA is to protect the public interest by carrying out investigations into mergers, markets and the regulated industries and by enforcing competition and consumer law. It can block mergers or force the break-up of cartels that it deems to be against the public interest.
Its investigations normally take up to six months, though this time can be extended. It may allow a takeover to go through if the parties involved agree to take measures to restore competition. For example, if two supermarkets merge, the CMA may require some outlets to be sold to rivals.
Regulators in Europe and the US have the power to block a deal. While they will leave any purely UK combination of businesses to the OFT, they may intervene if international markets are affected.
Bid timetable
The Takeover Code sets out a timetable designed to create an orderly procedure and to allow all parties adequate opportunity to safeguard their positions without letting the proceedings drag out for an undue length of time.
The offer document spelling out all the relevant details must be posted to the target company’s shareholders within 28 days of the announcement of a definite offer. Initially the offer will then be open for at least 21 days to allow time for shareholders in the target company to accept if they wish to do so.
The target company’s board is obliged to write to its own shareholders, setting out its opinion of the merits of the bid, and is expected to advise acceptance or rejection of the bid, giving its reasons. This advice can be changed if circumstances change, for example if the bidder raises its offer or a new bidder emerges.
The bidder can allow the bid to lapse at the first closing date. In other words it can scrap the bid and walk away after the 21 days are up. Alternatively, the bidder can extend the acceptance period – but if the bid is not unconditional as to acceptances 60 days after the offer document was sent out, then the bid has failed.
If a rival bid is made part way through the bid timetable, the timetable will start again.
Where a bid fails, the bidder cannot launch a new bid for at least 12 months, except under certain conditions. These are if the directors of the target company recommend a new offer or if another firm bidder emerges for the target company.
Competing bidders
If you are really lucky, two or more bidders will compete to buy your company. In this case the bidding will escalate as each bid tops the previous one.
Accelerated bids
Where there is a bid auction and the rivals keep making progressively higher bids there is a danger of the process dragging on for an inordinately long time, since the bid timetable goes back to day 0 every time a new offer document is posted.
To speed up the process, the Takeover Panel may hold an accelerated auction in which the rivals put forward competing bids over several days rather than weeks until one bidder outbids the rest.