Great expectations

Author: | Published: 1 Oct 2007
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After 14 long years of hard negotiation between member states and the EU institutions, 2006 finally saw the implementation of the Takeovers Directive. The Directive is just one part of the Financial Services Action Plan, the EU's master plan for the harmonization of financial services and markets across the EU. After those 14 hard years, ambitious plans for a level playing field for takeovers across Europe have been somewhat diluted. However, the May 20 2006 deadline for implementation saw many commentators in Europe expectant at the changes the Directive would bring to European takeover regulation.

Almost a year on, it is fair to say that the Directive has not (so far) created the level playing field across the EU that some might have hoped for. In fact, it is political and economic factors that have driven change, rather than legislative implementation.

Delays in implementation

Although the UK met the May 20 implementation deadline for the Takeovers Directive, along with Denmark, France, Hungary and Luxembourg, many of the remaining 23 countries required to implement the Directive have yet to do so. As of January 15 2007, the European Commission had received no notification of the procedure for implementation in respect of Belgium, Cyprus, Spain and Italy, and only partial notification in respect of the Czech Republic, Estonia, the Netherlands, Poland and Slovakia. The brave new world of takeover regulation remains a theoretical one in many member states.

The minimum standards approach

The Directive adopts a minimum standards approach, allowing member states to goldplate their own takeover regulation at a national level. This means that, even after full implementation, there will still be variations across the EU. The standardization applies in effect to the minimum, rather than the maximum, standard, which means there is still no real level playing field. Variations could create opportunities for regulatory arbitrage, opportunities that are unlikely to materialize fully until implementation is complete and players in the market have had an opportunity to assess the impact of the Directive in various member states.

The optional aspects

One of the reasons the Directive took so long to negotiate was the controversy surrounding some of the situations it sought to regulate. One controversy was the extent to which the board of a target could use defensive measures to block an unwelcome takeover bid. Germany, for example, was firmly opposed to a prohibition without an equivalent prohibition on multiple voting rights. This is because multiple voting rights are not a common feature of German companies, meaning that companies in Germany could be more open to takeovers, whereas companies incorporated in other member states could seek protection in their voting structure. The Nordic states and France were opposed to this approach, as multiple voting rights are a main protective mechanism in these jurisdictions.

The result of this controversy (of which the above is only one example) meant that a compromise text was finally agreed, which made Articles 9 (defensive measures) and 11 (breakthrough share restrictions and multiple voting rights) optional for member states. Member states would be free to allow companies to adopt restrictions on defensive measures during or post a bid, and make multiple voting rights and transfer restrictions unenforceable during a general meeting to decide on defensive measures during a bid.

The Directive also includes the so-called reciprocity option, which grants member states that have opted out of Articles 9 and 11 the power to grant companies that have chosen (on an individual company basis) to apply Articles 9 and 11 the ability to derogate from the provisions if they are the subject to a takeover bid from a company that does not apply the same provisions.

This has resulted in a situation where differing approaches to the implementation of the Directive by the member states have resulted in the scope and content of takeover regulation throughout the EU not being uniform, despite the EU Directive.

Table 1 sets out the options chosen by the member states, although some have not yet been implemented.

Table 1: Member states' implementation
Member state Article 9 opt
in/out?
Article 11 opt
in/out?
Article 9 reciprocity
allowed?
France In Out (partial) Yes
Germany Out Out Yes
Ireland In Out No
Italy In ?* Yes
Luxembourg Out Out Yes
Portugal In Out Yes
Spain In Out ?*
The Netherlands Out Out Yes
UK In Out No
* not yet announced

In addition, mandatory bid and squeeze-out thresholds continue to differ throughout the countries that have (or will) implement the Directive, resulting in further layers of regulation where uniformity has not been achieved.

Political involvement in takeovers

2006 was a year that was characterized by a large number of cross-border, highly contested, high-value takeover bids. Some of these bids were highly contested because the targets were in sectors where there was a certain (or at least perceived) amount of national interest at stake, for example, utilities, telecoms, and transport. It is in circumstances such as these that other factors (aside from the new legislation) surrounding takeovers manifest themselves. These bids and potential bids have highlighted continuing national differences in the approach to takeover bids.

One of the biggest factors that might come into play when national interest takeovers involving a foreign bidder are played out is the attitude of the target company's national government. There is often a large amount of public pressure not to sell companies that are perceived to be national assets to overseas bidders, and governments must respond (or be seen to respond) to this pressure. However, the extent of a particular government's response varies from country to country, and this attitude might impact on the result of the takeovers. It is possible to see two distinct schools of thought in Europe in relation to this. There appears to be a point at which the attitudes of member states re-converge (that is, when national security is at stake) but the point at which this re-convergence occurs is likely to differ from member state to member state.

Non-interventionism

The UK government and Ferrovial/BAA

BAA is the owner of seven UK airports (including Heathrow, Gatwick and Stansted), with interests in a number of overseas airports. Post September 11, and the Madrid and London bombings, transport networks are perceived by many to be an obvious target for future terrorist attacks, and so airports have recently taken on more of a national interest angle than they may have done in the past.

This meant that when Gruppo Ferrovial, a Spanish construction and infrastructure group, made a bid for BAA, reactions from the public and the press in the UK were mixed. The Telegraph website asked the following question of its readers in a discussion forum: "What about national pride though? Heathrow is the world's busiest airport, so shouldn't the UK be buying up rivals rather than being bought up itself?" One reader responded to say, "it is wrong in principle to allow strategic industries to be owned by foreigners because...at worst foreign governments will use such ownership to threaten us". Unions and politicians also expressed alarm about the deal. References to a new Spanish Armada, along with other war-like rhetoric, were to be seen in newspapers in Madrid, Paris and London.

Despite this reaction, the UK government took no direct action in relation to the bid. Certain commentators were concerned that there was an apparent conflict between BAA's long-term responsibility (implementing government policy to increase airport capacity in the south-east of England) and the perceived short-term interests of a purchasing financial consortium. However, the government had sold its golden share in BAA three years before Ferrovial's bid, meaning that it could take no action as a shareholder of BAA. The UK Department of Trade and Industry limited itself to monitoring the events surrounding the deal and making several carefully worded statements, such as "[the deal is] a commercial matter for the companies involved and their shareholders" and "these are two businesses owned by shareholders and we have no powers to intervene in private companies doing deals".

This attitude is reflected in the terms of reference of the UK takeovers regulator (the Panel on Takeovers and Mergers). The Panel makes it clear that it will not intervene in matters of a political nature, and will not opine on the commercial merits of an offer.

The limits of non-interventionism

While the BAA/Ferrovial deal is just one example of the UK government's long history of taking a non-interventionist attitude to such matters (bids for the privatized water and electricity companies being others), there is a limit to this attitude, and the UK government is willing to intervene if matters of national security are at stake. It is in situations such as this that the interests of protectionist member states and the views of the EU are aligned, as the EU permits a derogation from the principle of free movement of capital when the EU agrees that there is an overriding national interest, one of which is national security.

An example of the limits of the UK government's non-interventionism can be seen in relation to the US company KBR. KBR owns the majority stake in DML, the company that owns Devonport Dockyard, which has the contract with the UK government to refit the UK's nuclear submarine fleet. When KBR listed in New York at the end of last year, the UK government made its feelings in the matter quite clear, warning Halliburton (the owner of KBR) to withdraw the listing. In the end, the listing was delayed but still went ahead. It appears that the UK government's words may have had an impact. At the time of writing, KBR had just admitted publicly that it had been considering bids for its stake in DML.

Protectionism

The Spanish government and E.ON/Endesa

An interesting contrast may be drawn between the Ferrovial/BAA deal and the bid being made by German power and gas company E.ON for the Spanish electricity supplier Endesa. In response to this bid, the Spanish government passed a decree that increased the powers of the Spanish national energy regulator. This provided that any acquisition of a shareholding of more than 10% in an energy company would be subject to the prior approval of the regulator.

The EU subsequently brought proceedings against the Spanish government for violation of the principles of freedom of capital and freedom of establishment. After initiation of these proceedings, the Spanish government removed these blocks.

The French government and Mittal/Arcelor

There was a similar situation when Indian steel company Mittal made a bid for the Luxembourg steel company Arcelor (which had a large French shareholding) last year. After Mittal's approach, the French government made little effort to hide its displeasure at the deal, calling it "opaque," "thin" and "hostile". The CEO of Arcelor at the time, Guy Dolle, also famously stated, "our steel is like perfume compared with Mittal's eau de cologne". Soon after the Mittal approach, Arcelor announced a merger with the Russian steel company Severstal to counter the bid. However, shareholders rejected this merger and the Mittal bid was eventually successful.

Proof that intervention has an impact

One of the interesting consequences of the protectionism of national governments is the fact that, in certain circumstances, foreign investment can be curtailed. There has been an undeniable upturn in Spanish cross-border investment recently, highlighted by deals such as Ferrovial/BAA, Telefónica/O2, and Banco Santander/Abbey. A construction boom, a big increase in property prices and 10 years of economic growth, coupled with a tax advantage that certain Spanish companies receive relating to the amortization of goodwill of foreign subsidiaries, means that Spanish companies have been looking overseas to invest their cash.

However, when the Spanish group Abertis attempted to purchase the Italian transport infrastructure group Autostrade last year, the deal was blocked by successive decisions of the Italian authorities. Spanish companies attempting to purchase airports in Belgium and motorways in France encountered similar problems.

The fact that Spanish companies have encountered such problems in some other member states have led some commentators to speculate that Spain's interest in investment within those member states might have waned, and that it is instead looking to the US to invest its cash. This speculation might not in fact be without foundation – BBVA, Spain's second largest bank, recently announced that it was to buy the US bank Compass Bancshares for £5 billion (BBVA's largest foreign transaction to date).

Proof that intervention has little or no impact

Despite the interventions of the governments of certain EU member states, there is a school of thought that holds that protectionist efforts will usually be in vain. The actions of national governments will be inherently national in their outlook. However, the investment of capital in today's world is increasingly occurring on a global level (especially in relation to hedge funds), such that national boundaries are ignored.

In the absence of a golden share or specific legislation, there is little that national governments can do to counter a bid that is perceived to be contrary to national security or some other national interest. The concept of golden shares itself has come under fire recently. In September 2006, the ECJ ruled that the Dutch government was breaching the principle of free movement of capital by holding a golden share in TNT, the postal firm. This followed similar rulings against the governments of France, Portugal, the UK and Spain. In addition, on February 17 2007, Advocate General Ruiz-Jarabo gave an opinion in the ECJ that the Volkswagen Law (limiting the voting rights of any one shareholder in the car company Volkswagen to 20% of the share capital) was contrary to the principle of free movement of capital. So it appears that the use of golden shares by governments to prevent takeovers will become much less common. Here the actions of the EU (in particular the ECJ) could be considered to have had more of an impact than the Directive in removing barriers to the level playing field.

Aside from this, governments can attempt to pass legislation (as the Spanish government attempted with the E.ON bid), but it appears that the EU is also becoming increasingly averse to such tactics, and will take steps to prevent them (which again sees the EU removing barriers to the level playing field). Aside from these tactics, the only other option open to governments is to voice their displeasure at a bid, which might be seen as a fairly weak response compared to the economic proposition of the bidder.

The truth is that, whatever the circumstances, the decision as to whether or not a bid proceeds rests in practice with the shareholders of a company. Retail investors might choose not to accept an offer as a result of a sense of national pride or loyalty, but institutional investors are far less likely to (and might have a positive obligation not to) act in this way. If an offer is seen as a good deal, then in all likelihood shareholder pressure will prevail, and the bid will succeed. This is what occurred with the Mittal/Arcelor bid, despite the intervention of the French government, and one could with some justification speculate that, now the blocks have been removed by the Spanish government, the same thing will occur with the E.ON/Endesa offer (which is still open at the time of writing).

Hedge fund involvement in takeovers

Another trend in the 2006 public M&A market in the EU is the increasing influence of hedge funds in takeovers. Hedge funds are increasingly using their financial muscle to affect the outcome of takeover bids, as well as the corporate governance and strategies of listed companies. The influence of national governments and the EU could be seen as a factor external to the takeover process. In contrast, hedge funds are internal (or even inherent) to this process, because they are willing to make bids for companies, and they are also often powerful shareholders (or holders of other interests in shares) within a company, and so might have the power to let a bid succeed or fail.

The influence of hedge funds

The power of hedge funds has undoubtedly increased recently, first because they now have such a large (and growing) amount of capital at their disposal, and secondly because they are increasingly willing to be activist as shareholders.

An example of this activism could be seen in the US at the start of 2006. The Tracinda Corp investment fund put months of pressure on General Motors, until it finally succumbed by slashing its dividend, cutting executive pay, and naming a Tracinda adviser to the board.

It was recently reported that hedge funds were buying stakes in Sainsbury's, Britain's third-largest supermarket owner, on expectations of a bid by Marks & Spencer. It will be interesting to see how the actions of the activist shareholders will influence the outcome of any subsequent bid.

Certain hedge funds might have a shorter-term focus than other, more traditional types of institutional investor. This focus on short-term gain can mean that hedge fund shareholders can act in a different manner to other institutional shareholders. Also, the investment strategies of funds will differ, meaning that individual funds might act in a different manner to one another.

Regulatory issues

Until recently, there was little formal regulation in relation to hedge funds acting in takeover bids. This is because hedge funds could acquire virtual interests in shares, by way of derivative or synthetic instruments, such as contracts for differences (CFDs), which give the fund financial exposure to the shares underlying the instruments, without the requirement to purchase the shares themselves. The disclosure requirements that existed in relation to shares did not apply to these instruments in the past.

The Panel on Takeovers and Mergers in the UK subsequently extended the disclosure provisions of the City Code to disclosures of such interests. This is perhaps symptomatic of the important role that hedge funds now play in the outcome of takeovers. Another example of regulatory authorities taking the impact of hedge funds seriously is the fact that the FSA in the UK recently published a consultation paper on hedge funds, asking for the industry's views in relation to their regulation.

Hedge fund capital versus legislative change

Hedge funds are by their nature global. They are ordinarily based offshore, and their investors will be based in many countries across the world. National boundaries are irrelevant to where their cash is invested. This, coupled with their focus on maximizing return for investors, means that the national interests of governments will have less of an impact on them.

Hedge funds serve as an interesting contrast to the nationalist concerns that have manifested themselves in the past year. The fight between the actions of governments (whether national or supra-national) and those of shareholders will inevitably be an uneven one, as the glacial pace of legislative change (as perfectly highlighted by the implementation of the Directive) will never be able to compete with the nimbleness of dynamic shareholders such as hedge funds when it comes to anticipating and reacting to changing circumstances.

Money talks

The Directive might at one stage have given some commentators hope of more transparent and uniform takeover regulation in Europe, but in its watered down final version it was never likely to do so, as implementation in 2006 has proved. The attitudes of governments across Europe, far from being harmonious, have always been divergent. This divergence was brought into stark relief during 2006 as a consequence of the type of deals that took place.

Neither the actions of national governments, nor the (partial) implementation of the Takeovers Directive have so far acted as the catalyst necessary to create the level playing field that was the aspiration during those 14 long years of negotiation. The phrase money talks has a particular resonance here, as it will be the money of the shareholders, and the money of the bidders, that will always be the determinative factor of even the most hotly contested takeover. The fact that hedge funds are increasingly acting as both bidders and as shareholders, and that they are increasingly willing to be activist as shareholders, means that money now talks a little bit louder. This fundamental truth did not change in 2006, and it is unlikely that it will in 2007 either.

Author biography

Mark Curtis

Simmons & Simmons

Mark Curtis is head of the London corporate and commercial practice. He primarily advises investment banks, stockbrokers and companies on public and private M&A and equity offerings. From 1998 to 2000 he was seconded as joint secretary to the UK Panel on Takeovers and Mergers, where he was involved in regulating a number of high-profile public offers. Since his secondment, transactions include Telefónica's £17.7 billion offer for O2 and Amvescap's £1.05 billion offer for Perpetual. Curtis has also developed Simmons & Simmons' Takeover Code Resources, a selection of online tools for those engaged in UK public takeovers.

Isabella Roberts

Simmons & Simmons

Isabella Roberts is a senior associate in the London corporate practice. She has experience of a wide range of corporate work, in particular corporate finance, and mergers and acquisitions in the financial services and life sciences sectors. Recent work includes acting for Center Parcs on the £205 million takeover by Blackstone and for Sinclair Pharma on its £35 million vendor placing and acquisition of CS Dermatologie.

Jeremy Cruse

Simmons & Simmons

Jeremy Cruse is an associate in the London corporate practice. Since qualifying in September 2006, he has worked both on private and public M&A transactions, including Avaya's recent takeover of Ubiquity Software Corporation (an AIM-traded company), and the IPO of a company on the Official List. Cruse has also spent time working in the Paris and Hong Kong offices of Simmons & Simmons.