US tender offer threshold drops to 50%

Author: Danielle Myles | Published: 18 Jul 2013
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  • The Delaware Code has been amended to drop the tender offer threshold from 90% to the number of shares needed to approve a merger, which is usually a simple majority;
  • It takes effect from August, and will make it significantly easier for private equity sponsors to conduct two-step mergers;
  • Two-step mergers can now be completed within five weeks, while one-step mergers often take up to four months;
  • The change all-but eliminates the margin rule hurdle faced by sponsors looking to use the two-step structure, as the lower threshold it makes it easier to simultaneously close a tender offer and back-end merger.

A drastic but little-noticed change to US tender offer rules means from next month it will be significantly easier for private equity sponsors to takeover US-listed companies.

Starting from August 1, the US’s tender offer threshold drops from 90% to 50%. The amendment to Delaware General Corporation Law (DGCL) was passed with little fanfare on June 30.

It creates greater certainty for two-step mergers – private equity’s favoured take-private structure – by mitigating problems created by federal margin rules.

"We may see on the margin some more leveraged buyout (LBO) activity as a result of the new rules, but the real change is that you should see sponsors using more two-step structures in lieu of one-step deals," said Debevoise & Plimpton partner Andrew Bab. "The new rules should make tender offers a lot more attractive to private equity buyers."

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Two-step benefits

For private equity sponsors looking at a US take-private, two-step mergers – also known as short-form mergers – offer significant benefits over one-step, or long-form, mergers.

A two-step deal consists of a successful tender offer followed by a back-end merger to acquire the outstanding shares. It is significantly quicker and less burdensome than a long-form merger because there is no need to prepare and file a proxy statement or gain stockholder approval.

The insertion of subsection 251(h) into the DGCL makes two-step deals more attractive by creating greater certainty.

It allows a two-step merger to be closed, without a shareholder vote, if the buyer/s: obtain via a tender offer the number of shares needed to approve the merger; immediately close the back-end merger after the tender offer; and, collectively hold less than 15% of the target.

Delaware companies generally require a 50% majority to approve mergers, however it is possible that a company’s charter may stipulate a higher threshold.

The Delaware State Bar Association (DSBA) proposed the amendment in the second quarter of this year.

Commenting on the change, the DSBA’s immediate past president Theresa V Brown-Edwards said: "The DSBA believes the amendments to DGCL 251(h) make good business sense because it will create greater efficiency and speed in a tender offer merger transaction thus increasing the interest in these type transactions among financial bidders and, ultimately, will prove desirable to shareholders as it will allow them to reap the benefits of the transaction, their money, faster."

Margin rules: hurdle no more

The change will boost private equity buyers’ competitiveness, by putting them on more of a par with strategic buyers regarding their ability to take advantage of the timing and cost benefits associated with tender offers, according to Bab.

"While beneficial to strategic buyers, I don’t think the new rules would change their calculus as to whether to do a one or two-step deal," he said.

"What’s different for private equity sponsors is that the changes minimise problems associated with the margin rules, which have been a key impediment to their ability to do two-step deals in the past," he added.

The Federal Reserve’s (Fed) so-called margin rules prevent acquirers from securing borrowed funds with more than 50% of a public company target’s shares. This has proved problematic for LBOs.

According to Fed guidance, a back-end merger that closes simultaneously with the tender offer will comply with the margin rules. This is because the acquisition financing is essentially secured by the target and bidder’s combined assets.

But the 90% tender threshold has proved a real stumbling block, as very few private equity bidders can be confident of meeting such a high target. It means that neither simultaneous closings, nor top-up options or other fixes have proved a silver bullet in overcoming margin rule problems.

A 50% tender threshold, however, is promising.

This new, lower standard is tipped to make a private equity bidder significantly more comfortable embarking on a two-step merger. It makes the chances of reaching the tender threshold, simultaneously closing the back-end merger, and thereby sidestepping margin rule complications much more realistic.

The change makes US tender offers significantly easier than elsewhere in the world. Across Europe, thresholds are generally between 90% and 95%, although a UK scheme of arrangement can be effected with 75% approval.

The move also coincides with the apparent LBO revival in the US.

Future for one-step mergers

The market is, however, still thinking through the changes.

"The general notion is that it will make two-step mergers easier. But there are a number of questions that must be considered when looking at how it will work in practice," said Private Equity Growth Capital Council general counsel Jason Mulvihill.

For example, the speed offered by a two-step merger is futile if regulatory approvals or financing can’t be secured within that short timeframe.

Management buyouts may not be able to satisfy the 15% pre-acquisition ownership cap, meaning they can’t rely on the new rule.

While the amendment does not signal the end for one-step mergers, it is a more ominous sign for dual-track deals.

Dubbed the Burger King structure after its inaugural use in 3G’s takeover of the fast food chain in 2010, this structure allows a bidder to start both a one-step and two-step merger at the same time. If the tender offer is not successful, the bidder drops out of the two-step deal and proceeds with the one-step deal without losing any further time.

"This rule would eliminate the need in most cases for a dual-track structure, as sponsors will be more confident in their ability to close a tender offer, immediately do a back-end merger, and avoid the margin rule issue," said Bab.

See also:

PE needs help before SEC enforcement blitz

Subscription credit facilities to surge this year

What KKR did next

AsiaInfo: how a US-incorporated ChinaCo goes private