Australian M&A trends explained

Author: Ashley Lee | Published: 26 Sep 2013
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  • Success rates of public M&A deals in Australia have dropped, and there are fewer competitive bidders, said Herbert Smith Freehills’ fifth edition of its Australian public M&A report;
  • Fewer bidders are using schemes of arrangement, preferring takeover bids. But the report found that all schemes that made it to sending a scheme booklet to shareholders were successful;
  • A large majority of Australian bidders use material adverse change (MAC) clauses, but target boards are now more careful about carve-outs following lengthy deal processes;
  • Deal protection mechanisms such as break fees and lock-ins are also common. But the recent Takeovers Panel decision on Altamont Consortium’s Billabong financing sets some new guidelines.

Herbert Smith Freehills’ fifth edition of its Australian public M&A report revealed that the success rate of deals had fallen. As deals become more challenging, structures and mechanics have also changed.

Australia’s economy, bolstered by the commodities boom, was impacted as China’s growth slowed. Total public M&A success rates in the fiscal year of 2013 fell to 63% from 81% last year, the report said. Further, there were only 59 deals completed – the lowest amount since the report began in 2009 during the global financial crisis.

As for unsuccessful deals, as only one of the failed bids in 2013 was due to a competitive counter-bid the report said that competitive scenarios did not account for this reduction in transaction dynamics. Instead it emphasised that there are common structural and contractual measures across successful deals.

"Deal mechanics and transaction structure played an even more important part in this difficult year for structuring deals," it said. "Success rates were noticeably impacted by the specific components of each proposed deal."

The advantages of schemes of arrangement

Only 37% of all deals used a scheme of arrangement.

While schemes were used even less in mega-deals - classified as being over A$1 billion in value - with only 33% of such transactions utilising a scheme. In 2012 schemes were used in 64% of mega-deals, and in 2010, they were used in 87% of mega-deals.

But this might be due to the requirements for a scheme. Herbert Smith Freehills partner Simon Reed, the report’s author, noted that schemes require target bid support.

"During the global financial crisis, we saw a significant uptick in the use of bids over schemes, and we’ve seen the same this year," he explained.

There was a perception historically that schemes lacked flexibility, were clunky and didn’t allow bidders to adjust structures if a counterbid came along, he added.

However, there are two facts that point in their favour. First, the report noted when studying Australian deals from last year, that if a bidder got to a point where it was sending out scheme booklets, 100% of those deals were successful.

Further, because there are fewer competitive scenarios in this market, the perceived lack of flexibility was less relevant, Reed said.

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Deal conditions
"We’ve seen a bit more appetite from bidders to absorb some deal risk," he said. Such bidders had recognised that deals were difficult to get off the ground unless supported by boards.

Specifically, there has been a drop-off in bids with a minimum acceptance condition. Other forms of conditionality remained pretty high, however – 95% of deals had some conditions attached.

Material adverse change (MAC) clause
In 2013, 83% of deals included provisions that allowed a bidder to terminate a deal if there was a MAC in relation to the target.

However 56% of those MAC clauses included a carve-out for a change in economic or political conditions, up from the 29% four-year average.

In the last few years, Reed said there had been a rise of MAC conditions with no 'change of law’ carve-out. He also noted an increase in other conditions attached to bids relating to overseas regulatory approval, such as Chinese regulatory issues or African resources approvals.

"It’s a double-edged sword," he said. "While bidders continue to argue for these sorts of conditions, target boards have learned lessons recently after a number of conditional schemes have dragged on for months – if not years."

As a result, he said, targets were pushing harder to reduce uncertainty in deals through the incorporation of more carve-outs into MAC clauses.

Deal protection
There has also been an increase in the use of no-shop/no-talk provisions, break fees and lock-ups in Australian public M&A. Toe-holds were the only type of deal protection, common to Australian M&A, to decline - only 14% of transactions this year included this protection, down from 44% in 2012.

No-shop/No-talk
While the 'go-shop’ provision is common in the US, the opposite concept is most popular in Australia. In the last three years, over 90% of total deals have included a 'no-shop/no-talk’ clause.

But Reed noted that the success rate of the few negotiated deals without exclusivity was 100%.

The lack of exclusivity did not materially affect the outcome, he said. This was more likely to depend on the circumstances surrounding the deal. For example, he said, these deals might not have needed protection from counter-bidders because the bidder was already entrenched with a significant stake in the target.

Break fees
The Asia-Pacific region has recently seen significant break-fee innovation - in the Asia-Pacific Breweries take-private and the Fraser & Neave take-private, for example. It’s unsurprising therefore that this deal protection mechanism has been used effectively in Australia.

"Break fees have become an accepted piece of Australian M&A, subject to clear limits on quantum," Reed said.

Despite a regulatory response in the UK in relation to escalating levels of deal protection in use to, Reed said there was no appetite currently in Australia to wind back deal protection.

However, the report noted that adherence to Takeovers Panel guidance regarding break fees stretched in 2013, where 25% of break fees were valued higher than the panel’s 1% rule. But that might be due to the disproportionate amount of smaller deals in the period, with 33% of deals valued at less than A$20 million.

Lock-ups
Lock-ups were also more common during 2013 and were secured in 57% of deals. Reed expected that this trend would continue.

In the last few years, the report noted, in instances where a bidder was able to enter into a lock-up with a key shareholder, such as a pre-bid acceptance or voting agreement arrangement, then it was as important in achieving a successful outcome as getting initial target board support.

Fewer competitive scenarios had actually facilitated the use of lock-ups.

"Institutional investors that previously saw lock-up agreements as locking themselves out of potential upside due to a counter-bid might be more prepared to deliver a lock-up over their own shares to encourage initial bidders to take the leap," he added.

Recent developments
But a recent Takeovers Panel decision – not mentioned in the report – delineated some restrictions on deal protection in public M&A, particularly in distressed transactions.

Rival hedge funds Oaktree Capital Management and Centerbridge Partners filed an application in relation to restrictive deal protection measures against Altamont Consortium in its financing for Billabong, an Australian Securities Exchange-listed surfwear company.

There was a bridge facility termination fee of 20% of the principal amount payable if – among other things – there was a change of control of Billabong before 15 January 2014 and, as a result, the bridge facility was repaid on or before 31 December 2013.

The Takeovers Panel concluded that this acted as a lock-up device that deterred rival proposals.

Further the interest rate on the $40 million tranche of the long-term financing was 35%, if shareholder approval to permit conversion of the tranche into redeemable preference shares and the issue of some options was not obtained. It was 12%, if approval was ratified.

The magnitude of the interest rate and the circumstances it was under amounted to a 'naked no vote’ break fee, said the panel.

While the Australian market might not be limiting deal protection mechanisms, the Takeovers Panel might intercede in provisions that were likely to coerce shareholders to vote for a transaction. As Australia’s secondary loan market becomes more liquid and more experienced, and distressed debt players enter the market, more clarifications on deal protection mechanisms might be needed.

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