M&A Report 2021: Bahrain
Steven Brown and Rahul Sud, ASAR – Al Ruwayeh & Partners
The trend of consolidation continues to dominate the business scene in Bahrain's financial industry. This has been led by the completion of the public takeover offers of Bahrain Islamic Bank by the National Bank of Bahrain and further announcements relating to the acquisition of Ithmaar Bank by the Bank of Bahrain and Kuwait (BBK), as well as an auction of the closely held Bahrain AXA insurance firm. BBK's acquisition would bear similarities to the Bahrain Islamic Bank acquisition, in that a conventional bank would acquire an Islamic bank.
There has also been a notable increase in reorganisations, with major international players often buying out local partners, including in the food and beverage manufacturing industry and within the engineering field.
However, the delay of Kuwait Finance House's (KFH) proposed takeover of Ahli United Bank (AUB) is a clear example of the significant economic impact caused by COVID-19. Notably, the deal has yielded further clarification of the takeover mechanism in Bahrain, namely the apportionment of shareholder rights versus corporate actions.
An interpretation of the Bahrain Commercial Companies Law (CCL) posited by the acquirer suggested that an extraordinary general assembly meeting resolution could bind all shareholders to accept a takeover offer. The Bahrain Ministry of Industry, Commerce and Tourism (MOICT) has clarified that such interpretation is incorrect and that the decision concerning subscription to an offer rests in the hands of each individual shareholder. The Central Bank of Bahrain (CBB) appears to have embraced this interpretation while also reconsidering the squeeze-out threshold, presently 95%, to enhance the practical possibility of a 100% takeover.
Looking forward at 2021, two major geopolitical changes are likely to have an ongoing impact on the economy – the end of the Qatar embargo and the normalisation of trade relations with Israel. The long-term impact of each is hard to quantify at this time.
COVID-19 and recovery plans
As expected, deal flow in Bahrain slowed significantly during 2020 in light of the COVID-19 pandemic. Industries such as airlines, hotels and food and beverage, were hit hardest with extended restrictions on travel and dine-in services. Moreover, the requirement for virtual learning has dampened interest in the education sector, which had seen increased movement during 2019.
Private equity (PE) investment into Bahrain has also continued its downward trend. The continued low price of oil and the limitations of the tourism industry, each forming a substantial part of the Bahrain economy, are expected to continue to dampen interest from investors. Moreover, closely held start-up companies lack a practically enforceable structure for PE funds, such that the same would generally use an offshore vehicle in order to participate in a local entity.
A potential update to the CCL to facilitate start-ups and PE and venture capital participation eventually did not come to fruition, notwithstanding a different recent amendment, implying that those debt and equity financing provisions will likely not be enacted.
An increase in available credit in the market may eventually facilitate greater investment at more palatable interest and profit rates
Conversely, the changes in market and risk dynamics lends itself to reconsiderations by existing shareholders and prospective acquirers of their investment positions, enhancing the probability of M&A activity seeking to arbitrage such risk appetite adjustments. Moreover, there has been a glut of credit in the Bahrain markets as capital expenditures intensive financings are repaid and can be replaced with more efficient Basel III compliant financings to facilitate leveraged buyouts (LBOs) and similar acquisition structures.
Likewise, an increase in available credit in the market may eventually facilitate greater investment at more palatable interest and profit rates, which may influence a willingness to engage in leveraged transactions. The financial regulatory environment and the VAT environment have reached a state of reasonable certainty and therefore would not have the impact on M&A that may have applied in the past.
The future remains uncertain on M&A, though the need for efficiency and the financial distress of certain companies and sectors in light of COVID-19, can be expected to yield an uptick during 2021 as existing owners seek to extract some value of their going concerns, while buyers may approach the market on a fire-sale basis.
Legislation and policy changes
The Takeover, Mergers and Acquisitions Module (TMA Regulation) of Volume 6 of the Rulebook (Rulebook 6) issued by the CBB is the primary governing regulation for public M&A in Bahrain and it works in conjunction with other regulations issued under Rulebook 6.
It applies where there is an acquisition or consolidation of control of a Bahrain-domiciled publicly listed company; or an overseas company whose primary listing of equity securities is on a Bahrain exchange. Rulebook 6, including the TMA Regulation, is administered by the Capital Markets Supervision Directorate at the CBB. Private M&A, as such, is not a regulated activity beyond registration of share transfers and transfers of business premises, outlined primarily in Bahrain's Commercial Companies Law.
Barring the changes relating to shareholder rights, recent changes to the M&A space has been sparse. The lack of changes to regulations could have been influenced by COVID-19 and a country-wide focus on fighting the pandemic. Long-pending regulations concerning fintech have been issued by the CBB; however, these relate primarily to start-ups and are likely to be delayed until 2022.
A common misconception about the Bahrain market often leads to investors opting to structure and implement M&A deals following schemes and solutions developed in overseas jurisdictions without paying necessary attention to the local legal and regulatory framework, in cases of both cross-jurisdiction and of purely domestic transactions.
The PDPL and its similarity to the GDPR will continue to increase the interest of foreign companies
This can go unnoticed insofar as no conflict arises between vendor and buyer, although this may result in the completion process conflicting with local regulations. However, if a conflict arises, the pitfalls of such an approach may become readily intelligible, including difficulty in obtaining legal redress in the local jurisdiction, uncertainties surrounding application of foreign law provisions in domestic court proceedings, and an impasse to meeting local requirements for completion.
Post-closing activities are also an overlooked area. Action plans and timelines are often drawn up until the closing date, leaving post-closing activities to proceed without a clear structure, sometimes even managed by a team that did not work on the deal. This neglect often subsists notwithstanding the number and importance of post-closing activities that are often implicated, such as changes to public registers that cannot be completed at closing, etc. Transitional services arrangements involving continued seller involvement are common but may have dubious validity and enforceability.
With the implementation of the Bahrain Personal Data Protection Law (PDPL), considerations around data transfer in connection with an asset sale are increasing. However, there has been a long-standing grievance that little substantial development to the technology relating to the deal-making process. Likewise, it should be noted that Bahrain does not have a robust IP sector and, while Bahrain positions itself as an information technology (IT) centre in the GCC, this has not led to an increased focus on M&A until today.
On a positive note, the relative difficulty of travel, combined with an enhanced acceptance by Bahrain authorities of electronic meetings and electronic signatures, has enhanced the ability of technology to play a crucial role in the M&A negotiation and implementation process. The electronic transaction law had been introduced in 2018, and has enhanced the use of electronic signatures.
Obtaining control of a public company often involves the launch of a public tender offer (whether on a voluntary or a mandatory basis) unless de facto control is achieved by the acquisition of less than 30% of the target company voting share capital. The threshold triggering an obligation to launch a mandatory offer is set at 30% of the voting share capital of the target company and further thresholds are contemplated for certain incremental purchase between 30% and 50% of the voting share capital occurring within a specified timeframe. The launch of a tender offer is accompanied with the publication of an offer document subject to CBB approval.
In respect of competitive and hostile bids, there are regulatory provisions that prohibit certain frustrating actions.
Usually, conditions attached to an offer include levels of acceptance, approval of shareholders for the issue of new shares and listing/regulatory approvals. A voluntary offer must not be made subject to conditions whose fulfilment depends on the subjective interpretation or judgment by the bidder or lies in the bidder's hands. Once a firm intention to make an offer is formally announced, the bidder is committed to proceed. Scope to withdraw by invoking the conditions to the offer is limited. To the extent that the bidder intends to attach conditions other than normal conditions, the CBB must be previously consulted. As a general rule, with limited exceptions, financing for an offer must be fully committed when the announcement of the firm intention to make an offer is made.
COVID-19 has had little to no impact on the conditions; however, the AUB/KFH transaction has been permitted to postpone the offer period indefinitely in light of the pandemic. This appears to have been granted as per the CBB's discretion.
Break-fees are not used in Bahrain and their validity is uncertain as commitments to a break-up fee can be seen as unlawfully impinging upon each shareholder's right to decide whether to sell or retain their shares. In the absence of more legal clarity as to the permissibility of break-up fees, it is not expected that this instrument will be adopted in the structuring of public M&A deals.
The use of completion accounts is still the prevailing consideration mechanism in the realm of private M&A, though the financial data tracked for the purposes of determining any price adjustment with respect to the headline purchase price varies from working capital only adjustments to fully-fledged adjustments based on net worth variations.
Locked-box mechanisms are still relatively uncommon, though there is an expectation of seeing an increased use of these mechanisms especially in the context of vendor-initiated private auctions. There has been an increase in the use of earn-outs in private M&A, and it is believed that these are being used as a tool for bridging widening valuation gaps between sellers and buyers. Escrows are very common and are mostly used in connection with management of claims against representations and warranties.
Regulatory approvals are invariably attached to private offers in respect of target companies operating in regulated industries. It is not uncommon to also find material adverse change (MAC) clauses associated with specific quantitative metrics, though these are usually bitterly negotiated. It is quite common to bring down all representations and warranties to closing so that any breach (or material breach) may afford the buyer an exit hatch.
The lack of changes to regulations could have been influenced by COVID-19 and a country-wide focus on fighting the pandemic
Although it is a rather common practice, the use of foreign jurisdiction clauses in M&A transactions are strongly advised against in light of the enforceability issues that they create. In case of a foreign governing law, foreign arbitration should be seen as a must due to problems faced in proving the provisions of a foreign law in front of a Bahraini court and difficulties in enforcement in Bahrain of foreign court decisions.
Bahrain governing law with Bahrain court enforcement may be valuable to facilitate enforcement of local obligations associated with the transaction and may be favourable for a foreign party who received robust local law advice against a Bahraini counterparty.
The exit environment is very challenging. The main exit channel still consists of a private sale to an industrial or PE purchaser. The IPO exit route is uncommon in light of the structural liquidity issues affecting local capital markets. Sales to financial sponsors are also often unviable because of the reluctance by financial sponsors to take on balance sheet equities also considering the penalising capital treatment that this asset class receives under the newly implemented Basel III capital adequacy regulations.
Consolidation in Bahrain's financial industry can be expected to continue, propelled by structural reasons going beyond the existing economic cycle. The level of success in the Bahrain Islamic Bank – National Bank of Bahrain deal, and whether the impending Kuwait Finance House – Ahli United Bank transaction will be completed, is extremely telling of the ability for major consolidation of financial institutions.
The PDPL and its similarity to the GDPR will continue to increase the interest of foreign companies already bound by GDPR to extend their presence into Bahrain. On the other hand, the implementation of VAT will likely have a shrinking impact on M&A transactions, such that this effect may be realised more in the coming 12 months.
The length of the COVID-19 pandemic and the efficiency of the vaccine roll-out programme – where Bahrain ranks second in the GCC among vaccination doses only behind the UAE – will likely guide how the deal flow levels evolve. Moreover, external factors such as vaccination passporting regimes, and the re-opening of the causeway to Saudi Arabia, will significantly influence Bahrain's economic status and likewise the speed of M&A recovery.
ASAR-Al Ruwayeh & Partners
T: +973 17 533 182
Steven Brown is the managing partner of the Bahrain office at ASAR – Al Ruwayeh & Partners and works primarily in the corporate and financial field.
Steven has broad knowledge and experience in corporate law, including governance and compliance of public and regulated entities. He also leads the Bahrain finance practice. He has been involved in numerous banking and finance transactions, local and cross-border acquisitions and transaction structuring in Bahrain. His M&A experience includes acting as lead and local counsel on various transactions representing buyers, sellers and targets in addition to assisting underwriters and financiers on public entity transactions.
Steven holds a bachelor's degree from Marquette University and a JD from Washington University in St. Louis.
ASAR-Al Ruwayeh & Partners
T: +973 17 533 182
Rahul Sud is a senior associate with ASAR – Al Ruwayeh & Partners and has multi-jurisdictional experience of working in India, Singapore, Qatar and Bahrain.
Rahul is noted for his skills in advising innovative solutions to clients. He has extensive deal experience across domestic and cross-border M&A, foreign direct investments, joint ventures, restructuring and reorganisations. He also has experience on matter relating to banking, finance, intellectual property and technology laws.
Rahul holds a bachelor's degree from Symbiosis Law College and a LLM from National University of Singapore.