M&A Report 2023: Bahrain
Steven Brown and Rahul Sud, ASAR – Al Ruwayeh & Partners
The Gulf Cooperation Council (GCC) countries have seen a rise in consolidation as pandemic restrictions have been eased, including corporate strategic M&A transactions in Bahrain, particularly in the banking sector.
Kuwait Finance House (KFH) completed its acquisition of Ahli United Bank (AUB) in October 2022 and consequently created one of the largest banks in the GCC. More than 97% of AUB share acceptances were received, surpassing the minimum requirement of 90% for squeeze-out. KFH exercised its squeeze-out rights against the remaining shareholders.
Citibank exited the retail banking business by selling its consumer banking business to AUB in December 2022.
Al Salam Bank announced in November 2022 that it had completed the acquisition of the consumer banking business from Ithmaar Bank, thus creating one of the largest Islamic banks in the Kingdom.
Bahrain’s continued focus on promoting itself as an investment hub for information technology and cybersecurity businesses is also rapidly yielding benefits. In 2022, the Bahrain-incorporated Beyon Cyber group company acquired UAE cybersecurity company DTS Solutions, thus expanding its footprint in the region.
The impact of the Russia–Ukraine war appears to be neutral, largely due to the fact that Bahrain’s M&A deal inflow is more tilted towards the West.
In contrast to previous years, public M&A transactions in Bahrain have gained prominence over the last year. This change in dynamic may be related to lower energy revenues and the impact of the pandemic. There appears to be some interest in the consolidation of existing businesses to achieve better economies of scale.
KFH’s acquisition of AUB by way of a share swap at an exchange ratio of one new KFH share for 2.695 AUB shares was the first deal to test the squeeze-out provisions as amended in 2022, applying to the acquisition of publicly listed companies. Previously, the offeror had to offer to buy out the minority shareholders once it acquired 95% of the voting rights of the offeree company, but this threshold has been revised to 90%. Given that more than 97% of AUB share acceptances were received, this deal did not face meaningful challenges from dissenting minority shareholders.
This deal is also of particular relevance because it involved complex issues regarding the conversion of a conventional bank into an Islamic bank (post acquisition). This deal required innovation around issues relating to the conversion of existing conventional repo and other derivative bonds, and transitioning conventional lending businesses to Shari’a-compliant instruments and operations.
Economic recovery plans
In 2022, the Bahrain Economic Development Board (EDB), the Kingdom’s investment promotion agency, attracted over $1.1 billion of direct investment, a record year for the EDB. The data on the percentage of M&A activity contributing to this investment increase is not available; however, the M&A outlook appears more challenging, and conditions have been more volatile in recent months. The outlook of inflationary pressure on the United States dollar and the rising inflation across the globe has had a significant impact on the market outlook.
The next 12 months are expected to continue the trends of consolidation in light of:
World economies being fearful of recession;
The protraction of the Russia–Ukraine war; and
The inflationary pressures on the United States dollar.
M&A activity is expected to slow down during these times of uncertainty. However, this provides an opportunity for attractive valuations for deal seekers. Based on ASAR’s experience, the deal flow is expected to be slow; however, the authors remain optimistic about niche M&A deals and the exciting opportunities that lie ahead for some mature M&A transactions. The focus of such deals is expected to be anchored on managing competition and expanding digital capabilities.
In the short term, the acquisitions may be driven by strategies that align with long-term corporate strategies of purchasers, for cross-border and local transactions. Fintech and technology are expected to be the most active sectors for deal making in the coming years.
For outbound M&A activities, there has been recent interest in clients locating the headquarters of their global operations in Bahrain, especially for the fintech industry. The initiatives taken by the Central Bank of Bahrain – i.e., promoting fintech at local and regional levels – have been seen as a positive indicator. With Bahrain emerging as a gateway to the GCC countries, an upward trend in outbound M&A activity can be anticipated in the near future.
Local M&A work could include trends related to:
Industry consolidation, M&A-driven growth, financing considerations or other factors;
Distressed business acquisitions, takeover reorganisations, bidding, post-M&A closings; or
The impact of COVID on M&A-related disputes, and the use of indemnity provisions.
With the liberalisation of foreign ownership in about 33% of economic activities, there has been interest in the unwinding of old nominee structures, where foreign ownership was previously restricted to 49%.
On the financing front, there has been a glut of credit in the Bahraini markets as capex-intensive financings have been replaced with Basel III-compliant financings to facilitate LBOs and similar acquisition structures. However, recessionary fears and the interest rate hikes by the Central Bank of Bahrain, following the rate hikes in the United States dollar, have made the financing of M&A transactions more expensive and elusive, noting that Bahrain maintains a fixed exchange rate regime between the Bahraini dinar and the United States dollar. That being said, the profitability of key market players remains positive, as some share buyout offers have been announced on the Bahrain Bourse.
Furthermore, the visible impacts of COVID on M&A activity are fading and businesses have returned to normal. In the past, some caution was undertaken by the Bahrain government due to the rise of COVID numbers in China. The efficient monitoring and tackling of the situation by the government ensured a minimal, or no impact on business activities.
Private equity (PE) investment into Bahrain has stagnated, if not trended downward. The impact of the low price of oil was the downgrading factor in the preceding years; however, the previous years’ lackluster investments had also been attributed to the slowdown of the Western economies. The lack of structural reforms regarding the issuance of innovative securities is also impacting investments in start-up companies. Closely held start-up companies lack a practically enforceable structure for PE funds, such that the same would generally use an offshore vehicle to participate in a local entity.
Legislation and policy changes
The Take-over, Mergers and Acquisitions Module of the Central Bank of Bahrain Rulebook (Volume 6) is the primary governing regulation for public M&A in Bahrain and it works in conjunction with other regulations issued under the said rulebook. 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 the Bahrain exchange. Rulebook 6, including the TMA Regulation, is administered by the Capital Markets Supervision Directorate at the Central Bank of Bahrain.
Private M&A, as such, is not a regulated activity beyond the registration of share transfers and transfers of business premises, outlined primarily in the Commercial Companies Law. The Authority for Promotion and Protection of Competition is established under Bahrain’s Competition Law, which regulates all arrangements that are intended to hinder competition in the Kingdom and large M&A deals that reach a certain threshold of dominant position.
Of relevance to transactions relating to closed Bahraini shareholding companies is the transition of the share registry from the Ministry of Industry and Commerce to the Bahrain private market, through the modernised share registry platform operated by Bahrain Clear. Moreover, it is important to note that the registration of share transfers (post-closing) with the Bahrain Clear would be included as a condition to a private acquisition for closed Bahraini shareholding companies.
Also, the recent amendments to the Corporate Governance Code applicable to Bahraini shareholding companies would provide additional ‘red flag’ headings for any due diligence exercise. Environmental, social and governance (ESG)-related discussions are voluntary following the Bahrain Bourse’s launch of its voluntary ESG reporting guidelines for listed companies and other stakeholders in June 2020. However, the government has increased its activism on climate change issues and corporate social responsibilities associated with it.
COVID has left a permanent impression on how business is conducted in Bahrain. Remote working options explored during the pandemic continues to be part of some companies.
The Central Bank of Bahrain has issued a consultation paper for passing a resolution for defining a legal framework concerning the types of securities that may be offered and traded in the Kingdom.
Another active domain for progressive consultation is cyber security. Recently, the National Institute of Standards and Technology collaborated with the Central Bank of Bahrain to implement cybersecurity standards within the regulations of the Central Bank of Bahrain. In the foreseeable future, cybersecurity can be expected to take center stage in various government deliberations and law-making. The National Cyber Security Centre of Bahrain has developed baseline cybersecurity controls and templates of cybersecurity policies to provide entities in the Kingdom with an essential set of cybersecurity and policy controls. These controls cover a broad range of cybersecurity and policy topics and areas aimed to protect an entity's networks, systems, and applications against cyber threats and attacks by building a foundational layer of security. At present, these controls and policies are voluntary. Identification of the Kingdom's critical national infrastructure (CNI) is the next key stage followed by the identification of entities forming part of the CNI, and implementing these controls within such entities. Bahraini target companies that are part of the critical infrastructure and that manage systems, networks and assets essential to Bahrain’s national security, public health and safety may need to factor these additional costs into their operational plans.
Practice insight/market norms
With the increase in public M&A, the question has often arisen regarding the availability of due diligence reviews of public companies. While Bahrain maintains a special regime for underwriters (in relation to IPOs and subsequent offerings), there is no special mechanism for due diligence review of non-public information by a major investor in respect of public companies (whether coordinated by an off-market trade or strategic participation in a capital increase). This limitation, which arises through the confluence of insider trading regulations and market manipulation rules, has not even permitted a clean-team structure, much less a pre-disclosure in advance of subsequent public disclosure of information.
This regime appears to have dampened strategic investment in public companies and/or takeover offers without creating a more efficient and liquid market arising from the increased transparency.
One common mistake is to structure and implement M&A deals following schemes and solutions developed in overseas jurisdictions without paying the necessary attention to the local legal and regulatory framework, both in cases of cross-jurisdictional and purely domestic transactions. This mistake can go unnoticed insofar as no conflict arises between the vendor and buyer, though this may result in the completion process conflicting with local regulations. If a conflict arises, the pitfalls of such approach becomes readily intelligible, including difficulty in obtaining legal redress in the local jurisdiction, uncertainties surrounding the application of foreign law provisions in domestic court proceedings and an impasse in meeting the local requirements for completion.
A growing number of M&A professionals understand and appreciate the benefits of technology in M&A transactions. Bahrain has a conducive legal environment for complex M&A deals involving complexities associated with new-age technologies. A wide range of government actions – such as the implementation of the Personal Data Protection Law, the cloud law, the electronic transactions law, regulations concerning fintech, and the open-banking initiative – have helped Bahrain to position itself as a regional leader in attracting global technology businesses. Such initiatives, ultimately orchestrated by the Bahrain government, have subsequently sparked a need for more detailed due diligence exercises with a special focus on technology.
Merger controls may be introduced for critical sectors, especially for entities that service the technology of critical infrastructures. On the horizon are the cybersecurity controls that may be made mandatory for entities that are identified as critical to the national infrastructure.
Bahrain does not have a robust intellectual property sector and while Bahrain is positioning itself as an ICT hub in the GCC, this has not led to an increased focus in government policies.
Obtaining control of a public company often involves the launch of a 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 set forth for any incremental purchase between 30% and 50% of the voting share capital occurring within a specified timeframe. The squeeze-out threshold has been rationalised to 90% of acceptances. The launch of a tender offer is accompanied with the publication of an offer document subject to approval from the Central Bank of Bahrain.
In respect of competitive and hostile bids, there are regulatory provisions that prohibit certain frustrating actions.
Usually, conditions attaching to an offer include levels of acceptance, approval of shareholders for the issuance of new shares, and listing/regulatory approvals. A voluntary offer must not be made subject to conditions whose fulfilment depends on the subjective interpretation by, or judgment of, 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. The 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 Central Bank of Bahrain must be previously consulted. 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 did have an impact on the public offers announced during this period. The public offer for the acquisition of AUB shares by KFH was announced in 2020; however, the pandemic delayed this acquisition and it was completed in 2022 after obtaining several extensions from the regulators.
Break-up fees are not used in Bahrain and their validity is uncertain, because a commitment 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, this instrument is not expected to 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 increased use of such mechanisms is expected, 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 these are being used as a tool for bridging widening valuation gaps between seller sides and buyer sides. Escrows are very common and are mostly used in connection with the management of claims against representations and warranties.
Regulatory approvals are invariably attached to private offers in respect of target companies operating in regulated industries. The registration of share transfers (post-closing) with the Bahrain Bourse would now be included as a condition to the private acquisition for closed Bahraini shareholding companies subsequent to the migration of the registry of Bahraini shareholding companies to Bahrain Clear.
It is not uncommon to find material adverse change 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) of them may give a deal exit to the buyer.
The authors strongly advise against the use of foreign jurisdiction clauses in M&A transactions in light of the enforceability issues that these may give rise to, although it is common practice. In the case of foreign governing law, foreign arbitration should be seen as a must, largely due to the problems faced in proving the provisions of foreign law in front of a Bahraini court and the difficulties in enforcement of foreign-court decisions. Bahraini governing law with Bahraini court enforcement may be valuable to facilitate the enforcement of local obligations associated with the transaction and may be favourable for a foreign party that receives robust local law advice against a Bahraini counterparty.
The exit mechanism under Bahrain laws is very challenging. The main exit channel still consists of a private sale to an industrial or private equity 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, not to mention the penalising capital treatment that this asset class receives under the BASEL III capital adequacy regulations.
Fading signs of the impact of COVID on the economy are being seen; however, it leaves Bahrain with a new set of challenges. Inflationary pressure on the United States dollar is of concern to policymakers. Geopolitical factors will also dictate the sentiments for M&A deals, especially with the reform being undertaken in other GCC countries, and particularly with Saudi Arabia opening up for foreign investments.
Delayed VAT implementation by some GCC nations is not a welcome sign for Bahrain, which has efficiently implemented VAT. Bearing this in mind, VAT implementation by other GCC states would encourage Bahraini businesses to expand their market presence to other GCC countries, resulting in an increased level of M&A activity.