Public M&A: When is an entitlement issue really a minorities take-out?

On 27 June 2016, Sandon Capital Investments Limited commenced Takeovers Panel proceedings in relation to an entitlement offer announced by Warrnambool Cheese & Butter Factory Company Holdings Limited (WCB). These proceedings by a minority shareholder in the ASX-listed WCB have raised questions as to whether unacceptable circumstances exist with regards to an entitlement issue, notwithstanding compliance with Item 10 of Section 611 of the Corporations Act.

Saputo Dairy Australia Pty Limited (Saputo) holds 87.92% of WCB, acquired in early 2014 through a hotly contested competitive takeover bid process for WCB, which fell short of achieving the 90% ownership level necessary to enable Saputo to move to 100% ownership of WCB.  Lion-Dairy & Drinks Pty Ltd’s (Lion) shareholding at that time effectively blocked Saputo moving to 100% ownership of WCB. It now owns 10.22% of WCB and can continue to block Saputo from moving to 100% ownership of WCB.  That is, unless the potential outcome of the WCB entitlements offer described below, of which Sandon Capital complains, eventuates.

Under the Corporations Act, if Saputo comes to own 90% of WCB, it will have an ability to compulsorily acquire all outstanding shares, even if it has not achieved that 90% ownership as a result of making a takeover offer available to all shareholders.  The WCB entitlement issue announced on 10 June 2016 may result in  Saputo owning 90% of WCB, an outcome which it was not able to achieve from its earlier takeover offer.

Saputo Inc (Saputo’s holding company) has committed that Saputo will take up its full entitlement under the offer, thereby ensuring that it maintains a minimum 87.92% holding of WCB.  However, if no other shareholders take up their entitlements under the offer, Saputo’s ownership of WCB will move above the 90% threshold, thereby enabling it to take out all other shareholders.

The primary question for the Takeovers Panel would seem to come down to whether WCB requires the funds being raised under the entitlement offer and is the true purpose behind the entitlements offer being made really to enable Saputo to compulsorily acquire the other WCB shareholdings.

In essence, this is the thrust of Sandon Capital’s key submissions revealed in the Panel’s media release announcing the application.  Sandon Capital submits in its application that WCB does not require the funds being raised under the entitlement offer and there is no incentive for shareholders to participate in the offer.  It is further submitted that the offer is being inappropriately used as a mechanism to enable Saputo to proceed to compulsory acquisition of the remaining WCB shares and is therefore an abuse of Item 10 of Section 611 of the Corporations Act. On the face of it, WCB’s balance sheet and the existence of, one assumes, a supportive majority shareholder in Saputo, does not scream out the need for a WCB fundraising. WCB does however seem keen to repay debt, which is the principal reason given for the fundraising.

Item 10 of Section 611 of the Corporations Act provides an exemption to the prohibition which otherwise prevents shareholders of listed companies increasing their ownership interest when they already own more than 20% of the company.  This exemption allows a company in the position of Saputo to increase its ownership interest, notwithstanding that interest is 87.92% of WCB, if it acquires more shares through an entitlement issue that satisfies a number of conditions listed in Item 10.  Those conditions are met in the case of a WCB entitlement offer.  

However, the Takeovers Panel’s remit in this case is to decide if unacceptable circumstances exist, notwithstanding compliance with the law. The Panel has, on numerous occasions in the past, found fault with entitlement offers that, notwithstanding compliance with the Item 10 conditions, have an unacceptable effect on the control of a company.  This is what Sandon Capital is asking the Panel to find in the case of the WCB entitlement offer.  The key question which the Takeovers Panel will need to determine is whether or not the WCB entitlement offer is effectively a device to enable Saputo to move above the 90% ownership level, which would enable it to compulsorily acquire the remaining shareholdings in WCB.

The WCB entitlement offer does include features which the Panel has in the past indicated might mitigate against an entitlement offer being unacceptable, such as the availability of a top up facility under which shareholders can apply for additional new shares in excess of their entitlement (which Saputo itself will not take advantage of) and making the offer renounceable.  However, the existence of such features does not ensure that the WCB entitlements offer will pass muster with the Takeovers Panel.

The WCB offer booklet states that Saputo Inc has advised WCB that it has not yet made a decision as to whether it would procure Saputo to proceed with compulsory acquisition of any WCB shares not owned by Saputo.  The Takeovers Panel is likely to carefully investigate that statement.  Bidders under takeover offers routinely disclose their intentions on whether they will proceed to compulsory  acquisition if they achieve the threshold necessary to do so.  It certainly challenges conventional logic that Saputo Inc has not yet determined whether Saputo would proceed to compulsory acquisition if able to do so, following the entitlement offer.

It should be noted that the WCB Board, not Saputo, must decide that the entitlement offer will  proceed, as WCB is a separate legal entity remaining listed on the ASX and the WCB directors have obligations to all shareholders, not just to WCB’s majority shareholder Saputo.  

However, Saputo’s representatives have a significant voice at the WCB Board table, with two Board seats out of five.  The two Saputo representatives are not independent directors.  While the entitlement offer booklet states that an independent Board committee reviewed and approved the terms and pricing of the entitlement offer, it is not clear from the offer booklet whether or not the Saputo representatives were involved in the WCB Board decision to proceed with the entitlement offer in the first place.

It is fair to assume that they were involved, given that the offer booklet does not disclose that they were not involved but it specifically does disclose that they were not involved in decisions about the terms and pricing. Certainly Lino A. Saputo, Jr, the WCB Chairman and a Saputo representative, signed the letter to WCB shareholders accompanying the entitlement offer booklet.

It will be very interesting to see whether the Takeovers Panel allows WCB to proceed with an entitlement  issue, the result of which might be to enable its holding company Saputo to squeeze out all other shareholders, including Lion, when Lion has otherwise already made a sufficient investment to be able to prevent that occurring.  Lion would only be able to continue to prevent that occurring if it were to take up the vast majority of its own entitlement.  However, one has to question whether Lion should have to make a further significant investment into WCB to protect its position. The Panel will need to carefully consider this point.

If the Takeovers Panel does not make the orders sought by Sandon Capital to prevent the entitlement offer proceeding, Sandon Capital would still be able to commence Court proceedings seeking to prevent the shares being issued under the entitlement offer on an argument that the offer and consequent capital raising were being made for an improper purpose and constitute a breach of the WCB directors’ duties. Such proceedings would inevitably see the directors of WCB enter the witness box and be cross examined individually on their personal motivations in proceeding with the entitlement offer.  

While Court proceedings are a real possibility, the Australian market has come to expect commercial resolution in quick order to be achieved by the Takeovers Panel in circumstances such as these, so a prompt and well-reasoned response from the Panel may see an end to the matter.