UK Takeover reform - an opportunity for Asia?

As economic conditions in Europe remain challenging, market commentators continue to speculate that Asian investors may look to employ their capital by picking up discounted European assets. Listed companies in the UK are among the most talked-about potential targets.

The UK’s Panel on Takeovers and Mergers has recently revised its Takeover Code in a way which hands more control of takeover bids to the target company board. However, these changes potentially hand opportunities to cash-rich Asian investors who can move quickly to secure a desirable asset. This briefing looks at some of the competitive advantages that Asian investors may enjoy over traditional bidders in the UK takeover market, and suggests that the latest changes should give Asian investors an increasing reason to pay attention to the UK public M&A market and opportunities to acquire potentially under-priced UK listed assets.

Most of the high profile takeover transactions in the UK market in recent years have been cross-border acquisitions - buyers from outside the UK acquiring predominantly UK assets. The market has seen an increasing participation from strategic or financial investors in emerging markets, as well as players in developed markets looking to globalise. By way of example, in 2010 there were 24 takeover offers for UK listed companies with a value of over £100 million, 16 of which were made by non-UK bidders.

Asian buyers are talking more openly about the attractiveness of listed companies in Europe, and in particular the UK, as a means to utilise their cash:

• many Asian investors feel overexposed in Asia and are looking to diversify their portfolios and/or obtain strategic or “trophy” assets elsewhere;
• some Asian investors are looking to secure more predictable cashflows which involve little development risk;
• deal execution risks are relatively low in the UK, where traditionally the barrier to foreign ownership has not been set high (and the recent UK Takeover Code changes referred to in this briefing do not alter this position);
• the combined weakness of the UK equity markets and the UK pound sterling i has made these targets more attractive;
• the relative lack of competing domestic bidders and lack of available acquisition financing makes UK targets easier to capture.

Sectors which are seen as ripe for acquisition activity by Asian buyers include real estate, consumer goods, infrastructure & utilities and oil & gas. Some of the recent high-profile Asian takeover bids in the UK have included the following:

• In August 2010, Korea National Oil Corporation (KNOC) made a bid for Dana Petroleum, the first time an Asian state owned company has proceeded with a ‘hostile’ bid. The bid was successfully completed at US$2.6 billion.
• In October 2009, Carson Yeung, a Hong Kong tycoon (though Grandtop International Holdings Limited), successfully bid for Birmingham City Football Club at a price of GBP80 million. This was the second approach by Yeung who previously made an unsuccessful bid for Birmingham City in 2007.
• State owned India Oil Corporation and Oil India Limited made an unsolicited approach to Gulfsands Petroleum plc in May 2010, but confirmed they were not proceeding with an offer claiming they failed to receive the necessary due diligence information from the target company.
• Sinopec completed the largest overseas takeover transaction ever made by a Chinese company (at the time) when it successfully agreed a recommended US$7.3 billion bid for oil producer Addax Petroleum Corporation in June 2009.
• Cheung Kong Infrastructure Holdings made a recommended offer for Northumbrian Water Group plc. Cheung Kong successfully completed the US$3.93 billion dollar offer in October 2011.
• China Guangdong Nuclear Power Corporation (CGNPC), the Chinese state controlled uranium company, made an initial recommended cash offer for AIM-listed Kalahari Minerals in March 2011. The initial approach was derailed by the Fukushima disaster and a Panel ruling which prevented CNGPC from lowering its initial offer price for Kalahari. Kalahari has recently announced that it is again in talks with CNGPC.
• India’s Oil and Natural Gas Corporation made a successful GBP1.3 billion bid for Imperial Energy plc, which was de-listed following the acquisition. The bid took place against a background of ongoing oil price concerns, as well as a potential competitive bid from China’s Sinopec.
• Chengdu Geeya Technology Co. Ltd is also in the process of obtaining regulatory clearances for outbound investment from the relevant Chinese regulators to launch its offer for Harvard International PLC.
• China Minmetals made an attempt to take over Equinox Resources in April 2011 and has now agreed to buy Toronto-listed Anvil Mining.

As can be seen from the above, there is strong interest from Asian investors in acquiring UK listed companies whose assets are based in emerging markets - in particular in the mining and commodities sector.

In this briefing, we refer to “Asian investors” as a single group, although of course this term encompasses an extremely wide range of companies and individuals. Interest is being seen from a myriad of sources, ranging from Middle Eastern sovereign wealth funds, Chinese state owned enterprises, Indian and Korean conglomerates and private wealth. The purpose of this briefing is not to suggest that all these parties have a single strategic position, but to explore possible opportunities that Asian investors may have in common as a result of the current macro-economic situation as well as the recent regulatory developments in the UK.

Takeover bids in the UK have traditionally involved a possible bidder approaching a target company’s board to discuss terms. There has, however, been a trend in recent years for a bidder to announce publicly its possible interest in acquiring a target company in order to bypass the target board and go straight to shareholders to gauge their appetite for an offer (commonly referred to as the “virtual bid”). Unlike in Asia, few UK listed companies have controlling shareholders, so it is not generally possible to negotiate with an individual shareholder before proceeding to the bid. The role of the target board therefore assumes greater importance; however, the directors of a target company may feel threatened by a takeover. This might be because cultural or management changes will give rise to an unacceptable loss of autonomy, or more basically because they may see a risk that they will lose their jobs. A bidder must decide whether to make a bid with the co-operation and approval of the target board (a “recommended bid”) or to proceed to make an offer directly to the target shareholders without the board’s approval (a “hostile bid”).

The relative prevalence of hostile bids in the UK is in contrast to the position in Asia and, indeed, elsewhere in major capital markets. In Asia, controlling shareholders can normally prevent a bid simply by refusing to speak to or deal with a hostile or competing bidder (which, generally speaking, is the controlling shareholder’s prerogative). By contrast, in the UK, there is little by way of takeover regulation to stop an unwelcome competing bidder intervening in an offer from a “friendly” bidder which is recommended by the target board. The principles of the UK Takeover Code aim to regulate the process of competing bids and to help bring the situation to a head rather than creating obstacles to the making of competing bids.

An approach to the board of a target company does not need to be announced unless there is a leak. When a leak occurs, the target company must make an announcement about the possible offer, and this starts the “offer period”. Consequently many of the investor protection requirements (e.g. disclosure of dealings by the bidder and its related parties) begin to apply. Because of the greater likelihood of competing and hostile bids in the UK, this period is probably more strictly controlled than in many Asian markets and there are mechanisms to ensure that a possible bidder proceeds to make a firm bid, or withdraws from the race. Once a bidder announces a firm bid, it must prove it can fund its bid, and cannot withdraw other than in exceptional circumstances.

All UK and Channel Islands incorporated companies which are listed on the main market of the London Stock Exchange (LSE) in the UK are normally subject to the UK Takeover Code and those UK and Channel Islands incorporated companies which are listed on AIM (the LSE’s junior market) will also be caught by the UK Takeover Code if they are centrally managed and controlled in the UK or the Channel Islands.

The UK Takeover Code is similar to the Hong Kong Takeover Code which will be familiar to some Asian investors; indeed, the Hong Kong Takeover Code was based upon the UK Takeover Code. However, in the last decade, the UK Takeover Code has undergone a number of revisions which have been perceived to favour bidders (including hostile bidders) over target companies.

A number of high profile takeovers have led to political and public pressure to redress this balance. Most notably, the takeover of a beloved British institution - the confectionary company Cadbury - by US-based overseas buyer Kraft Foods was the catalyst for regulatory reform which sought to redress the balance and hand more power back to target boards.

The UK Takeover Code provides a structure under which all takeover transactions must be conducted. It does not have the force of law, but the UK Takeover Panel can seek court enforcement of its rulings (although it has never needed to resort to this). Compliance is effectively mandatory due to significant practical sanctions that can be imposed on those who depart from its requirements. The UK Takeover Code applies to transactions which involve a change of control, which means a change in the ownership of 30 per cent or more of the listed company’s voting rights.

The important concepts behind the UK Takeover Code are as follows:

• shareholders should be treated equally, so for example must receive the same price as each other and the same type of consideration (e.g. cash or securities);
• the target company board should ensure that target shareholders have the opportunity to decide a bid on its merits and that target companies are not able to frustrate bids by using blocking tactics;
• competing bidders (even if unwelcome) are given a fair opportunity to make a bid, and are entitled to receive the same information as other, perhaps favoured, bidders;
• target companies should not be subject to speculation about possible takeovers for an extended period of time, so potentially bidders must follow a strict timetable;
• bidders are allowed to react to the market perception of the bid, or to competing bids, by increasing the offer price, but are bound by any statements they make on increases;
• bidders are given flexibility as to how to structure their bid - for example they may choose to make it conditional on securing a certain percentage of acceptances, or they can use a structure known as a “scheme of arrangement” which gives them certainty of achieving 100 per cent ownership after the requisite voting thresholds have been passed;
• once a firm bid is announced, the bidder must follow through with its bid and must prove at the outset that its bid is fully funded;
• if a change of control occurs (effectively the acquisition of an interest in 30 per cent or more), shareholders should normally have the opportunity to exit their investment by the new controller making a mandatory general offer to shareholders; and
• shareholders should receive accurate and sufficient information, independent advice on the details of a bid, and information on the dealing activities of the bidder and its related parties.

In the last few years, bidders have arguably been in the dominant position when it comes to the conduct of takeover bids. For instance, bidders have increasingly flagged their interest in a possible acquisition of the target companies without any commitment to proceed, the so-called “virtual bid” tactic. It has also become common for “deal protection” agreements to be negotiated for the implementation of the takeover. These include provisions which improve the chances of success of the particular bidder’s takeover by requiring the target board not to solicit or engage in discussions with third parties, to give the bidder a right to “match” a competing bid and to require the target board to pay a break fee if it recommends a competing bid.

The changes to the UK Takeover Code introduced on 19 September 2011 represent the most significant changes to the UK Takeover Code for many years, and give greater power to target company boards as opposed to bidders. The key changes are as follows:

Protection against “virtual bids”: Increasing concern has been expressed that UK targets are being left in a state of limbo, when they are subject to a possible offer but no firm bids are forthcoming. Accordingly, the UK Takeover Panel has proposed two distinct measures aimed at dealing with this:

• identification of possible bidders - whenever a takeover is the subject of press commentary or market movements, the target company must make an announcement of the possible bid - i.e. the first “leak” announcement. Following the rule changes, the target must now identify all possible bidders with whom it is in talks or from whom it has received an approach which has not been rejected. The only way to avoid this is for a bidder to cease all work on the bid (“down tools”) and it cannot re-commence work for 6 months (an increase from 3 months previously) or for a target to effectively put itself up for sale publicly (by announcing a formal sales process).
• shorter timeframe to make firm offer - after a leak announcement had been made, the UK Takeover Code did not previously mandate a timetable for a firm offer, but instead left it to the target to apply to the Panel for an order that a bidder either makes a firm bid or withdraws from any possible bid - a so-called “put up or shut up” order. This would give the bidder a period of usually 6 to 8 weeks to make its bid. The recent rule changes instead require a bidder to make its firm offer within 28 days from the first announcement about the possible bid - i.e. the first “leak” announcement. The timetable for bidders is therefore significantly shorter. If the target does not consent to an extension of this deadline and the bidder is not in a position to make a firm offer, the bidder will be forced to withdraw its interest and then be embargoed from making another offer for 6 months (save in limited circumstances).

Removal of deal protections: Recommended bidders are now no longer allowed to agree implementation agreements with deal protection provisions:

• exclusivity and deal protection prohibited - provisions such as those relating to non-solicitation of competing bids and “matching rights” are no longer permitted.
• break fees - most significantly, break fees payable by the target are now not permitted in the majority of situations; they had previously been permitted but capped at 1 per cent of the overall offer value. This makes the UK one of the most restrictive regimes for the payment of break fees in the major, international capital markets.

Increased transparency on bidder arrangements and intentions: Bidders are now required to disclose details of:

• financing arrangements - previously this was only required in securities-exchange offers or where minority shareholders might remain within the target company and therefore might be affected by the financing. The financing documentation must also be put on display in an unredacted form.
• advisory fees - all advisory fees payable by either the bidder or the target company must be set out in the offer document.
• their intention for the business - in particular statements must be made about the bidder’s intention with regard to employees. There are additional mechanisms to increase the amount of engagement with a target company’s employees, who have augmented rights to make representations and statements in the offer document. The Panel will also have additional rights to require successful bidders to stick to their commitments after the bid is completed. This will make it less likely that the Kraft/Cadbury situation will be repeated, where Kraft made a statement suggesting it would not close a factory, which it then subsequently closed in the immediate aftermath of the offer.

Please refer to the fuller briefing we have prepared on the recent changes: A revised framework for UK public M&A.

There are a number of reasons why the new changes may present opportunities for Asian investors.

New protections against “virtual bids” favour buyers who can move quickly: Many Asian buyers are cash-rich and do not need (or prefer not) to rely heavily on leverage to make acquisitions. This makes them potentially more nimble in putting together an offer. By contrast, many traditional players in the public takeover market, such as private equity houses, may not be able to move so quickly, because they need to arrange finance or simply because their internal risk control procedures require fuller due diligence.

• The rule changes which impose the 28 day time limit to make a firm bid potentially discourage buyers who cannot move quickly (for example because they need to complete due diligence). If there is a leak about the deal at an early stage, the clock will start ticking and such bidders may not be able to make a firm bid in the 28 days available.
• The requirement to identify all potential bidders in the event of a leak may scare off domestic players who do not want the publicity of an ultimately unsuccessful bid. By contrast, some investors from outside of the UK market may be less concerned with this aspect. That said, there will be Asian investors who are similarly nervous about adverse publicity in connection with a possible bid which does not come to fruition.
• The above changes may make it more likely that leaks occur early in the process, either because the target board wants to force its bidders’ hands, or because better prepared existing bidders want to make life more difficult for potential competing bidders by starting the timetable as soon as possible. The protection against virtual bids potentially gives the initial bidder a first mover advantage, and reduces execution risk.

Deal protection limitations are more of a problem for “traditional” takeover bidders: Implementation agreements and deal protection tactics such as exclusivity arrangements and matching rights have not generally been seen much in the Asian public takeover markets. Even break fees tend to be more important to buyers in places such as the US. Accordingly, whilst the new restrictions on deal protection and break fees might be a discouragement to Western bidders, this may be less of a concern for Asian bidders who have been happy to proceed in their home markets without employing such techniques (although, from the perspective of execution risk, the prevalence of controlling shareholders has mitigated the need for sophisticated deal protection measures).

Increased transparency requirements may discourage leveraged bids: The enhanced transparency requirements may favour Asian bidders in two ways.

• The new requirements for bidders to disclose details of their financing, and put on display their financing documents, may discourage leveraged buyers who may be sensitive to full details of their financing arrangements being made public under the enhanced disclosure rules, although in practice leveraged buyers may simply accept this as a requirement of implementing deals in the UK and proceed as normal.
• The increased focus on the impact of takeover offers upon stakeholders other than shareholders (e.g. employees, local communities etc.) may make highly leveraged private equity bids increasingly difficult to execute due to political pressure from interest groups. Certainly, there is now a greater awareness in the UK about some of the effects of leveraged bids which seek to use target company cashflows to fund debt repayments. That said, the wider range of matters that directors are now asked to take into account, including employee representations, may be somewhat unfamiliar to Asian investors who may wish to reorganise the target’s employment structure following acquisition. Even so, these requirements are still significantly less onerous in the UK than in many other markets in Europe.

Other competitive advantages

Asian buyers may have some other fundamental competitive advantages over Western bidders at present. There has been a historic preference in takeover activity in western markets for buyers to be absolutely sure they can secure 100 per cent of the target company, and de-list it promptly. This was traditionally because it was necessary to enable a leveraged bidder to use the target’s assets to secure the bidder’s borrowings, although there is also a general perception among western bidders that it is undesirable to have minority shareholders. There is generally not such prejudice amongst Asian investors, who are more familiar with the concept of an “owner-manager” controlled listed company. Many Asian buyers actually prefer to retain the listing of a target company in order to use it as a vehicle for future growth. For example, on the offer earlier this year by Guoco Group for The Rank Group plc (where Norton Rose LLP advised Guoco), Guoco was content for Rank to retain its listing.

The fact that Asian buyers often need not acquire 100 per cent of the target gives them a possible competitive advantage because it reduces execution risk. A bidder only needs to secure statutory control or acceptances of 50 per cent + from shareholders to make a voluntary offer successful/allow the offer to be declared unconditional. Indeed, for the target board or target shareholders who do not wish to sell out, there may be some strategic attraction in having an Asian controlling shareholder, especially where the buyer is likely to be able to present additional opportunities to the business in terms of export markets or strategic co-operation.
Of course, the inability to negotiate with a single controlling shareholder potentially makes acquisitions more difficult. But this can also work in favour of Asian investors - if they play in their domestic markets they must generally be able to negotiate a deal with the controller, failing which there will be no deal. By contrast, in the UK the lack of controllers gives potential bidders the opportunity to explore any listed company, with the possibility of going hostile if the board is not receptive.

Takeover offers are one of the more difficult, and certainly more public, transactions to execute. Appropriate and expert advice from investment bankers, accountants and lawyers is essential in order to participate successfully; and indeed many of the disciplinary situations in the UK have arisen from bidders either obtaining poor advice, or ignoring good advice, or failing to obtain advice early enough in the process.
In light of the recent rule changes and the increasing trend for cross-border takeovers, potential bidders should bear the following in mind:

• Maintain secrecy: A bidder should do its utmost to preserve confidentiality in the initial stages. Failure to do so may result in a leak announcement, and the start of the 28 day time period for delivery of a firm bid. Accordingly, bidders may be well advised to do as much preparatory work as they can before even approaching the target board. A significant amount of due diligence can be undertaken based upon public information, and to the extent any financing is required, this should be progressed as far as possible before the approach.
• Gather shareholder support: In light of the prohibition of many deal protection techniques, the primary tactic which a bidder can use to shore up its bid is to gather irrevocable undertakings to accept the bid from major shareholders. There are rules surrounding how and when these can be obtained, but irrevocable undertakings will be important in reducing execution risk. Although some shareholders have resisted giving firm undertakings to accept offers in the past, bidders may be forced to seek stronger irrevocable undertakings - which for example bind the person giving the undertaking to accept the bidder’s offer even if a competing bid comes in. Typically irrevocable undertakings will provide a carve-out if the competing bid price beats the first bid by a certain margin - and bidders are likely to try to maximise this margin.
• Stakebuilding: Bidders may consider the tactic of stakebuilding - i.e. acquiring a stake in the listed company before launching a bid. The advantages are that this potentially gives the bidder a head start in achieving the number of acceptances it requires, and acts as a defensive position against competing bidders. Also, now that break fees are generally prohibited, stakebuilding in a clear acquisition target can often provide a hedge against the risk of losing to a competing bidder - a losing bidder may well have incurred wasted fees, but can at least cash out of its position at a premium by accepting the higher competing bid. The disadvantages of stakebuilding include the increased publicity at the early stages, and the risk that the bidder will be left with a stake that is difficult to exit if no bid emerges.
• Public relations: Bidders should not underestimate the importance of a good PR campaign. This is particularly important where the target is considered a “national treasure” - as Cadbury was - or there is likely to be some sensitivity of the UK target being acquired by a non-UK buyer. A well-structured PR strategy can help minimize the impact of employee issues, local/environmental lobby groups, politicians, regulators and shareholders. PR issues are likely to be all the more pertinent when the buyer comes from outside of the UK, as journalists may be able unfairly to turn the identity of an overseas acquirer into a “story” which needs an appropriate PR response.

There is no doubt that the recent changes to the UK Takeover Code hand greater control of takeover bids to the target company. The most significant changes are the automatic identification of bidders and the 28 day deadline for firm bids after the first announcement of a possible offer. These are likely to make deal execution more challenging for some buyers who need more time or do not want the publicity of their interest until they are certain they will proceed with and close an offer. The changes regarding deal protection and transparency, while significant, are expected to have a more marginal impact on the takeover market.

The rule changes, coupled with the current macro-economic conditions, may well make the execution of takeover transactions more challenging, but this potentially plays into the hands of Asian investors. Asian buyers may find UK listed targets more attractive than in the past, because of their desire to diversify portfolios, acquire stable cashflows and pick up discounted assets. Most importantly, many Asian investors will enjoy competitive advantages over other potential buyers in the market, because they are likely to be able to move more quickly, and accordingly be able to accommodate the strict timetable requirements in the event of a leak.

The last few years have seen a clear increase in Asian bidders in the UK market. Many Asian buyers have found that the competition for attractive assets in Asia is intense and are looking at new markets to explore. With the current depressed equity prices and continuing economic difficulties in the UK and Europe, we believe this trend is set to continue.