The takeover offer versus scheme of arrangement controversy is in the spotlight again.

It is the root cause of the attempt by Abano Healthcare shareholder Peter Hutson to dump chairman Trevor Janes at a special meeting of shareholders to be held on Friday, June 13.

The controversy goes back to the 1970s and 1980s when a number of predators, particularly Brierley Investments, gained control of a large number of NZX companies through “dawn raids”.

A “dawn raid” is where an acquirer purchases a controlling stake through the market in a matter of hours on a first come, first served basis. These “dawn raids” enabled a bidder to obtain a 20 per cent to 50 per cent plus stake in a listed company without paying an appropriate premium for control or making an offer to all shareholders.

“Dawn raids” were extremely popular because there was no effective takeover legislation in New Zealand and they gave bidders a clear advantage.

These raids contributed to the wild-west characteristics of the New Zealand sharemarket and there was widespread support for the introduction of orderly takeover rules following the 1987 sharemarket crash.

Six years after the crash the National Government enacted the Takeovers Act 1993 but it would not become effective until a Takeovers Code was approved by Cabinet.

A number of organisations representing big business, particularly the Business Roundtable, lobbied strongly against the implementation of a code and the code did not come into force until mid-2001, nearly eight years after the Takeovers Act was enacted.

Under the Takeovers Code an offer for control has to be made to all shareholders. There is a pause period between the announcement of the bid and the actual offer and a bidder can only move to full control once it has acquired 90 per cent of the shares on issue and enforces the compulsory acquisition provisions of the code.

Shortly after the code was introduced acquirers started using alternative schemes of arrangement to achieve control of target companies. Under a scheme of arrangement the bidder and target company directors usually agree to the terms of a takeover or merger before shareholders are informed. The bidder gains full control if 75 per cent of votes cast at a shareholders meeting are in support of the transaction.

In other words, full control can only be achieved under the code when the bidder has acquired 90 per cent of all the shares on issue whereas under a scheme of arrangement full control can be achieved when 75 per cent of votes cast at a shareholders meeting are in support.

Schemes of arrangement are also called “bear hugs” because they are designed to force the directors of the target company to quickly recommend an offer to shareholders under the threat that their refusal will be made public and be subject to shareholder and market scrutiny.

One of the most controversial schemes of arrangement first came to light on March 27, 2006 when Waste Management announced a proposed merger with Brisbane-based Transpacific Industries.

The initial announcement stated that “the merger has the unanimous support of both the Waste Management and Transpacific Industries boards”. The Waste Management directors declared their unanimous support five weeks before Grant Samuel’s appraisal report was made public.

A number of institutional shareholders were highly critical of the proposal because the 75 per cent voting threshold gave them less power than the 90 per cent needed for compulsory acquisition under the Takeovers Code.

In addition large shareholders argued that they take a portfolio approach towards equity investments and it would be difficult to replace Waste Management as it was probably the best defensive stock on the NZX. They were particularly annoyed when chief executive Kim Ellis told the Business Herald that shareholders should use the proceeds to “buy a bach or invest in Transpacific or take a holiday” when most of the money would have to be reinvested in NZX companies.

Ironically, Transpacific has been one of the worst performing ASX companies since 2006.

The transaction, which was really a takeover rather than a merger, received considerable media attention. A week before the shareholders’ meeting chairman Jim Syme issued a strongly worded statement condemning some of the media coverage and urging shareholders to vote in support of the transaction.

He said that the $8 million break fee was only payable by Waste Management to Transpacific if the target company directors changed their positive recommendation.

Fisher Funds, which owned 6.6 per cent of Waste Management, issued a press release under the heading “Fisher Funds to reluctantly vote for merger proposal”. Fisher said it “remains perplexed and disappointed at the behaviour of the Waste Management board”, particularly “negative comments in the media [by the company] about the long term viability of the business”.

The Waste Management/Transpacific transaction was approved at a meeting of shareholders on May 17, 2006 with 97.5 per cent of votes cast in support.

The Takeovers Panel was highly critical of schemes of arrangement in its 2006 annual report with chairman John King writing “that they do not have the same protection for shareholders” as the code.

The Abano Healthcare controversy began in July 2013 when Archer Capital wrote to chairman Trevor Janes with a proposal to purchase 100 per cent of the New Zealand company, in association with Peter Hutson, under a scheme of arrangement. Hutson was an Abano director and a 14 per cent shareholder.

Archer adopted the “bear hug” approach by insisting that their offer, which was highly conditional, was confidential and no announcement could be made public until:

An independent report had been completed which recommended the proposal.

The Abano board agreed to recommend the proposal.

Fisher Funds, which owned around 9 per cent, and ACC, with about 6 per cent, would publicly support the transaction when it was first announced to the stock exchange.

In addition Archer wanted to undertake substantial due diligence of Abano over a five-week period before any announcement to shareholders was made.

The private equity firm also wanted an exclusive agreement whereby no other potential bidders were approached by Abano during this five-week period.

Abano shareholders are fortunate that Trevor Janes is probably the last New Zealand director to try to “bear hug”. He wasn’t tempted by the seductive pot of honey offered by Archer under a scheme of arrangement. He asked Archer to make a proper offer under the Takeovers Code. Since then Hutson has gone on the attack and made numerous accusations against Janes and the Abano board.

If Hutson is so concerned about transparency why doesn’t he release the July 2013 Archer scheme of arrangement proposal?

Why is the Abano board being criticised for not releasing this proposal when it was submitted by Archer on the basis that it remained strictly private and confidential?

The problem is that schemes of arrangement are fundamentally flawed as far as shareholders are concerned because the offeror usually wants the target company board, and major shareholders, to agree to a proposal before it is announced and the independent analysis is completed. This substantially reduces the possibility of a competitive bidder process, a situation which would enable shareholders to maximise value and is one of the main objectives of the Code.

Unfortunately the Takeovers Panel seems to have softened its opposition to schemes of arrangement. This is a huge backward step in light of the inadequate way New Zealand shareholders have been treated under “dawn raids” and “bear hugs”.

The panel needs to return to its early 2000 roots and be more concerned about the interests of New Zealand shareholders instead of large corporate bidders. The appointment of Trevor Janes to the Panel would be a step in the right direction.

Portfolio Manager

Brian Gaynor

Disclosure of interest: Milford Funds Ltd. invests in Abano Healthcare shares and will be voting all of these shares in support of Trevor Janes at the June 13 meeting.