A new Australian study has reignited the debate about the merits of takeover offers versus schemes of arrangement.
The study, which was led by Martin Bugeja, head of the Accounting Discipline Group at the University of Technology in Sydney, examined 831 Australian takeovers and schemes of arrangement between 2000 and 2011. It concluded that shareholders received significantly larger premiums under takeover offers than under schemes of arrangement.
The study is particularly relevant for New Zealand because takeover activity is expected to pick up this year and schemes have become more and more popular on this side of the Tasman.
The big difference between takeover offers and schemes is that under a scheme the acquirer wants the target company board and major shareholders to agree to a proposal before it is announced and the independent analysis is completed.
This is because target companies have to arrange a special meeting of shareholders to approve the scheme, whereas under a traditional offer the bidder makes a direct approach to each and every shareholder.
Another major disparity is that compulsory acquisition can only be enforced when a bidder has acquired 90 per cent of the target company in takeover offers, but under schemes compulsory acquisition occurs when only 75 per cent of votes cast at the special meeting are in support.
Australia used to require a simple majority of shareholders present at the meeting as well as 75 per cent of the shares cast but the former is no longer required by the courts.
Under the traditional approach the bidder must offer an attractive price and convince shareholders to accept the offer. Once the offer reaches 90 per cent it automatically acquires the remaining 10 per cent even though the non-accepting shareholders may not want to sell.
Under schemes of arrangement only votes cast at the special meeting count. If only 50 per cent of shareholders vote, and 80 per cent of these vote in favour, then compulsory acquisition is enforced even though only 40 per cent of the total shares on issue voted in favour of the proposal.
The Bugeja study shows that 33 per cent of the 831 Australian transactions in the 12-year period between 2000 and 2011 were through schemes with the remaining 67 per cent through traditional offers.
However, schemes have become increasingly popular as they represented only 26 per cent of all transactions during the first four years, 35 per cent over the middle four-year period and 38 per cent over the final 2008 to 2011 period.
The Australian study has identified five main reasons why schemes have become more popular.
Schemes are more likely to be successful when target company shareholders are widely dispersed and don’t have a sufficiently large investment to encourage them to oppose a low-priced scheme. In contrast, concentrated shareholders in target firms are in a better position to insist that the acquirer’s offer is tested under the “open auction” rules that characterise takeover bids. In addition the offer price is fixed under a scheme and extremely difficult to increase, whereas it is easier for shareholders to extract a higher price under a traditional offer.
A prospective acquirer with a large shareholding is unlikely to use a scheme because it is not allowed to vote its shares at the meeting seeking scheme approval. A traditional takeover offer is much more attractive to a large existing shareholder because it gives that party the ability to test the market and give itself the option to increase the offer when there is a muted response to the initial price.
Target company size
Schemes are more widely used for larger target companies than for smaller ones with the Bugeja study showing that 33 per cent of transactions by number between 2000 and 2011 were through schemes compared with 55 per cent through schemes on a total value basis. Bidders prefer schemes for large transactions because there is more certainty with this approach and they don’t want to end up owning 60 or 70 per cent of a target company through a highly leveraged transaction.
Bidders using a high level of borrowing to finance an acquisition prefer to use schemes because this gives them more certainty over the price and timing of the transaction. Therefore it is not surprising that private equity buyers, who fund their acquisitions with a high level of borrowings, prefer scheme arrangements. This was evident in New Zealand two years ago when an Australian private equity firm tried to gain control of Abano Healthcare through a scheme of arrangement. This proposal was firmly rejected by the Abano board.
The Australian study concluded that schemes are more likely than takeover offers when board ownership of the target company is high. High board ownership is also more consistent with takeover offers that are friendly rather than hostile.
Two of the most controversial schemes in New Zealand were the acquisition of Fletcher Energy by Shell in 2001 and the Transpacific Industries/Waste Management deal in 2006.
Fletcher chairman Rod Deane had to contend with disgruntled shareholders Mark Dunphy of Greymouth Petroleum, Tony Gibbs and Gary Weiss of GPG, and Act MP Stephen Franks at the March 2001 meeting, while Waste Management chairman Jim Syme was strongly criticised by Fisher Funds at the company’s scheme meeting in 2006.
Scheme meetings can attract considerable shareholder opposition and media attention while there are no meetings for a traditional takeover offer.
Waste Management was strongly criticised for agreeing to pay an $8 million break fee to Transpacific if its board changed its positive recommendation on the proposal. Directors were also criticised for making negative media comments about the long-term viability of Waste Management’s business.
However, both the Fletcher Energy/Shell and Waste Management/Transpacific proposals received over 75 per cent support at their scheme meetings.
It is totally understandable that shareholders will receive a higher price under a traditional offer because when a bidder has to convince 90 per cent of shareholders to accept – instead of 75 per cent of votes cast at a meeting – then it will have to offer a higher premium. In addition schemes are unlikely to attract additional bidders.
The Bugeja report has a comprehensive analysis of premiums paid to target company shareholders under schemes and takeover offers.
It concludes: “Our results are largely consistent with target shareholders receiving significantly lower premiums in schemes of arrangements consistent with the public criticism of schemes.
“However, we caution against interpreting [those] results as evidence supporting regulatory change, as there is no guarantee that target shareholders involved in schemes of arrangements would otherwise have received a takeover bid if schemes were not an alternative.”
The last sentence is very important. Acquirers, particularly private equity firms, are driving much harder bargains and there is no obligation for them to make an offer. Some target company directors may believe that a low-priced scheme offer is better than nothing.
However, Abano Healthcare shareholders can thank their directors for rejecting a scheme proposal in 2013 that was below the NZX company’s current share price.
A low-priced offer under a scheme of arrangement may be above the current share price but this does not necessarily mean that it represents good long-term value.
Shareholders should always take the long-term view when assessing schemes of arrangement or traditional takeover offers.
Disclosure of interest: Milford Asset Management holds shares in Abano Healthcare on behalf of clients.