In early 2006 private equity had provided competitive bidders in a number of asset disposals, but had rarely, if ever, ventured into the public M&A arena. In the decade leading to 2006 only a handful of public to private transactions were undertaken by private equity.
The Australian government, after a long process of consultation, released new cross-media guidelines, which (once proclaimed) will remove the restrictions that prevent television from acquiring newspaper assets and vice-versa. This will be subject to voice and content rules.
Although it is hard to understand why the cross-media rules prompted private equity, the result was that a significant private equity consortium bought a 50 per cent interest in the key media assets of Publishing & Broadcasting, and a separate consortium a 50 per cent interest in the key media assets of the Seven Network in advance of the proclamation of the cross-media rules. This has continued in 2007 with the recent bid for APN News & Media.
At the same time Australia saw an unprecedented level of public M&A activity and the first hostile private equity transaction – the bid for clothing company Colorado. This deal was the first of its kind in Australia, showing a new willingness from private equity to proceed without a board recommendation and at the risk of acquiring less than 100 per cent control.
Australian M&A structures
In the Australian market there are two main ways to undertake a public M&A transaction: a scheme of arrangement or a takeover bid.
Australia’s rules on schemes of arrangement have not changed for 30 years and operate very much like the UK rules. There is one peculiar feature of the Australian rules, which is the prohibition on using a scheme of arrangement to circumvent the takeover rules.
This anti-takeover avoidance section was traditionally interpreted as preventing a scheme from being used to acquire 100 per cent where a takeover bid could be used. This section was first read down when schemes of arrangement were effected through a concurrent capital reduction. The courts held that, as a capital reduction was not a feature of a regulated takeover bid, undertaking a scheme of arrangement through a selective capital reduction could not infringe the anti-avoidance provision. As a result, all schemes that were used to implement takeovers proceeded by way of capital reduction.
Around five years ago changes to the tax rules made selective capital reductions generally unattractive.
Corporate practitioners held their breach waiting to see whether the anti-avoidance provision would be applied to schemes under which shares were transferred rather than cancelled. Their apprehension was unwarranted. Instead, the corporate regulator accepted schemes as a legitimate means of effecting a control transaction so long as the disclosure was equivalent to takeover bid disclosure.
Consequently, schemes are now a well-worn path in control transactions.
The attraction of schemes of arrangement
The reasons why, until last year, schemes were almost the exclusive vehicle chosen by private equity are numerous, but the significant ones are:
• lower effective threshold (apathy generally works in the bidder’s favour);
• an all-or-nothing result (bidder cannot get caught with control less than 100 per cent); and
• they are easier to debt finance where leverage levels are high and security arrangements are complex.
For private equity financing, it will usually be crucial to acquire 100 per cent of the target so that its cashflow can be accessed without minority shareholders, financial assistance issues and related party restrictions.
A number of private equity houses profess publicly their refusal to undertake hostile deals, which is another way of saying they prefer to do a deal through a scheme (which necessarily requires a target’s support and cooperation). Hostile schemes are not possible, although some bearhugs preparatory to engagement on a scheme have made this distinction a little less sharp.
A scheme gives a private equity buyer the inside track – with a strong board imprimatur (even if the board’s recommendation is qualified by the absence of a superior proposal) and often due diligence access. Merger implementation agreements that usually precede schemes can contain warranties, deal protection (eg non-solicitation and no-talk provisions as well as break fees) and restrictions on how the target runs its business from announcement to shareholder vote and court approval.
As a result of these advantages, private equity would always rather proceed through a scheme. The main disadvantage is a perceived lack of flexibility to adapt the consideration offered should an auction develop. There is some flexibility, however, as we have recently seen the Citect Share and Option Scheme, where the bidder increased the price several times during the scheme without having to restart the shareholder and court approval process.
Emergence of the private equity takeover bid
Despite private equity’s preference for schemes, two of the most significant recent public M&A deal developments by private equity involved takeover bids.
First, a hostile private equity buyout implemented by a takeover bid – the Colorado deal. Affinity Equity Partners made an unsolicited bid for Colorado after acquiring a pre-bid stake to deter rival bidders from emerging. The bid later turned friendly, with a board recommendation in return for an increase in the bid price. The bid was not entirely successful because a rival emerged and bought a 10 per cent blocking stake, leaving Affinity with control, but less than 100 per cent.
The second development, very late in 2006 and currently the subject of significant media attention, is a private equity-backed management buyout (MBO) for Australia’s national airline Qantas. This, too, although an MBO, is proceeding by way of a takeover bid.
The Qantas deal contrasts with a current MBO proposal that has turned sour. Alinta, a large energy infrastructure company, announced that its key management (chairman, chief executive officer (CEO), chief financial officer, business development chief and general counsel) was involved in a proposal with an investment bank and potential private equity investors to do an MBO. The audacious nature of this, and the unprecedented involvement of such a significant proportion of a target’s senior management, drew immediate criticism from both the press and investors.
Within days of the announcement the CEO stood down, the chairman stood down as a director and the remaining participants in the MBO were ‘quarantined’ in different premises, but remained available to the company to provide services on a transitional basis while presumably advancing the buyout proposal.
The press criticised vigorously Alinta’s management, chairman and advisers based on possible conflicts of interest. It is easy to see how, in the case of a bid backed by management, the board may, if it is not careful, also be criticised for giving management the inside running if it does not encourage a process that sets up competitive tension or an auction.
The new Alinta chairman put in place protocols to facilitate an auction, with a formal bid process and a data room intended to ensure that there is a level playing field for all potential bidders rather than the MBO team having the inside running.
The Qantas board has negotiated a takeover bid structure that offers more scope for competitive tension than a scheme and removes the risk of criticism to which the Qantas board may have been subject, if it instead agreed to a scheme and a substantial break fee.
Then, in February 2007, Multiplex announced that it had been approached regarding a possible MBO proposal involving the founding Roberts family, which contains three company executives.
Multiplex has been at pains to implement and publicise protocols to avoid the types of conflict concerns that arose regarding Alinta.
In the wake of 2007, perceptions in Australia have shifted. No company is now seen as too big or too efficient to be a potential private equity target. 2007 promises to be another action-packed year for private equity in Australia and we would not be surprised to see more blue-chip companies being taken private.
Braddon Jolley and Rebecca Maslen-Stannage are partners at Freehills