8 June, 2015
Summary
- A number of recent examples of high-profile transactions have involved complex and drawn out regulatory approval processes.
- Regulatory approvals often do not have clear timeframes, increasing transaction risk.
- Targets should prepare for, and protect themselves from, regulatory approval risks.
Following his election victory in 2013, Australia’s Prime Minister declared that the nation was 'open for business'. Using the last 12 months as a guide, it appears that foreign bidders have taken up the invitation, with the 7 largest completed public M&A transactions involving foreign bidders.1
Transacting with foreign bidders often results in greater transaction risk for a target than an Australian suitor. Parties generally accept that, where a foreign bidder is involved, the transaction will be conditional on regulatory approvals (e.g. foreign investment approvals). Bidders that participate in the same industry as the target also pose greater transaction risk due to requirements to obtain competition / anti-trust approvals. This article explores what targets can do to mitigate such risks.
Issues With Regulatory Approvals
The typical regulatory approvals in Australian M&A do not have clear timeframes. For example, while FIRB has a 30 day statutory review period, where the transaction is particularly complex, sensitive or involves a state-owned enterprise, a decision can take significantly longer (up to 6 months in some cases). New Zealand’s Overseas Investment Office (OIO), where approval is regularly required to be obtained by bidders seeking to acquire an Australian target (due to ownership of New Zealand assets or operations), has no statutory review period – rather, it has 'internal performance targets'.
The Goodman Fielder scheme is a recent illustration of the uncertainty of regulatory approval timeframes, with OIO approval and approval from the Ministry of Commerce (MOFCOM) in China finally obtained more than 7 months after entry into a binding scheme implementation agreement. In addition to creating risk, the uncertainty that arises in these circumstances make implementing a transaction a difficult task (e.g. when to schedule the shareholders meeting).
In the takeover battle for Warrnambool Cheese and Butter (WCB) in 2013/2014, despite having a considerably lower bid than Murray Goulburn, Saputo was ultimately able to succeed in acquiring control of WCB by making a 'best and final' offer to WCB shareholders. The offer period for Saputo’s bid was set to close approximately 2 weeks prior to the hearing date of Murray Goulburn’s authorisation application with the Australian Competition Tribunal. The WCB board consistently referred to the uncertainty of whether Murray Goulburn’s competition authorisation condition would be satisfied as a key factor in its decision to recommend Saputo’s bid over Murray Goulburn’s bid.
The lack of certainty around when a regulatory approval will be obtained poses significant issues for targets – the ability to operate the business in the ordinary course is often compromised where there is a protracted period of regulatory approval uncertainty. Some of the issues facing targets include potential for management to be distracted, problems attracting and retaining employees and fetters on making decisions that are in the longer-term interest of the target. A target feels greater pressure where its business is deteriorating while in 'caretaker' mode, with the risk of the bidder getting cold feet and looking for a way out of the deal heightened. For this reason, target boards should (and usually do) approach bids that are subject to complex regulatory approvals with a greater level of caution.
Protecting The Target
Target boards naturally will want to minimise completion risk and provide their shareholders with maximum deal certainty. Once a deal is signed, the target will be anxious to ensure that all conditions to the transaction are satisfied expeditiously. In the case of a regulatory approval condition, the bidder may well have less to lose than the target if the condition fails.
It is for this reason that the presence of regulatory approval conditions can be the determining factor as to whether a bid is or is not successful. Bidders who are concerned about the uncertainty attached to a regulatory approval condition sometimes use 'sweeteners' such as reverse break fees to strengthen their bid. For example, last month NYSE-listed Iron Mountain agreed in principle to pay Recall a reverse break fee equal to 3%2 of the deal value if any anti-trust / competition approval is not satisfied or waived within 12 months after execution of a definitive agreement.
While receipt of a reverse break fee is better than nothing, it can nonetheless offer cold comfort for a target as the size of the break fee is often insignificant relative to the broader implications of the transaction failing (e.g. unsettled customers and staff, damage to the target’s reputation, loss of confidence and loss of opportunity to complete a transaction, at least in the near term).
In accepting a regulatory approval condition, the target will usually look to narrow the circumstances in which the bidder can elect to walk away from the deal. In the absence of a material adverse change condition, the terms of the regulatory approval condition become even more significant in protecting the target.
For example, the bidder will want any regulatory approval to be given on an unconditional basis – a blanket obligation on the bidder to accept conditions linked to the approval could result in an unpalatable outcome for the bidder, such as requiring the bidder to divest certain assets. A common compromise is that the bidder must not unreasonably reject any conditions linked to the regulatory approval. However, this opens another can of worms where conditional approval is given as to what is or is not reasonable in the circumstances (e.g. if the bidder is made whole financially with respect to the matter that is the subject of the condition, is it reasonable for the bidder to refuse the conditional approval?).
At the other end of the spectrum, being prescriptive about conditions to regulatory approvals provides more certainty but is not without its own problems (e.g. it requires the parties to speculate on possible conditions and may result in a crude or inflexible outcome which unfairly benefits one party). It is not uncommon for targets and bidders to agree (sometimes in a side letter that is not made publicly available) the basis for an asset divestment in order to secure regulatory approvals. For example, in the proposed Recall / Iron Mountain scheme, Iron Mountain has committed in principle to undertaking divestments in respect of certain business lines and jurisdictions that are necessary in order to obtain required anti-trust / competition clearances.
Conclusion
To reduce transaction risk associated with regulatory approvals, targets should:
- obtain their own legal advice in relation to the relevant regulatory approval and assess the likelihood of the approval being given (with or without conditions) and the likely timeframe for approval,
- in the case of a bid that the target’s board is considering recommending, work with the bidder to ensure that the relevant regulatory approval is sought as soon as possible (noting that there may be practical limitations on how early this can be done in order to maintain confidentiality),
- consider a reverse break fee in the event of a failure by the bidder to obtain the relevant regulatory approval, and
- where the target expects that a regulator may give approval subject to conditions, consider negotiating at least the framework to accommodate that condition.
End Notes
- Completed public M&A transactions since 1 May 2014 – Japan Post (Toll); Frasers (Australand); Cheung Kong Group (Envestra); Woolworths (Country Road); Baosteel (Aquila Resources); Wilmar & First Pacific (Goodman Fielder); Expedia (Wotif.com).
- Reverse break fees are not subject to the Takeovers Panel’s 1% rule of thumb.
For further information, please contact:
Raji Azzam, Partner, Herbert Smith Freehills
raji.azzam@hsf.com
