Over the past decade, we have seen a marked trend towards schemes of arrangement as the predominant means to execute on merger and acquisition (M&A) activity.
There are several possible drivers of this trend, including the greater structuring flexibility afforded by schemes, particularly where complex financing engineering is involved, the ‘all or nothing’ nature of most schemes of arrangement and the perceived benefit of a lower approval threshold (although we have also seen high profile examples of schemes ‘held to ransom’ by interlopers who are able to exert outsized influence by acquiring a substantial stake on market).
Whether or not these benefits are more perceived than real, one effect of the preference for schemes is, indirectly, to hand greater leverage in M&A negotiations to target company boards. This is because a scheme requires the active support of the target, which must steward the transaction through the process of shareholder and Court approval: a practical impossibility in a hostile scenario.
That shift in dynamic could be perceived in some quarters as a good thing. But perhaps it is also time to ask whether a simple reform to the takeovers regime could assist in making takeovers a more viable alternative to schemes of arrangement. This change would be to amend Section 661A of the Corporations Act 2001 (Cth), which, requires a takeover bidder to acquire at least 90% of the shares in a target company before it can compulsorily acquire the minority.
The 90% compulsory acquisition threshold has featured in takeovers regulation in Australia, in one form or another, for more than half a century. It is high time to question whether it is still appropriate given the complexity of the modern corporate shareholder base: a mix of institutional investors, hedge, index and superannuation funds, strategic shareholders, high net worth and family office investors (and the odd HotCopper enthusiast). Securing 90% acceptance is a little like trying to rally a small village – everyone has a different opinion, follows a different schedule, reads different media and has a different level of interest in actually engaging with the process.
Indeed, many shareholders may be deceased or simply be untraceable, particularly for companies with a predominantly retail register. They’re hard (or impossible) to contact, and even harder to convince.
In this environment, the role of passive shareholders, including the index-tracking exchange-traded funds which have exploded in popularity in recent years, is particularly important. Index funds comprise around 15% of the current ownership of the ASX200, and if US trends are followed here, that will likely increase.
While there is limited visibility on the algorithms driving index fund activity in control transactions, generally most require a high level of support by others before their own acceptance switch is flicked. So, even if majority control is secured, the 90% mark often remains out of reach. The bidder, meanwhile, is effectively underwriting the market price of the target’s shares through its offer. Inevitably, to flush out the last recalcitrant holders, it must declare its offer unconditional before the 90% threshold is achieved, in the process exposing itself to the risk of greenmail.
These dynamics pose fundamental challenges to acquirers that need 100% ownership of the target to either extract synergies or implement their optimal financing structure and no doubt form a major part of strategic thinking on the ‘bid versus scheme’ analysis.
There is a famous judicial quote that the takeovers provisions of the Corporations Act do not need to be scaled just because they are there; they are “not Mount Everest”. But many bidders would see that analogy as apt: reaching the base camp of control might be easy enough, but achieving 90% is like summitting without oxygen.
This is where the rubber hits the road. The difficulty in achieving 100% control in takeovers isn’t just an inconvenience; it’s potentially putting a damper on the whole market for corporate control. Fewer takeovers mean fewer opportunities for assets to find their way to their most productive uses. More to the point, the disciplining effect of takeovers is diminished in an environment in which target company Boards think the threat of hostile takeover bids is remote.
The fix is actually pretty straightforward: lower the compulsory acquisition threshold from 90% to something more achievable, like 75% (which would at least notionally align with the threshold for schemes), or 80%, which is the inverse of the 20% takeovers threshold (and would align with the threshold for CGT rollover relief). This reform is not about undermining minority shareholders protection so much as diminishing the risk of oppression by the minority. It’s about recognising that times have changed since the 90% threshold was selected and the law needs to change with them. By lowering the bar for compulsory acquisition, we’d make it easier for bidders to achieve outright control, while still ensuring a substantial majority of shareholders are supportive of the deal.
This reform alone would not necessarily open the floodgates for hostile bids. Among other things, the ability of the target company’s board to withhold access for due diligence provides it with a key point of leverage in negotiating a better outcome for shareholders. However, at the very least, we would place takeovers on a more level playing field with schemes for negotiated deals, in the process avoiding some of the procedural abominations that have emerged in recent years (such as the ‘dual bid/scheme’ process) in an attempt to achieve that levelling by synthetic means. Most importantly, we would ensure that, more often than not, it is target company shareholders, not the target’s board, that has the final say on a control proposal.
By lowering the compulsory acquisition threshold, we can make the takeover process more practical and dynamic, benefiting shareholders, companies and the economy at large.
In the context of a national debate over improving productivity, this is an idea that deserves serious consideration.