Using shares as acquisition currency during a downturn

The proportion of deals involving share consideration has dropped in recent years as companies and financial investors have enjoyed prolonged periods of cheap, available cash and financial sponsors have had significant levels of dry powder. While these fundamentals remain largely unchanged, liquidity management issues for corporates are in focus like never before. With greater demands on cash and new challenges relating to valuations, some have predicted a rise in public deals involving share consideration which may compete with opportunistic cash offers from financial sponsors. For some companies, the catalyst may be to exploit growth and synergy opportunities. For other companies, survival and/or takeover defence tactics may also be at play – two companies coming together with one balance sheet may, after all, be better at weathering a storm and/or defending a predatory takeover bid. 

The dynamics of deals involving share consideration are different from those that are funded solely by cash. Additional issues need to be worked through, and share consideration deals typically involve significantly more work. The most contentious issue is often agreeing the valuations of the relevant companies and the future management structure, particularly where deals are presented as mergers of equals. But valuing two companies within the same sector on a relative basis may be easier than valuing a company on an absolute, standalone basis. If the valuation issues can be overcome, deals involving share consideration may become increasingly compelling for some companies during an economic downturn. 

This note explores some of the key issues that companies are likely to encounter when considering mergers that involve some or all of the consideration comprising shares. 

Market practice and recent examples

During 2019, 66 firm offers were announced for companies listed on the Main Market or AIM. In 53 of those offers, the consideration comprised solely cash – and in 13 of those offers, some or all of the consideration comprised shares. 

The high-profile all-share merger of Takeaway.com and Just Eat plc is particularly interesting. Takeaway.com and Just Eat announced a recommended all-share combination in August 2019 with the aim of creating one of the world’s largest online food delivery platforms. The transaction is noteworthy for a number of reasons, including the fact that Prosus launched a hostile all-cash offer for Just Eat plc in October 2019. Takeaway.com’s £6.2bn offer was eventually declared wholly unconditional on 31 January 2020 and will result in Just Eat’s shareholders owning approximately 57.5%, and Takeaway.com’s shareholders owning approximately 42.5%, of the share capital of the combined group. Just Eat’s board of directors supported Takeaway.com’s all-share offer over Prosus’ all-cash offer throughout the battle notwithstanding that the value fluctuated significantly. The parties estimate that the merger will result in recurring annual pre-tax cost benefits of approximately €20m by the fourth anniversary of completion, with around €10mn by the first anniversary of completion.

More recently, Aon and Willis Towers Watson announced a recommended all-share deal in March 2020 that values Willis Towers Watson at approximately $30bn. The deal would combine the world’s second and third-largest insurance brokers into a new industry leader. It has been stated that $800m of pre-tax synergies are expected to be realised by the third full year of the combination. 

Other examples of all-share mergers from 2019 include the combinations between: (i) Northgate plc and Redde plc; (ii) Premier Asset Management Group plc and Milton Group plc; and (iii) One Savings Bank plc and Charter Court Financial Services Group plc. Meanwhile, in the global automotive sector, Fiat Chrysler Automobiles has agreed to merge with Peugeot to create a $50bn enterprise.

Why use shares as consideration?

For the acquiring company, the most obvious benefit is that its cash resources will not be depleted and it can avoid the need to obtain third party debt financing. 

For the shareholders of the company to be acquired, consideration shares create opportunities to benefit from the future growth and expected synergies of the combined business. In addition, shareholders may be able to defer any tax on gains associated with the sale.

Where a combination is characterised as a merger of equals, many of the benefits may be shared between the relevant parties. For instance, future growth prospects and expected synergies are likely to be of just as much interest to the existing shareholders of the acquiring company as they are to the shareholders of the company to be acquired. 

Overcoming the valuation hurdle

Shareholders of the company to be acquired will need to assess whether the exchange ratio fairly values the two companies. This can be particularly challenging in volatile markets and when growth and/or synergy benefits are uncertain. The shareholders of the company to be acquired will need to be satisfied that: (i) the consideration shares are not overvalued; and (ii) a fair proportion of the expected growth and synergies will be shared (and are therefore reflected in the proposed premium for the deal). 

Valuation exercises can be equally challenging from the perspective of the acquiring company. If an acquiring company believes that its shares are undervalued relative to the current valuation of the shares in the target company, agreeing the exchange ratio may be more difficult. Acquiring companies will also need to assess the risks that the expected growth and synergy benefits needed to justify the acquisition premium do not materialise. And if the acquiring company needs to obtain approval from its own shareholders to complete the transaction, it will need to be confident that it can convince them that the exchange ratio fairly values both companies. 

The prevailing practice in the UK is for exchange ratios to be fixed at the time deals are announced. This means that changes in the market valuation of the acquiring company between the announcement of the deal and the date of completion can have a material impact on the value of the consideration received by the selling shareholders at completion. Interestingly, and as an exception to the prevailing approach, IP Group plc’s £490m offer for Touchstone Innovations plc in 2017 included an unusual mechanism to adjust the exchange ratio if, as a result of an increase in the price of an IP Group share, the implied value per Touchstone Innovations share exceeded a fixed amount. 

Understandably, these can be difficult exercises for boards to undertake and directors will be mindful of their fiduciary duties. For this reason, some boards will seek a fairness opinion from an independent financial adviser on the financial aspects of the proposed transaction. Please see the section below for further details.

Key legal, regulatory and commercial considerations

Share consideration deals give rise to a range of legal, regulatory and commercial considerations. We touch upon the key ones below.

• Disclosure and control of information: Normal issues arise regarding the disclosure and control of information under the Market Abuse Regulation, the Disclosure Guidance and Transparency Rules and the City Code on Takeovers and Mergers (the City Code). However, these issues are, unsurprisingly, amplified where two listed companies are involved. Each listed company will need to comply with its continuous obligations in relation to the disclosure of inside information and, if it seeks to rely on a reason to delay the disclosure of inside information, keep such decision under constant review. Both listed companies will also need to prepare separate leak announcements and insider lists. 
• Due diligence: Due diligence will usually require twice the amount of work. The acquiring company will want to understand the business it proposes to combine with and to test its valuation assumptions. If the relevant companies are within the same sector, the due diligence exercise is likely to have a focus on exploring potential synergy benefits, including the costs of realising such benefits. Similarly, a target company will likely want to undertake reverse due diligence on the proposed acquiring company. If the target company is subject to the City Code, it will also be mindful of the equality of information rules under the City Code. These provide that, if a target company has previously given information to one bidder or potential bidder, whether publicly identified or not, then the same information must be given to another bidder or bona fide potential bidder that requests such information. Concerns regarding equality of information may be particularly acute for target companies who fear an unwelcome, perhaps predatory, approach from a third party. Antitrust issues should always be given careful thought before information is shared, and “clean team” arrangements may need to be put in place. 
• Listing Rules and reverse takeovers: Particular issues will arise for a listed company under the Listing Rules if the proposed transaction would constitute a reverse takeover. For the purposes of the Listing Rules, a reverse takeover is where a listed company acquires another company and either: (i) any one of the percentage ratios under the “class” tests is 100% or more; or (ii) the transaction would result in a fundamental change in the business or a change in the board or voting control of the listed company. Following changes to the Listing Rules which came into force in 2018, there is no longer a rebuttable presumption that the shares of the acquiring company should be suspended on the announcement of a reverse takeover (except for shell companies). However, the following points should still be noted:
  • Shareholder approval will be required (as would be the case for a class 1 transaction).
  • The FCA will generally seek to cancel the company’s listing when the reverse takeover completes. If the company wishes to remain listed, it will need to re-apply for admission and satisfy the relevant eligibility requirements.
  • A sponsor will need to be engaged and discuss the proposed transaction with the Financial Conduct Authority.
• Board roles and governance: In merger of equal transactions, an open discussion regarding the board roles of the combined group will be required at an early stage. The market will expect to be informed as to who will fulfil the top roles of the combined group (e.g. Chairperson, CEO, CFO, etc.) at the time the transaction is announced.
• Quantified financial benefits statements: A quantified financial benefits statement (QFBS) often plays an important role on a merger combination involving shares being issued as consideration. A QFBS is also sometimes referred to as a “synergy statement” or a “merger benefit statement”. If the City Code applies, its QFBS regime will apply. 
  

  The City Code defines a QFBS as either: (i) a statement by a securities exchange bidder or the target company quantifying any financial benefits expected to accrue to the enlarged group if the offer is successful; or (ii) a statement by the target company quantifying any financial benefits expected to accrue to the target company from cost saving or other measures and/or a transaction proposed to be implemented by the target company if the offer is withdrawn or lapses.

  The City Code provides that the document or announcement in which a QFBS is first published must include:

  • A report from its reporting accountants stating that the QFBS has been properly complied on the basis stated; and
  • A report from its financial adviser(s) stating that the statement has been prepared with due care and consideration.

  In addition, if a QFBS has been made, a specific form must be completed and submitted to the Takeover Panel by the financial adviser to the acquiring company or the target company (as applicable).
  
  If a class 1 circular issued under the Listing Rules includes a statement of synergy benefits, the statement must also include prescribed disclosures.
  
  Additional rules apply under the City Code in relation to profit forecasts. 

• Intention statements: Where the City Code applies, the intentions of the acquiring company with regards to the business, employees and pension scheme(s) of the target company (including in relation to research and development) will need to be confirmed publicly. If any material changes to the conditions of employment or in the balance of skills and functions of the employees and management are intended, this should also be disclosed. While these rules apply equally on all-cash deals, intention statements may be particularly sensitive on strategic mergers which seek to exploit synergies. 
• Opinions of employee representatives and pension trustees: Where the City Code applies, the acquiring company and the target company are required to send a copy of the announcement of the offer (or a circular summarising the terms and conditions of the offer) to their employee representatives or, where there are no representatives, to the employees themselves. Under the City Code, employee representatives (or employees) are entitled to have a separate opinion appended to the target board’s circular setting out their views on the proposed transaction on employment. Pension trustees have similar rights regarding the effects of the offer on the pension scheme(s). Depending on the acquiring company’s intentions for the combined business, the views of the employees and pension trustees may be particularly relevant (and could potentially impact the target board’s willingness to recommend the transaction to its shareholders). 
• Offeree protection conditions: When shares are offered as consideration, it is common for the board of the target company to insist upon the inclusion of offeree protection conditions within the terms of the offer (which generally mirror the offeror conditions). This is to protect against the risk that the consideration shares to be received by the target company’s shareholders have a value which is materially different from that contemplated by the board of the target company at the time it gave its recommendation due to some intervening event. The City Code makes it clear that the circumstances in which a target company will be allowed to invoke a condition will not necessarily be restricted to those in which the Takeover Panel would permit a bidder to invoke a condition (where the bar is generally higher). If the target company is not allowed to invoke a condition, the Takeover Panel may instead determine in the light of all relevant facts that accepting shareholders should have the right to withdraw their acceptance on such terms as the Takeover Panel considers appropriate. If the target company wishes to preserve the power of the Takeover Panel to introduce withdrawal rights, this should be incorporated within the terms of the offer. 
• Pre-completion dividends or other equalisation steps: A merger ratio will often be calculated on the basis of pre-completion dividends, the demerger of parts of the business to shareholders or other pre-closing equalisation steps (as in the Fiat Chrysler Automobiles / Peugeot merger mentioned above).
• Class tests and shareholder approval: When a bidder is publicly listed, it may be required, depending on the “class” of transaction within which the takeover falls, to obtain approval from its own shareholders prior to completing the transaction. The Listing Rules classify transactions by assessing the size of the target relative to that of the acquiring company. If any of the “class” tests suggest that the size of the target company is 25% or more of the size of the acquiring company, the prior approval of the shareholders of the acquiring company will be needed.
• Prospectus: Unless an exemption applies, a prospectus must be made available in relation to: (i) any offer of transferrable securities to the public (broadly, 150 people or more (other than qualified investors)); or (ii) an admission to trading of securities on a regulated market (which includes the Official List but not AIM). If the transaction is structured as a scheme of arrangement (rather than a takeover offer), the requirement for a prospectus may be avoided (on the basis that a scheme of arrangement is not regarded as involving an offer of securities to the public). However, a prospectus could still be required if the consideration shares would be admitted to a regulated market and represent 20% or more of the acquiring company’s current issued share capital.
  
  The production of a prospectus is not a straightforward exercise. Please see our separate briefing on equity fundraisings by public companies during a financial crisis, which considers prospectus issues in further detail.
• Break fees: If the target company is subject to the City Code, it will be prohibited from agreeing to pay a break fee to the acquiring company (subject to certain limited exceptions). However, the City Code does not prohibit acquiring companies agreeing to pay a break fee to the target company. By way of example, on the £4.3bn merger between Ball Corporation and Rexham plc, a complex structure was agreed that could have resulted in Ball Corporation paying a reverse break fee of up to 7% of the value of its offer in certain circumstances. 
  

  If the acquiring company has a premium listing on the Official List, care should be taken to ensure that the sums payable under any break fee arrangement do not, in and of themselves, render the transaction a class 1 transaction under the Listing Rules (which would require shareholder approval and the publication of a circular). In the context of an acquisition of a listed company, a break fee arrangement will be considered a class 1 transaction under the Listing Rules if the total value of those sums exceed 1% of the value of the listed company calculated by reference to the offer price on the basis of the fully diluted equity share capital of the listed company. 

• Fairness opinions: While not legally required, fairness opinions may be a feature on some transactions. The primary purpose of a fairness opinion is to give the board of directors comfort that it has satisfied its fiduciary duties in recommending the transaction to its shareholders. The opinion will usually be given by an investment bank and conclude that the specific financial terms of the proposed transaction are fair to the relevant company’s shareholders from a financial point of view. They are more common on transactions that involve US companies, and specific SEC disclosure rules can apply. If the City Code applies, the target company will be required to obtain an opinion from an independent financial adviser on the merger terms (and disclose the substance of such opinion to its shareholders). And if the deal constitutes a related party transaction under Chapter 11 of the Listing Rules, a “fair and reasonable” opinion from the issuer’s sponsor may be required as a matter of law. 

• Regulatory clearances: As with any transaction, regulatory issues (including issues relating to gun-jumping) should be considered early. Antitrust issues can be particularly sensitive where the merging parties are within the same sector. If one or both of the merging parties operate in a regulated sector (e.g. financial services), the approval of a regulatory authority may be required in order to complete the transaction. Some regulatory authorities will also want to scrutinise the business plan for the combined entity as part of their review process. In fast changing and volatile markets, producing business plans and preparing pro forma financial accounts may be more challenging than normal. 
  

  Please see our separate briefing on the impact of Covid-19 on competition law. 

• Tax: Tax treatment for shareholders and for the merging companies will need careful consideration. For example, any pre-closing demerger might need to be structured as a capital reduction rather than a dividend to obtain the optimal tax treatment. Also, in some jurisdictions, an indirect transfer of a subsidiary may trigger local taxes.
• Pension issues: Where defined benefit pension schemes are involved, pension issues can be complex and require early thought and planning (both from a valuation and structuring perspective). 
• Integration: While the legal and financial aspects of the transaction will be the immediate focus, attention will soon turn to the practicalities of integration. In some cases, regulatory considerations will prohibit any integration before receipt of the appropriate regulatory clearances. On the merger of Takeaway.com and Just Eat plc, the Competition and Markets Authority in the UK made an eleventh-hour intervention in January 2020 that the two companies do not integrate their operations until it probed the deal (although that measure was later revoked on 23 April 2020). Integration will usually be a significant exercise and take a considerable amount of time to prepare and implement. Depending on how long social distancing measures continue for, these practicalities may be more challenging than ever. 
• Share schemes: Listed companies typically have a number of share schemes in existence at any time. The implications of the transaction on such share schemes should be considered carefully and taken into account when agreeing the exchange ratio. 
• Cash alternatives, underpinnings and other methods of providing cash to shareholders of the target: As noted above, in some mergers, shareholders of one or both of the merging companies may receive some cash pursuant to a pre-merger special dividend. It may also be possible to provide a full or partial cash alternative by the acquiring company entering into a cash underpinning agreement whereby new investors agree to acquire the consideration shares from the selling target shareholders who prefer to cash out. Finally, where the acquiring company is a significant blue chip company acquiring a much smaller company, arrangements can be put in place to sell the consideration shares (as was seen in the offer by GE for Amersham plc). However, it should be noted that cash underpinning and vendor placing arrangements tend to be less common in the UK. 
• Structuring and overseas considerations: There are a number of ways in which merger combinations can be structured under English law (e.g. takeover offers, schemes of arrangement, dual listed company structures, etc). While the advantages and disadvantages of the various structures are outside the scope of this briefing note, it will be important to consider structuring issues at the outset. The structuring considerations are likely to be more complex where an overseas company is involved, and overseas securities rules should be considered in parallel. For instance, the securities rules within the US can be very prescriptive for transactions that have a US nexus.

Conclusions

Share for share transactions are complex but provided the commercial rationale is strong, they can enable combinations which create long term value for shareholders. In an environment where financial sponsors and sovereign wealth funds have significant cash to draw upon but corporates may not want to increase leverage and deplete cash reserves, we can expect more competition between cash deals and all share mergers.

Macfarlanes has market leading expertise in advising on public company mergers and acquisitions. We are recognised for our skills in high-end complex matters and have considerable experience advising on cross-border transactions. Macfarlanes advised Altria Group, Inc., the largest shareholder in SABMiller, on the £79bn offer from AB Inbev and Altria’s investment in the enlarged group. We are currently advising a financial adviser providing a fairness opinion on the merger between Fiat Chrysler Automobiles and Peugeot to create a $50bn enterprise.