Saturday, May 06, 2006

Brian Gaynor: Merger schemes deserve to be trashed

Two controversial issues stand out regarding the takeover offer for Waste Management, namely the process and the target company's valuation.

The main reason for the opposition to the bid, which is being presented as an amalgamation or merger under Part XIII of the Companies Act 1993, is the process, although the offer price is also a concern.

These amalgamations or schemes of arrangement, which require a majority of 75 per cent instead of 90 per cent under a takeover, have also been criticised in Australia. A recent report by the Financial Services Institute of Australasia (Finsia) had several important points to make about amalgamations or schemes of arrangement.

The study is called "Takeovers Package - Finsia's proposal to reform Australia's takeovers regime to improve the market for corporate control, remove existing anomalies and protect the rights of minority shareholders".

According to Finsia, schemes of arrangement have become increasingly popular in Australia and now represent nearly 40 per cent of all large (over A$1 billion) change of control transactions across the Tasman.

These schemes are derived from traditional English laws that were drafted before modern corporate takeover activity was contemplated.

Until recently amalgamations or schemes of arrangement were mainly used in the following situations:

* For complex transactions that couldn't be achieved by a takeover.
* For agreed mergers where the premiums were much lower than in hostile or contested takeovers.

Finsia, which is a merger between the Securities Institute of Australia and the Australasian Institute of Banking and Finance, argues that there has been a growing tendency to go down the amalgamation/schemes of arrangement route as potential bidders put a "bear hug" on the target company.

A "bear hug" is when the bidder offers a market premium price to the directors of the target company under an amalgamation or scheme of arrangement process but not under a takeover offer. The target company directors are forced to recommend this offer to shareholders under the threat that their refusal will be made public and will be subject to shareholder and market scrutiny.

Finsia believes that this "bear hug" strategy is successful because directors have become increasingly sensitive to public pressure, which has been heightened by greater shareholder activism and higher standards of corporate governance and director's duties.

The "bear hug" also reduces the prospect of a counter bid, as does the potential payment of a break fee (a break fee of $8 million is payable by Waste Management to Transpacific if the proposed merger does not proceed).

The reduced prospect of a competing bid is particularly relevant to Waste Management's shareholders because the company has an open share registry, and there would have been a greater opportunity for alternative bidders if its directors had not agreed to amalgamation.

These "bear hugs" have meant that a large number of change-of-control transactions in Australia, which previously would have been effected as takeovers, are now being achieved by amalgamations and schemes of arrangement.

This Australian analysis should be particularly interesting to New Zealand shareholders because the two most controversial transactions, Origin/Contact Energy and Transpacific/Waste Management, have been initiated across the Tasman and the directors of the New Zealand companies have vigorously supported the deals before an independent appraisal report has been commissioned.

Finsia is concerned that schemes of arrangement adversely affect rights of shareholders. Its biggest worry is that these schemes become effective if 75 per cent of shares voted at a meeting support the scheme, whereas 90 per cent of all shares are required for a bidder to move to compulsory acquisition. It believes the difference is difficult to justify as careful consideration was given to the compulsory acquisition threshold when Australia's takeover rules were drafted.

Finsia's takeover study recommends that the threshold for effecting schemes of arrangement should be brought into line with the compulsory acquisitions provisions of the takeover rules. This proposal would still be different from takeovers in that it would apply only to shares voted at the meeting as distinct to 90 per cent of the target company's entire capital under the compulsory acquisition provisions of the takeover rules.

Finsia believes this proposal would significantly reduce the advantages that schemes of arrangement have over takeovers, particularly in their ability to force dissenting minority shareholders to sell their shares. It proposes that schemes of arrangement resolutions would fail if more than 10 per cent of the shares on issue voted against the resolution.

The Australian analysis raises the prospect that the directors of Contact Energy and Waste Management have been trapped in clever "bear hugs", particularly as they rushed to endorse their respective deals before any independent analysis was available.

The Waste Management board has been caught in a particularly awkward situation because one minute it refers to the deal with Transpacific as a merger, yet in the next it quotes a statement from the Grant Samuel independent report that refers to the deal as a takeover. (The independent report was released after the Waste Management board had strongly recommended the deal.)

According to Grant Samuel's appraisal report, "The Amalgamation Payment cum dividend of $8.80 represents a premium of 25 per cent to the closing share price of $6.99 on 24 March 2006, the day prior to announcement of the proposed transaction and a premium of 32 per cent to the volume weighted average price of $6.66 in the month prior to announcement. The premium for control is consistent with the premiums for control observed in other successful takeovers of other listed companies in New Zealand and Australia".

Grant Samuel is correct, it is a takeover because Waste Management shareholders are being offered a premium, whereas in a traditional merger most of the control premium is retained and is available to shareholders of the merged group if an outside party makes a takeover offer at a later stage.

In addition, the name of a merged entity usually contains elements of the constituent companies and they contribute equally to the board and management. One company usually provides the chairman and the other the chief executive.

The Waste Management board is entitled to the view that the Transpacific offer is fair, but to agree to an amalgamation process, where the compulsory acquisition threshold is 75 per cent of shareholders instead of 90 per cent under the Takeovers Code, is totally unacceptable to many shareholders.

New Zealand shareholders have becoming increasingly sceptical about board recommendations because they consistently undervalue top quality New Zealand companies. Bill Gates would never have become an extremely wealthy man in this country because the first bidder to offer a 30 per cent premium for Microsoft in the late 1980s would have received support from a board with a majority of independent New Zealand directors.

On May 17 Waste Management shareholders will have the opportunity to question their directors and vote on the amalgamation proposal. Whatever the outcome, the process is unsatisfactory as far as New Zealand shareholders are concerned.

The amalgamation or schemes of arrangement process reduces the prospect of an alternative bidder and seriously curtails the ability of shareholders to stop the offeror from compulsorily acquiring their shares.

Amalgamations and schemes of arrangements should be available for complex situations, and when companies want to initiate a genuine merger with a limited premium for control on offer. But to avoid the increasingly common "bear hugs" they should be subject to the same 90 per cent shareholder threshold as compulsory acquisition under the Takeovers Code.

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