What has been and what will be: recent and emerging trends in the UK public M&A market
June 2020 | SPECIAL REPORT: MERGERS & ACQUISITIONS
Financier Worldwide Magazine
June 2020 Issue
This article examines some of the key recent trends in the UK public M&A market, in particular the return of 'public-to-private' (P2P) takeovers, various themes in debt financing of takeovers and the continuing rise of consortium deals. We then look at some emerging trends, including changes in the market related to the coronavirus (COVID-19) pandemic.
The return of the ‘P2P’
The main trend in the past year has been the return of P2P takeovers in the UK, with there being nearly as many private equity, or other fund-backed, takeovers of UK listed companies in 2019 as there had been in 2017 and 2018 combined. This has included bids backed by investment funds and infrastructure funds, as well as private investment companies and pension funds. The value of P2Ps also increased significantly with nine announced take-private transactions in 2019 having a value of over £500m. Notable transactions include the £4bn offer for Cobham by Advent, the $3.82bn offer for Sophos Group by Thoma Bravo and the £1.91bn offer for BCA Marketplace by TDR Capital. Linked to P2Ps are consortium bids, which often comprise one or more private equity or other investment funds, which have also become increasingly prevalent in the UK market.
Notwithstanding the current hiatus that the UK public M&A market is experiencing as a result of the COVID-19 pandemic, there are good grounds to suggest that the uptick in P2Ps will not simply be a ‘flash in the pan’ but will instead continue, once market conditions allow.
Making that commitment
As one would expect, debt financing has continued to be a very common source of financing on large UK takeovers and all the large P2P deals in 2019 relied on debt financing in some form, usually combined with capital called from equity investors. However, one of the features of the UK takeover regime is that a bid cannot be made subject to a financing condition. In practice, this requires bid financing for a cash offer to be on ‘certain funds’ terms, and the financial adviser to a bidder must make a public statement that the bidder has sufficient funds available to it to satisfy in full any cash element of the consideration payable to target shareholders. The financial adviser takes on a significant regulatory obligation because it may be liable to meet any shortfall if, in giving the cash confirmation, it did not act responsibly or take all reasonable steps to assure itself that the cash was available.
One other notable trend is the increasing number of non-traditional lenders, for example credit funds, participating as initial lenders on P2Ps. The nature of the diligence exercise that a financial adviser conducts on the robustness of that non-traditional lender’s commitment differs from that conducted on a more traditional lender, such as a global bank, to take account of the differing corporate structure and sources of financing of that non-traditional lender.
The UK takeover regime puts a strong emphasis on the importance of secrecy prior to a public announcement of a takeover. Discussions or negotiations are limited to a very restricted number of people, outside those who need to know in the parties concerned and their immediate advisers, known as the ‘rule of six’. This means that any new debt facilities are often provided by either a sole or a small number of financial institutions which, for large transactions, can, absent syndication, require financial institutions to provide a significant commitment on ‘certain funds’ terms, potentially for a prolonged period of time.
Sharing the load
While syndication has been a feature of UK takeovers for many years, the increased P2P activity, and the size of the deals, has resulted in initial lenders approaching a larger pool of potential syndicatees. Again, we have seen an increasing number of non-traditional lenders being involved too where previously, initial lenders may not have considered syndicating to them in the context of public takeovers in the UK at all, or only after the P2P had completed.
Increased scrutiny of M&A activity by regulators globally has, generally speaking, resulted in prolonged transaction timetables. That inevitably increases the pressure on the initial lenders to syndicate the debt and is likely to be a contributing factor to the heightened focus from certain lenders seeking to syndicate debt as quickly as possible following the announcement of a takeover.
Club membership: not anyone can join
In addition to a rising number of take-private transactions, another recent trend has been the continuing increase in the number of consortium or ‘club’ bids. Notable transactions include the £4.77bn offer for Merlin Entertainments by a Blackstone/KIRKBI/CPPIB consortium and the $3.4bn offer for Inmarsat by an Apax/Warburg Pincus/CPPIB/OTPP consortium. Although consortium structures allow the members to bid for larger cap listed companies than might otherwise be possible, they do raise new issues outside of the usual UK Takeover Code and funding aspects of a takeover.
Choosing who will form the consortium is crucial. Not only will potential consortium members need to consider any issues around governance, control and exit mechanisms, but in an increasingly regulated global M&A environment, they will also need to consider any potential antitrust or other regulatory issues that a proposed consortium member may create as a result of either the proposed consortium member itself or its portfolio companies which operate in the same sector as the target company. Careful consideration by the consortium of these, and other, types of execution risk will be required when considering the likely response of a target company and its shareholders to an offer.
Emerging trends
Predicting with any degree of certainty what will happen in the coming months is challenging in these unprecedented times and clearly activity levels have been severely affected by COVID-19. During the first month of the UK ‘lockdown’, only one takeover was announced in the UK. Prior to that, in March 2020, only two offers had been announced. By comparison, there were six announced in March 2019. That said, we predict a number of current themes will continue, as outlined below.
First, target company boards, bidders and shareholders alike will face challenges in assessing the fundamental valuation of a target company. Traditionally, the premium of an offer price to the prevailing or volume weighted average share price has been used as an important valuation benchmark. However, in current volatile market conditions, the utility of such a benchmark is clearly being questioned.
Second, where initial lenders intend to syndicate the acquisition facility prior to the completion of the acquisition, they will typically benefit from a right to flex the terms of the facilities, including by increasing the fees and margin. If, as we anticipate, there is less liquidity in the market for acquisition financing, there is likely to be increased discussion over these flex terms, and we may see them being exercised on a more regular basis.
Third, bridge financing is often put in place due to confidentiality or structural reasons with the intention to replace it with a bond. While the capital markets are proving relatively resilient, the perception of market volatility will inevitably impact the availability and pricing of any bridge facility.
Fourth, as pricing on facilities is trending upward, this tightens the return on equity model for private equity firms and we may see capital structures where more equity is invested than has recently been the case, favouring the large private equity houses which have plenty of dry powder.
Fifth, to a certain degree, private equity firms will focus on their portfolio companies given that many companies are potentially facing a prolonged period with significantly reduced revenues.
Sixth, in many cases, there will be a ‘flight to quality’ in relation to the assets being acquired.
Finally, there is likely to be a certain level of opportunistic M&A activity, both from P2P and trade buyers, particularly given the amount of dry powder available to many private investors at the moment.
The uncertain road
Another feature of the UK takeover regime which we anticipate will continue to be an area of focus for potential bidders is the very high bar that is set for bidders to invoke a condition, and in particular a material adverse change (MAC) condition, once a takeover has been announced. Therefore, in practice, we anticipate that bidders may be more wary of announcing an offer for a UK listed company in the near-term, given that very low likelihood of being able to terminate the offer post-announcement if, for example, the COVID-19 situation worsens or should a ‘second wave’ of infections occur.
Another challenge bidders will need to navigate in the current circumstances is the preparation of appropriate and workable bidder statements in offer documentation regarding the future of the target business. Post-offer intentions are regulated statements that a bidder is required under the UK Takeover Code to make in its offer documents, and a bidder will ordinarily be held to those statements by the UK Takeover Panel. Care will therefore be required in making these statements considering the current macroeconomic uncertainty, which may impact on the target company’s future business and prospects. For example, in the final few weeks of April alone, five announcements were made by acquirers that they have decided to deviate from their intention statements.
Further, should a bidder’s financing not be in the currency in which the offer is made (usually, but not always, pounds sterling), it will need to manage foreign exchange (FX) risk. This links to the requirement for financing to be on ‘certain funds’ terms and the cost of obtaining a hedging instrument or maintaining a sufficient ‘FX buffer’ in the available funds will all need to be accounted for by bidders when pricing an offer.
The light at the end of the tunnel?
However, in light of these various challenges, once market conditions stabilise following the shock of the severe restrictions that have been imposed in the UK and beyond, private equity buyers in particular may see a window of opportunity open through the combination of lower share prices and low interest rates on debt, both of which are factors to suggest that P2Ps will remain a feature of the UK public M&A landscape when some form of normality returns.
James Fletcher and Tim Rennie are partners and Harry Thimont is a senior associate at Ashurst. Mr Fletcher can be contacted on +44 (0)20 7859 3156 or by email: james.fletcher@ashurst.com. Mr Rennie can be contacted on +44 (0)20 7859 1323 or by email: tim.rennie@ashurst.com. Mr Thimont can be contacted on +44 (0)20 7859 2408 or by email: harry.thimont@ashurst.com.
© Financier Worldwide
BY
James Fletcher, Tim Rennie and Harry Thimont
Ashurst