Preparing for a merger

The recent uptick in mergers and acquisitions in many Australian business sectors has led to speculation about an impending boom. Christopher Niesche reports.

The board of Toll Holdings wasn’t expecting a takeover bid when Japan Post came knocking earlier this year. Yet just 10 weeks after that initial approach, the two companies announced a takeover deal, which secured a healthy premium for shareholders in the Australian transport and logistics group.

“For a $6.5 billion transaction, that’s probably as quick as it’s ever been,” says Ray Horsburgh AM FAICD, who as chairman of Toll, led the negotiations.

The quick result is testament to the preparation of the Toll board. “In the case of Toll, we had advisers appointed for some time, perhaps never expecting a takeover, but should one occur we had a procedure in place,” says Horsburgh, who as the former managing director of Smorgon Steel Group for 15 years had experience in takeovers from the acquisition side.

Such preparation also puts a board in a strong negotiating position rather than having to scramble to line up bankers, lawyers and communications advisers. Being unprepared can be particularly problematic for the target company in a hostile takeover bid. The acquirer usually finds a way to make these bids public and then the chair is under pressure to respond. If they don’t have a procedure and valuation prepared, they’ll be buying time. “Having that done means you’re going in to battle well-prepared from day one,” says Horsburgh.

The Toll board already had an up-to-date valuation of the company when the takeover bid arrived.  “We then looked at our updated strategy because we were planning some other moves and asked about the likely valuation of those because the acquirer didn’t know about that,” says Horsburgh. “We then said ‘by the way, before you knocked on our door we were about to invest in a new venture doing this which we think is worth X amount per share, so we want you to take that into consideration.’”

One of Japan Post’s conditions during negotiations was that they remain confidential. So Horsburgh formed a board subcommittee to run the negotiations and ensure that as few people as possible knew about the deal. Chief executive officer  Brian Kruger was brought into the loop, but most other senior management including the chief financial officer were not told about the bid. They also employed a little subterfuge, requesting financial numbers and information on the pretext of a board strategy session or budgeting.

The approach also ensured management didn’t become distracted by the bid, as this is a key risk. When a takeover is public, some staff start seeking and potentially accepting new jobs and clients can also depart if they do not like the acquirer or are concerned about stability.

Seeking opportunities

Boards and management have been increasingly active in looking at mergers and acquisitions (M&A) opportunities over the past year, but this hasn’t necessarily translated into more activity, says Kelvin Barry, joint head of advisory at investment bank UBS.

“I think boards and management teams remain sensibly cautious about M&A, notwithstanding that we’re in a very positive funding environment,” says Barry. Indeed, equity markets, credit markets and hybrid markets are all strong, both domestically and internationally, making the availability and terms of funding very positive.

Barry says there’s been significant interest in buying Australian assets over the past 12 months and this will continue, thanks to the lower currency and perceptions that Australia has a well-developed M&A framework. More broadly, he expects boards and management to remain “sensibly cautious” about M&A, because they’re closely watching their cost of capital and want to have some contingency in their capital structure.

“If boards are thinking about M&A, they should assess that against other alternatives, which include growth capital expenditure – whether it’s brown field or green field – and capital management,” he says. “It should be a conscious and rigorous exercise to make sure it’s the right decision for a company.”

As more companies come to the attention of potential acquirers, it’s important that their directors be prepared should a takeover offer eventuate.

One of the first decisions a board has to make when it receives an unsolicited takeover bid is whether they have to disclose this to the market. Rory Moriarty, national corporate practice group head at law firm Clayton Utz, says recent guidance from the ASX has made it easier for companies to assess whether and what they have to disclose to comply with the continuous disclosure regulations, particularly around what is an incomplete proposal and what boards can hold back.

Factors include how definitive the proposal is, the level of detail, information on the identity of the bidder, the conditions and the price. Sometimes, of course, boards do not get this choice. The bid is either leaked to the media or if the bidding company is listed, it discloses the bid under the guise of complying with the continuous disclosure regulations.

The Oz experience

In Australia, unlike many other jurisdictions, there are no specific legal obligations for target companies in takeover bids or proposed schemes of arrangement, including putting the bid to shareholders. But there is an overarching obligation to act in the best interest of the company as a whole and that obviously informs what boards should do in response to a takeover. “Obviously, directors are under a duty to properly consider the proposal and give it due consideration, and ask any questions of the bidder which are appropriate in order to come to a full and proper view and essentially to give it a reasonable opportunity to be considered,” Moriarty says.

Directors also need to take into account any potential conflicts of interests on the part of the management who are helping to assess the bid. In this regard, private equity investors can often offer bonus and other incentive arrangements to senior management to stay on and continue running the company.

Among the decisions that a board has to make is whether it will recommend an offer to shareholders. Bill Koeck, a partner in law firm Ashurst’s corporate group, says this should not be done lightly because it is a valuable bargaining chip. “The recommendation of the target board is a really, really valuable thing that is essential to getting a deal done,” he says.

Koeck says boards also have to be wary about the quality of information they hand over for expert reports. “The problem with expert reports is rubbish in, rubbish out. If you put in the wrong information, you’re going to get the wrong answer,” he says. “Forecasts may become an important issue to be managed by the target’s board. There is potentially a lot of liability for a board when it starts putting forecasts in the hands of bidders as their justification for increasing their price.”

Knowledge is power

Along with potentially handing over information, target boards should be trying to find out as much as they can about the potential acquirer, says Jon Stewart MAICD, chairman of Australis Oil & Gas. Stewart as former executive chairman of Aurora Oil & Gas oversaw its acquisition by Canadian group Baytex for $2.6 billion last year.

“You want to try and get as much information out of the approaching party as you possibly can before committing to anything yourself,” he says. “You want to know exactly what they’re prepared to do, and determine their capacity to actually execute. For example, are you confident they can pay for it? What’s their position vis-à-vis staff?”

Another bargaining chip which target company boards have is due diligence. “Allowing a third party to come in and do due diligence on your company is a really big step and it is a very valuable weapon for the target company in terms of negotiation and ensuring that you get as much information as possible. You don’t give up due diligence for nothing,” Stewart adds.

Engaging with your shareholders before any offer emerges is also important.“Boards need to understand who owns their company and their investment horizon – are they long-term holders or looking to make a quick gain?” says Stewart.

It’s a point picked up by Horsburgh. “You’ve got to have that dialogue because a good acquirer will have a couple of shareholders in his back pocket before he calls you,” he says. “I’ve never done a hostile takeover without knowing I’ve got a couple major shareholders who are going to come with me before I make the call.”

NFP mergers on the rise

The pace of not-for-profit (NFP) mergers is picking up. In part, it’s due to a change in the way governments fund charities. Many agencies prefer to deal with a handful of larger charities rather than a whole string of smaller NFPs. Secondly, some of these charities have an ageing committee and a shrinking client base, without any alternate leaders waiting in the wings.

Finally, there’s the introduction of the national disability insurance scheme, which moves from a block-funding model to a model that funds the individual, who then decides how to spend the money.

NFP mergers present a particular set of challenges for directors. Libby Klein GAICD, a principal leading the NFP team at law firm Moores is seeing a lot of merger activity and says directors sometimes forget to ask the fundamental question of why they’re merging and what they want to achieve. “That should be all around their mission: what is their organisation set up to do and what’s the best way of doing that in the future – to merge with another organisation or to try to carry on?”

Before an NFP starts merger discussions and due diligence, they should identify the criteria they’re looking for with a merger partner. Due diligence is about each organisation understanding what they’re getting themselves into. Of course, there is no purchase price as there is in corporate mergers and acquisitions. “Typically, it’s about one organisation transferring its asset and liabilities to another and shutting up shop. So the purpose of due diligence is more about trying to identify any ‘no-go’ areas rather than to adjust the purchase price. It’s a matter of ‘is this merger going to help us collectively achieve our respective missions?’” Klein says.

Vera Visevic MAICD, a partner who heads up the NFP team at law firm Mills Oakley, says the amount of due diligence depends on what sort of merger model the organisations pursue.

If one organisation takes over the assets and liabilities of another then it takes on all of the assets and liabilities. “They have to do a thorough due diligence to work out exactly what they’re taking on board,” says Visevic.

Visevic says it’s also important that NFP directors and chief executive officers (CEOs) put their egos aside when negotiating a merger. “What often happens is you have two CEOs of two organisations talking to each other and they’re all excited about merging but they don’t appreciate that at the end of the day one CEO is going to lose their job, or at board level you’re going to have to combine two boards into one,” she says.

“I’ve seen a lot of mergers fall over at the last minute because it’s suddenly occurred to the people involved that the merger is going to result in a number of people out of a position.

“In the charities and NFP sectors you’ve really got to be quite selfless about that in that there’s a bigger picture here. Someone may need to lose their position for the merger to happen so they can serve the community better.”