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Focus: Private Equity – August 2008

Take-privates involving 'stub equity'

In brief: A significant recent development for 'take-private' offers in Australia is the inclusion of an unlisted scrip offer to shareholders (ie 'stub equity'1 ), as an alternative to cash, to facilitate continued investment in the underlying business. Partner Tom Story (view CV) and Senior Associate Julian Donnan report on the use of 'stub equity' in take-private transactions and provide an overview of the key legal issues.

How does it affect you?

  • Bidders wishing to offer stub equity to investors as part of a take-private acquisition may: do so either through a scheme or takeover bid; make the stub equity offer subject to minimum and maximum thresholds; and provide for shareholder rights consistent with a privatised entity.
  • From an investor perspective, the offer of scrip, as an alternative to cash, may present a welcome opportunity to participate in the future performance of the privatised entity. This may need to be weighed against reduced liquidity and a position as a minority shareholder with limited rights and regulatory protections.
  • The target board and independent expert may need to separately consider and assess the value of the scrip alternative, as compared to the cash alternative, including the risks inherent in a stub equity offer such as reduced liquidity.

Background

Acquisitions of publicly listed entities by private equity consortiums in Australia have generally been implemented through the offer of cash consideration rather than scrip. The acquisition by Macquarie Advanced Investments Group (MAIG) of Macquarie Capital Alliance Group (MCAG) includes the first 'stub equity' offer as part of an Australian take-private transaction. The recently announced proposal by TPG Capital and Global Infrastructure Partners to acquire all the securities in Asciano Group also includes a scrip alternative of unlisted securities in a bidding company.

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Why provide stub equity?

One of the key commercial drivers for bidders in providing stub equity is to improve the attractiveness of a proposal to target boards and investors through the opportunity for investors to participate in the future performance of the privatised entity. By providing stub equity, the bidder may also reduce the amount of cash required for the acquisition.

Shareholders who consider that the bidder and its management team can create greater value in a privatised structure may elect to receive stub equity. Alternatively, shareholders may prefer to take the cash alternative at a premium to the pre-bid trading price.

In determining whether stub equity will be offered, bidders should have regard to the existing shareholder base and who they may target as shareholders in the privatised structure. For example, hedge funds may be more willing to invest in stub equity than some institutional fund managers with investment mandates that restrict investment in unlisted securities. Similarly, founding shareholders who may have held interests before the initial listing of the target may also be willing to take an interest in an unlisted vehicle.

The stub equity offer included as part of Apollo Management's bid for UK real estate business Countrywide plc in 2007 was structured to appeal to hedge fund shareholders in the target. In that transaction, the proportion of equity in the bid vehicle available to Countrywide shareholders was ultimately increased to 55 per cent, a much higher proportion than would normally be the case under a stub equity offer.

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Schemes and takeovers

Take-privates involving stub equity may be implemented by way of a members' scheme of arrangement under section 411 of the Corporations Act 2001 (Cth) or a takeover bid under Chapter 6. In some instances, such as the MCAG acquisition, the target entity may comprise a stapled company and trust. Therefore, in addition to the company scheme, a 'trust scheme' may also be required to acquire the units issued by the target entity's trust.

For a range of reasons, including enhanced certainty of outcome, we consider it more likely that bidders who make offers of stub equity will adopt the scheme route for the acquisition, rather than making a takeover bid.

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Conditions to the offer of stub equity

An offer of stub equity can be made conditional upon a certain minimum percentage of target shareholders electing to receive scrip under the scheme. It is also possible for an offer of stub equity to be subject to a cap. To the extent that scrip elections cannot be satisfied in full, the entitlements of shareholders must be scaled back on a pro rata basis. For example, in the MCAG transaction, MAIG's offer was subject to a 5 per cent minimum acceptance of the stub equity, with a pro-rata scaleback if demand exceeds 20 per cent.

Features such as a minimum acceptance threshold make commercial sense, as a small number of stub equity holders may increase overall costs for the unlisted entity. However, imposing minimum and maximum thresholds does mean that there is some uncertainty as to the eventual outcome, including whether the scrip alternative will, in fact, be available.

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Disclosure and risks

An offer of stub equity will require disclosure in the scheme booklet or bidder's statement of a standard that is equivalent to that of a prospectus. Disclosures of relevance to a stub equity offer will include:

  • the terms of issue of the stub equity securities;
  • the management and ownership structure of the bidder;
  • any new management or fee arrangements;
  • intentions of the bidder regarding future management of the business;
  • pro forma financial information about the bidder;
  • the bidder's debt and equity funding arrangements; and
  • risks applicable to the stub equity securities, such as the absence of liquidity (assuming no listing is sought) and details of any loss of existing regulatory protections.

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Capital gains tax rollover relief

The taxation consequences of the stub equity offer for securityholders will depend on a range of matters, including the structure of the offer and each securityholder's position. For many Australian resident securityholders, it is likely that, on the disposal of their target securities, they will realise a taxable capital gain. To the extent that the consideration is in the form of cash, there will not be any relief from such gain being taxable.  However, where a scrip alternative is offered, certain securityholders may be eligible to claim scrip-for-scrip capital gains tax (CGT) rollover relief to defer a capital gain derived on disposal if certain conditions are met:

  • The bidder must end up with at least 80 per cent of the shares in the target entity. This is not an issue under a scheme of arrangement which, if approved, will result in the bidder acquiring 100 per cent of the target's equity.
  • Where there is a pro-rata scaleback on the scrip-for-scrip arrangement, such that the proceeds consist of both cash consideration and stub equity, the target entity's securityholders may be able to rollover the capital gain only to the extent of the stub equity. CGT rollover, however, would not be available to the extent that capital gains are attributable to the cash consideration received from the bidder.
  • Rollover relief only applies on a share-for-share or unit-for-unit basis (and not a share-for-unit or unit-for-share). Therefore, where the target comprises 'stapled' entities, the acquirer may also need to comprise of 'stapled' entities.
  • Proposed amendments may restrict the ability of the acquiring entity to achieve full cost 'push down' to the target's assets under the tax consolidation rules to the extent that the target's shareholders can claim a scrip-for-scrip rollover.

A class ruling may be sought from the Australian Taxation Office to confirm the availability of the scrip-for-scrip rollover for eligible shareholders in the target.

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Continuing disclosure requirements

Assuming that no listing is sought for the stub equity, the bidder would not be required to comply with the continuous disclosure obligations under the ASX Listing Rules following the acquisition. However, if the bidder is an Australian entity with more than 100 members as a consequence of the issue of stub equity, it will be characterised as a 'disclosing entity' under the Corporations Act.

That means that if the entity becomes aware of information that is not generally available in the market and which would have a material effect on the value of its securities, it would need to lodge a document containing the information with the Australian Securities and Investments Commission unless an exception exists. Disclosing entities are also subject to a number of periodic financial reporting requirements under the Corporations Act, including the requirement to prepare half-year and annual financial reports and directors' reports.

If the stub equity vehicle is an unlisted Australian public company, it should also be noted that the vehicle will be subject to the takeovers provisions in Chapter 6 of the Corporations Act if there are more than 50 members holding shares.

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Independent expert's report

Where an acquisition involves the issue of stub equity, the independent expert may need to provide a separate valuation of the scrip offer and the cash offer. That valuation may need to apply any discount that is attributable to the absence of liquidity in the market for the bidder's securities as an unlisted entity (assuming that the stub equity is not, in fact, listed and no alternative liquidity mechanisms have been incorporated in the structure).

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Voting and exit by stub equity holders

Generally, stub equity holders will have limited voting rights in the new entity and be regarded as passive investors. If the stub equity is not listed, there may be limited opportunity for stub equity holders to dispose of their securities. As is commonplace in private equity shareholder arrangements, stub equity holders may also be subject to 'drag along rights' to enable the bidding consortium (or its manager or sponsor) to facilitate an exit of 100 per cent of the vehicle at the appropriate time.

It is worth noting that stub equity may, in some cases, be listed. This was the case in the UK acquisition of Canary Wharf Group plc by Songbird Estates plc in May 2004. In that transaction, the class B shares offered as part of the consideration were listed on the Alternative Investment Market (the AIM)2 . Another offer of stub equity (albeit unsuccessful) that involved issues of stub equity that was to be listed on the AIM included the Grupo Ferrovial SA consortium's bid for BAA plc in June 2006.

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The future

We expect to see an increasing use of 'stub equity' in the current environment where private equity consortiums are seeing attractive opportunities to acquire listed vehicles. Under a stub equity offer, investors who consider that the underlying asset value of a listed entity in which they have invested remains strong, despite a relative decline in the share price, may be inclined to 'stay in the game' and take any future upside that is presented by a new ownership and management structure. At the same time, those investors looking to exit their investment at an appropriate premium to the pre-bid trading price, or who cannot hold unlisted securities, will be happy to receive cash.

Where stub equity is involved, target companies and bidders will need to consider carefully:

  • how the deal is structured, including tax consequences;
  • the risk profile relating to the stub equity and appropriate disclosure of those risks; and
  • what obligations will apply to the new vehicle in relation to matters such as voting, shareholder rights and exit strategies.

If you have any queries about this, or any other similar matter feel free to contact us.

(Our Sydney Partners Ewen Crouch, Guy Alexander, Victoria Poole and Tom Story acted for MAIG on its A$836 million offer to acquire all the securities in MCAG. That transaction, conducted by way of scheme of arrangement, was approved by the NSW Supreme Court on 25 August 2008.)

Footnotes
  1. So named for its connotation with a ticket stub after the original ticket is clipped (presumably on the basis that the stub represents the right to participate in the venture after access has been granted or, in this case, after the acquisition has been approved).
  2. The AIM, by way of background, was created by the London Stock Exchange to facilitate smaller listings in a less regulated environment. The AIM imposes no minimum requirements in terms of size or number or shareholders on the applicant for listing and requires no financial track record or trading history.

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