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European public to private transactions: What the future may hold
13/04/2004. Source: Weil Gotshal & Manges. Will Rosen and Alicia Hardy 
Despite the inherent complexities of public to private transactions, last year saw a record number of companies departing from European stock exchanges. But with major new legislation pending, it remains to be seen whether the take-private market can maintain this momentum going forward. Will Rosen and Alicia Hardy of Weil, Gotshal & Manges discuss what the future may hold for public to private transactions in Europe. European public to private transactions (PTPs) are extremely complex, costly and
time consuming deals, usually combining the typical characteristics of a management
buy-out while being required to meet the demands of the public takeover regulatory
framework as well. The challenges facing a private equity house looking to de-list
a European company are considerable. The economic arguments for embarking on a
PTP, therefore, must be extremely compelling to make it worthwhile.
The challenges
As the target company will be publicly listed the transaction will be conducted
in the public eye and the parties are obliged to adhere to strict obligations
with regards making public announcements at various stages of the transaction,
for example, if there is a leak about any proposed bid. 'Special deals' for
management will also generally be carefully regulated. The amount of due diligence
that the potential offeror is able to undertake with regard to the public company
target is often restricted and warranty comfort will tend to be far more limited
than in a private transaction. In addition to this, considerable advisers' fees
are often incurred by the potential bidder before a deal is announced, although
private equity investors will usually offset the risk of this by agreeing a
"reasonable" inducement or break fee with the target if the transaction
should fail (other than in certain jurisdictions such as France where inducement
fees are prohibited).
Current trends
Despite the inherent difficulties in successfully conducting and completing
a PTP transaction, last year saw a record number of companies departing from
European stock exchanges. The number of PTPs in Western Europe reached 95 in
2003 with approximately $20bn of equity leaving the market. This compares to
71 PTP deals in 2002 and 83 in 1999, the previous record year. In fact, last
year the value of PTPs outweighed the money raised by companies joining the
market for the first time in three years. Indeed, in the UK alone, over $9bn
of equity left the market which is more than double the $4.5bn that came into
the market from new issues.
Breaking down these figures, over a third of the PTPs in Western Europe occurred
in the UK and these transactions accounted for just under half of the total
deal value. The second quarter of 2003 saw the highest quarterly total for PTPs
in the UK (sixteen) for over three years. While there was activity in the mid
market, 2003 will probably be best remembered for several high profile transactions
such as Debenhams and this trend seems to have continued into 2004 with the
battle for Canary Wharf.
France saw a growth in the number of PTPs in 2003 both in terms of deal numbers,
seven compared to four in 2002, and also in deal value. This growth seems to
have been maintained in the first quarter of 2004 with two deals having been
announced with $2.2 billion of deal value, which is greater than the three previous
years combined. Germany has also shown significant growth with sixteen PTPs
in 2003, compared to four in 2002, and with aggregate deal values in excess
of $3.5bn.
The picture across the rest of Western Europe is far patchier in terms of activity
with approximately two-thirds of the PTP transactions taking place in three
countries, the UK, France and Germany.
Why was 2003 a record year?
The reason 2003 was a record year, according to many commentators, was because
of a set of unusual market conditions, which saw low equity valuations coupled
with low interest rates. This set of circumstances made PTPs unusually affordable.
Growing familiarity with the regulatory and business framework of PTPs also
encouraged an increase in the number of PTPs in many European jurisdictions,
particularly bearing in mind continued dissatisfaction by management of small
to mid-cap companies in the public arena. This dissatisfaction is engendered
by the lack of liquidity, flexibility and interest in the smaller listed companies
and the constant pressure for such companies to demonstrate performance. However,
many consider that the majority of likely take private candidates in the UK
have been taken off the market by private equity houses over the last few years,
while mainland Europe remains a relatively untapped market with significant
potential for an increase in PTPs.
Looking ahead
Despite a record year for PTP transactions in 2003 the future is less certain.
Improving company valuations in Europe are likely to affect the PTP market,
with all the major stock markets having recovered substantially in 2003. The
impact of the currency markets should also not be underestimated. With many
of the largest private equity houses having funds denominated in US dollars,
the significant devaluation of that currency against Sterling and the Euro has
effectively meant major price increases in the targets for potential PTP transactions.
This is likely to make potential bidders think carefully about whether or not
they can expect acceptable returns from this type of transaction, particularly
if they acquire assets at the most expensive point in the currency cycle.
In the UK, in particular, there is expected to be continued resistance from
institutional fund managers against what they perceive as cheap takeovers, and
institutional shareholders in other jurisdictions may adopt this attitude as
they observe the stance that has been taken in the UK. Over the last year or
so the UK market has seen a number of bids where institutional shareholders
have bought sufficient shares to prevent bidders reaching the 90 per cent level
required to squeeze them out. Examples include Deutsche Asset Management, which
prevented Cinven acquiring 100 per cent of Fitness First and the approach taken
by Fidelity and M&G to the bid for Pizza Express by Gondola Express. There
is an emerging consensus that there needs to be more cooperation between the
public and private operators: Institutions do not want to be seen to sell at
a low price and watch private equity buyers subsequently sell high; they want
to be able to share in the upside.
One way that this has been achieved has been through the use of "stub
equity" where shareholders in the target have been given the opportunity
to take equity in the bidder and thus they are able to participate in the potential
upside enjoyed by the private equity houses. This method was used in the Northumbrian
Water deal in 2003 and is currently being offered by both bidders in the Canary
Wharf transaction where shareholders have indicated that they do want continued
participation in the company. However, the use of "stub equity" by
a bidder does involve significant additional complexities and obligations, for
example if the "stub equity" is listed, on AIM for example, there
will be ongoing disclosure obligations for the bidder.
The impact of European legislation
But the operating environment for PTPs in Europe is set to change still further
over the coming years as a result of extensive legislative changes, designed
to relieve some of the regulatory burden previously faced by private equity
firms. At present the region's disparate legislative framework makes for a complex
and inconsistent playing field. In certain European jurisdictions there is currently
no compulsory acquisition or 'minority squeeze out' rule at all which means
that a private equity investor may be left post-completion with a minority stake
in a target held by a third party or parties. Furthermore, the threshold for
the squeeze out varies between jurisdictions, for example, in the UK it is 90
per cent, Germany and France 95 per cent, and Italy 98 per cent.
The compromise text of the Takeover Directive, which was finally approved by
the EU Parliament in January 2004 and is due to be implemented by Spring 2006,
contains a requirement that all EU Member States takeover regimes include a
minority squeeze out right where 90 per cent of the shares and votes are obtained
by the offeror. This may increase the attractiveness in the future to private
equity investors of target companies whose securities are admitted to trading
on a regulated EU market in countries where there was not formerly a squeeze
out provision or where the squeeze out threshold was very high.
In certain EU jurisdictions a potential takeover can currently also be blocked
by shareholders with enhanced or multiple voting rights. However, the Takeover
Directive provides for a "breakthrough rule" whereby restrictions
on transfer of offeree securities during the offer period, and multiple voting
rights and restrictions on voting rights post-bid in relation to a shareholder
vote to amend the company's constitution or make changes to the boards, are
rendered ineffective. This provision has the potential to increase the appeal
and accessibility of public company targets for private equity investors to
take private. However, in order to get this Directive approved the compromise
text allows for countries to 'opt out' from these provisions. Therefore, member
states where multiple voting rights are more common than in the UK, for example,
France and the Scandanavian countries, are likely to opt out of the provisions.
Similarly, member states can 'opt out' of the requirement contained in the
Directive that a public company target must obtain shareholder approval before
taking any defensive measures against an unwelcome bid. Had this provision been
mandatory for implementation by member states, potential target companies in
countries where use of 'poison pills' does not currently require shareholder
approval, such as Germany, may have been rendered more accessible to private
equity take private bids. US bidders, in particular, may be put off from approaching
targets in member states which 'opt out' from this provision because, although
'poison pills' are common in the US, their use is tempered by litigation that
arises out of bids blocked by such defences.
There is currently a 'certain funds' requirement in various EU jurisdictions
such as the UK, Germany, France and Italy, whereby the offeror must have funds
unconditionally available to fund the bid before announcing an offer. The Takeover
Directive introduces a 'certain funds' requirement for all EU member states,
which may act as a disincentive to debt providers providing acquisition finance
for PTPs in the less active PTP jurisdictions, where there is currently no such
requirement.
There is also a prohibition in various EU countries such as the UK, Germany,
France and Italy, for a public company to give financial assistance in relation
to the acquisition of its own shares. Therefore, a public company target cannot
give security over its assets in relation to any debt financing, except in certain
jurisdictions, for example the UK, where the company has been delisted, and
a 'financial assistance whitewash' confirming solvency of the target, has been
completed. A review of company law in the EU and the UK has mooted the idea
of removing the prohibition on public companies giving financial assistance,
which would make the process of taking public companies private more attractive
because the requisite level of security could be put in place earlier on in
the transaction. However, any such changes are likely to be some considerable
time in coming, if at all.
Looking at other prospective regulation, which may affect the PTP market in
Europe, the imminent implementation of the 'maximum harmonisation' EU Prospectus
Directive may make listing, and remaining listed on EU regulated markets, less
attractive. Although the aim of the Directive is to make it easier and cheaper
to make offers to the public or list on regulated markets in the EU, for the
short term there is a considerable amount ofuncertainty regarding certain key
provisions of the Directive, for example, the scope of liability for issuers,
and determining which member state is the home member state for the purposes
of identifying the competent authority for approving such prospectuses. In addition,
the proposed and continuing disclosure obligations for listed companies are
being harmonised but are generally more onerous than national requirements currently
in force.
Additional burdens will be placed on companies listed on an EU regulated market
when the EU Market Abuse Directive comes into effect, requiring companies to
promptly disclose various matters which may affect their securities. There will
also be significant pressure, cost and time involved for all EU listed companies
in preparing for the introduction of International Reporting Standards in 2005,
and in ensuring compliance with the financial and other disclosure requirements
of the Financial Instruments Markets Directive. This may make it more attractive
for some companies to go private, in particular companies in member states with
hitherto minimal disclosure requirements.
In addition, continued and increasing focus on enhanced corporate governance
standards for European companies in the public arena, and the time and cost
that is likely to be involved in complying with such standards, may also provide
further encouragement for public companies, particularly the smaller ones, to
leave to the public arena.
Conclusion
Despite the inherent difficulties in taking a company private there are still
a number of reasons for public companies and their management to see the benefits
of going private and conducting their business out of the public eye, not least
the prospect of increasing regulation and disclosure requirements for public
companies. There is a general sense of optimism in the private equity market
and there is plenty of money there to invest. And there are still signs of management
dissatisfaction in the smaller to mid-cap companies, which are listed on regulated
EU markets.
However, although there are some aspects of the forthcoming legislation in
the form of the Takeover Directive which may make conducting takeovers in Europe
easier, the presence of the "opt out" provisions has significantly
diluted the potential positive impact of this directive in facilitating and
levelling the playing field for takeovers in Europe.
Although the long term future for private equity backed PTPs in Europe is still
uncertain, when assessing the immediate future of PTPs in Europe, we must bear
in mind the inherent complications of the PTP transaction, the impact of the
weak US dollar and the relatively buoyant European markets. It is considered
likely that, until the negative impact of the upcoming EU legislation in respect
of remaining listed on an EU regulated market makes itself felt, the appetite
for private equity investors to spend their money taking public companies private,
may be rather less than that for investing their money in other ways. However,
the counter balancing factors include an increasing familiarity with and sophistication
of PTP techniques such as the use of schemes of arrangement in the UK, and an
increasing willingness by private equity houses to pursue PTP opportunities
even where the target is not entirely willing to be taken private.
We can be sure of one thing, however - that whatever the relative volumes of
this type of transaction in the future prove to be, we will continue to see
European companies being taken private by private equity houses where there
is no strong commercial justification for them retaining a listing.
Copyright © 2004 AltAssets
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