European public to private transactions: What the future may hold

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 of