The challenges raised by the Coronavirus (COVID-19) crisis initially led to a dramatic fall in share prices and market uncertainty. Although the capital markets have largely recovered their value since the initial COVID-19 outbreak (somewhat bizarrely, given COVID-19’s underlying impact on many businesses), there has been a knock-on impact on public M&A, both in terms of ongoing processes and with regard to how potential bidders assess potential publicly listed targets. Although dips in share prices in the midst of the pandemic may have enticed bidders to look for opportunistic bids, the challenges posed by market volatility, lack of accounting information to show the impact of COVID-19 and lack of bank funding for bids resulted in very few bids being made.
The Takeover Panel’s decision in relation to Moss Bros Group plc shone a spotlight on the challenges of making a bid in a turbulent market, with the Panel reasserting the high threshold potential bidders must overcome when seeking to rely on material adverse change (MAC) conditions to lapse an offer (even against the backdrop of a global pandemic).
In this article we consider the implications of the Panel’s decision in relation to Moss Bros Group plc for targets, their shareholders and potential bidders, and identify factors that potential bidders should take into account when looking at public M&A opportunities in the second half of 2020.
Moss Bros Group plc
On 22 April 2020, Brigadier Acquisition Company (“Brigadier”) sought a ruling from the Panel to invoke conditions to, and as a result lapse, its firm offer of £22.6 million (made in the previous month) for Moss Bros Group plc. The bidder sought primarily to rely on a MAC condition and several “boilerplate” conditions to lapse its offer.
On 19 May 2020, the Panel concluded that Brigadier had failed to show that the relevant conditions were of “material significance” to it in the context of its offer (as required by Rule 13.5(a) of the Takeover Code) and could not therefore lapse its offer.
Although the Panel did not provide detailed reasons for its refusal, the decision is unsurprising for a number of reasons:
High threshold – It has long been established (affirmed in 2015 in the Panel’s decision in relation to WPP/Tempus) that a bidder must overcome a high threshold to invoke any condition (including a MAC condition) to lapse an offer. An adverse change must “strike at the heart of the transaction” and must be analogous (albeit not identical) to circumstances that may frustrate a contract.
Long-term commercial impact – It is generally accepted that any adverse change must have a long-term commercial impact on the target. While COVID-19 restrictions undoubtedly will affect business, they are only temporary.
Foreseeability – It is debatable whether the bidder could have foreseen the potential impact of COVID-19. However, references to COVID-19 were made in the firm offer announcement and offer document, demonstrating that COVID-19 was considered as potentially affecting the business when the bidder made its bid.
Clear explanation – Practice Statement 5 sets out several conditions the Panel will consider when deciding whether a condition can be invoked to lapse an offer. Importantly, the bidder must draw any MAC condition to the attention of the target’s shareholders with a clear explanation of the circumstances that might give rise to the right to invoke it.
Impact on Public M&A
Targets and Target Shareholders
With the Panel reaffirming the decision in WPP/Tempus, Target shareholders who were previously uncertain about the status of MAC conditions in a COVID-19 world now know that once a firm announcement offer is made, it will be nearly impossible for the bidder to walk away from its offer. Nonetheless, the decision should be approached with caution. It is notable that the bidder in Moss Bros Group plc posted the offer document/scheme document at the same time as the COVID-19 pandemic was developing. Had the offer documentation been submitted before the pandemic took hold in the United Kingdom (for example, in January 2020), there is no guarantee that the Panel would have reached the same decision. Similarly, while it is likely that the Panel would have still followed the WPP/Tempus decision, if the bidder had complied more fully with the conditions as set out in Practice Statement 5, the Panel could well have reached a different outcome.
It is expected that there will be an uptick in public M&A activity in the coming months, as private equity houses and financial sponsors look to use their dry powder to bid for listed assets. There is an expectation that stock market prices will fall again as the full impact of COVID-19 is felt on publicly listed businesses, so the expectation of cheaper pricing coupled with the potential cost savings from relieving the regulatory burden faced by smaller listed companies may drive an increase in take-private transactions in the coming months.
In this context, bidders should pay particular attention to the following factors when considering any potential takeover offer:
Valuation dislocation There is now significant potential for value dislocation in the market. In contrast to recent years, when it was arguably difficult for bidders to justify public M&A given prohibitive premiums that shareholders expected, COVID-19-related pressures may pave the way to new opportunistic and cheap acquisitions. However, bidders should remain alert to the potential impact of an impending second COVID-19 wave and how that could make valuation even more of a challenge.
Risk mitigation There may be an increase in publicly listed bidders looking to offer share consideration in listed M&A transactions to protect their cash reserves while also giving the target shareholders the chance to share in potential future growth. However, such bidders will have to consider how best to protect against fluctuations in their own share price during the offer period.
Due diligence/timetablesCOVID-19 restrictions will undoubtedly slow down any proposed M&A transaction. Each stage of the deal will require careful planning. Conducting site visits and in-person meetings with key management personnel may be difficult in a socially distanced environment, although such meetings are gradually starting to take place again.
The scope of due diligence will also extend to evaluation of COVID-19’s impact on the target business in terms of its financial performance during the crisis and likely performance post crisis, plus the business’s dependency on COVID-19 government support packages, such as the UK’s Coronavirus Job Retention Scheme and relevant government loan schemes in the jurisdictions where the business has operations. Relevant considerations include the date of repayment of such monies and the ability of the underlying business to repay the monies borrowed at the end of the 12-month period, how the target is prepared for long-term remote working, the impact of continued social distancing on the business and impact of regional lockdowns, and more specific analysis on information governance matters.
Cash confirmations As a result of the Moss Bros Group plc decision, bidders will likely face increased scrutiny from their risk committees, as it is now quite clear that COVID-19 will not allow a bidder to back out of a firm offer. Similarly, financial advisers will be particularly focused on the conditions and termination rights in relation to any finance arrangements to ensure these are closely aligned with the offer conditions as part of any cash confirmation process. There may also be a greater focus on hedging products to offset the potential exchange risks that may arise during the offer period.
Acquisition financeTraditional debt financing sources have at times been reluctant to engage with acquisition financings in the midst of the ongoing COVID-19 crisis. As traditional lenders have been out of the market generally for new acquisition finance loans, this gap is being filled by alternative lenders (private equity debt funds, hedge funds, insurance companies, asset managers and other institutional investors).
Increased regulatory scrutinyUnder section 42 of the Enterprise Act, the Secretary of State may issue an intervention notice to the Competition and Markets Authority if the Secretary believes that one or more public interest considerations are, or may be, relevant to a merger situation. Non-UK-based bidders should bear in mind that the UK government is now armed with and (having intervened in the Cobham/Advent transaction, amongst others) seems ready to use broader powers to protect UK companies from acquisition by overseas investors if the business operates in a sector where there is a strategic concern or a perceived public interest.
There are likely to be challenging times ahead for all businesses, but this period may provide fresh opportunities for bidders. Bidders will be wrestling with many COVID-19-related uncertainties as they run the ruler over potential targets and although market volatility presents an increased risk, for those who make bids for the right businesses, there should be rich rewards.