November 3, 2009

The United Kingdom: A Hostile Paradise?

The thoughtful analysis below was written a little while back by Nelson Seraci of RiskMetrics’ M&A Edge Research Team:

On September 7th, U.S. food giant Kraft announced a “bear hug” offer for U.K. confectionary company Cadbury. In a typical initial response to an unsolicited offer, Cadbury publicly rejected the offer because it “undervalues the group and its prospects.”

Hostile M&A activity in the United States typically comes down to an argument over whether an unsolicited bid is “fair” enough that target shareholders should get the chance to accept or reject the offer, and whether the target management is seeking to entrench itself, or is deluded in its view of its stand-alone prospects. U.S. takeover battles like Exelon-NRG, Agrium-CF-Terra, and Broadcom-Emulex can end up as proxy fights, with the bidder seeking to take control of the board to dismantle the myriad defenses available to U.S. companies and to nullify state takeover laws that work to prevent shareholder choice.

In the United Kingdom, a target board’s latitude to defend itself against a hostile offer is restricted. Target boards are bound by the “neutrality rule,” which prohibits a board from taking any action that would discourage an unsolicited bid or deny target shareholders the opportunity to decide whether to accept the offer.

There are no poison pills in the U.K., while the thresholds for a shareholder vote on defensive actions like asset disposals or share issuances are quite low. And although the 2006 U.K. Companies Act states that directors must pay regard to the interests of employees, suppliers, consumers and the environment, market practice dictates that such stakeholders’ interests are not typically invoked when rejecting an unsolicited bid.

Unlike in the U.S., where most companies do not allow for shareholders to call a special meeting and many issuers do not allow for the removal of directors without cause, the U.K. Companies Act gives investors the right to call extraordinary meetings with 5 percent or more of the voting share capital and put forward proposals to remove any and all directors. As a result, formal proxy fights at mid- and large-cap U.K. companies extremely rare.

The U.K. Takeover Panel, the government’s takeover watchdog, ensures that the hostile bid process runs smoothly, including issuing upon request a deadline for a bidder to put forth a firm bid or walk away for six months (the so-called “put up or shut up” rule). The Takeover Code does not allow for some conditions present in some U.S. deals (like due diligence or financing conditions) and requires disclosure of all investor holdings (including derivatives) over 1 percent of the outstanding during the takeover period, providing detailed insight into a target’s shareholder base.

The U.K. regulatory system, not surprisingly, leads to a higher probability of a hostile deal closing. Over the 10-year period ending in September 2008, 42 percent of announced unsolicited bids in the U.K. were consummated (40 out of 95), as compared with 33 percent in the U.S. (44 out of 134). This data likely understates the relative impact of the respective regulatory regimes, as it is reasonable to presume that many would-be hostile bidders in the U.S. may be put off from making a bid after private negotiations fail, given the arsenal of defenses available to U.S. targets.

Perhaps U.S. defenses benefit shareholders, however. The median one-day premium paid in completed hostile deals in the U.S. valued over $100 million during the same 10-year period was 38 percent versus 34 percent for hostile U.K. transactions. An open question remains whether this increased average premium in the U.S. offsets forgone transactions due to a more target-friendly regime.

The U.K. regime–by making it clear that a fully financed bid with minimum conditions ultimately will be considered by target shareholders–helps to focus the debate on valuation, rather than on the personal predilections of the target board and management team.

Kraft has not yet made a formal offer for Cadbury, instead opting to issue a bear hug indication of interest, complete with conditions that are unlikely to pass muster with U.K. authorities. At some point, absent a friendly deal, Cadbury is likely to ask the Takeover Panel to force Kraft to submit a formal offer not subject to due diligence or financing conditions. If Kraft fails to submit an offer by the deadline, a cooling-off period will ensue. If Kraft submits a formal offer, the fate of Cadbury will rest in the hands of shareholders.