The perks and pitfalls of pre-bid stakebuilding in companies governed by the UK Takeover Code
Going into 2023 hopes for UK public M&A activity were high but expectations low as the news reported predictions of recession and continued market turmoil. However, as a number of investment banks have commented, such conditions and uneven market performance often act as a catalyst for public bids. So far in 20231 there have been seven firm offers announced via Rule 2.7 Announcements and five possible offer announcements2, compared to five Rule 2.7 Announcements and two possible offer announcements for the same period in 20223. This may be evidence of that catalyst in action and should provide the public M&A sector with hope that there are still deals to be done and that there remains an appetite for public M&A across the market.
In times of increased market volatility, potential bidders may seek to establish a greater degree of certainty before launching a formal bid. One possible strategy to achieve this is pre-bid stakebuilding, where the potential bidder builds up their stake in the prospective target company through purchases of shares (usually in the market) prior to (and sometimes during – although that is not the focus of this article) the commencement of an offer period.
For the purposes of this article, an "offer period" refers to any period during which target is in an offer period under the UK City Code on Takeovers and Mergers (the "Code"), irrespective of whether the potential bidder was contemplating an offer when the offer period commenced. For example, where there is a competing bidder, or target has made a possible offer announcement, the three-month period starts from the date of such earlier announcement, rather than the date of the new bidder's announcement.
Pre-bid stakebuilding can offer a number of 'perks' to would-be bidders, which include helping to increase their chances of securing ultimate control of a target, providing momentum and credibility to a bid, acting as a deterrent to prospective competing bidders, potentially lowering the overall cost of a bid through the acquisition of shares at a lower price in the market before the offer period and even the possible consolation of a 'dealing profit' should a bidder ultimately be outbid by a rival offering a higher price (which can help to offset failed bid costs).
However, there are a number of pitfalls too and potential bidders considering pre-bid stakebuilding need to carefully consider a number of questions before taking any action, certain of which we set out below.
Q: Is the potential bidder subject to standstill obligations?
In the early stages of a possible bid, a potential bidder will usually enter into a "non-disclosure" or confidentiality agreement with the target in order to receive confidential information from it for the purposes of the bidder's due diligence exercise. It is not uncommon in such agreements for potential bidders to accept "standstill" obligations preventing them from acquiring any shares in target unless and until such time as an offer may be announced that is recommended by the target board, or otherwise with target's consent. A potential bidder would therefore need to ensure that its legal advisers negotiate such agreements carefully if there is a firm intention to retain the flexibility to stakebuild.
Q: Does the potential bidder possess inside information on the target?
If the potential bidder is in possession of any non-public, price sensitive information relating to target, for example information it may receive from target in response to initial due diligence enquiries, it should take great care not to acquire any further shares in target until such information has been made public or otherwise 'cleansed', as such purchases could well constitute market abuse or insider dealing.
If the only inside information held by the potential bidder in relation to target is the very fact of it possibly bidding for target at some point in the future, it should be possible for the potential bidder to acquire shares in target prior to announcing any offer without being in breach of the relevant insider dealing rules.
Q: Could stakebuilding activity trigger the mandatory bid requirement under Rule 9 of the Code?
The potential bidder will be required to make a mandatory bid for the entire issued share capital of target if (i) the stakebuilding activity results in it acquiring 30 per cent. or more of the voting rights of target; or (ii) if it is already interested in more than 30 per cent. but less than 50 per cent. of target, the stakebuilding activity results in an increase to the percentage of shares carrying voting rights in which it is interested. In monitoring whether these thresholds are, or may be, crossed, the potential bidder will also need to take account of the interests of its concert parties in target's shares and their dealings. This is because shares purchased by persons acting in concert with a bidder are treated, for the purposes of a number of rules of the Code – including Rule 9 - as if they had been purchased by the potential bidder itself.
Rule 9 mandatory bids must be made in cash, or accompanied by a cash alternative, for not less than the highest price paid by the potential bidder (or its concert parties) during the 12 months prior to the announcement of the bid. Therefore, the highest price paid as part of any stakebuilding activities in the 12 months leading up to a Rule 9 bid will set the floor for the price that would have to be offered to all remaining target shareholders.
Rule 9 of the Code deliberately limits a bidder's control and discretion over the terms and exercise of its bid, therefore it is very important that a bidder only breaches the Rule 9 threshold in circumstances where it is - on the basis of proper legal advice - content to do so.
Q: Will the stakebuilding activity impact the terms of the potential bidder's offer?
No less favourable terms
If the potential bidder or its concert parties acquire an interest in target's shares within the three-month period prior to the commencement of an offer period (or such longer period as the Panel may determine in order to give effect to General Principle 1 (equality of treatment) of the Code), then the offer made to holders of that class of shares by the potential bidder must not be on less favourable terms.
Type of consideration
In the event that stakebuilding activity in the 12 months prior to the commencement of an offer period results in the potential bidder and/or any of its concert parties acquiring 10 per cent. or more of the shares of any class in the capital of target for cash, any eventual offer for target made by the potential bidder must also be made in cash or accompanied by a cash alternative at not less than the highest price paid by the potential bidder or its concert parties for those shares. The Takeover Code sets out the method for determining the price paid for any acquisition of an interest in target's shares.
If, at any time during the three-month period prior to the commencement of an offer period, the potential bidder and/or any of its concert parties acquires 10 per cent. or more of the shares of any class in the capital of target in exchange for securities in the potential bidder or relevant concert party, then the potential bidder will usually be required to offer the same securities to target's remaining shareholders as part of any bid. The number of any such securities offered must be based on the same number of consideration securities received by the vendor or other party to the transaction that gave rise to the interest in each target share, rather than on the value of the securities received by them. Where there has been more than one relevant acquisition, the potential bidder must offer the securities on the basis of the greater or greatest number of consideration securities received or receivable by it for each target share.
As well as publicly announcing an intention to bid for a target, stakebuilding can alert other shareholders that a potential offer may be on the horizon. One risk is that opportunistic existing shareholders in target or others increase their stakes to be used as leverage to extract improved offer terms from the potential bidder at a later date.
Q: How are target shares acquired by the potential bidder treated once an offer is made?
Stakebuilding in the context of a bid that is to be structured as a scheme of arrangement has different implications for the bidder compared to stakebuilding in the context of a bid made using a contractual offer.
Schemes of arrangement
A bid structured as a scheme of arrangement requires the approval of a majority in number of members, representing at least 75 per cent. in value of the members or class of members voting. In a scheme of arrangement, target shares already held by the bidder fall outside of the scheme and cannot be voted to approve the scheme. Therefore, stakebuilding in this context has the effect of concentrating the voting power of the remaining target shareholders on the scheme. Notwithstanding, there are still a number of benefits to stakebuilding in the context of a scheme. These include acting as a deterrent to competing bidders and/or any arbitrage shareholders who may seek to manipulate the outcome of any competing bid and providing the bidder with a right to vote on any competing offer (and thereby a means through which to prevent any such competitive offer from succeeding).
In the context of a contractual offer, obtaining more than 50 per cent. control of target usually means that the bidder will be successful and pre-bid stakebuilding can count towards that threshold. However, importantly any target shares acquired by a potential bidder prior to their making a contractual offer under the Code will not count towards satisfying the 90 per cent. acceptance level required to commence the process of "squeezing-out" minority shareholders who do not accept.
Q: Could stakebuilding compromise pre-bid secrecy?
As a consequence of mandatory disclosure obligations that apply to UK-listed companies pursuant to the Disclosure Guidance and Transparency Rules (and AIM Rules, depending on the London market on which the target is listed), potential bidders may be required to make public disclosure of their acquisitions of target shares as certain voting rights thresholds are met and/or exceeded. This can inadvertently leak the identity of a potential bidder to the market or fuel rumour or speculation about the possibility of an offer for target being made, which might lead the Takeover Panel to require the potential bidder to clarify their position publicly. Further, the UK Companies Act 2006, provides UK public companies with the right to investigate who holds interests in their shares and that investigative power could 'out' a potential bidder before they are ready to commit to making a firm offer.
Any stakebuilding which comes to the market's attention could also lead to an increase in the price of the target's shares, negating any further cost-benefit of stakebuilding to the potential bidder.
Q: Are there are any control thresholds to be aware of when stakebuilding?
As well as remaining acutely aware of the 30% trigger for mandatory bids under Rule 9 of the Code, potential bidders also need to be mindful other legal or regulatory regimes which could be triggered by reaching certain voting rights thresholds. For example, the UK's National Security and Investment Act 2021 (the "NSIA") could be relevant, depending on the activities that the target performs. The NSIA gives the UK Government greater power to scrutinise and potentially intervene in acquisitions and investments on the grounds of protecting national security. If the activities of the target fall within one of the 17 mandatory areas set out under the NSIA, then acquisitions of shares in it which take the potential bidder from 25% or less to more than 25%, for example, could trigger a notification to the Department for Business, Energy & Industrial Strategy ("BEIS") to obtain clearance.
Always seek advice before acting
Pre-bid stakebuilding can form part of a valuable strategy: giving credibility to a potential bidder by demonstrating their commitment to the possible offer; helping to ward-off any prospective competing bidders; and potentially lowering the overall cost of making a firm offer. However, pre-bid stakebuilding can also raise a number of challenges.
Careful, advanced planning and consideration should be undertaken before embarking on any pre-bid stakebuilding activity and potential bidders should seek advice from their financial and legal advisers as part of that preparation.
1 Correct at the date of writing on 1 March 2023.
2 Including announcements of strategic reviews including formal sale processes.
3 Not including offers that were announced and subsequently withdrawn or lapsed.