Pre-bid stakes – A double edged sword? - M&A/Private Equity

In contrast to previous years, in 2015 having a pre-bid stake did not correlate with a higher prospect of success. In fact, based on statistics alone, bidders were far less likely to succeed without a pre-bid stake, than if they entered a deal with an interest in the target. The benefits of, and how to best leverage, a pre-bid stake always need to be carefully considered in the context of each transaction. We expect bidders in 2016 will carefully consider whether the potential advantages of a pre-bid stake outweigh the risks – particularly where the deal proceeds by way of a scheme.

Pre-bid stakes generally offer a valuable tactical "head start" for bidders in control transactions, and in previous years the majority of bidders have commenced deals with a pre-bid stake of some form. However, this strategy was not as popular with bidders in 2015, with only 47% of the deals in our sample commencing with the bidder holding a pre-bid stake – dropping from 55%, 65% and 75% in previous years.

The majority of pre-bid stakes were acquired as a deliberate strategy in the lead up to a control transaction: 73.7% of bidders with pre-bid stakes acquired these stakes as part of, or shortly before, the relevant control transaction. The remaining pre-bid stakes were either long term cornerstone investments or holdings of a majority holder from a previous unsuccessful control transaction.

Pre-bid stakes do not assure success

The statistics from 2015 suggest that bidders are in fact far less likely to succeed with a pre-bid stake than without. There was an overwhelming difference in the likelihood of getting to 100% for bidders which started with no pre-bid stake at all. In contrast to the results of our previous surveys (where a pre-bid stake has been highly correlated with the likelihood of success), the statistics from 2015 show that the rate of achieving 100% was only 43% for bidders which started with a pre-bid stake, compared to a 78% rate of getting to 100% for bidders which started with no interest in the target⁵ .

There is no clear reason for this difference. What statistics alone do not show however is that stake building is one of the most strategically sensitive considerations involved in structuring a public M&A deal – and each transaction will have any number of factors which go to whether an existing stake will influence the likelihood of success. Bidders and their advisers need to consider:

whether or not to acquire a stake;
how much to acquire;
which form of interest to acquire (such as a direct stake, pre-bid acceptance agreement, or equity swap);
how to use a stake to gain leverage with the target, shareholders or a rival bidder;
any blocking stakes that other shareholders hold or could obtain; and
the bidder's appetite for continuing to hold shares in the target if the deal does not succeed, which goes to the credibility (and therefore the effectiveness) of using the pre-bid stake to deter and block potential rivals.

The battle for Asciano

Matching blocking stakes have also emerged as a tactic in the battle for Asciano which remains ongoing at the date of writing. After Brookfield entered into a scheme implementation agreement with Asciano, Qube Holdings announced that it (as the lead in a consortium) had acquired a 19.9% stake in Asciano with the view to either voting against the Brookfield acquisition, engaging with Brookfield / Asciano in relation to an alternative transaction to carve up Asciano's assets, or holding an ongoing strategic stake in Asciano and seeking board representation. Brookfield subsequently announced that it had acquired a 14.9% direct stake and an economic interest in an additional 4.3% through equity swaps. Qube then made an indicative proposal and was granted due diligence, in response to which Brookfield announced it would launch a takeover bid (and the scheme would remain on foot, albeit deferred). Asciano recommended the Brookfield takeover (or scheme) in the absence of a superior proposal, but then deemed a subsequent proposal from the Qube consortium to be superior. At the time of writing, the battle continues...

Battle of the blocking stakes

While pre-bid stakes are generally considered valuable as deterrents to rival bidders in a contested situation, 2015 saw some notable examples where a pre-bid stake did not impede interlopers. Eight targets in our sample were contested by more than one bidder. Of these contested deals, the initial bidder in seven deals had a pre-bid stake, yet only one of these was successful in the face of a rival bidder. Interestingly however, in each case (other than in Affinity Education deal*) where a rival bidder came up against an initial bidder with a pre-bid stake, the rival (and successful) bidder had an even larger stake.

Structure matters

Another factor which will generally influence pre-bid stake considerations is the structure of the deal. In both a scheme and a takeover, a pre-bid stake may be helpful as a blocking stake. While a pre-bid stake in a takeover represents a 'head start', in a scheme a direct holding by the bidder will be excluded from voting, allowing other shareholders with significant stakes to have an even higher proportion of votes.

The risks associated with using a pre-bid stake in a scheme context were demonstrated in the Amcom scheme. Vocus had acquired a 10% interest in Amcom in late October 2014 and announced its intention to acquire the remaining shares. Following this announcement, TPG announced it had acquired a 5.4% interest in Amcom. One month after the scheme booklet was despatched to shareholders, TPG announced that it had increased its shareholding to 19.99%, and that it intended to vote against the scheme (but did not intend to make an acquisition proposal for Amcom). In an effort to mitigate the effect of TPG's objection, Vocus sold its 10% shareholding on-market – given the otherwise strong support for the scheme, Vocus would have assumed that purchasers of the shares would be shareholders who wanted to vote in favour. In the end, following a novel and aggressive social media campaign by Vocus, there was a high voter turn out to the scheme meeting which helped in having the scheme narrowly approved by 77.19% – one of the closest scheme contests in the past few years. If Vocus had retained its 10% stake, taking it out of the voting pool, it is highly likely that TPG's blocking stake would have instead won the day.

Risks v rewards

There are certainly benefits of a pre-bid stake for bidders to consider in the prelude to making an offer for a target, including:

building momentum and closing the gap required to gain control;
the ability to deter or disrupt a competing bid;
influencing shareholder voting outcomes more generally;
shifting the dynamics of target engagement for the purposes of due diligence and recommendation discussions;
potentially being able to get a "seat at the table" in terms of board representation in the future; and
participating in any upside if a rival superior bid is successful.

However, we expect bidders in 2016 will carefully consider whether the advantages of a pre-bid stake outweigh the potential risks – particularly where the deal proceeds by way of a scheme. Used well and in combination with other tactics and a sound strategy, a pre-bid stake can influence the prospects of success – however, a pre-bid stake alone will not be enough to save a deal.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.