Reverse takeovers – what about the shareholders?
What is the issue?
The key protection against dilution for a shareholder in an ASX company is the rule that prevents more than 15% of new shares being issued in any 12 month period. So should an issuer be able to buy a more valuable competitor by issuing an unlimited amount of scrip without seeking shareholder approval? We don’t think so, but this has happened all too often in the Australian market.
We see this as an issue of property rights – why should the economic interest in the property you own (a share) be fundamentally transformed by a “merger” with a third party at a price that you and a majority of other owners don’t agree with?
Many jurisdictions, including the UK and South Africa, give both sets of shareholders a say in major transactions, including on the very specific situation of this note: all scrip mergers.
However, Australian law and the ASX listing rules only requires approval from the company nominally being taken over (usually by way of a scheme of arrangement) even when the situation is effectively a reverse takeover because it is much smaller than the prey.
This has created a loophole for clever players in the market for corporate control who can choose which set of shareholders get to vote, regardless of the number of new shares being issued. Surprise, surprise, it is often the shareholders who are giving too much value away who don’t get to vote.
This wouldn’t matter so much if a capital base was only being expanded by 15% (the current limit) through the issue of new shares, but under Australian law there is no limit to the amount of new shares which can be issued as part of a takeover without shareholder approval.
This whole situation could be fixed by a quick amendment to the ASX listing rules or some legislative changes to the Corporations Act to bring our listing rules into line with those in London, Singapore and Hong Kong at a minimum.
The revised rules should mandate that no company can issue a quantum of new shares representing more than 25% of its issued capital, net assets, market capitalisation, revenue or profits in in a merger transaction unless it first has shareholder approval for the transaction.
The market for corporate control hasn’t stopped in other jurisdictions that have similar protections and it won’t here either.
Oxiana Resources & Zinifex
Think back to the merger between Oxiana Resources and Zinifex in 2008, which was billed as a ‘merger of equals’ transaction because each set of shareholders would own precisely 50% of the combined company.
However, Oxiana shareholders were less likely to approve a transaction which would see its popular CEO Owen Hegarty replaced, so it was decided that Oxiana was the acquirer meaning that only Zinifex shareholders got to vote. They supported the deal with more than 99% of voted shares in favour.
Rather than creating Australia’s 3rd biggest mining house with a market capitalisation of $12 billion, the renamed OZ Minerals almost went broke in 2009. All this could have been avoided if Oxiana shareholders had been able to vote the deal down.
Australian shareholders get to approve even the smallest issue of new shares to a director, yet the current law can theoretically exempt shareholders from approving a 100-fold increase in a company’s total issued capital in what is effectively a reverse takeover.
Roc Oil & Horizon Energy
Perhaps the best recent example of this was when Roc Oil and Horizon Energy proposed merging in 2014. Roc was deemed the less valuable merger partner with just 42% of the stock in the new entity, but it was also the nominated acquirer which denied its shareholders a vote.
In a rare example of institutional direct action, the late fund manager Simon Marais from Allan Gray called an EGM and proposed a constitutional change at Roc Oil so that it could not issue more than 30% of its stock in a merger transaction without shareholder approval.
The resolution was supported by 46% of voted shares, falling short of the 75% super-majority required but sending a powerful message that shareholders want their rights protected in these reverse takeover situations.
Skilled Group & Programmed Maintenance Services
The same issue also arose when Skilled Group was nominally bought by the smaller Programmed Maintenance Services in 2015.
Programmed shareholders only ended up with 47% of the combined company and its share price under-performed after the deal was announced, suggesting it had offered Skilled a sweet deal, which was overwhelmingly endorsed by its shareholders.
Federation Centres & Novion Property Group
This was repeated with the 2015 merger between Federation Centres (the old Centro Retail) and Novion Property Group.
Federation Centres was the nominated predator (Federation centres shareholders only owned 36% of the combined group) snapped up a much larger rival so its shareholders didn’t get a vote. Surprise, surprise, Federation Centres under-performed on the market after the deal was announced, suggesting its shareholders, many of whom were smaller retail investors, got the worst of the deal.